Magnetar -- Remember This Name

(c) 2010 F. Bruce Abel

This posting by James Kwak (skip over the Simon Johnson piece for the moment), is a must, must read.


The Baseline Scenario


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Greek Bailout, Lehman Deceit, And Tim Geithner

Posted: 13 Apr 2010 04:53 AM PDT

By Simon Johnson

We live in an age of unprecedented bailouts. The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.

The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures. Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?

But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).

The sharp decline in market confidence last week – marked by the jump in Greek yields – scared the main European banks, and also showed there could be a real run on Greek banks; other Europeans are trying to stop it all from getting out of hand. But there is no new program that would bring order to Greece’s troubled public finances.

It’s money for nothing – with no change in the incentive and belief system that brought Greece to this point, very much like the way big banks were saved in the US last year.

If anything, incentives are worse after these bailouts – Greece and other weaker European countries on the one hand, and big US banks on the other hand, know now for sure that in their respective contexts they are too big to fail.

This is “moral hazard” – put simply, it is clear a country/big bank can get a package of support if needed, and this gives less incentive to be careful. Fiscal management for countries will not improve; and risk management for banks will remain prone to weakening when asset prices rise.

If a country hits a problem, the incentive is to wait and see if things get better – perhaps the world economy will improve and Greece can grow out of its difficulties. If such delay means that the problems actually worsen, Greece can just ask Germany for a bigger bailout.

Similarly, if a too-big-to-fail bank hits trouble, the incentive is to hide problems, hoping that financial conditions will improve. Essentially the management finds ways to “prop up” the bank; on modern Wall Street this is done with undisclosed accounting manipulation (in some other countries, it is done with cash). If this means the ultimate collapse is that much more damaging, it’s not the bank executives’ problem any way – their downside is limited, if it exists at all.

The Greeks will now:

Lobby for a large multi-year program from the IMF. They’ll want a path for fiscal policy that is easy in the first year and then gets tougher.
When they reach the tough stage, can’t deliver on the budget, and are about to default, the Greek government will call for another rapid agreement under pressure – with future promises of reform. The eurozone will again accept because it feels the spillovers otherwise would be too negative.
The Greek hope is that the global economy recovers enough to get out, but more realistically, they will start revealing a set of negative “surprises” that mean they miss targets. If the surprises add to the feeling of crisis and further potential bad consequences, that just helps to get a bailout.
The Greek authorities will add a ground game against the European Central Bank, saying things like: “the ECB is too tight, so we need more funds”. We’ll see how that divides the eurozone.
In their space, big US banks will continue to load up on risk as the cycle turns – while hiding that fact. Serious problems will never be revealed in good time – and the authorities will again have good reason (from their perspective) to agree to the hiding of issues until they get out of control, just as the Federal Reserve did for Lehman Brothers. Moral hazard not only ruins incentives, it also massively distorts the available and disclosed information.

As for Mr. Geithner, head of the New York Fed in 2008 and Secretary of the Treasury in 2009: Those who cannot remember the bailout are condemned to repeat it.





The Cover-Up

Posted: 12 Apr 2010 06:59 PM PDT

By James Kwak

Wall Street is engaged in a cover-up. Not a criminal cover-up, but an intellectual cover-up.

The key issue is whether the financial crisis was the product of conscious, intentional behavior — or whether it was an unforeseen and unforeseeable natural disaster. We’ve previously described the “banana peel” theory of the financial crisis — the idea it was the result of a complicated series of unfortunate mistakes, a giant accident. This past week, a parade of financial sector luminaries appeared before the Financial Crisis Inquiry Commission. Their mantra: “No one saw this coming.” The goal is to convince all of us that the crisis was a natural disaster — a “hundred-year flood,” to use Tim Geithner’s metaphor.

I find this incredibly frustrating. First of all, plenty of people saw the crisis coming. In late 2009, people like Nouriel Roubini and Peter Schiff were all over the airwaves for having predicted the crisis. Since then, there have been multiple books written about people who not only predicted the crisis but bet on it, making hundreds of millions or billions of dollars for themselves. Second, Simon and I just wrote a book arguing that the crisis was no accident: it was the result of the financial sector’s ability to use its political power to engineer a favorable regulatory environment for itself. Since, probabilistically speaking, most people will not read the book, it’s fortunate that Ira Glass has stepped in to help fill the gap.

This past weekend’s episode of This American Life includes a long story on a particular trade put on Magnetar (ProPublica story here), http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going a hedge fund that I first read about in Yves Smith’s ECONned. The main point of the story is to show how one group of people not only anticipated the collapse, and not only bet on it, but in doing so prolonged the bubble and made the ultimate collapse even worse. But it also raises some key issues about Wall Street and its behavior over the past decade.

This will require a brief description of what exactly Magnetar was doing. (If you know already, you can skip the next two paragraphs.) It’s now a cliche that a CDO is a set of securities that “slices and dices” a different set of securities. But it’s slightly more complicated than that. First there is a pile of mortgage-backed securities (or other bond-like securities) that are collected by an investment bank. The CDO itself is a new legal entity (a company) that buys these MBS from the bank; that’s the asset side of its balance sheet. Its liability side, like that of any company, includes debt and equity. There’s a small amount of equity bought by one investor and a lot of debt, issued in tranches that get paid off in a specific order, bought by other investors. The investment bank not only sells MBS to the CDO, but it also places the CDO’s bonds with other investors. Whoever buys the equity is like the “shareholder” of this company. There is also a CDO manager, whose job is to run the CDO — deciding which MBS it buys in the first place, and then (theoretically) selling MBS that go bad and replacing them by buying new ones. The CDO itself is like an investment fund, and the CDO manager is like the fund manager.

According to the story, in 2006, when the subprime-backed CDO market was starting to slow down, Magnetar started buying the equity layer — the riskiest part — of new CDOs. Since they were buying the equity, they were the CDOs’ sponsor, and they pressured the CDO managers to put especially risky MBS into the CDOs — making them more likely to fail. Then Magnetar bought credit default swaps on the debt issued by the CDOs. If the CDOs collapsed, as many did, their equity would become worthless, but their credit default swaps on the debt would repay them many, many times over.

