naked capitalism

Is Obama’s leaked view that a “quick and surgical bankruptcy” was a “likely option” for GM and Chrysler form of bizarre brinksmanship? If not, Obama has just painted himself in a corner based on what looks to be some very bad advice.

As we will explain below, the notion of a “quick and surgical” bankruptcy for GM, and probably Chrysler too, is a fantasy. GM would be the most complicated bankruptcy ever. It simply isn’t amenable to a prepack or a fast track variant. In fact, somme bankruptcy experts think a Chapter 11 restructuring simply isn’t possible and a filing would morph in the courthouse into a liquidiation. That in turn would take out many suppliers, and many of the foreign transplants too.

And before you insist that Obama has access to the best legal and economic advice, I suggest you review the record on the banking industry front and think twice. The policy moves so far have been dictated by faux constraints, such as “no more Lehmans” and “we can’t go back to Congress for more money” and “we don’t do nationalizations”. The same sort of contorted thinking that produced the public private partnership monstrosity seems to be at work here.

Update 2:00 AM. The New York Times sets forth how the Administration intends to ram a deal through, namely, by, splitting the company in two and getting “some” creditors to agree to the split. The problem with this construct, however (and BK experts welcome to opine), it appears from the long-form description of how a big complicated BK normally proceeds, that having “some” creditors agree doesn’t cut it. As we recount further down, bankruptcy experts had earlier ruled out a pre-pack as being undoable due to the impossibility of getting the needed number of parties to consent in a compressed timetable, I don’t see how having a structural proposal solves that fundamental problem.

From the Times first, then back to the earlier post:

The government may seek to ease General Motors into what it calls a “controlled” bankruptcy, somewhere between a prepackaged bankruptcy and court chaos, by persuading at least some creditors to agree to a plan that would cleave the company into two pieces, according to people briefed on the matter.

Instead of signing on every creditor as is typically required in prepackaged deals, administration officials are using as leverage the promise of taxpayer financing….

“As lawyers would say, it’s sui generis, at least in my experience,” said Joel B. Zweibel, the retired co-head of restructuring at the law firm O’Melveny & Myers…..

Under a plan being worked out by the administration, G.M. would file for prearranged bankruptcy, according to these people. It would then use a sale authorized under Section 363 of the bankruptcy code to quickly sell off the desirable assets to a new company financed by the government. These good pieces might include Cadillac and Chevrolet, as well as assets the company needs to run the business.

Less desirable assets, brands like Hummer and underperforming factories, would be left in the old company. Proceeds from the sales, including stock in the new company, would be given to the old G.M., helping to settle claims….

The administration hopes to win support from some of G.M.’s creditors, notably the United Automobile Workers, which would be forced to pare its health care benefits and whose pension obligations would probably remain in the old company. But the bankruptcy code allows a judge to approve a sale even over creditor objections in an emergency under Section 363, legal experts say. Such was the case with the Lehman sale….

History offers almost no precedent for a G.M. bankruptcy filing. Companies like Continental Airlines and the Delphi Corporation, the auto parts maker, have used the courts to transform their businesses and reduce their costs. But none matched the size and interconnectedness of G.M.

Yves again. This is very high stakes poker. If this gambit fails, the Administration will have staked its credibility on not bailing out GM and will likely feel compelled to withhold support, which will force a BK, controlled or conventional. And if you read between the lines, while none of the experts were willing to dash cold water on the idea, they signaled strong reservations:

“You’re introducing politics into the process,” said David A. Skeel, a law professor at the University of Pennsylvania.

The administration may still encounter surprises in its efforts, Mr. Skeel said.

“The hope is that if we call it a controlled bankruptcy, that’s what it will be,” he said.

The Administration had no problem lending what amounted to $250 billion to Citigroup, plus the equity infusions (if memory serves me right, $45 billion). Sure pays to be a bank.

Back to the original post.

Let us review some key sections of an article at The Deal in December on what a GM BK would look like,:

After the short-term bailout fails, GM files for bankruptcy, ousts Wagoner and receives a $25 billion debtor-in-possession financing provided by the federal government either directly or out of the Treasury’s Troubled Assets Relief Program, or TARP. The company make its Chapter 11 filing in the U.S. Bankruptcy Court for the Eastern District of Michigan in Detroit. It’s neither prepackaged nor, for that matter, significantly prenegotiated. Congress has been throwing the prenegotiated concept around, but in reality, because of GM’s size, only a partial prenegotiated filing is practical.

Why no prepack? GM simply lacks the time to prepare a prepack, where a company works with lenders, creditors and shareholders to craft a reorganization plan and then solicits votes, all before entering bankruptcy. A prepack would require a “bajillion” creditors to buy in, says veteran auto industry attorney Jean Robertson of Calfee, Halter & Griswold LLP, an inordinately lengthy process when GM is burning through roughly $1 billion in cash a month.

According to James Wilton of Ropes & Gray LLP, who was debtor counsel to auto parts maker Holley Performance Products Inc., a complex case such as GM’s would require negotiation after filing instead of before…

Yves here. OK, got that? No pre-pack. Too many moving parts. Back to the story:

So GM prenegotiates a deal with creditors only. The company has already said in Securities and Exchange Commission filings that it has begun negotiations with lenders, bondholders and its unions to whittle its debt at year’s end by $32 billion to roughly $30 billion. It hopes to complete the process by March 31, the deadline under the tentative bailout bill for agreement on a long-term viability plan…..

Yves again, We are two months behind that timetable. Back to the article:

Downtown Detroit — at least the hotels and restaurants — rapidly fills up with all the visiting lawyers and advisers. GM isn’t going to pull an Enron Corp. and make its petition hundreds of miles away in New York (too expensive) or Delaware (the appellate court isn’t kind to the idea of abrogating collective bargaining agreements)….

The sheer size of a GM proceeding mandates that other high-profile cases not overwhelm a court. Many of GM’s suppliers are nearby, as is the United Auto Workers’ headquarters…..

Another factor: Delaware isn’t a particularly friendly place to break union contracts. “The standard for doing that in the 3rd Circuit [Delaware, New Jersey and Pennsylvania] is hard to accomplish,” says David Stratton of Pepper Hamilton LLP, debtor co-counsel for Holley.

The feds charge LIBOR plus 300 basis points on the DIP, 300 basis points below the current rate, but still capable of providing a return for taxpayers without killing GM. And by providing the DIP, taxpayers get paid before other GM creditors. Providing DIPs, says Saul Ewing’s Jerome, is “a more rational use of bailout money, less political.”….

But what about GM’s financial creditors? GM’s debt load, SEC filings show, includes a secured revolving credit facility with the full $4.4 billion drawn on it, a $1.5 billion secured term loan, three series of unsecured convertible debentures with more than $6.9 billion outstanding, about $16 billion in unsecured bonds and $19 billion in other long-term liabilities, ranging from municipal bonds and capital leases to contingent convertible debt and foreign currency-denominated bonds. Then, of course, there are GM’s bailout funds. It’s unlikely that all those debtholders will reach agreement, even after substantial talks.

Thus the seeds of dissension among creditors will have already been sown, and the chances of even a prenegotiated deal exploding are high, Calfee Halter’s Robertson says. “I would hope that the creditors would work together, because they have everything to lose,” she says.

Barnes & Thornburg’s Thorne is more hopeful. “Even if all the ‘I’s weren’t dotted and the ‘T’s weren’t crossed [before the filing], constituencies would come together,” she says. “There will be fights over money, but creditors will be working together because if they can’t and production stops, the costs are monumental.”

Nearly every constituency, of course, wants its own official committee in order to have its professional expenses paid out of the GM estate. As in almost every bankruptcy, an official committee of unsecured creditors is appointed. But U.S. Trustee Daniel M. McDermott, who oversees bankruptcies in Michigan and Ohio, wants to keep committees to a minimum. (The judge in the case has some say here, too.) McDermott must decide whether GM retirees and bondholders get official committees. Ditto for car dealers. Those without official status assemble informal panels. GM shareholders try to get an equity committee, and they’re laughed out of court….

While this jockeying is going on, Cooper [the presumed new CEO] turns his attention to his biggest task: reshaping GM’s operations. He will have to downsize the company, cutting brands, dealers, workers. The only thing to increase will be mobs of unhappy people. Cooper decides to retain Cadillac as GM’s luxury brand, Chevrolet as its core and GMC as its truck line. Everything else has to be unloaded through Section 363 sales.

GM will become more like Nissan, Toyota Motor Corp. and Honda Motor Co. Ltd. Gone are Buick, Pontiac, Hummer, Saab and Saturn. For GM, it serves as more than a catharsis. There is now much less duplication, less overhead and more cash from sales to pump back into the business. Some discarded brands don’t sell quickly (Hummer), while others will (Buick operations in China, where the nameplate is very popular). Overall, GM must sell millions of fewer cars a year to become profitable again. “The fundamental change [for GM] is that it’s going to have to not be all things to all people and create all these niche cars for niche markets,” says the restructuring adviser, adding that GM has to realize that being a carmaker is simply not about grabbing the biggest market share. “It’s better to say, ‘Lets find products to build profitably.’ “

But before GM can begin 363 sales, it must deal with labor and dealers, says Conway MacKenzie & Dunleavy managing director Gregory A. Charleston. “Once you deal with that baggage,” the turnaround consultant says, “you can potentially sell the pieces.”

Yves here. So you think this can be quick and surgical? Look at all the stuff that has to happen. Returning to the piece:

At the very least, GM needs to modify labor pacts to lower costs for existing, longtime workers, which may be difficult if not impossible, given recent contract modifications. And then there’s the question of brand elimination and its effects. While such actions might not be technically included in labor deals, any actions concerning workers would force more talks……A new deal doesn’t necessarily drastically alter GM’s pension or healthcare costs. According to GM spokeswoman Julie Gibson, the U.S. pension plans for salaried and hourly employees are “overfunded on a combined basis.”

UAW retiree healthcare costs of roughly $46.7 billion, meanwhile, are set to shift to a voluntary employee beneficiary association, or Veba, in January 2010, in exchange for set payments by GM negotiated last year. A similar deal with another union, the IUE-CWA, takes effect two years later.

