Major Banks May Report Toxic Assets As Profits

Banks that bought "toxic assets" from failed financial companies like Wachovia, WaMu, and Countrywide may be able to report huge profits on their financial statements due to an accounting loophole. This loophole allows banks to report income based on projected future earnings on these loans. Investment Director of Money Morning, Keith Fitz-Gerald explains why this window-dressing could make the major banks look much healthier than they actually are.

Remember the infamous leaked Vikram S. Pandit memo we wrote to you about awhile back that suddenly saw Citigroup Inc. (NYSE: C) turn a profit on nothing more than vapors?

Stay tuned: We’re about to see more of these puffed-up profits. JPMorgan Chase & Co. (NYSE: JPM), Bank of America Corp. (NYSE: BAC) and PNC Financial Services Inc. (NYSE: PNC) will reportedly be booking as much as $56 billion in windfall profits using similar financial chicanery in the months ahead.

Sadly, millions of investors will likely interpret this as a sign that the U.S. financial sector is once again a viable “profit” play - when the reality is that Wall Street hasn’t learned a single darned thing from the financial crisis and is up to its old tricks once again.

This time around, the biggest U.S. banks - including JPMorgan, BofA, and PNC - will employ an obscure accounting rule to magically transform the “toxic debt” that they obtained from such “zombie banks” as Wachovia Corp., Countrywide Financial Corp., National City Corp., and Washington Mutual Inc. (OTC: WAMUQ) into actual income.

Yes, you heard me correctly - income. It makes me furious. This is kind of a corporate accounting version of “the dog ate my homework.” Only this time around, the joke is on us - the taxpayers - since we’re the ones who are bailing these bozos out.

Called “accretable yield,” these mega banks will book income on loans that have “reduced credit quality” by recognizing - hang with me on this one, it’s tough to believe - the value of the bonds on their balance sheets and the cash flow those securities are expected to earn. Please understand, we’re not talking about cash that’s already been earned, and not cash in the bank … we’re talking about cash flow those banks are expected to earn.

Talk about making a silk purse out of a sow’s ear. This is an obscene abuse of the accounting system - whether it’s legal or not. No wonder nobody ever went broke using accrual accounting. These guys need to be forced to recognize the money they have actually earned - not the amount they can account for using clever financial trickery.

To understand just how absurd this actually is, let’s take a close look at JPMorgan Chase - which alone reportedly stands to reap as much as $29 billion in windfall income. It started when JPMorgan literally bought WaMu from the dumpster (technically acting as something called “the receiver”) last year for $1.9 billion, and was allowed to mark the toxic debt that came with it down to “fair value” - which was 25% less than the $118.2 billion it was officially carried on the books for, or $88.65 billion. But now, the bank says that those same debts may appreciate by some $29.1 billion over the life of the loans. That’s before taxes and expenses, of course.

According to Financial Accounting Standards Board (FASB) rules, buyers such as JP Morgan Chase carry these loans on their books at fair value. Then, as borrowers repay those loans they are allowed to book profits. Therefore, by keeping the value of the loans low, the profits on such a small base are obviously king-sized.

The incentive, as I noted when I reviewed a similar tax loophole regarding BofA’s Countrywide Financial purchase back in February, is to write down the value of the loans so aggressively that they are practically worthless. That way, when the buyer folds them into its business, the returns are huge.

JPMorgan’s spokesman, Thomas Kelly, told Bloomberg News that “the accretion is driven by prevailing interest rates.” That said, JPMorgan said first quarter gains from the WaMu loans resulted in $1.26 billion in interest income and made it possible for the bank to reap additional potential income of $29.1 billion.

The other factor that’s not being talked about - at least openly - is the impact that an economic turnaround could have. You see, the eroding economy contributed to the erosion in the value of the securities. Conversely, when U.S. economic activity picks back up, we could see an accompanying improvement in the value of these securities being carried on the company’s balance sheet.

In an April 22 interview with Bloomberg, Wells Fargo & Co. (NYSE: WFC) Chief Executive Officer Howard I. Atkins said that “to the extent that the customers’ experience is better or we can modify the loans, and the loans become more current, that could help recapture some of the write-down.”

That will lead to massive “profits.”

In other words, if the government is successful in reducing mortgage rates and the housing markets stabilize, the banks get to make up entirely new numbers and “bring more of [the loans] current” which is bank speak for being able to assign whatever brand new values they can to the very same toxic slime these same banks wrote down only months ago during the purchasing process.

Naturally - and I think you can see where I’m going with this - the more these guys wrote down these securities as part of the acquisition process, the higher they can write them “up” in the months ahead - and the more powerful the “profit” surge we’ll see.

Not surprisingly, JPMorgan wouldn’t comment when I called - nor would any of the other big banks - so it’s especially difficult to get to the bottom of exactly when this will come to a head and how much of an outsized “manufactured” profit we could be looking at.

But we can guess as to their motivation:

• First, the banking industry remains in a state of chaos. Despite widespread attempts to calm things down, the banks don’t trust each other and the public trusts them even less. So profits - whether illusory or not - would go a long way to reestablishing some sense of the ordinary.

• Second, to the degree that the banks remain on the federal dole and their balance sheets a wreck, the ability to add new earnings is a lifesaver. Not only does this practice give them the ability to smooth out earnings, but it also arguably makes their stock more attractive because of the apparent “growth” potential that exists going forward. Never mind that the growth is nothing more than a paper shuffling and some fancy accounting; under FASB regs, this practice is completely legal.

• Third, because newly accreted earnings will flow directly to income and the banks have stockpiled a huge war chest of write-downs, financial institutions maintain a substantial buffer that can be used at their discretion whenever they need to goose their earnings. One brokerage house chief financial officer told me privately years ago that it was his goal to maintain enough of a buffer that he could swing earnings by as much as 10% in any given quarter - depending on what the company “needed.”

Now for the trillion-dollar question: What can we do about this?

Sadly, when it comes to changing the legally approved accounting nonsense component, the answer right now is “not much.”

While an investor wanting to capture this “growth” could buy shares in the banks or in any one of a half a dozen financial exchange-traded funds (ETFs), I think a better choice is to buy LEAP options on each of the banks. Not only are long-term options frequently mis-priced, but the risks for any investor buying them are strictly limited to the capital used to buy them and the returns can be proportionately higher for options buyers than for the straight-stock alternatives available at the moment.

And those profits are real enough for me - even without accretion.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

European Banks Offer Another Potential Problem

Here in the U.S. we just finished the widely publicized "stress tests," which showed us a great deal of capital shortfalls with the major banks. This was more or less to be expected, but what is getting less press here at home are the potential problems over in Europe. Many people had mistakenly thought Europe was buffered from the financial problems being experienced in the U.S., but the more we look into it the more we see that is not the case. Many European banks were exposed to the same products and other issues that brought down the U.S. financial system, and the struggles these European banks are facing could bring down the global financial system even further. For more on this, read the following article from Money Morning.

Now that the results of the U.S. bank stress tests are finally in the books, the extent of the capital shortfalls are known and – in many cases – are actually being addressed.

But there’s now another problem looming – one that could ultimately weigh down the global financial system.

The problem: Europe’s banks.

As economies slow in other parts of the world, rising joblessness and plunging housing prices and escalating loan losses are putting banks under pressure. That’s especially true in Europe, where consumers and companies are continuing to run into trouble.