The key is that Magnetar was exploiting the flaws in Wall Street’s process for manufacturing CDOs. Because the banks made up-front fees for creating CDOs, the actual human beings making the decisions did not particularly care if the CDOs collapsed — they just wanted Magnetar’s money to make the CDOs possible. (No one to buy the highly risky equity, no CDO.) Because the ratings agencies’ models did not particularly discriminate between the contents that went into the CDOs (see pages 169-71 of The Big Short, for example), Magnetar and the banks could stuff them with the most toxic inputs possible to make them more likely to fail.

Now, one question you should be asking yourself is, how is this even arithmetically possible? How is it possible that a CDO can have so little equity that you can buy credit default swaps on the debt at a low enough price to make a killing when the thing collapses? You would think that: (a) in order to sell the bonds at all, there would have to be more equity to protect the debt; and (b) the credit default swaps would have been expensive enough to eat up the profits on the deal. Remember, this is 2006, when several hedge funds were shorting CDOs and many investment banks were looking for protection for their CDO portfolios.

The answer is that nothing was being priced efficiently. The CDO debt was being priced according to the rating agencies’ models, which weren’t even looking at sufficiently detailed data. And the credit default swaps were underpriced because they allowed banks to create new synthetic CDOs, which were another source of profits. So here’s the first lesson: the idea that markets result in efficient prices was, in this case, hogwash.

By taking advantage of these inefficiencies, Magnetar made the Wall Street banks look like chumps. This American Life talks about one deal where Magnetar put up $10 million in equity and then shorted $1 billion of AAA-rated bonds issued by the CDO. It turned out that in this deal, JPMorgan Chase, the investment bank, actually held onto those AAA-rated bonds and eventually took a loss of $880 million. This was in exchange for about $20 million in up-front fees it earned.

But who’s the chump? Sure, JPMorgan Chase the bank lost $880 million. But of that $20 million in fees, about $10 million was paid out in compensation (investment banks pay out about half of their net revenues as compensation), much of it to the bankers who did the deal. JPMorgan’s bankers did just fine, despite having placed a ticking time bomb on their own bank’s balance sheet. Here’s the second lesson: the idea that bankers’ pay is based on their performance is also hogwash. (The idea that their pay is based on their net contribution to society is even more absurd.)

So who’s to blame? The first instinct is to get mad at Magnetar. But this overlooks a Wall Street maxim cited by TAL: you can’t blame the predator for eating the prey. Magnetar was out to make money for its limited partners; if it had bet wrong and lost money, no one would have bailed it out. Although I probably wouldn’t have behaved the same way under the circumstances, I have no problem with Magnetar.

I do have a problem with the Wall Street bankers in this story, however. Because losing $880 million of your own company’s money to make a quick buck for yourself is either incompetent or just wrong. And allowing Magnetar to create CDOs that are as toxic as possible — and then actively selling their debt to investors (that’s where the banks differ from Magnetar, in my opinion) — is either incompetent or just wrong. But even so, I don’t think the frontline bankers are ultimately at fault. Maybe they were simply incompetent. Or maybe, they were knowingly exploiting the system to maximize their earnings — only in this case the system they were exploiting was their own banks’ screwed-up compensation policies, risk management “systems,” and ethical guidelines.

In which case the real blame belongs to those who created that system and made it possible. And that would be the bank executives who failed at managing compensation, risk, or ethics, endangering or killing their companies in the process. And that would be the regulators and politicians who allowed these no-money down no-doc negative-amortization loans to be made in the first place; who allowed investment banks to sell whatever they wanted to investors, with no requirements or duties whatsoever; who allowed banks to outsource their capital requirements to rating agencies, giving them an incentive to hold mis-rated securities; who declined to regulate the credit default swaps that Magnetar used to amass its short positions; who allowed banks like Citigroup and JPMorgan Chase to get into this game with federally insured money; and who failed at monitoring the safety and soundness of the banks playing the game.

The lessons of Magnetar are the basic lessons of the financial crisis. Unregulated financial markets do not necessarily provide efficient prices or the optimal allocation of capital. The winners are not necessarily those who provide the most benefit to their clients or to society, but those who figure out how to exploit the rules of the game to their advantage. The crisis happened because the banks wanted unregulated financial markets and went out and got them — only it turned out they were not as smart as they thought they were and blew themselves up. It was not an innocent accident.

Frank Rich Wants to Know: Robert Rubin -- Are You Nothing But a Sandwich 30% of the Time?

(c) 2010 F. Bruce Abel

Frank Rich is sensational. I'll leave it at that.



http://www.nytimes.com/2010/04/11/opinion/11rich.html?hp

Rubin -- Are You Just a Sandwich?

(c) 2010 F. Bruce Abel

If you were to ask me ten years ago to name my heroes in a quick moment Robert Rubin would be one of them -- out of a very few. Today before Congress Rubin is just a sandwich.

Of course this is troubling. Our world is so complicated that Robert Rubin can be paid by his company $100 million (as he was during the relevant time) and have no idea that his company is on the verge of bringing not just itself down, but the entire financial system down, with all that this implies.

We at this high level could not have been expected to get involved with the "granularity" of the bank's dealings, he says today to Congress.

This man saved the government from Newt Gingrich's plan to shut down government one weekend.

Was this done without "granularity?"

My Gawd.

This man saved Mexico through slogging through our debt package.

Was this done without "granularity?"

Maybe after all it was simply Young Goldman Sachs Men Looking Cool on the Beach. Robert Rubin is now not so young and he can't carry out on the granularity things?

Speaking of carry-out, Robert Rubin, here's a "granularity" assignment that would at least take care of lunch. Would you go down to Izzys and tell them to spread slices of bread with 1000 Island dressing; top each with 1 tablespoon sauerkraut and corned beef, lay cheese on top. Put in broiler and grill until hot ...

Meanwhile, mixing metaphors if not mega-phors, and, as Woody Allen would say,

"You are Citigroup; What are we, chopped liver?"

OK, put aside the above and read a stunningly good piece from the Washington Post by Ezra Klein:

Ezra Klein
The complexity problem
Earlier in the crisis, the line was that "too big to fail" was too big to exist. I'm coming around to an altogether more radical view: What if "too complex to understand" is too complex to exist?