Still, even here lurk potential pitfalls. Thomas Salerno of Squire, Sanders & Dempsey LLP says “overfunded is an estimate” and that the debtor has to work to avoid contingent liabilities — another sign that Section 1113 or related Section 1114, which governs rejection of retiree benefits, needs to be invoked. Plant closures can spark early retirements, which can turn overfunded plans into underfunded ones in a hurry.

GM won’t reject its pension plans, however. To do so, says attorney Carol Connor Cohen of Arent Fox LLP, the debtor would have to show that it and related entities couldn’t stay in business with the need to make payments on the plans. “I’d be very surprised if they could meet that test,” she says.

But healthcare is a different matter. The automaker has already deferred $1.7 billion in payments to the UAW Veba and could seek further deferrals; SEC filings indicate GM must either contribute $5.6 billion in 2010 — a tall order — or make annual payments of anywhere from $421 million to $3.3 billion through 2020. An additional $1 billion contribution is due in 2011, and $285 million of other payments is due on the implementation date.

Robert P. Simons of Reed Smith LLP says GM “shouldn’t kick the can down the road like what happened with the steel industry during the 1980s.”….

With fewer personal ties to union management, new GM management is in a better position to invoke Section 1113 and Section 1114 and negotiate rolled-back benefits.

The same equation holds for GM’s bloated dealer network….

Less cut and dried are GM contracts with parts makers. The ripple effect of GM’s woes extends over hundreds of suppliers. That’s why payments to them won’t be interrupted. But there are certain suppliers GM realizes it no longer needs as the bankruptcy progresses….

The remaining suppliers will have to restructure with the support of GM — and their lenders — to supply parts for future GM vehicles, Robertson says. She acknowledges this won’t be painless. “There will be a lot of casualties along the way. A lot of people going out of business….”

Yves here, I’ve spared you a lengthy discussion of GMAC and how that impacts dealers. Again to the story:

Eventually, sometime in late 2010, GM resolves its issues with GMAC, dealerships, parts suppliers and unions. Asset sales are now well under way or concluded under the auspices of the bankruptcy court. A new capital structure has been welded to a new, streamlined operational chassis. And there are some nifty, new fuel-efficient cars, too….

And after a creditor vote and a closely watched confirmation hearing, a trim GM rolls out of court one blustery winter day in Detroit and heads into the automotive future.

I’m always a bit leery of relying on single source, but The Deal is for lawyers and M&A/private equity/bankruptcy professionals. Its reporters cover that beat intensively and (as you can see) do detailed reporting. The timetable their sources gave for a GM bankruptcy is close to two years.

What is Team Obama smoking? It isn’t to their advantage to have an unrealistic view of the process, yet the pronouncements strongly suggest they haven’t done sufficient due diligence on what this entails.

And consider this comment from a reader:

The “Chapter 11″ reorganization idea is an assumption. There is little contemporary evidence that a Chapter 11 reorganization of GM can succeed under the current system. A Chapter 7 bankruptcy liquidation is more likely. And there is no evidence Chrysler will do anything other than liquidate.

It would be better if we were wrong, but this looks like Lehman redux. The powers that be are getting bailout pushback, and aren’t willing to take any financial perps out, so by default it’s Big Auto. And if they miscalculated, the consequences will be catastrophic. It won’t simply be GM and Chrysler, but the parts makers, and the transplants will take hits due to the loss of suppliers. GM and Chrysler are not isolated players, but major components in a large ecosystem. There are no good answeres here, but the Administration does not appear to have thought this out (how many balls does Geithner have in the air, including the G20?). A miscalculation here would have major repercussions. But Andrew Mellon would be pleased.

Posted by Tyler Durden, Publisher of Zero Hedge

And Northern Trust thought it had problems when Barney Frank went postal for the company’s House Of Blues romp. A smoking gun lawsuit filed March 30 in Northern Illinois District Court (09-cv-01934) by Joseph Diebold on behalf of the pension scheme of one of the world’s largest companies, Exxon Mobil, alleges Northern Trust breached its fiduciary responsibility under ERISA and claims Northern Trust invested the fund’s capital since 2007 “recklessly and imprudently, by acting disloyally and causing massive losses.”

One could surmise that Northern Trust, despite having pledged to repay its $1.6 billion in TARP funding, should at this point promptly change its mind and keep that cash, as this lawsuit may potentially have staggering adverse consequences.

This could be a seachange in terms of corporate pension funds, who are on the hook for massive losses, turning their anger instead at pension plan custodians and managers.

In a nutshell, the lawsuit purports that collateral collected from lending out of shares, had been invested too riskily by Northern Trust. Pension schemes traditionally use custodians and investment managers to lend out certain securities in their portfolios to hedge funds and other third parties. In exchange, the schemes receive collateral payments that are further invested to create additional returns. As once securities are returned the collateral has to be repaid immediately, investors generically prefer investing in liquid, low-risk assets. It appears this is where NTRS has made a big blunder, and effectively ended up generating losses for the ExxonMobil pension estate.

The Exxon Mobil pension fund, which is represented in the lawsuit by Joseph Diebold, Jr., and is pursuing class action status, was worth $13 billion at the end of 2007, and states in the lawsuit that “defendants inappropriately invested the collateral in collateral pools that were illiquid, highly-leveraged, and unduly risky, containing mortgage-backed securities and other securitized debt instruments. These investments were inappropriately risky for retirement plan investments – especially when compared to the relatively small amount of gains that the plans could expect to receive from securities lending arrangements.”

While no definitive figures have been set for total losses yet, the lawsuit is set for class-action status, and other plaintiffs are being sought to join the class-action suit, according to a news release from the four law firms representing plaintiffs. The suit represents 600 pension schemes for which Northern Trust was carrying out securities lending collateral investment services.

While on one hand it is surprising that NTRS could generate losses on lender arrangements, which traditionally have a 0 lower return bound, what is much more shocking, is that such a large company as Exxon is taking legal action to recover pension losses. This will likely soon become the modus operandi for all major corporate pension schemes that have experienced losses, who piggy back on this example as a means of recouping at least a portion of losses. And taking from Newton’s 3rd law, the defendants will likely end up having to pony up billions of new dollars.

Lastly, as Northern Trust (at least for now), and many of the other collateral custodians, are TARP recipients, this will present a brand new and unanticipated cog in the taxpayer-bank relationship, as banks will end up having to potentially pay out taxpayer money to pension funds, which invest the capital of these very same taxpayers. The circularity is enough to make one’s head spin.

A Census Taker for Penguins in Argentina New York Times

Woman who plays classical music to soothe horses told to get licence Telegraph

Merrill socked with $39.8 million arbitration ruling Investment News

CEO Change Begs Question About Banks Wall Street Journal (hat tip reader Don). I’ll admit to having only a limited sample, but this is just about the only mention I’ve seen of the disparity between how Big Auto and Big Finance are being treated.

Mark-to-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes Bloomberg (hat tip reader Paul)

Oil Price Breakdown Inside Futures (hat tip reader Michael). Chinese demand down 15% v. last year.

Financial Rescue Approaches GDP as U.S. Pledges $12.8 Trillion Bloomberg

OECD predicts 10% jobless rate for 2010 Financial Times. This is “practically with no exceptions”. Kiss the idea of a recovery in equities goodbye.

Blogging From Inside AIG: Exec Says Everyone Else Is Lying Clusterstock

Majors at Harvard Greg Mankiw.

ABC: FBI & Prosecutors “Closing In” on AIG’s Cassano Paul Kedrosky

PM tells Canada’s banks to expand overseas Financial Times. One of the big things that kept Canada’s banks out of trouble was its regulators discouraging international forays. Iceland, England, and Switzerland show the danger of having an overlarge banking sector relative to GDP.

Bond Bailout Independent Accountant

Do Obama Administration Officials Think That Krugman is Naive, or Do They Just Say That to Naive Reporters? Dean Baker. I must confess I must be the only person in the blogosphere not to have read the Newsweek cover story on Krugman, but it sounds as if the piece dissed him. Krugman ought to be relieved. That treatment may spare him the magazine cover curse.

The fiscal stimulus debate: “Bone-headed” and “Neanderthal”? Volker Wieland, VoxEU. Argues for much lower stimulus multipliers.

Financing the Empire Michael Hudson, Counterpunch. A bit rambling, but highlights the differences in US vs. European views of the crisis.

Antidote du jour:

To his credit, Eric Dinallo, the New York Superintendent of Insurance, did take the brewing mess at bond insurers MBIA (under his jurisdiction, and completely intransigent) and Ambac seriously enough to try to Do Something About It. In the end, his efforts came to nought, swept aside in the tidal wave of credit messes. But MBIA and Ambac were writing policies that in economic substance were very similar to the ones issued by AIG (regulated by the Office of Thrift Supervision). While AIG had stopped writing the toxic contracts by then, earlier action might have led to a less catastrophic unwind (look, it’s hard to imagine any outcome worse than the unsupervised decay now in motion).

As a New Yorker who has prevailed upon the insurance division, I must say I have found it to be exceptionally well run, more professional than the vast majority of private businesses I deal with. I don’t know whether Dinallo can take credit for it, but he certainly did not mess it up.

Dinallo has penned a colorful and informative piece for the Financial Times describing why having an unregulated market that makes side bets on securities prices isn’t such a hot idea. And he points to some legal avenues that could have been used to rein in credit default swaps that were blocked that were new to me.

From the Financial Times:

Many compare this financial crisis to the stock market crash of 1929, but it is closer to the credit freeze and bank panic of 1907….

The bank panic of 1907 is remembered for J.P. Morgan forcing all the bankers to stay in a room until they agreed to contribute to fixing the crisis. What has been forgotten is one major cause of the crisis – unregulated speculation on the prices of securities by people who did not own them. These betting parlours, or fake exchanges, were called bucket shops because the bets were literally placed in buckets.

The states responded in 1908 by passing anti-bucket shop and gambling laws, outlawing the activity that helped to ruin that economy.

What has that got to do with today’s crisis? Credit default swaps are the rocket fuel that turned the subprime mortgage fire into a conflagration….AIG Financial Products, the unit that sold almost $500bn (€379bn, £353bn) of them, may therefore be viewed as the biggest bucket shop in history.