Royal Bank of Scotland PLC (NYSE ADR: RBS), now 70% state-owned, fell to a loss in the first quarter and wrote down $3.17 billion in risky assets after its bad debts quadrupled to $4.37 billion.

Bank executives "[expect] a slowdown in financial-market activity compared with the very buoyant conditions seen in Q1," Chief Executive Officer Stephen Hester told Reuters.

In Germany, Commerzbank AG (OTC ADR: CRZBY) had to take a $1.61 billion charge from its investment bank and a $72.38 million charge from commercial real estate initiatives, resulting in a $1.2 billion loss for the quarter.

In late December, the Institute of International Finance released its global economic outlook for 2009, and estimated that banks around the world had collectively lost nearly $1 trillion – $678 billion from U.S. banks and $300 billion from their European counterparts.

That was in December. We know it got worse – a lot worse – for U.S. banks after that point. Thanks to a mix that included lots of government bailout and an injection of new capital from investors, U.S. banks have experienced an improvement in their outlook.

Indeed, U.S. Federal Researve Chairman Ben S. Bernanke stated that the banks tested are all solvent and the results should provide "considerable comfort about the health of the banking system.”

But in the five months since that Institute of International Finance report was issued, it’s likely that European banks have experienced a major decline in their fortunes.

Last week’s release of the bank stress tests results removed significant uncertainty about the U.S. banks, since it created a blueprint of what the troubled institutions needed to do to stabilize their finances. Morgan Stanley (NYSE: MS) and Wells Fargo & Co. (NYSE: WFC) have announced plans to raise an aggregate $15 billion in capital. Bank of America Corp. (NYSE: BAC) plans to sell assets and issue more common stock after being told by the federal government that it must raise $33.9 billion to adequately guard against “more adverse” economic conditions.

Bank of America was one of 10 banks told by the government to raise more capital following the so-called stress test. The government concluded that BofA faces a potential $136.6 billion in losses from troubled loans and investments in 2009 and 2010. The bank’s $34 billion capital shortfall was more than twice that of Wells Fargo, which had the second greatest capital need.
Are we destined to see this all play out now in Europe?

Market Matters

Shifting back to autos, General Motors Corp. (NYSE: GM) lost $6 billion in the first quarter and is shopping Saturn to Renault SA of France as it moves closer to its restructuring deadline (and potential bankruptcy). China’s Geely Automobile Holdings Ltd. (PINK: GELYF) has interest in GM’s Saab unit, and Fiat SpA (OTC ADR: FIATY) may look to complement its Chrysler LLC line with the German Opel (also late of GM). Meanwhile, Ford Motor Co. (NYSE: F) claims to be on track with its restructuring plan and still believes it can manage just fine without any government assistance. On the earnings’ front, The Walt Disney Co. (NYSE: DIS) and Kraft Foods Inc. (NYSE: KFT) bested estimates, while Cisco offered some mixed results as its better than expected numbers actually prompted some profit-taking among techs.

A poorly received 30-year Treasury auction sent bond prices tumbling as fixed income investors focused on the massive programs the government will need to finance over the next few years. Oil prices surged above $58 a barrel for the first time in six months as traders seemingly failed to consider rising inventory levels and instead bought on signs (feeble as they are) of an economic recovery that would lead to enhanced energy demand.

The Standard & Poor’s 500 Index pushed beyond the crucial 900 level and ended the week in positive territory for the year. Techs struggled late as investors realized any economic rebound would not translate into capital expenditures overnight. Still, the Nasdaq Composite Index has outperformed the other indexes on a year-to-date basis. With stress tests out of the way, where will the next leaks come from?

Market/ Index	Year Close (2008)	Qtr Close (03/31/09)	Previous Week (05/01/09)	Current Week (05/08/09)	YTD Change
Dow Jones Industrial	8,776.39	7,608.92	8,212.41	8,574.65	-2.30%
NASDAQ	1,577.03	1,528.59	1,719.20	1,739.00	+10.27%
S&P 500	903.25	797.87	877.52	929.23	+2.88%
Russell 2000	499.45	422.75	486.98	511.82	+2.48%
Fed Funds	0.25%	0.25%	0.25%	0.25%	0 bps
10 yr Treasury (Yield)	2.24%	2.68%	3.17%	3.29%	+105 bps

Economically Speaking

U.S. retailers released same-store sales data for April and the results were actually quite promising. As usual, Wal-Mart Stores Inc. (NYSE: WMT) led the charge with a 5% increase in activity, while Children’s Place Retail Stores Inc. (Nasdaq: PLCE), Stage Stores Inc. (NYSE: SSI), Gap Inc. (NYSE: GPS), and The TJX Cos. Inc. (NYSE: TJX) were among those stores that posted better-than-expected results and beat analysts’ expectations. A late-Easter holiday (April instead of March) helped many retailers as consumers waited until the last minute (as has become the norm) for their related holiday shopping.

On the global front, the European Central Bank dropped its key lending rate by 25 bps to 1%, and initiated other monetary moves to stabilize its (16-country) economy. Likewise, the Bank of England announced a plan to buy up government and corporate bonds, thus, increasing its money supply.

Speaking of the labor market, the U.S. unemployment rate climbed in April to 8.9%; however, only 539,000 jobs were lost from the economy. The contraction represented the smallest in six months and was below most analysts’ expectations. Still, since December 2007, about 5.7 million domestic jobs have disappeared and businesses continue to be slow to hire until they see additional signs of greater stability in the economy.

Construction spending climbed in March after five consecutive monthly declines, though the gains were attributed to non-residential activity and the housing sector remains sluggish at best. In more promising news, the National Association of Realtors reported a 3.2% increase in pending homes sales, the second straight monthly gain. Because the release is considered a predictive indicator, analysts took it as a favorable sign that sales activity may pick up in the months ahead.

This article can also be found on moneymorning.com.

Fed Delays Release Of Bank Stress Test Results

The Federal Reserve has decided to delay the release of results from its recent stress test on banks. It appears that the Fed is trying to limit damage to the banks who will appear weak based on the results, and allow them more time to figure out how they will raise the necessary funds. It will no doubt be interesting to see how investors react to the information provided by the stress test. For more on this, read the following article from Money Morning.

The results of the bank stress tests are in, but instead of releasing them today (Monday), the U.S. Federal Reserve is holding them close to its chest until after the markets close Thursday.

The amount of information awaiting disclosure seems to have grown, as have the reasons to postpone the potentially damaging data.

Not only will the government unveil which banks require more capital, it will also disclose potential loss estimates for certain loan categories and the banks’ ability to “absorb those losses” assuming economic conditions worsen through 2010, a government official told The Wall Street Journal.

Negative results could deal a huge blow to both the banks and government, as a sub-par grade may be viewed as an indictment not only of the failed management of the banks, but the government’s decision to loan them billions of taxpayer money. The banks also are concerned that anything but a tactful release of the results will cause internal and investor panic.

Government and banking industry officials told Bloomberg that both sides needed the extra time to debate preliminary results, as well as plans regarding how banks can recover capital.

On April 24, the government showed the tests’ preliminary results to the 19 U.S. firms it reviewed – from behemoth banks like Bank of America Corp. (NYSE: BAC) and Citigroup Inc. (NYSE: C) to the smaller GMAC LLC (NYSE: GMA) and MetLife Inc. (NYSE: MET). The banks involved in the stress tests hold more than half the loans in the U.S. banking system and two-thirds of the assets.

