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Obama’s Financial Reform Proposals: Less Than Meets the Eye

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Team Obama has started to preview some of its financial reform proposals. And if the New York Times has represented it accurately, it falls far short of what is called for.

Consider the opening sentence of the article:

The Obama administration plans to move quickly to tighten the nation’s financial regulatory system.

If all the Obama administration intends to do is tinker around the margins of our existing framework, the US will make perilous little headway in cleaning up the financial system. In the Great Depression, the Securities Act of 1933 and the Securities and Exchange Act of 1934 were bold, root and branch reforms that proved to be remarkably effective and lasting.

That isn’t to say we have to start from a blank sheet of paper, but the powers that be need to be willing to question and probe our existing institutional arrangements more deeply than they seem willing to.

Let’s go through some relevant sections of the Times’ story:

Officials say they will make wide-ranging changes, including stricter federal rules for hedge funds, credit rating agencies and mortgage brokers, and greater oversight of the complex financial instruments that contributed to the economic crisis….

A theme of that report [by an international committee headed by Paul Volcker], that many major companies and financial instruments now mostly unsupervised must be swept back under a larger regulatory umbrella, has been embraced as a guiding principle by the administration, officials said.

Yves here. So far, motherhood and apple pie circa 2009, but look at the particulars:

Officials said they want rules to eliminate conflicts of interest at credit rating agencies …The core problem, they said, is that the agencies are paid by companies to help them structure financial instruments, which the agencies then grade….

Yves here. Notice the problem has been defined narrowly: rating agency conflicts. No consideration of rating agency competence (they were unduly dependent on issuer input for some structured products), or the depth of the conflicts (even if you change the pay arrangements, rating agencies have long been a revolving door, with the best staff going to Wall Street. Even in a brave new world of lower financial firm pay, that pattern will still persist. And staff will therefore still have an incentive not to be as tough as they might need to be.

Back to the article:

The administration is also preparing to require that derivatives like credit default swaps, a type of insurance against loan defaults that were at the center of the financial meltdown last year, be traded through a central clearinghouse and possibly on one or more exchanges. That would make it significantly easier for regulators to supervise their use.

We have long been in favor of getting as many OTC products as possible traded on exchanges. But there is a second issue with credit default swaps. The size of the market is so large relative to the size of the underlying volume of bonds that it has produced significant distortions in the pricing of bonds in new issues (there was a period last summer when the correlation models were blowing up, and one of the side effects was that AAA issuers were suddenly facing insanely high spreads if they financed due to the arbitrage the cash and derivative markets (see here and here for more detail). Similarly, the financial press too often last summer took up financial firm CEO claims that evil stock short sellers were driving down the prices of their stocks, when in fact, CDS were a better vehicle and the cognisenti argued were a far more likely culprit.

The justification for financial “innovation” is that it lowers the cost of financing, improves liquidity, and produces other benefits to the real economy. But there are numerous examples of CDS creating distortions to the detriment of the real economy. Thatt suggests that some thought should be given as to whether and how measures might be put in place to reduce the size of the CDS market (personally, I think the justifications for its existence are weak, but I see no willingness in the Obama crowd to make bold moves in this arena).

Another reason to rein in the CDS market is that the scale of the risks involved may be too large even for an exchange. As we noted last fall:

The most valuable element of moving CDS to an exchange, as far as lowering systemic risk is concerned, is centralized clearing, since if anyone defaults, the counterparty is the exchange, not an individual firm. Thus regulators have been moving forward as quickly as possible to set up a central clearinghouse. In particular, the CME Group proposed acting as a clearlinghouse, which means that its members would absorb the losses if any counterparty failed. Some rival proposals suggested setting up a new clearinghouse, which is a much sounder design, but would take longer to implement.

However, some savvy and influential and savvy CME members are now objecting to the idea, arguing that the additional risk of CDS clearing on top of their existing CME obligations is more than the members can realistically support. Moreover, they contend that putting together CDS and futures under the same umbrella is too much risk in one venue, and will increase, not reduce systemic risk.

