Friday, January 28, 2011

Today's links

1-- FCIC Insiders Say Report Gives Wall Street a Free Pass, Simply Sought to Validate Conventional Wisdom About Crisis, Naked Capitalism

From the very outset, the Financial Crisis Inquiry Commission was set up to fail......So with expectations for the FCIC low, recent reports that the panel urged various prosecutors to launch criminal probes were a hopeful sign that the commission might nevertheless come out with some important findings. But correspondence from insiders in the last few days suggests otherwise. One, for instance, wrote, “I’m still in the process of getting the stink out of my clothes.”

These ideologically-neutral sources close to the investigation depict the commissioners as having pre-conceived narratives and of fitting various tidbits unearthed during the investigation into these frameworks, with the majority focusing more on the problems caused by deregulation and the failure of the authorities to use even the powers they had, while the minority assigns blame to government meddling, particularly housing-friendly policies.....

These insiders see both sides as wrong, and want to encourage investigative reporters to challenge both the majority and dissenting accounts. They contend that both versions help perpetuate the myth that Wall Street was as much a victim of the crisis as anyone else.

One of these sources sent this document in an effort to question the notion that any of the reports coming out of the FCIC were the result of a fact-based investigative process, meaning operating in an objective manner, scouring information to see which theories or storylines seemed most consistent with what had been unearthed. As you will see, he makes clear that he regards all of the FCIC narratives as falling well short in explaining the crisis....

The Commission was able to do comparatively little in the way of forensic work; the bulk of its effort was devoted to the hearings, which delivered relatively little in the way of new insight

As indicated above, the FCIC report is guilty of “drunk under the streetlight” behavior, of trying to fit its story to already known or easily found information. Even though the report makes extensive use of salacious extracts from e-mails, the insiders content that none of these information in these e-mails illuminates information critical to the crisis trajectory.

As a result, the report underplays or completely misses the real drivers of the crisis. Specifically, it gives short shrift to the obvious epicenters:

– How a previously benign securitization process allowed for the creation and sale of bad mortgages on a widespread basis

– How inadequate disclosure as alleged in a number of recently filed big lawsuits allowed mortgage backed bonds that contained many loans that fell below the underwriters’ promised standards to be sold to investors

– How a shadow banking system ballooned with products increasingly based on dubious financial instruments

– How CDOs that were devised by subprime shorts, most importantly the hedge fund Magnetar, drove the demand for the worst sort of subprime loans, extended the toxic phase of the subprime bubble well past its sell-by date

– How the dealer banks knowingly created toxic products, and via flawed risk management processes, allowed traders to retain significant portions of them via strategies that amounted to gaming of the banks’ bonus systems...

As FCIC commissioner Peter Walliston observes:

Like Congress and the Obama administration, the Commission’s majority erred in assuming that it knew the causes of the financial crisis…The Commission did not seriously investigate any other cause and did not effectively connect the factors it investigated to the financial crisis. The majority’s report covers in detail many elements of the economy before the financial crisis that the authors did not like, but generally fails to show how practices that had gone on for many years suddenly caused a worldwide financial crisis. In the end, the majority’s report turned out to be a just-so story about the financial crisis, rather than a report on what caused the financial crisis…..

From the beginning, the Commission’s investigation was limited to validating the standard narrative about the financial crisis—that it was caused by deregulation or lack of regulation, weak risk management, predatory lending, unregulated derivatives, and greed on Wall Street. Other hypotheses were either never considered or were treated only superficially. In criticizing the Commission, this statement is not intended to criticize the staff, who worked diligently and effectively under difficult circumstances and did extraordinarily fine work in the limited areas they were directed to cover. The Commission’s failures were failures of management.

By having the FCIC validate widely accepted, superficial, and ultimately inadequate explanations of the crisis, the Obama administration continues in its policy of looking forward rather than back, when looking back is the foundation of any serious scientific, investigative, or prosecutorial process. The odds are high that the media and the public at large will mistake the extensive use of anecdote in the FCIC report for accuracy and completeness. As with so many accounts of the crisis, the artful use of detail will yet again have the effect of diverting attention from the true drivers of the crisis and thus leave Wall Street free to devise new ways to wreck the economy for fun and profit.

2--Sarkozy mauls JP Morgan's Dimon in Davos brouhaha, Reuters

Excerpt: French President Nicolas Sarkozy clashed with the head of U.S. bank JP Morgan Chase (JPM.N) at the Davos forum on Thursday, telling him bankers had done things which defied common sense....

