What Does Regulation Regulate?
Here’s one of the simple truisms that gets lost in the political (i.e., bumper sticker) discussions.
Don’t regulate the free markets! Don’t interfere with innovation! Don’t stifle incentives!
WAPO: Treasury Illegally Repeals Tax Law
We learn from WaPo that the Treasury Department slipped through a $140 billion tax windfall to US banks -- in theory repealing 1986 legislation, passed by Congress and signed by President Reagan.
The likely illegal change was aggressively lobbied for by banking officials, who sought to take advantage of the market turmoil and credit crisis.This is an ongoing issue we have witnessed in every prior bailout: Opportunism knows no sense of decency.
Private Sector Loan Losses vs Fannie/Freddie
Joe Kernan on CNBC continues to get this not just a little bit wrong, but terribly, horribly, mind numbingly wrong.
His favorite NYT article comes form 1999 (he referenced it again this morning). This piece has become a right wing meme: Fannie Mae Eases Credit To Aid Mortgage Lending. The article discusses a 24 bank, 15 market pilot program -- teeny tiny in the overall total mortgage market -- as if its the Rosetta stone of Housing/Credit crisis.
The article states that "banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans." It was the lenders themselves who were pressing the GSEs to buy these loans. The private sector lenders were pursuing this market due to fatter potential profits -- not Fannie and Freddie.
These facts don't stop the pundits; nor does an apparent lack of understanding of the actual causes of the housing boom/bust and the credit crisis. Their cognitive dissonance has also prevented them from acknowledging the role deregulation had in these events.
Some people actually look at the data, while others foolishly parrot talking points. Consider this Federal Reserve Board data, compiled by McClathcy. It shows that:
- More than 84% of the subprime mortgages in 2006 were issued by private lending institutions.
- Private firms made nearly 83% of the subprime loans to low- and moderate-income borrowers that year.
- Only one of the top 25 subprime lenders in 2006 was directly subject to the CRA;
- Only commercial banks and thrifts must follow CRA rules. The investment banks don't, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans.
- Mortgage brokers, who also weren't subject to federal regulation or the CRA, originated most of the subprime loans.
The "Blame Fannie/Freddie/CRA" crowd, do provide a service: I know anyone who repeats this meme is an empty headed parrot, a mindless drone without an ability to think. This is a huge timesaver, as it has allowed me to dismiss many of the ditto heads I might have otherwise wasted time on.
So whoever came up with this silly talking point, despite your lack of concern for facts and your attempts at muddying the waters -- thanks! You've saved me an enormous amount of time in identifying people not to bother reading, and to ignore.
Hat tip Econbrowser
Private sector loans, not Fannie or Freddie, triggered crisis
David Goldstein and Kevin G. Hall |
McClatchy Newspapers October 12, 2008
S&P: We Knew Nothing! Nothing!
Repeat that headline in your best Sergeant Schultz voice for maximum effect. Then read the testimony of Deven Sharma, President of Standard & Poors in the same voice:
S&P is not alone in having been taken by surprise by the extreme decline in the housing and mortgage markets. Virtually no one -- be they homeowners, financial institutions, rating agencies, regulators, or investors -- anticipated what is occurring. Although we highlighted to investors looming issues we saw in the housing market as far back as early 2006, the reality remains that in publishing our initial ratings on many of these securities we never expected such severe, negative performance in the housing and mortgage markets. There is no doubt that had we anticipated the extraordinary events that have occurred -- and we did not -- we would have utilized different economic forecasts and would not have assigned many of the original ratings that we did . . . (emphasis added)
You decide: Perjury, or mere ignorance?
A significant number of economists, strategists, academics and blogs all forecast the housing disaster way way in advance. Not only me, but Nouriel Roubini, and James Grant and John Paulson and Jim Rogers and Peter Schiff, and lots of sites: Calculated Risk and The Mess that Greenspan Made and ML-Implode and Mish and Housing Doom and NJ Real Estate Report and iTulip, and, well, you get the idea.
