Links 12/28/10

Just a few links, rather heavy on banks.

The ‘Subsidy’: How a Handful of Merrill Lynch Bankers Helped Blow Up Their Own Firm ProPublica. Traders sticking it to another department of their own bank is nothing new, but the impudent nihilism of the looting here is impressive. They didn’t have to look very far afield to find the fool in the market. With Iceland, Ireland (and maybe others to come) in mind, look out for variations of this article in due course, with different bank names, and ‘Country’ instead of ‘Firm’ in the title.

To make up for no post from me on the latest regulatory iterations (I felt my life force ebbing away as I contemplated yet another bunch of slowly-changing and presumably flawed regulatory docs last week, definitely a 2010 theme, that, and promising to stretch out until about 2020; lovely), here are some variations on the “Basel III/Dodd Frank no good” idea.

Basel liquidity rules, going neo-medieval FT Alphaville. Zero risk weights hobby horse, but this time, applied to liquidity rules, not capital rules.

The privatisation of liquidity ops FT Alphaville. A dubious looking liquidity enhancement mechanism, via insurers. Basel III is already outpaced by innovation, and it won’t “go live” for another 8 years.

Gaming The Bank Regulation System: A Primer CNBC. Sketch of a mechanism that migrates bank credit exposure to the shadows, and how Basel III makes no difference. All it needs is a pliant or deluded insurer (again); they are admittedly a little thinner on the ground after the demise of the monolines and AIGFP, so incentives might be needed. Aha! Devised by ProPublica’s ex-Merrill people perhaps?

Floored (homophonically) Deus Ex Macchiato. A goofy piece of Dodd-Frank rule making that requires two capital computations to be performed, but ensures that only one of them, and always the same one, applies.

Zombie banks FT. Lex wondering about those toxic bank balance sheets.

The Curious Incident of Financial Theft in the Broad Daylight Modeled Behavior puzzling about how banks actually “socialize the losses”.

Stop Servicer Scams, 1: Why You Should Care and Stop Servicer Scams, 2: Dissecting the Letter and Its Requests. Mike Konczal explicating this political campaign.

The Limits to Racketeering Attempter’s take on the endgame, from a much wider perspective than banking.

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  1. Jim Haygood

    attempter wrote: ‘According to Joseph Tainter’s theory of imperial collapse, as societies become more complex, they must expend an ever greater portion of the energy they have available simply on maintaining their complexity.’

    This point was well illustrated in a NY Times analysis of Wikileaks cables pertaining to the DEA (Drug Enforcement Administration). As it has expanded internationally and gotten inextricably involved in foreign politics, intelligence gathering and violent interdictions, the DEA has become both a shadow State Department and a shadow Defense Department — at a cost in the tens of billions.

    No one stops to ask, do normal countries do this? Does Spain, or Canada or Russia have drug enforcement agents in dozens of offices and embassies all over the world, operating largely in secrecy, beyond parliamentary oversight?

    Ever since the fanatical Lincoln vaporized half a million americans perfecting his bloody union, Usgov has evinced a bristling, out-of-control megalomania. It just doesn’t know when to stop.

    So as attempter said, the tyrannical regime will just drive itself right over a cliff. Good effing riddance …

    1. Stelios Theoharidis

      Sure this is getting pedantic, but, this diminishing returns to complexity argument depends upon a very narrow view of complexity that lacks nuance altogether. Lets be clear, there are many different types of complex systems. Certainly our specific system has its major failings but that does not suggest that all complex societies are destined to ultimately fail. We have a long way to go in accurately determining these tipping points (social and material) and the role of new technologies. Similarly the extent of rentier behavior that is sustainable is likely to be determined by the surplus available to the complex system based upon material/resource/social limitations. The extent of that rentier behavior has varied in intensity historically in the USA, often in response to social pressure and popular resistance. We end up within this neo-malthusian versus cornucopian dynamic based on our discussion on new technologies and our ability overcome resource limitations through adaptation, efficiencies, recycling, or substitution. Despite the reality of declining resources, Europeans live at about half the resource intensity as Americans and many within the eco-efficiency dialogue are suggesting that we could comfortably live at one tenth or one hundredth of the resource intensity which we currently live with little development technologically. I am seriously concerned but not convinced, if we are willing to make the right choices many of these collapse scenarios are completely avoidable. There are also wild cards, developments at the National Ignition Facility (fusion) as well as other technological developments that are promising over the long term as well as on the negative side like runaway feedback loops in the climate sytem.