Credit default swaps started out as essentially an insurance policy. If you owned a bond in a company and were concerned it might default, you bought the swap to protect yourself….Banks bought them to reduce the amount of capital they were required to hold against investments – in other words, to avoid regulation. Because they owned the swap, banks claimed they no longer had the risk of a default of the bond. Others bought swaps without owning the bond to place a bet on a company’s future.

But there was serious concern that swaps violated the old bucket shop laws. Thus, the Commodity Futures Modernisation Act of 2000 exempted credit default swaps from these laws. The act also exempted them from regulation by the Commodities and Futures Trading Commission and the Securities and Exchange Commission. Unregulated, the market grew enormously.

Thus, one of the major causes of the financial crisis was not how lax our regulation, or how hard we enforced, but what we chose not to regulate.

Indeed, what we decided was old fashioned and in need of modernisation was, in fact, an effective check on an activity that for 100 years had been illegal, for good reason. As a result, we modernised ourselves into this ice age.

The fear in 2000 was that if we regulated credit default swaps and required holding sufficient capital, the market would go where unregulated sellers could make more money. We forgot that the biggest competitive advantage of the US financial system has always been safety, security and transparency. If we destroy that perception, the long-term cost to our society is incalculable.

Yves here. That view may sound antique to those brought up on the “regulations drive activity elsewhere” mantra, but in fact, until perhaps 10 years ago, when the new ideology became entrenched, one would regularly read that the success of the US capital markets was due to its perceived safety, which in turn was due to its high standards of disclosure and investor protection. In other words, regulation. Back to the article:

What did we learn at the start of the last century that we then disregarded either through amnesia or hubris? What lessons, now learnt twice, can be gained from all this?

There are basically four ways people hand over money to financial institutions: 1. Bank deposit accounts. You deposit your money and the return of principal and interest is guaranteed. Banks are required to hold enough capital to deliver on that promise. 2. Insurance. If you suffer a loss, you are guaranteed recovery. Insurance companies are required to hold capital to meet that guarantee. 3. Gambling. If your bet wins, you are guaranteed your winnings. Casinos and racetracks are required to hold enough funds to ensure payouts. 4. Investment. There are no guarantees when you invest in a stock or a bond. You could lose everything. Appropriately, investment bank capital requirements are much lower. The first three categories contain guaranteed payments against future events; the fourth is merely aspirational.

We thought we could use alchemy to create a perfect fifth category that allowed guarantees supported by little or no capital, and that would produce hefty profits with no real risk. Instead, we re-created the old bucket shop gambling parlours on steroids and another credit crisis. Financial products should be seen as belonging in one or another of those four categories and regulated appropriately. If there is a guaranteed outcome, then the guarantor must hold sufficient capital to make good on that guarantee. A key lesson of this crisis is the danger of insufficient capital and the risks of alchemy.

Credit default swaps must be regulated and sellers must be required to hold sufficient capital. That will make them more expensive, but it will mean the guarantee has real value.

Does requiring adequate capital mean the end of financial innovation? Of course not, it just means that most institutions will operate with less leverage. Risk and reward are integral to capitalism. But innovators should risk their own capital, not the entire financial fabric. Setting that balance is where effective regulation comes in.

In sum, if you offer a guarantee – no matter whether you call it a banking deposit, an insurance policy, or a bet – regulation should ensure you have the capital to deliver. If you offer investments, be transparent, but buyer beware. No one should ever again get to bet the store called the Entire American Economy. And certainly do not assume we are smarter than folks 100 years ago. As Mark Twain is supposed to have said, history may not always repeat itself, but it sure rhymes.

Submitted by Leo Kolivakis, publisher of Pension Pulse.

There is a lot to cover today, so let’s begin with U.S. automakers. President Obama gave General Motors and Chrysler deadlines to “fundamentally restructure” or lose government aid that has kept them alive. The steps to force a restructuring by U.S. automakers drew a mixed reaction from members of Congress.

In rejecting the “viability plans” submitted by the struggling automakers, the U.S. government put both the companies and their stakeholders on notice that government-mandated bankruptcy is very much a possibility:

Highlights of the administration’s action include:

• Forced the resignation of longtime GM CEO Rick Wagoner. (My Note: Wagoner walks away with a $20 million retirement package while the rest of GM employees get a pension fund running on fumes.)
• Gave GM 60 days to present new cost-cutting plans and will provide funds to keep it afloat until that time. “The administration is prepared to stand by GM throughout this process to ensure that GM emerges with a fresh start and a promising future,” the White House said, The Wall Street Journal reports.
• Gave Chrysler 30 days to complete a pending transaction with Fiat, reduce debt and restructure its healthcare obligations. The government’s auto task force “doesn’t believe Chrysler is viable as a standalone company,” according to The Journal.
• The government will guarantee warranties on all new GM and Chrysler cars; the warranties will lapse back to the automakers once they reemerge from this process (assuming they do).

This may just be a negotiating ploy by the government to get all parties to make major concessions in short order, but the sharp reaction in both stock and bond markets suggests traders see this as more than just a bluff.

Curiously, one major stakeholder which hasn’t been asked to make any major concessions yet is Cerberus Capital Management, which controls 80.1% of Chrysler and 51% of GMAC. The private equity firm counts former high-ranking government officials John Snow and Dan Quayle among its board members, and had about $27 billion of capital under management as of December 2008.

Is it really curious that Cerberus Capital Management hasn’t been asked to make any major concessions? Not really; they get all upside if the restructuring goes through and taxpayers will protect their downside if things go wrong. Welcome to Capitalism II.

Reuters reports that private equity and hedge funds are concerned about the proposed rules that threaten their secretive industry:

For years, U.S. hedge fund managers have worried that their loosely regulated and secretive industry would one day face tougher regulations.

Now that day seems to be here.

“It was inevitable that this would happen,” said Brad Alford, founder of Alpha Capital Management, an advisory firm that invests in hedge funds. “From the time Congress had the industry’s top hedge fund managers testify late last year, we knew something was coming.”

But exactly what that something will be remains unclear, said managers, their lawyers and investors on Thursday hours after the Obama administration said it plans to press for broad reforms to curb risk taking on Wall Street.

“People want a road map and some clarity,” Alford said.

All agreed that putting hedge funds on a tighter leash will add new nervousness to an industry already facing poor returns, struggling with redemptions and being blamed for a financial crisis its managers say they did not cause.

Specifically, many hedge fund managers and their lawyers fear that public outrage over enormous bonuses paid to executives at nearly failed American International Group plus news of hefty paychecks at hedge fund firms could prompt lawmakers to try to impose unduly harsh rules.

“There is a concern that you will end up with ill-fitting regulations,” said Elizabeth Shea Fries, who works with hedge funds as a partner at law firm Goodwin Procter.

The private equity industry also voiced concern, saying the proposal “for the first time would impose potentially significant regulation on the private equity industry.”

“We believe that private equity investments do not create systemic risk,” Douglas Lowenstein, president of industry group the Private Equity Council, said in a statement.

“Private equity firms invest in companies, not exotic securities, and their investors are long-term investors, eliminating the ‘run on the bank’ type of risk that helped create the current financial crisis,” said Lowenstein.

He said the PEC aims to work with the government to ensure that any legislation enacted wouldn’t impose “undue burdens on private equity firms.”

Undue burden on PE firms? Give me a break! These guys schmooze with Washington’s top brass, pass laws to help them mitigate their fair tax bills and then claim that they did not contribute to systemic risk? This is laughable given all the leverage they used to rack up “profits” in their multi-billion dollar buyout funds.

Moreover, as top hedge fund earners take home billions, an astute observer notes that hedge fund inequity is going unnoticed:

Congress has been grandstanding the past weeks in its usual windy style regarding the compensation paid to AIG executives. Amazingly careless confiscatory special tax bills were designed and placed in the legislative hoppers in a matter of days.

Why will Congress not seriously and hastily deal with one of the most unfair and obviously flawed sections of the Internal Revenue Code: the ability of hedge fund managers to pretend that their compensation is really capital gain that should be taxed at 15 percent while the rest of us have our compensation or business profits taxed above 35 percent?

I can’t imagine that it would have anything to do with political contributions flowing to Washington from politically active hedge fund managers like George Soros, who made $1.1 billion in 2008, largely by betting against the US dollar. I suppose that the favorable tax rates are due to the enormous value these hedge fund managers add to our national productivity and wealth! I don’t know how our country ever grew and prospered before the birth of thousands of hedge funds in the late 1980s.

Perhaps this is why the proposed new rules worry hedge fund and private equity. For so long, they were able to borrow cheaply, leverage up to wazoo, market this as “alpha” and collect huge fees for what was essentially “beta on steroids”.

Total nonsense. One senior pension industry insider wrote me tonight, telling me the following:

“Just read an interesting statistic that 37% of all private equity capital raised over the last 30 years was raised in the last three years. A giant experiment whose results won’t be known for another 5 to 10 years.”

A scary thought indeed, and he is absolutely right, we simply do not know how all these billions of dollars into hedge funds, private equity and real estate funds will pan out over the next decade.

Turbulent financial markets have caused institutional investors to reduce hedge fund exposure temporarily, but not permanently, according to State Street Corp.’s fifth institutional investor hedge fund study:

The study, conducted late last year in conjunction with the 2008 Global Absolute Return Congress, polled representatives from public and government pensions, corporate pensions, endowments and foundations and insurance companies with an estimated $1 trillion in total investable assets.

It found a moderate decline in overall portfolio allocations to hedge funds, but revealed that nearly 90% of institutions intend to increase or maintain current hedge fund allocations over the next 12 months.

“Hedge funds have not been immune to the extremely volatile market environment,” said Gary Enos, executive vice-president and head of relationship management and client strategy for State Street’s alternative investment solutions team. “While alternative investments, including hedge funds, largely outperformed traditional investments in 2008, negative returns understandably disappointed. Although hedge fund allocations declined slightly over the past year, we anticipate growth will resume later in 2009, as institutional investors continue to focus on diversification and risk management.”