The article recites a host of rather conventional ideas that have been bandied about that Team Obama has latched on to, such as requiring hedge funds to register with the SEC. Bernie Madoff was registered; the SEC skipped his normal inspection and ignored a detailed letter by one Harry Markopolos (“The World’s Largest Hedge Fund is a Fraud“) that concluded that the Madoff funds were most likely a Ponzi scheme. So exactly what is this going to accomplish? Eliot Spitzer in an article at The Big Money tells us that the SEC is not serious about enforcement:

The traditional critiques of the SEC have been that it was underfunded and didn’t have up-to-date laws needed to regulate sophisticated financial transactions in evolving markets. That’s not accurate. The SEC is a gargantuan bureaucracy of 3,500 employees and a budget of $900 million—vast compared with the offices that actually did ferret out fraud in the marketplace. And the general investigative powers of the SEC are so broad that it needs no additional statutory power to delve into virtually any market activity that it suspects is improper, fraudulent, or deceptive. After each business scandal (Enron, Wall Street analysts, Madoff …), the SEC claims a need for more money and statutory power, yet those don’t help. The SEC has all the money and people and laws it needs. For ideological reasons, it just didn’t want to do its job, and on the rare occasions when it did, it didn’t know how.

Now in theory, with a new SEC chief, the SEC might get a bit more aggressive, but even in the Clinton era, reform minded Arthur Levitt was reined in by Congress that threatened to SEC budgets if it made life too hard for Wall Street (and Democrat Joe Lieberman was the biggest perp). So aside from some cosmetic moves, I doubt much will change here.
Now let us return to the Times article, which illustrates that the underlying problem:

Officials said that the proposals were aimed at the core regulatory problems and gaps that have been highlighted by the market crisis. They include lax government oversight of financial institutions and lenders, poor risk management efforts by banks and other financial companies, the creation of exotic financial instruments that were not adequately supported by their issuing companies, and risky and ill-considered borrowing habits of many homeowners whose homes are now worth significantly less than their mortgages.

In other words, this is a symptom oriented, patchwork approach. And it misses some of the underlying drivers: the opaqueness and complexity of many of the new instruments, texcessive leverage (oh wait, the powers that be think excessive leverage is the solution) and widespread accounting fraud.

For instance, how could Lehman have collapsed with what turned out to be a hole in its balance sheet of in excess of $100 billion when its financial statements gave no clue of problems of that size? And as we noted at the time, its executives were claiming, forcefully, that everything was OK, the converse of what was actually the case (see here, here and here for examples).

Or consider the views of William Black (a bank regulator during the S&L crisis who went after Lincoln Savings, owned by the powerful Charles Keating. Black’s efforts were thwarted but he was eventually vindicated) on Merrill:

Thain portrayed himself as a hero of capitalism and the embodiment of a successful CEO deserving of millions of dollars in bonus compensation because he “sold” Merrill to B of A — minimizing the losses of Merrill’s shareholders. There was, of course, criticism of the scale of these bonuses, but no fundamental rejection of his claim to be a hero.

The lack of rejection illustrates why we are in crisis. We need to be blunt. Thain transferred a loss that risk capital is supposed to bear to the taxpayers of the United States (not B of A). He was able to transfer that loss to the taxpayers because Merrill, under his leadership, engaged in monumental accounting fraud (which means it also engaged in securties fraud). We have to start taking accounting fraud seriously. It is a crime. It is a felony. It is the “weapon of choice” among financial control frauds. It causes staggering direct losses and indirectly, by eviscerating trust, it causes entire markets to shut down. This should not surprise economists. We make things crimes in large part because they produce material negative externalities.

So, Thain “was part of the problem.” The fact that he could (A) lead such a massive fraud and (B) think that he should be rewarded with many billions of dollars for defrauding the citizens of the United States shows two key reasons why the crises keep getting worse. Our most elite business leaders now embody traits we used to understand were loathsome. The fact that this is not obvious even to skilled, sceptical financial reporters shows how serious a problem we face.

Until we start talking addressing the root causes, these financial “reforms” will prove as effective as trying to treat gangrene with antibiotics.

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36 comments

  1. Anonymous

    How does society go forward without some “responsible” rule of law around financial transactions? Why are the laws that we have not being enforced is maybe a better question? Since when is the American government in the practice of supporting a class society? Seems pretty obvious to everyone that this is what is occuring.

    Oh my. What will the children think?

    It is so stupid to read some of the comments on the various blogs where people are attacking all sorts of made up demons of our situation but the underlying wealth inequity and subsequent control of the world economies.

    Duh!

  2. bg

    So it boils down to fraud in the private sector and regulator capture in the public sector. I think this is what Minsky said (the economy becomes a ponzi scheme.)

    The answer is more government, but it is also better oversight *of* government. Two comments got my attention:

    “The fact that this is not obvious even to skilled, sceptical financial reporters shows how serious a problem we face.”

    “savvy CME members are now objecting to the idea”

    The complacency that lead to our Minsky winter extends to our cognisenti, savvy and skilled. It also extends to you and I.

    We simply need to find better ways to have the populace supervise our democracy.

