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How banks learnt to play the system

Published: May 6 2009 20:02 | Last updated: May 6 2009 20:02

Pinn illustration

Those who cannot remember the past, wrote George Santayana, are condemned to repeat it.

Twenty years ago, global banking regulators declared that every bank ought to hold core capital equivalent to 4 per cent of its risk-weighted assets. Today, the US government will say the same thing differently.

This repetition will be expensive. It may force Bank of America to raise an extra $34bn (€25.6bn, £22.6bn) of common equity, and Citigroup to raise up to $10bn. More than half of the 19 banks under scrutiny could be told to drum up capital.

The difference between 1988 and today is that tangible common equity is the new tier 1 capital.

To all but bankers or regulators, that last sentence is incomprehensible, of course. Yet it encapsulates why two decades of reform intended to protect banks against collapse not only failed to work but had the perverse effect of hiding the problem.

If governments want to do better this time, they must learn the lesson that banks faced with new balance sheet rules will expend an inordinate amount of time and effort trying to evade those rules. Indeed, the cleverer the rules, the greater the opportunity for financiers to arbitrage them. This is why investors have lost faith in tier 1 and prefer a more basic sum.

The stress tests on the largest 19 US banks carried out by regulators over the past couple of months, the results of which will be disclosed this Thursday, echo the 1988 Basel Accord. Basel I was the first effort by regulators to set capital adequacy standards for global banks.

The accord tried to do two things: to raise the level of capital held by banks – notably those in Japan – and to measure leverage (their ratios of capital to assets) better.

That was how the trouble started.

Banks are highly leveraged institutions that hold only a small amount of capital compared with their assets. That is what gives them their economic importance – they can lend far more to people and companies than their capital base – but also what makes them vulnerable.

A comparatively small loss in the values of assets, including commercial and residential property, during recessions can eat through the capital base of a bank, making it insolvent. This is what has occurred over the past 18 months.

Basel I attempted to address this by setting a maximum leverage ratio – or a minimum ratio of capital to assets – for global banks. That figure was 8 per cent, which is equivalent to allowing a bank to be leveraged a conservative 12.5 times.

If that was how leveraged banks actually were, we would not be in half this trouble. But some investment banks entered this downturn with capital-to-asset ratios of 30 times or more. That was because neither their assets nor their capital were what they seemed.

On assets, Basel introduced the notion of risk weighting, which essentially meant that some kinds of loans – for example, highly rated corporate bonds and, yes, residential mortgages – were considered less risky than others, so less capital needed to be held against them.

It was not a bad idea in principle but it set off two decades of financial engineering by banks to classify as many of their assets as possible as low-risk weighted in order to swell their balance sheets and so make a higher return on capital.

One of the puzzles of the financial crisis is why banks were caught with huge amounts of securitised mortgage debt when the point of securitisation – turning assets into securities – is to be able to sell loans.

Viewed through the Basel lens, however, the hoarding of securities made sense. By transforming 50 per cent risk-weighted mortgage loans into triple A securities, and with the help of rating agencies, banks reduced the amount of capital that they needed to hold against these assets.

A bit of insurance wizardry took the regulatory arbitrage further. Banks could cut their capital charge to near zero by laying off the credit risk of mortgage securities to AIG through credit default swaps. Hey presto, billions of dollars of assets absorbing virtually no capital!

On capital, Basel was not as strict as it sounded. The 8 per cent figure was split into two groups – tier 1 and tier 2 capital. Nobody talks much about tier 2 capital now because it is pretty flimsy stuff – it includes subordinated debt and other securities only distantly related to equity.

For years, regulators and investors have focused on tier 1 capital, which is made up of equity, preferred shares, goodwill and intangibles. Banks must hold a minimum of 4 per cent tier 1 capital to risk-weighted assets.

Yet even tier 1 is a loose measure of capital strength, since it includes preferred shares and other miscellany. In practice, it is a bank’s common equity that absorbs the losses from its troubled loans and assets.

The result of this relentless deflation of assets and inflation of capital is the absurdity that the banks the US will today instruct to raise billions more in equity are, by Basel standards, in rude health.

Bank of America, for example, had a tier 1 ratio of 10.1 per cent in the first quarter of this year, while Citi’s tier 1 ratio was 11.9 per cent. Both banks had between two and three times the minimum ratio.

It would be wrong to throw away the entire Basel framework (including the Basel II revision of 2004) because global banks found ways to game the system. There is still a place for broad measures of banks’ capital strength and risk weighting of assets.

But this Thursday’s stress test results are both a harsh judgment on the biggest US banks and a damning verdict on Basel and two decades of capital adequacy regulation. We should remember that.

john.gapper@ft.com

Anold one from Picking Nits....

Monday, March 9, 2009
Tangible Common Equity: Useful Tool or Wild Goose Chase
T.C.E. has suddenly become one of those vogue things everyone wants to know more about. Pundits have begun asking, some proclaiming, about the notion of T.C.E. becoming the “new Tier 1 Capital” for investors. In a world where wiping out equity investors is rapidly becoming a “too bad for you buddy” event as the banking community strives to bankrupt common equity to protect pay off losses over in the neighboring fixed income casino, people are right to ask the question.

But what is the real T.C.E. condition of these banks. An equity investor sees their investment through the eyes of the Securities Act. They buy stock through a market regulated by the Securities and Exchange Commission (SEC). They analyze their investments looking at the whole entity which in the most complex institutions is only partially a regulated bank.

For those of you who don’t know this, the regulated bank portion of your stock is overseen by an entirely different set of regulators operating under the authority of the Banking Act. The Securities Act and the Banking Act are immiscible. They do not interact. The identification numbers at the SEC and the FDIC are separate lists. There are 885 publicly traded banks and over 5,000 bank holding companies. So for over 80% of the banking industry, publicly traded stock price doesn’t figure anywhere in the analysis. And it’s the bank regulators who hold the power of U.S. law when it comes to capital adequacy. It’s their equations that govern what is enough, when prompt corrective action is required and when resolution is necessary. The computations are specific and they are not based on reading 10-K’s.

There are a number of T.C.E. figures floating around right now and we thought it would be a good idea to assess whether these are in fact helping public transparency or distorting it. The most common one we’ve found is the simplistic method. It’s,

T.C.E = (Common Equity less Intangible Assets) divided by (Total Assets less Intangible Assets)

These numbers are found in SEC 10K’s and are part of the standard 800 or so fundamental variables in all of the vended data feeds. It’s quick to calculate and it gives reasonable data for banks with business models that are primarily in the basic business of banking. It begins to distort as the bank participates in exposures to external risk sensitive activities such as trading and securities that are better tracked using Economic Capital (EC) analysis. And it can be as much as 200% to 400% off the mark for large complex multinational public companies with portfolios of operations that include significant portions of non-banking lines of business. For this last set of companies you really do have to separate them in to their bank and non-bank components and analyze the risk of each using differing techniques and then make the equity decision. Yes it’s more complex that quick glancing at the 10K and watching the price-volume but we’re in a brave new world and the winners are going to be the ones that figure out the new math.

Take poor Citigroup. I saw an article with a table indicating Citi’s T.C.E. was down to 1.8%. We ran the simplified formula for Citi and came up with 1.78% for 3Q2008 pulling figures from the 10-Q's matching the number from the source quoted in the articles. The figure is alarming because the conventional rule about T.C.E. is that it should be 3% of higher to be “adequate” from a banking safety and soundness perspective. The outcome of the equation puts quite a bit of “market” pressure on Citi to say the least. Adding insult to injury, it also opens up an arbitrage gap. The question in the end of course, is it real?

At the moment we’re not so sure at IRA because certain cross checks don’t fit. The three official tests of Capital Adequacy(1) for the Citi’s banking operations all show that this portion of the business is capitally adequate. Citi does carry a high degree of stress in our Bank Stress Rating system but it’s not because of any regulatory capital adequacy issues. Their loss provisions are in line with the Maximum Probable Loss (MPL) stress factors in our system so it looks like their operations scenario planning is being done properly as far as capital reserve positioning is concerned. So we ran a version of a bank operations-only T.C.E. and came up with a figure of 5.53% for Citi at the end of 4Q2008. This last figure for the bank portion of Citi agrees better with the regulatory indicators from the three official Capital Adequacy tests. We remain a little wary because the oddball number out of the lot is the simple calc TCE.

If all the numbers are true one thing it might imply is that the interests of the banking regulators, counterparties, et al and the interests of equity shareholders are not aligned by a conflict ratio of 3-to-1. That gets kind of interesting when the two become one.

Bottom Line

I’m not saying that banks like Citi don’t have their share of challenges. They certainly do and yes they are scary daunting. But what I am saying is that they, the other banks, and this country’s economy do not need imaginary ones. In these times, we need to be sure the dots are connecting.

The financial alchemists prepare to build their zombie bank..
http://www.youtube.com/watch?v=DVMshMIPNUg

New angles: March 2004 | Volume17/No3

New Angles

Securitisation specialists urge last-minute changes to Basel II

The securitisation industry is keeping the pressure on in the hope of some last-minute fine-tuning of the new Basel Accord, due for completion in mid-2004.

The Basel Committee announced its planned changes to the new Accord’s treatment of securitisation at the end of January.

The European Securitisation Forum (ESF) and the American Securitisation Forum (ASF), both part of the Bond Market Association, have been at the forefront of the securitisation industry’s lobbying effort on Basel-related issues. The announced changes from the Basel Committee come as a result of the ESF and ASF’s intensive work to put securitisation on a more even footing with other asset classes.

“It is evident that they [the Basel Committee] have been listening,” says Leon Dadoun, member of the ESF and ASF’s legal, regulatory and capital committees, and a managing director at CIBC World Markets. “At the start of the process there were some hurdles, many of which had to do with properly defining securitisation in relation to other kinds of credit risk.”

Dadoun adds: “In any standard-setting process there is a conceptual stage, an application stage, and a fine-tuning and calibration stage, which is where we are now. We wanted a neutral approach to securitisation, for there to be capital charges commensurate with risk, but no regulatory incentives or disincentives for doing securitisations.”

One big change set out by the committee is to use an internal assessment approach (IAA) for banks’ exposure to asset-backed commercial paper (ABCP) conduits, based on banks’ own methodologies, in lieu of the supervisory formula approach. The committee has outlined the prerequisites to be able to apply IAA and now those need to be clarified, says Dadoun.

“ABCP is a huge business. It will continue to flourish, notwithstanding the introduction of capital charges to liquidity facilities. The reason we couldn’t use the supervisory formula for all unrated exposures was because when assets are purchased by ABCP conduits, they are often from third parties, and getting the detailed information necessary for the supervisory formula is hit or miss,” says Dadoun.

Sore point

While the introduction of the internal assessment approach is a huge step for the ABCP business, the 100% credit conversion on liquidity facilities is a sore point. Currently, ABCPs do not have to hold any capital against liquidity facilities for ABCPs.

Another pleasant surprise was that the new ratings-based approach to risk weighting for securitisation has eliminated the originator-held weightings. Previously, Basel II had different risk weightings depending on whether an asset was held by the originator or an investor.

Some weightings for the ratings-based approach have been lowered but, significantly, the 7% floor for triple-A tranches remains. Dadoun says the ESF and the ASF are providing the committee with extra data to make a case for lowering the floor. To date, the committee has been reluctant to lower the 7% floor as there was not enough historical loss data for triple-A tranches.

There is also concern that junior granular tranches still have the same risk weightings as their non-granular counterparts. The committee has made a differentiation between the risk weightings’ granular and non-granular tranches on the senior level.

“Under the current proposal, the risk weighting for granular and non-granular tranches rated at and below BBB– is the same,” says Birgit Specht, head of securitisation research at Dresdner Kleinwort Wasserstein.

However, Specht says there is a significant difference in ratings migration between granular and non-granular pools. While tranches of non-granular pools have experienced sometimes severe downgrades in the past, those of granular pools have almost exclusively seen upgrades. This has also been reflected in spreads. Treating them in the same way could lead to similar arbitrage as seen in the past, where a 100% risk weighting for corporate risk regardless of its rating led banks to invest in higher yielding, riskier assets.

Another item on the agenda will be to add triple-A tranches to risk weights for senior tranches, as for synthetic deals there is a super senior tranche. “We want all triple-As to qualify for the lowest risk weights whether or not the tranche is senior. If not, subordinated synthetic triple-As would be penalised,” says Dadoun.

With the committee indicating that it intends to meet the mid-2004 deadline for presenting the completion of the Accord, the securitisation industry will have to act quickly to have its demands met.

If you want to comment on this article, please email the Editorial Director, Nick Sawyer on nick.sawyer@incisivemedia.com

from voxeu, "Recession to Recovery, a Long and Hard Road"

http://www.voxeu.org/index.php?q=node/3534

Recessions associated with financial crises tend to be severe and recoveries from such recessions are typically slow. It takes almost 3 years to return to the pre-recession output level—which is twice the time it takes to recover from other recessions. Financial crises typically follow periods of rapid expansion in lending and strong increases in asset prices. Recoveries from these recessions are often held back by weak private demand and credit, reflecting, in part, households’ attempts to increase saving rates to restore balance sheets. They are typically led by improvements in net trade, following exchange rate depreciations and falls in unit costs.

Someone put too much basel in my financial soup...

Basel Squared
— By Kevin Drum | Mon April 27, 2009 10:35 AM PST

Ezra Klein gets geeky:

One of the pieces of the crisis that I hadn't understood until recently, for instance, was the role that Basel II banking regulations played in the growth of the structured securities market. In essence, Basel II, which went into effect a couple years ago, held that a bank only had to keep half as much capital on hand for AAA-rated securities as for other types of assets. That created a huge incentive for banks to get more things rated AAA....

And that in turn made the creation of allegedly AAA-rated securities a growth industry. If a bank holds a $100 BBB-rated security, for example, they're required to maintain $8 in capital reserves to back it up. However, if they ring up their friendly broker at AAA-rated AIG and buy a credit default swap on that bond, it's suddenly rated AAA too and the bank only has to hold $1.60 in capital. That $6.40 freed up, and with leverage of 20:1 that's $128 available for productive investments in America, my friend! What a bargain.

(Though it's worth noting that European banks engaged in this kind of regulatory arbitrage at least as much as American banks. Maybe more, in fact, which is why AIG ended up paying out so much money to Société Générale and Deutsche Bank. American banks have gotten the lion's share of the attention so far for their shoddy asset portfolios, which is fair enough since America was the focal point for the subprime crisis, but European banks were pretty eager consumers of regulatory shenanigans as well.)

In any case, there are plenty of reasons to be skeptical of Basel II, and among other things it goes to show the difficulty of setting international standards in the world of finance. One of the reasons Basel II is weaker than Basel I is that every country has its own financial industry idiosyncracies, and every country wants banking accords to treat their particular idiosyncracies lightly. Basel II did that, and then took things even further by allowing banks to use their own internal models for credit risk because, you know, internal models had proven themselves so sophisticated and reliable. Oops.

On the other hand, the Basel II accords weren't even published until 2004, and didn't get adopted in most countries for several years after that. As weak as Basel II is, the credit bubble and its associated financial rocket science far predates it. I'm not really sure how far you can go in blaming it for our current meltdown.

Ezra Klein is always geeky. And I love him to pieces for it.

A must-read for the day. Posner "Capitalism in Crisis" cc, this is what I meant when I said there wasn't a level playing field for developers and buyers in new developments. bankruptcy isn't that risky for an llc created by a developer. buying was extremely risky for the purchaser, who is largely unaware of how little a developer cares about bankruptcy.

http://online.wsj.com/article/SB124165301306893763.html

First, businessmen seek to maximize profits within a framework established by government. We want businessmen to discover what people want to buy and to supply that demand as cheaply as possible. This generates profits that signal competitors to enter the market until excess profit is eliminated and resources are allocated most efficiently. Financial products are an important class of products that we want provided competitively. But because risk and return are positively correlated in finance, competition in an unregulated financial market drives up risk, which, given the centrality of banking to a capitalist economy, can produce an economic calamity. Rational businessmen will accept a risk of bankruptcy if profits are high because then the expected cost of reducing that risk also is high. Given limited liability, bankruptcy is not the end of the world for shareholders or managers. But a wave of bank bankruptcies can bring down the economy. The risk of that happening is external to banks' decision-making and to control it we need government. Specifically we need our central bank, the Federal Reserve, to be on the lookout for bubbles, especially housing bubbles because of the deep entanglement of the banking industry with the housing industry. Our central bank failed us.

Bless her:

http://www.businessinsider.com/henry-blodget-elizabeth-warren-wake-up-wall-street-the-world-has-changed-2009-5

Credit risk tumbles...

http://www.bloomberg.com/apps/news?pid=20601087&sid=aIjVBf6YUMe8&refer=home

With Rubin and his acolytes Summers & Geithner in charge. This will not happen. The public is just not outraged enough to created the impetus for another Pecora commission. Obama himself has stated he's not interested in splitting investment banking and commercial banking, a move seemingly backed by Volcker. He just wants to slap on some oversight ala Canada. Summers still believes this is a liquidity crises and not a solvency one...

Riversider, I'm not sure how long that team is with us. And I posted a link earlier, the senate I believe has already passed a bill creating a "percora-like" commission.

How much good will be done by such a commission? Not much, I suspect. Maybe by 2013 the political arena will be such that a meaningful investigation could occur. But these are indeed interesting times we live in.

The fact that Volcker has come out for it just gives me hope. I suspect it's a deal Obama has made. Give him some time, and he'll revisit later. Remember, Rahm and Axelrod were for nationalizing.