The hedge fund study shows that the proportion of institutions allocating more than 5% of their portfolio to hedge funds fell from 68% in 2007 to 51% in 2008.

But 49% of institutions said they would increase their allocation to hedge funds in the next year, and 39% will maintain their current allocation. Of the funding for new hedge fund positions, 80% is expected to come from equity allocations. The study also found increased institutional interest in private equity funds. More than half of institutions have allocated more than 5% of their portfolio to private equity funds, and half intend to increase their allocation to private equity over the next 12 months.

Among the challenges arising from the recent market volatility has been the growing difficulty in accurately valuing derivatives and other complex financial instruments. As a result, 77% of institutions reported that accurately valuing hedge fund holdings can be problematic, up from 55% last year.

The study participants expressed a need for more transparency. Of the institutions, 84% expect more disclosure of hedge fund positions and 49% anticipate more frequent reporting from hedge fund managers. Only 19% said they currently receive some level of consistent transparency across hedge fund holdings.

To gain a more meaningful assessment of risk across their portfolio, nearly two-thirds of institutional investors either intend to, or already are, aggregating alternative investment risk exposures with other portfolio exposures.

“The recent unprecedented market volatility has prompted institutions to increase their focus on risk management,” said Enos. “To address these concerns and the increasingly difficult challenges inherent in the financial markets, the hedge fund community and allied third-party providers and administrators are stepping up efforts to develop and expand risk management solutions for institutional investors.”

Expand risk management solutions? What is that some euphemism or hedgespeak for trying to pull the wool over our clients’ eyes? When are people going to wake up and finally realize that the majority of hedge funds are selling beta as alpha? (Note: Bloomberg reports that hedge funds are using emerging-market exchange-traded funds “quickly raise risk levels”. And why are they charging 2 & 20 for this “alpha”?!?)

After getting clobbered in 2008, some large pension funds are now taking a tougher stance. CalPERS is now playing hard ball with hedge funds, demanding changes:

The nation’s largest public pension fund is not happy with hedge funds, and it’s not going to take it anymore.

The California Public Employees’ Retirement System issued a stern warning to the asset class, in which it is a large and pioneering investor. The $173 billion pension said it plans to demand greater transparency and greater control of its assets invested with hedge funds.

“In recent years, institutional investors have displaced wealthy individuals as the main clients of hedge funds,” CalPERS said in a statement. “However, the hedge fund marketplace has not evolved sufficiently to accommodate what institutional investors require to maximize long-term benefits for their beneficiaries.”

Among the pension’s plans to “restructure” its hedge fund investments are more investments in managed accounts and other customized vehicles, as well as pushing hedge funds it invests with to reshape their fee system to focus more on long-term performance by spreading fees out rather than charging them annually. CalPERS also wants more clawback provisions, allowing investors to recoup some fees when performance takes a dive.

“We believe that investors and managers alike stand to benefit over the long-term when interests are better aligned, asset controls are properly instituted and transparency of risks and exposures is improved.”

CalPERS made its demands in a March 11 memo sent to 26 hedge funds and nine funds of funds it invests with, The Wall Street Journal reports. Among those counting CalPERS as a client are such luminaries as Atticus Capital, Och-Ziff Capital Management and Tremblant Capital.

The pension called the desired changes “extremely important,” and warned that it would “no longer invest in managers” that ignored them.

It’s about time CalPERS wakes up and stops being the 800-pound monkey that shoves billions into hundreds of alternative investment funds.

Tyler Durden of Zero Hedge blog wrote all about CaliPERSnication this past Saturday. I quote the following:

Two years ago it was said that you if had a direct line to the CIO of CalPERS, one of the nation’s largest public pension funds, and specifically to its Alternative Investment Management group, you had it made. None of that Goldman Sachs partners being masters of the universe garbage – this was the real deal. Say you needed $100 million for fund XYZ – you simply dialed that one number in Sacramento, and if you made it past the secretary, you were golden.

Of course, this worked best if your name started with Leon and ended with Black, but other managers were also sitting pretty. The reason for this is that unlike the public pension funds of New York State for example, where the bulk of the investments were in the public markets via an internal asset manager (who was pretty horrible at his job judging by the fund IRR), and only occasionally did NY invest in external private and public fund managers (which more often than not included a variety of kickbacks, bribes, and other illegal schemes as recently reported by NY’s own Andrew Cuomo), CalPERS has the bulk of its assets invested in 3rd parties.

While Thomson Banker gives the total amount of CalPERS public investments at $38 billion, an obscure site within the CalPERS website labyrinth presents the amount allocated and invested in various 3rd parties. And the amount is staggering: it seems that a vast number, maybe even a majority of U.S. private equity firms, owe their existence to CalPERS.

Tyler goes on to analyze some of the IRRs reported by CalPERS AIM and concludes:

We highly doubt -10.7% is anything even remotely close to where CalPERS should consider its residual equity value in Apollo VI. And by fair estimates, this is merely the tip of the iceberg. Nonetheless, presenting public data that shows that the public pensions manager is disclosing over $14 billion in profits when it is hiding potentially much more than that in losses could be interpreted as borderline illegal. The question is, is this a responsibility of Apollo (to show the true sad state of affairs), or of CalPERS (to actually check these numbers and not to pull a Fairfield Greenwich “sorry, we had no clue what was really going on until it was too late”).

Regardless, as CalPERS itself points out, the numbers were as of September 30. It is a fact, that the December 31 numbers are due any minutes and we are salivating at the prospect of feasting out eyes on these numbers, to see just how much disconnected from reality the column known as IRR as presented by CalPERS has become. And just as Apollo VI is merely the tip of the asset manager iceberg, so is CalPERS merely a blip in the Alternative Investment Management universe of all public pension managers. Combined together, and based on realistic performance, these two will result in an explosive deterioration in both fund IRRs and public pensioners’ patience and empathy, once they realize their money has been mismanaged into oblivion.

Note my comment at the end of that post. The bursting of the alternative investment bubble will expose the true value of many of these investments.

But hold on just a minute. A buddy of mine sent me a Bloomberg article that proposed changes to mark-to-market rules are about to go into effect:

Four days after U.S. lawmakers berated Financial Accounting Standards Board Chairman Robert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. by more than 20 percent.

The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.

FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.

Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” said Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York. “I’d say there was a pretty close cause and effect.”

Willens, investor-advocate groups including the CFA Institute in Charlottesville, Virginia, and former U.S. Securities and Exchange Commission Chairman Arthur Levitt oppose changes that would enable banks to put off reporting losses.

‘Outrageous Threats’

“What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.

FASB spokesman Neal McGarity said the proposal allowing significant judgment was “in the works prior to the Washington hearing and was merely accelerated for the first quarter, instead of the second quarter.” The plan on impaired investments “was an attempt to address an important financial reporting issue that has emerged from the financial crisis,” he said.

I guarantee you that private equity funds were lobbying hard to change mark-to-market rules, enabling them to “fudge” their numbers going forward. In the pension world, they call this “alpha”.

This brings me to my concluding thoughts. In late January, Pensions & Investments published an article, PBGC Premium Boost. I quote the following:

The agency’s huge deficit and Mr. Millard’s desire to avoid any eventual PBGC taxpayer bailout spurred the most significant contribution during his tenure: a major change in the agency’s asset allocation policy in February 2008 that permits the agency to invest up to 10% of the $55 billion it has available in private equity and real estate. Both are new asset classes for the PBGC.

Under the new asset allocation, designed to close the PBGC’s deficit over the next 10 to 20 years, 45% of assets will be in equities, 45% in fixed income and 10% in alternatives. Previously, 75% to 85% was in fixed income in a strategy designed to match assets with liabilities. The remainder was invested in stocks.

Some critics have charged the new asset allocation is too aggressive for an agency that is supposed to backstop failed private pension plans. But Mr. Millard said the new policy has a far better chance of closing the PBGC deficit than the previous policy did.

“I would urge people to recognize that it is a long-term policy, and that PBGC’s liabilities will last for decades, and we need an investment policy that focuses on the long term,” Mr. Millard said.

Today, the Boston Globe reports that the pension insurer shifted to stocks (also, read Yves’ post below):

Just months before the start of last year’s stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds.

The agency refused to say how much of the new investment strategy has been implemented or how the fund has fared during the downturn. The agency would only say that its fund was down 6.5 percent – and all of its stock-related investments were down 23 percent – as of last Sept. 30, the end of its fiscal year. But that was before most of the recent stock market decline and just before the investment switch was scheduled to begin in earnest.

No statistics on the fund’s subsequent performance were released.

Nonetheless, analysts expressed concern that large portions of the trust fund might have been lost at a time when many private pension plans are suffering major losses. The guarantee fund would be the only way to cover the plans if their companies go into bankruptcy.

“The truth is, this could be huge,” said Zvi Bodie, a Boston University finance professor who in 2002 advised the agency to rely almost entirely on bonds. “This has the potential to be another several hundred billion dollars. If the auto companies go under, they have huge unfunded liabilities” in pension plans that would be passed on to the agency.

In addition, Peter Orszag, head of the White House Office of Management and Budget, has “serious concerns” about the agency, according to an Obama administration spokesman.

Last year, as director of the Congressional Budget Office, Orszag expressed alarm that the agency was “investing a greater share of its assets in risky securities,” which he said would make it “more likely to experience a decline in the value of its portfolio during an economic downturn the point at which it is most likely to have to assume responsibility for a larger number of underfunded pension plans.”

However, Charles E.F. Millard, the former agency director who implemented the strategy until the Bush administration departed on Jan. 20, dismissed such concerns. Millard, a former managing director of Lehman Brothers, said flatly that “the new investment policy is not riskier than the old one.”

He said the previous strategy of relying mostly on bonds would never garner enough money to eliminate the agency’s deficit. “The prior policy virtually guaranteed that some day a multibillion-dollar bailout would be required from Congress,” Millard said.

He said he believed the new policy – which includes such potentially higher-growth investments as foreign stocks and private real estate – would lessen, but not eliminate, the possibility that a bailout is needed.

Asked whether the strategy was a mistake, given the subsequent declines in stocks and real estate, Millard said, “Ask me in 20 years. The question is whether policymakers will have the fortitude to stick with it.”

