Follow The Money

The Times ran an editorial today about the monster that is the American Insurance Group and the now-tired phrase, "Too Big To Fail". Not only did the Treasury throw more money at AIG, they loosened the restrictions on their prior bailout attempts.

In a joint statement with the Federal Reserve on Monday, the Treasury justified the move, saying that “the potential cost to the economy and the taxpayer of government inaction would be extremely high.”

That’s a textbook rationale for any bailout. What no one is saying — the Bush folks wouldn’t, and the Obama team seems to have taken the same vow of Wall Street omertà — is which firms would be most threatened by an A.I.G. collapse. The Treasury and the Federal Reserve noted in their statement that A.I.G. is a “significant counterparty to a number of major financial institutions.”

That means that by enabling A.I.G. to avert bankruptcy proceedings, the taxpayer is also bailing out — whom exactly?

Sorkin writes about AIG in his column too, only he is more of a man to toe the Wall Street party line. He drones on about the unspoken catastrophe that will occur should AIG collapse:

In the United States, A.I.G. has more than 375 million policies with a face value of $19 trillion.

If policyholders lost faith in A.I.G. and rushed to cash in their policies all at once, the entire insurance industry could falter.

How we got here is a well-worn tale that others have detailed extensively: A.I.G. used its triple-A rating from the insurance part of its business to run a huge casino that then overwhelmed the entire business.

He disposes of the colossal piracy examined in great extent by his colleagueJoe Nocera, in three words. Two if you count "well-worn" as one. Joe is asking the same question as the editorial: Who is really getting bailed out in the AIG fiasco?

Sorkin pretends that it's the good ole insurance policyholders. He cries, if the U.S. doesn't step in, there will be a run on all that $19 trillion worth of insurance, and the little old lady won't get a deal anywhere else. What he doesn't mention is that nothing will prevent a run on policies in any case, especially if policyholders are leery about the government's plan working. The plan seems to be pour as much money down the bottomless pit of human greed.

Andrew, Andy Boy, don't pretend it's the taxpayers. It's those goddamned counterparties. And who are they? No transparency at all. Are they European hedge funds? Or Goldman Sachs itself, whose CEO Lloyd Blankfein sat in on the original Fed-AIG transfusion plan, and from whom came Hanky Panky Paulson? Haven't all these parties profited hugely from AIG's coy leveraging of its Triple-A rating? If they have (and certainly that can be looked into, I hope) then they should shoulder some (if not all) of the losses. If we, the taxpayers, have to participate forcibly in lemon socialism, why can't they participate in some of the losses? If that kind of deal, that the profiteers must commit to some loss, shakes the foundation of our financial system, then we truly are doomed. Because there has to be a tipping point.

At least Sorkin admits that the Treasury should have taken over 100% ownership. For a man who speaks well of Wall Street (and it is reciprocated--remember, the WSJ tried to lure him away when Rupert first took over the helm) that was a hard thing to claw out of his throat.

My brother called me two days ago to say hi and to let me know he was still at Citigroup. I had been predicting Citigroup's demise for 1-1/2 years already. The following is our email exchange (redolent of the times):

Good to hear from you, bro.
>>
>> I'm happy that you're still plugged into Citigroup (the new joke is that
>> =
>> its share price is lower than its ATM fees). I got laid off from =
>> Alzheimer's on Feb 10 (even tho 2 weeks before the prez/CEO said she was
>> =
>> sharing my ideas for maximizing income at no cost with the senior staff;
hope she doesn't use these ideas or I'll be miffed).
>>
>> Jeff also just got laid off (Fri). I've been doing some career coaching
>> =
>> here and there and just started sending out feelers re: different =
>> consulting ideas. At least I don't have any debt and I have savings. =
>> Man oh man this is some global situation. I blame it all on the =
>> internet (as do Roubini and Taleb). Everything was done at once and is =
>> now crashing at the same time. Trading in unison, de-leveraging in =
>> unison, foreclosing in unison and firing in unison is NG. (:.
Love,
>> Kathi

From: "Wayne Berke"
To: "Kathi Berke"
Sent: Tuesday, February 24, 2009 8:16 PM
Subject: Re: Victim of Catastrophic Economic Meltdown (ha!)