The banks made money from re-fi, pent-up debt demand, and if you are getting money from the gov't at 0%, it's tough not to make a buck. This helped their balance sheets immensely (and Goldman is having a grand time trading). But for how long? How many credit-worthy (even stretching it) are out there waiting to refi? Just how much debt can be tolerated, by the government, consumer and corporations? Where are the future income streams that will pay for the over $2 trillion in unrealized losses on outstanding bad or soon to become bad debt? The taxpayer of course. Inquiring minds would like to know how that's going to turn out.

The bears have been rather quiet. Shiller even offerred up some rather bullish advice. I wonder if this had anything to do with it?

http://www.calculatedriskblog.com/2009/05/krugmans-white-house-dinner.html

On the night of April 27, for instance, the president invited to the White House some of his administration's sharpest critics on the economy, including New York Times columnist Paul Krugman and Columbia University economist Joseph Stiglitz. Over a roast-beef dinner, Obama listened and questioned while Krugman and Stiglitz, both Nobel Prize winners, pushed for more aggressive government intervention in the banking system.

Sad.

http://baselinescenario.com/2009/05/07/stress-tests-and-the-nationalization-we-got/

The big hurt is continuing for CRE:

http://www.calculatedriskblog.com/2009/05/commercial-mortgage-delinquencies.html

401k funds are restricting withdrawals and reallocations of assets:

http://online.wsj.com/article/SB124148012581385199.html?ref=patrick.net

Washington Post.. The Obama administration today unveiled program details of a $3.4 trillion federal budget for the fiscal year beginning in October, a proposal that includes substantial increases for a number of domestic priorities as well as a plan to trim or eliminate 121 programs at a savings of $17 billion.

In a statement delivered at the White House after the budget details were released, President Obama defended the cuts from critics on both sides -- those he said would fight to preserve the targeted programs and others who consider the reductions insignificant.

"We can no longer afford to spend as if deficits don't matter and waste is not our problem," he said. "We can no longer afford to leave the hard choices for the next budget, the next administration -- or the next generation."

Although many government employees do valuable, thankless work, Obama said, "at the same time, we have to admit that there is a lot of money that's being spent inefficiently, ineffectively and, in some cases, in ways that are actually pretty stunning." He cited several examples, including a $465 million program to build an alternate engine for the Defense Department's joint strike fighter, a program that Pentagon brass neither wants nor plans to use.

Obama said some proposed cuts are larger and more painful than others, while some would produce less than $1 million in savings. "In Washington, I guess that's considered trivial," he said. "But these savings, large and small, add up." He said of the $17 billion total in projected savings, "Even by Washington standards, that should be considered real money."

Obama also stressed that the proposed cuts do not replace the need for "large changes" in entitlement spending.

The new budget documents, totaling more than 1,500 pages, fill in the details of a broad outline that Obama released in February. They include a massive appendix listing program-by-program information on the roughly 40 percent of the fiscal 2010 budget that constitutes discretionary spending, which will be set by Congress in what is expected to be a contentious appropriations process.

Also included is a separate tome that provides details on the programs targeted for cuts or elimination. If approved by Congress, those trims would amount to only about half a percent of the $3.4 trillion federal budget. But the proposed reductions are expected to be equally controversial on Capitol Hill, with some lawmakers battling for programs they favor and others demanded deeper cuts.

Congressional Republicans immediately denounced the cuts as insufficient when some details of them emerged yesterday. The criticism drew a retort this morning from White House budget director Peter Orszag, who went on MSNBC to stress that the cuts are just a start on the long-term work of curbing government spending, notably the growth of the Medicare and Medicaid health-care programs.

In any case, Orszag said, "$17 billion a year is not chump change by anyone's accounting."

About half of the trims would come from curbing defense programs that have been identified by Defense Secretary Robert M. Gates as expendable. They include ending production of the F-22 fighter plane -- thus saving $2.9 billion next year -- and canceling a new $13 billion presidential helicopter fleet, which would save about $750 million in fiscal 2010.

In a letter to Congress accompanying the new budget documents, Obama said his proposals make "long-overdue investments and reforms" in education, health care and renewable sources of energy while "beginning to rein in unsustainable deficits and debt." He said the proposed program cuts "are just the next phase of a larger and longer effort needed to change how Washington does business and put our fiscal house in order."

"I have little doubt that there will be various interests -- vocal and powerful -- who will oppose different aspects of this budget," he wrote. "Change is never easy. However, I believe that after an era of profound irresponsibility, Americans are ready to embrace the shared responsibilities we have to each other and to generations to come. They want to . . . reconstruct an economy that is built on a solid new foundation."

In his letter and in his remarks at the White House, Obama vowed again to cut the federal budget deficit in half by the end of his first term, and he pledged to bring nondefense discretionary spending over the next decade to its lowest level as a share of gross domestic product since 1962.

Under the budget request for the Pentagon, Afghanistan war funding surpasses that for Iraq for the first time, part of a shift in priorities that Gates seeks in defense spending.

The $130 billion in war funding that is part of the 2010 budget request includes $65 billion for Afghanistan operations and $61 billion for Iraq. The budget covers Obama's plan to increase U.S. troop strength in Afghanistan by 21,000 this year, but more funds would be required if he decides to meet the request of U.S. commanders for an additional 10,000 troops next year. The budget also includes $700 million for improving Pakistan's counterinsurgency capability -- a major increase in such assistance.

Meanwhile, the Pentagon's $534 billion base budget -- $21 billion, or 4 percent, larger than last year's -- also includes key initiatives to reshape the U.S. military for fighting today's wars. Major shifts include increasing spending on intelligence and reconnaissance, helicopters and Special Operations Forces, while stopping production of unneeded weapons systems and terminating or restructuring other programs considered "troubled."

In addition to the F-22 and presidential helicopter programs, proposed cuts include halting a $19 billion transformational satellite program and trimming $1.2 billion from missile defense.

Emphasizing the need to care for the all-volunteer force, the budget includes a 2.9 percent pay raise for active and reserve military personnel and increased spending on research for common wounds such as traumatic brain injury and mental health problems. Health-care costs for military personnel have ballooned in recent years and are projected to consume $47 billion of the 2010 defense budget.

With the 2.9 percent across-the-board pay raise and other compensation increases, but excluding special pay and bonuses, military salaries will average nearly $52,000 a year for enlisted personnel and $98,000 a year for officers, the document says.

The budget includes $2.3 billion more for personnel costs than the level enacted in 2009, an increase that would help pay for the Bush administration's decision to permanently increase the size of the Army by 65,000 soldiers and the Marine Corps by 27,000 Marines.

The volume separately lists budget items for "overseas contingency operations" covering pay and other personnel costs for service members in Iraq, Afghanistan and other trouble spots. Included in this category is $115.3 billion for the "Iraq Freedom Fund" during fiscal 2010, an amount that includes up to $100 million "to support the relocation and disposition of individuals detained at the Guantanamo Bay Naval Base, relocate military and support forces associated with detainee operations and facilitate the closure of detainee facilities."

In addition, nearly $7.5 billion is budgeted for assistance to Afghan security forces.

The proposed budget immediately came under fire today from congressional Republicans. Sen. John Cornyn (R-Tex.) charged in a speech that the Obama administration "seems to be forcing the Pentagon to make some needlessly tough choices -- even as they justify trillions of dollars for domestic spending in the name of economic stimulus." He said growth of discretionary federal spending by 7.7 percent next year, compared with 4 percent growth in defense spending while the United States fights two wars, "shows the wrong budget priorities for our country."

Cornyn also complained about the plan to cut missile defense spending. "Given the threats we face, now is not the time to cash in a peace dividend," he said.

However, Senate Majority Leader Harry M. Reid (D-Nev.) hailed the budget and praised Obama for reaffirming his pledge to cut waste. "No spending should be immune from review," he said in a statement.

Obama's list of proposed cuts is less ambitious than the hit list former president George W. Bush produced last year, which targeted 151 programs for $34 billion in savings. Like most of the cuts Bush sought, congressional sources and independent budget analysts predict, Obama's also are likely to prove a tough sell.

"Even if you got all of those things, it would be saving pennies, not dollars. And you're not going to begin to get all of them," said Isabel Sawhill, a Brookings Institution economist who waged her own battles with Congress as a senior official in the Clinton White House budget office. "This is a good government exercise without much prospect of putting a significant dent in spending."

Administration officials defended their approach, saying the list of program reductions and terminations is just the start of a broader effort to cut spending and rein in a skyrocketing budget deficit, which is projected to approach $1.7 trillion this year. They also noted that the list does not include more than $300 billion in savings Obama proposes to squeeze from federal health programs and use to finance an expansion of coverage for the uninsured.

"This is an important first step, but it's not the end of the process. We will continue to look for additional savings," said a senior administration official, speaking on condition of anonymity because the list of cuts had not been officially released. "You have not heard everything to be said on this topic from us."

The president has already scored a victory on the budget. Congress last week decisively approved his request to devote billions of dollars in new spending to health care, energy and education in the fiscal year that begins in October. But that plan depends in part on the administration's ability to identify budget cuts elsewhere. The document being released today details some of those savings.

The relatively short list of proposed program cuts quickly drew fire from Republicans who learned of them yesterday.

"While we appreciate the newfound attention to saving taxpayer dollars from this administration, we respectfully suggest that we should do far more," House Minority Leader John A. Boehner (R-Ohio) said.

In separate briefings with congressional Democrats and reporters, administration officials yesterday said the proposed savings were evenly split between defense and nondefense programs, and that many of the most significant reductions had already been revealed by the president or by Gates.

They also said the majority of the reductions were new targets not previously identified by the Bush administration. But the two lists clearly have some overlap.

For example, congressional sources said Obama is proposing to eliminate a program that reimburses states and localities for holding suspected criminals who turn out to be in the country illegally. Created in 1994, the program was repeatedly targeted by Bush officials, who argued that it is ineffective. But Congress restored funding for the program because it was popular with state and local officials. The program handed out $400 million last year.

Administration officials said Obama also wants to do away with Even Start, a program created in the late 1980s to promote literacy for young children and their parents. Starting in 2005, Bush tried annually to persuade Congress to eliminate the program. Lawmakers gradually reduced funding from $247 million to $66 million, but never proved willing to eliminate it.

Yesterday, an administration official said that, though Obama considers early childhood education a priority, "The evidence is unfortunately clear that this specific early childhood program does not work very well."

The officials previewed four other programs marked for termination on the grounds that they are not needed or are not effective. Obama officials have previously identified three of them as being out of favor: a $35 million-a-year long-range radio navigation system that officials said has been made obsolete by Global Positioning System devices; a Department of Education attache based in Paris that costs $632,000 per year; and a $142 million program that officials said continues to pay states to clean up abandoned mines even though that task has been completed.

In addition, the White House is proposing to cancel the Christopher Columbus Fellowship Foundation, an independent federal agency established to "encourage and support research, study and labor designed to produce new discoveries in all fields of endeavor for the benefit of mankind," according to its Web site. The program costs $1 million a year, and officials said 80 percent goes to administrative overhead.

The proposed cuts, if adopted by Congress, would not actually reduce government spending. Obama's budget would increase overall spending; any savings from the program terminations and reductions would be shifted to the president's priorities.

But the more likely outcome, budget analysts said, is that few to none of the programs targeted by Obama will be terminated. Presidents from both parties have routinely rolled out long lists of spending cuts -- and lawmakers from both parties routinely ignore them.

"You can go through the budget line by line, but there's no line that says 'waste, fraud and abuse,'" said Robert Bixby, executive director of the nonprofit Concord Coalition, which promotes deficit reduction. "What some people think is waste, other people think is a vital government service."

The administration officials said they think their cuts will be taken more seriously by lawmakers because the economic crisis and the accompanying rise in deficit spending is focusing fresh attention on the need to trim spending. House Speaker Nancy Pelosi (D-Calif.) has told committee leaders to offer their own spending cuts by the beginning of June.

"The spirit on Capitol Hill is now cognizant of the need to find some efficiencies," the administration official said. "I think you're going to see proposals not just from us, but from lawmakers to find savings."

Still, in the context of an enormous deficit, the sums under discussion are a drop in the bucket, analysts said.

"Obviously, the bottom line is frightening," said Rudolph Penner, a senior fellow at the Urban Institute and a former director of the Congressional Budget Office. "They have a long way to go to show fiscal restraint."

Peter Schiff on why American assets' prices will rise in nominal value, but diminish in real one.
http://www.europac.net/radioshow_archives.asp

April 29th broadcast is quite interesting

elena
(broker)

By David M. Levitt
April 2 (Bloomberg) -- Commercial property loans in default
or foreclosure rose in the first quarter as the U.S. recession
cut occupancies and the credit crisis stymied refinancing.
Delinquent loans climbed 43 percent in the first three
months of this year to $65.9 billion, according to data from New
York-based research firm Real Capital Analytics Inc. That’s up
from $46 billion at the end of 2008.
A total of 3,678 U.S. properties are now listed as in
distress by Real Capital. Commercial real estate values have
fallen at least 30 percent since their 2007 peak and may decline
another 11 percent this year, increasing the number of
properties that may be repossessed, Deutsche Bank AG’s real
estate unit said in a March 25 report. AREA Property Partners
Managing Partner William Mack said today lost value may already
stand at 33 percent.
“We haven’t yet seen the worst of the effects of the
recession on the commercial markets,” said Stuart Saft, a
partner at the law firm of Dewey & Leboeuf LLP in New York, who
specializes in real estate. “That’s still to come.”
Landlords who financed purchases with at least 60 percent
debt are now dangerously close to zero equity, said Mack, whose
New York-based firm was formerly known as Apollo Real Estate
Advisors. He spoke at a New York University panel today with
billionaire real estate investor Sam Zell.
“If 100 was your equity, the value is down to 67,” Mack
said. “All you have to do is have a 50 percent mortgage, or 60
percent mortgage, and your equity is almost wiped out.”

Distress Rises

Boston’s John Hancock Tower, New England’s tallest
skyscraper, was sold at auction March 31 to Normandy Real Estate
Partners and Five Mile Capital Partners LLC for $661 million,
about half of the purchase price of just three years ago.
Broadway Partners, founded by Scott Lawlor, paid $1.3
billion for the property in 2006 and defaulted on its loan. The
building was part of Broadway’s $3.3 billion purchase of 10
buildings from Boston-based Beacon Capital Partners LLC in
December 2006.
Zell, speaking at the NYU conference, said values are now
‘’below any rational analysis.”
The Los Angeles metropolitan area has about $7.5 billion
distressed properties, a 168 percent jump from December. Las
Vegas had a 54 percent increase, to $6.1 billion, Real Capital
said.

Manhattan Properties

Metropolitan areas with more than $1 billion of commercial
properties in distress more than doubled to 11 from five.
Philadelphia, Chicago, San Francisco, Austin and Houston, Texas,
and Detroit joined New York, Las Vegas, Miami, Phoenix and Los
Angeles.
Manhattan distressed commercial real estate has risen by 36
percent this year to $4.2 billion, according to Real Capital.
The Nobu Hotel & Residences in lower Manhattan is among
properties on Real Capital’s troubled asset list. Real Capital
called it a “challenged development” because Nobu has lost
some construction funding. The planned 62-story tower, the Nobu
sushi restaurant chain’s first U.S. hotel, was being built by
investor Kent Swig and is near the New York Stock Exchange.
Swig, 48, is delinquent on $49 million of construction
loans, according to a complaint filed by his lender Lehman
Brothers Holdings Inc. in New York State Supreme Court. The
project has been halted.

Lehman Claims

Swig, who has developed properties worth about $3 billion,
including two office buildings on Wall Street, is also fighting
default proceedings on a suspended Lehman-financed condominium
conversion project at 25 Broad St. in Manhattan. Lehman claims
in a separate lawsuit that Swig and his partners owe $273.7
million of unpaid principal on that project, plus interest and
fees.
Swig declined to comment through a spokesman. In a motion
in U.S. Bankruptcy Court in New York, he said Lehman
“continually set arbitrary and unrealistic deadlines and
changed the structure and terms of the transaction.” Lehman
spokeswoman Kimberly Macleod declined to comment.
Developer Sheldon Solow’s planned East River housing and
office development near the United Nations is also identified as
delinquent on Real Capital’s list.
Solow owes $85.7 million in construction loans and letters
of credit on the project, Citigroup Inc. said in a Dec. 16
default claim in state court.

Solow Case

In an answer to the complaint filed Feb. 20, Solow said the
bank rebuffed his offer to provide additional collateral.
Instead, Citigroup sold the initial collateral for millions
below fair market value, he said. Citigroup spokesman Alexander
Samuelson said in an e-mail, “we do not comment on
litigation.”
Solow is planning to build six waterfront apartment towers
and a 1.4 million square foot office tower on 9.7 acres,
according to the New York Department of City Planning. Solow
declined to comment for this story through a spokesman.
Real Capital defines distressed properties as those in
which a lender has taken steps to foreclose or declare a
borrower in default, as well as properties that have been
returned to the bank, or in cases where landlords were given a
loan extension or the debt was restructured.
In Chicago, among the delinquent properties is a Mandarin
Oriental Hotel development site at 160 North Stetson Ave. near
the Aon Center, according to Real Capital.