“Everybody understands they’ve got a tiger by the tail here,” Mark Tenhundfeld, a senior vice president at the American Bankers’ Association in Washington, told Bloomberg. “If they don’t let him go gently, there will be a lot of mauling going on.”

Already, reports have leaked that two specific banks need more capital, and reaction hasn’t been pleasant.

After showing Bank of America and Citigroup test results, the government told the banks to raise more capital despite receiving a combined total of $95 billion in bailout loans.

At least three more banks need more capital, either from converting common shares to equity and/or receiving more government cash, sources told Bloomberg.

Sensing blowback from Congress, as well as the public, Federal Reserve chairman Ben S. Bernanke said that banks requiring more capital will have to attempt to raise it on their own before receiving another lifeline loan from the government.

Confusion On Evaluation’s Methodology

Debate over the results isn’t the only reason for the postponement. Disputes and confusion over the Fed’s methodology has also erupted.

According to a Fed’s test criterion, common shareholder equity should be the “dominant” portion of Tier 1 capital. Officials favor tangible common equity of about 4% of a bank’s assets and Tier 1 capital worth hovering around 6%.

But The Wall Street Journal reported last week that some bank executives got mixed signals during a meeting with regulators.

The regulators are asking “a million questions” and it’s “very unclear what they’re aiming at,” a senior executive told The Journal. “We can’t discern a pattern.”

Citigroup officials argued that regulators haven’t given the bank enough credit for its efforts to offload large asset chunks, such as Smith Barney and its Japanese brokerage arm Nikko Cordial Securities.

On Friday, Citigroup agreed to sell Nikko Cordial Securities, its Japanese brokerage arm to Sumitomo Mitsui Financial Group (OTC: SMFJY) for about $5.5 billion. The deal, which is to be completed by Oct. 1, also includes a transfer of about $2 billion in excess cash from Nikko Cordial to Citigroup.

The deal will boost the bank’s Tier-1 capital ratio by approximately 27 basis points.

Individual Result Releases

One insider told Reuters that the government is leaning toward releasing individual results for each bank involved in the stress test – a move away from issuing a summary of results.

The source said the plan “is not very far along,” and that regulators also aim to disclose a lot of confidential supervisory information about the banks.

One analyst says that test results could be so specific to a bank’s portfolio that it’s not wise to use them as a litmus test for the overall health of the banking sector.

“Once you try to take that information and extrapolate it, it gets very complicated and it’s dangerous," Kevin Petrasic, who served at the Office of Thrift Supervision from 1989 to 2008 and is now an attorney at law firm Paul Hastings in Washington, told Reuters.

Whatever the results – or how they are disclosed – Money Morning’s Shah Gilani, a former Wall Street hedge fund manager, said the evaluation process has several flaws.

“What’s missing, unfortunately, is an assumption of how much additional capital would be necessary to facilitate credit expansion – which, in turn, would serve to fuel economic growth. That, after all, should be the ultimate stress-test objective,” he wrote.

And the end result is more stress added to an already stressed banking sector, as too much information and/or misinformation only makes a sound assessment more difficult.

Money Morning’s Stress Test

The government’s pushback of stress test results only made the public more hungry for the their release. But you don’t have to wait until Thursday to know which of the 13 biggest U.S. banks are diamonds or duds.

Last week in “Money Morning’s Bank Stress Test,” Martin Hutchinson highlighted the four secrets that will let you separate the winners from the losers in the U.S. banking system

• Banks that made profits in the very difficult fourth quarter of 2008 and first quarter of 2009 are probably in good shape, especially if their loan-loss provisions exceeded their charge-offs (the amount actually lost.)
• Banks that lost money in the fourth quarter and first quarter may or may not be in terminal trouble; it depends on the amount of those losses and whether the red ink is expected to continue to flow going forward.
• With the run-up in bank stocks in recent weeks, there’s been an accompanying rise in the ratio of share price to book value (stock price per share/book value per share). If that ratio is still below 30% - even after the recent price increases - the market lacks confidence in the bank’s ability to solve its own problems. Unfortunately, the market currently appears to be overly optimistic about some of the banks that still have considerable ongoing problems.
• Management’s dividend policy is less of an indicator than it was just a few short months ago; several banks have sharply cut their dividends in order to repay the Troubled Assets Relief Program (TARP) capital they got in late 2008. Reasonably, profitable banks don’t want the government meddling in their business or compensation structures

Hutchinson also gave an individual analysis of each bank, highlighting their strengths and pulling a curtain on their weaknesses.

This article can also be found on moneymorning.com.

We Need A Root-And-Branch Reorganization Of The Financial System

Some people are open to the government handing over trillions of dollars to the banks, but no taxpayers want the money handed over without proper controls in place that will ensure it goes to good use. This has been one of the biggest issues the public has had with the bailout efforts thus far. For that reason Steve Waldman is calling for a root-and-branch reorganization of the financial system. For more on this, read the following blog post from Mark Thoma.

Steve Waldman says "we need a root-and-branch reorganization of the financial system":

Value for value, Steve Waldman: Would it have been better if Timothy Geithner had had the power to guarantee all bank debt early on? As James Surowiecki reminds us, that was part of the Swedish solution. Justin Fox plausibly suggests that we might have avoided a lot of pain with a fast, full guarantee.

But that's not the point. The question isn't whether we could have avoided this crisis, if only we had cut a big check. We could have, and that was not lost to any of us debating these issues more than a year ago. (See e.g. me or Mark Thoma.) Had we done so, the near-to-medium term fiscal costs might have been less than they probably will be now. So, with 20/20 hindsight, would it have been a good idea?

How you answer that question depends upon how you view the crisis. Is it an aberration, a shock to a basically sound financial system, or is it a painful symptom of an even more dangerous condition? ...

If you think that our financial system just needs some tweaks, some consolidation of regulators' organizational charts and sterner supervision, then you should prefer that we had just cut a check, passed Sarbanes/Oxley Book II, and moved on. But that is not what I, or most proponents of temporary receivership for insolvent banks, believe.

If you believe, as I do, that we need a root-and-branch reorganization of the financial system, which must necessarily involve the dismemberment and intrusive restraint of deeply entrenched institutions, does that mean pain is the only way forward, "the worse the better" in the old revolutionary cliché? It need not mean that. But it does mean that palliative measures, like giving the banks money, would have to be attached to curative measures, like enacting capital requirements and imposing regulatory burdens that would force financial behemoths to break themselves up or become boring narrow banks. For almost two years, policymakers at the Fed and the Treasury, including Secretary Geithner, have offered bail-out after bail-out and asked for nothing serious in return.

Do I regret that Henry Paulson was not empowered to issue a blanket guarantee of bank assets early on, as the Swedes did? No, I don't regret that at all. Why not? Because I think that "Hank the Tank" was a crappy negotiator... He would have offered the financial system sugar without requiring it to make the medicine go down. He may believe, quite sincerely, that a cure would be worse than the disease. He may believe that, but he is wrong. ...