>
> Kathi,
>
> Good one (about the ATM fees). Bummer about you and Jeff getting laid
> off.
> Do either of you qualify for unemployment insurance? Who are Roubini and
> Taleb? Even Wikipedia hasn't heard of them.
Blame it on capitalism with its inherent cycles of boom and bust. It's
> pretty
> similar to a bipolar disorder I think. The higher the highs, the lower
> the
> lows kind of thing. Unfortunately, we're coming off a very extreme high
> (fueled by the Internet among other things). What we should learn going
> forward, if we're smart which we're not, is that regulation is very, very
> important in the financial world. And anyone who starts talking about
> how great it is to rely solely on the invisible hand of the marketplace
> should be summarily shot.
BTW, here's a really cool, artistic depiction of how we got into this
> mess:
>
> Disaster Capitalism
>
> Love,


Nouriel Roubini is a professor at the graduate school of business at NYU.
He is also known as Dr. Doom. He predicted the collapse of the housing and
credit market back at some conference (Davos? The IMF Happy Hour?) in 2006
and they laughed at him. Now they don't laugh so much. He is omnipresent.
A rockstar.

Nassim Nicholas Talebis the writer of
"The Black Swan: The Impact of the Highly Improbable" (April 2007). He is
also a rockstar. At Davos, people like Michael Dell and others lined up to
kiss these guys' rings. Taleb's theory basically is that the financial
system pretended that it was eliminating risk by seeking to disregard the 1%
possibility that the house of cards the system was built on could fall over.
He called his book "The Black Swan" to say in essence that just because
every swan you see is white, that does not mean there are no black swans.
And by ignoring that possibility you build in the greatest risk of all,
especially if the scale is massive.

There is an equation known as the Gaussian copula function. It was
formulated by a mathematician named David Li who was trying to reduce
correlative risk to one factor. He did that by measuring credit default
swap costs (the cost of insuring against default), instead of doing the
messy job of considering all the variables involved in, say, one mortgage
pool making up a mortgage-backed security (gauging the probability of
default on the part of each of thousands of mortgage holders, all with
different situations that could all work out very differently in the
future). He merely looked back historically as far as credit default swaps.
CDSs have only really been in existence for about 10-15 years. During that
time housing prices went up, up, up. Li's equation, based on the theory
that housing prices would alway go up, delivered a single number considered
the risk factor. Everyone in the financial sector used this number to
determine the risk in their trades. And guess what, they didn't think there
was any risk!

The managers didn't understand the mathematicians, but they liked the risk
reduction represented by that single factor. The mathematicians loved the
beauty of the equation, but they couldn't see the NINAs (no income, no
assets) borrowers or the cheap crooks selling the loans making thousands on
fees. There was no overlap. No Venn diagram.

But what's going on is no longer a "subprime" crisis. It is a credit
crisis. Companies are divebombing because they can't get credit. Even very good companies. Their debt is coming due (everything runs on credit; did
you ever see anyone walk into an auto dealership with $20,000 stuffed in
their pockets?) and they can't roll it over. Even investment grade
companies (like Southwest Airlines) have to pay 10% interest to raise money
now. I only pay 12% on my credit card line. The cost of debt service alone
can kill companies. So they're selling all their assets at fire sale
prices. Or they're going into bankruptcy because the banks are calling in
their loans. Banks that are getting billions in taxpayer money.

But the real problem that hasn't been solved by any statistical equation or
the financial wizards in Washington is that of credit default swaps. The
notional value of credit default swaps is something in the range of $50
trillion (for/against default)
my dailykos
diary. That's why AIG is hemorrhaging money: they owe so much on the
"insurance" contracts (credit default swaps) they made with counterparties
that things wouldn't default. AIG didn't hedge against the CDSs they wrote
(no capital cushion-credit default swaps aren't regulated at all, in fact no
one knows how many there are); it just kept collecting premiums. Now the
entities it wrote contracts on are defaulting and the gov't is pouring money
into it to keep it (futilely) from defaulting itself.

Fun, huh?

Love,
Kathi

Satire: $50 Trillion Notional Value vs. $15 trillion GDP

You may well be asking yourself, what the hell? How come the banks are getting trillions of dollars and they’re still broken? Didn’t I give them all my deposits and now my taxes? And the people with their hands on the spigot keep saying that if I don’t give them more they’ll collapse. Aren’t we trying to raise the dead?

WTF happened? Credit default swaps. $50 trillion notional value. $14 trillion U.S. 2008 GDP.

Just think of the financial system as a gigantic casino, kind of like the Sands before a wrecking ball knocked it down, where people bet against the house or on the house but the house burned down.

People bet even though they had no chips. Now the chips are down and they owe money to the bookies, aka "counterparties". But they have no money. But we do. Or rather, the Treasury and the Fed can keep printing money in the back room.

This entire betting area was unregulated, done in a dark alley. No one could see in and no one kept a record of his or her "contracts" or bets. A lot of the time they were made over the phone.

The reason these "agreements" were called credit default swaps: if they were called insurance, they would be regulated. No wagers without capital reserves to back them up in case of default. But people bet without any money in case of default. Or people bet without owning the underlying asset, as if someone could bet on your house burning down while you pay the premiums to the insurance company that couldn’t pay your claim.

No money put aside for a rainy day. Not enough rain to put out the fire.