  3. Anonymous

    The truly savvy will recognize that the elephant in the room is the combination of a Federal Reserve and a Fractional Reserve Banking system which enables all of these shenanigans by allowing the virtually unrestrained creation of money out of thin air.

    We wouldn’t need to rely nearly as much on good regulation without the fuel for the fire. Good regulation would still be important, but its occasional failure will not likely be catastrophic. As long as that fuel remains, it will ignite. Sometimes sooner, sometimes later, but it *will* ignite.

    Now there’s a subject that hardly anyone wants to touch. Such is the power of indoctrination.

  4. Anonymous

    This what happens when the fox gets to keep looking after the hen house.

    Too many skeletons. Better to do the kabuki thingy. That’s Obama’s job – the salesmanship.

    Reform. Only after epic fail.

  5. GM

    From the NYT article. The report being referred to follows. It’s a short read with broad sweeping recommendations.

    “and in a recent report by an international committee led by Paul A. Volcker”

    http://www.group30.org/pubs/recommendations.pdf

    ——-

    This Group of 30 report is the template the new regulations are being drawn from. The Group of 30 led by Paul Volcker is the leading bankers from the US and Europe. See page 8-9 for a list of members and when you recognize the names and the banks they represent then ask yourself how these guys having led us into this debacle are giving us the game plan to fix the problems they created.

    I’d compare it to using Gen Custer’s Last Stand as a road map on how to wage war.

  6. Joe Pomykala

    In the aftermath of every financial crisis, there is usually some gargantuan set of new regulations. After the South Sea Bubble, the British government almost made it illegal to sell stock. The Great Depression had the SEC, Glass-Segal Act, after Enron and Worldcom accounting scandals, we hade Sarbanes-Oxley. This period will be no different.

    We do need more regulation of OTC Credit Default Swap (CDS) market. CDS should be standardized and put on exchanges. The press did not talk about it much, but the US taxpayer bailout of AIG was caused by their one-sided exposure as counterparty on something like $500 billion, a good chuck related to MBS and subprimes. This is a huge amount, higher than GDP of many countries. If AIG failed and could not make good as counterparty on insuring all this debt, then all those owning AIG counterparty CDSs would have to write down their assets. European banks hold CDSs as regulatory capital under Basil. If AIG failed, the European banking system would have collapsed, remember the rush to raise depositor insurance all over Europe toto prevent capital flight? This potential contagion prompted the AIG bailout. CDS exposure should not be held off the books as executory contracts, but fully disclosed. Counterparties should not be able to write CDS if they do not have sufficient collateral. This same CDS issue and potential contagion also helped prompt the US auto bailout. Something like $1 trillion in CDS exist over US automaker debt (I assume much has to be synthetic). If GM went bankrupt, such a triggering event would cause counterparties to pay out, some counterparties, say hedge funds, former investment banks (turned bank holding companies to access TAF), etc., probable could not pay. Contagion possibilities on CDSs helped drive the bailout of GM and GMAC.

    I do not favor regulation in general, but for the CDS market I think it is necessary. We do not know since it is OTC, but likely $45-55 trillion in CDS exist. US GDP is only a paltry $14.4 trillion in comparison. CDS exposure is a multiple of all existing mortgage debt existing. Jezz – total US subprime mortgages are what? – $1 trillion. The numbers are scary, but many positions are hedged to make profits on spreads. However, (OTC) counterparty default could produce contagion and snowball. We regulate automobile insurance, homeowner insurance, and private mortgage insurers, to hold sufficient capital to pay potential loses. The CDS market should be much the same, counterparties should hold sufficient collateral. This potential default by CDS counterparties and possible world wide financial contagion (which would be a stunning Act II after Act I in the mortgage market) has helped driven taxpayer bailouts. The current CDS market is something like me being able to write hurricane insurance, but completely unable to pay claims if a hurricane happened, but OTC buyers of my CDS insurance may, or may not, know my position for potential claims or collateral. We need more disclosure. CDS should be standardized and exchange traded on CME instead of OTC, CDS counterparties should be fully collateralized.

  7. GG

    I don’t think there us any use discussing “reforms” in ANYTHING in the US. The old has to completely die-off to make way for the new, which may also include the US as a nation state.

  8. Richard Kline

    Look y’all, PresO has _no_ interest in extensive financial reforms. Messy. He’s tight with the Money Boys. Always a pro-market man. You can tell that he has _NO_ ambitions at reform by the folks who he has chosen for appointments. Not a credible reformer or new face amongst that lot of bankster’s hierlings, not one. We will get nothing but cosmetic or minor reforms from his Admin. The real hope for change is from Congress, and that is a hope both scant and faint.

