Tuesday, November 29, 2011
The deal was agreed to earlier this year, after the SEC accused the New York company of selling investors slices of a $1 billion mortgage-bond deal called Class V Funding III, without disclosing it was betting against $500 million of those assets. Judge Rakoff, a vocal critic of SEC settlements, dismissed the . . . penalty Citi agreed to pay as 'pocket change' for a firm of its size."
In 2009, as detailed by Professor Joseph Grant previously on this blog, Judge Rakoff rejected a settlement between the SEC and Bank of America for its allegedly fraudulent activities leading up to the mortgage meltdown. In both instances, Judge Rakoff indicated in his rulings that the public was not being protected by these settlements and that the SEC was failing to uncover the truth behind each companies role in the financial crisis.
CNN reports: "Judge Jed Rakoff said that the settlement announced last month, under which Citi neither admitted nor denied the SEC's allegations, deprived the public 'of ever knowing the truth in a matter of obvious public importance.' He instead ordered Citi to face trial over the allegations in July 2012. '[I]n any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth,' Rakoff, a U.S. district judge in Manhattan, wrote in his decision."
In both the Bank of America settlement and the proposed Citigroup settlement, Judge Rakoff has chided the SEC for failing to protect the public by entering into "pocket change" settlements where the firms refuse to take responsibility for the alleged fraudulent activity.
In the case of Citigroup, the SEC alleged that Citi created and sold a collateralized debt obligation (CDO) consisting of securitized subprime mortgages that was described by its own traders and employees as an asset group that was "a collection of dogshit" and in other internal documents as "possibly the best short EVER!" However, in Citi's marketing material, the CDO was referred to as "an attractive investment rigorously selected by an independent investment adviser." After marketing the CDO as attractive, Citi then took a short position against the offering and as the housing market deteriorated, brought in a net profit of $160 million while investors lost more than $700 million on the CDO.
This allegation is similar to the one that Goldman Sachs was accused of and settled previously, in a settlement that gained the approval of Judge Rakoff.
Friday, November 25, 2011
Things similarly darkened in Spain this week. As the chart at right shows, Spanish 10 year bonds now yield 6.7 percent. Spain too now pays more to rollover its debt than Greece and the market issued a negative verdict on Spanish austerity this week:
"Bond market investors have given Spain no relief despite the election victory on Sunday of Mariano Rajoy, the centre-right Popular party leader who has pledged further austerity and economic reforms once he becomes prime minister in December."
Meanwhile, the contagion from the debt problems in southern Europe has now gone viral. S&P downgraded Belgium today due to political instability and the lack of growth throughout the Eurozone. French debt yields are now surging with the expectation of a imminent downgrade. Hungary solicited an IMF bailout and was downgraded to junk yesterday. Fitch downgraded Portugal to junk. And, perhaps most ominously, Germany (yes, Germany), suffered a failed bond auction, and the Bundesbank had to step in and buy 39 percent of the bonds offered. Suddenly, pundits are discussing the possibility of a German downgrade.
A fairly horrendous week, by any standard. The market reaction confirms this. The Euro sits at a seven week low. The European stock market now has lost over 30 percent in the last six months. Over the same period, US financials are down 25 percent. Over the last two weeks, the Dow is down 7.6 percent and the S&P 500 is down 7.9 percent in just the last seven sessions. Due to the exposure of our banks to Eurozone debt and to European banks (almost $ 2 trillion), the US cannot survive a European collapse unscathed. Think MF Global times 100.
Over the next few weeks I will explain how we got into this mess, and how the Eurozone cratered. For Europe the story is excess current account imbalances and the failure of austerity as a means of addressing a debt crisis. For the US it boils down to the failure of Dodd-Frank to change any of the following:
1) Derivatives deregulation that allowed global financial institutions to manipulate the system for their personal profit;
2) Corporate governance law and regulation that continues to permit CEOs to impose huge risks upon their firms in pursuit of short term bonuses;
3) The failure to limit excess leverage in the financial sector and thus excess risk;
4) The failure to end Too-Big-to-Fail which leads to excess risk in the financial sector and excess debt in the government sector, while limiting growth;
5) The failure to institutionalize fiscal policy in an economically rational way to limit excess debt while maximizing growth.
Tuesday, November 22, 2011
MF Global's CEO Jon Corzine, former CEO of Goldman Sachs as well as former governor and Senator from New Jersey, expanded the companies reach in recent years from its brokerage base by making an aggressive move into proprietary trading. Many believe that this move into proprietary trading spelled its downfall.