When Lehman went bankrupt (or "was allowed to fail") all bets were off. Lehman owed money on bets against it and couldn’t pay off on bets it made. Shareholders were wiped out. Debt holders got pennies on the dollar. And credit froze. Investors were scared and still are. What if the government decides on a whim not to back up a failed bank/insurance company/commercial paper/money market fund? They’ll never get paid back. The banks don’t even trust each other.

No one can get money now unless it’s from the government and it’s a failed financial institution and it has well-paid lobbyists. Investment grade companies can’t borrow for less than 10% interest. Who can afford that kind of debt service? A lot of companies are being downgraded by the very credit rating agencies that slapped triple-A ratings on worthless paper.

What is the endgame?

The estimates as to how much money is committed to these CDS’s varies, but an oft-repeated figure is $50 trillion. $50 trillion. According to the Financial Forecast Center, the U.S. gross domestic product calculation ending in 12/08 (4th Q ’08) was $14.5 trillion. Simple arithmetic compels the question: how the hell are the American taxpayers supposed to cover these bets, if the goods and services we produce fall $35.5 trillion short?

Gretchen Morgenson, Pulitzer-prize winning reporter of the NYT, in her article "Time to Unravel the Knot of Credit Default Swaps" offers two ways to resolve this real problem at the bottom of the financial crisis.

Christopher Whalen, managing partner at Institutional Risk Analytics, suggests that:

Insurers (those collecting the premiums) have to put up 50% of their net exposure on a contact. By doing so, they eliminate doubts about financing of credit default swaps.

Regulators bar underwriters of credit protection from selling new insurance on financial institutions participating in TARP. “It is absurd for the government to allow private speculators to profit by trading about public-guaranteed liabilities of banks.

Sylvain R. Raynes, mathematics professor at Baruch College in New York and an expert in structured finance at R&R Consulting states that, “The financial system is frozen largely because of credit-default swaps. His suggestions include:

Unwinding all outstanding CDSs through a process he calls inversion. Insurance premiums would be refunded to buyers of credit protection from the entity that wrote the initial contract. And the seller would no longer be under an obligation to pay if a default occurred. The premium repayments would be made over the same period and at the same rate that they were paid out. If a contract was struck 3 years ago and charged quarterly premiums, the premiums would then be refunded quarterly over the next 3 years.

Remember the distinction between speculators and hedgers? They would be treated differently.

Hedgers—buyers who bought CDSs to protect themselves because they actually hold the underlying debt—would have their premiums refunded and get the difference between the underlying debt’s face value (say, $100) and an independent assessment of its intrinsic value.

How are these debts (especially mortgage-backed securities, which are illiquid) valued? Ascertained by third-party analyses using loan servicing data on delinquencies, defaults and performing mortgages.

Stop the clock. Reverse it. Then the entire system will be able to breathe again. Said Raynes, “And over time, at the same speed that you got into the mess, you get out of it.

Morgenson: “It won’t be easy: Wall Street and other beneficiaries of the current setup will scream. But since they are among those who helped bring our economy to its knees, let’s try ignoring their objections.”

Great Depression 2.0 according to the experts

Michael Lewis, author of "Liars Poker", contributing editor of Vanity Fair and editor of "Panic", a new book I bought tracing booms and busts including the 1987 crash, the death of portfolio insurance, the collapse of Long Term Capital Management (which Joe Nocera also covers in last Sunday's Magazine Section cover story), including the dot-com, housing and now, much more extreme, the credit bust, has written an article with David Einhorn, the president of Greenlight Capital. He bet against mortgage-backed securities in 2008 and cleaned up. The article is called The End of The Financial World as We Know It. It ran in Sunday's Week In Review Op-Ed section.

Off the top of my head: Nocera focused on financial institutions' reliance on a risk management factor called "VaR". VaR was the number that companies looked at to reassure themselves about their portfolio risk, especially when dealing with illiquid structured financial vehicles. Because these vehicles never traded on the open market and no one, including the CEOs of the companies, understood them, the risk measurement had to be based on something else that was similar. One step removed from an assumption. The risk factor was changed day by day, and it supposedly included previous history. But history for how long? Maybe only since the market went up, up, up since 2002. As some asshole said in the article, (I paraphrase), this is a factor for peacetime, not wartime. In other words, the goddamned institutions never factored in the idea that everything would go to hell. Or that anything would go to hell. Nocera threw in Taleb, a former hedge fund manager who is hot right now (I'm suspicious of anyone who is "hot right now"), who wrote the book "The Black Swan" which basically states that the 1% of events not considered is crucial because if that eventuality occurs, everything goes to hell.