But when he rose at a later session of the World Economic Forum to ask Sarkozy to get the G20 to avoid overregulation of banks, the French president launched into a broadside accusing financiers of behaviour that he said had caused the crisis.

"The world has paid with tens of millions of unemployed, who were in no way to blame and who paid for everything," Sarkozy said to Dimon. "It caused a lot of anger."... "The world was stupefied to see one of five biggest U.S. banks collapse like a house of cards," he told a plenary session of the Davos Forum.

"We saw that for the last 10 years, major institutions in which we thought we could trust had done things which had nothing to do with simple common sense. That's what happened."

The United States government spent hundred of billions of dollars of public money to bail out financial institutions, after the dramatic failure of Lehman Brothers in 2008, through the controversial Troubled Asset Relief Program (TARP). "Not all banks needed that TARP. Not all banks would have failed," Dimon said at the earlier session. "A lot of banks were stabilising the problem -- JP Morgan bought Bear Stearns because the U.S. asked us to."

However, Federal Reserve Chairman Ben Bernanke told a U.S. investigative panel last year that the credit crisis surpassed the Great Depression of the 1930s in severity and put 12 of the 13 most important U.S. financial firms at risk of failure.

"If you look at the firms that came under pressure in that period ... only one ... was not at serious risk of failure," he said in comments disclosed earlier on Thursday.

"Even Goldman Sachs (GS.N), we thought there was a real chance that they would go under," he said....

Sarkozy said bankers were wrong to resist tough rules. "There is an ocean between flexibility and the scandal we saw," he said. "So if people present me as obsessed with regulation, it's because there is a need for regulation.

"I don't contest the principle of securitisation, but when one offshore country guaranteed 700 times its GDP, are we in the market economy or in a madhouse?"

3--Financial Crisis Inquiry Commission report, Calculated Risk

Excerpt: Here are the conclusions.

• We conclude this financial crisis was avoidable. ...

Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. ... Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner.

The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not.

This is absolutely correct. In 2005 I was calling regulators and I was told they were very concerned - and several people told me confidentially that the political appointees were blocking all efforts to tighten standards - and one person told me "Greenspan is throwing his body in front of all efforts to tighten standards".

• We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis. ...

• We conclude a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis. ...

• We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets. ...

• We conclude there was a systemic breakdown in accountability and ethics....

• We conclude collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis. ...

• We conclude over-the-counter derivatives contributed significantly to this crisis. ...

• We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction." (many mea culpas)

4--Global food prices and inflation targeting, VOX

Excerpt: Rising food prices once again pose central banks a tricky question. How far should they ignore food price inflation? This column suggests that food tends to have stronger predictive power on global inflation cycles than oil. The problem is more severe in emerging markets where consumption basket weights for food are two or three times larger than in rich nations. Central banks should pay close attention....

* Following a steep acceleration initiated last summer, global food prices (as measured by the IMF global food price index) rose by 21% in the year leading up to November 2010 (latest available figure).
* Global average food prices are now back to their pre-crisis peak, despite a collapse in the wake of the 2008/09 financial crisis,

Coupled with the most recent round of weather setbacks and slashes in key crop forecasts worldwide, there is little hope that such inflationary pressures will abate. If anything, the US and EU economic recovery will exacerbate them....

With food typically weighing 20% to 50% in national consumption baskets in developing countries, as opposed to 12% to 15% in core advanced countries (see Table 1), this “decoupling” in the inflation outlook is hardly surprising. But it does not make the issue of global food inflation any less critical looking forward....

every single inflation upturn over the past four decades has been preceded (with a one to two-year lag) by an uptick in world food prices; this causality relation is confirmed by formal econometric tests. To be sure, one could arguably blame such past slippages on the looser monetary regimes of the 1970s and 1980s. Yet, later experience indicates that this transmission mechanism remains quite alive in the more recent era of inflation targeting too....n short, there is substantial evidence – both recent and well-past – that food prices lurk behind large international swings in inflation rates.

5---Rich Rest Up as Markets Forget Crisis Lessons, Susan Antilla, Bloomberg

Excerpt: Investor protection is out. Remember all the talk about making the markets safe for investors? Well, get over it. Dodd-Frank instructed the Securities and Exchange Commission to set up five new offices, including one to handle whistleblower cases, and a committee to represent the interests of investors on issues like fees and disclosure. But on Dec. 2, the agency put those efforts on hold because of “budget uncertainty.”