But Bodie, the BU professor who advised the agency, questioned why a government entity that is supposed to be insuring pension funds should be investing in stocks and real estate at all. Bodie once likened the agency’s strategy to a company that insures against hurricane damage and then invests the premiums in beachfront property.

Since he issued that warning, he said, the agency has gone even more aggressively into stocks, which he called “totally crazy.”

The agency’s action has also been questioned by the Government Accountability Office, the investigative arm of Congress, which concluded that the strategy “will likely carry more risk” than projected by the agency. “We felt they weren’t acknowledging the increased risk,” said Barbara D. Bovbjerg, the GAO’s director of Education, Workforce and Income Security Issues.

Analysts also believe the strategy would not have been approved if the government had foreseen the precipitous decline in the stock market.

Now, they warn about a “perfect storm” scenario in which the agency’s fund plummets in value just as more companies go into bankruptcy and pass their pension responsibilities onto the insurance fund. Many analysts say it is inevitable that the agency will face significantly increased liabilities in coming months.

“The worst case scenario is coming to pass,” said Mark Ruloff, a fellow at the Pension Finance Institute, an independent group that monitors pensions. He said the agency leaders “fail to realize that they are an insurer of pension plans and therefore should be investing differently than the risk their participants are taking.”

The Pension Benefit Guaranty Corporation may be little-known to most Americans, but it serves as a lifeline for the 1.3 million people who receive retirement checks from it, and the 44 million others whose plans are backed by the agency.

The agency was set up in 1974 out of concern that workers who had pensions at financially troubled or bankrupt companies would lose their retirement funds. The agency operates by assessing premiums on the private pension plans that they insure. It insures up to $54,000 annually for individuals who retire at 65.

Despite its name, the agency does not necessarily guarantee the full value of a person’s pension and is not backed by the full faith and credit of the government.

Nonetheless, agency officials say that if the pension agency fails to meet its obligation, the government would come under intense political pressure to step in. That means taxpayers – including those who don’t get pensions – could be asked to pay for a bailout.

Currently, the agency owes more in pension obligations than it has in funds, with an $11 billion shortfall as of last Sept. 30. Moreover, the agency might soon be responsible for many more pension plans.

Most of the nation’s private pension plans suffered major losses in 2008 and, all together, are underfunded by as much as $500 billion, according to Bodie and other analysts. A wave of bankruptcies could mean that the agency would be left to cover more pensions than it could afford.

In the early years of the George W. Bush presidency, the agency took a conservative investment approach under director Bradley N. Belt, who favored putting only between 15 and 25 percent of the fund into stocks.

Belt said in an interview that he operated under “a more prudent risk management” style and said he “would have maintained the investment strategy we had in place.” Belt left in 2006 and Millard arrived in 2007.

Under Millard’s strategy, the pension agency was directed to invest 55 percent of its funds in stocks and real estate. That included 20 percent in US stocks, 19 percent in foreign stocks, 6 percent in what the agency’s records term “emerging market” stocks, 5 percent in private real estate and 5 percent in private equity firms.

Millard said he thought he had little choice but to seek a higher investment return in part because Congress had limited the agency’s ability to charge higher premiums based on each plan’s likelihood of drawing on the agency’s funds.

The agency’s board – which consists of the secretaries of Treasury, Labor, and Commerce – approved the new investment strategy in a meeting in February 2008. But the board members have had only a limited role in the agency’s operation, meeting only 20 times over the 28 years before 2008.

The board is also too small to meet basic standards of corporate governance, according to an analysis by the Government Accountability Office.

“The whole model of having three sitting Cabinet secretaries with day jobs overseeing a $60 billion investment portfolio and occasionally owning significant percentages of large American companies is fundamentally flawed,” said Belt, the former agency director.

The Government Accountability Office is preparing a new review of the investment policy, but in the meantime it continues to place the agency on its list of federal programs at “high risk.”

And the article above brings me to another excellent post by Ian Williams that appeared on the Barricade blog over the weekend, Who Killed U.S. Public Pension System?

Ian was kind enough to email me and share his insights with me. The charts above are from his post and I quote the following:

Professor and Nobel Laureate Paul Samuelson in late 1998 was quoted as saying, a bit sadly, “I have students of mine – PhDs – going around the country telling people it’s a sure thing to be 100% invested in equities, if only you will sit out the temporary declines. It makes me cringe.”

When someone tells you that stocks always beat bonds, or that stocks go up in the long run, they have not done their homework. At best, they are parroting bad research that makes their case, or they are simply trying to sell you something.

Which leads nicely into our 2nd bullet point – politically connected pension systems promising benefits and COLA’s assuming and I am likely being conservative a 7.5% investment return assumption on their portfolio which is now skewed heavily into stocks over bonds. Their investment return assumptions are PIE IN THE SKY or RAINBOW PONIES WITH WINGS depending which fantasy reference you prefer. I think it is time for pension systems to allocate 200% into equities with leverage provided by the US Govt as the retirement and pension systems are woefully underfunded.

The misleading numbers posted by retirement fund administrators help mask this reality: Public pensions in the U.S. had total liabilities of $2.9 trillion as of Dec. 16, according to the Center for Retirement Research at Boston College. Their total assets are about 30 percent less than that, at $2 trillion. With stock market losses this year, public pensions in the U.S. are now underfunded by more than $1 trillion.

I urge to read Ian’s entire post and to start taking a closer look at how your pension funds are being managed or mismanaged.

The solution to the pension crisis won’t be easy. But we have to start by admitting that the crisis exists and that pension funds have not taken adequate steps to address their underfunded status. Only then will we be in a better position to confront the challenges that lie ahead.

You simply cannot make this stuff up.

The Pension Benefit Guaranty Board, which backstops defined benefit plans (yes, Virginia, they still exist) faced a rather sizable gap between its expected returns on its $64 billion in holdings and its expected liabilities.

So in a stroke of sheer genius, it increased its allocation to risky assets considerably at precisely the time those assets started tanking. It even managed to cut its allocation to Treasuries way back, reducing its participation in the big Treasury rally of last year.

Now anyone who was finance literate would look at the PGB’s new asset allocation and recognize it as conventional wisdom as dispensed by pension fund consultants. And if you had read Benoit Mandelbrot or Nassim Nicolas Taleb, you’d also know that those pension fund consultants base their prescriptions on theories that simply do not pan out empirically, and worse, greatly understate risk.

This was patently a silly move. First, it seemed to reflect a classic trader’s bad reflexes, of taking bigger bets to dig his way out of a loss, although the former head honcho vociferously denies that (hat tip readers John, Michael and Chris) :

Charles E.F. Millard, the former agency director who implemented the strategy until the Bush administration departed on Jan. 20, dismissed such concerns. Millard, a former managing director of Lehman Brothers, said flatly that “the new investment policy is not riskier than the old one.”

He said the previous strategy of relying mostly on bonds would never garner enough money to eliminate the agency’s deficit. “The prior policy virtually guaranteed that some day a multibillion-dollar bailout would be required from Congress,” Millard said.

He said he believed the new policy – which includes such potentially higher-growth investments as foreign stocks and private real estate – would lessen, but not eliminate, the possibility that a bailout is needed.

Yves here. This is double-speak, and pretty inept at that. We are supposed to believe that foreign stocks and private equity are less risky than Treasuries? Even if you have a dim view of government securities, trust me, if that market hits a down draft, equity related instruments will do worse.

So Millard wants us to believe that there are financial free lunches, that he can invest in “higher growth investments” without taking on more risk. I have a bridge I’d like to sell him.

Now some will say I am being unfair to jump on the fund’s utterly wretched timing. Wrong. It was obvious a train wreck was starting (and this isn’t 20/20 hindsight, any reader of the Financial Times would have seen the warning signs). Risky assets were clearly overvalued, as Martin Wolf pointed out in March 2007:

It is always a mistake to confuse a cycle with a trend. In the case of corporate earnings, it is worse than a mistake, it is a huge blunder. The intense cyclicality of corporate earnings is the most important reason why the unadjusted p/e ratio is a worthless indicator of value. The question one has to ask is whether they will be sustained or fall back again, as they have done in the past.

Over the past 125 years, real earnings of companies in the [S&P composite] index have grown at only 1.5 per cent a year – lower than in the economy as a whole, because the index is always underweight in new and dynamic companies. Over the past quarter century real earnings have grown at an annual rate of 3 per cent. The annual growth of 25 per cent seen since the most recent trough will not last. On past experience, it is far more likely to turn negative….

The dangers ahead look big. One is that markets will overreach themselves, so generating a destabilising correction. Another is a reduction in excess savings outside the US and a tightening of world interest rates. Another is a slowdown in US productivity growth. Yet another is a shift in global monetary conditions that threatens the soaring profitability of the US financial sector. But the biggest risk is that the end of the US property boom will persuade US households to tighten their belts at last, thereby ending the US role as the world’s big spender before the big savers are prepared to spend in turn.

We can be confident that profit growth will not continue at recent rates. But a sharp reversal, though possible, may not be imminent either. The economic risks are evident and the market does look expensive. But I would not dare to forecast a turning point. Forecasting is for far cleverer and braver people than I am.

So making a big shift to assets that look overpriced is not a winning investment formula. And the Boston Globe article gives other reasons why this investment approach wasn’t so wise:

Last year, as director of the Congressional Budget Office, [Peter] Orszag expressed alarm that the agency was “investing a greater share of its assets in risky securities,” which he said would make it “more likely to experience a decline in the value of its portfolio during an economic downturn the point at which it is most likely to have to assume responsibility for a larger number of underfunded pension plans.”

This investment blunder is going to create a new set of woes sooner rather than later, particularly if Team Obama does push GM or Chrysler into bankruptcy.

Currently, the agency owes more in pension obligations than it has in funds, with an $11 billion shortfall as of last Sept. 30. Moreover, the agency might soon be responsible for many more pension plans.

Most of the nation’s private pension plans suffered major losses in 2008 and, all together, are underfunded by as much as $500 billion, according to [Zvii] Bodie [former advisor to the fund] and other analysts. A wave of bankruptcies could mean that the agency would be left to cover more pensions than it could afford.