How the Greedheads and the Internet Destroyed Thought

On this last day of 2008, I mourn the loss of the thinking writer. What is this shit with Twitter (164 characters worth of discussion at one time? Rachel said last night that Israel "tweaked[?]" its current bombing and possibly ground troop campaign against Hamas in the Gaza through Twitter. "Isrl bomb only mil instal; civ dths sad but nec."

Meanwhile, just read in the
New York Times that Nat Hentoff and Lynn Yaeger were laid off. According to Tom Robbins, who is still a staff writer there, half the staff of the VV has been laid off since the New Times Media (a Phoenix-based publisher of alternative weeklies that later changed its name to Village Voice Media) bought it in 2005.

Nat Hentoff has been there for 50 years, since 1958. I disagreed with him on many issues, particularly abortion, but he was always a worthy adversary. He could think in print. He discussed detailed constitutional issues, like the urgency of protecting first amendment rights. How can you discuss this shit in 164 characters without being extremely reductive, if not totally stupid? Is this what everyone is evolving towards (whether they want to or not), public discourse based on Valley Girl text messaging?

I am guilty of the same short-term responses myself. If my homepage hesitates for a milisecond, I get impatient. The thought of pulling down the Encyclopedia Britannica to research something seems anachronistic and a waste of time. Why look it up in a deliberate fashion: selecting the proper book, leafing through the pages, and reading all those goddamned words when all you have to do is type "key" words into a search box to get answers? But what the fuck kind of answers are they?

Banks, Automakers and (T)he (A)ct to (R)eward (P)lutocrats

This is a horrible economy (that is the understatement of the year). Some estimate that the official unemployment rate will rise to 10% from around 6.7% now. 1 in 7 homes will be in foreclosure. And the TARP bailout is causing more problems, not less.

“Banks Need More Than Just A Tuneup” 12/1/08 from “Heard on the Street” column

The banks’ business model has failed. That’s the truth. They lent poorly, gave out credit to anyone with a pulse and were sorely undercapitalized. They used off-balance-sheet vehicles (like SIVs) to sock away their bad debt. And the incentives were set up to make a killing and walk away. You got paid on the basis of your deals, not how the deals unraveled.

Congress is closely monitoring the auto bailout (if there even will be one) with the sticky fingers promise of maybe $25 billion, a mere drop in the bucket for the failed banks. In order to get the money, Detroit will have to genuflect, including cutting down the union. By contrast, banks get money with few strings attached. There is no demand to lend, no requirement to reveal collateral, no requirement to cut salaries or dividends, fucking nothing.

The banks blame everything but themselves. It’s the volatile, unpredictable market. It’s predatory hedge funds; short sellers; a “perfect storm” of events coming together at the same time (I mean, who could predict that housing prices would actually go down?). If the fault, dear Brutus, lies not in ourselves, then why change?

This is the exact opposite of the argument being made against the Big Three. They’re dinosaurs; their business model failed; the market should let them die. But the business model for banks has also failed, as stated in above article:

The reality is the crisis is due to bad lending, and investment decisions. And those, after all, form the core of the banking business. In auto terms, it’s as if banks designed cares that suffer from catastopic mechanical failures, or can’t be driven during snow storms.

Banks need to adjust incentive structures so bad lending decisions aren’t as likely, slim costs to reflect reduced future profitability and rethink capital.

If the Fed and the Treasury keep rewarding bad players, if they reward reckless decisions with more money while requiring nothing in return, this catastrophe (if it ever ends) will continue.

I know that Bloomberg News service filed a Freedom of Information Act (FOIA) to force the Fed to reveal what it is accepting in return for all the taxpayer money it is printing and doling out. The Fed refuses. It is laughable to believe that we will make anything back from all the shitty debt they’re shoveling onto us. What collateral is the Fed accepting?

From 11/25/08 www.rgemonitor.com :

The U.S. government is prepared to lend more than $7.4 trillion on behalf of American taxpayers, or half the U.S. GDP, to rescue the financial system since the credit markets seized up 15 months ago. Bernarke’s Fed is responsible for $4.4 trillion of pledges, or 60% of the total commitment of $7.4 trillion. The unprecedented pledge of funds includes $2.8 trillion already tapped by financial institutions. The commitment dwarfs the only plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program (aka The Act Rewarding Plutocrats). Regulators refuse to disclose who is receiving how much while Congress starts pushing for transparency and give authority over taxpayer money back to elected officials.

In today’s NYT, Andrew Ross Sorkin writes about how Paulson, Bernarke, et al lent money to a Lehman subsidiary AFTER they let Lehman go bankrupt, ostensibly because (as Paulson claimed) they didn’t have the legal authority to lend to Lehman based on Lehman’s collateral. So why did they lend to its subsidiary after Lehman crashed? Didn’t Lehman still have the same collateral?

Municipalities Going Down The Drain

Buyers Shun Port Authority Bond Issue