A frozen budget has also forced the SEC to scale back its plans to get up to speed with the dynamics that resulted in the so-called flash crash on May 6, 2010, when the Dow Jones Industrial Average fell almost 1,000 points in a matter of minutes. The agency had planned to hire five math whizzes acquainted with the sorts of financial algorithms involved in the instant meltdown. Instead, it’s settled for one.

-- Pandering to business is in. Darrell Issa, the car- alarm millionaire twice accused of auto theft (both charges were dropped), and now the California Republican who is chairman of the House Oversight and Government Reform Committee, sent letters to 150 companies and business trade groups in December asking them which regulations and rules might be restraining job growth. He didn’t really have to ask, because we all know that the answer, of course, is: “All of them.”

6---Wage Inflation Rampant In China As More Provinces Plan Minimum Salary Hikes, zero hedge

Excerpt: Several days ago we highlighted that wage inflation in China spreading after Shanghai announced it would hike minimum salaries by 10%. Today, through Global Times we learn that this is just the beginning. Or the continuation rather: it seems that 30 provinces had already hiked minimum wages in 2010: "By the end of 2010, 30 provincial-level regions had raised the standard for the minimum wage, with an average increase of 22.8 percent year-on-year., Yin Chengji, spokesman for the Ministry of Human Resources and Social Security (MHRSS), said Tuesday.

According to him, 29 provinces have issued the guideline for the minimum wages, and the benchmark line grew about 2 percent. In Shanghai, the local minimum wage was the highest nationwide, totaling 1,120 yuan ($170.2) per month." And 2011 will be even worse: " Also, according to a China Business News (CBN) report Tuesday, in 2011, many areas would continue to raise the standard. A Xinhua News Agency report Wednesday revealed that northern Chinese city of Tianjin is considering raising the minimum working wage by 16 percent this year amid rising inflationary pressure and labor shortages." We are confident America's workers will be delighted to know that Bernanke's massively destructive monetary policies are finally resulting in higher salaries... In China. But wait: this also means US consumer purchasing power is about collapse as since very soon all imported Made in China trinkets are about to get far more expensive as already razor thin margined China producers scramble to raise costs to their primary export market.

7---Banking `Toxic Cocktail' Is Too Big to Forget: Simon Johnson, Bloomberg

Excerpt: ...the very effectiveness of Treasury actions and statements in late 2008 and early 2009 had undeniable side effects, “by effectively guaranteeing these institutions against failure, they encouraged future high-risk behavior by insulating the risk-takers who had profited so greatly in the run-up to the crisis from the consequences of failure.”

And this encouragement isn’t abstract or hard to quantify. It gives “an unwarranted competitive advantage, in the form of enhanced credit ratings and access to cheaper capital and credit, to institutions perceived by the market as having an implicit Government guarantee.”

Of course, the Dodd-Frank financial-reform legislation was supposed to end too big to fail in some meaningful sense. But Barofsky is skeptical -- and with good reason. Our largest banks are now bigger, in dollar terms, relative to the financial system, and relative to the economy, than they were before 2008. So how does that make it easier to let them fail?

Big Gets Bigger

At the end of the third quarter of 2010, by my calculation, the assets of our largest six bank holding companies were valued at about 64 percent of gross domestic product -- compared with about 56 percent before the crisis and about 15 percent in 1995. Barofsky quotes Thomas Hoenig, president of the Kansas City Federal Reserve, who uses similar numbers and draws the same conclusion: The big banks have undoubtedly become bigger.

8----Fed Watch: The “Recalculating” Debate, Tim Duy, via Economist's View

Excerpt: Supporting sufficient aggregate demand to maintain full employment looks to have required supporting relative levels of net worth well above a decades-long baseline. And pushing net worth to those levels was a consequence of asset price bubbles. Hence, it appears that the demand generated by that wealth was “fake.” Moreover, that “fake” demand arguably induced a supply side effect by pushing capital first into information technology and then into housing. To be sure, ultimately the impacts of such capital misallocations will fade away. Information technology depreciated rapidly, and the excess housing stock will eventually be absorbed by a growing population. It is not quite obvious, however, why this adjustment needs to extend to such a large portion of the workforce. The answer, I think, is not the housing adjustment itself, but the loss of general demand precipitated by the housing decline and subsequent balance sheet malaise.