You may believe that we have learned our lesson, that if we can just get some stability and comfort for a while we are prepared to do what must be done. That's a respectable position. But I don't share it, and neither do the majority of Americans who are unwilling to allow their representatives to sign off on any more expensive aspirin. We want value for value, an ironclad commitment of root and branch reform in exchange for the unimaginable sums of money we are being asked to hand over. ... Congress would, because the public would, support large, explicit transfers, if they were attached to reforms sufficiently radical to prevent a recurrence, and suitably punitive towards the people who managed the system that brought us here. Value for value. ...

I ... would be willing to hold my nose and tolerate a Swedish-style guarantee of bank creditors. I'd acquiesce to that even without formal nationalization. Nationalization is ... a means to an end, and the desired end is a world in which too big to fail is too big to exist for any financial institution that originates or holds credit risk in any form. Secretary Geithner could send a bill to Congress today that would put all banks with a balance sheet of over $50B into run-off mode... I'd fax my Congressman and support a $2T on-budget buyout of bank creditors as part of that bill, as long as it had teeth. ("Teeth" would imply making sure that off-balance-sheet and derivative exposures were included in the size cap, etc.)

It's not that us pitchfork-totin' populists are unwilling to pay the bill. It's that we want to know that in exchange for writing a very, very large check, the people that we are paying will actually deliver the goods. Given the behavior of bankers before the crisis and of shifty policymakers during, we have every reason to watch warily and to insist upon every precaution while we hand over suitcase after suitcase of freshly printed Federal Reserve notes.

This post can also be found on economistsview.typepad.com.

Stress Tests Reveal Three Banks In Need Of Additional Funding

The controversial stress tests commissioned by the government on the 19 largest financial institutions have revealed at least 3 in need of additional funding. These stress tests were meant to ensure that banks have enough capital reserves to last through the recession. For more on this, read the following article from Housing Wire.

At least three of the 19 financial institutions with assets in excess of $100bn may face pressure to build up capital reserves after failing to meet desired operational projections through the government-mandated stress tests, unnamed sources told the Wall Street Journal. The identities of the three firms remained confidential at the time this story went to press, but analysts told the Journal they likely include regional banks with commercial real estate exposure in the Midwest and Southeast.

The stress tests aimed to determine whether major US banks retain enough capital to weather even the more adverse economic projections. Federal officials offered three alternatives to banks that lack sufficient reserves: raise private investor funds, receive additional government aid or convert the government’s existing preferred shares into common shares, effectively placing part of the firm in government ownership.

The Federal Reserve, in reporting stress test methods late Friday, say most banks retain enough capital to weather a longer, more severe recession, although deteriorating economic conditions affect the reserve capital held among some banks.

This article can also be found on housingwire.com.

What Will The Government Do With Goldman Sachs?

Storied investment banking firm, Goldman Sachs, is preparing to pay the government back around $5 billion in borrowed TARP funds, but whether or not the government will allow it to happen is the real story. Goldman no longer wants to be burdened with the rules and regulations being imposed on them by the government, and thanks to a $12 billion windfall from the AIG bailout the firm is in a position to return the funds. If they are allowed to return the funds, though, there is worry that it will put the other bailed out banks in a precarious position. For more on this, read the following article from Money Morning's Shah Gilani.

Not a fan of socialism? Me either. But, if the federal government has to backstop free market excesses with taxpayer dollars, how will it eventually unravel the veil, or tarp of intervention? Or should it? The answers are about to unfold before our eyes.

In the case of the government and Goldman Sachs Group Inc. (GS), a decision on whether Goldman can repay government bailout money and be freed to pay its employees whatever it wants, may determine the winners and losers coming out of this financial collapse, and what kind of government Americans will end up with.

In her extraordinary 1999 book, “Goldman Sachs the Culture of Success,” Lisa Endlich vividly chronicles the “history, mystique and remarkable success of the world’s premier investment bank.” That same year, the storied partnership structure of Goldman was junked in a wildly successful initial public offering (IPO).

I still keep three pages of notes distilled from Endlich’s book on how to create and foster a culture of success, a la the Goldman model. They now seem quaint in light of the winner-take-all at the expense of the shareholders mentality that eviscerated the old-school standards.

That’s not to say that Goldman isn’t still wildly successful. On Monday, Goldman pre-announced first quarter net income of $1.81 billion. Record net revenue of $6.56 billion from trading fixed income, currencies and commodities was offset by losses in stock trading, real estate, investment banking and money management. Nonetheless, earnings were almost twice analysts’ expectations.

Yesterday (Tuesday), on the heels of its good performance, Goldman announced that it had priced a public offering of 40,650,407 shares of common stock at $123 per share. Goldman will be its own sole underwriter and total gross proceeds are expected to yield approximately $5 billion.

Ironically, $5 billion is what Goldman needs to pay back the U.S. government in order to escape the salary and bonus caps imposed on bailout recipients.

A brief history.

On the remarkable day of September 15, 2008 Lehman Brothers Holding Inc. announced its intention to file a Chapter 11 bankruptcy petition. On the same day, venerable investment bank Merrill Lynch disappeared into the waiting arms of Bank of America Corp. (BAC). Six short days later, on a Sunday afternoon, the U.S. Federal Reserve announced approval of expedited applications by Goldman Sachs and Morgan Stanley (MS) to change their status from investment banks to bank holding companies. The rapid approval of their applications would, the Fed said, “provide increased funding support” allowing both banks to borrow directly and permanently from the Fed’s Discount Window and its other capital liquidity enhancing facilities.

But that wouldn’t be enough. As the crisis mounted, on Sept. 23, Goldman raised $5 billion from billionaire investor Warren Buffet’s Berkshire Hathaway Inc. (BRK.A, BRK.B). And with the storied investor now onboard, Goldman rushed to raise another $5.75 billion in a common stock offering.

On Oct. 14, with the mushrooming cloud of the crisis enveloping seemingly every major bank in the country, then-Treasury Secretary Henry M Paulson (formerly Goldman Sachs’ Chairman and CEO) and Federal Reserve Chairman Ben S. Bernanke summoned the nine largest bank chief executives to Washington where they were told that they would each take a piece of government capital. Only Wells Fargo & Co. (WFC) is on record as saying it didn’t need the money, but the handout was forced on it too. Goldman itself took $10 billion.

On Wall Street, and nowhere more so than at Goldman, it’s about compensation. But recipients of bailout money are now facing the full disclosure of their executive compensation deals, as well as having to obtain nonbinding shareholder voting on compensation issues.

The Treasury is advocating a salary ceiling for recipient senior executives of $500,000 and any additional compensation to be paid in restricted stock that vests only when government funds have been entirely repaid. And there are restrictions on golden parachutes and threats that Congress will impose a 90% bonus tax.

It’s enough to make Wall Street quake in its canyon.

With the public backlash against the taxpayer-funded bonuses paid to executives and traders at crippled firms, banks are desperate to return government bailout money so they can be freed from government salary and bonus oversight.

But unfortunately for many of these banks, oversight is mandated for any recipient of “exceptional assistance,” which is defined as assistance of more than $5 billion.

No wonder Goldman wants to pay back $5 billion of the $10 billion it got.

I have nothing against the free market setting compensation benchmarks, or private companies paying successful executives whatever their shareholders vote to be acceptable. And I’m not singling out Goldman Sachs. But, nowhere else in the U.S. economy - or at the highest levels of government - is there anything like Goldman’s visible and invisible hands at work. And they’re working in the open and more insidiously, behind the scenes and through lobbyists, to make themselves a lot of money.