More Foreclosures

A unit of IStar Financial Inc., a New York-based real
estate lender, filed a foreclosure action on Feb. 3 against a
partnership led by Mandarin developer Gerard Kenny and his
company, Palladian Development Inc., claiming it is owed $44
million. Kenny’s lawyer Cornelius Brown didn’t return calls
seeking comment.
Foreclosures will “continue to grow, probably for at least
another year or so,” Peter Culliney, Real Capital research
director, said in an interview. The increase in distressed
properties may spur more purchases, he said.
“Our problem now is people don’t know what the baseline
price is, and they don’t know whether they can get any kind of
financing,” he said. “So unless you’re strong enough that you
can do a cash deal, everybody’s really sitting on their hands.”

time for my daily dose of depressing news. the memo in the kedrosky post is particularly interesting. it's titled "Are US Investors Pathologically Optimistic." The information arbitrage one is similar. The article from the Economist just points out how broke Americans should feel. The one from clusterstock discusses Elizabeth Warren's credibility and powers. The Slate article describes the bankers' club (oops, I meant the NY Fed). Interesting to see who Timmy has been hangin' with the past few years. SE isn't letting me post all the links, so they'll be split up.

http://paul.kedrosky.com/archives/2009/05/are_us_investor.html

http://www.informationarbitrage.com/2009/05/what-keeps-me-awake-at-night-economy-edition.html

http://www.economist.com/world/unitedstates/displayStory.cfm?story_id=13605679&source=features_box_main&ref=patrick.net

http://www.businessinsider.com/henry-blodget-elizabeth-warren-wake-up-wall-street-the-world-has-changed-2009-5

http://www.slate.com/id/2217811/

http://economistsview.typepad.com/economistsview/2009/05/stiglitz-the-spring-of-the-zombies.html

May 08, 2009
Stiglitz: The Spring of the Zombies

More on "the muddle-through strategy":

The Spring of the Zombies , by Joseph Stiglitz, Commentary, Project Syndicate:
As spring comes to America, optimists are seeing "green sprouts" of recovery... The good news is that we may be at the end of a free fall. The rate of economic decline has slowed. The bottom may be near - perhaps by the end of the year. But that does not mean that the global economy is set for a robust recovery any time soon. Hitting bottom is no reason to abandon the strong measures that have been taken to revive the global economy.

This downturn is complex: an economic crisis combined with a financial crisis. Before its onset, America's debt-ridden consumers were the engine of global growth. That model has broken down, and will not be replaced soon. ... The collapse of credit made matters worse; and firms, facing high borrowing costs and declining markets, responded quickly, cutting back inventories. Orders dropped abruptly ...

We are likely to see a recovery in some of these areas... But examine the fundamentals:... real estate prices continue to fall, millions of homes are underwater..., and unemployment is increasing... States are being forced to lay off workers as tax revenues plummet.

The banking system has just been tested to see if it is adequately capitalized - a "stress" test that involved no stress - and some couldn't pass muster. But, rather than welcoming the opportunity to recapitalize, perhaps with government help, the banks seem to prefer a Japanese-style response: we will muddle through.

"Zombie" banks - dead but still walking among the living - are, in Ed Kane's immortal words, "gambling on resurrection." Repeating the Savings & Loan debacle of the 1980's. the banks are using bad accounting... Worse still, they are being allowed to borrow cheaply from the United States Federal Reserve, on the basis of poor collateral, and simultaneously to take risky positions. ...

The American government, too, is betting on muddling through: the Fed's measures and government guarantees mean that banks have access to low-cost funds, and lending rates are high. If nothing nasty happens - losses on mortgages, commercial real estate, business loans, and credit cards - the banks might just be able to make it through... In a few years time, the banks will be recapitalized, and the economy will return to normal. This is the rosy scenario.

But experiences around the world suggest that this is a risky outlook. Even were banks healthy, the deleveraging process and the associated loss of wealth means that, more likely than not, the economy will be weak. And a weak economy means, more likely than not, more bank losses. ...

Fixing the financial system is necessary, but not sufficient, for recovery. America's strategy for fixing its financial system is costly and unfair, for it is rewarding the people who caused the economic mess. But there is an alternative...: a debt-for-equity swap.

With such a swap, confidence could be restored to the banking system, and lending could be reignited with little or no cost to the taxpayer. It's neither particularly complicated nor novel. Bondholders obviously don't like it - they would rather get a gift from the government. But there are far better uses of the public's money, including another round of stimulus. ...

In spite of some spring sprouts, we should prepare for another dark winter: it's time for Plan B in bank restructuring and another dose of Keynesian medicine.

I love Stiglitz. He's like a softer, less edgy Krugman. This is from Robert Reich's blog, and follows the same theme.

http://robertreich.blogspot.com/2009/05/what-will-happen-to-banks-that-fail.html

What Will Happen to Banks that Fail the Stress Test, When You and I Own Wall Street

The outcome of the "stress tests" will be that the banks needing extra capital will get it from the Treasury. But where will the money come from, now that the TARP fund is almost exhausted and Congress is dead set against providing more bank bailout money? The Treasury will simply swap debt for equity – turning what the banks owe the government into shares of stock in the banks. Presto. Ailing banks will get more capital, and Tim Geithner won’t have to go back to Congress to ask for it.

But by this sleight-of-hand, the public takes on more risk. Much of the money we originally gave Wall Street took the form of senior debt. We were preferred creditors, meaning that in the event of bankruptcy (or some form of it) we’d get repaid first. But as shareholders, we’d get nothing. As we’ve seen time and again during this economic crisis, shareholders lose big.

It’s possible, of course, that this is the perfect time to get shares in major Wall Street banks, because the economy is poised for recovery. But it’s just as possible this is the worst time – especially in banks judged by the Treasury to be inadequately capitalized – because nonperforming loans keep mounting. They won’t be repaid because so many people continue to lose their jobs, even though the pace of job losses may be slowing. And because they’re losing their jobs, they can’t pay their mortgages or credit card balances, or even shop at stores that are closing on Main Street, thereby threatening commercial real estate as well.

There’s a second problem with the debt-for-equity swaps. We the public become controlling shareholders in several large Wall Street banks. Should we be active shareholders – using our clout to get management to do things management might not otherwise do? Or passive shareholders, relying on the remaining private shareholders to police management? I’d say we should be active. But that only raises a whole host of questions. First, who represents us?

More importantly, if we’re active shareholders, is our main objective to make sure the banks become profitable and our we get repaid? Or should we push management to take actions that are in the public interest but not necessarily geared toward higher shareholder returns in the foreseeable future – such as limiting executive compensation, limiting the payout of dividends, and pushing the banks to make more loans to Main Street? I’d say we should do the latter. Otherwise, why bother bailing out the banks to begin with?

Elizabeth Warren Cares! She wrote me back

Congressional Oversight Panel

732 North Capitol Street, NW

Rooms: C-320 and C-617

Mailstop: COP

Washington, DC 20401

May 8, 2009

Dear XXXXX,

Thank you for taking the time to share your thoughts and your questions with the Congressional Oversight Panel.

As part of the Emergency Economic Stabilization Act of 2008, Congress established the Panel to oversee the U.S. Department of Treasury’s administration of the Troubled Asset Relief Program (TARP) and to provide recommendations for future regulatory reform. To fulfill that mission, the Panel is empowered to hold hearings, review official data, and provide regular reports to Congress and the American public. These reports can be found online at http://cop.senate.gov/reports/.

Because the Panel relies on direct input from the American people in going about our oversight work, we appreciate your views and your thoughtful questions, and we will take them into account as we continue to pose our own questions to Treasury.

We are approaching our work with great urgency and seriousness. We will do our best to ensure that the Treasury Department uses TARP funds in a transparent, accountable, and responsible manner and that reforms to the financial regulatory system are adopted in a way that serves the best interests of the American public. Thank you for your contribution to this effort.

Sincerely,

Elizabeth Warren

Chair

Please do not reply to this message. To provide additional comments or suggestions, please use the form available on our website, http://www.cop.senate.gov. Thank you.

aboutready,

Excellent article. Thank you.
http://baselinescenario.com/2009/05/07/stress-tests-and-the-nationalization-we-got/

dwell, didn't that one just depress the crap out of you? the love is waning again. i really can be a fairly sunny person, but my parade is definitely being rained upon these days. the last eight years i just expected it. now it hurts a bit more.

http://dealbook.blogs.nytimes.com/2009/05/08/hedge-fund-sees-disaster-brewing/

yes, aboutready. We are the sheeple & the powers that be retain the power. What are the repercussions down the line? fascism?

I may post this elsewhere. I've seen something like it before (mish?) but I hadn't been focusing. If this doesn't scare the crap out of you, I don't know what will. But it looks as though the effects will be largely felt after the mid-term elections, if that can give you any comfort or discomfort these days. BTW, this is primarily just posted for the chart (love CR, but he knows the picture paints two or three thousand words). Only a chart, of the recast schedule for option arms. We don't even want to think of what could happen if interest rates go up. We really don't.

http://www.calculatedriskblog.com/2009/05/loan-reset-recast-schedule.html

Saw this, perhaps this is a non-issue. Libor is under 1%.

AR: I read CR every day. In the comments, someone mentions negative amort OA. NEG AM OA!!!! *&%#&@%^&!!!!! They gave mtgs to anyone who could fog a mirror & add to that Neg Am OA!!!!!!! WTF??? And people who did not engage in this crap now pay for it. I'm livid. And, who's 'correcting' the situation? The ones that caused it. puke.

riversider, it's a non-issue for resets, but only as long as interest rates stay low (not all loans are libor-based, btw). this is about the recasts, totally different situation.

BofA continued to make sketchy loans right up through the spring of '08.

dwell, this is a bit twisted, but my husband and I were talking about sotomayor's possibilties today, and i said i thought they might put forth elizabeth warren just to shut her up.

my husband is a huge history geek (previously in Ivy Ph.D. history program). i laughed at him today (with all the love in my heart of course) when I mentioned the Pecora commission and he said who was Pecora.

Everyone stressed over payment shock on mortgages, until we all realized that the option arm buyers were defaulting almost immediately. This is true else where as well. A lot of the users of this product were flippers. The NEGAM coupled with home price depreciation created underwater loans that much sooner providing double the incentive for the borrower to put the loan(default)....And I almost forgot to add. The borrowers were ALT-A so never fully disclosed their ability to repay. Bunch of NINJA'S I suspect...

Riversider, that chart is for EXISTING option arms, not the ones already foreclosed upon. Some of those loans, yes, may be in the foreclosure chain already, but certainly not all of them.

WaMu and Wachovia were the poster-children for the Ninjas I believe. WaMu's book was horrific. But BofA was also pumping out these loans, and I have no way of knowing if the underwriting was better or worse than WaMu's, but they didn't stop offering option ARMs until spring of '08. Most of the immediate defaults occured in non-recourse states. Not all option ARMs were alt-a, that's overgeneralizing.

Stress test sham: We're encouraging the banks to fudge earnings...
We may not like the quality of earnings in the next couple of quarters, but it
will evidently result in very solid tangible book value creation.” WHAT THE????

Banks critical of stress-test sceptics

By Francesco Guerrera and Saskia Scholtes

Published: May 8 2009 18:32 | Last updated: May 8 2009 18:32

In the tense back-room negotiations that preceded Thursday’s release of the US government’s “stress tests”, bank executives were able to persuade regulators to roll back many of their direst assumptions on the sector’s future health.

As bank executives flooded the briefcases of Treasury and Federal Reserve investigators with brightly-coloured charts, spreadsheets and long presentations, the authorities’ predictions of losses on anything from credit cards to mortgages fell.

But on one point, the 19 financial groups involved in the tests made little inroads with the officials charged with forecasting the lenders’ capital requirements should the economy worsen in 2009 and 2010: the banks’ own earnings predictions.

The issue is crucial because, after a good first quarter, most banks thought that they could earn their way out of the economic crisis by using rising profits to reduce their needs for fresh capital.

But in its forecast that the 19 banks would require an extra $74.6bn in additional equity to withstand future economic shocks, the government took a relatively dim view of the US financial sector’s earnings power.
EDITOR’S CHOICE
US banks attract $11.5bn in a day - May-08
US belatedly learns lesson from Japan - May-08
Wells Fargo chief takes stand against Fed - May-08
Interactive graphic: Stress tested - May-08
In depth: US banks - May-07
BofA aims for $34bn in fresh capital - May-08

In some cases, the discrepancy between the companies’ numbers and the authorities’ findings was marked. Citigroup, for example, told investors its earnings over the next two years could total about $80bn, substantially more than the $49bn forecast by the authorities.

Admittedly, Citi, which will have to add $5.5bn in additional equity after the tests, did not include future writedowns in the forecast – a move that boosted its earnings predictions. But Ned Kelly, its chief financial officer, also complained that the authorities had given the bank “less credit than we would have hoped for . . . expense reductions efforts”.

Bank of America, found to have the biggest capital shortfall at $33.9bn, made similar noises, and even banks that were found not to need any capital, such as JPMorgan Chase, said they would earn more than the authorities think.

Howard Atkins, chief financial officer of Wells Fargo, spoke for many of his colleagues when he decried the government’s view of his bank’s profits.

“The Fed’s results differ considerably from our results,” he said. “We’ve had a 20-year record here at Wells Fargo and if there’s one thing we do know, it’s revenue.”

This is why the San Francisco-based lender only raised $7.5bn in equity to plug the $13.7bn capital gap identified by the tests. Wells pledged to make up much of the remainder through the use of a chink in the tests.

Mr Atkins said that if Wells’ revenues are greater than the government’s assumptions for the next two quarters – before the November 9 deadline for filling the capital shortfall – Wells will receive credit for the difference between its actual earnings and the government’s assumptions, thus reducing its capital need.

Wells said this difference accounted for $2bn in the first quarter.

Scott Siefers, analyst at Sandler O’Neill, said: “If anyone can generate the several billion dollars of excess capital internally, it is Wells Fargo. We may not like the quality of earnings in the next couple of quarters, but it will evidently result in very solid tangible book value creation.”

About Ready. The percentage of Option Arms done with full doc was in the low single digits..They were almost all packaged as Alt-A product with nothing more than a FICO score as proof. A big sham.

riversider, alta-s were also used quite frequently by self-employed individuals. i personally know a few myself. that is a category that is hurting pretty badly, but the people I know who had them were high-income individuals who didn't have easily-produced records. having said that, at least one of those people that I know has been foreclosed upon. a lovely sole practitioner who wasn't prudent enough, but probably would have been given a mortgage with a little effort without the alt-a.

but I haven't seen any statistical info on the option arms that were written late 2007-08, only for those awful 2004 to early 2007 loans. have you seen anything? i'd love a source.

be that as it may be, these are loans that currently exist.

Two of my favorite programs from one of my favorite lenders Countrywide..
Verbal verfication of income and telephonic verification of employment. So much effort when all they needed to do was ask for a year end tax filing. No wonder this country is such a mess. I didn't include appraisal method consisted of a drive by..... Loan sharks perform more due dilligence.

The CLUES Plus Documentation Program permits the verification of employment by alternative means, if necessary, including verbal verification of employment or reviewing paycheck stubs covering the pay period immediately prior to the date of the mortgage loan application. To verify the borrower's assets and the sufficiency of the borrower's funds for closing, Countrywide Home Loans obtains deposit or bank account statements from each prospective borrower for the month immediately prior to the date of the mortgage loan application. Under the CLUES Plus Documentation Program, the maximum Loan-to-Value Ratio is 75% and property values may be based on appraisals comprising only interior and exterior inspections. Cash-out refinances and investor properties are not permitted under the CLUES Plus Documentation Program.

The Streamlined Documentation Program is available for borrowers who are refinancing an existing mortgage loan that was originated or acquired by Countrywide Home Loans provided that, among other things, the mortgage loan has not been more than 30 days delinquent in payment during the previous twelve-month period. Under the Streamlined Documentation Program, appraisals are obtained only if the loan amount of the loan being refinanced had a Loan-to-Value Ratio at the time of origination in excess of 80% or if the loan amount of the new loan being originated is greater than $650,000. In addition, under the Streamlined Documentation Program, a credit report is obtained but only a limited credit review is conducted, no income or asset verification is required, and telephonic verification of employment is permitted. The maximum Loan-to-Value Ratio under the Streamlined Documentation Program ranges up to 95%.

Love the stated income method of borrowing... Reminds me of Tommy Flanagan(john Lovitz)
http://snltranscripts.jt.org/85/85bliar.phtml

Under the Stated Income/Stated Asset Documentation Program, the mortgage loan application is reviewed to determine that the stated income is reasonable for the borrower's employment and that the stated assets are consistent with the borrower's income. The Stated Income/Stated Asset Documentation Program permits maximum Loan-to-Value Ratios up to 90%. Mortgage loans originated under the Stated Income/Stated Asset Documentation Program are generally eligible for sale to Fannie Mae or Freddie Mac.

How come Mozillo is still freely ambulatory? Really.

This is why....

Bush Picks Ameriquest Owner as Ambassador
Firm's Lending Tactics Investigated

By Kirstin Downey
Washington Post Staff Writer
Friday, July 29, 2005; Page D01

On the same day that the White House announced that President Bush is nominating California billionaire Roland E. Arnall to be ambassador to the Netherlands, the company he controls said it would set aside $325 million for a possible settlement of allegations of predatory lending tactics.

Arnall's company, Ameriquest Mortgage Co., is being investigated by regulators in 30 states. A $325 million settlement would be one of the largest ever in a predatory lending case.

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Ameriquest is the nation's biggest privately held mortgage company. The company, which is in negotiations with a group of attorneys general to resolve the investigations, said in a filing with the Securities and Exchange Commission yesterday that the amount "represents the company's best estimate of its maximum financial liability for a comprehensive resolution of this matter."

Arnall is the firm's principal shareholder. He, his wife and their companies have been the biggest political contributors to Bush since 2002.

Speaking about the ambassadorial nomination, White House spokeswoman Erin Healy said: "The president . . . feels Mr. Arnall is well qualified for the position. He had a long career in the private sector and has contributed a great deal to his community."

In a written statement, Arnall said he was "humbled and honored" to be nominated.

Ameriquest is facing complaints of wrongdoing from coast to coast, with thousands of customers seeking restitution. The Connecticut Banking Commission settled cases two weeks ago for $7 million, and a private class-action lawsuit in California, representing about 62,000 claimants, was recently settled for as much as $50 million.

"We've made a lot of progress, but the talks are continuing," said Connecticut Attorney General Richard Blumenthal, who is in the group negotiating with Ameriquest. He said his office had received hundreds of complaints, "numerous and long-standing," about the lender.