      1. attempter

        Despite the reality of declining resources, Europeans live at about half the resource intensity as Americans and many within the eco-efficiency dialogue are suggesting that we could comfortably live at one tenth or one hundredth of the resource intensity which we currently live with little development technologically. I am seriously concerned but not convinced, if we are willing to make the right choices many of these collapse scenarios are completely avoidable.

        That’s quite an “if”. If every criminal stopped being a criminal tomorrow, stopped stealing, and gave back just part of what he already stole (leaving them still very rich; so it’s not like they’d really be giving anything up), we’d immediately have the most materially bountiful society ever.

        Somehow I don’t see that theoretical possibility having any practical chance of becoming reality. And the same is true of green cornucopian energy scenarios. (It proposes the exact same radical sea change in elite mentalities and rationing.)

        BTW, even at its lower-impact lifestyle, Europe still lives mostly off what it steals from the Global South. Those corporate environmentalists who participate in those eco-dialogues usually seem curiously unaware of such inconvenient truths.

        1. Toby

          I agree with you, attempter, but also feel there is value in pointing out what is technically feasible, regardless of the low likelihood of best-case outcomes flourishing suddenly into being. As long as the priorities in our attempts to describe and hammer out a path to a better system are sustainability, alongside environmental and human concern, at least we are doing no harm. Guided by what makes the most sense (as far as we can tell), we should not rule anything out.

      2. Jim Haygood

        ‘if we are willing to make the right choices …’

        Choices are made within perceived constraints — often INCORRECTLY perceived ones. This is especially true at the level of government, where social frauds such as fiat currency and economic fallacies such as Modern Monetary Theory lead policy makers to believe that ‘federal funding’ is a bottomless well, unconstrained by practical limits.

        Given the perverse incentive of believing that it can endlessly borrow and service its debt with prestidigitated currency, Usgov’s choices are exactly what you would expect — spend freely, borrow incontinently, let the negative net worth soar into the hundreds of trillions.

        Democracy combined with paper money is a certain doomsday mechanism. The US constitution is quite explicit in requiring metallic backing for the currency. But it has long since been suspended, first piecemeal and then wholesale by martial law (the USA PATRIOT Act). Imposition of martial law represented a fairly advanced stage in the accelerating degenerative process; QE2 a second, more desperate, and more unhinged one.

        Eighteenth-century French peasants — many of them illiterate — recognized John Law as a conniving scoundrel, but college-educated Americans blithely tolerate Bernanke’s brazen $600 billion currency fraud. Time magazine named him Person (‘Poison’ if you live in Brooklyn) of the Year. A culture this dysfunctional deserves to be looted blind by laughing plutocrats in Joker masks — and that’s exactly what’s happening! BWA HA HA HAAAA …!!!

        1. Toby

          Comparing John Law’s debt-based money with MMT is a misrepresentation of MMT. MMT spends money into existence, where Law’s fiat is lent into existence. The two models are worlds apart. Debt-based money is a form of ponzi which must perpetually grow, whereas money spent into existence can, at least in theory, be restrained by facts on the ground. “Bottomless well” is also too strong. The quantity of money and its velocity, as both relate to goods and services available and other factors (such as employment), give the money-well a natural bottom.

          And before you leap all over my beliefs, I do not support all of MMT, only parts of it. If I had my way (fat chance of that!) much else would have to change, and radically, before those parts I feel are sound could be supported/coped with by society.

      3. Anonymous Jones

        I agree, Stelios. It is quite amusing how people try to segregate complex systems into simple categories.

        Complexity is complex.

        It’s amazing how apoplectic this makes people. They’re convinced the world is as they see and understand it. But it’s not. Oh well…

        1. attempter

          I think it’s funny the way those who are always looking for insidious ways to justify crime (because they’re too cowardly to make a frontal assault) always try to pretend things are so much more complex than they are.

    1. Cynthia

      Our military elites see the world as a battlefield to conquer, while our corporate elites see the world as theirs for the taking. It’s one thing for our elites to be looting and pillaging other countries, but it’s another thing for them to be looting and pillaging their own country.

      Parasites do this to their hosts, and like all parasites, they don’t differential between their own country and the countries of others. Our elites are no exception to this.

      This gets to the heart of what being a banana republic is all about. And what amazes me the most is how our elites can get away with calling themselves undying patriots, who hold their country so near and dear to their hearts!

  2. Ina Deaver

    I remember Gibbon saying that Rome was like an elaborate tapestry that eventually collapsed into shreds under its own weight. I’ve thought of that analogy many times over the past decade.