According to Eric Lewis writing for CNN: "MF Global's Company Overview and Financial Overview, both dated October 2011, tell a story quite different from that of a company about to plunge into insolvency. At the end of September, it touted $41.05 billion in net assets, $3.7 billion in available liquidity and $2.5 billion in total capital. It was able to sell $325 million in unsecured notes in August. It claimed 'solid risk management,' a 'strong capital position,' 'strong liquidity' and an 'extremely liquid and high quality balance sheet.'
Its balance sheet was huge but terribly fragile. While it had lots of assets on its books, it also had a huge amount of borrowing. For every dollar of its own capital on its books, it had borrowed $40, a leverage even greater than that of Lehman Brothers at the time of its collapse.
Why is that a problem in a time when near-zero interest rates extend as far as the eye can see? Because leverage is always treacherous and 40-to-1 leverage is madness. Even when interest rates are low, lenders demand security. When the value of that security goes down, the demand for margin -- additional collateral to secure the debt -- goes up."
Lewis argues that too-tepid "leverage requirements" in the wake of Dodd-Frank are to blame for MF Global's downfall. "Many will view the demise of MF Capital as just another bit of the 'creative destruction' of capitalism. The Republican candidates complain that Dodd-Frank, last year's financial reform bill passed in response to the credit crisis, is stifling healthy risk-taking. The reality is that Dodd-Frank does not do enough to prevent financial institutions from taking excessive risks with investors' money. While it imposes leverage requirements on banks, those requirements are still quite limited, and institutions not regulated by federal banking agencies are not restricted in their risk-taking in any meaningful way."
As described, Corzine and his traders made very aggressive bets on European debt which would have resulted in spectacular profits had the bonds moved favorably for MF Global, even just slightly. They did not. As Lewis concludes: "Leverage is the steroid of modern finance that creates the hazardous incentives to bet big, keep the winnings and dump the losses onto others. What MF Global shows is that the problem is not too much regulation but too little. Without meaningful leverage restrictions on borrowers and meaningful lending restrictions on those who are willing to underwrite this steroidal debt expansion, MF Global is likely to be the tip of yet another iceberg. And we have yet to recover from the last financial Titanic."
Finally, as reported by Leah McGrath Goodman for CNN/Money yesterday, the MF Global mess keeps getting messier as the bankruptcy trustee announced perhaps as much as $1.2 billion may be missing from customer's accounts, indicating potential misappropriation.
Thursday, November 17, 2011
Harcourt's thesis perfectly situates the failed American War on Drugs. The explosive rise in mass incarceration in the United States over the past 25 years (imprisonment increase of 335% as a result of the War on Drugs) occurred when the presidential administrations of Reagan, Bush Sr., Clinton and Bush Jr. simultaneously worked tirelessly to deregulate the U.S. capital markets. Free market advocacy and deregulation have been occurring at exactly the same time that prison rates and populations have been skyrocketing. Harcourt describes how this is not just an American anomaly, but is a global historical reality.
The question that this historical reality begs is why? Why during eras of powerful free market advocacy do governments' radically imprison their own citizens?
From the front flap of The Illusion of Free Markets: "It is widely believed today that the free market is the best mechanism ever invented to efficiently allocate resources in society. Just as fundamental as faith in the free market is the belief that government has a legitimate and competent role in policing and the punishment arena. This curious incendiary combination of free market efficiency and the Big Brother state has become seemingly obvious, but it hinges on the illusion of a supposedly natural order in the economic realm. The Illusion of Free Markets argues that our faith in 'free markets' has severely distorted American politics and punishment practices.
Harcourt traces the birth of the idea of natural order to eighteenth-century economic thought and reveals its gradual evolution through the Chicago School of economics and ultimately into today’s myth of the free market. The modern category of 'liberty' emerged in reaction to an earlier, integrated vision of punishment and public economy, known in the eighteenth century as 'police.' This development shaped the dominant belief today that competitive markets are inherently efficient and should be sharply demarcated from a government-run penal sphere.This modern vision rests on a simple but devastating illusion. Superimposing the political categories of 'freedom' or 'discipline' on forms of market organization has the unfortunate effect of obscuring rather than enlightening. It obscures by making both the free market and the prison system seem natural and necessary. In the process, it facilitated the birth of the penitentiary system in the nineteenth century and its ultimate culmination into mass incarceration today."