There is simply not enough space in any book, let alone any article, to list the power, placement and influence of current and former Goldman Sachs alumni pulling the levers of hedge funds, corporations, politicians and governments. If you want to enlighten yourself about what you don’t know about these players, simply Google: “List Goldman Sachs alumni.”

Goldman, as much as any investment bank, got its hands dirty in the subprime securities business and the credit default swap business. As to its influence and its claim to premier bank status, the first question that comes to my mind is: Would Goldman even exist today if Hank Paulson hadn’t had Goldman’s current CEO Lloyd Blankenfein in on meetings about saving American International Group Inc. (AIG)?

Out of the $185 billion that AIG received from taxpayers, Goldman got $12.5 billion for exposure it had to credit default swaps written by AIG. I’ve been told by some of my hedge fund and investment banking friends that Goldman deserved that money and that the entire counterparty structure related to almost every credit default swap was a risk.

But I like to point out that Goldman is only smarter than its peers because its trading desks are lighter on their feet. I remind them that Goldman stuffed the pipelines with toxic structured collateralized debt obligations (CDOs), and then was nimble enough to cover themselves better by buying credit default swaps to hedge their exposure to their own toxic slime and institutions that are too-big-to-fail, exactly like AIG.

What happens now with Goldman Sachs will set the precedent for everything else that the government will do or allow in the future with bailout recipients and industries. Will Goldman be freed up to overpay its risk takers and to make greater wagers as it also seeks to become too-big-to-fail? Will impositions be made on the corporate level, industry level, systemic level? Will free markets be free to leverage taxpayers indefinitely?

The argument, most recently made in yesterday’s Wall Street Journal op-ed page by Jonathan Macey, a law professor at Yale, that “demonetizing executive pay will also drive the best managers out of private companies and into hedge funds and other boutique investment firms” implies that there is a limited amount of talent available in America, which is a supposition that I find myopic, at best.

Besides, aren’t these the same people that got us into this mess?

And while letting public companies be run by shareholders - as Macey suggests - is supposed to work in principle, shareholders have been marginalized by the same Wall Street system that protects the institutions whose stocks and bonds they sell, trade and profit from.

All eyes should be on the curious relationship between government and Goldman for clues as to what shape the landscape will take when we eventually exit this calamity.

I don’t want our companies, our institutions or our economy socialized any more than Adam Smith would. But I do want to see the public tail wagging the dogs of Wall Street and government.

This post can also be viewed on moneymorning.com.

From Money Morning:

"I'd rather have this than gold." That's what one well-known fund manager recently told Barrons. Why? This special group of investments is set to pay out $4,201 guaranteed cash next month. And they pay out juicy cash sums all year long. But they're not income trusts, corporate bonds, or foreign bonds. In fact, only Martin Hutchinson is talking about them. Read his full report here...

Longing For The Days Of Boring Banking

When the financial industry gets too creative, bad things tend to happen. The current financial crisis was not the first example of this either. If you look all the way back to before the Great Depression, whenever the financial industry was loosely regulated, and overly creative, things would eventually blow up. Paul Krugman is calling for us to return to the days of boring banking, but wonders if that is going to happen anytime soon. For more on this, read the following blog post from Mark Thoma.

Does congress have the will to pursue serious financial reform?:

Making Banking Boring, by Paul Krugman, Commentary, NY Times: Thirty-plus years ago, when I was a graduate student in economics, only the least ambitious of my classmates sought careers in the financial world. Even then, investment banks paid more than teaching or public service — but not that much more, and anyway, everyone knew that banking was, well, boring.

In the years that followed, of course, banking became anything but boring. Wheeling and dealing flourished, and pay scales in finance shot up... And we were assured that our supersized financial sector was the key to prosperity. Instead, however, finance turned into the monster that ate the world economy. ...

Thomas Philippon and Ariell Reshef ... show that banking in America has gone through three eras over the past century. Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some ... based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929.

During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.

The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative.... Banking became boring, partly because bankers were so conservative about lending: Household debt ... stayed far below pre-1930s levels.

Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans.

After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.

As these changes took place, finance again became a high-paying career... Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age. Needless to say, the new superstars believed that they had earned their wealth. ... And many economists agreed.

Only a few people warned that this supercharged financial system might come to a bad end. Perhaps the most notable Cassandra was Raghuram Rajan... But other[s]..., including Lawrence Summers..., ridiculed Mr. Rajan’s concerns.

And the meltdown came.

Much of the seeming success of the financial industry has now been revealed as an illusion. ... Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry.

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

This post can also be viewed on economistsview.typepad.com.

Why Dropping "Mark to Market" Rules Won't Solve Anything

In an effort to shore up the balance sheets of banks the government decided to drop the "mark to market" rules that have been causing so much trouble in the financial industry. As Peter Schiff points out in his article, though, this won't solve anything. The rule was created in order to give investors a better idea of the true value of bank assets — basing the valuations on market activity rather than arbitrary assessments by the bank's accountants. Letting the banks decide how much their assets are worth, rather than the market, is a recipe for deception and ultimate failure. Read about what Schiff has to say in the article below from Money Morning.

When elementary school kids want to escape the confines of their circumstances, they pretend to be pirates, princesses and Jedi knights. Now, with the relaxation of "mark to market" valuation rules announced by the accounting trade’s self-regulatory body, our bankrupt financial institutions can escape their own reality by pretending to be solvent.

The unraveling of our fairytale economy over the last few months has not yet convinced us that the time has come to put away childish things. The applause that greeted the Financial Accounting Standards Board’s (FASB) ruling on Wall Street is a clear sign that we still have some growing up to do.

The imaginative conceit that lies behind the accounting change is that the toxic assets polluting bank balance sheets are not really toxic at all. They are in fact highly valuable assets that for some irrational reason no one wants to buy.

Using the "mark to market" accounting method, mortgage-backed securities were valued relative to the latest prices fetched by the sale of similar assets on the open market. Currently, those bonds are being sold at deep discounts to their original value. By "marking" their unsold bonds down to those prices, the insolvency of our financial institutions had been laid bare. But the new accounting changes will allow the nervous owners to assign more "appropriate" (i.e. higher) values. Problem solved.

It is important to note that the FASB made its rule modifications only after both Washington and Wall Street applied intense pressure. In their heart of hearts, I can’t imagine that there are too many bean counters happy with the outcome.

The banks and the government have argued that the assets should be valued based solely on current cash flow. Most mortgages, after all, are not delinquent. Therefore, a few bad apples should not spoil the whole bunch, and those that are not yet delinquent should be valued at par. This method assumes we have no ability to look into the future and make assumptions about what is likely to happen, which is presumably what the market is already doing by valuing the assets lower than the banks wish.

All kinds of bonds (corporate, government and municipal, etc.) that are not in default frequently trade at discounts. In fact, the reason agencies such as Moody’s Corp. (MCO) and Standard & Poor’s rate bonds is to assess the probability of default. The higher that probability, the lower the value placed on the bonds, regardless of their current cash flow.

For example, General Motors Corp.’s (GM) 10-year bonds currently trade for only 8 to 10 cents on the dollar, despite the fact that GM is current on all interest payments. The 90% discount reflects investor awareness that GM will likely default long before the bonds mature. By the new logic, financial institutions with GM bonds on their balance sheets should be able to ignore the market and value these bonds at par.