In response to requests for comment, Ameriquest yesterday issued a statement that said it "continues to be engaged in discussions with a number of state attorneys general and regulators about the company's business practices. We are focused on resolving the issues under discussion with these agencies and hope to reach a reasonable resolution that is fair to our customers and fair to the company. We do not comment on the specifics of regulatory or legal matters."

In depositions, Ameriquest customers have alleged that they were promised good loan terms but instead got high rates, sometimes higher than they had previously been paying; that their incomes were overstated so they could qualify for the high-price loans; that appraisers overvalued their homes so they seemed valuable enough to secure the loan; and that they learned only after closing that they would be required to pay steep prepayment penalties if they sought to move to other lenders.

Patti Thompson, a secretary, was paying 6.1 percent on the $175,000 loan on her Minneapolis home when a pop-up ad on her computer offered the chance to reduce her monthly payments. She clicked on the ad, filled out a questionnaire and 24 hours later, she was contacted by an Ameriquest employee, who said he could lower her monthly payments and pay off her high-interest credit cards. Within about a week, a closing officer came to her home with documents for her to sign.

The hastiness of the transaction raised "red flags" for the Thompsons, and they tried unsuccessfully to cancel the transaction. They went to another lender, who reviewed their documents and told them their interest rate had been increased to 9.1 percent and that they had been charged $17,000 in settlement costs, bringing their new loan total to $193,000. Their monthly payment rose from $1,300 a month to $1,700 a month. The company did not pay off the credit cards, according to Thompson, and she and her husband filed for bankruptcy in April.

An Ameriquest spokesman said the company would not discuss specific cases but "works very hard" to resolve problems.

Thompson was stunned to learn that the White House would consider Arnall for such a prominent post.

"Does Bush realize what they are doing?" she said. "I hope not. This guy is ripping off people, hardworking people."

And one originator of Liar Mortgages stated exceptions would be granted to guidelines if borrower exhibited ,"PRIDE IN OWNERSHIP"...What is that a welcome doormat?

An investigation into the mortgage crisis by New York State prosecutors is now focusing on whether Wall Street banks withheld crucial information about the risks posed by investments linked to subprime loans.
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Uli Seit for The New York Times

In Queens, an advertisement for a company offering refinancing or credit services to those in danger of foreclosure. The state and others are studying the role of Wall Street banks in enabling the mortgage boom that led to a sharp rise in defaults and foreclosures.

Reports commissioned by the banks raised red flags about high-risk loans known as exceptions, which failed to meet even the lax credit standards of subprime mortgage companies and the Wall Street firms. But the banks did not disclose the details of these reports to credit-rating agencies or investors.

The inquiry, which was opened last summer by New York’s attorney general, Andrew M. Cuomo, centers on how the banks bundled billions of dollars of exception loans and other subprime debt into complex mortgage investments, according to people with knowledge of the matter. Charges could be filed in coming weeks.

In an interview Thursday, Connecticut’s attorney general, Richard Blumenthal, said his office was conducting a similar review and was cooperating with New York prosecutors. The Securities and Exchange Commission is also investigating.

The inquiries highlight Wall Street’s leading role in igniting the mortgage boom that has imploded with a burst of defaults and foreclosures. The crisis is sending shock waves through the financial world, and several big banks are expected to disclose additional losses on mortgage-related investments when they report earnings next week.

As plunging home prices prompt talk of a recession, state prosecutors have zeroed in on the way investment banks handled exception loans. In recent years, lenders, with Wall Street’s blessing, routinely waived their own credit guidelines, and the exceptions often became the rule.

It is unclear how much of the $1 trillion subprime mortgage market is composed of exception loans. Some industry officials say such loans made up a quarter to a half of the portfolios they saw. In some cases, the loans accounted for as much as 80 percent. While exception loans are more likely to default than ordinary subprime loans, it is difficult to know how many of these loans have soured because banks disclose little information about them, officials say.

Wall Street banks bought many of the exception loans from subprime lenders, mixed them with other mortgages and pooled the resulting debt into securities for sale to investors around the world.

The banks also did not disclose how many exception loans were backing the securities they sold. In prospectuses filed with regulators, underwriters, in boilerplate legal language, typically said the exceptions accounted for a “significant” or “substantial” portion. Under securities laws, banks must disclose all material facts about the securities they underwrite.

“Was there material information that should have been disclosed to investors and/or ratings agencies which was not? That is a legal issue,” said Howard Glaser, a consultant based in Washington who worked for Mr. Cuomo when he was secretary of the Department of Housing and Urban Development in the Clinton administration.

Mr. Blumenthal said the disclosures offered by banks in their securities filings appeared to be “overbroad, useless reminders of risks.”

“They can’t be disregarded as a potential defense,” Mr. Blumenthal said. “But a company that knows in effect that the disclosure is deceptive or misleading can’t be shielded from accountability under many circumstances.”

Under Connecticut law, Mr. Blumenthal could bring only civil charges in his inquiry. In New York The Martin Act in New York gives the attorney general broad powers to bring securities cases, and Mr. Cuomo could bring criminal as well as civil charges.

Mr. Cuomo, who declined to comment through a spokesman, subpoenaed several Wall Street banks last summer, including Lehman Brothers and Deutsche Bank, which are big underwriters of mortgage securities; the three major credit-rating companies: Moody’s Investors Service, Standard & Poor’s and Fitch Ratings; and a number of mortgage consultants, known as due diligence firms, which vetted the loans, among them Clayton Holdings in Connecticut and the Bohan Group, based in San Francisco. Mr. Blumenthal said his office issued up to 30 subpoenas in its investigation, which began in late August.

Officials at Wall Street banks and the American Securitization Forum, which represents industry, declined to comment, as did the due diligence firms. Credit-rating firms would not say if they had been subpoenaed but said that they were generally not provided due diligence reports, even when they asked for them.

The S.E.C. is also examining how Wall Street banks sold complex mortgage investments. The commission has about three dozen active investigations in the area, said Walter G. Ricciardi, the deputy director of enforcement. “We have not yet concluded whether the securities laws were broken,” he said.

Investment banks that buy mortgages require lenders to maintain standards outlining who is eligible for loans and how much they can borrow based on their overall credit history. But as home prices surged, subprime lenders, which market to people with weak credit, relaxed their guidelines. They began lending to people who did not provide documents verifying their income — so-called no-doc loans — and made exceptions for borrowers who fell short of even those standards.

The New Century Financial Corporation, for instance, waived its normal credit rules if home buyers put down large down payments, had substantial savings or demonstrated “pride of ownership.” The once-highflying lender, based in Irvine, Calif., filed for bankruptcy last year.

William J. McKay, who was the chief credit officer at New Century, said the company usually made exceptions so homeowners could borrow more money than they qualified for under its rules. In most cases, the decisions raised borrowers’ credit limits by 15 percent, he said.

New Century measured pride of ownership in part by how well buyers maintained their homes relative to their neighbors, Mr. McKay said, adding that this usually was not enough on its own to qualify a borrower for an exception.

Investment banks often bought the exception loans, sometimes at a discount, and packaged them into securities. Deutsche Bank, for example, underwrote securities backed by $1.5 billion of New Century loans in 2006 that included a “substantial” portion of exceptions, according to the prospectus, which lists “pride of ownership” among the reasons the loans were made.

Nearly 26 percent of the loans backing the pool are now delinquent, in foreclosure or have resulted in a repossessed home; some of the securities backed by the loans have been downgraded.

Mr. McKay defends the lending and diligence practices used in the industry. He said Wall Street banks examined exception loans carefully and sometimes declined to buy them. But they often bought them later among mortgages that New Century sold at a discount, he said.

Some industry officials said weak lending standards, not exceptions, were largely to blame for surging defaults. “The problem is not that those exceptions are going bad — you don’t have a lot of exceptions in the pools,” said Ronald F. Greenspan, a senior managing director at FTI Consulting, which has worked on the bankruptcies of many mortgage lenders. “To me it’s a more fundamental underwriting issue.”

To vet mortgages, Wall Street underwriters hired outside due diligence firms to scrutinize loan documents for exceptions, errors and violations of lending laws. But Jay H. Meadows, the chief executive of Rapid Reporting, a firm based in Fort Worth that verifies borrowers’ incomes for mortgage companies, said lenders and investment banks routinely ignored concerns raised by these consultants.

“Common sense was sacrificed on the altar of materialism,” Mr. Meadows said. “We stopped checking.”

And as mortgage lending boomed, many due diligence firms scaled back their checks at Wall Street’s behest. By 2005 , the firms were evaluating as few as 5 percent of loans in mortgage pools they were buying, down from as much as 30 percent at the start of the decade, according to Kathleen Tillwitz, a senior vice president at DBRS, a credit-rating firm that has not been subpoenaed. These firms charged Wall Street banks about $350 to evaluate a loan, so sampling fewer loans cost less.

Furthermore, it was hard for due diligence firms to investigate no-doc loans and other types of mortgages that lacked standard documentation.

“Years ago, it used to be, ‘Did the due diligence firm think it was a good loan?’ ” Ms. Tillwitz said. “We evolved into the current form, which is, ‘Did I underwrite these loans to my guidelines, which can sometimes be vague and allow exceptions?’ ”

The attorneys general are leaning heavily on due diligence firms to provide information that could prove damaging to their clients, the investment banks.

These firms played such a critical role in the mortgage securities business that New Century set aside up to eight large conference rooms in its offices where due diligence experts reviewed loan files. With billions of dollars worth of loans being traded monthly, these specialists had to keep up with a frenetic pace.

“There was somebody in most of the rooms all the time,” Mr. McKay said.

Federal lawmakers have highlighted due diligence in mortgages as a potential problem. A bill by Representative Barney Frank, Democrat of Massachusetts, that the House passed last year would require federal banking regulators and the Securities and Exchange Commission to create due diligence standards. Another measure introduced by Senator Christopher J. Dodd, Democrat of Connecticut, would subject banks to class-action lawsuits unless diligence was conducted by an independent firm.

In recent months, Moody’s and Fitch have said that they would like to receive third-party due diligence reports and that the information should be provided to investors, too. Glenn T. Costello, who heads the residential mortgage group at Fitch, said his firm would not rate securities that include loans from lenders whose procedures and loan files it was not allowed to review.

Correction: January 16, 2008

I think a nice wreath might be considered sufficient also.

Isn't that always the question? Just how stupid was Bush? Dumb or venal. I'm going with both.

George was just following a proud tradition....

Capital Eye
Embassy Row
President Bush continues the tradition of awarding ambassadorships as political favors

By Center for Responsive Politics

August 15, 2005 | U.S. presidents have long rewarded big campaign donors, fundraisers and other loyalists with ambassadorships to desirable countries around the world, and President Bush is no exception.

At least 40 well-connected individuals who have contributed or raised generous amounts of money to help elect Republican candidates since Bush's first campaign for president are currently serving or have been nominated by him to serve as ambassadors.

As a group, they and their immediate families gave a total of $8.8 million to federal candidates and political parties between 1999 and 2004. Of that, $7.7 million, or 88 percent, went to Republicans. Nearly 9 percent, or $757,000, went directly to Bush's two presidential campaigns, his two inaugural funds and the Florida recount fund he formed following the 2000 election.

Twenty-three of the 40 ambassadors and nominees were top Bush fundraisers, raising at least $100,000 for one or both of the president's campaigns for the White House.

Almost all of the nearly $974,000 contributed by the group to Democrats came from Roland Arnall, the billionaire owner of Ameriquest Capital Corp. who Bush nominated last month to be the U.S. envoy to the Netherlands. Arnall and his wife contributed nearly $943,000 to Democrats over the period studied. Their contributions to Republicans were slightly higher, totaling more than $1.1 million.

Not counting the Arnalls' contributions, the remaining ambassadors and nominees donated a total of $6.7 million between 1999 and 2004, of which nearly $6.6 million, or 98 percent, went to Republicans. Totals include contributions to third parties.

The presidential practice of awarding ambassadorships to donors and fundraisers goes back at least as far as Franklin Roosevelt, who nominated Joseph Kennedy to serve in Great Britain. Presidents traditionally reserve about a third of all ambassadorships for friends and political loyalists.

In his first term, Bush nominated the likes of Richard Egan, chairman of data storage giant EMC, to be ambassador to Ireland, and investor Mercer Reynolds as envoy to Switzerland. Egan and his wife contributed $480,100 during the 2000 election cycle alone to Republican candidates and party committees, the Bush-Cheney Inaugural Committee and Florida recount fund. Reynolds and his wife gave a total of more than $456,000 to Republican causes that cycle.

Arnall is by far the biggest Republican donor of the current crop of ambassadors and nominees. His $1.1 million to the GOP between 1999 and 2004 includes a $1 million contribution to the RNC in October 2002 by his wife, Dawn. She also contributed $5 million in August of last year to Progress for America, a Republican-leaning group that worked for Bush's reelection.

Roland and Dawn each were listed as Bush Rangers last year for having raised at least $200,000 for the president's campaign. Roland's company, Ameriquest, contributed a total of $1,000,000 to the president's second inaugural committee. (Company contributions are not included in an individual's totals.)

Investment banker Ronald Spogli, nominated to be ambassador to Italy, is the second-highest Republican donor on the roster of ambassadors and nominees. He and his wife contributed nearly $803,000 to Republicans between 1999 and 2004, including $100,000 to Bush's first inaugural committee. The gave nothing to Democrats.

Spogli, who was Bush's classmate at Harvard Business School, founded the Los Angeles-based investment firm of Freeman Spogli with fellow Bush loyalist Brad Freeman. Spogli attained Pioneer status in both 2000 and 2004 for having raised at least $100,000 for each of Bush's presidential campaigns.

The third-highest donor is GOP fundraiser Catherine Todd Bailey, who is currently serving as ambassador to Latvia. Bailey and her husband, a venture capitalist and former insurance company executive, contributed nearly $621,000 to Republicans between 1999 and 2004. Bailey was listed as a Bush Ranger last year; her husband achieved Pioneer status.

During the 2004 election, Bailey served as Kentucky finance chairwoman for the Bush campaign. She once served as co-chair of Republican Regents, a donor designation of the Republican National Committee.

In all, six ambassadors and nominees, and their immediate families, contributed at least $500,000 to Republicans between 1999 and 2004. Twenty-one gave at least $100,000.

Research by Zach Barter and Doug Weber.

More Information
# Embassy Row: Ambassadors Under President Bush (Opensecrets.org)
Note: Capital Eye Archives contain articles published prior to our site redesign. Unfortunately they may contain old links that no longer function. For more recent content, check out the Capital Eye blog on the News & Analysis tab.

Fair Game
Stress Tests Are Over. The Stress Isn’t.

By GRETCHEN MORGENSON
Published: May 9, 2009

THE beginning of the end of the banking crisis or merely the end of the beginning?
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Times Topics: Gretchen Morgenson

That is what inquiring Americans want to know after last week’s pronouncement that 10 of the nation’s biggest banks must raise $75 billion by November if regulators are going to give them a clean bill of health.

Bank of America, Wells Fargo, GMAC and Citigroup are the neediest institutions, said government stress testers. Nine others, including Bank of New York Mellon, American Express and U.S. Bancorp, were deemed healthy.

“The results released today should provide considerable comfort to investors and the public,” Ben Bernanke, the chairman of the Federal Reserve Board, said in a statement last Thursday when his office released the Supervisory Capital Assessment Program. He added that nearly all of the tested banks had enough capital to absorb higher losses the Fed expected under its “hypothetical adverse scenario.”

With almost 40 pages of charts, graphs and scenarios, the program was a “deliberately stringent test,” its authors said. Clearly, the message they want to send is that the banking mess we have endured for the last two years is finally becoming manageable.

All is under control. Nothing to see here, folks. Move along.

Much as it would be a relief to move on, anyone in search of reality cannot yet conclude that the big banks are out of the woods. The government tests were, in truth, not exceedingly tough. And some of the program’s “adverse” scenarios look more like a day at the beach.

“Let’s not call it a stress test,” said Janet Tavakoli, founder of Tavakoli Structured Finance, a consulting firm in Chicago. “This was a test to try to get a measure of capital adequacy, using broad-brush percentages. I think what they are hoping is that the banks are going to be able to earn their way out of this.”

Some might be able to do that, given the immense taxpayer subsidies they are receiving. Cheap money from government programs translates to delightfully low expenses and the potential for profits where there might otherwise be only losses.

But not all banks will be able to earn enough to see them through. And while no one knows how long our economy will remain under pressure, Ms. Tavakoli said she was certain that the stress tests’ assumptions on worst-case losses at banks were too rosy.

Under the government’s so-called adverse scenario, for instance, banks may experience losses of 8.8 percent over the next two years on first mortgages they hold. A more likely figure, Ms. Tavakoli says, is 10 percent.

“Given what has happened with the economy and unemployment, they are in massive denial,” she said. Losses recently seen in Fannie Mae’s portfolio support this view. In the first quarter, its subprime loans had average losses of around 68 percent; the Fed expects two-year losses in subprime to be, at worst, 28 percent.

For investors interested in a stress test that is free of government spin, Institutional Risk Analytics, a bank analysis and risk management firm, published its own assessment of financial institution soundness last week. Using first-quarter 2009 reports on 7,600 institutions from the Federal Deposit Insurance Corporation, the analysis showed that banks were under increasing pressure.

Christopher Whalen, the editor of Institutional Risk Analyst, said that the data told him that bank losses would not peak until the end of the year; before he combed through the figures, he had thought losses would hit their highs in the second quarter.

Mr. Whalen said he pushed back his estimate for peak losses because banks continued to provision more for loan losses — the reserves bankers set aside for future damage — than they are actually writing off. “We don’t see charge-offs yet,” he said. “When you see banks charging things off, the reserve bill will have ended. Then, you’ll know you are done.”