Listen to Robert Rubin -- the former co-chairman of Goldman Sachs, celebrated secretary of the treasury and director of Citibank -- tell the Financial Crisis Inquiry Commission that

"All of us in the industry failed to see the potential for this serious crisis. We failed to see the multiple factors at work.”

Listen to Alan Greenspan -- former Federal Reserve chairman, holder of the nickname "The Oracle" -- say that we need regulations that kick in "without relying on the ability of a fallible human regulator to predict a coming crisis."

If you're an investment bank, the stock market has become a bit of a bummer. It's so transparent and user-friendly that there's really no place for a middleman to make major profits. That's normal: Efficient markets reduce margins. To put it another way: It's hard to make money doing simple things in a competitive market unless you have a monopoly. But Wall Street has leveraged incredible levels of complexity into something that's more like a monopoly than a market.

The really neat trick was that this worked even after the market crashed. Because no one could understand it, the people who crashed the place were also given a major role in the rescue effort. And that wasn't just true at the top level. Think back to the AIG employees threatening to quit and make it (theoretically) impossible to unwind the company's financial products division if they didn't get their retention bonuses. Their retention bonuses!

It would be one thing if this complexity had done great things for the country. But not so much, as we all know. Some innovations (pdf) have been good. But the opaque complexity that gave rise to credit default swaps and collateralized debt obligations and risk profiles that no one understood turned out to be almost unimaginably bad. Complexity helped bankers bully ratings agencies and regulators into signing off on products they didn't understand, it helped mortgage lenders entice consumers into contracts that they couldn't fulfill, and it's now helping Wall Street beat back necessary regulations because Congress is nervous about mucking with an industry they don't really grasp. And beyond all that, the complexity that allowed Wall Street to become a more profitable and significant segment of the economy also sucked talent away from other sectors.

How does this translate into regulation? I'm not really sure. It's not like there's a standard measure of unnecessary complexity or useless opacity. But watching these Wall Street titans tell the FCIC that they didn't understand what the banks were doing is making me a lot less sympathetic when their lobbyists tell Congress that Washington simply doesn't understand what the banks are doing.

By Ezra Klein April 8, 2010; 5:07 PM ET
Categories: Financial Crisis , Financial Regulation

Comments (not by me):

Restricting complexity ultimately translates into restricting interconnectedness.

Fundamental properties of structures in computer science and mathematics called graphs* show that at a certain level of interconnectedness, the corporate graph will show cyclical dependencies that are fairly intractable in terms of answering the questions we want to ask.

Compound this with the fact that you'll only be aware of a subset of the data structure at any time, and any densely interconnected financial system will be "too complex to understand".

*Note, this is very different from a plot or your common bar graph,

Posted by: zosima April 8, 2010 5:35 PM Report abuse

Ezra: I hope you do follow the TED conference and their videos. Two key speakers talks about the need to reduce complexity whether it's legal or societal.

http://www.ted.com/talks/alan_siegel_let_s_simplify_legal_jargon.html

http://www.ted.com/talks/barry_schwartz_on_our_loss_of_wisdom.html

Posted by: AD1971 April 8, 2010 5:48 PM Report abuse

From reading Michael Lewis it is clear that the subprime/CDO/CDS stuff was really complex--so much so that one had to have Asperger's and spend 6 months at it to understand it. It was way, way too complex, and deliberately so. Moreover, the Rubins and Princes didn't ask someone to explain the products to them. There were people in their firms who understood the level of risk, or at least how the products worked. In addition, there were people gaming the ratings agencies who knew that the towers of mortgages and derivatives were largely sh*tpiles. But no one wanted to upset the applecart, and the people with responsibility never wanted to inquire very far.

So what did Rubin do to warrant his $20 million? Provide access? Cachet? He ought to give most of it back.

Greenspan also won ;t acknowledge the role that low interest rates played in (1) fueling the housing boom and (2) encouraging savers/investors to look for higher yields in products like CDOs.

If we want to encourage genuine savings, higher yields were needed, and it would have provided a margin for easing when things went bad. Now, of course, we need low rates. But still. It is a hell of an environment for savers.


Posted by: Mimikatz April 8, 2010 6:05 PM Report abuse

This combined size and complexity is not manageable or controllable in a democracy.

We face very hard choices that we are not socially/politically prepared to make.

There are many aspects that need radical redos:
- numbers and types of biz's that financial firms are allowed to participate in
- max. size of a organization allowed before a anti-trust/anti-complexity trigger is hit that results in breakup into smaller pieces.
- regulators that are tailored to various segments of biz that are created after monoliths are outlawed.
- no financial innovation that isn't fully studied and pre-prescribed remedies are enacted to automatically kick in when inevitably things go awry in one of the newly arranged segments/sectors.

It is almost a fool's errand to think about this, since the beast controls the keeper in multiple ways. We haven't and won't learn from our mistakes. Denial is the order of the day. A return to democratic control of our society is probably now impossible.

Learn to love your financial masters, because they are now your destiny.

Posted by: JimPortlandOR April 8, 2010 7:01 PM Report abuse

The key to regulation is to make CONSUMER PROTECTION paramount. If rules are made with consumer protection in mind AT ALL LEVELS then it will eliminate most of the cheats frauds and loan sharks.

Especially if we take a broad definition of consumer protection to include pension funds and 401Ks. Protecting consumers by cracking down on loan sharks would have prevented the housing bubble.

Trying to regulate the banksters directly is unlikely to work. What can work is to protect small investors and the types of products that can be marketed. The cost of regulation will be small compared to the huge inefficiencies created by the cheats frauds and loan sharks.

Posted by: bakho April 8, 2010 8:01 PM Report abuse

I always though we should just make it a criminal offense to lose $X billion when you can't cover it with assets. Financial meltdowns causes much more societal damage than any particular single criminal act from drug use to trespassing to murder.

You designate a CEO and/or CFO or whoever to be responsible. If the losses include contracts made under a previous CEO, you include him or her.

This is effectively a leverage ratio of 1, but only coming into place when you leverage near the limit. Say, X = $50 billion dollars. I can leverage $4 billion in assets at 13:1 and still make it under the "cap" if it goes bad (4 x 13 - 4 = 48).