    Anyone who believes that the “tragedy of the commons” is a lie is not familiar with the fisheries or hydrocarbons extraction industries. It’s just the old name given to the phenomenon of private profit and public loss. But entirely accurate as an observation, of course – they will suck the productive economy dry.

    I don’t think I’ll be sorry to see the empire fail; but I do indeed worry what rough beast, its hour come round at last, is waiting in the wings.

    1. attempter

      It sure is a lie the way it’s been used to justify privatization, when a better name for it would have been, “the tragedy of the commons where assaulted by the propertarian ideology”. But as usual that kind of psychopathy was fraudulently depicted as normal human nature.

      As the comment thread discusses further, managed commons have been the most prevalent, and most successful, historical practice, except where destroyed by propertarian violence.

    2. Toby

      Anyone who believes the tragedy of the commons is not a lie should read “Governing the Commons” which lays out, quite clearly, that tragedies of the commons are neither necessary nor organic consequences of ‘human nature.’ Not only our invention, but also our morality, is easily sufficient to solve such ‘problems’ as sharing common resources. It all depends on the setting, the expectations, the wisdom and the will.

      1. Ina Deaver

        People, the “tragedy of the commons” as that term is used in economics, is what happens when players appropriate privately what was a common resource. It occurs when the benefit of taking more than the amount that results in an equitable, self-sustaining level of a resource is profitable for the first few individuals who do so – leaving everyone, in the end, with nothing (but a few with rent they extracted along the way by externalizing the damage done by hogging the resource at an unsustainable level).

        It occurs. It is not “natural,” but it is undeniably part of the “Natural State of Man” as postulated by the likes of Hobbes. It can also be successfully managed if the motivation to mine the resource is redirected to a motivation to conserve it. An example of this in real life, relatively recently, is the success in restricted inland fisheries of “individual transferable quotas.”

        I suggest that you take a look at how the “tragedy of the commons” is used in classical economics (and examples in real life from history). It’s entirely possible that the term is being misused in popular culture somewhere I’m not aware of – but that doesn’t make the phenomenon as it has been studied in resource management for literally a hundred years a “lie.”

        1. Toby

          “I suggest that you take a look at how the “tragedy of the commons” is used in classical economics (and examples in real life from history).”

          That’s exactly what Elinor Ostrom does in “Governing the Commons”, indeed, she won the ‘Nobel’ prize for economics (2009) for her efforts. The point is that the ‘lie’ is precisely the way in which the idea is propagated as a ‘human nature’ necessity by mainstream economics (and elsewhere), rather than the avoidable situation it actually is. Debunking this lie was why Ostrom wrote the book. Of course it is not true that tragedies of the commons never happen — such an assertion would be absurd — but it is far truer that they are avoidable.

          1. Anonymous Jones

            Elinor is a fine thinker. It is unkind to condemn her by grouping her with the other people who have that awful ‘Nobel’ thing on their resume.

      2. Ina Deaver

        Also, Toby, the fact that a thing can be managed or regulated does not make it either a lie or an unnatural result. In fact, the tragedy of the commons is pretty well prevented when a community can punish any who step over the line – either by shaming them or by more brutal methods. Of course tragedies of the commons are not necessary: nor should they occur unless something prevents a community from understanding that someone is stealing from them, or from preventing the theft. Unfortunately, those two circumstances happen every damn day.

          1. skippy

            Ummm…social imprinting via various media sources (cough industry propaganda), a spartan like “win or lose” mentality perpetuated by the controlling class, immediate gratification dressed up as sustainable living and my personal favorite…a tilted political / financial playing field so acute that only those that engage in massive fraud them[selves can be trusted to enter the last rooms, unavailable to the commons, not unlike a temples inner sanctums, reserved for only the priestly class.

            This last observation is the most intriguing as the country that served as the crucible for this last, maybe final wealth / ownership transfer, proclaims to be the most populated land in Christendom. The key figure in of, hated the inner sanctums, road blocks, to his father…sigh…

            Skippy…BTW nice post on your blog.

          2. Lidia

            …social fragmentation and alienation instilled by the consumer model? …increased mobility which leaves no incentive to conserve the state of things, or build up a community, since you’re just going to leave?…the Cartesian grid which carves up the world using un-natural property boundaries?