In the meantime, taxpayer subsidies to banks will help offset some of the losses, he said. But keeping interest rates in the cellar to revive banks has significant costs, Mr. Whalen said. For example, institutions that have agreed to pay out interest on investments that are higher than prevailing rates — think insurance companies and pension plans — are getting killed. “The Fed can’t do this for much longer,” he said.

What’s more, banks’ costs for working out bad loans — whether mortgages or credit card debt — are rising, Mr. Whalen said. In previous downturns, for example, investors would step up and buy bad credit card debt from banks. Yes, the prices they paid were discounted, but at least the banks could write off the loans and move on.

Now, though, buyers for these hobbled portfolios are so rare, and the prices they will pay so low, that banks are hiring their own workout specialists to recover what they can from troubled borrowers. That costs.

It is good that the stress test circus is over. But two lessons remain. First, the effects of a debt binge like the one we have just experienced cannot be worked off either quickly or painlessly. Second, there is the matter of the government’s credibility deficit. Maybe $75 billion will be enough to pull the big banks through this woeful period. But weren’t some of the folks providing these estimates also those who assured us subprime would not be a problem? That, in fact, it would be “contained”?

Yes, indeedy.

So the banks are getting their money at 0% thanks to the Fed and more importantly the taxpayer, yet they need 32% on the credit cards due to the tough economic times they more than helped to create? Can you say usury?

http://abcnews.go.com/Business/Economy/Story?id=7547916&page=1

This is one prediction that I sincerely hope is wrong. Takes a look at the continuing claims unemployment data and projects 13% unemployment(U3) by the end of the year.

http://www.ritholtz.com/blog/2009/05/continuing-claims-vs-economically-lagging-unemployment/

Nice when the regulated can get their way.

http://online.wsj.com/article/SB124182311010302297.html

By DAVID ENRICH, DAN FITZPATRICK and MARSHALL ECKBLAD
The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

The overall reaction to the stress tests, announced Thursday, has been generally positive. But the haggling between the government and the banks shows the sometimes-tense nature of the negotiations that occurred before the final results were made public.

Government officials defended their handling of the stress tests, saying they were responsive to industry feedback while maintaining the tests' rigor.

Interactives: Compare Banks Tested
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Bank by Bank Findings
View Interactive

More interactive graphics and photos When the Fed last month informed banks of its preliminary stress-test findings, executives at corporations including Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. were furious with what they viewed as the Fed's exaggerated capital holes. A senior executive at one bank fumed that the Fed's initial estimate was "mind-numbingly" large. Bank of America was "shocked" when it saw its initial figure, which was more than $50 billion, according to a person familiar with the negotiations.

At least half of the banks pushed back, according to people with direct knowledge of the process. Some argued the Fed was underestimating the banks' ability to cover anticipated losses with revenue growth and aggressive cost-cutting. Others urged regulators to give them more credit for pending transactions that would thicken their capital cushions.

At times, frustrations boiled over. Negotiations with Wells Fargo, where Chairman Richard Kovacevich had publicly derided the stress tests as "asinine," were particularly heated, according to people familiar with the matter. Government officials worried San Francisco-based Wells might file a lawsuit contesting the Fed's findings.

The Fed ultimately accepted some of the banks' pleas, but rejected others. Shortly before the test results were unveiled Thursday, the capital shortfalls at some banks shrank, in some cases dramatically, according to people familiar with the matter.

Bank of America's final gap was $33.9 billion, down from an earlier estimate of more than $50 billion, according to a person familiar with the negotiations.

A Bank of America spokesman wouldn't comment on how much the previous gap was reduced, though he said it resulted from an adjustment for first-quarter results and errors made by regulators in their analysis. "It wasn't lobbying," he said.

Wells Fargo's capital hole shrank to $13.7 billion, according to people familiar with the matter. Before adjusting for first-quarter results and other factors, the figure was $17.3 billion, according to a federal document.

"In the end we agreed with the number. We didn't necessarily like the number," said Wells Fargo Chief Financial Officer Howard Atkins. He said the company was particularly unhappy with the Fed's assumptions about Wells Fargo's revenue outlook.

At Fifth Third Bancorp, the Fed was preparing to tell the Cincinnati-based bank to find $2.6 billion in capital, but the final tally dropped to $1.1 billion. Fifth Third said the decline stemmed in part from regulators giving it credit for selling a part of a business line.

Citigroup's capital shortfall was initially pegged at roughly $35 billion, according to people familiar with the matter. The ultimate number was $5.5 billion. Executives persuaded the Fed to include the future capital-boosting impacts of pending transactions.

Stress Test: Complete Coverage
Wells, Morgan Stanley Quickly Raise $11 Billion WSJ.com/Finance: More stress test news Vote and Discuss
Do the stress test results paint an accurate picture of the financial industry? Weigh in at WSJ.com/Community SunTrust Banks Inc. also persuaded the Fed to significantly reduce the size of its estimated capital gap to $2.2 billion, after identifying mathematical errors in the Fed's earlier calculations, according to a person familiar with the matter.

PNC Financial Services Group Inc., saw a capital hole materialize at the last minute. As recently as Wednesday, PNC executives were under the impression they wouldn't need to find any new capital, according to people familiar with the matter. Thursday morning, the Fed informed PNC that it had a $600 million shortfall.

Regulators said other banks also were told they needed more capital than initially projected.

The Fed's findings were less severe than some experts had been bracing for. A weeklong rally in bank stocks continued Friday, with the KBW Bank Stocks index surging 10%. Investors were especially relieved by the relatively small capital holes at regional banks. Shares of Fifth Third soared 59%, while Regions Financial Corp.'s $2.5 billion deficit led to a 25% leap in its stock.

With the stress tests, government officials were walking a fine line. If the regulators were too tough on banks, they risked angering their constituents and spooking markets. But if they were too soft, the tests could have lost credibility, defeating their basic confidence-building purpose.

All the back-and-forth is typical of the way regulators traditionally wrap up their examinations of banks: Regulators often present preliminary findings to lenders and then give them time to respond. The process can result in changes to the regulators' initial conclusions. Some of the stress-test revisions, for instance, were made to account for the beneficial impact of the industry's strong first-quarter profits.

On Friday, some analysts questioned the yardstick, known as Tier 1 common capital, that regulators chose to assess capital levels. Many experts had assumed the Fed would use a better-known metric called tangible common equity.

According to Gerard Cassidy, an analyst with RBC Capital Markets, the 19 banks' cumulative shortfall would have been more than $68 billion deeper if the government had used the latter metric, which accounts for unrealized losses.

Federal officials said their projections reflected the most comprehensive analysis ever conducted of the industry.

The test results showed that the 19 banks faced a total of $599 billion in losses over the next two years under the government's worst-case, Depression-like scenario. The Fed directed 10 banks to add a total of nearly $75 billion to their capital buffers to insulate themselves from potential losses.

Banks pressed ahead on Friday with plans to fill their capital holes by tapping public markets. Wells Fargo raised $7.5 billion in stock through a public offering. The bank originally planned to raise $6 billion, but expanded the offering, which was valued at $22 a share, due to robust demand. Shares of Wells Fargo rallied $3.42, or 14% to $28.18.

Morgan Stanley, which is facing a $1.8 billion capital hole, raised $4 billion by selling stock. Shares of Morgan rose $1.06, or 4%, to $28.20.

—Robin Sidel and Maurice Tamman contributed to this article.
Write to David Enrich at david.enrich@wsj.com, Dan Fitzpatrick at dan.fitzpatrick@wsj.com

Good article. Can be summed up with
loans valued via accrual accounting will use rediculously generous assumptions
politically motivated swithc to use tier1 capital instead of tangible common equity
banks will retain earnings to beef up capital so don't expect banks to lend
U.S. saver can expect no interest on savings because the banks need NIM
U.S. taxpayer can expect higher taxes. because WHY NOT...

Go Janet!

Ponzi Schemes and Stress Tests
May 8, 2009
by Janet Tavakoli, president of Tavakoli Structured Finance

Now that we are stress testing banks that have merged with entities involved in the housing and municipal bond market debacles, we should also revisit the Ponzi scheme. But first, I'll digress to comment on how we will handle the results of the "stress test" , since that is how we will claim we have solved the banks' problems. While the government will convert preferred shares to voting common shares, this is otherwise simply an accounting game.

Credit derivatives were used for this nonsense in Europe, and we have a name for it: regulatory capital arbitrage. This time the U.S. will dilute shareholder value and claim banks have new capital. Moreover, the "stress tests" are anything but that. The "stress" scenario used in the "test" is my probable base case. You'll recall in August of 2007, Ben Bernanke said subprime losses would only be $50 billion to $100 billion, and I called for more than triple that amount. It turns out I was too optimistic. I was in the right direction then, and I am in the right direction now. Our government is in the habit of telling the truth much too slowly.

We need fiscal stimulus and need to strengthen banks. I believe, however, that we should experience more pain now to gain a better future. Specifically, we should put some banks into receivership and not continue to bail out bank creditors with public money. Likewise we need to enforce controls on securitization (shadow banking) to restore credibility to this powerful tool. Until we confront the fact that global confidence in securitization was shattered by a massive Ponzi scheme, we cannot fix the securitization industry and unfreeze the capital markets. Global investors are waiting for us to clean up our own backyard.

Pundits claiming this was merely a bubble or merely a case of bad models do the industry no favors. There were no black swans or swans of any other color. There were simply Black Barts imitating the highwayman that engaged in bloodless robbery. I just ran across this article in The Deal, which suggest I may be confusing a bubble with a Ponzi scheme. That is not the case. While there was a bubble, it was inflated by a Ponzi scheme. While apologists for our industry may wish otherwise, I explain it again in Dear Mr. Buffett for those who missed it the first time in my book for industry professionals, Structured Finance.

The Wall Street Journal missed a golden opportunity (“Top Broker Accused of $50 Billion Fraud,” December 12, 2008). It wrote that if Madoff’s alleged losses exceeded $50 billion, it would “dwarf past Ponzi schemes.” Yet, Madoff was a piker.

The largest Ponzi scheme in the history of the capital markets is the relationship between failed mortgage lenders and investment banks that securitized the risky overpriced loans and sold these packages to other investors—a Ponzi scheme by every definition applied to Madoff. These and other related deeds led to the largest global credit meltdown in the history of the world.

Investment banks raised money from new investors to pay back old investors (mortgage lenders' dividends to shareholders and investment banking creditors of mortgage lenders which often included themselves). When mortgage lenders imploded, investment banks sped up opaque securitizations to offload worthless tranches of CDOs mixed in with others to careless so-called sophisticated investors along with naive investors. Raising money from new investors to pay back old investors, even if you are the old investor covering up losses, is a Ponzi scheme.

Bernard Madoff confessed—not the securitization “professionals” who work or worked for famous investment banks, certain CDO managers and certain hedge funds. One securitization professional gave an interview to Reuters in which he tried to claim that shady activity was not a Ponzi scheme since CDOs are legal. But using a legal financial instrument to commit fraud is still fraud. If you pawn off product by mixing it into a CDO portfolio, and you know or should know it is worthless (or even simply misrepresented), you must disclose that fact. But that is not what happened. Overpriced and overrated tranches of RMBS, CDOs and even CDO-squared, that on their own wouldn't get a decent bid from any knowledgeable securitization professional, were repacked to sell on to other investors. When new investors dried up, these products were held on the books as if the irresponsible ratings had meaning. This delayed the recognition of losses long enough to get through another bonus cycle.

The SEC has been silent on the dodgy securitization activities it “regulated’ over the past several years. Congress and others agree claiming there will be time to find out who is responsible later. Bail now, scapegoat later.

Legacy investment banks and other bailout recipients have hundreds of billions of dollars worth of assets in opaque accounting buckets known as Level 2 (mark-to-model) and Level 3 (mark-to-management assumptions). Good luck trying to find details. This makes the "stress tests" less meaningful than they already are.

Self proclaimed sophisticated investors like bond insurers are responsible for their own due diligence, and they may not be able to press claims against errant banks and investment banks. But now that the taxpayer has bailed out these entities, and now that the Fed is using taxpayer money to subsidize the funding costs of the banking system, the situation has changed. The U.S. housing market has been damaged along with the municipal bond markets. The net effect is a massive crime on the U.S. economy, and taxpayers, at least, may wish some form of satisfaction in the form of greater regulation and economic clawback.

Some pundits want to claim the problem was mathematical outliers. The real problem is there were too many outright liars hiding behind the curtain of structured finance. Until we squarely face our problems, we cannot fix them. We had a financial Pearl Harbor, but investment bankers piloted many of the planes. We need to face that problem to restore confidence in the financial system. Once-over-lightly stress tests combined with regulatory capital window dressing will not solve our problem. What we need now is financial military police action combined with a financial Marshall Plan to restore our devastated financial system.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008), and
Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (John Wiley & Sons January 2009)

That is fabulous. Madoff was a piker, chilling but hilarious. I called it all a ponzi scheme on here a few months ago and someone told me I was insane. I am insane, but that wasn't the proof.

The ark was build by an amateur. It took professionals to build the Titanic!

Old story.. somehow it seems relevant...

Senate Report Says Rubin Acted Legally in Enron Matter
By RICHARD A. OPPEL Jr.
Published: Friday, January 3, 2003

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A report by the staff of a Senate panel has concluded that Robert E. Rubin ''did not act contrary to law'' in the weeks before Enron collapsed by suggesting to the under secretary of the Treasury that he urge major credit-rating agencies to delay issuing a downgrade of Enron.

Mr. Rubin, who resigned as Treasury secretary in July 1999 and several months later became chairman of Citigroup's executive committee, called Peter R. Fisher, the under secretary of the Treasury, on Nov. 8, 2001, after learning that Enron was close to losing its investment-grade rating.

Citigroup stood to lose more than $1 billion that it had lent to Enron if its credit rating was downgraded and the company subsequently collapsed. Mr. Rubin had been asked to make the call by the head of Citigroup's investment banking unit at the time, Michael A. Carpenter, according to the staff report by the Senate Governmental Affairs Committee.

After news reports last year detailing Mr. Rubin's call, some Republicans in Congress demanded that his actions be investigated, suggesting that his contact with Mr. Fisher was an improper attempt to press his former agency to help Citigroup avoid a huge loss from its exposure to Enron.

The staff report, expected to be released on Friday, says that ''it does not appear that Rubin violated any laws or regulations in contacting Fisher and proposing that the Treasury Department contact a credit rating agency in connection with Enron's rating.''

Mr. Rubin remains a leading Democratic figure, and his call to Mr. Fisher was a delicate issue for Democrats in Congress, including the committee chairman, Joseph I. Lieberman of Connecticut. Revelations of any improper conduct by Mr. Rubin would also have been an embarrassment for Democrats at a time when they were seeking to use the Republican Party's ties to Enron as an election-year issue.

Tonight, a senior Republican staff member on the committee said, ''The report accurately reflects the conclusions that the bipartisan committee staff drew from its investigation.''

Still, the report's findings may prompt criticism from Republicans who have suggested that the phone call was inappropriate and have questioned why Senate Democrats sought to investigate White House links to Enron but did not examine Mr. Rubin's actions more closely.

One Republican senator, Peter G. Fitzgerald of Illinois, demanded in July that the panel examine the actions of Mr. Rubin.

''Any attempt,'' Mr. Fitzgerald said at the time, ''to influence or pressure a credit-rating agency, or to encourage government officials to do so, particularly by a creditor such as Citigroup, with a financial interest in the agency's determinations, is potentially troublesome.''

Tonight, a spokeswoman for Mr. Rubin said, ''This bipartisan report concludes there was nothing improper about this call, and it should put the matter to rest.''

The Senate report concluded that Mr. Rubin did not violate federal rules limiting contacts between cabinet-level officials and their former agencies. Either enough time had passed -- avoiding, for example, the one-year ban on contacting the agency for advocacy purposes -- or because the lifetime ban on contacts involving issues the official worked on ''personally and substantially'' did not apply in this case.

According to the report, officials at Moody's Investors Service -- a major credit-rating agency -- decided the night of Nov. 7, 2001, to downgrade Enron's rating, putting it below investment grade. Within hours, Enron and officials at Citigroup and J. P. Morgan Chase -- which had also lent the company large sums -- started an aggressive campaign to forestall the downgrade.

By 9 a.m. the next day, two top officials of J. P. Morgan -- its chief executive, William B. Harrison Jr., and its vice chairman, James B. Lee -- had called a senior Moody's official, Debra Perry. Ms. Perry later told staff members on the Senate committee that ''she had never been contacted by such high-level bank officials'' about a rating on a company. J. P. Morgan and Citigroup officials met with Moody's officials for three hours that afternoon. After lenders agreed to provide additional financing and changes were secured in terms of a proposed acquisition of Enron by Dynegy Inc., Moody's officials agreed that night to lower Enron's rating but to keep it above investment grade.

At 2:30 that afternoon, Mr. Fisher returned a message from Mr. Rubin. According to Mr. Rubin, the report says, he first told Mr. Fisher that the suggestion he was about to make was ''probably a bad idea.'' Then he stated that a downgrade of Enron might ''wreak havoc in the markets.'' He ''then asked Fisher what he thought'' of calling the credit-rating agencies and asking them to delay downgrading Enron while lenders decided whether to lend more money to the proposed Enron-Dynegy merger.

Mr. Fisher refused, and, according to the Senate report, ''Rubin replied that he thought that was probably the right decision.'' According to Mr. Fisher, the report says, Mr. Rubin also mentioned that a ''nonpublic equity investor'' was involved in discussions about Enron.