But I can only leverage $10 billion at just under 5:1, or else risk 20 years in prison.

But the best part is that no one has to calculate it until after the fact if it goes bad and it motivates people to get it right in the first place. The creditors will act as the police and bring it to everyone's attention because they are making the claims.

Not that I've worked out every aspect of this. You can mitigate sentences for bad luck or duped CEOs.

We used to throw people in jail for debts but got rid of it because it was inhumane for the poor. They can't leverage assets however, so they would just go bankrupt before they reached the limit.

I don't think debtors prison is inhumane for rich CEOs, though.

Posted by: JasonFromSeattle April 8, 2010 8:20 PM Report abuse

RobRub?


Posted by: pj_camp April 8, 2010 8:56 PM Report abuse

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© 2010 The Washington Post Company

Baseline Scenario -- A Good One

(c) 2009 F. Bruce Abel

Simon gets an award and Volcker Picks Up a Bat, very good.

The Baseline Scenario

Paul Volcker Picks Up A Bat
Posted: 17 Dec 2009 04:15 AM PST

For most the past 12 months, Paul Volcker was sitting on the policy sidelines. He had impressive sounding job titles – member of President Obama’s Transition Economic Advisory Board immediately after last November’s election, and quickly named to head the new Economic Recovery Board.
But the Recovery Board, and Volcker himself, have seldom met with the President. Economic and financial sector policy, by all accounts, has been made largely by Tim Geithner at Treasury and Larry Summers at the White House, with help from Peter Orszag at the Office of Management and Budget, and Christina Romer at the Council of Economic Advisers.
With characteristic wry humor, Volcker denied in late October that he had lost clout within the administration: “I did not have influence to start with.”
But that same front page interview in the New York Times contained a well placed shock to then prevailing policy consensus.
Volcker, legendary former chairman of the Federal Reserve Board with much more experience of Wall Street than any current policymaker, was blunt: We need to break up our biggest banks and return to the basic split of activities that existed under the Glass-Steagall Act of 1933 – a highly regulated (and somewhat boring) set of banks to run the payments system, and a completely separate set of financial entities to help firms raise capital (and to trade securities).
This proposal is not just at odds with the regulatory reform legislation then (and now) working its way through Congress; Volcker is basically saying that what the administration has proposed and what Congress looks likely to enact in early 2010 is essentially — bunk.
Speaking to a group of senior finance executives, as reported in the Wall Street Journal on Monday, Volcker made his point even more forcefully. There is no benefit to running our financial system in its current fashion, with high risks (for society) and high returns (for top bankers). Most of financial innovation, in his view, is not just worthless to society – it is downright dangerous to our broader economic health.
Volcker only makes substantive public statements when he feels important issues are at stake. He also knows exactly how to influence policy – he has not been welcomed in the front door (controlled by the people who have daily meetings with the President), so he’s going round the back, aiming at shifting mainstream views about what are “safe” banks. Many smart technocrats listen carefully to what he has to say.
This strategy is partly about timing – and in this regard Volcker has chosen his moment well. The economy is starting to recover, but this process is clearly going to take a while and unemployment will stay high for the foreseeable future. At the same time, our biggest banks are making good money – mostly from trading, not much from lending to small business – and they are lining up to pay very big bonuses.
Not only is this contrast – high unemployment vs. bankers’ bonuses – annoying and unfair, it is also not good economics. Bankers are, in effect, being rewarded for taking the risks that created the global crisis and led to massive job losses. And they are being implicitly encouraged to do the same thing again.
The case for keeping big banks in their current configuration is completely lame. Even if we are lucky enough to avoid another major any time soon, the fiscal costs are enormous and coming right at you (and your taxes).
Now that Paul Volcker has picked up his hammer, he will not lightly set it aside. He knows how to sway the policy community and he knows how to escalate when they don’t pay attention. Expect him to pound away until he prevails.
By Simon Johnson
This is a a slightly edited version of a post that previously appeared on the NYT’s Economix; it is used here with permission. If you would like to reproduce the entire piece, please contact the New York Times for permission.


Move Over, Bernanke
Posted: 17 Dec 2009 04:00 AM PST

Ben Bernanke is Person of the Year. Matt Yglesias has criticism, although he does say it was an appropriate choice. Now, the Time award is meant to recognize newsworthiness, not necessarily exceptional conduct, and it’s hard to deny that Bernanke has been newsworthy. But I think that 2008 was Bernanke’s year, not 2009–that was the year of the real battle to prevent the collapse of the financial system. As far as the crisis is concerned, I would say the face of 2009 has been Tim Geithner–PPIP, stress tests (largely conducted by the Fed, but Geithner was the front man), Saturday Night Live, regulatory “reform,” and so on. But I can see why Time didn’t want to go there. Besides, I’m not sure that the financial crisis was the story of 2009; what about the recession? They’re related, obviously, but they’re not the same thing.
But in real news, Simon was named Public Intellectual of the Year by Prospect Magazine (UK). (This year they seem to have restricted themselves to financial crisis figures; David Petraeus won in 2008.) Over Ben Bernanke, among others. (Conversely, Simon didn’t make Time’s list of “25 people who mattered”–but Jon and Kate Gosselin did, so that’s no surprise.) The article says that Simon “has also done more than any academic to popularise his case: writing articles, a must-read blog, and appearing tirelessly on television,” which sounds about right to me.
Prospect got one thing wrong, though. The article has a cartoon of Simon holding a sledgehammer and towering over a Citigroup in ruins. But no matter how many times you keep taking whacks at Citigroup, it refuses to die. One hundred years from now, maybe people will still be saying there are two common ingredients in all U.S. financial crisis: excess borrowing … and Citibank.c
By James Kwak

Krugman -- Money for Nothing

This is a Must Read. Is "it" over and the bankers have won? Krugman hopes not. I hope not. Because they have produced nothing of value except pain.

It occurs to me that May 4th is a key day. Through trading (turned into a "hold") I own 500 Citigroup, and 200 Regions Financial. But still I want there to be some "solution" to the banking problem and some real understanding of what really happened.

The "quants" did this, broadly speaking.