Some argue that the comparison is invalid because GM’s bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds would be illiquid too. The reason GM bonds are trading is that sellers are realistic.

The same should apply to bonds backed by mortgages. To assume that a 30-year, $500,000 mortgage on a house that has declined in value to $300,000 has a high probability of remaining current to maturity is ridiculous. The borrower could lose his job, his adjustable-rate mortgage (ARM) might reset higher, or he may simply tire of paying an expensive mortgage for a house that is unlikely to be sold at a profit.

Any bond investor with half a brain will factor in these probabilities and look for deep discounts. The only way to accurately assess a real present value is to let the market discover the price.

Despite the pleas from bankers and politicians, mortgages are not plagued by a lack of liquidity but a lack of value. If sellers would be more negotiable, there would be plenty of liquidity. Who knows, at the right price I might even buy a few. The problem is that putting a market price on these assets would render most financial institutions insolvent, which is precisely why they do not want to let that happen.

Simply pretending that all these mortgages will be repaid does not solve the underlying problems. It may keep some banks alive longer, but when they ultimately do fail, the losses will be that much greater. In the meantime, solvent institutions are deprived of capital as more funds are funneled into insolvent "too big to fail" institutions - hiding their toxic assets behind rosy assumptions and phony marks.

Going from the sublime to the completely ridiculous, in a speech at the just-concluded Group 20 summit in London, President Barack Obama urged Americans not to let their fears crimp their spending. It would be unwise, he argued, for Americans to let the fear of job loss, lack of savings, unpaid bills, credit card debt or student loans deter them from making major purchases.

According to the president, "we must spend now as an investment for the future." So in this land of imagination (where subprime mortgages are valued at par), instead of saving for the future, we must spend for the future.

I guess Ben Franklin had it wrong too – apparently a penny spent is a penny earned.

This post can also be viewed on moneymorning.com.

Banks Believed To Be Holding Around 600,000 Foreclosure Properties Off Market

RealtyTrac believes that banks are keeping around 600,000 foreclosure properties nationwide off the market. This number would represent a huge portion of the available housing stock, and it is believed that banks could be strategically withholding these properties in order to prevent the housing market from collapsing even further. For more on this, read the following blog post from Tim Iacono.

If ever there were a "squishy" data set, one that is quite difficult to get a good handle on due to the paucity of reliable, publicly available data, it is the inventory of foreclosed homes that have yet to make it onto the resale market.

A report by Carolyn Said in the San Francisco Chronicle provided the first graphic on the subject that I've seen, an image that was splashed across the front page of yesterday's paper.
With bank repossessions and notices of default set to pick up dramatically in some parts of the country as detailed by Mr. Mortgage the other day, all the prognosticators with rosy housing outlooks for 2009 may be in for a wake up call come summer time.

If the Alt-A and Option ARM loans begin to sour in large numbers (as many predict) at about the same time that banks look to unload some of their inventory after all the recent optimism, there could be another big leg down in home prices.

Some details from the SF Gate story:

A vast "shadow inventory" of foreclosed homes that banks are holding off the market could wreak havoc with the already battered real estate sector, industry observers say.

Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at fire-sale prices, are a major factor driving home values down.

"We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market," said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. "California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You'd have further depreciation and carnage."

In a recent study, RealtyTrac compared its database of bank-repossessed homes to MLS listings of for-sale homes in four states, including California. It found a significant disparity - only 30 percent of the foreclosures were listed for sale in the Multiple Listing Service. The remainder is known in the industry as "shadow inventory."

You have to wonder about a bank like BofA, after having acquired Countrywide and their stable of bank owned properties, as to exactly how these properties are being valued in light of changing mark-to-market rules and critical earnings announcements.

Everyone seems to be sooooo anxious for the banking sector to show some stability so we can all get on with our stock investing lives again but, if it is coming via the accounting "sleight of hand" that some believe is the real reason for holding back these properties (i.e., valuing them much higher than today's market would), we may all be in for a big letdown.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Mark-To-Market Rule Change Controversy

The new mark-to-market rule changes are very controversial. On one hand they have the potential to help stem some of the mounting losses being reported by financial institutions, but on the other hand there is the potential for some ambiguity in relation to the use of “judgment”. For more on this, read the following post from Mark Thoma.

John Berry likes the recent changes in the rules for valuing distressed assets:

Mark-to-Market Rule Gives More Clarity, Not Less, by John M. Berry, Commentary, Bloomberg: Mark-to-market accounting rules are being brought a little closer to economic reality -- accompanied by misplaced howls of outrage. ...[T]he standards have forced many financial institutions to overstate losses on trillions of dollars worth of assets, intensifying the global financial crisis.

Defenders of the rules say they protect bank investors and changing them will allow institutions to hide future losses. To the contrary, they have helped drive down the value of bank stocks, made shorting the shares much easier and caused bank stockholders to lose hundreds of billions of dollars in such companies as Citigroup Inc. and Bank of America Corp. ...

The problem with mark-to-market accounting is that it officially has presumed there’s a functioning market in whatever asset is being valued -- and that means a deal between a willing buyer and seller that isn’t being forced to sell. Actually, no such market exists for many mortgage-backed securities.

Nevertheless,... accountants have required many banks to calculate values based on distressed sale prices. That has meant large writedowns even on mortgage-backed securities that the institutions intend to hold to maturity.

Take the case of the Federal Home Loan Bank of Atlanta. Following the mark-to-market rules, it wrote down the value of its portfolio of mortgage-backed securities by $87.4 million in last year’s third quarter. Its actual projected loss on the securities: $44,000. For the fourth quarter the bank recorded a further $98.7 million loss on the securities.

That result makes no sense when the bank doesn’t trade such assets. ... A writedown might still be required under the changes FASB approved yesterday. Yet auditors can now use “significant professional judgment” when valuing illiquid securities. That’s what they should have been allowed to do all along. ...

The key points in this example are that almost all the mortgages involved are still performing and the bank plans to hold the securities to maturity -- and yet large writedowns were required. ...

Now accountants are supposed to use their judgment... That’s a big improvement over just using the last transaction price, as many auditors have been doing. ...

Here's an opposing view.

This post can also be viewed on economistsview.typepad.com.

More Economists Predicting A Depression

According to a couple economists our present financial crisis looks like a recipe for a depression. The main difference they see between a normal recession and a depression, is that a depression originates in consumer debt. If these economists are correct in their theory, the recent positive market movement will only be a suckers rally. Tim Iacono looks closer at the recent article published by these economists, and adds some of his own thoughts, in his blog post below.

In this commentary in today's Wall Street Journal, economists Steven Gjerstad and Vernon Smith offer a theory about why we could again be going from a bubble into a depression.

Over the years, there have been quite a few bubbles, but not all of them cause the sort of economy-wide damage that was seen in the 1930s or over the last year or so. Why?

Why does one crash cause minimal damage to the financial system, so that the economy can pick itself up quickly, while another crash leaves a devastated financial sector in the wreckage? The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of the wealth and income distribution, can be transmitted quickly and forcefully into the financial system. It appears that we're witnessing the second great consumer debt crash, the end of a massive consumption binge.