Interviewed by Senate staff members, Mr. Rubin said the phone call to Mr. Fisher was ''not only proper, but I would do it again,'' and that the effect Enron's collapse would have on energy markets was worth bringing to the attention of Treasury officials. Asked whether government officials should intervene in a ratings action, Mr. Rubin told staff members that ''he had not given the matter a great deal of thought.''

According to the Senate report, Mr. Carpenter of Citigroup also called Moody's chief executive, John Rutherfurd, about Enron. Also, both Mr. Carpenter and Mr. Harrison of J. P. Morgan Chase called William J. McDonough, the president of the Federal Reserve Bank of New York, on the morning of Nov. 8, though Mr. McDonough did not recall being asked to intervene with the credit-rating agencies.

The report also concluded that Moody's decision that day not to rank Enron below investment grade ''was not based on improper influence or pressure, but on new information'' that ''changed Enron's circumstances.'' The calls to Mr. McDonough do not appear to have violated any regulations, it said.

This sounds about right....

from zero hedge

unday, May 10, 2009
Deutsche Bank's Socialization Of Risk Culture Redux
Posted by Tyler Durden at 1:43 PM
Deepak Moorjani shares the below letter, which initially appeared in NYT's DealBook, but subsequently was taken down for reasons known, and now only a big gaping 404 hole remains in its place (http://dealbook.blogs.nytimes.com/2009/04/16/another-view-deutsche-banks-culture-of-risk/). Moorjani, who is currently involved in litigation with Deutsche Bank, shares his perspectives on his former firm's risk policies and the culture and reward structure that encouraged these, with Zero Hedge readers. The story is all the more relevant as it intersects a core theme for Zero Hedge, that of commercial real estate and the skewed risk/return investment perspective from the bubble years, which we may very well be returning to if the administration gets its releveraging ways.

When speaking about the banking sector, many people mention a “subprime crisis” or a "financial crisis” as if recent write-downs and losses are caused by external events. Where some see coincidence, I see consequence. At Deutsche Bank, I consider our poor results to be a “management debacle,” a natural outcome of unfettered risk-taking, poor incentive structures and the lack of a system of checks and balances.

In my opinion, we took too much risk, failed to manage this risk and broke too many laws and regulations.

For more than two years, I have been working internally to improve the inadequate governance structures and lax internal controls within Deutsche Bank. I joined the firm in 2006 in one of its foreign subsidiaries, and my due diligence revealed management failures as well as inconsistencies between our internal actions and our external statements.

Beginning in late 2006, my conclusions were disseminated internally on a number of occasions, and while not always eloquently stated, my concerns were honest. Unfortunately, raising concerns internally is like trying to clap with one hand. The firm retaliated, and this raises the question: Is it possible to question management’s performance without being marginalized, even when this marginalization might be a violation of law? Two years later, our mounting losses are gaining attention, and I offer my experiences and my thoughts in the hopes of contributing to the shareholder and public policy debate.

Background

Born and raised in Toledo, Ohio, I was infused with Midwestern values of hard work, individual responsibility, honesty, quiet integrity and fiscal prudence. After careers in New York City and Menlo Park, Calif., I moved to Tokyo in 2005 to pursue investments in corporate restructurings and distressed assets. At the time, the Japanese market offered unique opportunities.

I joined Deutsche Bank in 2006 to build an investment business within its commercial real estate lending operation, and I was generally surprised by the aggressive sales culture within our firm. While many people consider the banking sector’s problems to be caused by residential lending, I witnessed multibillion-dollar loan proposals for commercial property.

With funds provided at more than 90 percent loan-to-value, these loans were “priced to perfection” and assumed that property prices and rental rates would continue to rise. For perspective, a single billion-dollar commercial real estate loan is equivalent to 2,000 residential loans of $500,000.

In general, my colleagues are hard-working, decent people, but the system of incentives encourages people to take risks. I have seen honest, high-integrity people lose themselves in this cowboy culture, because more risk-taking generally means better pay. Bizarrely, this risk comes with virtually no liability, and this system of O.P.M. (Other People’s Money) insures that the firm absorbs any losses from bad trades.

As these losses have grown, taxpayers are being forced to absorb these losses. As an example, my firm recently received nearly $12 billion from American International Group (which has effectively been nationalized with $180 billion in taxpayer funds). Essentially, every American household sent my firm a check for $105. The reason for this payment: my firm bought credit default swaps from A.I.G. In plain-speak, we bought unregulated “insurance” from A.I.G. to cover losses from bad trades. What did taxpayers get in return?

Nothing. Taxpayers simply paid an I.O.U. triggered by our gambling losses. (Note: This $12 billion payment was more than 50 percent of our market capitalization at the time of its disclosure).

Solution

While shareholders (and taxpayers) are becoming angry, I think they should be furious. Our management has eviscerated the concept of moral hazard by systematically adopting pay schemes that reward excessive risk-taking despite its long-term implications. If governments have decided to socialize our losses, governments are implicitly saying that the banking industry is fundamentally sound. In effect, governments would be voting in favor of the status quo. In my opinion, the status quo does not work, and we need to address the core issues of structure and compensation. Capping executive compensation is a first step, but as a solution, it is insufficient.

While I am on the “inside” at Deutsche Bank, much of my career has been within partnership structures, and I continue to advocate a partnership-like structure for our firm. With collective liability, partnerships provide a proper alignment of incentives between management and its stakeholders. In a partnership, bonuses are paid from co-investments and profits, not revenues. Losses are shared, and these losses introduce an appropriate penalty for excessive risk-taking. If profits are overstated in one-year, the already-paid bonuses are clawed-back (returned to the partnership).

Conclusion

Our asymmetric incentive structure is fundamental to our problems. The question remains: Do we maintain the status quo and naively hope for better results, or do we begin to implement structural reforms in order to align the incentives? If taxpayers are forced to pay for the losses from bad trades, this socialization of risk adds to the moral hazard problem. This socialization of risk actually encourages more aggressive behavior in the future.

The call-option bonus structure has led to the ascendency of sales over risk management. Maintaining the status quo is not a smart bet, and we cannot afford to ignore the fundamental issues of structure and compensation. We need to introduce personal responsibility into the system, because accountability is glaringly absent. The collective liability aspect of partnerships achieves this goal; collective liability is the most powerful way to align incentives and encourage rational risk-taking.

As an employee and as a shareholder, I am doing my part to build a better firm. Unfortunately, the political landscape within our firm finds it difficult to assimilate any criticism of management’s leadership. To my fellow employees, I ask that you resist the incentives that reward groupthink. To my fellow shareholders, I ask that you implement the changes needed to address our asymmetric incentive structures.

The Born Prophecy
More than a decade ago, Brooksley Born warned that unregulated financial markets were getting out of hand. Now many in Washington wish they’d listened.

May 2009 Issue
By Richard B. Schmitt
Shortly after she was named to head the Commodity Futures Trading Commission in 1996, Brooksley E. Born was invited to lunch by Federal Reserve Chairman Alan Greenspan.

The influential Greenspan was an ardent proponent of unfettered markets. Born was a powerful Washington, D.C., lawyer with a track record for activ­ist causes. Over lunch in his private dining room at the stately headquarters of the Fed in Washington, Green­span probed their differences.

“Well, Brooksley, I guess you and I will never agree about fraud,” Born, in a recent interview, remembers Greenspan saying.

“What is there not to agree on?” Born says she replied.

“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” she recalls him saying. Greenspan, Born says, believed the market would take care of itself.

For the incoming regulator, the meeting was a wake-up call. “That underscored to me how absolutist Alan was in his opposition to any regulation,” Born says.

Over the next three years, Born would learn firsthand the potency of those absolutist views, confronting Greenspan and other powerful figures in the capital over how to regulate Wall Street.

More recently, as an­­alysts sort out the origins of what has be­come the worst financial crisis since the Great Depression, Born has emerged as a sort of modern-day Cassandra. Some people believe the debacle could have been averted or muted had Greenspan and others followed her advice.

Chairing the CFTC, Born advocated reining in the huge and growing market for financial derivatives. De­rivatives get their name because the value is derived from fluctuations in, for example, interest rates or foreign exchange. They started out as ways for big cor­porations and banks to manage their risk across a range of investments. One type of derivative known as a credit-default swap has been a key contributor to the economy’s recent unraveling.

The swaps were sold as a kind of insurance—the insured paid a “premium” as protection in case the cred­itor defaulted on the loan, and the insurer agreed to cover the losses in exchange for that premium. The credit-default swap market—estimated at more than $45 trillion—helped fuel the mortgage boom, allowing lenders to spread their risk further and further, thus generating more and more loans. But because the swaps are not regulated, no one ensured that the parties were able to pay what they promised. When housing prices crashed, the loans also went south, and the massive debt obligations in the derivatives contracts wiped out banks unable to cover them.
UNFORTUNATE TRUTH

Brooksley Born, pictured in 1964 with senior editors
and classmates, was the first woman at Stanford
to become president of the law review.
Photo courtesy of Brooksley E. Born

Back in the 1990s, however, Born’s proposal stirred an almost visceral response from other regulators in the Clinton administration, as well as members of Congress and lobbyists. The economy was sailing along, and the growth of deriv­atives was con­sidered a sign of American innovation and a symbol of the virtues of deregulation. The instruments were also a growing cash cow for the Wall Street firms that peddled them to eager takers.

Ultimately, Greenspan and the other regulators foiled Born’s efforts, and Congress took the extraordinary step of enacting legislation that prohibited her agency from taking any action. Born left government and returned to her private law practice in Washington.

“History already has shown that Greenspan was wrong about virtually everything, and Brooksley was right,” says Frank Partnoy, a former Wall Street investment banker who is now a professor at the University of San Diego law school. “I think she has been entirely vindicated. ... If there is one person we should have listened to, it was Brooksley.”

Speaking out for the first time, Born says she takes no pleasure from the turn of events. She says she was just doing her job based on the evidence in front of her. Looking back, she laments what she says was the outsize influence of Wall Street lobbyists on the process and the refusal of her fellow regulators, especially Greenspan, to discuss even modest reforms.

“Recognizing the dangers ... was not rocket science, but it was contrary to the conventional wisdom and certainly contrary to the economic interests of Wall Street at the moment,” she says.

“I certainly am not pleased with the results,” she adds. “I think the market grew so enormously, with so little oversight and regulation, that it made the financial crisis much deeper and more pervasive than it otherwise would have been.”

Greenspan, who retired from the Fed in 2006, acknowledged in congressional testimony last October that the financial crisis, which he described as a “once-in-a-century credit tsunami,” had exposed a flaw in his market-based ideology.

Alan Greenspan, Robert Rubin,
Lawrence Summers, Arthur Levitt
Photos, clockwise: Claudio Vargas/APF/Getty
Images, Chip Somodevilla/Getty Images,
Chip Somodevilla/Getty Images, Tim Sloan/APF/
Getty Images

He says Born’s characterization of the lunch conversation she recounted does not accurately describe his position on addressing fraud. “This alleged conversation is wholly at variance with my decades-long-held view,” he says, citing an excerpt from his 2007 book, The Age of Turbulence, in which he wrote that more government involvement was needed to root out fraud. Born stands by her story.

Robert Rubin, who was Treasury secretary when Born headed the CFTC, has said that he supported closer scrutiny of financial derivatives but did not believe it politically feasible at the time.

A third regulator opposing Born, Arthur Levitt, who was chairman of the Securities and Exchange Com­mis­sion, says he also now wishes more had been done. “I think it is fair to say that regulators should have considered the implications ... of the exploding derivatives market,” Levitt says.

In a way, the battle had the look and feel of a classic Washington turf war.

The CFTC was created in the 1970s to regulate agricultural commodities markets. By the ’90s, its main business had become overseeing financial products such as stock index futures and currency options, but some in Washington thought it should stick to pork bellies and soybeans. Born’s push for regulation posed a threat to the authority of more established cops on the beat.

“She certainly was not in their league in terms of prominence and stature,” says a lawyer who has known Born for years and requested anonymity to avoid appearing critical of her. “They probably thought: ‘Here is a little person from one of these agencies trying to assertively expand her jurisdiction.’ ”

Brooksley Born
Photo by Erika Larsen

Some of the other regulators have said they had problems with Born’s personal style and found her hard to work with. “I thought it was counterproductive. If you want to move forward ... you engage with parties in a constructive way,” Rubin told the Washington Post. “My recollection was ... this was done in a more strident way.” Levitt says Born was “characterized as being abrasive.”

Her supporters, while acknowledging that Born can be uncompromising when she believes she is right, say those are excuses of people who simply did not want to hear what she had to say.

“She was serious, professional, and she held her ground against those who were not sympathetic to her position,” says Michael Greenberger, a law professor at the University of Maryland who was a top aide to Born at the CFTC. “I don’t think that the failure to be ‘charming’ should be translated into a depiction of stridency.”

Others find a whiff of sexism in the pushback. “The messenger wore a skirt,” says Marna Tucker, a senior partner at Feldesman Tucker Leifer Fidell in D.C. and a longtime friend of Born’s. “Could Alan Greenspan take that?”

Greenspan dismisses the notion that he had problems with Born because she is a woman. He points out that when he took a leave from his consulting firm in the 1970s to accept a job in the Ford administration, he placed an all-female executive team in charge.
PERSISTENCE PERSONIFIED

It was not the first time that Born, 68, had pushed back against convention.

Her doggedness over a career spanning more than 40 years propelled her into the halls of power in Wash­ing­ton. She was a top commercial lawyer at a major firm, as well as a towering figure in the area of women’s rights and a role model for female lawyers. Born was on President Bill Clinton’s short list for attorney general.

One of seven women in the class of 1964 at Stanford Law School, she graduated at the top of her class and was elected president of the law review, the first woman to hold either distinction. She is credited with being the first woman to edit a major American law review.

In the early 1970s, at a time when women had few role models at major law firms, she became a partner at the Washington firm of Arnold & Porter, despite working part time while raising her children.

Born helped establish some of the first public-interest firms in the country focused on issues of gender discrim­ination. She helped rewrite American Bar Associ­ation rules that made it possible for more women and minorities to sit on the federal bench, and she prodded the ABA into taking stands against private clubs that discriminated against women or blacks.

She was used to people trying to push her around, or being perceived as a potential troublemaker. Born remembers being shouted down during an ABA meeting in the 1970s when she proposed that the organization take a position supporting equal rights for gay and lesbian workers. A former ABA president stood up and said “that the subject was so unsavory that it should not be discussed ... and was not germane to the purposes of the ABA,” she recalls. She lost that fight, although the association reversed its stand years later.

“She looks at things not just from a technical perspective or the perspective of an insider. She looks at the perspective of outsiders and how people without power are going to be affected,” says Esther Lardent, president and CEO of the Pro Bono Institute at Georgetown Uni­versity, who worked with Born on various ABA matters. “That is a theme constantly running through her life and career.”

“She is a very polite and low-key person, but she is never somebody who steps back from a disagreement or a fight if it is a matter of importance to her,” Lardent adds. “Did that make people uncomfortable? Did that make the men who dominated the leadership fail to take her seriously enough? I am sure that was the case.”
THE COMMISH

Clinton named her to head the CFTC in 1996. she was not without experience: At Arnold & Porter she had represented the London futures exchange in rule-making and other matters before the commodities agency.

Born also knew how markets could be manipulated, having represented a major Swiss bank in litigation stem­ming from an attempt by the Hunt family of Dallas to corner the silver market in the 1980s.

“Brooksley had the advantage of knowing the law and understanding the fragility of the system if it weren’t regulated,” says Greenberger, her former ad­viser at the CFTC. “She could see that the data points, by lack of regulation, were heading the country into a serious set of calamities—each calamity worse than the one before.”

Under a Republican predecessor, the CFTC had in 1993 largely exempted from regulation more exotic derivatives that involved just two parties. The thinking was that sophisticated entities negotiating individually tailored derivatives could look out for themselves. More generic de­rivatives still had to be traded on exchanges, which were subject to regulation.

By 1997, the over-the-counter derivatives market had more than doubled in size—by one measure reaching an estimated $28 trillion, based on the value of the instruments underlying the contracts. (It has now reached an estimated $600 trillion.)

And some cracks were already surfacing in the landscape. Several customers of Bankers Trust, including Procter & Gamble, sued for fraud and racketeering in connection with several OTC derivatives deals. Orange County, Calif., had gone bankrupt in part because of an OTC derivatives-trading scheme gone awry.

What’s more, all the growth had taken place at a time of economic prosperity. Some people were beginning to ask what would happen if the market suffered a major reversal.

“The exposures were very, very big and if it was your job to worry about things that could go wrong, and I think it was, this is one of the things you couldn’t help but notice,” says Daniel Waldman, a partner at Arnold & Porter who was the CFTC general counsel under Born. “It was only your blind faith in the partic­ipants that could give you much comfort because you really did not know much about the real risks.”

“There was no transparency of these markets at all. No market oversight. No regulator knew what was happening,” Born says. “There was no reporting to anybody.”

She chose what she thought was a middle ground, circulating a draft “concept release” to regulators and trade associations, which was intended to gather information about how the markets operated. She and her staff suspected the industry was trying to exploit the earlier regulatory exemption.

But even the modest proposal got a vituperative response. The dozen or so large banks that wrote most of the OTC derivatives contracts saw the move as a threat to a major profit center. Greenspan and his deregulation-minded brain trust saw no need to upset the status quo. The sheer act of contemplating regulation, they maintained, would cause widespread chaos in markets around the world.

“We would go to conferences and it would be vi­ciously attacked,” Waldman says. “They would just be stomping their feet and pounding the tables.” With Born unlikely to change her mind, the industry focused on working through the other regulators.

Born recalls taking a phone call from Lawrence Summers, then Rubin’s top deputy at the Treasury Department, who complained about the proposal and mentioned that he was taking heat from industry lobbyists. She was not dissuaded. “Of course, we were an independent regulatory agency,” she says.
TUSSLE WITH TREASURY

The debate came to a head April 21, 1998. during a Treasury Department meeting of a presidential working group that included Born and the other top regulators, Greenspan and Rubin took turns attempting to change her mind. Rubin took the lead, she recalls.