The wealth-supported demand surely was not “fake,” as real goods and services were indeed purchased. But it was ephemeral, evaporating with the popping of bubbles. So it should be of little surprise the Federal Reserve is viewed by some as doing nothing more than supporting another round of “fake” demand. Fed officials probably compound this problem by citing the stock market increase as evidence that QE2 is working. Via the Wall Street Journal:

In recent weeks, the Federal Reserve has been turning to an unusual metric to prove the potency of its bond-buying program: the stock market.

Comments from Fed Chairman Ben Bernanke and other officials, as well as research by the central bank, cite rising stock prices as a sign that the central bank’s $600 billion bond-buying program is working to bolster the economy.

Of course, it is perfectly reasonable for officials to note that high equity prices signal improving economic prospects, the latter a consequence of their policy stance. Some, however, may interpret this as further evidence that the Fed is simply trying to create another asset price bubble, which will, if history is any guide, will also prove to be fleeting. The resulting aggregate demand will then be viewed as “fake.” In this light, the Federal Reserve is not really fixing anything, just papering over the underlying problem.

9--Stop the Austerity Craze, Mark Ames,

Excerpt: Now, at last, the same austerity programs that have led to massacres, wars, pain and catastrophe all over the world are finally coming home to the very people and country they were intended to poison all along.

Why now, you ask? Why, after all the economic destruction and inequality that resulted from decades of deregulation, privatization, slashing taxes on the rich, and relentless bashing of evil big-government—why would we adopt a far more purified, radical version of the same disastrous free-market program? Why would we have to take more pain medicine from the same people who already poisoned us?

Simple: Because we’re weakened from having our wells poisoned by free-market, libertarian ideology over the past three decades. We’re weaker, poorer, we’ve turned against the unions and the government, the only two potential sources of counter-power to billionaires and corporations — what predator wouldn’t move in for the kill at this very moment? Now’s the perfect time to take everything that Austrian economics has to offer to its practitioners. Plundering the weak and shooting them in their heads when they resist — that’s the definition of courage to America’s degenerate ruling class.

10---New-home sales in 2010 fall to lowest in 47 years, AP via

Excerpt: Buyers purchased the fewest number of new homes last year on records going back 47 years.

Sales for all of 2010 totaled 321,000, a drop of 14.4 percent from the 375,000 homes sold in 2009, the Commerce Department said Wednesday. It was the fifth consecutive year that sales have declined after hitting record highs for the five previous years when the housing market was booming.

.... economists say it could be years before sales rise to a healthy rate of 600,000 units a year.

"The percentage rise in sales looks impressive but 10 percent of next-to-nothing is still next-to-nothing," said Ian Shepherdson, chief U.S. economist at High Frequency Economics, referencing the December increase. "New home sales are bouncing around the bottom and we see no clear upward trend in the data yet."

11-- Ian Fraser: Is the House of Lords’ Crisis Inquiry Putting the FCIC to Shame?
Naked Capitalism

Excerpt: The many inquiries into the financial crisis have turned over plenty of stones but have failed to find any smoking guns. But the House of Lords economic affairs committee’s inquiry “Auditors: market concentration and their role” is making strides in identifying and maybe rooting out the accounting shenanigans that lay at the heart of the crisis.

At a recent session of the HoL inquiry, UK-based investors said that IFRS (international financial reporting standards) had encouraged imprudent, reckless and even illegal behavior by UK and Irish banks, enabling them to deceive investors, boost executive bonuses and ultimately destroy their institutions at taxpayers’ expense. (See text pages 72-73 of this report for a fuller explanation of the shortcomings of IFRS)

The investors told the Lords – who included the former UK chancellor Lord Lawson – that IFRS had enabled bank boards and auditors to present their institutions as massively profitable, when in fact they were barely profitable or even loss-making — and all in ways that auditors could invariably claim “complied with the standards”.

In turn this enabled the banks to make imprudent payouts to executives (in the shape of bonuses) and to shareholders (in the shape of dividends) which in truth they could not afford to make.....IFRS’s biggest flaw, however, is that it gave bank managements and their auditors too much latitude in the valuation of assets, which in the upcycle created an illusion of capital strength and egged managements to indulge in more and more poor quality lending, creating a Ponzi-like scenario in the frothiest market sectors. It also enabled bank managements to make ludicrously low provisions for bad debts.

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