Most people forget that it wasn't just a stock market bubble in 1929 that led to America's last lost decade. There was an enormous housing and credit bubble in the mid-1920s during which Groucho Marx and others lost a good deal of money on Florida swampland.

As has been the case thoughout history, you can't get a really good bubble going until you get broad participation from the public - preferably lots of people at the lower end of the socio-economic scale levered up courtesy of a banking system that is gushing with easy money.

That pretty much described the situation in the 1920s and in the 2000s.

The entire piece is worth a look as they go through the recent history of financial bubbles in the U.S., a sequence that really accelerated about 20 years ago when you-know-who started sitting in the big chair at the Federal Reserve boardroom.

Interestingly, they touch on one of my all-time favorite subjects since this blog began a few years ago - how owners' equivalent rent duped the Fed.

During the 1976-79 and 1986-89 housing price bubbles, the effective federal-funds interest rate was rising while housing prices rose: The Federal Reserve, "leaning against the wind," helped mitigate the bubbles. In January 2001, however, after four years with average inflation-adjusted house price increases of 7.2% per year (about 6% above trend for the past 80 years), the Fed started to decrease the fed-funds rate. By December 2001, the rate had been reduced to its lowest level since 1962. In 2002 the average fed-funds rate was lower than in any year since the 1958 recession. In 2003 and 2004 the average fed-funds rates were lower than in any year since 1955 when the rate series began.

Monetary policy, mortgage finance, relaxed lending standards, and tax-free capital gains provided astonishing economic stimulus: Mortgage loan originations increased an average of 56% per year for three years -- from $1.05 trillion in 2000 to $3.95 trillion in 2003!

By the time the Federal Reserve began to slowly raise the fed-funds rate in May 2004, the Case-Shiller 20-city composite index had increased 15.4% during the previous 12 months. Yet the housing portion of the CPI for those same 12 months rose only 2.4%.How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.

With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since "owners' equivalent rent" is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.

Yes, "an important component of inflation remained outside the index" - that sort of thing almost always ends badly as noted here on many occasions before.

After years of writing on this subject, yours truly still comes out high in a simple Google search on the phrase owners' equivalent rent - right there in second place, behind the Bureau of Labor Statistics with "How owners' equivalent rent duped the Fed" and then again in fifth place with the memorable "The complete and utter failure of owners' equivalent rent".

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

America's Tarnished Reputation Threatens Global Response To Financial Crisis

One of the biggest casualties from the financial crisis — and our handling of it — has been the loss of America's reputation on financial matters. As far as most of the world can tell we are the ones who started this financial mess — which is enveloping much of the world — and even worse we have appeared incompetent to fix it. Why then would the rest of the world listen to us when we try to piece together an effective global response? As Paul Krugman points out in his recent article, America quite possibly could have lost one of its most valuable assets — its reputation — right when they — and the world — need it most. For more on this, read the following blog post from Mark Thoma.

The financial crisis has damaged our global authority, credibility, and leadership, and that will make it much harder for the world to accomplish the essential task of coordinating a common response:

America the Tarnished, by Paul Krugman, Commentary, NY Times: Ten years ago the cover of Time magazine featured Robert Rubin,... Alan Greenspan,... and Lawrence Summers... Time dubbed the three “the committee to save the world,” crediting them with leading the global financial system through a crisis..., although it was a small blip compared with what we’re going through now.

All the men on that cover were Americans, but nobody considered that odd. After all, in 1999 the United States was the unquestioned leader of the global crisis response. ... The United States, everyone thought, was the country that knew how to do finance right.

How times have changed..., ... our claims of financial soundness — claims often invoked as we lectured other countries on the need to change their ways — have proved hollow.

Indeed, these days America is looking like the Bernie Madoff of economies: for many years it was held in respect, even awe, but it turns out to have been a fraud all along. ...

Simon Johnson..., who served as the chief economist at the IMF..., declares that America’s current difficulties are “shockingly reminiscent” of crises in places like Russia and Argentina — including the key role played by crony capitalists.

In America as in the third world, he writes, “elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.”

It’s no wonder, then, that an article in yesterday’s Times about the response President Obama will receive in Europe was titled “English-Speaking Capitalism on Trial.”

Now, in fairness ... the United States was far from being the only nation in which banks ran wild. Many European leaders are still in denial about the continent’s economic and financial troubles, which arguably run as deep as our own... Still, it’s a fact that the crisis has cost America much of its credibility, and with it much of its ability to lead.

And that’s a very bad thing... I’ve been revisiting the Great Depression,... one thing that stands out ... is the extent to which the world’s response to crisis was crippled by the inability of the world’s major economies to cooperate.

The details of our current crisis are very different, but the need for cooperation is no less. President Obama got it exactly right last week when he declared: “All of us are going to have to take steps in order to lift the economy. We don’t want a situation in which some countries are making extraordinary efforts and other countries aren’t.”

Yet that is exactly the situation we’re in. I don’t believe that even America’s economic efforts are adequate, but they’re far more than most other wealthy countries have been willing to undertake. And by rights this week’s G-20 summit ought to be an occasion for Mr. Obama to chide and chivy European leaders, in particular, into pulling their weight.

But these days foreign leaders are in no mood to be lectured by American officials, even when — as in this case — the Americans are right.

The financial crisis has had many costs. And one of those costs is the damage to America’s reputation, an asset we’ve lost just when we, and the world, need it most.

This post can also be viewed on economistsview.typepad.com.

Renter's Rights When Landlord Is In Default

As CNN reports, renters are definitely at risk in today's collapsing real estate market. In the event a home goes into foreclosure the lease agreement on said property is typically voided. The good news is that new laws have recently been passed that help renters in situations like this, but so far only Freddie Mac and Fannie Mae loans are required to be part of the program. If your landlord has their mortgage with a different provider, you may be out of luck. With 40 percent of all foreclosures happening to homes with renters in them, sadly there are a lot more people who are going to be in the same situation as the lady in the video. For more on this, read Tim Iacono's blog post below:

Wow! About 40 percent of all foreclosures are for properties that are being rented. We'll have to keep this in mind when looking for a new place - a report the other day said there are ten new foreclosures every day in Deschutes County, Oregon, where we're headed.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Produce The Note: A New Way To Fight Foreclosure

Thanks to a recent TV spot on Good Morning America (along with other press exposure) banks are going to be hearing these words a lot, "Produce the note." A new movement is under way that is causing banks a lot of pain and grief. Essentially how it works is that a homeowner in foreclosure will submit paperwork requesting that the bank produce a copy of the original note. Sounds easy enough, but with the number of times these notes have been bought, sold and transferred, the paper trail can be hard to follow. Desperate homeowners are finding that if nothing else this tactic is buying them a little more time in their home. Tim Iacono looks at this new tactic in his blog post below:

The little guy fights back by making a simple request - prove that the borrower owes the money to the bank before foreclosing.

It really is hard to have much sympathy for the borrower, at least in this case - the lady borrowed $140,000 against a house for which she paid just $39,000.