    . . . I expect no serious attempt at financial reform until the double dip of our Re/Depression. Just in time—the talking that is, not any action—for the run-up campaign for the O II Administration.

    And on the subject of Thain, Is It Fraud?, by rejecting nationalization the powers that be have all but guaranteed numerous multi-billion dollar contexts in the banking industry which will have the appearance of fraud, the substance of fraud, but will for the most part be unprosecutable. If you hand billions to big banks, with no directives, and no oversight, and then they go out of business with said billions unrepaid, that looks like a fraud. But Paulson ensured that every Thief in Chief and their assistants will walk scot-free. This is what we have come to, and PresO’s team wants a Second Increment. And he’ll be back for a Third, and a Fourth, too, and Congress will back him. That is my view. Because there is absolutely no accountability to anyone about anything in this—except you and me. If we don’t pay our taxes, that is counted against us.

    . . . But so what if the game is rigged, sez they, “If you don’t play, you can’t win.”

  9. bena gyerek

    i think your criticisms of the cds market miss the point. criticisms based on counterparty risk (the main argument behind a central clearing house) and market size (i.e. “oh my god this market is a multiple of global gdp so it just has to go wrong”) miss the point.

    the failings of cds are basically the same well-known problems inherent in insurance, namely:

    – moral hazard (e.g. indymac and countrywide sourcing and mis-selling toxic mortgages because they don’t sit on the risk)

    – adverse selection (investors focusing on statistical analysis and not really understanding the credits underlying their cdos)

    i think the best way to address these failures are (i) to impose a much higher standard of personal criminal liability (fiduciary obligation) for individuals involved in originating and brokering synthetic credit deals, (ii) requiring a high level of co-investment in transactions by these same parties (except possibly in the case of “vanilla” single-name cds traded in the interdealer market)

    add to these two other key issues:

    – cds as a source of systemic leverage (i.e. insurance cos and hedge funds being big net protection sellers without reserving sufficient liquidity for a major downturn). the solution is rules on minimum margin posting by credit protection sellers (again with possible exception for exchange-based interdealer market) akin to the 1930s rules on minimum equity margining.

    – the complexity of most cdo transactions. but let’s be clear what the pitfalls of compexity are: (a) the impossibility of fairly valuing an investment when this depends on key variables like credit risk correlation that are unmeasurable and necessarily arbitrary, (b) the bastardisation of lending with ownership atomised and substituted by agents that have mandates that are too narrowly defined to afford them the kind of discretion and good judgment to needed to sensibly triage borrowers, renegotiate repayment terms and therefore minimise credit losses in a major downturn. problem (a) can be solved by pre-deal regulatory signoff of transactions and related pricing models on a case-by-case basis. problem (b) is really a variant of adverse selection and can be solved by co-investment by a lead investor responsible for the borrower relationship.

  10. Anonymous

    «The fact that he could (A) lead such a massive fraud and (B) think that he should be rewarded with many billions of dollars for defrauding the citizens of the United States shows two key reasons why the crises keep getting worse. Our most elite business leaders now embody traits we used to understand were loathsome.»

    But that’s a minority ideological position; Real Americans think that all that matters is to be winners, whatever it takes, and CELEBRATE the astuteness of Thain, and just wish to be winners like him. What Real Americans think is loathsome is the stealing and thieving of the money of the winners by the voracious hordes of welfare queens to buy cadillacs, of strapping your bucks wolfing down off t-bone steaks.

    The defrauding that is loathsome to Real Americans is the hundreds of billions of dollars in taxes extorted every years from the best and brightest, from the deserving producers, by the vicious coercion of the government.

    «The fact that this is not obvious even to skilled, sceptical financial reporters shows how serious a problem we face»

    Sell-side financial reporters?

  11. Anonymous

    Finally reading some of my old NYT from December; did anyone else read the expose on Schumer from around the 14th? I am surprised that there was so little comment on it. What a tool of the industry…easily manipulable and malleable. And the appointment of Gensler to the CFTC confounded me…is Obama really just putting the foxes in charge of the house again? It’s almost as if Obama is just trying to get the old financial model back and running again. Talk about moving Cds to an exchange is sort of tangential to the grittier issues of character and trust. As long as people like Schumer are in Congress and Geithner is running Treasury, how can anyone expect normal, working Americans to venture into the investing market again for either stocks or bonds. Most people I know are staying in cash until the current team proves its worth[lessness]. Wow, makes one long for Paul O’Neill again.

  12. Anonymous

    One thing that might help with the quality of ratings is if the Rating Agencies had to put some of their own skin in the game rather than just reputation.