“I was told by the secretary of the Treasury that the CFTC had no jurisdiction and, for that reason and that reason alone, we should not go forward,” Born says. “I told him ... that I had never heard anyone assert that we didn’t have statutory jurisdiction ... and I would be happy to see the legal analysis he was basing his position on.”

She says she was never supplied one. “They didn’t have one because it was not a legitimate legal position,” Born says.

Greenspan followed. “He maintained that merely inquiring about the field would drive important and expanding and creative financial business offshore,” she says. CFTC economists later checked for any signs of that and came up with no evidence, Born says.

“It seemed totally inexplicable to me,” Born says of the seeming disinterest her counterparts showed in how the markets were operating. “It was as though the other financial regulators were saying, ‘We don’t want to know.’ ”

She formally launched the proposal on May 7, and within hours, Greenspan, Rubin and Levitt issued a joint statement condemning Born and the CFTC, expressing “grave concern about this action and its possible consequences.” They announced a plan to ask for legislation to stop the CFTC in its tracks.

At congressional hearings that summer, Greenspan and others warned of dire consequences; Born and the CFTC were cast as loose cannons.

Reverting to a theme Born claims he raised at their earlier lunch, Greenspan testified there was no need for government oversight because the derivatives market involved Wall Street “professionals” who could patrol themselves.

Summers, Rubin’s deputy (and now director of the National Economic Council), said the memo had “cast the shadow of regulatory uncertainty over an otherwise thriving market, raising risks for the stability and competitiveness of American derivative trading.”

Born assailed the legislation, calling it an unprecedented move to undermine the independence of a federal agency. In eerily prescient testimony, she warned of potentially disastrous and widespread consequences for the public. “Losses resulting from misuse of OTC derivatives instruments or from sales practice abuses in the OTC derivatives market can affect many Ameri­cans,” she testified that July. “Many of us have interests in the corporations, mutual funds, pension funds, insurance companies, municipalities and other entities trading in these instruments.”

That September, seemingly bolstering her case, the Federal Reserve Bank of New York was forced to organize a rescue of a large private investment firm, Long-Term Capital Management, which was a big player in the OTC derivatives market. Fed officials said they acted to avoid a meltdown that could have affected the wider economy.

But the tide of opinion that had risen up against Born was irreversible. Language was slipped into an agriculture appropriations bill barring the CFTC from taking action in the six months left in her term.

“I felt as though that, at least, relieved me and the commission of any public responsibility for what was happening,” she says. Clinton aides sounded her out about a second term, but she said she wasn’t interested and left the agency in June 1999.

A year later, Congress enacted the Commodity Futures Modernization Act, which effectively gutted the ability of the CFTC to regulate OTC derivatives. With no other agency picking up the slack, the market grew, unchecked.

Some observers say now that the episode and infighting showed how, even a decade ago, a patchwork system of regulating Wall Street was badly in need of reform.

“The fact that the ... issue created such a threat to the marketplace to me confirmed the fact that something was not right,” says Richard A. Miller, vice president and corporate counsel for Prudential Insurance Company of America and editor of the widely read Futures and Derivatives Law Reporter.

“How could we have a system that hangs together by such a narrow thread?” Miller asks. He testified at the time that the idea Born proffered should at least have been considered.

The Obama administration has pledged an overhaul of the financial system, including the way derivatives are regulated. Worrisome to some observers is the fact that his economic team includes some former Treasury officials who were lined up in opposition to Born a decade ago.

Born, who retired from her law firm in 2003, is not playing a formal role in the process. An outdoor en­thusiast, she traveled to Antarctica last winter, as the Obama team was settling in. “The important thing,” she advises, “is that the new administration should not be listening to just one point of view.”

Fascinating piece on the history of the government pushing for home ownership:

http://www.city-journal.org/2009/19_2_homeownership.html

reminds me of the plan to bring democracy to iraq and the rest of the middle east. will we ever learn?

i usually don't read HuffPo, but Naked Capitalism linked to this. Very interesting analysis, particularly of what might or might not be Obama's game plan.

http://www.huffingtonpost.com/robert-kuttner/collateral-damage-and-dou_b_201373.html

Bloomberg reporting on the stressors caused by uncertainty:

http://www.bloomberg.com/apps/harvardbusiness?sid=H39706cab47d56cbc19d95ae97d1f83e4

Evans-Pritchard, always a cheery sort:

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/5301123/bEnjoy-the-rally-while-it-lasts---but-expect-to-take-a-sucker-punchb.html

BUT 80% thought citi had GOOD OVERSIGHT? THIS IS WHAT'S WRONG WITH CORP AMERICA....

Shareholders of Citigroup withheld more than 20 percent of their votes for the re-election of four directors, after critics said the board’s lack of oversight contributed to a series of government bailouts and $37.5 billion of losses over 15 months.

According to a regulatory filing, C. Michael Armstrong, the former chief executive of AT&T and a former chairman of the bank’s audit committee, received just 70 percent of votes in his favor at Citigroup’s annual meeting last month, Reuters reports.

John M. Deutch, his successor on the audit committee and an M.I.T. professor, got 72 percent. Two other directors — Alain J.P. Belda, Alcoa’s chairman, and Anne Mulcahy, Xerox’s chief executive — each got 77 percent of the vote in their favor.

Citigroup’s chief executive, Vikram S. Pandit, won 91 percent support, and the bank’s chairman, Richard D. Parsons, the former chief executive of Time Warner, got 86 percent, the bank’s filing with the Securities and Exchange Commission shows.

Citigroup’s board has 14 members, after the replacement of five directors over the last year and installation of four new directors. The departing directors include former Treasury Secretary Robert E. Rubin and Winfried F.W. Bischoff, who preceded Mr. Parsons as chairman.

The government is expected to become Citigroup’s largest shareholder, with a potential 34 percent stake, when the bank, based in New York, completes a preferred stock conversion as soon as this month.

More oversight, A great video too. You decide stonewalling or clueless...Either way we'll never know what happened to our money..

http://www.salon.com/opinion/greenwald/2009/05/07/oversight/

Good morning Riversider!

Economists (that spot on group) now downgrade recovery prospects:

http://www.bloomberg.com/apps/news?pid=20601087&sid=a_sshBl4b2ok&refer=home

Rosenber (spot on, without sarcasm, calls the suckers rally, is still calling it ugly, oh, and goodbye MER):

http://www.bloomberg.com/apps/news?pid=20601087&sid=a_sshBl4b2ok&refer=home

Tyler Cowen discusses the chain of command in tackling the economic crisis and find congress wanting (who doesn't find congress wanting, is what I'd like to know):

http://www.nytimes.com/2009/05/10/business/economy/10view.html

Meredith Whitney STILL hates bank stocks, is stunned by stress test leaks, and says to short retail. She also repeats what I think is one of the most important keys to moving forward, the banks cutting consumer credit lines.

http://www.calculatedriskblog.com/2009/05/meredith-whitney-on-cnbc.html

Meredith's the babe! She's right. The banks are GSE's so they won't fail. A bunch of zombies. Can't expect growth from the living dead...

What have we learned?

http://www.federalreserve.gov/boarddocs/testimony/19981001.htm

NPR exposes Elizabeth Warren's agenda..

http://www.npr.org/blogs/money/2009/05/hear_elizabeth_warren_checks_i.html

i'm hoping you're being saracastic.

Sorry Columbia, she was hired to be a TARP watch dog. Her goals are admirable, but she's overstepping her authority.

well, here we go. I don't like to post entire articles usually, but this one i'll do.

In Defense Of Elizabeth Warren
John Carney|Apr. 23, 2009, 8:30 AM|26
PrintTags: Economy, Treasury, TARP, Tim Geithner, Politics, U.S. Government, Financial Crisis, Banks, Bailout, Financial Services, Credit Crisis, Federal Reserve
Elizabeth Warren has quickly emerged as one of the leading critics of the Obama administration's bailout plans. Her sharply worded missives on the faults of the bailout plans have surprisingly rubbed some pundits the wrong way, resulting in a fierce backlash. Most of this backlash, however, is more confused than it is convincing.

At the heart of the matter is the contention that Warren has somehow stepped beyond the parameters of her role as a TARP watchdog to become a shadow Treasury Secretary. This accusation, however, is built on an uninformed and unduly constrained view of her role as chair of the Congressiional Oversight Panel. The panel was not charged with simply watching the TARP funds go and monitoring their effectiveness. It was charged, in a law duly passed by both houses of Congress and signed by the president, with reporting to Congress on "the current state of the financial markets and the regulatory system."

That's a very broad mandate. Is it too broad? Critics who take this position are actually not criticizing Warren but the underlying statute. Still, they'd be wrong to do this. Warren's mandate needs to be broad because the TARP is overly broad.

When it passed the TARP, Congress granted the executive branch an almost unprecedently broad authority to rescue the financial system. The programs for rescuing the financial system have dramatically changed shape several times. None of those that have been put into effect are anything like the program that was touted when the law was passed. There's an argument to be made that this original grant was unconstitutionally broad, a surrender of rule-making authority that should properly sit with the legislative branch. But that's water under the bridge. Given the open-endedness of the TARP, Warren's authority also had to be somewhat open ended.

If anyone should be criticized for improper power grabs, it should be Tim Geithner. He attempted to unilatterally exempt players in his deranged P-PIP scheme from legally mandated salary caps, and had to be reigned in by Treasury's own lawyers. He has been putting conditions on the repayment of TARP funds in violation of the law. The scope of his office is far beyond anything dreamed of by the framers of the constitution or even most recent occupants.

Keep in mind that Warren's actual authority is quite limited. She lacks subpoena power. She has no ability to enforce her opinions. She cannot order Treasury or banks to perform any tasks, answer any inquiries or withhold from any activities. All she can do is talk. She's something of a public advocate, speaking as an outside critic. That's something that's very valuable given the refusal of the Obama administration to engage in public deliberation about its bailout plans.

Is it beyond the pale for her to question the underlying assumptions of the TARP rather than simply critiquing its execution? Well, if she were doing that, it would be a problem. After all, the TARP was approved by both houses of Congress and signed into law by the president. She isn't questioning the availability of billions to rescue the financial system. Instead, her critique has been far narrower, confined to the programs developed by the administration to carry out this legal mandate. That is certainly within the legally mandated scope of her office.

By the way, her job is not simply to watch the TARP money flows. That job sits with the Treasury Department, which has its own internal watchdog--Neil Barofsky--who has also been sharply critical of the lack of internal controls over the TARP. Warren's job was intentionally created to be much broader than Barofsky's.

Probably the best critique of Warren's office is to say that it allows lawmakers to get off the hook when it comes to their own oversight duties. Rather than delegate supervision to an oversight panel, it would be far better if oversight was handled directly by a Congressional committee led by an elected representative. Congressmen love to delegate their powers, however, because it allows them to have their cake and eat it too: they escape direct accountability for the critique while still keeping a check on executive power.

But a strict non-delegation requirement would put Congress on an uneven footing with the adminstration, which has a delegation problem of its own. The Treasury Secretary is, after all, exercising authority that should properly sit with the president himself. The president too enjoys the non-accountability of delegation. Basically, the system now works with delegation on both sides. That's regretable but trying to limit delegation in one branch and not another would shift the constitutional balance of powers.

There's also an objection that Warren's experience is lacking and her arguments lack depth. This is also wrong-headed. While Warren may lack experience in judging the best way to prevent the financial system from collapsing, so does everyone else in the world. We're in uncharted waters here, tryng to peice together what might work from limited historical examples. No one's experience running an investment bank, running a branch of the Federal Reserve, handling corporate bankruptcies, working for the FDIC or doing anything else during more normal times can possibly provide authoritative experience in our current situation.

Most importantly, whatever Warren's short-comings might be, she is right about several problems at the core of the Obama administration's bailout programs. The financial system will not be fixed by providing subsidies to market failures. It's strange to hear otherwise market oriented people react with disgust to this basic insight. If anything, they should be thanking Warren for reminding us that even in these panicked times, basic ecoomic principles continue to operate.

http://www.house.gov/delahunt/bailoutsummary.pdf

http://www.publicmarkup.org/bill/emergency-economic-stabilization-act-2008/1/104/

I'll summarize
congress dropped the ball(Barney Frank, Chris Dodd?
OTS dropped the ball...James Gilleran , Darrel Dochow
Fed dropped the ball ...Greenspan
Treasury drooped the ball Rubin,Summers, Geithner
Presidents dropped the ball Clinton, Bush

people we should listen to more
Brooksley Born , Sheila Baird, William Black, Joseph Stiglitz, Paul Volcker

Yes, but I would add Elizabeth Warren to the plus. Joseph Stiglitz and Volcker are superb. But I think we can add a few analysts. David Rosenberg hasn't really been wrong (macro) much the last few years, although if you were in it just for the stock market going long, maybe a bit (shorts can be a bitch). Bill Fleckenstein, Meredith Whitney, MacroMan, etc., all people committed to making money out of the market, who told us repeatedly to watch out.

Can we redo the last 20 years? Nobody would ever suggest that the Drug companies run the FDA, but somehow when it comes to finance, this isn't an issue....

Elziabeth Warren's blog in case anyone is interested....
http://www.creditslips.org/creditslips/2007/11/hostage-value.html

puke. revolution.

"Can anyone tell us where The Fed has put their couple of trillion in "Help" for the economy, who they're lending to, whether or not the collateral is performing reasonably well, or....

Is Bernanke and the rest of The Fed simply doing whatever the hell they'd like, and the so-called "Inspector General" is literally sitting on her hands and refusing to do her job?"

http://market-ticker.denninger.net/archives/1031-Fed-Oversight-Intentionally-Absent.html

This was such an obvious case of stonewalling!

More lying..... Anyone belive Timmy's story?

By David Cho and Brady Dennis
Washington Post Staff Writers
Wednesday, May 13, 2009

As American International Group chief executive Edward M. Liddy returns to Washington to face Congress today, new details are emerging about how long federal officials were aware of the company's recent bonus payments to its executives and of how inflammatory the payments could be.
This Story

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Officials Knew of AIG Bonuses Months Before Firestorm
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Special Report: AIG

Documents show that senior officials at the Federal Reserve Bank of New York received details about the bonuses more than five months before the firestorm erupted and were deeply engaged with AIG as well as outside lawyers, auditors and public relations firms about the potential controversy. But the New York Fed did not raise the alarm with the Obama administration until the end of February.

Timothy F. Geithner, who became Treasury secretary early this year, was the head of the New York Fed when it became aware of the bonus details. But his name is not among those of senior New York Fed officials mentioned in the summaries of phone calls, correspondence and other documents obtained by The Washington Post.

Those documents also illuminate who in the government, beyond the New York Fed, knew what about the bonuses at AIG's most troubled unit, and when.

Key members of Congress began investigating the payments as long ago as October and, beginning in January, repeatedly warned the Treasury about the matter.

In early February, Fed officials in New York sent details about the bonus program to their counterparts at the Federal Reserve in Washington, to prepare Chairman Ben S. Bernanke in case he was asked about the payments at a congressional hearing.
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By the time the Obama administration was fully engaged in early March, the New York Fed had determined that AIG was legally bound to pay the bonuses to its Financial Products division, the documents show. Top New York Fed officials also huddled with AIG about developing a strategy to mollify angry lawmakers -- but that did little to quell the firestorm that ensued.

The furor over the bonus payments at AIG -- the crippled insurance giant that is benefiting from a government bailout of more than $180 billion -- disappeared from public view as quickly as it erupted in mid-March.

At the height of the controversy, the House passed a resolution that would tax the bonuses at 90 percent and the Senate introduced an even harsher bill, which it abandoned as AIG employees began promising to return the money.

But even after the storm, the fallout remains. As the financial crisis demands their attention, senior Treasury officials have met several times a week since March to review, one by one, the bonuses of even lower-ranking AIG executives, sources familiar with the discussions said. Geithner attended some of the initial meetings.

Ongoing Legal, Tax Issues

AIG is still grappling with the legal and tax issues surrounding the bonuses while trying to stay afloat. And while employees of AIG's Financial Products division have said they intend to repay nearly a third of their $165 million in bonuses in response to the public outcry, it is unclear when or how much will be returned.

After the initial $85 billion federal bailout of AIG in September, the New York Fed, which is accustomed to dealing with banks, struggled to understand a complex global insurance company.
"They really didn't know us at all," said one AIG executive, who was not authorized to speak publicly. "We had a real education process with them. They were asking us questions on a gazillion different issues."
This Story

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Officials Knew of AIG Bonuses Months Before Firestorm
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Special Report: AIG

By Sept. 29, the bonus matter first appeared on the radar of the New York Fed, which was designated as the primary contact for AIG, documents show. Senior officials from the New York Fed met with AIG officials to discuss the compensation plans in place at Financial Products, whose risky derivative contracts had brought the insurance giant to the brink of collapse.

AIG e-mailed officials at the New York Fed copies of the company's compensation plans, which detailed bonuses and retention payments, including those at Financial Products, documents show. The issue arose in scores of meetings and conference calls over the ensuing months. AIG also disclosed its retention programs in public filings.

For the New York Fed, the primary contacts were Jim Hennessy, counsel and vice president, and Sarah Dahlgren, a senior vice president and head of its bank supervision group. Leading the effort at AIG was Anastasia Kelly, the company's executive vice president and general counsel. Ernst & Young participated as an outside auditor, along with New York law firms including Sullivan & Cromwell.

Throughout the fall, the correspondence between New York Fed officials and AIG proceeded but without the urgency of later discussions. The company was still in danger of imploding -- along with the rest of the financial system -- so examining bonus payments to several hundred employees was not a top priority among the Fed officials.