But it turns out that two S&P analysts, April 2007, via an IM conversation, were also discussing it:
Rahul Dilip Shah: btw: that deal is ridiculous
Shannon Mooney: I know right ... model def does not capture half of the risk
Rahul Dilip Shah: we should not be rating it
Shannon Mooney: we rate every deal
Shannon Mooney: it could be structured by cows and we would rate it
IM Conversation via House Oversight Committee
TESTIMONY OF DEVEN SHARMA, PRESIDENT, STANDARD & POOR’S
BEFORE THE COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM UNITED STATES HOUSE OF REPRESENTATIVES
OCTOBER 22, 2008
Ratings agencies 'put system at risk,' CEO says
Testimony shows watchdogs were 'Kool-Aid drinking' lapdogs
MarketWatch 5:19 p.m. EDT Oct. 22, 2008
Credit Rating Agency Heads Grilled by Lawmakers
NYT, October 22, 2008
Is Wells Fargo "Sugarcoating" Balance Sheet?
NY Post quotes a trader fearful of SEC reprisal on
When Wells Fargo reported third-quarter earnings last week - which beat Wall Street expectations by a few pennies - investors cheered, and watched the bank's shares keep most of the 9 percent gain they had pocketed the previous day.
But banking and mortgage-sector analysts cast a wary eye on the San Francisco-based bank. That's because Wells Fargo, despite booking a near $1 billion increase in non-performing loans in the third quarter compared to the previous three-month period, cut its loan-loss reserve by $500 million. The slick accounting moves, while perfectly legal, gave a false impression of just how strong Wells Fargo's balance sheet actually was, the analysts said in separate interviews and reports last week.
"Wells Fargo are pretenders," said a trader at one top hedge fund, who spoke on condition of anonymity because he is afraid of trouble from the Securities and Exchange Commission, in light of the regulatory body's recent threat to prosecute short sellers.
The trader said trimming the loan-loss reserves had the effect of boosting profits, which in turn boosted its share price, which in turn made it easier for the bank to successfully move forward with a move it announced this week to raise $20 billion of capital."
Note that earlier this year, Wells Fargo increased its definition of non performing loans, from 120 delinquent to 180 days. This made their balance sheet appear stronger than it was.
Analysts fearful of SEC reprisal for doing analysis -- that is the net result of the ruinous tenure of the worst SEC chair in decades -- Christopher Cox.
click for larger graphic:
THE PRETENDERS: ANALYSTS SAY WELLS FARGO SUGARCOATS BALANCE SHEET
NYPost, October 19, 2008 4:00 am
The Invisible Man
SEC Chairman Cox has often been missing in action during the financial crisis, even while Treasury Secretary Paulson and Fed Chairman Bernanke tread on his turf
Jesse Westbrook and Robert Schmidt
Bloomberg Markets, November 2008
There is a terrific opinion piece in the Sunday Washington Post, titled Bad Medicine that is your MSM Saturday morning reading for the day.
Its by James Grant, purveyor of the Grant's Interest Rate Observer.
While some folks (myself and Nouriel Roubini and Jimmie Rogers and Mark Faber) have been warning about Housing and Credit for two or three years, Grant has been warning that this crack up was the inevitable result of Greenspan's easy money policies for at least decade.
Here's his take:
"Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes. The unifying theme of the new bailout bill, all 451 pages of it, is the hair of the dog that bit you.
The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are "upside down," as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards.
But inflation and debasement are the very policies being put in place. The Federal Reserve, not waiting for Congress, embarked last month on a radical program of money-printing. Reserve Bank credit -- the raw material of bank lending -- is growing at the year-over-year rate of 61 percent.
Credit creation is the Fed's signature crisis-management policy: Let a bubble inflate, then watch it burst; clean up with lots of dollar bills. After the stock market broke in 2000, then-Fed Chairman Alan Greenspan set about easing policy. In company with Fed Governor Ben S. Bernanke, the man who wound up succeeding him, Greenspan warned against "deflation." He vowed that this country would not sleepwalk through a decade of falling prices, as Japan had done. Rather, the Fed would push interest rates low enough to jolt the U.S. economy back into prosperity."
I'll bet being right is small consolation for him . . .
Washington Post, October 5, 2008; Page B07
Quote of the Day: Fair Value Accounting
"In reality, however, fair value and mark-to-market have little to do with what is happening. It is companies' refusal to properly and clearly value their assets that's getting them in trouble...
"The Citigroup-Wachovia deal is the latest example of that. Citigroup agreed Tuesday to buy Wachovia's banking operations, the bulk of the company, for $2.16 billion plus the assumption of debt. That's a shockingly cheap price for a company with a book value - assets minus liabilities - of $75.1 billion...
"Which means either that Citi got an unprecedented bargain, or that Citi and the market didn't believe that the values Wachovia placed on its assets were realistic."
>-Michael Rapoport, Dow Jones
Floyd Norris asks, "Wachovia went out with a book value of $75 billion. Citi paid $2 billion. Could it be that asset values are overstated, not understated?"
Gee, I dunno. Better obscure them as soon as possible . . .
Lying Bank Accounting
September 30, 2008, 1:37 pm
Understanding the Significance of Mark-to-Market Accounting
"Suspending mark-to-market accounting, in essence, suspends reality."
-Beth Brooke, global vice chair, at Ernst & Young
Misinformation, bad dope, and spin seem to be dominating the current discussion on Mark-to-Market accounting. Let's see if we cannot simplify the arcane complexity of the accounting rules regarding FASB 157.
Understand why this is even an issue: Many banks, brokers, and funds chose to invest in certain "financial products" that were difficult to value and were at times thinly traded. If you are looking for the underlying cause of why some arcane accounting rule is an issue, this is it.
In my office, we don't buy our clients beanie babies or Star Wars collectibles or 1964 Ferrari 275GTBs. We purchase stocks and ETFs and bonds and preferreds for them (some clients also own options and commodities). Why? Because we believe -- and our clients have insisted upon -- the need for instant liquidity. Nothing we have purchased cannot be liquidated on a moments notice. We know what the fair value of these holdings are second by second.
While we may have been tempted by potential greater returns that some of these other products offered, we simply could not justify the risk of owning hard to value, thinly traded, hard to sell items. And, we never had to rely on the models of the individuals who created and sold us these products in the first place, to determine an actual price. If ever a product was rife with self-interested conflicts of interest, this one is it.
That is one of the key elements of the current situation. A decision was made to bypass the broad, deeply traded traditional markets (Equities, Fixed Income, Commodities and Currency) and instead create new markets for new products. No one should be surprised that the net result was a flawed system of garbage paper, with too little room at the exits in case of emergency.
Let's puts this into some context:
"Accounting is a way of portioning economic results by time periods. It doesn’t affect the cash flows, but tries to allocate economic profits proportional to release from risk. If we were back in an era where the financial instruments were simple, then the old rules would work. But once you introduce derivatives, and securities that are called bonds, but are more akin to equity interests, you need to mark them to market."
Exactly. Otherwise, you are left with public companies, who have made capital allocation and investment decisions that are hidden from their owners (shareholders) and the investing public.
Now that the garbage is on the books, no one wants to admit the original error of purchasing this class of assets. Its not just that the trade has gone bad, its the original buying decision was so flawed even if the trades were not such giant losers.
Recent actions of corporate titans in the financial sector are essentially an admission that their business model was deeply flawed. No one would invest any capital for a ROI of 50 bps per year. They of course knew this -- so they leveraged up that 50 bps 35X or so, creating the false appearance of more attractive returns. This higher risk, potentially higher return paper was part of that misleading process.
Suspending FASB 157 amounts to little more than an attempt to hide this broken business model from investors, regulators and the public. Its not just getting through the next few quarters that matters; Rather, its allowing the market place to appropriately reallocate this capital to where it will serve its investors best. That is what free market capitalism is, including Schumpeter's creative destruction. (A WSJ OpEd today get this issue precisely wrong).
I have been steadfast over the past 2 years about why I did not want to own any of the financials that held this paper on its books. The key was that we could not figure out what the liabilities were relative to the assets. That is investing 101.
If FASB 157 is suspended, I would advise our clients and the investing public that owning any financials that failed to disclose their holdings accurately were no longer investments -- they were pure speculations, with more in common to spinning a roulette wheel than owning Berkshire Hathaway (BRK) or Apple (AAPL) or Google (GOOG). Indeed, I know of no faster way to end up on the DO NOT OWN list than to hide from your shareholders what is on your books.
If investors cannot trust the valuations of what is on a firms books, they simply cannot invest in these firms PERIOD.
There are other alternatives for the institutions that now must deal with this discounted, thinly traded hard to value junk paper. They can sell it for whatever price a the market will bear, they can spin it off into a separate holding company, they can write it down to zero and reap the rewards of mark ups in future quarters.
But suspending the proper accounting of this paper is the refuge of cowards. It reflects a refusal to admit the original error, it hides the mistake, and it misleads shareholders. I find it to be totally unacceptable solution to the current crisis.
As Japan learned, not taking the write downs only delays the day of reckoning. They propped up insolvent banks, and suffered a decade long recession for it. That way disaster lay . . .
S&P500 ex-Risk ? (November 06, 2007)
Summary of Statement No. 157
Fair Value Measurements
Auditors Resist Effort To Change Mark-to-Market
WSJ, SEPTEMBER 30, 2008, 4:29 P.M. ET
What part of mark-to-market don't you understand?
Time's Curious Capitalist, September 30, 2008 8:17
SEC, FASB Resist Calls to Suspend Fair-Value Rules
Bloomberg, Sept. 30 2008
How to Start the Healing Now
Fix accounting rules and private money will come.
WSJ, OCTOBER 1, 2008
Fair-Value Accounting & FASB 157
"Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.''
-Dane Mott , JPMorgan Chase & Co.
Banks don't want to lend to each other because they are not sure how much explosive dreck is in the other guy's balance sheet. Hiding the junk isn't going to help this at all . . .
"The U.S. Securities and Exchange Commission probably will resist calls to suspend the fair-value accounting rules that some members of Congress blame for exacerbating the global financial crisis, people familiar with the matter said.
The SEC and Financial Accounting Standards Board today issued "clarifications'' on how banks should interpret existing rules requiring them to review assets each quarter and report losses if values decline. A moratorium isn't being considered, said the people, who declined to be identified because the plan hasn't been completed.
Congressmen, banking lobbyists and companies including American International Group Inc. have urged the SEC to suspend fair-value accounting, saying it forces firms to report losses they never expect to incur. Federal Reserve Chairman Ben S. Bernanke and other proponents say removing the rule would erode confidence that firms are owning up to losses."
I don't see how transparency and accurately reporting investment holdings works against investors. I can see how allowing banks to hide this junk might prevent them from lending to each other.
SEC, FASB Resist Calls to Suspend Fair-Value Rules
Bloomberg, Sept. 30 2008
Summary of Statement No. 157
Fair Value Measurements
SEC: Less Personnel Than the Smithsonian
These are some truly amazing details:
"The number of enforcement personnel, the people who go after the financial engineers, is expected to decline. That's right. Despite the trillion-dollar meltdown now underway, the number of SEC enforcement personnel will decline from 1,209 this year to 1,177 in 2009. In all, the SEC expects to have 3,771 employees next year. For comparison, the Smithsonian Institution budget for 2009 includes funding for 4,324 employees.
That's not meant as a slap at the Smithsonian. It houses a myriad of the nation's most treasured objects. But the SEC actually guards the nation's treasure. And yet, Congress treats it like a bastard stepchild. Indeed, Congress doles out more than five times as much money for corn subsidies ($4.9 billion in 2006, the most recent year for which data are available) as it does for the SEC.
Those pitiful numbers lead us to the innumerable problems posed by derivatives, the same financial instruments that led to the chaos at Enron, which before it failed operated a huge—and almost completely unregulated—derivatives exchange business. According to the Bank for International Settlements, the global derivatives market is now worth some $676.5 trillion. That's $676,500,000,000,000. That's a fivefold increase over the value of derivatives that were traded in 2003. Further, that $676.5 trillion is 51 times America's current gross domestic product. (emphasis added)
Gee, how on earth did the 3 million people working in the finance industry ever mange to get away with anything with that type of police enforcement?
From Enron to the Financial Crisis (with Greenspan in Between)
US News, September 24, 2008