    Maybe you could have a mandatory percentage of each security rated put into escrow by the CRA, with a sliding scale so the higher the rating the more they have riding on it. (I think a non-linear scale would be best, with the steps getting higher as you moved up the quality scale.)

    When the security is redeemed they get the escrow money back, with accumulated interest, but if the security defaults they lose the lot.

    You would need to set up the system so that the CRA got SOME (but definitely far less than 100%) of the escrow differential back when they downgraded a security, because this would positively encourage early vis-a-vis late trouble calls. Again I think it would be preferable to have a non-linear loss to the CRA based on the number of steps any security is downgraded; subject to some overall speed limit (one downgrade per month perhaps, with a once-only inter-month emergency capability for each security ??) the market is best served by a lot of little steps rather than one leap off the cliff.

    I leave it to wiser heads than mine to work out appropriate numbers.

    (And, I note out of idle speculation, one thing that I have NEVER seen discussed on any blog is that in this era of financial market globalisation all three major CRA’s remain US-based companies.)

    ozajh

  13. Bob_in_MA

    Obama, I’m afraid, is just another hypocrite. I saw him sign those executive orders banning lobbyists from his administration on Wednesday. By Friday, he had issued his first exemption, William Lynn at the Pentagon.

    I won’t even ment the god-damned tax cheat at Treasury…

  14. Bernard

    Oh gee, if Lehman and Merrill have been proven to have engaged in massive accounting fraud, what are the odds that Goldman, Morgan and Bear have been doing the same?

    Hey, when you have tools like Level 2/3 accounting at your disposal, there is just so much you can do (“when there is no price, just make it up”).

    By the way, do we know yet what the hell is in that $30 billion garbage barge of Bear assets that Federal Reserve lent money against for the benefit of JP Morgan?

    Given that Obama has promised to open the US government’s dealings to the light of day (“transparency”), I am looking forward to seeing FULL disclosure of exactly who are all the counter-parties that the Federal Reserve has lent to and what collateral it has received in return during it’s recent balance sheet expansion amounting to in excess of $1 TRILLION.

    In which case, I would expect they will discontinue blocking the Freedom of Information Act requests from Bloomberg and Fox News for this information.

    When are the reporters going to question Obama directly on this issue?

  15. Anonymous

    Based on precedent they will jail two or three scapegoats and let the underlying corruption fester. With his last big grab of the Federal tit Thain has likely locked up one of the scapegoat slots; Madoff is a shoe-in for another. At most there will be one more. Any bets on the final fecal roster? And who among the worst will skate?

  16. Anonymous

    Apropos of nothing, doesn’t the whole Martha Stewart scandal of a few years’ back seem quaint these days?!

  17. Anonymous Monetarist

    Sunday, January 25, 2009
    Hustling the hustlers…
    First into the archives for an amusing anecdote supplied by Maureen Dowd back in July 2008:

    ‘In Berlin, the tabloid Bild sent an attractive blonde reporter to stalk Obama at the Ritz-Carlton gym as he exercised with his body man, Reggie Love.

    Obama marveled: “I’m just realizing what I’ve got to become accustomed to. The fact that I was played like that at the gym. Do you remember ‘The Color of Money’ with Paul Newman? And Forest Whitaker is sort of sitting there, acting like he doesn’t know how to play pool. And then he hustles the hustler. She hustled us. We walk into the gym. She’s already on the treadmill. She looks like just an ordinary German girl. She smiles and sort of waves, shyly, but doesn’t go out of her way to say anything. As I’m walking out, she says: ‘Oh, can I have a picture? I’m a big fan.”‘

    Wall Street is anxiously awaiting for its’ version of the Marshall Plan. It would seem that the collective financial universe has agreed that some type of bad bank with guarantees will be delivered to save the banksters from themselves. The issue of significance is what is the clearing cost for the cancer. If you don’t overpay then you hurt the banksters, and they are vital, the nancy capitalists cry out, they are vital to any recovery! Much like the concept of compassionate conservatism ,we really really would like to help the poor but we just can’t, folks are gagging for compassionate capitalism, we really really would like to value theses assets but we just can’t.

    As previously mentioned on this blog :’Neel Kashkari, the official who administers the Troubled Asset Relief Program, wrote to Citigroup Inc., Bank of America Corp. and 18 others on Jan. 16 seeking figures on business and consumer loans. Treasury also wanted details on purchases of mortgage-backed and asset-backed securities, according to documents obtained by Bloomberg News. The Treasury also asked the banks for commentary on their lending activity, to provide “qualitative” updates on trends. In addition, the government wants information on secured lending and underwriting of debt and equities. The first report covers data for October, November and December and is due by Jan. 31. Results will be made public.’