As readers of this blog know, I believe the heads of the banks had no idea what the quants were doing. (I'm not sure "quants" is the right all-inclusive category here, as it also takes "traders" to do the deed.) So, using Brooks's terms, the heads of the banks were "stupid," not "greedy." (If one must choose a dominating term above all.)



Op-Ed Columnist
Money for Nothing


By PAUL KRUGMAN
Published: April 26, 2009
On July 15, 2007, The New York Times published an article with the headline “The Richest of the Rich, Proud of a New Gilded Age.” The most prominently featured of the “new titans” was Sanford Weill, the former chairman of Citigroup, who insisted that he and his peers in the financial sector had earned their immense wealth through their contributions to society.
Soon after that article was printed, the financial edifice Mr. Weill took credit for helping to build collapsed, inflicting immense collateral damage in the process. Even if we manage to avoid a repeat of the Great Depression, the world economy will take years to recover from this crisis.
All of which explains why we should be disturbed by an article in Sunday’s Times reporting that pay at investment banks, after dipping last year, is soaring again — right back up to 2007 levels.
Why is this disturbing? Let me count the ways.
First, there’s no longer any reason to believe that the wizards of Wall Street actually contribute anything positive to society, let alone enough to justify those humongous paychecks.
Remember that the gilded Wall Street of 2007 was a fairly new phenomenon. From the 1930s until around 1980 banking was a staid, rather boring business that paid no better, on average, than other industries, yet kept the economy’s wheels turning.
So why did some bankers suddenly begin making vast fortunes? It was, we were told, a reward for their creativity — for financial innovation. At this point, however, it’s hard to think of any major recent financial innovations that actually aided society, as opposed to being new, improved ways to blow bubbles, evade regulations and implement de facto Ponzi schemes.
Consider a recent speech by Ben Bernanke, the Federal Reserve chairman, in which he tried to defend financial innovation. His examples of “good” financial innovations were (1) credit cards — not exactly a new idea; (2) overdraft protection; and (3) subprime mortgages. (I am not making this up.) These were the things for which bankers got paid the big bucks?
Still, you might argue that we have a free-market economy, and it’s up to the private sector to decide how much its employees are worth. But this brings me to my second point: Wall Street is no longer, in any real sense, part of the private sector. It’s a ward of the state, every bit as dependent on government aid as recipients of Temporary Assistance for Needy Families, a k a “welfare.”
I’m not just talking about the [1] $600 billion or so already committed under the TARP. There are also the [2] huge credit lines extended by the Federal Reserve; [3] large-scale lending by Federal Home Loan Banks; the [4] taxpayer-financed payoffs of A.I.G. contracts; the [5] vast expansion of F.D.I.C. guarantees; and, [6] more broadly, the implicit backing provided to every financial firm considered too big, or too strategic, to fail.
One can argue that it’s necessary to rescue Wall Street to protect the economy as a whole — and in fact I agree. But given all that taxpayer money on the line, financial firms should be acting like public utilities, not returning to the practices and paychecks of 2007.
Furthermore, paying vast sums to wheeler-dealers isn’t just outrageous; it’s dangerous. Why, after all, did bankers take such huge risks? Because success — or even the temporary appearance of success — offered such gigantic rewards: even executives who blew up their companies could and did walk away with hundreds of millions. Now we’re seeing similar rewards offered to people who can play their risky games with federal backing.
So what’s going on here? Why are paychecks heading for the stratosphere again? Claims that firms have to pay these salaries to retain their best people aren’t plausible: with employment in the financial sector plunging, where are those people going to go?
No, the real reason financial firms are paying big again is simply because they can. They’re making money again (although not as much as they claim), and why not? After all, they can borrow cheaply, thanks to all those federal guarantees, and lend at much higher rates. So it’s eat, drink and be merry, for tomorrow you may be regulated.
Or maybe not. There’s a palpable sense in the financial press that the storm has passed: stocks are up, the economy’s nose-dive may be leveling off, and the Obama administration will probably let the bankers off with nothing more than a few stern speeches. Rightly or wrongly, the bankers seem to believe that a return to business as usual is just around the corner.
We can only hope that our leaders prove them wrong, and carry through with real reform. In 2008, overpaid bankers taking big risks with other people’s money brought the world economy to its knees. The last thing we need is to give them a chance to do it all over again.

The Word "Bank"

(c) 2009 F. Bruce Abel



It occurs to me that for the bailout to work we must wipe out a word from our vocabulary: "Bank," as in "Oh, you work for a bank, do you? I don't trust you, even though I work for a bank myself. In fact I don't even trust myself here at this bank, because I am addicted to trading credit default swaps."

We must now create another word, another category.

What is that word? I don't know. What about "Trank." This implies trust. But, now that I think about it, the phrase "Bank Trust Department" must be removed also.

A Little Mayo-naise on Mayo's Face For His Bearish Calls on the Banks

http://blogs.wsj.com/deals/2009/04/06/the-history-of-mike-mayo-bank-downgrades/

Auction Rate Securities Back in the Headlines

http://www.nytimes.com/2009/04/04/technology/companies/04chip.html?hpw

Barrons -- What the Stress Test Will Show

http://online.barrons.com/article/SB123577855400397607.html?mod=googlenews_barrons

Citi! Again! Too Good to be True?

http://www.nytimes.com/2009/02/27/business/27deal.html?_r=1&hp

Citi! Again! Too Good to be True?

http://www.nytimes.com/2009/02/27/business/27deal.html?_r=1&hp

No Sex in Citi

A 3rd Rescue Would Give U.S. 40% of Citigroup

By ERIC DASH
Published: February 23, 2009
Nationalization, at least a partial one, seems inevitable for Citigroup. As Washington prepares to tighten its grip on the struggling company, the implications — for the troubled financial giant and the rest of the industry — are starting to sink in.