  3. dejavuagain

    Re: “The ‘Subsidy’: How a Handful of Merrill Lynch Bankers Helped Blow Up Their Own Firm”.
    I read this twice and guess I am just dumb. It was either subjected to editing that removed all the technical stuff or the authors really did not understand what went on enough to explain it in plain language.

    The take away is that junior investment bankers at Merrill were forced to participate is some type of off-balance sheet fund to absorb unsold tranches sot that Merrill could do even more deals.

    What is not explained at all is:

    Why was Merrill unable to sell the highest “super senior” tranches – those should go first.

    How did the off-balance sheet fund finance it repos or whatever it did to “take on” these tranches: what was the vehicle? It says that Merrill traders would “buy” or “accept” the “super-senior” pieces – so, how were they “buying” these pieces. Were these being “bought” at the behest of Merrill or being stuffed into a fund managed by Merrill with outside investors.

    How did Merrill’s accountants miss this and how was it reported?

    The article is is points to a lot of smoke and clearly there is smoke and perhaps even fire – but, something is very incomplete in the telling of the story. At least I could not explain it to another person after reading the article.

    Can anyone help??

      1. dejavuagain


        Thanks – I took your suggestion and read the comments on the pro publica site. I guess others hand the same response I had.

        As Jon says, his comments appear to better than the article and he explains a lot that should have been in the article.

        I think the article has a good headline and pitch, but, it really should be pulled and rewritten so that is is understandable and backs up the headline and pitch.

        I still do not understand how the “unit” paid for the tranches purchased, though.

  4. alex

    re “The Curious Incident of Financial Theft in the Broad Daylight”

    Karl Smith: “The jury is, of course, still out on whether anything could have been done in to stop this recession”

    Then the jury is brain dead. Any such uncertainty is for those (perhaps willfully) ignorant of history and/or those who learn their “reasoning” from Very Serious People.

    Tyler Cowen (who the article rebuts) is hardly a screaming pinko, and yet he can see the scam and how it impoverishes most of us.

      1. Climate

        Huh? As the owner of this blog, Yves has a right to censor anything she wants. However, she claims that she does not, which is simply not true (several of my comments pointing out inaccuracies and flaws in her articles were deleted in the past).

        As for your “A guy said a thing” comment, it’s not just that. A (yet another) respected scientist calls AGW bullsh*t. The whole AGW crap has been discredited on multiple levels. Yves hasn’t noticed yet apparently, and she keeps posting AGW propaganda dressed up as science.

        1. Anonymous Jones

          It’s all so obvious, isn’t it? It’s got to be one or the other, and you have the answer, without question? We just lack the capacity to think as clearly as you do, huh? It’s so nice to have smart people in the reality based community visit us and smack us upside the head. Thanks, Climate! Job well done…see, dbt, sometimes there really *is* someone chasing after the paranoid people.

    1. Toby

      I read the original interview, and the professor offers but one thing as ‘proof’ that climate change is not influenced by human activity; ‘CO2 is not responsible for keeping planet earth warm.’ This begs the question: why is earth not frozen over?

      It’s a poor article free of any science, is merely a list of unsupported claims. There is nothing in it proving anything one way or the other.

  5. Hugh

    Our elites only know how to loot. They can not govern even minimally. Nor can they reform themselves, again, minimally. At some point, this will fall apart. They are killing the goose that lays the golden eggs but they can’t stop themselves from killing it. It is sort of the opposite of the paradox of thrift. If one person loots a little and can get away with it, they have an incentive to do so. But if everyone who can loots, and loots a lot, the whole economic structure falls in. Too many looters, not enough lootees.

    Excellent piece, attempter.

  6. scraping_by

    I suppose it’s the viewpoint thing, but my first thought on the ML story was “Office politics run amok!”

    You have the usual local advantage at the expense of the greater enterprise. Cabals of white collars scheming with other white collars. Resource capture and personal empires within a larger context.

    But of course, most office politics I’ve seen are about time on the copy machine or whose butt buddy’s going to get the six figure job; not an excursion to Enron City.

  7. Cynthia

    Anti-government crusaders love to use Fannie and Freddie as poster children for government being lousy at running any form of business, but they fail to mention that mega-banks like Bank of America and Citigroup are pushing their losses back onto Fannie and Freddie in order to make themselves appear profitable. Think about it: no company would need any business savvy whatsoever, if it could push its losses back onto government-sponsored entities like Fannie and Freddie!

  8. Doug Terpstra

    Great links, Richard. The rampant fraud and “impudent nihilism of the looters” (great phrase) is nicely wrapped up by Attempter’s “Limits of Racketeering”

    His analogy of free market cannibalism seems to fit our imperial death rattle well. It brings to mind the incurably fatal Creutzfeldt–Jakob (mad-cow) disease thought to be caused by cannibalism or eating infected animals (fed animal protein). Though it normally progressed over decades, newer mutations cause more rapid genetic corruption within years in a grotesque progression from dementia, psychopathy and convulsions to spasmic death. In this analogy, we seem to be in the dementia-psychopathy transition, with some spasms foreshadowing convulsions and collapse.

    As attempter writes, “in the acceleration of modern times, where tyrannies take only years to go through the same life cycle which once took centuries, we can reasonably aspire to soon see the collapse of this one.”

    Currently, the striking convergence of multiple, overlapping crises — climatological, ecological, energy, economic, political, and military — make this appear especially imminent. The acceleration of civilizational cycles also fits the Mayan prophecies of the exponential progression of history’s tightening time spirals, in which they predict a significant collapse, passage or shift in 2012. Let’s hope systemic collapse and transformation comes before planetary ecocide or Armageddon.

    Echoing other prophetic voices like Chris Hedges, Attempter makes it clear that reform from within the system is now fruitless. What things can we do individually and collectively to hasten the necessary “transition”?

    1. attempter

      When I was younger I used to be fascinated by that Mayan schedule. It’s uncanny how the projected transformation coincides with a time where so many of these secular trends may be coming to a head.

    2. Lidia

      Doug, the reasons everything seems to be happening at once are not mystical, imo; it’s just that we’re on the down side of peak resource extraction. First, the system has shrinking, rather than expanding, inputs (this is new to modern history). Second, the system has become global, which is why everything is failing in concert.

      Like fractional-reserve lending, capitalism only works when it can cheat by getting resource inputs from outside its system. With the fall of China to capitalism, the system now encompasses the globe, hence no more inputs from under the table.

      attempter’s “looters” exist, but it’s too easy to make it sound as though they are the protagonists. Instead, the looting is a symptom of the mathematical process set into motion by the choice of capitalism, whose exponentially-increasing debt and waste is impelled, as an operating regime.

      The only way to hasten the transition, as I see it, is to get out from under the bad actors as best you can, depending on your circumstances. Downsize, simplify, localize.

  9. john c. halasz

    So more explanation of the “AAAA” “supersenior” tranches of CDOs. A bunch of BBB, at best, mortgages are pooled into a structured RMBS, with 80% rated “AAA”. But the BBB mezzanine tranches contain the concentration of the risk in the pool, and, though bearing a much higher interest rate, there is little market for them. What to do? Buy them up and put them into a CDO pool for re-securitization by the same structuring magic. Once again 80% “AAA”, but unsalable mezzanine tranches. Resecuritization into a CDO^2! 75% “AAA”! The problem, of course, is that, though the mortgages won’t go bad all at once, when you concentrate the mezzanine tranches in a CDO the tranches tend to go bad in a much more correlated manner, and a forteriori for a CDO^2.

    So what’s this “supersenior” tranche business? By carving out the top 10-15% of the structure as “supersenior”, you pay a much lower interest rate and save some bps. to sprinkle over the rest of the structure to amke them more salable to the market. But if the market cost of borrowing is, say, 500 bps. and the supersenior tranche is paying 525 bps., then no one wants to by the “supersenior” tranche, even if, in the last loss position in the structure, it’s “risk-free”. However the bank’s internal cost of funding is lower than the market’s. SO at, say, 450 bps. the supersenior tranche yield the bank 75 bps. rather than the market’s 25 bps., and since they are the lowest risk category they only cost the bank a capital charge of 20% against the risk-weight Tier 1 capital of 8%, so for a $10 million dollar tranche retained on the books, the charge is only $160,000 for $75,000 in annual income. Pretty sweet, eh? But better, go to AIG and purchase a CDS for 20 bps. and there is no capital charge for $55,000 in annual return! And since the contract lasts 5 years and is guaranteed risk-free, book the full 5 year return this year and collect from this year’s bonus pool. Sugar high! Except, of course, for the aforementioned problem of increasingly correlated risk concentrations among increasingly crappy mortgages.

    If Yves, or any other insider, wants to correct this account, please do so.

    1. skippy

      Really nice john…but, what about all that high voltage low amperage electrons looking for a new uses…ummm.

      Skippy…electrons disguised as value dancing on a Möbius strip…to zombie trance music and some wonder why a few are paranoid…sigh.

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