Geithner has said in interviews that he was getting regular updates as president of the New York Fed and was vaguely aware of the bonus issue but that he was not apprised of the specifics.
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A Political Storm Erupts

The spark that would grow into a political firestorm began in October when lawmakers began to request documents about the compensation at Financial Products.

Rep. Elijah E. Cummings (D-Md.) in particular latched on to the issue.

By January, AIG was feeling heat from lawyers at the House Financial Services Committee, and from the offices of Rep. Paul E. Kanjorski (D-Pa.) and Rep. Joseph Crowley (D-N.Y.), who one staff member noted in an e-mail to AIG was "very upset about these payments." Kanjorski has said that around this time his staff began calling the Treasury about the issue and sending letters, but communication was hindered by the transition between administrations.

The frequency and urgency of the correspondence between AIG and the New York Fed ratcheted up. Fed officials openly debated with AIG officials over how to handle the coming storm and examined whether there was a legal way to escape making the bonus payments or at least delay them.

"Did we think people were not going to like this? Sure," an AIG executive said. "But did we think it was going to be the Armageddon of compensation? No, we didn't."

The New York Fed officials continued to keep their bosses in Washington updated. On Feb. 9, Hennessey e-mailed the Fed in Washington, informing officials that the retention programs were devised in 2007 -- "another fact relevant to any question Bernanke gets on FP retention."

Bernanke has said in congressional testimony that he was not made aware of the issue until around March 10. After his staff informed him about it, he tried to stop the payments but was counseled by Fed attorneys that there may be no legal way to do so.
This Story

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Officials Knew of AIG Bonuses Months Before Firestorm
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Special Report: AIG

In Plain Language

As the outcry on Capitol Hill grew louder, Hennessy of the New York Fed sent an e-mail to Stephen Albrecht, a Treasury attorney, on Feb. 28, documents show. The correspondence was intended to set off alarm bells: More than $160 million in bonuses would be paid in March to AIG's Financial Products unit, the e-mail stated plainly.

"This was triage, Treasury triage," said the AIG executive, noting the department had been largely absent from the discussions to that point. "When they finally realized it was a heart attack and not the measles, it was too late."

By that time, senior officials at the New York Fed and AIG were resigned that nothing could be done to stop the bonuses. On March 2, Hennessy received an opinion from an outside legal counsel concluding that AIG could be sued if it failed to make the payments as originally crafted.

That same day, the company posted a $62 billion loss for the first quarter of 2008, the largest corporate loss in U.S. history. The government announced its fourth bailout for the firm, raising the total rescue package to more than $180 billion.

After growing convinced they could not restructure the payments, Hennessy, Dahlgren and top AIG officials focused on devising a strategy for presenting the matter to Capitol Hill.

Senior Treasury officials have said they had been aware of the bonuses, but not their specifics, since early February. But the e-mails from Hennessy alerted the department that big trouble was on its way.
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Geithner said in interviews that he had been preoccupied with the financial crisis and was taken aback when he was told about the extent of the bonuses. But he said he took responsibility for not knowing about the details of the bonuses earlier.

Geithner called Liddy on March 11, demanding that the company restructure the bonuses. Liddy began drafting a letter that bowed to some of Geithner's concerns. Because the letter was to be released publicly, Treasury officials reviewed drafts and suggested changes.

The letter was released March 14. But it was too late. The bonuses to executives at Financial Products were already heading out the door.

http://blogs.ft.com/maverecon/2009/05/inflection-points-and-turning-points-since-you-asked/

This can't be making the banks happy. GS caved in, Mass AG, over predatory lending:
http://brucekrasting.blogspot.com/2009/05/goldman-folds-in-boston-what-does-it.html

This is for Mmafia, a psalm for gold.
http://nihoncassandra.blogspot.com/2009/05/financial-psalm-16.html

Greenspan,Rubin,Summers & Geithner must be choking on this one.. Go Brooksley!

Obama Pushes Broad Rules for Oversight of Derivatives
By STEPHEN LABATON
Published: May 13, 2009

WASHINGTON — Marking its first major effort to overhaul financial regulation, the Obama administration will seek new authority to supervise the virtually unregulated complex financial instruments, known as derivatives, that were a major cause of the market crisis, Congressional aides and others who have been briefed on the decision said Wednesday.
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The administration will ask Congress to approve legislation that would impose a new government oversight structure for the instruments, which Warren Buffett once called “weapons of mass destruction.”

In a two-page letter to Congressional leaders, Treasury Secretary Timothy F. Geithner asked for the swift approval of a measure that would require many kinds of derivative instruments, including credit default swaps, to be traded on exchanges and subject to tighter regulation. Derivatives can take many forms, but in total there are trillions of dollars’ worth exchanging hands every day around the globe.

The letter asked the lawmakers to give regulators the authority to impose new capital and business conduct requirements on the large Wall Street companies that issue the financial instruments. Capital requirements would, for example, require companies that issue derivatives to hold capital in reserve in case of a default, much the way banks must hold reserves when they make loans.

The letter leaves it to Congress to decide whether the Securities and Exchange Commission or the Commodity Futures Trading Commission would be playing the lead role in supervising the new system for trading such instruments.

People briefed on the plan said the administration had asserted four major principles guiding the legislative process. The legislation should be aimed at reducing trading practices that pose major risks to the financial system. The regulatory overhaul should promote efficiency and transparency in the markets. The legislation should discourage market manipulation and fraud. And it should protect investors.

Credit default swaps, a type of derivative instrument that acts like an insurance policy by protecting investors from defaults of mortgage backed securities, played a central role in the collapse of American International Group. The company, one of the largest issuers of such swaps, nearly collapsed as a result of issuing a huge volume of such instruments that it was unable to support.

Mr. Geithner, along with the leaders from the two agencies, was set to brief reporters about the proposal at the Treasury Department late Wednesday afternoon.

The proposal would not require that derivative instruments with unique characteristics negotiated between companies be traded on exchanges or through clearinghouses. But standardized or uniform ones would. If approved, the plan would require the development of timely reports of trades, similar to the system now used for corporate bonds.

During his confirmation hearings in January, Mr. Geithner vowed to move quickly to push for regulation of derivative instruments, and both Mary Schapiro, the new head of the Securities and Exchange Commission, and Gary Gensler, the nominee to head to the C.F.T.C., also made similar commitments.

Lawmakers in the House and Senate have already introduced legislation to regulate derivative instruments. But a number of members have pressed the administration to put out its own plan. Last Friday, at the confirmation hearing of Neal Wolin to be the next deputy Treasury secretary, Senator Maria Cantwell, Democrat of Washington, pressed the nominee to move quickly to get the administration’s views on the regulation of derivatives.

In his memoir, Seidman offered a set of lessons learned. They included, “Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid.”
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May 13 (Bloomberg) -- L. William Seidman, who chaired the government agency that seized and liquidated hundreds of failed savings-and-loans in the late 1980s and early 1990s, has died. He was 88.

Seidman died today in Albuquerque, New Mexico, after a brief illness, according to an article posted by CNBC, which employed him as a commentator.

In a long career, Seidman ran businesses, oversaw them as the nation’s top banking regulator and analyzed them as part of the media. He was, among his many roles, managing partner of the accounting firm founded by his family, the top economic adviser to President Gerald Ford, chairman of the Federal Deposit Insurance Co. and chief commentator at CNBC.

He led the FDIC -- the government agency that insures bank accounts -- from 1985 to 1991, a period when rising interest rates, deregulation, changes in tax law and bad real-estate loans triggered thousands of bank and thrift failures. He worked with Congress on 1989 legislation that created the Resolution Trust Corp. to solve the mess.

Seidman, as FDIC head, became chairman of the RTC, which was given until the end of 1995 to accomplish a massive job with goals that Seidman later said were “forever in conflict” -- to sell the shopping centers, vacant office buildings, residential developments and other assets of failed savings and loans institutions quickly, for maximum value, and with minimal impact to the larger market.

Bad Situation

“The job combined all the best aspects of an undertaker, an IRS agent and a garbage collector,” Seidman wrote in his 1993 memoir. “Each savings and loan arrived with records in disarray, key personnel gone, lawsuits by the hundreds and a management that was still mismanaging or had departed and left the cupboard bare.”

The current FDIC chairman, Sheila Bair, said in a statement today that Seidman presided “with courageous leadership and sharp intellect” during a difficult time for the FDIC. “His plain-speaking and straightforward approach made him a gifted communicator,” she said.

Seidman shaped the RTC along with David C. Cooke, his deputy at the FDIC, who took on the added role of RTC chief executive.

Asset Sales

Top priority was given to closing deals. Prices on real estate and other assets were marked down to make sales. In a 1990 speech in Washington, Seidman laid out a marketing strategy that included retiring the phrase “bad assets” in favor of the sunnier “opportunity asset inventory.” He thought up “the world’s biggest real-estate auction,” an international event to dispose of properties collectively worth $300 million. It was canceled in a dispute between the RTC and its auctioneer.

Seidman stepped down from the FDIC and RTC in October 1991 and began his television career at CNBC. The RTC shut down at the end of 1995, having closed or otherwise resolved 747 thrifts, with total assets of $394 billion. The cost of bailing out the U.S. thrift industry totaled $152.9 billion, according to an FDIC analysis -- $123.8 billion paid by taxpayers, $29.1 billion by banks and solvent thrifts.

In his memoir, Seidman offered a set of lessons learned. They included, “Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid.”

Fixing Broken Banks

When that next crisis arrived, in 2008 in the form of a credit crunch caused by bad mortgages, Seidman called for swift government intervention modeled on the RTC experience. “What we did, we took over the bank, nationalized it, fired the management, took out the bad assets and put a good bank back in the system,” he said on CNBC in January 2009.

Lewis William Seidman was born on April 29, 1921, in Grand Rapids, Michigan, where he was an all-conference halfback for his school football team. His father, Frank, had come to the U.S. from Russia as a child and became a multimillionaire through Seidman & Seidman, the accounting firm he founded in 1910 with his brother, Maximillian.

Seidman earned a bachelor’s degree at Dartmouth College, where he majored in economics, in 1943, and went on to receive a law degree from Harvard University and a master’s in business administration from the University of Michigan. A year after graduating from Dartmouth he married his wife, Sally. They had six children.

He served in the U.S. Navy during World War II. As an ensign on a destroyer in the Pacific Ocean, he earned a Bronze Star Medal for his actions during a torpedo run on a Japanese warship.

Early Career

In 1950 he joined Seidman & Seidman and served as managing partner from 1968 to 1974. Under his tenure, the firm -- which today is BDO Seidman LLP -- became one of the 10 largest public accounting firms in the U.S. He also founded and ran a media company called Sumercom.

Entering politics, he was special assistant on financial affairs to Michigan Governor George W. Romney and worked on Romney’s ultimately unsuccessful bid for the Republican presidential nomination in 1968.

In his one bid for public office, backed by Romney, Seidman ran for Michigan auditor general in 1962. He won the Republican nomination with help from his friend Ford, then a congressman and the future president, only to lose the general election by just 22,000 votes out of 2.6 million cast.

President Ford

Seidman left his family firm in February 1974 to consult on management and budget issues for Ford, his longtime friend from Grand Rapids who then was U.S. vice president. When Ford ascended to the presidency 18 months later, he made Seidman his assistant for economic affairs. In that role from 1974 to 1977, Seidman helped develop proposals to deregulate transportation and led economic summit meetings on inflation. He enjoyed direct access to Ford, bypassing the chief of staff, Robert T. Hartmann.

From 1977 to 1982, Seidman was vice chairman and chief financial officer of the Phelps Dodge Corp.

He was dean of Arizona State University’s business school when, in 1985, President Ronald Reagan chose him to lead the FDIC.

As the savings and loan crisis developed, the agency was left to “baby-sit” failed institutions, Seidman recalled. “We argued long and hard that the FDIC should not be the agency entrusted with this mess.”

His orangeness may finally be going down. I am putting up a cnbc link. It's also being reported at the WSJ, but I don't link to things that aren't accessible.

http://www.cnbc.com/id/30729475

i don't know where I found this, maybe kedrosky, but it's hilarious. for you traders who might be having a hell of a week (or not, depending):

http://www.rattraders.com/methodology

Angelo Mozillo reminds me of a great Seidman quote...

In his memoir [published in 1993], Seidman offered a set of lessons learned. They included, “Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid.”

The first is an article on the dangers of deflation, the camp I happen to be in:

http://www.economist.com/opinion/displaystory.cfm?story_id=13610845

I usually don't quote from Financial Armageddon (Panzer is respected, but the phrase itself seems over-the-top. The site is interesting in that it is one of the few to try to examine how this actually affects people on a daily basis, and it has the best blog roll), but this caught my eye. A discussion on where the wealthy are spending, and their attitudes. Underlying data seems good.

http://www.financialarmageddon.com/2009/05/not-so-different-from-you-and-me.html

Have a look at this chart, states' tax receipts. we're bailing out the banks, but letting the states implode:

http://economix.blogs.nytimes.com/2009/05/13/state-taxes-take-a-nose-dive/

I recommend having a look at the complete Stanford piece:

http://www.nakedcapitalism.com/2009/05/munger-on-phony-accounting-cultural.html

Mark Thoma calls bs on the green shoots:

http://economistsview.typepad.com/economistsview/2009/05/fed-watch-not-so-green-wednesday.html

"the dangers of deflation"

i LOVE deflation, happy to see it seems i'm up to dangerous things. like they say in the FT, those in the country side say "have good wealther" those in the cities should say "have cheap prices". "those" are people that have stable source of income and had to tolerate rampant asset inflation for years while the gov look the other way.

admin, personally, as long as the husband remains employed, deflation is my friend as well. but so sad that we needed to go this route to correct unjustifiable asset appreciation. as you well know, many do not have that stable source of income.

of course, but many had to pay more than 50% of their income for shelter for YEARS. those are the victims that the gov didn't care about. not those that FC due to being overextended with HELOCs, cash out refis adn the like, those enjoy the party. of course luck more than skill is what's going to define whether you are a victim or a beneficiary.

my point is that the gov and the fed have to learn that rampant asset price inflation on necessities are a killer for many even while they are celebrating the apparent success of their crappy monetary policies.

on the same lines, why on earth would you allow speculation on energy prices? even pension funds were doing it. this is lucky people with pensions trying to get more gravy on the back of those w/o them? regulation to not allow for this and a policy towards guarantying cheap housing like the netherlands does will be really welcome (by me at least).

If you think deflation is only prices getting lower, you're in for a world of shock.

Its effectively economic collapse.

it's asset deflation, might get combined with consumer price inflation (non durables). economic collapse? how much of the econ growth of the last 2 decades had been there due to lax monetary policy? that will have to go as we enter a long period of deficits, the imbalances have to go too. hey, it's not collapse, it's more of a hangover, long overdue.

excess capacity is rampant. it used to be the case that you actually needed deflation in those sectors (w/o monopolies, if the supply is fragmented) to bring that excess capacity back down. now tell me, how can you achieve this while making sure deflation doesn't happen? ... cause it's supposed to be a bad thing. it's a normal process that for long time the masters of hte universe thought they had avoided thanks to "how far we have come, how much we know of monetary policy". oh, really?

we are just realizing that the business cycle does exist. that's it. brutal dislocations? yes, of course. but they were there while the party was going on, they are not brought up by deflation.

Bernanke has stated inflation target of 1-2% coupled with price stability. All those dollars in circulation, I would not be worrying about deflation.

nyc10022, in all likelihood, yes. commodity inflation and deflation is one thing. systemic price deflation due to wage deflation is another.

"inflation target of 1-2% coupled with price stability"

sorry for the irreverence, but a guy that puts both things in the same line is an idiot. having these guys is what really worries me. paulson: happy to see him gone, bernanke: idiot that still thinks that the great depression has nothing to do with the roaring 20s, geithner: anybody thinks he's too green/too young/too inexperience for the job of printing press master?.

"All those dollars in circulation, I would not be worrying about deflation."

this is yet another big issue. bernanke/neither only control the amount of confetti printed, not were it's going to show up in the economy nor velocity. so don't take for granted that the confetti will conveniently sit tight where you need it to go.

this team frightens the hell out of me. so far, the holes are bigger than the dollars.

the real issue, as I see it, is that the oversupply of higher income wage earners (by that I mean anything above simple service industry employment) may never be able to reclaim their wages. employers may become more willing to employ again, but they will do so at lower wages. Wal-Mart may not hire Grandpa Joe to stock shelves, they can hire Bob the former Back-hoe operator instead. That could be alleviated by a massive investment in infrastructure and new technology, but i haven't seen any credible proof of interest in that yet.

And worse, Obama has a MASSIVE debt he owes the union.

You notice that UAW owns 55% of Chrysler now? Completely unprecedented...

And the EFCA... which Obama WROTE.

Well, it gets rid of, uh, free elections for unions, so employees can be strongarmed into joining, and then the law MANDATES arbitration if the company doesn't cave to union demands.

We're going to be paying for this election for a long time to come.

fed is targeting 1-2% inflation and printing oodles of money. i would not worry about deflation....

Admin, telling us to worry about deflation is a gimmick designed not to worry about inflation... The whole idea that the fed is going to do a mop-up before inflation picks up is ludicrous. It's like owning a stock and saying you won't lose money because you're watching it and will sell at the first sign..easier said than done.. and the fed doesn't have the ability to put in stop limit orders

http://www.nytimes.com/2009/05/14/opinion/14Roubini.html

Brief summary: From a financial standpoint America is beginning to resemble Britain as it declined from power. China is looking like the next country to carry the mantle of reserve currency. This may be years away, but we have to start getting spending under control if we're going to resist this.

My $.02: with the Boomers retiring, spending will not be going down. This is an extremely sticky wicket.