    Like any industry, you can break down politics into retail and wholesale. Retail is the narrative, the marketing arm of you will. Wholesale is the sausage grinder. The Federales have had folks in each major bank since September. Undoubtedly they already have within their possession all the information that they are requesting. The retail narrative is that Federales are requesting info to support the plan they(on the wholesale side) have already contemplated.

    There is a level of hopefulness in the prognostication that I’m about to put forth. My suspicion and expectation is that Obama is a pragmatic liberal intellectual.

    The part of the bailout exercise that folks are drawing a blank on is how do you value the ‘toxic assets’. I’ve stated that a private-public partnership that balances investors’ interest with taxpayers’ interest is the way to go.

    How do you get there? The answer is simple … time and price.

    Set up a ‘data swat team’ to analyze the ‘reports’ coming back on January 31st.

    Set up a bad bank, issue FDIC bonds out the back end to finance purchases and then … just wait.

    State that the government would be willing to entertain offers from folks that want to sell assets, each offer will be reviewed by the ‘data swat team’ to review whether the terms are satisfactory and then … just wait.

    And then pick the weakest sister that the Federales are pulling the strings on, say Citigroup, and purchase (Citigroup presents assets to the Federales at the price they choose) a batch of assets on a dollar-matched basis with pirate equity. You don’t have to buy much … set a price and let the markets take it from there.

    Let Citi (or a bankster equivalent) be the pretty blonde at the gym Barry … let the markets reprice based on the initial ‘rigged’ transaction.

    Hustle the hustlers…

  18. john bougearel

    RK, re: Pauson ensuring thiefs-in-chief they walk scott free…absolutely no accountability in this—except you and me. If we don’t pay our taxes, that is counted against us.

    The taxpayer revolt is coming to a theater near us soon…one can only hope!

  19. Anonymous

    The US goverment is at best incompetent and at worst corrupt on all levels and across all parties and the banking system is insolvent. End of story.

  20. Krakpotkin

    Bill Seidman this week said that They can’t price the wounded MBS etc, and that therefore a reversion to the original TARP idea (buy the assets from the banks)won’t work.

    Further comments showed that what he meant is NOT that a “hold-to-maturity price” (Bernanke’s term) is unfathomable, but, rather, that in October the banks and the feds couldn’t agree on a price.

    That is:

    – Tsy didn’t want to pay best guess hold-to-maturity because that would be assuming all risk and paying all/most value to the miscreant banks.

    – And the banks weren’t willing to take anything in the neighborhood of (non-existent) market value.

    A fortiori: Instead of BUYING the wounded assets, the feds should prescribe controlled prices for them (segmented demographically across the wounded sectors of the structured finance universe).

    These controlled prices would be based on short-term trailing performance (how much interest actually be paid and how much principal actually being lost) and best guesses on housing price and foreclosures for coming six months or so. Prices would then be adjusted quarter by quarter.

    The banks would get immediate write-ups to something near best guess hold-to-maturity price, while retaining risk going forward.

    The feds would have to do a ton of spreadsheeting and regulating, but would not have to lay out the several trillions more that Paul Volcker spoke of this week while introducing Tim Geithner.

    The problem is NOT that a fair price cannot be estimated. It’s that nobody wants to TRANSACT today (and this past October) at those prices. FINE. No transaction. Keep the assets on the books at prices gauging performance, not the broken market.

    The market for mortgage bonds and related has been broken for 18 months, and the markets for credit card bonds are weakening. Broken markets do not always fix themselves. These are not. Time to open the toolbox.

    Price controls WERE in the toolbox during the postwar era (Eisenhower, Kennedy, Nixon) — until the owner-operator class realized in the 80s that globalization was the ticket and got laissez-faire religion.

    People who spent their formative years watching Age of Reagan television have driven the global economy into the ground. It’s time to bench them, and open the toolbox.

  21. Anonymous

    Looking backward through the eyes of history
    to the events of past generations, we observe that
    —while man has always tried to put the best face
    upon the social condition of his day, and has
    always given the most favourable account of his
    times—nevertheless, failure has been ever the
    record of the human race.Nations rise and fall
    ;
    and whenever another fair experiment in government
    is attempted, under new conditions and with
    all past experience for a guide, it is only a matter
    of time before the very ends sought for—increase
    of wealth and power—show that they are but
    agents of destruction.
    What can explain all this so clearly as the fact
    that the god and prince of this world, with all his
    transcendent abilities, lacks the power and wisdom
    of the Infinite?
    As we write these lines, the attention of the
    public is being drawn to surprising revelations of
    dishonesty in the management of large insurance
    companies, revelations which would certainly
    shock the moral sense of the community if the
    community had any residuum of moral sense to
    be shocked. One who looks at all beneath the
    surface of these shameful disclosures cannot fail
    to realize that they are but indications, surface
    eruptions, of diseased conditions which lie deep in
    human nature and human society. Once again,
    as in the days before the Flood, the Lord God,
    looking down from heaven, sees that ” all flesh
    “As in the Days of Noah” has corrupted its way upon the earth.” Is it
    not so?
    And is it not also true that the very worst and
    most significant feature of these revelations is
    that they produce little or no expression of deep
    or widespread public indignation? A few caustic
    editorials appear in the newspapers, and a few
    denunciations are heard from the pulpit ; but the
    people, as a whole, are indifferent, unmoved, or
    what is even worse, are merely entertained.
    Meanwhile, the blind and fatuous leaders of the
    enterprises of the age and the exponents of the
    much-lauded “spirit of the age” continue to prate
    of progress and improvement, of the conquests of
    civilization and of the great strides of science
    !
    Only the few who have sought and obtained
    wisdom from the sole Source of wisdom recognize
    that the state of things around us now is “as it
    was in the days of Noah.”
    And this is the outcome of the free application
    of human genius and intelligence, backed
    up by the amplest natural resources and aided
    by every factor which is supposed to make for
    progress !
    What conclusion is to be drawn from it, and
    what remedy is to be applied ? We hear ” enticing
    words of men’s wisdom,” such as ” legislation,”
    “education,” “culture,” “publicity,” “honest
    enforcement of laws,” etc. But who is so shallow
    and ignorant as not to know that these have all
    been tried, have done their utmost, and have
    failed!. The corruption now appearing in the
    “highest circles,” where education and culture
    have done their utmost, where every experiment
    of legislation has been attempted, and where every
    natural incentive to honest dealing exists, has its
    source in the heart of man. It flows from that
    fountain of sin which sprang from the transgression
    of the first Adam, and which can be
    purified only by the fountain of life which springs
    from the blood of the last Adam.
    What sane conclusion, then, is possible but this,
    that man’s experiment has been tried out to the
    very end? And what remedy remains, but that
    which the arrogant and unbelieving heart has
    always sought to avoid, but which God has always
    urged in such words as these : ” Look unto Me
    and be ye saved, all the ends of the earth ; for I
    am God, and there is none else ” (Isa, xlv. 22)
    And do we not see written large and clear upon
    the events of our day that but little time remains
    wherein to learn wisdom, to heed the oft-repeated
    warnings, and to turn unto Him before He leaves
    His mediatorial throne, before the day of grace
    is ended, and He comes again to shake terribly
    the earth ?

    Philip Mauro/The World and its God/June 1907

  22. Anonymous

    I’m curious why more consumer centric changes are not being contemplated.

    Why shouldn’t we have complete information on credit score calculation methodology?

    Am I the only one who thinks it insane that how your credit score is calculated is shrouded in secrecy?

    This is monitored by employers all the time, yet we are only given broad guidelines as to how it is calculated. In fact why the hell have we allowed this number to control so much of our lives?

  23. Anonymous

    While I’m a fan of free markets, what the comments are suggesting is control growth. About the only way is to tether the currency.

    Again, greed abhors controlled growth. (‘The powers that be’ are some banks and bankers you’ve never heard of running the show)

    This meltdown began about August 07′ when a pile of OTC contracts blew up and began the chain reaction we see continuing to occur. This is all damage control since 07′. It’s the nuclear fallout that does the most damage.

    Seemingly, the commenters here are on the same page, to OTC instrument losses dwarfing the world’s GDP, to a president not presidential and a congress not congressional IOW will not address the fundamental issues.

    Get your own house in order and secure your own being first. Many are depending on you.

  24. mmckinl

    Yves,

    Thanks for a timely and informative analysis of Obama’s “reforms”.

    Obama will trot these reforms out, people will think that these are an answer, then when the banking system dives again it will Obama’s head in the noose, not Bush’s.

    Obama needs to implement real, total, comprehensive reform of the financial system. He has\had the mandate to do this but seems bent on incrementalism which will undermine everything he tries to get done.

    Obama wants his omelet without breaking any eggs.

  25. Gentlemutt

    Hello Yves,

    “If all the Obama administration intends to do is tinker around the margins of our existing framework, the US will make perilous little headway in cleaning up the financial system. In the Great Depression, the Securities Act of 1933 and the Securities and Exchange Act of 1934 were bold, root and branch reforms that proved to be remarkably effective and lasting.”