Note the underfunding is not the amount due in any one year, but the net present value of the total shortfall in future years.

The Pension Guaranty Board is not formally backed by the US government, but pressure to correct the agency’s blunders will be considerable. How can you bail out bankers and not hapless retirees?

Submitted by Edward Harrison of the site Credit Writedowns

I like the fact that President Obama has drawn a line in the sand and signaled that no more funds will be given to U.S. automakers without their presenting a viable long-term plan for restructuring. Ultimately, the automakers cannot survive merely as a result of government largesse, but through the discipline of a competitive auto market.

In my view, the American automakers are viable companies which can produce cars that sell well. It is their poor operating cost structure and disastrous balance sheets which make them bankrupt organizations. This should mean they are prefect candidates for restructuring.

Nevertheless, other aspects of Obama’s treatment of the automakers are troubling. The dichotomy between how the big three automakers are being treated and how the big banks are being treated plus the sacking of a CEO at a critical juncture leave a lot of questions.

First, as to what Obama has done.

• The Obama Administration used the threat of withholding bailout funds from General Motors to induce that firm’s CEO Rick Wagoner to resign and its board to seek replacement members.
• GM has received 60 days to come up with a viable restructuring plan or they will face Chapter 11 bankruptcy. Chrysler gets 30 days to forge a deal with Fiat or they too face the same fate. The Obama Administration has indicated that it will help the companies with liquidity during this time, but will not give them any ‘bailout’ funds.
• Any bankruptcy will be heavily ‘directed’ by the Obama Administration to mitigate any fallout in terms of jobs, suppliers, regional economies or the broader American economy.
• Meanwhile, the Administration has indicated that it would guarantee any vehicle warranties offered by either firm on existing and newly purchased vehicles if either firm were to go into bankruptcy.
• The Administration has also made green car production, federal car purchases, an tax breaks for buyers a large part of helping increase demand for domestic vehicles. Very smart. The green emphasis is something the Germans have also done.

In short, the Administration is credibly threatening to withhold support for GM and Chrysler unless those organizations can create a restructuring plan that Obama’s people consider viable, the penalty for failure being bankruptcy.

This approach has several benefits. Here are a few:

• Taxpayers will not need to commit more money without the certainty that this money will be used effectively.
• The carrot and stick approach forces the unions, management and bondholders to the table because their best alternative to a negotiated agreement (BATNA) is clearly inferior in each case. Bankruptcy would mean significant losses for each constituency. That is the stick side of things. Simultaneously, if they do reach agreement, their concessions will be met with additional capital from the government. This is the carrot.
• Even if the parties cannot agree, the Administration can make sure that bankruptcy will not mean Armageddon for workers and local communities by taking a direct role in the proceedings. Moreover, by withholding funds until bankruptcy, the government will be senior to all other creditors including bondholders.

All in all, this seems like a difficult choice, but the right one.

But, is this not what should be happening with the big banks? Why the differential treatment here? Here’s my take. I see two reasons.

First, the Obama Administration suffers from cognitive regulatory capture. Former denizens of Wall Street are so ensconced in the Administration that they cannot but see events from a ‘Wall Street perspective.’ In effect, they operate like a horse with blinders. Their view takes as axiomatic the importance and needed continued existence of the big banks that they dismiss alternative workout solutions out of hand.

Second, the Obama Administration is well aware of rising populist sentiment. They understand that bailing out the big three automakers would weaken them politically as this would be seen as another outrageous subsidy to big business. However, Obama errs politically because the juxtaposition between his treatment of the big three and his treatment of the banks is obvious to everyone. the big three are seen as representing ordinary blue collar Americans. While the big banks are seen as Gordon Gekko-like rapers and pillagers of the robber baron class. This alone increases populist outrage at the administration. Effectively, Obama’s unwillingness to deal with the banks in the same fashion earlier has put him in a lose-lose situation.

Then there is the dismissal of the GM CEO and re-composition of its board of directors. While the need for someone to take ‘responsibility’ for failure has been obvious, the timing is questionable. GM is about to go through the most crucial phase of its existence. To subject the organization to the type of turmoil that a change in leadership entails at such a juncture is a catastrophic misstep.

Finally, the uncertainty surrounding the Big Three has led to a major selloff globally. In my view, this eliminates all of the positive momentum we saw earlier this month and after the Geithner bank plan was announced. Tactically, this announcement, then, has been another major misstep.

My conclusion, therefore, is that the Obama Administration has developed a fairly good plan here. It looks to force necessary concessions from all interested parties without bankruptcy. It is also still viable in bankruptcy. However, tactically, I see the plan as having misfired for the reasons enumerated above. And, this is unfortunate because this auto plan may end up weakening the Administration rather than pushing it forward.

Submitted by Edward Harrison of the site Credit Writedowns

Edward Harrison here. For months now, we have been hearing the Obama – FDR comparisons, all suggesting that Barack Obama is a modern day Franklin Delano Roosevelt, with the opportunity to lead us out of Depression with a new New Deal. I have some serious problems with this comparison. In my view, a comparison between Barack Obama and Herbert Hoover is more apt.

Let’s look back at the Depression for a second. Now, if you recall, Herbert Hoover became president in March 1929 when signs of a slowing economy were evident. By August 1929 recession hit.

This recession turned into the Great Depression, with the economy hitting bottom in March 1933. So, the entire recession we remember as being the depths of the Great Depression occurred while Herbert Hoover was President, not during FDR’s presidency.

Fast forward to December 2007 when this recession began and we can see that George W. Bush presided over 11 months of recession. So, Obama comes into office during recession unlike Hoover, but also unlike Roosevelt. However, the key difference here is that the economy had already hit bottom when Roosevelt entered and is continuing to worsen for Obama.

What historical period should Obama be looking to then? Clearly, he should be looking to Hoover. And I believe this is very important with the G-20 right around the corner. Any number of pundits from Simon Johnson to Wolfgang Munchau will tell you the G-20 summit will be a big failure. While the Americans are trying to reflate the bubble and bring back the same unbalanced system which got us here, the Europeans are putting their heads in the sand, wishing all of this would go away.

And that’s not a good thing at all. If one thinks back to Hoover again, after a long period of globalization, an interconnected world meant problems in one country quickly became manifest elsewhere. The world’s major nations failed to come together and build a common solution. Some thought themselves immune. But, when the depths of Depression finally came, it was little Austria which ushered it in. And soon, depression was everywhere.

This was 1931. Herbert Hoover was president, not Franklin Roosevelt.

Source
Business Cycle Expansions and Contractions – NBER

‘War’ on poisonous Australia toad BBC. Notice how this is basically a community effort? Aussies are good about that sort of thing.

What they Used to Teach You at Stanford Business School and Newsweek’s Fearful Krugman Profile Felix Salmon

Equities show us the way to recovery Alan Greenspan and A new plan needed as the cycle grows vicious Wolfgang Munchau. Financial Times. I doubt this juxtaposition was intentional, but it certainly looks like someone at the FT was having a bit of sport. I’m clearly biased, but the Greenspan bit strikes me as barmy, and confirms his long-standing obsession with equity valuations, which dates back to well before 2000 (the Wall Street Journal reported on it then). Seeing how well he did with it over the years, I see it as a negative indicator. The Munchau piece is worth reading, regardless (I broke down and featured it separately).

Japan Output Slumps for Fifth Month as Exports Tumble Bloomberg

Inflation Is Tempting for Indebted Nations Wall Street Journal. The Journal has only figured that out now?

Trust Your Guts William Greider, The Nation (hat tip Ed Harrision)

Study Predicts 50% Cut in Free Cash Flow CFO

Morgan Stanley Says Sell Following Best S&P 500 Rally Since ‘38 Bloomberg

Antidote du jour (hat tip reader Barbara):

In 2003, police in Warwickshire, England, opened a garden shed and found a whimpering, cowering dog. It had been locked in the shed and abandoned. It was dirty and malnourished, and had clearly been abused.

In an act of kindness, the police took the dog, which was a greyhound female, to the nearby Nuneaton and Warwickshire Wildlife Sanctuary, run by a man named Geoff Grewcock and known as a willing haven for animals abandoned, orphaned or otherwise in need.

Geoff Grewcock and the other sanctuary staff went to work with two aims: to restore the dog to full health, and to win her trust. It took several weeks, but eventually both goals were achieved.

They named her Jasmine, and they started to think about finding her an adoptive home.

The dog had other ideas. No-one remembers now how it began, but Jasmine started welcoming all animal arrivals at the sanctuary. It wouldn’t matter if it was a puppy, a fox cub, a rabbit or, probably, a rhinoceros, Jasmine would peer into the box or cage and, where possible, deliver a welcoming lick.

Geoff Grewcock relates one of the early incidents. “We had two puppies that had been abandoned by a nearby railway line. One was a Lakeland Terrier cross and another was a Jack Russell Doberman cross. They were tiny when they arrived at the centre and Jasmine approached them and grabbed one by the scruff of the neck in her mouth and put him on the settee. Then she fetched the other one and sat down with them, cuddling them.”

“But she is like that with all of our animals, even the rabbits. She takes all the stress out of them and it helps them to not only feel close to her but to settle into their new surroundings.

“She has done the same with the fox and badger cubs, she licks the rabbits and guinea pigs and even lets the birds perch on the bridge of her nose.”

Jasmine, the timid, abused, deserted waif, became the animal sanctuary’s resident surrogate mother, a role for which she might have been born. The list of orphaned and abandoned youngsters she has cared for comprises five fox cubs, four badger cubs, 15 chicks, eight guinea pigs, two stray puppies and 15 rabbits.

And one roe deer fawn. Tiny Bramble, 11 weeks old, was found semi-conscious in a field. Upon arrival at the sanctuary, Jasmine cuddled up to her to keep her warm, and then went into the full foster mum role. Jasmine the greyhound showers Bramble the roe deer with affection and makes sure nothing is matted in her fur.

“They are inseparable,” says Geoff Grewcock. “Bramble walks between her legs and they keep kissing each other. They walk together round the sanctuary. It’s a real treat to see them.”