Related
U.S. Pressed to Add Billions to Bailouts (February 24, 2009)
Across the Atlantic, Echoes in R.B.S.’s Lifeline (February 24, 2009)
Times Topics: Citigroup Inc. Credit Crisis — The Essentials
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J. B. Reed for The New York Times
Washington is preparing to tighten its grip on Citigroup, but it’s already calling many of the shots for the company.
Under a plan federal regulators were discussing on Monday, the government may end up owning as much as 40 percent of Citigroup, which has already grabbed two multibillion-dollar lifelines from Washington.
The question is, what happens then? Perhaps not all that much, at least for now.
Even before rescue No. 3 — which will not involve additional taxpayer money — federal regulators were clamping down on the company. The government has ordered Citigroup to sell businesses, shake up its board, cut its dividend and reduce risky trading. It has also moved to curb bonuses and perks like corporate jets.
Moreover, Citigroup already relies on the government to finance its operations and insure hundreds of billions of risky assets. It has bowed to Democratic lawmakers on bankruptcy legislation that the financial industry had long opposed, and is now required to fill out a public report card on its lending activities monthly.
“What is the big deal?” said Charles R. Geisst, a financial historian. “They are wards of the state anyway.”
The Obama administration says it has no plan to nationalize banks outright, and government officials say they want to avoid taking a big stake in Citigroup. The hope is that more equity capital from the government, supplied through the conversion of preferred stock, will help Citigroup pass a new “stress test” that federal regulators are preparing to administer to 20 or so large banks. The administration’s strategy seems to point in the direction of stopping short of outright nationalization — where the government takes control — and stepping up regulatory scrutiny.
But with greater ownership, there is always the risk that the government might try to exert a lot more influence over Citigroup. The entire banking industry, after all, remains under acute stress. JPMorgan Chase, widely regarded as one of the healthier big banks, announced on Monday that it would sharply reduce its dividend to stockholders to conserve cash in case the economy deteriorates further.
Citigroup, with operations in more than 100 countries, encapsulates many of the ills plaguing the global banking industry. In the future, the company will almost certainly be smaller and less profitable than it was in the past, analysts say.
“A year from now, it will be more like a large financial utility,” said Michael Mayo, a Deutsche Bank analyst. “Less risk, less leverage, less growth.” Analysts say the worst-case situation is that the government eventually steps in, breaks up Citigroup and sells off the pieces. Citigroup, they said, could end up half of its current size.
A big question is whether the government will press to replace Vikram S. Pandit, Citigroup’s chief executive. Citigroup insiders insist that Mr. Pandit, who inherited many of the problems at the company when he became chief executive in late 2007, has the government’s backing. Analysts say it would be hard to find someone willing to take his job.
In many ways, Mr. Pandit is already grappling with the same problems that the government would face if it took control.
He was forced to split off Citigroup’s prized Smith Barney brokerage unit, for instance, to raise capital. He is also scaling back the company’s mortgage and proprietary trading operations. He has created a “bad bank” structure to hold Citi’s money-losing businesses, like private label credit cards and Primerica insurance, and tens of billions of dollars’ worth of toxic assets. While the government might demand that Mr. Pandit accelerate plans to sell bad assets, buyers are scarce. The government has also not yet revealed details of its plans for a so-called aggregator bank that might buy some of these assets.
Nationalizing Citigroup outright would be a huge challenge, given the company’s size and international sweep. In countries like Mexico, for instance, a state-controlled bank might run afoul of local ownership regulations.
Analysts also wonder whether a full government takeover of Citigroup would place its rivals at a disadvantage. Customers, for example, might prefer to park their money at a bank backed by the full faith and credit of the United States, rather than a smaller bank that has federal insurance on deposits up to $250,000. Traders might prefer to trade with a bank backed by the federal government.
Shares of Citigroup rallied on Monday in the hope that the government’s plan would stabilize the company. Shares rose 19 cents, to $2.14. The stock was still down 68 percent for the year.
Gerard Cassidy, an analyst at RBC Capital Markets, said it could take years for Citigroup to right itself, even with the government’s help. “I don’t think they can do it in a short time,” he said.

Krugman -- On Nationalization of the Banks

Nationalization is as American as Apple Pie. As usual, he is excellent, if wonkish:

http://www.nytimes.com/2009/02/23/opinion/23krugman.html?_r=1

Three Worthy Financial Articles This Morning

Morgenson has two excellent pieces today, one fresh in the New York Times, on exactly what the elephant in the room is and ideas on how to nurse it to health. The first gleam of hope I think. But it will take some time.

http://www.nytimes.com/2009/01/25/business/25gret.html

The other Morgenson article "fresh" in the Cincinnati Enquirer from the syndicated file of a few days ago (missed it somehow in my daily reading of the NYT):

http://www.nytimes.com/2009/01/18/business/18gret.html?scp=3&sq=morgenson%20banking&st=cse

And then a tour-de-force on Bernie Madoff. This one also points out the great, great falacy of deregulation.

"The Talented Mr. Madoff"

http://www.nytimes.com/2009/01/25/business/25bernie.html?_r=1&8dpc

Catching up on Cramer -- and Citicorp

Without cable, I missed "Stop Trading" and "Mad Money" all week. So I'm starting to catch up.

Jim: This market is all about confidence... who do investors have confidence in and who they are worried about. The market has spoken. It has put Goldman Sachs (GS*) in the Sell Block... You look at what happened to Goldman's stock today... at one point, it was down like $85... that's through book value... That's a vote of no confidence if there ever was one... It's not a vote that I necessarily agree with... In fact, since I own it for my charitable trust, and have since I started the Trust, I obviously don't believe in the market's judgment but, not only that, I have faith in the management of the firm... something the market says is dreadfully wrong... even GS* has no home equity loans, or car loans, or second... whatever... any of the nonsense that a Wachovia Corp. (WB) or a Wells Fargo (WFC) - that are so loved now -or a Washington Mutual (WM), which is... you know, puh-lease... But I'll accept Mr. Market's judgment... Remember, I am on the hunt for bull markets wherever I can find them... and, right now, the bull says don't go with the investment banks, go with the food banks... and that's what the market has confidence in... That's right... the food bank...General Mills Inc. (GIS*)... isn't that the perfect example?... It reported a great quarter yesterday. The stock's flirting with a 52-week high... Or how about the Heinz (HNZ)?... Right, let's do the "catch up" trade... That stock, at one point today... was yielding a little more than 3%... better than Treasuries...The market has declared that GS* is in the Sell Block, and that makes GIS* a buy... and that's why I'm calling companies like General Mills the "new banks"... The market's decided we don't need investment banks anymore... that it's an unprofitable business... it doesn't matter anymore what I think... We need food banks... like GIS*. That's where people are putting their money.Now, obviously, you can't run the economy without investment banks, but this market's verdict for now - if not Cramer's - is that you've got to sell them... Now, the market has faith in the "really old banks" so to speak... commercial banks... the ones that rely on deposits... not money in hedge funds... the ones that I've been recommending like US Bancorp (USB) and Wells Fargo (WFC)... either hitting a 52-week high or coming close... It has confidence in deposit banks... just not investment banks... Now, I've been a huge supporter of the commercial banks, like the Fortress Four... the US Bancorp (USB), Wells Fargo (WFC), Bank of America (BAC) and JPMorgan (JPM*)... and I added BB & T Corp. (BBT) recently, and I added Wachovia Corp. (WB)... If I were one of these companies, you know what I'd actually do right now?... Ready... I would consider buying Goldman Sachs... It's book value is for real, and we're always going to need investment banks... and the deal could be pretty lucrative with a strong deposit base to fund the takeover... and they're allowed to now, after a change in the rules that they snuck in...It's kind of funny that, last week, all the talk was about how Goldman might buy Wachovia. Now it could be the other way around!...It's so nuts up here that, get this one... Citigroup (C) should use its strength to go raise equity... C'mon guys... I'm back on if you do it, right... never put you on the Wall of Shame if you raise a little money... and Citi should go buy Goldman... I said it.But this market likes the "new banks" just as much, if not more, and that's why you can see the market likes companies like HNZ and GIS* and Coke (KO)... which are all benefitting from the big decline in commodities. These are companies that can borrow money recklessly, endlessly... whatever they want... because they have strong, solid consistent earnings streams... and they make a profit, pay it back, and have a good dividend.Hey, that sounds like kind of what a bank's supposed to do, right?... Right now, the "new banks" are beating the old ones... even the deposit banks that the people have more faith in, because the market has confidence in them... confidence.If we get a recession... I don't think we will... If we get a severe one, I think we could have a big slowdown... these are the stocks that will thrive... total "fallout shelter" names...When I think of GIS*... hey, I think of Hamburger Helper, a real "trade-down" brand if there ever was one... I lived on this when I lived in my car... People don't want to go to the Cheesecake Factory... they want to have in-home Cheesecake Factory!... They want Gold Medal flour... They don't want Denny's grand slam... they want "the breakfast of champions" (Wheaties)... The market is speaking, and we hear, even though we don't necessarily agree... In Wheaties, not leverage, we trust...
. . . . .
The Bottom Line!: The market says Goldman Sachs (GS*) belongs in the Sell Block, so buy the "new banks"... General Mills Inc. (GIS*), Heinz (HNZ), Coke (KO) and Tootsie Roll (TR)! I rest my case.
. . . . .







© 2005-2008 MadMoneyRecap.com ■

Citicorp -- The New Hero?

Having been without electricity for most of the week, I would pick up the New York Times and Cincinnati Enquirer each morning in the dark (around 5:30 am) and walk down to our empty house for sale down on Greenville, which did have electricity from Tuesday night onward.

The NYT of September 18, or was it 19?, was chock full of the most amazing articles on the business situation created by the events of last week. The entire banking world was either thrown into chaos or rescued, depending on your point of view. Now Wachovia is the White Knight??? Nad now Citicorp is "good" whereas it was "the worst!"

Read on:

new_york_times:http://www.nytimes.com/2008/09/21/business/21citi.html

By JULIE CRESWELL and ERIC DASH
Published: September 20, 2008
YOU’RE one of the largest commercial banks in the United States. Your international reach is beyond compare, with customers in scores of countries relying on you for credit cards, mortgages and auto loans. Corporations worldwide turn to your investment bankers for advice.
You’re Citigroup, and on paper, you look perfectly suited to withstand these tumultuous times.
As the stocks of once-high-flying brokerages firm gyrated wildly last week and some smaller banks struggled to survive, Citigroup even found itself named as a potential suitor.
“We were a pillar of strength in the markets,” said Citigroup’s C.E.O., Vikram S. Pandit, in an interview late Friday afternoon. Sitting calmly in his quiet office after one of the most chaotic weeks of trading in Wall Street history, Mr. Pandit said that his bank had some funds flow in from competitors’ coffers.
“That’s a great place to be,” he says, smiling.
Of course, even Citi’s stock was whipsawed last week as fears about a financial collapse appeared to overwhelm even the mightiest of Wall Street’s titans. And Citi’s fortunes also may be buttressed by a huge government bailout plan unveiled on Friday.
Regulators plan to create a taxpayer-financed depository for withering mortgage securities — and Citi holds billions of dollars of such stuff.
Until the government works out all the details, it’s unclear how much Citi stands to gain. The biggest unknown is the price that the government will pay for the assets. If it’s below the price that Citi has assigned them, the bank could face further losses.
Mr. Pandit said he did not know exactly how the fund would work or what impact it might have on Citi’s holdings. But he expressed confidence that the proposed bailout could go a long way toward restoring confidence among investors and eventually free up banks to make new loans. “That’s going to be good for housing prices as consumers are able to get mortgages again,” he said.
While the proposed bailout and the newly buoyant market raise Citi’s prospects, the large bank — which has been inundated with an unusual array of managerial and financial debacles in recent years — still isn’t out of the woods.
If consumers continue to be hammered by the economy, the bank may have to add to the billions it has set aside to cover potential losses in credit-card, home-equity and auto loans. And Citigroup’s large international base (two-thirds of its deposits are outside the United States) could expose it to further hits as economies in Europe and emerging markets slow.
Other problems that Citi’s executives must tackle are homegrown. A decade has passed since Citigroup was formed after the landmark $70 billion merger between Citicorp and the insurance company Travelers, shattering the Depression-era law that hemmed in the size and power of America’s banks. Yet Citigroup is still struggling to make all the parts perform.
While Mr. Pandit is scrambling to put out fires, he also must find a way to integrate the dozens of companies that his predecessors acquired over the years. Even during the good times, Citi underperformed its peers. And since the credit crisis struck last year, the bank’s market value has plunged more than $125 billion. It is on track to have four consecutive quarters of multibillion-dollar losses.
Since taking over the banking giant late last year, Mr. Pandit has made many moves to shore up the company’s finances. In recent months, Citi has raised $50 billion in capital, cut the dividend by almost half, slashed expenses and headcount, and put underperforming businesses up for sale. He is also trying to refine the bank’s strategy and has brought in new heads for several important divisions.
Until recently, however, Citigroup hasn’t been given much credit for its new steps.
“What’s not clear to people from the outside is that we’ve done a lot to clean up the business,” said Mr. Pandit. Indeed, a handful of analysts give Mr. Pandit kudos for addressing many of Citi’s longstanding problems and argue its diverse business lines position it well if markets stabilize.
“No one financial company has the geographic and product breadth that Citigroup has,” says Richard X. Bove, an analyst with Ladenburg Thalmann. “But the company has been massively mismanaged for 15 years.”
MUCH of Citigroup’s woes trace back to Sanford I. Weill, Citigroup’s former chairman who transformed the bank into a financial services behemoth during more than a decade of flashy acquisitions. Citigroup’s stock soared during his reign as he bought company after company, then slashed expenses to show quick profits.
Mr. Weill’s successors, first Charles O. Prince III, and now Mr. Pandit, have had to deal with the devastating consequences of Mr. Weill’s tenure. Analysts say that he instituted a cowboy culture that pitted managers against one another, did not share information with employees and forced them to battle for every last nickel of spending. He underinvested in technology, leaving Citigroup with outdated systems that analysts say could still take another five years to update.
More important, Mr. Weill and Mr. Prince did not keep the bank up to date with risk analysis systems and personnel, leaving it vulnerable to the dangers associated with complex products like collateralized debt obligations, or C.D.O.’s, which have loomed ever larger on Citigroup’s balance sheet in recent years.
Mr. Pandit is a former Morgan Stanley executive who left to start a hedge fund, Old Lane Partners, which Citigroup acquired in 2007 for $800 million. When Mr. Prince resigned late last year amid gigantic losses in the mortgage portfolio, Mr. Pandit was tapped to take his place.
Even though he had no retail banking experience, Mr. Pandit so far has earned fairly strong marks from some Wall Street analysts. He quickly started raising capital and announced plans to slash nearly 20,000 jobs. Thousands more layoffs are likely. And this spring, he said Citigroup would shed $400 billion in assets over the next three years. Still, Citi is exposed to significant risks.
While it has written down about $27.6 billion of its subprime and related mortgage securities, Citi still holds about $22 billion of the mortgage-linked securities on its balance sheet. Gary L. Crittenden, Citigroup’s chief financial officer, says that most of the securities predate 2006, when mortgage lending practices really went off the rails, and that Citigroup has marked many of those C.D.O.’s down to 61 cents on the dollar. If the government values them below that level, Citi will have to mark them down even further.
The bank also has $16.4 billion in another type of risky loans on its books. Defaults on so-called alt-A loans, which were made to slightly more creditworthy customers but with little to no proof of their income or assets, is accelerating.
Citigroup must also reckon with new problems created by the credit crisis, like losses on its Fannie Mae and Freddie Mac securities, and the collapse of supposedly safe auction-rate debt.
Still another unknown for Citigroup is its exposure to loans provided to buyout firms, which paid what now seem like high prices to privatize publicly traded companies. As the economy slows, the values of those acquired companies are also declining. So far this year, the bank has written down about $3.5 billion of those loans but still has a further $24 billion outstanding.
While Citigroup’s huge deposit base has given it more stability in these rocky markets, its retail customers may also give it some trouble in the coming quarters. Consumers, hit hard by falling housing prices and rising gas prices, are struggling to keep up with sky-high credit card bills and auto loans.
In the last year, Citigroup has more than doubled the money it has set aside to cover potential losses in its consumer loans, ranging from mortgages to credit cards and auto loans, to $16.5 billion. And its losses will increase if the unemployment rate keeps rising.
“If you look at the last three credit-card cycles, they typically last somewhere between 8 and 10 quarters long. We’re now in the fourth quarter,” says Mr. Crittenden, who worked at the credit-card giant American Express for seven years before joining Citi in 2007. “We’re likely to see additional deterioration.”
Still, an even bigger potential problem for Citigroup is the $1.2 trillion in assets that shareholders do not see because they are not on its balance sheet. (JPMorgan Chase also holds hundreds of billions of dollars’ worth of special securitization vehicles off its books.)
While Citigroup provides ample disclosure of these assets — 23 pages worth of discussion in its second-quarter filing — it doesn’t address one big question: How much of that $1.2 trillion might wind up back on the balance sheet? In the last year alone, Citigroup has shifted $55 billion of assets back onto its books.
Last week a Senate banking subcommittee held a hearing on how accounting rules for off-balance-sheet entities may have contributed to the explosive growth of risky subprime mortgages and mortgage securities.
Earlier this year, the Financial Accounting Standards Board proposed rules that could require banks to bring these potentially distressed assets back onto their books — a move that could seriously weaken the banks’ financial well-being. The board, however, has delayed implementation of the rule, which will give banks more time to lobby against the changes.
While Citigroup has struggled to get its sprawling operations under control, its closest competitor, JPMorgan Chase, has performed much better during the current credit meltdown. While some analysts say JPMorgan’s C.E.O., James L. Dimon, has proved himself to be an adroit leader, others say the biggest factor dividing the two banks’ performance is the business mix.
JPMorgan, unlike Citigroup, had relatively little exposure to mortgage securities. On the flip side, JPMorgan’s extensive retail branch network in the United States makes it much more vulnerable to consumer defaults on home equity and auto loans than Citi, analysts say.
STILL, in these uncertain markets, Citigroup’s business mix has offered it protection that some of its investment banking brethren would have lusted after last week. Mr. Pandit continues to staunchly resist calls to break up the banking giant. After all, in today’s market pandemonium, a stand-alone Citigroup investment bank might not have survived, he says.
“If there’s anything I’m right about 100 percent it’s the strategy we’re on and what we’re doing,” Mr. Pandit says.