Category Archives: ECONNED

Magnetar Strikes Again: JP Morgan Negotiating Settlement with SEC on Toxic CDO

As longstanding readers of this blog presumably know, we broke the story of Magnetar, a Chicago-based hedge fund. Magnetar was arguably the biggest player in driving toxic subprime demand through its program of creating hybrid CDOs (largely consisting of credit default swaps, but also including cash bonds by design).

Magnetar constructed a strategy that was a trader’s wet dream, enabling it to show a thin profit even as it amassed ever larger short bets (the cost of maintaining the position was a vexing problem for all the other shorts, from John Paulson on down) and profit impressively when the market finally imploded. Both market participant estimates and repeated, conservative analyses indicate that Magnetar’s CDO program drove the demand for between 35% and 60% of toxic subprime bond demand. And this trade was lauded and copied by proprietary trading desks in 2006.

As a source who worked in the structured credit area of a firm that did Magnetar trades explained in ECONNED:

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OMG, Greenspan Claims Financial Rent Seeking Promotes Prosperity!

I was already mundo unhappy with an Alan Greenspan op-ed in the Financial Times, which takes issue with Dodd Frank for ultimately one and only one disingenuous and boneheaded reason: interfering with the rent seeking of the financial sector is a Bad Idea. It might lead those wonderful financial firms to go overseas! US companies and investors might not be able to get their debt fix as regularly or in an many convenient colors and flavors as they’ve become accustomed to! But the Maestro managed to outdo himself in the category of tarting up the destructive behaviors of our new financial overlords.

What about those regulators? Never never can they keep up with those clever bankers. Greenspan airbrushes out the fact that he is the single person most responsible for the need for massive catch-up. Not only due was he actively hostile to supervision (and if you breed for incompetence, you are certain to get it), but he also gave banks a green light to go hog wild in derivatives land. And on top of that, he allowed banks to develop their own risk models and metrics, which also insured the regulators would not be able to oversee effectively (there would be a completely different attitude and level of understanding if the regulators had adopted the posture that they weren’t going to approve new products unless they understood them and could also model the exposures).

And the most important omission is that the we just had a global economic near-death experience thanks to the recklessness of the financial best and brightest.

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The Stigmatization of the Unemployed

One thing I have never understood in America is the way that people who lose their jobs become pariahs in the job market. We’ve now had a spate of commentary on the fact that official unemployment figures are looking a tad less dreadful by dint of the fact that increasing numbers of the long term unemployed have dropped out of the job market entirely. Even the conservative Washington Post woke up last week, Rip Van Winkle like, to take note of the growing number of long-term unemployed. Bizarrely, or perhaps as a fit illustration of the spirit of the day, the article was titled: “Hidden workforce challenges domestic economic recovery.” In other words, they are Bad People because if the economy ever picks up, they might come out of the woodwork and start looking for jobs!

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Shades of 2007: Synthetic Junk Bonds

Aha, the level of financial innovation spurred by super low interest rates is starting to have that “I love the smell of napalm in the morning” feel to it.

The Financial Times reports that there is a frenzy to create synthetic junk bonds, ostensibly to satisfy the desire of yield-hungry investors. Any time you see a lot of long money flowing into synthetic assets rather than real economy uses, it’s a sign that Keynes’ casino is open for business (“When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”)

The author compare this development to that of the asset backed securities CDO market, one of our betes noirs which blew up spectacularly in the crisis. There are some similarities and differences.

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A Straightforward Criminal Case Against Wall Street CEOs and Senior Executives

Various people who ought to know better, such as the New York Times’ Joe Nocera, haven taken to playing up the party line of the banking industry and I am told, the SEC, that we should resign ourselves to letting senior financial services industry members get away with having looted their firms and leaving the rest of us with a very large bill.

It is one thing to point out a sorry reality, that the rich and powerful often get away with abuses while ordinary citizens seldom do. It’s quite another to present it as inevitable. It would be far more productive to isolate what are the key failings in our legal, prosecutorial, and regulatory regime are and demand changes.

The fact that financial fraud cases are often difficult does not mean they are unwinnable. And a prosecutor does not need to prevail in all, or even most, to serve as an effective cop on the beat.

Contrary to prevailing propaganda, there is a fairly straightforward case that could be launched against the CEOs and CFOs of pretty much every US bank with major trading operations.

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Michael Lewis: Will Defamation Charges by His “Big Short” Villain Stick?

One of the dangers of framing stories as Manichean tales is the purported bad guys can take offense and try to get even. And if you do it in a book, the threshold for liability is low enough that they might indeed be able to inflict some real pain.

Michael Lewis, author of the bestseller The Big Short, along with his publisher, W.W. Norton and his source Steve Eisman, were sued today in Federal court for defamation by one Wing Chau. In case you are one of the five people in America who is interested in finance but has managed not to read The Big Short, there is a scene in the book in which FrontPoint’s Eisman, who is Lewis’ main subprime short hero, has asked to meet someone who is on the other side of his trade. That “someone” is a CDO which in practical terms means a CDO manager. Eisman and two of his employees have dinner with Wing Chau, who is the head of the CDO manager Harding. Needless to say, Lewis’ account makes it clear that he regards Chau as very much part of the problem.

Now we’ve written a LOT about CDOs; in fact, our book ECONNED broke the story of Magnetar and demonstrated how its CDO program, which it used to establish a risk-free short position, drove the demand for a large portion of the subprime market in the toxic phase. And we have taken issue with Lewis’ characterization of the shorts as heros.; Knowingly or not, the strategy that reaped them billions also distorted normal market pricing signals on a massive scale, not only allowing the subprime mania to continue well beyond its sell-by date but also by actively promoting the creation of the “spreadiest” or very worst mortgages.

Our reading of Lewis’ plight is that Chau’s claims seem to be a stretch, given that the facts are less on his side than a reading of his suit might suggest. But as we will discuss later on, litigation on books is so plaintiff friendly that even a weak claim can succeed in court.

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Another Reminder That Crime Pays: No Charges Filed Against Countrywide’s Mozilo

The New York Times’ Gretchen Morgenson dutifully tells us, based on a Los Angeles Times sighting, that federal prosecutors will not be filing charges against the Tanned One, Angelo Mozilo of Countrywide. This follows the failure of investigations to lead to a criminal prosecution of another major perp in the financial crisis, one Joseph Cassano, the head of AIG’s Financial Products unit.

There has been far too little discussion of why no legal action has been taken.

Readers can no doubt come up with additional reasons, but I see at least two.

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Bernanke Blames the Global Financial Crisis on China

They must put something in the water at the Fed, certainly the Board of Governors and the New York Fed. Everyone there, or at least pretty much everyone who gets presented to the media, seems to have an advanced form of mental illness, namely, an pronounced inability to admit error. While many in public life suffer from this particular affliction, it appears pervasive at the Fed. Examples abound including an overt ones like an article attempting to bolster the party line that no one, and hence certainly not the central bank, could have seen the housing bubble coming, or subtler ones, like a long paper on the shadow banking system that I did not bother to shred because doing it right would have tried reader patience Among other things, it endeavored to present the shadow banking system as virtuous (a necessary position since the Fed bailed it out) because it was all tied to securtization and hence credit intermediation. That framing conveniently omits the role of credit default swaps and how they multiplied the worst credit risks well beyond real economy exposure levels and concentrated them in highly geared financial firms.

Another example of the “it is never the Fed’s fault” disease reared its ugly head in the context of the G20 meetings.

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Guest Post: The Price of Oil – Where the Outrage?

By Payam Sharifi, an economics Graduate Student at the University of Missouri-Kansas City

Here in the United States, discussions of our troubled times revolve around any of the following: the housing crisis, the federal debt, unemployment, the fiscal health of particular states, and sometimes even income inequality. Overseas, discussions can include these topics, as well as the plight of the Euro. One issue that I personally feel has gotten the short end of the stick is that of commodity prices, and in particular food and oil. There is a special significance to this issue: its ramifications affect nearly every human being in the world. As seen in prices on the NYMEX and other markets, oil and food prices are beginning to soar again, with the price of WTI futures hitting $90/barrel and Brent crude going over $100/barrel. This issue ought to be discussed again with a renewed interest – but the media and much of the populace at large have simply accepted high food and oil prices as an unavoidable fact of life, without any discussion of the causes of these price rises aside from platitudes. For example, a recent AP report quoted an opinion that gasoline was going to hit $4/$5 a gallon in 2011, but did not mention the possible relevance of speculation in the futures market. It seems that everyday observers (as well as even the financial media) find this issue so complex that they shrink from discussing it. I will now give my opinion on these issues, buttressed by what I have learned from a recent interview with commodities trader Daniel Dicker. His new book “Oil’s Endless Bid” is due out in April.

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Paulson Denies Culpability in Crisis, Yet Even Bear Turned Down His Deals

The release of the first batch of FCIC interview reveals interesting finger-pointing among some of the major players. We’ve argued (and in ECONNED, provided a considerable amount of supporting analysis) that the subprime shorts drove the demand for bad mortgages. There is no other explanation for the explosion of demand for “spready,” meaning bad, mortgages that started in the third quarter of 2005. As Tom Adams and I describe in a recent post:

Signs of recklessness were more visible in 2004 and 2005, to the point were Sabeth Siddique of the Federal Reserve Board, who conducted a survey of mortgage loan quality in late 2005, found the results to be “very alarming”.

So why, with the trouble obvious in the 2005 time frame, did the market create even worse loans in late 2005 through the beginning of the meltdown, in mid 2007, even as demand for better mortgage loans was waning? It’s critical to recognize that this is an unheard of pattern. Normally, when interest rates rise (and the Fed had begun tightening), appetite for the weakest loans falls first; the highest quality credits continue to be sought by lenders, albeit on somewhat less favorable terms to the borrowers than before.

In other words: who wanted bad loans?

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Krugman, Commodity Prices, and Speculators

Paul Krugman was gracious enough to acknowledge our past differences on the matter of commodities speculation, which was specifically about oil markets. It was the subject of a long running argument conversation between his blog and mine in spring 2008, which I recapped in ECONNED.

In brief, Krugman contended that the skyrocketing oil prices of early 2008 were the result of fundamental factors (and we pointed out that we were puzzled by his stance, since he, unlike the vast majority of Serious Economists, has been willing to call some past bubbles in their making). As he reiterates on his blog today, if the prices exceed the level dictated by supply and demand in the real economy, a standard microeconomic analysis would expect there to be inventory accumulation, aka hoarding.

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The Specious Logic of Wall Street Pay

It’s remarkable how Masters of the Universe, the new financial elite first identified by Tom Wolfe in 1986, remember nothing and regret nothing. And why should they? Their position remains remarkably secure 25 years later.

We see the “Who us, take responsibility for our actions?” stance in full view courtesy one of their most effective spokesman, Steve Eckhaus, an attorney who has negotiated many big ticket Wall Street compensation contracts. From the Wall Street Journal:

“It was understandable why there was anger,” says Mr. Eckhaus, but “the crisis was not caused by Wall Street fat cats. It was caused by a confluence of economic, political and historical factors.”..

In general, he said his clients are “pure as the driven snow” and doing work that supports the economy and justifies their pay….

“You have to know what the profits are” to know what someone should make, said Mr. Eckhaus, noting Wall Street’s top performers usually gobble up 80% of the bonus pool. “Those who are responsible for profits should share in the profits in a way that rewards them.””

This is the usual “heads I win, tails you lose” logic. The rationale for bulging pay packets is that the producers created it, therefore they deserved their cut. But Eckhaus says any bad events are due only to bad luck. Sorry to tell you, but only narcissists and their agents take credit for good stuff and lay the blame on everyone else. Unfortunately, we breed for that in Corporate America, it happens to be a very effective career strategy in large organizations.

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FCIC Report Misses Central Issue: Why Was There Demand for Bad Mortgage Loans?

By Tom Adams, an attorney and former monoline executive, and Yves Smith

In common with other accounts of the financial crisis, the Financial Crisis Inquiry Commission report notes that mortgage underwriting standards were abandoned, allowing many more loans to be made. It blames the regulators for not standing pat while this occurred. However, the report fails to ask, let alone answer, why standards were abandoned.

In our view, blaming the regulators is a weak argument.

A much more sensible explanation can be found by asking: what were the financial incentives for such poorly underwritten loans? Why would “the market” want bad loans?

All the report offers as explanation is that the “machine” drove it or “investors” wanted these loans. This is lazy and fails to illuminate anything, particularly when there are other red flags in the report, such as numerous mortgage market participants pointing to growing problems starting as early as 2003. Signs of recklessness were more visible in 2004 and 2005, to the point were Sabeth Siddique of the Federal Reserve Board, who conducted a survey of mortgage loan quality in late 2005, found the results to be “very alarming”.

So why, with the trouble obvious in the 2005 time frame, did the market create even worse loans in late 2005 through the beginning of the meltdown, in mid 2007, even as demand for better mortgage loans was waning?

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Jesse Hearts ECONNED

Jesse gave us a generous comment on his blog yesterday:

Why people care about these sorts of things puzzles me but here goes…

I do keep a select set of books next to my chair for reading in the late and quiet hours of the evening after all the family is put to bed, the doors locked, and the windows closed.

From this I am re-reading sections of Econned by Yves Smith which is an awesome work about the financial crisis and its roots. If you do nothing else read the introduction thoroughly and you will know more about the financial crisis than most. I rarely read the same book twice unless it has real substance.

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Barclays’ Bob Diamond to Non-Bankers: Drop Dead

Bob Diamond, Barclays’ chief executive officer, no more said something as inflammatory as “drop dead” to the UK Treasury select committee yesterday than Gerald Ford did in a 1975 speech refusing to extend financial assistance to save New York City from bankruptcy. But the substance was every bit as uncooperative.

Despite its artful packaging, Diamond’s presentation was yet another reminder of the banking industry’s continued extortion game, namely, that they can take outsized, leveraged risks and when they work out, pay themselves handsome rewards, and when they don’t, dump them on the taxpayer. And they’ve only been encouraged to up the ante. Not only did they get to keep their winnings from their last “wreck the economy” exercise, no senior executive was fired, no boards were replaced, and UBS was the only major bank required to give a detailed account of how its screwed up so badly as to need government support. And before you tell me Barclays was never bailed out, tell me exactly how well it would have fared had any other major UK or international bank failed, or had the officialdom not provided extraordinary liquidity support when interbank funding dried up.

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