    Love your blog, and more importantly your commentary. Sadly I seem to be suffering growing ‘repetition overload,’ from both my own powerlessness vis a vis the kinds of financial chicanery our system permits and the unceasing tangle of comments posted by me and others on your website. Is this despair happening to many well-intentioned and informed citizens, and will the righteous anger slowly dissipate into resigned disgust at how little reform is achieved?

    So, how about trying to work up a petition to our leaders on your website, to see how much of a consensus can be established amongst your readers? This might be a way to channel all the intelligence of your audience into ONE constructive communication to the professional politicians and bureaucrats upon whose wisdom we now depend.

    Alan Blinder’s recent piece on 6 key problems is good, but how about Yves Smith’s petition to Obama, Geithner, Schapiro, et al on how to restructure our financial landscape to make our form of capitalism work better? Maybe start with Helmut Schmidt’s recent list, or another, and see what your readers can agree on to the point they would actually be willing to sign their names? For my part, I would propose making CDSs illegal to purchase/own absent a demonstrable ‘insurable interest,’ and require that all ownership and transactions be recorded with the new super-regulator this country surely needs, not unlike the Commitments of Traders reports long required by the CFTC.

    Anyway, happy lunar new year, and thank you for running such a good website,

  26. John

    I’m glad to see someone finally call out Thain for accounting fraud. He was lauded all last week on CNBC as being “the smartest man in the room”. More like the most crooked man in the room (and that’s saying something!)

    The massive reforms Yves is looking for may take a while to come about. The Great Depression started in 1929 and massive reforms didn’t come about until ’33. We are only just starting this current downturn. If citizens start rioting like they did back in ’33 such that politicians start feeling afraid, then I believe we’ll start seeing some massive reforms. Probably not before then, though.

  27. Eric L. Prentis

    The financial ruling class is decadent, corrupt, incompetent, arrogant, over paid, spoiled, egotistical and has an overwhelming sense of self-entitlement. Before one more dime of TARP funds is spent or the Federal Reserve unilaterally adds another bank bailout program, all board members and senior management at failed institutions must be replaced. Giving more taxpayer money to the same financial ruling class and expecting a different result is the epitome of insanity.

  28. artichoke

    I saw that Geithner, in his written testimony for confirmation as SecTreas, wrote that we should move “the standardized part” of CDS business onto exchanges.

    Weasel words! There will still be an OTC market, just that there will also be exchange traded contracts. I’ll assume he is speaking for Obama’s intended policy.

    It’s incredible how little Obama is doing. The man I think has no idea what to do, he’s an amateur. We’ve elected a beginner. A corrupt one too who will foist tax cheat Geithner on us.

  29. Anonymous

    @artichoke,

    What was their other hand doing whilst we watched the McCain-Obama show. Politics is the
    Punch and Judy side show to keep us kids entertained while the adults work out their problems in the other room.

    I fear Obama is just a bit of fairy dust to brighten up the days, till their work is done.

    skippy

  30. Merry-will-go-round

    And here are some more political carrots to offset the flimsy regulatory switching of the bad boys of finance…

    Create Automatic Workplace Pensions: Under the Obama-Biden plan, employers who do not currently offer a retirement plan will be required to enroll their employees in a direct-deposit IRA account.

    Expand Retirement Savings Incentives for Working Families: Obama and Biden will create a savings match for low and middle-income Americans. The savings match will be automatically deposited into designated personal accounts.

    See — http://www.whitehouse.gov/agenda/seniors_and_social_security/

    We have a double-header here: justification for Social Security benefit rollbacks AND creation of immediate financial windfalls with new streams of guaranteed revenue for Wall Street in perpetuity.

    Stay tuned for more change we can believe in.

  31. Anonymous

    financial capital, in general fictitious capital, could not have attained its dominant role had it not been for a combination of falling/weak nonfinancial rate of profit and a ruling class unfit to rule. parasites can kill their host and do so without the least bit of intent…

  32. Anonymous

    "As previously mentioned on this blog :'Neel Kashkari…"

    That's really the last name? As in Cash & Carry?

  33. Francois

    As long as the financial industry can shower money on the political class, I cannot see how needed reforms could take place, unless we really descend into a 2nd Great Depression. Obama has picked up an economic team that is way too much a syndicate of entrenched interests to be truly effective.

    As for the CDSs: the only solution i can think of is to force a smell test of any buyer of CDS: “DO you own the underlying security you are buying a CDS for?” If not, no deal! And btw, did we mention that you must own the security as long as you own the CDS?

    Otherwise, a CDS is a license to permits all my neighbors to buy fire insurance against my house. Do you know one insurance company that would allow such a scheme?

    Didn’t think so.

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