Jasmine will continue to care for Bramble until she is old enough to be returned to woodland life. When that happens, Jasmine will not be lonely. She will be too busy showering love and affection on the next orphan or victim of abuse.

Wolfgang Munchau often has a dour outlook, but his Financial Times comment today, “A new plan needed as the cycle grows vicious” is gloomy even by his standards.

Munchau argues that the heroic seeming measures to aid the banks are insufficient to compensate for the losses they are and will continue to suffer, and that as they understandably rein in lending, it will make the contraction more severe, worsening credit losses and deepening the cycle. Meredith Whitney has been making similar comments, but with a tad less urgency than Munchau.

While I agree with his concern, that a contraction can slip into a vicious circle, focusing on recapitalization as the primary policy response is wrongheaded. The Swedish in their salvage operation not only took over dud banks and hived off the bad assets, but they restuctured those loans and sin some cases even extended more credit to borrowers. And bailouts to banks without banking reform is a bad idea (and I see the Geithner talk of new measures as window dressing to appease the public in the hopes of eliciting support for the inevitable next round of rescues).

The only way out of a financial crisis is default, whether overt, through writeoffs and resturcturings, or covert, through inflation. This process isn’t even seriously underway until we see a lot more renegotiation.

From the Financial Times:

So you think you can see the green shoots of recovery? You draw comfort from the recent stabilisation of forward-looking indicators such as new home sales in the US? Or you think the stock market rally marks the end of the crisis? Of course, economic growth rates are bound to improve soon for technical reasons. Otherwise, not much would be left of the global economy by the end of the year.

Even if a recovery were to start early in 2010, as some optimistic forecasters believe, most of the pain of the recession is still ahead of us: unemployment and default rates will rise sharply everywhere. Most of the pain in the financial sector is also still ahead of us. This will feel like a depression long after it has ceased to be one.

I am more worried now than I was a month ago. The main problem is that the feedback loops between the real economy and the banking sector are truly scary….

At this rate of contraction, the number of private and corporate defaults is likely to increase massively beyond some of the stress-test assumptions made by the banks themselves. After the crisis caused by toxic securitised assets, the financial industry is now hit by another crisis of potentially similar magnitude…

Economists and policymakers who wonder how much it will take to recapitalise the banking sector are discovering that rescuing the banks is a much more dynamic exercise than they thought. Whatever you think it costs – and there have been widely different estimates – it is likely to end up costing you a lot more for that precise reason….

By the end of December, global banks had written off about $1,000bn (€752bn, £699bn) in bad assets, approximately half of that in the US. Since the onset of the crisis, the writedown of assets in the US has exceeded the provision of new capital. Even the Geithner public-private partnership plan is not going to reverse the expected deterioration of capital ratios….

In the absence of such plans, the banking sector will continue to contract its balance sheet by cutting lending. This is a totally rational response by the banks. To unfreeze the global financial market therefore requires significant increases in bank capitalisation, not just to the status quo ante, and not just to account for the toxic securitised assets themselves, but to adjust for the stuff that is getting toxic right now and tomorrow. The estimate by Alan Greenspan, the former chairman of the Federal Reserve, that one needs to push the ratio of banks’ equity capital to assets from 10 per cent to 13 or 14 per cent seems plausible to me. After a long period of undercapitalisation, you need a period of overcapitalisation just to get back to normal.

In other words, you have to do quite a bit more than you think you need to do, rather than quite a bit less. This is the main reason why the Geithner plan is not an optimal policy response. …. For all its technical ingenuity, this plan is at best insufficient – and more likely an expensive distraction that delays the inevitable policy response of a government-led recapitalisation programme.

Europeans think they have less of a problem because they already put bank rescue packages in place last Octo….But we have moved beyond the immediate emergency, and need a strategic response. Europe, too, will have to start to address the problem, by forcing banks to write down their assets in exchange for new capital. And not all the banks should survive. We must allow the sector to shrink while we recapitalise. This means many painful and unpopular decisions have yet to be taken….

The Europeans need a new plan. And the US needs a better plan.

Oh, so there was even more to the GM Wagoner resignation than met the eye.

So how come no bank turnaround plans? Oh, if they were no good, the government might have to get tough with them. Can’t have that, now can we?

From CNBC (hat tip reader Dwight):

The announcement by the White House autos panel headed by former investment banker Steve Rattner marked a stunning reversal for management at both automakers and for GM investors and creditors who had bet on a softer line.

“We have unfortunately concluded that neither plan submitted by either company represents viability and therefore does not warrant the substantial additional investments that they requested,” said a senior administration official, who asked not to be named…..

he White House says neither GM nor Chrysler submitted acceptable plans to receive more bailout money, setting the stage for a crisis in Detroit and putting in motion what could be the final two months of two American auto giants.

President Barack Obama and his top advisers have determined that neither company is viable and that taxpayers will not spend untold billions more to keep the pair of automakers open forever.

In a last-ditch effort, the administration gave each company a brief deadline to try one last time to convince Washington it is worth saving, said senior administration officials who spoke on the condition of anonymity to more bluntly discuss the decision.

Obama was set to make the announcement at 11 a.m. ET Monday in the White House’s foyer.

From Bloomberg:

General Motors Corp. and Chrysler LLC must overhaul their recovery plans with deeper concessions to justify further taxpayer aid, and bankruptcy may ultimately be their best chance, an Obama administration official said….

Detroit-based GM sought as much as $16.6 billion in additional aid after receiving $13.4 billion since December. Chrysler sought $5 billion after receiving $4 billion. Both had to show progress by the end of this month in matters such as GM’s need to reduce unsecured debt by two-thirds.

Neither company completed the tasks, the administration official said. The aid plans submitted to the government Feb. 17 don’t warrant additional assistance, the administration concluded. GM’s plan to cut unsecured debt by two-thirds wasn’t sufficient, and Chrysler’s debt was far beyond what the company could sustain, the official said.

GM’s plan wouldn’t lead to success even in an improved economy, the administration found. The new strategy sought by the administration would focus on sustainable profit and significant changes in brands, workforce, nameplates and the retail network.

It would be better if we were wrong, but we are of the school that putting the big automakers into bankruptcy, despite its attractions (being able to restructure debt and dealer networks; the UAW contracts are far less significant economically than the media makes them out to be) misses out on one crucial element: you don’t have a business if you don’t have customers. And a GM bankruptcy would be a protracted affair. Even if consumers believe the company will make it, what about their local dealer? If they worry they might have to schlepp to get their car serviced, is it worth it?

In typical backwards American deal and contract focused thinking, the officialdom has not spent enough time assessing the single most important issue: how would customers react? If GM and Chrysler were to lose as many as 20% of sales they’d otherwise get as a result of a bankruptcy filing, that it is a very big change in outcomes. And the drop could be considerably higher than that.

I worry that this punitive move will wind up being Lehman redux. Recall that bailout disgust was running high post Bear and Fannie and Freddie, and Someone Had to Suffer to show the Administration was made of real men. Now since no one even dares bitch slap a bank (the bonus stuff is mere Punch and Judy), all the hostility is channeled at Big Auto. And the danger is going into overkill literally, not just figuratively, to make up for being too easy on the financiers.

And if GM or Chrysler were to be liquidated, the knock-on effects would be grim. They are important to quite a few parts suppliers. If those suppliers fail, it threatens the viability of the foreign transplants.

The markets appear to share these reservations. The Nikkei had been down, but has fallen further, S&P futures declined from 10 points down to 13 points down, and Treasuries have strengthened from their earlier in the evening levels.

Submitted by Tyler Durden, publisher of Zero Hedge

Zero Hedge is rarely speechless, but after receiving this email from a correlation desk trader, we simply had to hold a moment of silence for the phenomenal scam that continues unabated in the financial markets, and now has the full oversight and blessing of the U.S. government, which in turns keeps on duping U.S. taxpayers into believing everything is good.

I present the insider perspective of trader Lou (who wishes to remain anonymous) in its entirety:

“AIG-FP accumulated thousands of trades over the years, all essentially consisted of selling default protection. This was done via a number of structures with really only one criteria – rated at least AA- (if it fit these criteria all OK – as far as I could tell credit assessment was completely outsourced to the rating agencies).

Main products they took on were always levered credit risk, credit-linked notes (collateral and CDS both had to be at least AA-, no joint probability stuff) and AAA or super senior portfolio swaps. Portfolio swaps were either corporate synthetic CDO or asset backed, effectively sub-prime wraps (as per news stories regarding GS and DB).

Credit linked notes are done through single-name CDS desks and a cash desk (for the note collateral) and the portfolio swaps are done through the correlation desk. These trades were done is almost every jurisdiction – wherever AIG had an office they had IB salespeople covering them.

Correlation desks just back their risk out via the single names desks – the correlation desk manages the delta/gamma according to their correlation model. So correlation desks carry model risk but very little market risk.

I was mostly involved in the corporate synthetic CDO side.

During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent – these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were “we have never done as big or as profitable trades – ever“.

As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks – effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities – run a chart from say last September to current of say S&P 500 and Itraxx – credit has underperformed massively. This is largely due to AIG-FP unwinds.

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period.“

For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman’s terms:
AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.

In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were 1) one-time in nature due to wholesale unwinds of AIG portfolios, 2) entirely at the expense of AIG, and thus taxpayers, 3) executed with Tim Geithner’s (and thus the administration’s) full knowledge and intent, 4) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this “one time profit”, which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity (soon coming to a prospectus near you), also funded by taxpayers’ money flows into the market. If the administration is truly aware of all these events (and if Zero Hedge knows about it, it is safe to say Tim Geithner also got the memo), then the potential fallout would be staggering once this information makes the light of day.

And the conspiracy thickens.

Thanks to an intrepid reader who pointed this out, a month ago ISDA published an amended close out protocol. This protocol would allow non-market close outs, i.e. CDS trade crosses that were not alligned with market bid/offers.

The purpose of the Protocol is to permit parties to agree upfront that in the event of a counterparty default, they will use Close-Out Amount valuation methodology to value trades. Close-Out Amount valuation, which was introduced in the 2002 ISDA Master Agreement, differs from the Market Quotation approach in that it allows participants more flexibility in valuation where market quotations may be difficult to obtain.