It does, however, add great irony to the situation.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Why We Should Break Up The Big Banks

Last week there was a lot of speculation that the US government would privatize mega banks, Citigroup and Bank of America, but now it appears that they are going to be happy with large stakes in the banks. The government believes that nationalizing the banks would ultimately cause more harm than good, and would like to avoid that path. Simon Johnson has a different view, though, he believes that the best course of action is to nationalize the big banks causing us so much grief, and then sell them off again in smaller pieces. This would ultimately remove much of the political power these monsterous institutions have over the government and our economy as a whole. Mark Thoma from the Economist's View looks at Johnson's article and adds some thoughts of his own in his blog post below:

Simon Johnson:

Privatize The Banks Already, by Simon Johnson: ...In some important and not good ways, we have already nationalized the financial system.

There’s the direct ownership that the government received through TARP and the reupping with Citi, BoA and some others. These stakes are obviously not (yet) voting stock, but the taxpayer certainly has capital at considerable risk.

Then we have the lines of credit provided by the Federal Reserve which, without a doubt, were instrumental to the survival of almost all major banks during the fall - and arguably remain critical today. The taxpayer has further downside risk here.

And, most importantly perhaps, we have the expansion of the Fed’s balance... In effect, the Fed is becoming a commercial bank as well as a central bank.

The government is essentially taking over the role of intermediation - take funds in and lend them out - for the US economy. This is a form of nationalization, and it will lead to all the lobbying and politically directed credits we have seen in other nationalized financial systems; taking away this credit once the economy starts to recover will not be easy. We have state control of finance without, well, much control over banks or anything else - we can limit executive compensation (maybe) but we don’t get to appoint directors (or replace entire boards) and we have no say in who really runs anything. Responsibility without power sounds accurate. ...

How then do we really privatize? By exercising leadership: take over insolvent banks and immediately reprivatize them. ... The taxpayer retains a significant number of shares (or the option to buy common stock) as a way to ensure upside participation...

Above all, we need to encourage or, most likely, force the large insolvent banks to break up. Their political power needs to be broken, and the only way to do that is to pull apart their economic empires. It doesn’t have to be done immediately, but it needs to be a clearly stated goal and metric for the entire reprivatization process.

No argument here. If there are good reasons to have banks so large their failure could bring down the entire system, a situation that gives them quite a bit of political leverage, I haven't heard them. There are questions about whether having many small banks as opposed to a few big banks reduces systemic risk, and if not, whether having lots of small banks makes policy intervention to stabilize and clean up the system more difficult when problems do arise - having just a few banks might be easier. But breaking up the banks does reduce political and economic power and I see no reason not to make this "a clearly stated goal and metric for the entire reprivatization process."

This post can also be viewed on economistsview.typepad.com.

Secret TARP Bailout Details To Be Released By Court Order

It appears that we finally (hopefully) will be able to see where our tax dollars are going, thanks to a recent court ruling. This court order will force the Treasury to release some of the information that they have been concealing from the American public in regards to the massive bailout of the country's financial system. Anthony Freed provides us with more information on this development in his blog post below:

Advocates of an open Government and transparent allocation of taxpayer funds celebrated the news late Friday afternoon (2-20-09) that the U.S. District court has moved to enforce a Freedom of Information Act (FOIA) request to release more details about exactly how TARP bailout funds have been and are being used.

The TARP was passed in early October, 2008, in an effort to stem the damage to the nation’s financial industry incurred during a decade of lax risk-abatement that pervaded the banking culture after the legislative emasculation of the Glass-Steagall Act.

FOX Business sued Treasury on Dec. 18 over failure to provide information on the bailout funds or respond to FBN’s expedited requests filed under the FOIA. The initial request, filed on Nov. 25, sought actual data on the use of the bailout funds for American International Group (AIG) and the Bank of New York Mellon (BK), and an additional request, filed on Dec. 1, sought similar data on the bailout funds for Citigroup (C).

FBN asked the Treasury Department to identify, among other issues, the troubled assets purchased, any collateral extended, and any restrictions placed on these financial institutions for their participation in this program.

The Treasury Department - along with the other banking regulators like the FDIC, OTS, and the Federal Reserve - are notoriously secretive concerning the data they collect and their subsequent analysis of the viability of any particular institution, preferring to operate instead behind closed doors.

This tendency often leaves investors in the dark, which generally tends to work in the banks’ favor. Regulators would argue that they are not in the business of moving markets, and that some data may be misinterpreted and inadvertently cause a run on funds at named institutions, evidenced by Schumer’s now infamous disclosure of details that may have led to the collapse of Indy Mac Bank in 2008.

That argument may have held some water until the TARP bailout effectively made the U.S. taxpayer a shareholder in any number of as yet identified institutions, and the owner of any assortment of exotic financial instruments which have proved toxic to Global capital markets.

Judge Richard J. Holwell of the U.S. District Court for the Southern District of New York said in a decision Friday that the government is directed to comply with FOX Business’s request under the FOIA “within 30 days and to produce a Vaughn index with 45 days.” That means Treasury must comply with FOX Business’s request by Monday, March 23, and must produce a Vaughn index by Monday, April 6.

The Treasury will have the chance to withhold some documents and information they deem too sensitive, but now have to provide an itemized “Vaughn index” of which documents and information have been redacted, and for exactly what reason.

“A Vaughn Index must: (1) identify each document withheld; (2) state the statutory exemption claimed; and (3) explain how disclosure would damage the interests protected by the claimed exemption.”

This may open the door to further FOIA challenges to release the remaining information if the Treasury fails to convince the courts that their vetting of information was reasonable.

I don’t think Treasury has realized that they are not the only ones who have new powers and responsibilities in the implementation of this historic bailout - the courts have yet to weigh-in on much of this, including who is ultimately going to be held responsible for the mess that is the economy, even if it is still taxpayers who have to foot the bill to clean it all up.

My guess is that the courts feel very differently about full disclosure than does the insider Wall Street elite who regulate themselves from Washington D.C. in seeming perpetuity.

Frank Rich of the New York Times wrote a good op-ed piece called What We Don’t Know Will Hurt Us, which helps further the argument that it is time to get to bottom of exactly what is going on with our economy, and why their seems to be so little consequence for the perpetrators of so much devastation.

Americans are right to wonder why there has been scant punishment for the management and boards of bailed-out banks that recklessly sliced and diced all this debt into worthless gambling chips. They are also right to wonder why there is still little transparency in how TARP funds have been spent by these teetering institutions. If a CNBC commentator can stir up a populist dust storm by ranting that Obama’s new mortgage program (priced at $75 billion to $275 billion) is “promoting bad behavior,” imagine the tornado that would greet an even bigger bank bailout on top of the $700 billion already down the TARP drain.

Remember, the fundamental point of the TARP bailout is to funnel incredible amounts of taxpayer money - debt, actually - to the very institutions and people who are responsible for driving the markets off the cliff in the first place.

And they got paid handsomely for doing it.

It is time for our nation’s financial machine to drop the self-righteous arrogance they have cloaked themselves in for too long, for all of those paper-pushing money lords to release their false sense of entitlement, relinquish their ill-gotten wealth from the last 10 years, and to return to their proper place in the economic landscape as facilitators of capital creation, not the creators of capital.

Accountability in the largest disbursement of public funds in history is not only a good idea, it is essential to our democracy, as is ending the revolving door between corporate boardrooms and the regulatory offices of our government.

The Fox Business FOIA request and the court’s decision to release more information should serve as a warning to the Wall Street good ol’ boys that their orgy of omnipotence is truly over, and that the era of accountability is in.

This post can also be viewed on yourmortgageoryourlife.wordpress.com.