Monday, November 14, 2011
Nobel laureate Paul Krugman of The New York Times opines that, even though the Occupy Wall Street movement is correctly portraying the wealth disparity in a 99% to 1% disparity, wealth concentration in the top 1% is misleading, it is more like the top thousandth (0.01%) of Americans who are seeing their income rise exponentially. From 1979 to 2005, this group, the 0.01%, which includes Wall Street executives, saw an income increase of more than 400 percent! With such a concentration of wealth in a tiny number of a select few, Krugman argues that democracy in America is becoming nothing more than a façade. The American oligarchy is growing more wealthy and influential, leaving behind most of America, and thus, threatening America’s real democracy.
Cross-posted on the Salt Law Blog
Friday, November 11, 2011
This cash from the proposed settlement would be split in the following way: $750 million to the federal government, $90 million to state bank regulators, and $60 million each to the roughly forty-five participating states, and the remainder of the $25 billion would be part of loan modifications, consisting of credits to banks for reducing the principal owed on mortgages that they own or service for private investors. Nevertheless, if past settlements and loan modifications are any indication, borrowers will not be seeing much relief. For this reason, the Attorney General's from New York, Delaware, and California have withdrawn from participation in these settlement talks.
Wednesday, November 9, 2011
Here is a canvas of expert opinion:
Alistair Darling, Former UK Chancellor of the Exchequer: “I despair of the way in which EU leaders are constantly behind events. I do not think enough people realise how serious this crisis is, and how hard it is going to hit us. This is far worse than the banking crisis of 2008.”
Paul Krugman, Noble Prize Winning Economist: "I believe that the ECB rate hike earlier this year will go down in history as a classic example of policy idiocy. We would probably still be in this mess even if the ECB hadn’t raised rates, but the sheer stupidity of obsessing over inflation when the euro was obviously at risk boggles the mind. I still find it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure. Irresistible force, meet immovable object — and watch the explosion."
Jim Rogers, legendary hedge fund manager: "We're certainly going to have more crises coming out of Europe and America; the world is in trouble. The world has been spending staggering amounts of money that it doesn't have for a few decades now, and it's all coming home to roost now. Last time, America quadrupled its debt. The system is much more extended now, and America cannot quadruple its debt again. Greece cannot double its debt again. The next time around is going to be much worse. In 2002 it was bad, in 2008 it was worse and 2012 or 2013 is going to be worse still – be careful."
Jeremy Warner, business columnist for the London Telegraph: "[UK] Treasury analysis points to negative consequences for the UK from a disorderly break-up of the euro, with economic contraction and financial chaos at least as bad as that which followed the Lehman Brothers collapse three years ago.With the Government’s deficit reduction strategy in ruins, interest rates would soar, condemning the UK to the sort of disastrous debt dynamics which have engulfed Italy. The whole of Europe would soon slip into prolonged depression. The UK economy may already be in some form of renewed recession and a eurozone breakdown would multiply its effects. But despite the threats posed, there is still very little sign of the eurozone adopting the policies necessary to save the single currency. As recently as last July, the ECB was still raising interest rates, greatly exacerbating a serious economic slowdown outside its doors. Even if the euro survives, the austerity imposed on the eurozone periphery will deny growth and could condemn the single currency area to years of stagnation or worse."
Simon Johnson, MIT economist and former IMF Chief Economist: "We have built a dangerous financial system in the United States and Europe. We must step back and reform the system. Like 1931, people thought the worst was behind them, but instead the crisis just broadened. The last crisis cost 50% of GDP and involved the socialization of losses but even that has failed to address the fundamental issues. We are looking straight into the face of a great depression.”
Brad Delong, UCal Economist and former Treasury Official: "Time to spread foam on the runway: The Federal Reserve needs to act Now to firewall off the Eurocrisis. I have been complaining for some time now that Reinhart and Rogoff think that the time is always 1931 and that we are always Austria--that the great fiscal crisis is about to erupt and send us lurching down toward Great Depression II. Well, right now guess what? The time is 1931, and we are Austria. The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip. The Federal Reserve needs to do so now."
Christine Lagarde, Managing Director of the IMF: "There are clearly clouds on the horizon. Clouds on the horizon particularly in the advanced economies and particularly so in the EU and the United States. Our sense is that if we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand. We could run the risk of what some commentators are already calling the lost decade."
From The Economist: "I have been examining and re-examining the situation, trying to find the potential happy ending. It isn't there. The euro zone is in a death spiral. Markets are abandoning the periphery, including Italy, which is the world's eighth largest economy and third largest bond market. This is triggering margin calls and leading banks to pull credit from the European market. This, in turn, is damaging the European economy, which is already being squeezed by the austerity programmes adopted in every large euro-zone economy. A weakening economy will damage revenues, undermining efforts at fiscal consolidation, further driving away investors and potentially triggering more austerity. The cycle will continue until something breaks. Eventually, one economy or another will face a true bank run and severe capital flight and will be forced to adopt capital controls. At that point, it will effectively be out of the euro area. What happens next isn't clear, but it's unlikely to be pretty."
Ok, that is all pretty grim. But I worry things may still darken more. France is now seeing a rise in its cost of borrowing, and French financial strength is the only hope for any solution at this point. And, Spain now appears to be worsening too. Also, the margin required to hold Italian debt was increased so if investors want to continue to hold (or buy) Italian debt they need to pony up more cash. Imagine that, paying for the right to get hammered on an investment. Last, but not least, Germany and France are now openly discussing the break-up of the Eurozone, under something called "two-speed Europe." Yikes!
On a more happy note: tomorrow must be better than today. Right?
Tuesday, November 8, 2011
While Goldman Sachs has responded that it “acted appropriately and refute[s]” any indication of false misrepresentation, the complaint alleges that Goldman pushed a strategy to invest in its subprime residential home mortgage-based vehicles—Point Pleasant and Timberwolf, which were specifically manufactured to perform poorly. In light of a U.S. Senate report in April 2011, the allegations (and the report) claim that Goldman Sachs was touting these products, even though it expected them to fail. According to Basis Capital, these products ended as toxic inventory, and consequently, brought down their $1 billion hedge fund with it.
Sunday, November 6, 2011
Therefore, I anxiously await the response to the following: the real culprits have already fessed up to (or at least paid for) monumental frauds of unprecedented audacity and scale in the subprime market. And, Fannie and Freddie played zero role in this story. A massive number of real estate loans were made with the specific intent of default (i.e. the ultimate in predatory lending) so that Wall Street could make a killing (killing American capitalism for their enrichment) on undisclosed short positions on subprime assets they selected for portfolios that they then foisted on investors across the globe. THEY DEMANDED LOAN DEFAULTS! Wall Street literally loaded up mortgage backed securities (in the form of collateralized debt obligations or CDOs) with the riskiest loans possible so they could cash in on their secret short positions on the very securities they were selling to firm clients.
So, Goldman Sachs paid an all time record $550 million to settle charges that it marketed securities based upon subprime loans without disclosing that a hedge fund was short those very same securities and that the hedge fund played a role in selecting the underlying mortgages for inclusion in the portfolio. In Goldman's own words: "it was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors." This rare admission, betrays a brazen fraud and explains why so many senseless loans were made at the height of the subprime frenzy. In short, the great Wall Street derivatives machine demanded subprime loans that would default.
Citigroup also settled similar charges, on Oct. 19, 2011, with the SEC, for $285 million. Here, Citigroup held an undisclosed short position in the very securities they were selling to investors. Citigroup also allegedly exercised "significant influence" in selecting the underlying portfolio. According to the SEC complaint: "One experienced CDO trader characterized the . . . portfolio in an e-mail as 'dogsh!t' and 'possibly the best short EVER!' An experienced collateral manager commented that “the portfolio is horrible.'” Again, Citi sold securities that it wanted to default, and therefore demanded the riskiest loans possible. Perhaps this explains why private subprime loans failed at over twice the rate of even the riskiest Fannie loans as shown on the chart at right. Banks like Citi wanted loans that would default and default fast. In fact, the portfolio at issue in the SEC action closed in February of 2007, and defaulted by November, in synch with the subprime collapse. Citi made $160 million on this sordid deal.
JP Morgan Chase paid the SEC $153.6 million for its misconduct in subprime lending. According to an SEC official: “What J.P. Morgan failed to tell investors was that a prominent hedge fund that would financially profit from the failure of CDO portfolio assets heavily influenced the CDO portfolio selection. With today’s settlement, harmed investors receive a full return of the losses they suffered.” The SEC also alleged that when the deal closed in May 2007, the hedge fund--called Magnetar--held a $600 million short position that dwarfed its $8.9 million long position in the portfolio. "In an internal e-mail, a J.P. Morgan employee noted, 'We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart.'" The SEC further found that Chase frantically sold interests in the portfolio because it knew how bad the portfolio and it knew the market was starting to come unglued.
The SEC continues this line of enforcement actions. Still, we probably will never know the full scale of these predatory frauds. The FCIC found that more than half of all CDOs generated in the second half of 2006 appeared infected with this so-called "Magnetar Trade." (FCIC Report, p. 192). Notably, all the deals underlying the SEC securities fraud actions hail from 2007. The three settlements above already total in excess of $1 billion. Thus, billions and billions worth of subprime mortgages resulted from this demand for loans that would default.
This newfangled source of predatory lending adds to the predatory loans generated for fees, or to grab collateral, or other old-fashioned predatory lending. Thus, Illinois Attorney General Lisa Madigan (Loyola University Chicago, Law Alum) spearheaded a multistate predatory lending action against Countrywide leading to an $8.7 billion dollar settlement (affecting over 400,000 homeowners nationwide) and currently is again suing Countrywide as well as Wells Fargo for steering racial minorities into high-cost, subprime loans. And, even the Fed took action against Wells Fargo for predatory lending and steering involving 10,000 home mortgages, as noted on this blog, by dre cummings. The bottom line is that massive predatory lending occurred, by any measure, and formed a core cause of the subprime debacle. According to the Wall Street Journal, 61% of all subprime loans in 2006 went to prime borrowers. An LA Times expose' found that 32 former Ameriquest employees "across the country say they witnessed or participated in improper practices, mostly in 2003 and 2004. This behavior was said to have included deceiving borrowers about the terms of their loans, forging documents, falsifying appraisals and fabricating borrowers' income to qualify them for loans they couldn't afford."
So, my question to the right is simply this: given the indisputable evidence of massive predatory lending, how can you ignore this as one (of many) cause? Do you really want to continue to maintain that it was all the GSEs in the face of overwhelming evidence of this massive predatory lending and fraud?
Professor Steven A. Ramirez
Loyola University Chicago
Saturday, November 5, 2011
Greece is toast, and the only issue remaining is the extent of the default. Political chaos reigns in Athens and apparently the bailout requires a super majority approval of 180 votes in the Greek Parliament. Today, this appears dubious at best. Even if these hurdles can be overcome, the deal on the table is problematic at best, as developing nations like China balk at adding to the Eurozone bailout while France and Germany seem to have reached their political, economic and financial limits. The bottom line is that further bailout funding appears unlikely.
This is all unbelievably bad. Economists like Nouriel Roubini now see a significant risk of a Eurozone blow-up, with global financial markets following. On Sept. 24, I saw unlimited downside. Today, despite repeated efforts by everyone, the Eurozone situation is even worse. That is precisely what the above chart is saying.
Since Sept. 24, some degree of clarity regarding US exposure emerged. According to the Congressional Research Service the US financial sector has at least $641 billion in exposure to problematic Eurozone debt and $1.2 trillion in exposure to European banks. This also can only be termed bad news. If a Eurozone meltdown strikes, the US will get badly burned.
Thursday, November 3, 2011
Bill Gates stated that the “FTTs already exist in many countries, where they generate significant revenue, so they are clearly technically feasible. According to the IMF, 15 of the G20 countries have some form of securities transaction tax. In the seven countries where the IMF estimates revenue, these taxes raise an estimated $15 billion per year." Fifteen billion is a lot of money and would go a long long way towards relieving the suffering of many Americans who find themselves living in the aftermath of the financial crisis. For example, the money could be used to provide housing for thousands of Americans who are homeless as a result of foreclosure. The money could be used to create jobs for thousands of unemployed Americans whose companies were forced to let them go as a result of the double dip recession. The money could be used for educational programs to help re-tool the unemployed for jobs in growing sectors. The money could be used for food programs to feed children and adults that are unable to purchase food because there is not a steady source of income in the family or to develop urban farming programs where familie can grow fresh fruits and vegetables. The money could be used to provide healthcare to the uninsured because health care is a benefit of employment and if one is unemployed it is almost a certainty that one will not have health care. The money could be used for ….
However, I am intrigued as to why Congress has not adopted some form of FTT legislation. We seem to have a tax for everything else such as an income tax, property tax, sales tax, capital gains tax, so why not a financial transactions tax to fund programs for the poor? Perhaps it is time for a revamping of old ideas into new ideas that are designed to address specific harm or inequity especially when Wall Street’s mishandling of certain financial transactions is the proximate cause of such harm or inequity. Perhaps this is an idea whose time has come.
Lydie Nadia Cabrera Pierre-Louis