Of course ISDA made it seems that it was doing a favor to industry participants, very likely dictating under the gun:

Industry participants observed the significant benefits of the Close-Out Amount approach following the default of Lehman Brothers. In launching the Close-Out Amount Protocol, ISDA is facilitating amendment of existing 1992 ISDA Master Agreements by replacing Market Quotation and, if elected, Loss with the Close-Out Amount approach.

“This is yet another example of ISDA helping the industry to coalesce around more efficient and effective practices, while maintaining flexibility,” said Robert Pickel, Executive Director and Chief Executive Officer, ISDA. “The Protocol permits parties to value trades in the way that is most appropriate, which greatly enhances smooth functioning of the market in testing circumstances.”

And, lo and behold, on the list of adhering parties, AIG takes front and center stage (together with several other parties that probably deserve the microscope treatment).

So – in simple terms, ISDA, which is the only effective supervisor of the Over The Counter CDS market, is giving its blessing for trades to occur (cross) below where there is a realistic market bid, or higher than the offer. In traditional equity markets this is a highly illegal practice.ISDA is allowing retrospective arbitrary trades to have occurred at whatever price any two parties agree on, so long as the very vague necessary and sufficient condition of “market quotations may be difficult to obtain” is met. As anyone who follows CDS trading knows, this can be extrapolated to virtually any specific single-name or index easily. In essence ISDA gave its blessing for below the radar fund transfers of questionable legality. The curious timing of this decision and the alleged abuse of CDS transaction marks by and among AIG and the big banks, is striking to say the least.

This wholesale manipulation of markets, investors and taxpayers has gone on long enough.

Business as usual continues in Washington DC. From The Hill (hat tip Tom Ferguson):

A new business trade group run by Democrats close to President Obama may offer K Street an avenue into a White House extremely wary of lobbyists.

Valerie Jarrett, a senior adviser to and close friend of Obama; Michael Strautmanis, Jarrett’s chief of staff; and Tina Tchen, the White House public liaison director, met with more than 40 executives and lobbyists from several Fortune 500 companies at a reception last Friday at the Hay-Adams Hotel.

The reception was the first official function sponsored by Business Forward, a new trade group founded by several Democratic consultants.

Some lobbyists said Jarrett’s appearance was a huge selling point for the new group.

“If I am a company and if I see these folks are delivering Valerie Jarrett, I am signing up because there are few people in town who can deliver her right now,” a Democratic lobbyist said.

Yves here. Notice the use of words, “deliver”, like property. Ugh. Back to the piece:

Several former aides to President Obama and other high-profile Democrats are associated with the new group. Business Forward’s board includes Erik Smith, a paid media adviser to Obama’s campaign, and David Sutphen, former general counsel to Sen. Edward Kennedy (D-Mass.) and now a partner with the Brunswick Group, the public-relations giant.

Also involved are Hilary Rosen, the former chairwoman and CEO of the Recording Industry Association of America, and Julie Andreeff Jensen, who directed get-out-the-vote efforts in Pennsylvania for the Obama campaign. Both now work at Brunswick.

There are also family connections between the group and Obama’s circle of advisers.

Sutphen is the brother of Mona Sutphen, deputy White House chief of staff. Doyle is married to Patti Solis Doyle, who worked for both Hillary Rodham Clinton’s and Obama’s presidential campaigns.

Several lobbyists said the association is targeting the tech industry in particular. AT&T, Google, Microsoft, Cisco, Pfizer and Time Warner were named as potential recruits.

Doyle said the association is seeking a 501(c)(6) tax status, which is for trade groups, from the IRS.

“We are going to focus on events and policy briefings. We do not expect to lobby,” Doyle said.

Yves here. And the Pope isn’t Catholic, either. Back to the story:

Membership fees are expected to be $75,000 for founding companies and $1,500 for small businesses.

The formation of the new association comes at a time when the White House has ramped up its criticism of K Street.

Last Friday, Obama announced new rules to limit the interaction between administration officials and lobbyists regarding projects in the stimulus package. Lobbyists will have to submit materials to be published online, and their meetings with officials will also be disclosed publicly.

Lobbyists say they are finding it difficult to set up meetings or get their calls returned by officials in the White House — even longtime friends made in former campaigns or congressional offices years ago.

“You have lobbyists shut out of the game,” said the Democratic lobbyist.

“In the end, they don’t want to be a liability,” the lobbyist added, talking about White House aides.

Some business trade association representatives see Business Forward as an invention of the White House to create a fissure within the business community, which typically leans Republican.

“The president is trying to convince businesses to join this new association to replace the Chamber [of Commerce], NFIB [National Federation of Independent Business], NAM [National Association of Manufacturers] and the Wholesalers all in one,” said Jade West, senior vice president of government relations for the National Association of Wholesaler-Distributors (NAW), one of the few business groups to oppose Obama’s stimulus package.

“Obama’s policies are so viscerally anti-business that it makes no sense to join this group.”

Doyle rejected the contention that administration aides are behind the association, saying they plan to have Republicans and independents join the group.

“We are very pleased to have the support of the administration, but this is an opportunity created by the 2008 campaign. We want to create a way to have these people stay involved and speak as business leaders, not just as supporters,” Doyle said.

Having a reliable voice of support from the business community for his policies would be a powerful political weapon for Obama as he works to right the economy. During the stimulus debate, the White House would often trumpet support from CEOs and business groups for the recovery effort.

Yves again. So If I am reading this correctly, the gimmick is that business executives will pled their case directly rather than through lobbyists, and presumably the lobbyists will be in the background helping them hone their message.

The whole point of lobbying in the old days was to give businessmen and other special interests plausible deniability by creating organizations (often with innocuous to Orwellian names) to provide cover for who was behind them. Stripping away the veil is now deemed to be progress.

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Before getting into this weekend’s food for thought topic, I think you should all watch Secretary of the Treasury Tim Geithner’s interview on ABC’s This Week and the roundtable discussion where Paul Krugman expressed his concerns with the plan.

Interestingly, Krugman thinks the U.S. government is not doing enough to combat the crisis and that the plan will lead to another Japanese-style lost decade. I agree and I also agree that deficits do not matter in times of crisis because if you don’t get the economy working again, the deficits will only get worse in the future.

But I want to take a step back this weekend and look at the historical events that laid the foundation to this global crisis. On Friday morning, I listened to an excellent interview on CBC Radio’s The Current with Bill Kleinknecht, author of the new book, The Man Who Sold The World: Ronald Reagan and the Betrayal of Main Street America.

Ever since the global economic crisis took hold, people have been looking for a place to park the blame for it. Over-extended homeowners. Greedy bankers. Lackluster regulators. Inept elected officials.

Mr. Kleinknecht has another idea. He says the roots of this crisis go all the way back to the early 1980s and land at the feet of U.S. President Ronald Reagan. Click here to listen to the interview (scroll down to part 3).

Here is a review from Joe Conason published in BuzzFlash Reviews:

From the Nation:

The myth of Ronald Reagan’s greatness has reached epic proportions. The public rates him as one of the most popular presidents, and Republicans everywhere seek to cast themselves in his image. But award-winning journalist William Kleinknecht shows in this penetrating analysis of his presidency that the Reagan legacy has been devastating for the country—especially for the ordinary Americans he claimed to represent.

So much that has gone wrong in America—including the subprime mortgage crisis and the meltdown of the financial sector—can be traced directly to Reagan’s policies. The financial deregulation launched in the 1980s freed banks and securities firms to squander hundreds of billions of dollars and make a shambles of the economy.

Boom-and-bust cycles, obscene CEO salaries, blackouts, drug-company scandals, collapsing bridges, plummeting wages for working people, the flight of U.S. manufacturing abroad—these are all products of Reagan’s free-market zealotry and his gutting of the public sector. Reagan pioneered the use of wedge issues like race and the war on drugs to distract America while his administration empowered corporations to lay waste to our traditional ways of life.

In the spirit of Thomas Frank’s What’s the Matter with Kansas?, Kleinknecht takes us to Reagan’s hometown of Dixon, Illinois, to show that he was anything but a friend to Main Street America. Relying on detailed factual analysis rather than opinion, The Man Who Sold the World is the first major work to explode the Reagan myth.

This book is a great companion to Will Bunch’s Tear Down This Myth: How the Reagan Legacy Has Distorted Our Politics and Haunts Our Future (Hardcover)

“A seasoned crime reporter of the old school, William Kleinknecht has penetrated the showbiz curtain to expose the venality and cynicism of the Reagan era—and tells us why the crimes of that time still matter so much today.”

So should we blame this mess on the Gipper? It’s easy to blame a dead president for laying the foundations of today’s global financial crisis, but there are many other figures from both political parties that followed the Gipper and cemented this crisis.

I leave you with another Go Left radio interview with Bill Kleinknecht (two parts; click below to listen). As you listen, keep in mind that it is important to remember the historical context of this global financial mess and the ideological undertones that played a role in shaping our financial markets.

Also, think about the wedge issues that are diverting attention from today’s bigger problems, including the fundamental breakdown of our pension system.

Part 1:

Part 2:

Cities switch off for Earth Hour BBC. But not much in the US.

Why Toddlers Don’t Do What They’re Told LiveScience. Now if someone would figure out why adults don’t do what they are told, we’d be making real progress.

Shareholders Who Act Like Owners Gretchen Morgenson, New York Times

Did Goldman Goose Oil? Forbes

CDS Recoveries: Down and Out Seeking Alpha

Will there be blood? Economist

Learning How to Think Nicholas Kristof, New York Times (hat tip reader Don)

Only a united front at the London G20 can save the world from ruin Ambrose Evans-Pritchard, Telegraph

Follow the Bailout Cash Newsweek

US commercial banks lost $9.2bn on derivatives trades in Q4 08 FT Alphaville

Mr. Taleb Goes to Washington Marion Maneker The Big Money (hat tip reader Olaf)

The Quiet Coup Simon Johnson, The Atlantic. Several readers pointed to this. A must read.

Antidote du jour (hat tip reader Scott). Do not try this at home: