Bear Stearns on The Huffington Post

Janet Tavakoli: Inside the Wall Street Journal 's Future of Finance Initiative

2009-12-14T19:15:16Z

Last week I was a participant in the Wall Street Journal's Future of Finance Initiative in England. WSJ has written a summary of the conference highlights, and missed some key points. Allow me to fill in the blanks.

Paul Volcker, former Fed Chairman and current Chair of the President's Economic Advisory Board, made the most worthwhile comments. Moral hazard was not discussed in the open forums, so Volcker reminded the assembly. Yet even Volcker did not broach the topic of fraud.

Alistair Darling, Chancellor of the Exchequer, spoke on the opening evening. I asked him why massive financial fraud remained unaddressed. Darling appeared momentarily confused and seemed to suggest this was exclusively a U.S. problem to be handled by the courts. I pushed back on this notion. By the time one needs a lawyer, it is too late. I noted that we, the middle aged financiers in the room, are responsible for taking action. If we don't face this issue head on, we will never restore trust in the financial system.

Ana Botin, Banesto's Executive Chairman, suggested that the risk manager should report to the board. Then she blew it with the assertion--made several times--that the CEO can also be Chairman. (Ken Lewis defended his dual role as CEO and Chairman of Bank of America at a Fed conference in 2003. How did that work out?)

I didn't challenge Botin's assertion, because I used my two minutes (literally) during the "Too Big to Fail" breakout session to (unsuccessfully) try to carry the point that when banks fail, we should allow shareholders to be wiped out, and debt holders should take losses. (Under that scenario, most of the current managers would be booted out.) Instead, the group posted the need for a "living will" to be designed by the managers that made life support during our recent crisis a debatable necessity.

Elizabeth Corley, CEO of Allianz Global Investors in Europe, presented conclusions from her panel's discussion of the "Regulatory Frontier." The panel's idea of upgrading regulatory resources was to deploy senior financial institution officers to regulators for two or three years and vice versa. Meanwhile, the financial institutions should chip in to maintain the regulators' former high pay. Howard Davies of the London School of Economics saved me from having to explain the concept of regulatory capture. After he spoke, I was the only one to clap. Apparently everyone else thought the panel was titled the "Predatory Frontier."

Robert Diamond, president of Barlcays PLC, sounded like a financial holocaust denier. He seemed to think that the idea of breaking up banks has only to do with the threat to the financial system, if they fail. The point is that some of these institutions threatened the financial system--and continue to threaten the financial system--because they are too big to manage.

Diamond seemed to dislike the term "socially useless" to describe recent financial innovation and defended Barclays' proprietary trading. Since Barclays has dropped its suit involving its total return swap with Bear Stearns' imploded hedge funds, Diamond may have already forgotten this relevant example of financial innovation gone wrong. Hedge fund investors were wiped out, the hedge funds' dodgy assets landed on Bear Stearns's balance sheet, and later on JPMorgan Chase's balance sheet, after it acquired Bear Stearns. Our past crisis taught us that hedge funds are not independent of the banking system. This transaction wasn't merely socially useless, it had negative social utility.

Mario Draghi, Bank of Italy's Governor and Chairman of the Financial Stability Board, seemed to think that hedge funds are independent. This is simply incorrect. If the example above didn't persuade him, he might consider the assets that came back onto bank balance sheets and contributed to market instability. For example, in March of 2008 as Bear Stearns bit the dust, the Carlyle Group's CCC fund assets and the assets of Peloton's funds boomeranged back on bank balance sheets at the most inopportune time.

Bob Diamond defended structured credit products saying there is a real purpose for structuring credit for pension funds. He was probably unaware that state pension funds in the United States were damaged by the unintended consequences of a "AAA" rated structured credit product. The pension funds were wise enough to avoid investing in the product, yet as I explained in my February 2007 letter to the Securities and Exchange Commission, large fixed income pension funds were unintenionally harmed by the market distortions caused by this financial innovation.

My letter to the SEC cited this financial innovation as an example of why the special NRSRO designation of the rating agencies should be revoked. The product did not deserve its "AAA" rating. It had substantial principal risk and deserved a non-investment grade, or junk rating. Within a year all of these new "AAA" innovations blew up. Moody's estimated that investors in one of them would get back only around ten cents on the dollar.

Not all financial innovation is harmful, but it is undeniable that in recent years it was a runaway train that nearly derailed the global financial system. You wouldn't have realized that, if you listened to most of the participants. They chiefly represented the interests of large financial institutions, and the financial system is still attached to the privileged placenta of central banks doling out taxpayer subsidies. Most of the conference reflected the insulated thinking of this protective womb.

Tom Gregory: Goldman Bans "Last Suppers"; Suspends 1st Amendment!

2009-12-01T01:03:21Z

Editor's note: the following blog post is satire.

Reuterz, New York - In swift reaction to recent calls for his resignation, Lloyd Blankfein, Chairman of the Wall St. Church-State Goldman Sachs, issued an edict banning employees from assembling in groups of twelve.

Employees received the seasonally-festive, "no parties of 12 " command via voicemail blast as part the CEO's Weekly PR Blunder Address.

"He considers any gathering resembling The Last Supper a bad omen" said a spokesperson for the financial Pontiff, noting " They don't end well."

The directive is part of a broader corporate strategy called " Don't Know; Don't Tell" in which employees are encouraged not to fraternize. "The theory is if employees do not know who each other are, they are less likely to conspire or collude", adding hastily " except in the normal course of the way Goldman Sachs does business.

Jamie Dimon, Treasury Secretary? Evaluating The Rumors

2009-11-23T16:27:14Z

The New York Post reported this morning that lawmakers are discussing JPMorgan Chase CEO Jamie Dimon as a potential replacement for current Treasury Secretary Timothy Geithner.

Leaving aside concerns that appointing a Wall Street CEO to the Treasury's top position would draw heavy criticism over Wall Street's coziness with Washington, it's not clear that Dimon would be a natural fit in the Obama administration. According to the Wall Street Journal, Dimon departs from White House policy on a handful of key issues.

For one, President Obama has pushed establishment of a consumer-protection agency that would keep watch over credit card and mortgage companies, but Dimon opposes the agency on grounds that it will drive up costs. JPMorgan says recent legislation regulating credit cards could cost the bank up to $750 million a year, a burden that may be passed along to consumers.

And while the White House's position on how to handle too-big-to-fail banks is still evolving, Dimon has staunchly defended big banks' right to exist -- and to fail. In a Washington Post op-ed this month, Dimon wrote:

"...ending the era of "too big to fail" does not mean that we must somehow cap the size of financial-services firms. Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole. Artificially limiting the size of an institution, regardless of the business implications, does not make sense. The goal should be a regulatory system that allows financial institutions to meet the needs of individual and institutional customers while ensuring that even the biggest bank can be allowed to fail in a way that does not put taxpayers or the broader economy at risk."

Anonymous sources told the NY Post that Dimon "would love to serve his country," but is demurring. He has no plans, he says, to leave JPMorgan for the next "six or seven years."

For now, Geithner is still contending with critics in Congress. He was attacked last week during an appearance before Congress's Joint Economic Committee. "Mr. Secretary, the public has lost all confidence in your ability to do your job," Rep. Kevin Brady (R-Texas) told him.

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Mort Zuckerman: Federal Reserve Should Retain Its Authority And Independence

2009-11-23T12:10:04Z

In the grip of our Great Recession, with more job losses to come, we have yet to fix the broken financial system that is an underlying cause of this whole mess. How can we do it? Some of the ideas being talked about in the halls of Congress are as dangerous as the reckless congressional activity that helped to precipitate the disaster in the first place.

Lehman, Bear Stearns Execs Cashed In As Their Firms Failed: Study

2009-11-23T08:05:13Z

If you thought that the executives at Lehman Brothers and Bear Stearns paid dearly in when their firms famously imploded last year, think again.

A new study by three professors at the Program for Corporate Governance at Harvard Law School reexamines the "standard narrative" of the loss of wealth suffered by top leaders at Bear and Lehman. The top five executives at Bear and Lehman were able to sell billions in stock holdings from 200-2008, the study notes, while most shareholders saw their investments in the two firms decimated.

During the same period, the study notes, "the shareholder payoffs these teams produced were indisputably poor." From the study:

Overall, we estimate that the top executive teams of Bear Stearns and Lehman Brothers derived cash flows of about $1.4 billion and $1 billion respectively from cash bonuses
and equity sales during 2000-2008. These cash flows substantially exceeded the value of
the executives' initial holdings in the beginning of the period, and the executives' net
payoffs for the period were thus decidedly positive. The divergence between how the top
executives and their shareholders fared implies that it is not possible to rule out, as
standard narratives suggest, that the executives' pay arrangements provided them with
excessive risk-taking incentives.

While it's tempting to examine the paper loses suffered by execs at Bear and Lehman (Jimmy Cayne's stock holdings fell by over $900 million, for example) the report suggests that those figures may be misleading. The authors -- Lucian Bebchuck, Alma Cohen, and Holger Spamann -- assert that the fact that Bear and Lehman leaders simply lost large sums of money in the crisis, doesn't mean they weren't tempted by skewed incentives:

There can be little doubt that the banks' executives had strong reasons to prefer
that their companies survive. Furthermore, the executives' holding so many shares at the
time of the collapse indicates that they had not foreseen in 2007 or early 2008 that such a
collapse was around the corner. The important question, however, is whether the
executives had an incentive to make decisions that created an excessive risk - though by
no means certainty - of massive losses at some (uncertain) time down the road.

In particular, excessive incentives to take risks might have been generated by
executives' ability to cash out compensation based on the firms' short-term results. To
the extent that executives did cash out large amounts of such compensation, their
decisions might have been distorted by an excessive focus on short-term results. This
problem, first highlighted several years ago in a book and accompanying articles co-
authored by one of us,22 has received much attention in the wake of the crisis from both
public officials and business leaders.

The study arrives a conclusion long-held by critics of the financial industry. In short, Wall Street pay was specifically structured to encourage short-term gains:

"...the executives were the able to obtain large amounts of bonus compensation based on high earnings in the years preceding the financial crisis, but did not have to return any of those bonuses when the earnings subsequently evaporated and turned into massive losses. Such a design of bonus compensation provides executives with incentives to seek improvements in short-term earnings figures even at the cost of maintaining an excessively high risk of large losses down the road."

Interestingly, the study suggests that Wall Street's bonus culture may not be the largest cause of the excessive risks taken by the industry. Fixing compensation isn't merely an issue of increasing stock awards and limiting bonuses; in fact, the study steers clear of suggestions that pay should be capped. Instead, the study argues that the failure of Bear and Lehman suggest that compensation clawbacks should be considered.

READ the report here:

BCS-Wages-of-Failure-Nov09 -

Paul Krugman: Government Squandered Our Trust In Wall St. Bailout

2009-11-20T11:24:28Z

Earlier this week, the inspector general for the Troubled Asset Relief Program, a k a, the bank bailout fund, released his report on the 2008 rescue of the American International Group, the insurer. The gist of the report is that government officials made no serious attempt to extract concessions from bankers, even though these bankers received huge benefits from the rescue. And more than money was lost. By making what was in effect a multibillion-dollar gift to Wall Street, policy makers undermined their own credibility -- and put the broader economy at risk.

Blake Fleetwood: The $20 Billion Gamble: The Greatest Coup in Financial History

2009-11-17T12:05:04Z

In 2007 a little known hedge fund manager pulled in a personal profit $4 billion (firm profit $20 billion), with a daring bet against a real estate boom that everybody knew was going to bust ... someday.

In 2006 John Paulson (of no relation to Treasury Secretary Henry Paulson ) bet that the sub-prime mortgage market would tank and housing prices would fall on a national scale, according to a new book The Greatest Trade Ever by Greg Zuckerman.

Paulson, a prophet of doom for homeowners, committed more than $1 billion to buy insurance on what he saw as risky mortgages. Many economists and savvy investors knew that the bubble was too good to last, but most were not willing or able to put up or keep up their bets until it did.

Since 2004 many investors bet against the real estate bubble, but if you had done so in 2004, you would have lost a lot of money, as real estate prices kept rising for the next two years. It was too early.

Paulson made his bets in late 2006 just as the sub-prime mortgage markets were starting to weaken. His timing was impeccable, as was his luck.

When the bubble burst, one of Paulson's funds rose more than 500% that year, according to Zuckerman in the Wall Street Journal. In 2008 Paulson shorted financial shares leading to the collapse of Lehman Brothers and Bear Stearns and reaped another round of enormous profits when they subsequently tumbled.

Paulson's investing lessons:

Don't Rely on Experts

Bubble Trouble

Focus on Debt Markets

Master New investments

Insurance Pays

Experience Counts

Don't Fall In Love

Luck Helps

Paulson, who is shy in the face of his recent success, has stayed out of the public eye; perhaps realizing that short sellers are among the most hated of human species. The mega-trader with a $36 billion fund should take a cue from George Soros. Although his currency trades in the 1990s were reputed to have broken the Bank of England, Soros has spent much of his career making up for his shady bounty with endeavors such as the Open Society Institute.

Meanwhile, Paulson - whose criticism of Zuckerman's laudatory book contains no specific grievances - called The Greatest Trade Ever a "tabloid-style disappointment" that contains "numerous inaccuracies and fails to capture the essence of the credit bubble."

What is Paulson betting on now? He has sold more than $300 million worth of stock in Goldman Sachs and invested in Citigroup. Citi was a great buy when it was selling for under $1, but now it is over $4. Paulson thinks it is really too big to fail.

Wonder where your money went? "John Paulson took it," wrote Peter Cohen of BloggingStocks.

Want to know what Paulson is buying this year? Gold. Betting against the dollar is his latest ploy and so far seems to be working.

To create manufacturing jobs in the U.S. the dollar has to decline, according to Martin Murenbeeld, chief economist at Dundee Wealth.

Over the last seven months the dollar is down more than 15%, a fifteen month low.

Write:jfleetwood@aol.com

David Fiderer: The Moral Compass Missing From The Greatest Trade Ever

2009-11-16T08:47:16Z

John Paulson was dissatisfied. The marketplace had not satiated his appetite for placing bets against subprime mortgage securities. So he cooked up a scheme to issue billions more in new securities designed by him to fail. The scheme worked, and his hedge fund earned billions.

The most interesting part of The Greatest Trade Ever, by Wall Street Journal reporter Gregory Zuckerman, describes Paulson’s plan to give irrational exuberance an extra boost. It’s one thing to trade against the value of securities that have already been issued. That’s what the free market is all about. But it’s quite another thing to direct your banks to originate new securitizations for no legitimate business purpose. No wonder Paulson slammed the book for “numerous inaccuracies” without citing specifics.

Here’s how Zuckerman recounts the scheme, which was initiated by Paulson and one of his fund managers, Paolo Pellegrini:

Paulson and Pellegrini were eager to find ways to expand their wager against risky mortgages. Accumulating it in the market sometimes proved to be a slow process. So they made appointments with bankers at Bear Stearns, Deutsche Bank and Goldman Sachs, and other banks to ask if they would create CDOs that Paulson & Co. could essentially bet against.

More specifically, Paulson asked his investment banks to create new issues of repackaged subprime mortgage securities, known as collateralized debt obligations, or CDOs, so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs’ subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities, which had been ignored by the

rating agencies, Paulson could collect up to $5 billion.

Paulson not only initiated these transactions, he also specified the terms he wanted, identifying which mortgages would be stuffed into the CDOs, and how the CDOs should be structured. Within the overall framework set by Paulson’s team, banks and investors were allowed to do some minor tweaking. Zuckerman writes:

Paulson’s team would pick a hundred or so mortgage bonds for the CDOs, the bankers would keep some of the selections and replace others, and then the bankers would take the CDOs to the ratings companies to be rated…To try and protect themselves, the Paulson team made sure that at least one of the CDOs was a “triggerless” deal, or a CDO crafted to be more protective of [the] equity slices by making other pieces of the CDO [which Paulson had bet against] more likely to take early hits. Paulson’s goal was to make the equity piece at bit safer, but this step made the other parts of the triggerless CDO even more dangerous for anyone who had the gumption to buy them.

Prior to 2006, there were not many opportunities for naked short selling on subprime securitizations. But in January of that year, investment banks launched a new product, which enabled Paulson to place those bets on a large scale. The ABX index, a sort of Dow Jones Average of subprime mortgage securities, facilitated benchmarking the price of credit default swaps. But it appears that Paulson made much more money by betting against the newly issued CDOs.

Here’s how Trader Daily reported it:

Paulson and Pellegrini then skinned the subprime cat two ways, via an ABX index position and by shorting individual CDO names. Their real score came through the second approach, which involved a huge purchase of credit default swaps tied to certain handpicked CDOs;Paulson homed in on the most troubled mortgage pools, regardless of rating-agency or Wall Street assurances. The value of the CDS instruments he amassed went through the roof when the CDOs’ value plummeted as subprime borrowers, many with adjustable-rate hikes kicking in, began to default. [Emphasis added.]

Among the banks that Paulson had approached, Bear Stearns saw the deal for the sham that it was, and refused to play along. Trader Scott Eichel said that, “it didn’t pass the ethics standards; it was a reputation issue, and it didn’t pass our moral compass. We didn’t think we could sell deals that someone was shorting on the other side.”

Paulson felt unburdened by any moral compass. Though he had made clear that the CDOs should be stuffed with only risky slices of debt, Paulson accepted no personal responsibility, claiming “it was a negotiation; we threw out some names, they threw out some names, but the bankers ultimately picked the collateral. We didn’t create the securities, we never sold the securities to investors…”

Again, we are not talking about the supply and demand in a transparent market. The banks were not responding to the demand for financing these mortgages, which had already been placed into securitizations. Nor were the banks responding to investor demand for repackaged versions of the once-sold securitizations. Paulson asked his banks to artificially inflate the supply. “We want to ramp it up,” Pellegrini told Bear Stearns. Nobody could make the pretense that he was acting in good faith.

The Greatest Trade Ever doesn’t dwell on the legal and moral implications of Paulson’s collaboration with the investment banks. The book, which devotes no more than three pages to the scheme, remains sketchy about a lot of details. (Who issued the CDOs? What were their names? Who sold the credit default swaps?) This may make for a breezier narrative, but it points to the inherent limitations of books that recount private conversations. Sources like Paulson are clearly selective and self-serving in their recitation of facts. I wonder if any of Zuckerman’s sources was candid about the real reason Paulson was able to get so rich so fast: The utter lack of transparency in the markets for private label mortgage securitizations and credit default swaps. The most important part of the story was what no one was talking about.

The other part of the story that no one was talking about was an open secret: Everyone knew that subprime lenders aided and abetted mortgage fraud. To my knowledge, the only investment banker who wrote candidly about the subject was Joseph Tibman, who was at Lehman when it collapsed, and wrote The Murder of Lehman Brothers: An Insider’s Look at the Global Meltdown. Tibman, who clearly has great affection for his old firm, recounted how in 2000, Lehman was tainted because of its financing arrangements with a sleazy subprime lender called First Alliance. The New York Times and 20/20 did a joint expose of First Alliance’s shady practices, and internal documents showed that Lehman knew exactly what was going on. First Alliance was a “financial sweatshop,” where you checked your “ethics at the door,” to promote “high pressure sales for people…in a weak state.” At the time, the head of Lehman’s commitment committee was an executive named Allan Kaplan, who had been with the firm for more than 30 years and was known as “the conscience of Lehman.” Kaplan had opposed the financing of First Alliance on the basis of his moral compass. After the scandal, his decisions on the committee, at least with regard to ethical concerns, were never challenged.

Kaplan’s style was antithetical to that of Dick Fuld, Lehman’s CEO. Tibman recounts a story where Fuld, then a young fixed income trader, rushed into Kaplan’s office insisting that he needed an immediate approval of his trade. Kaplan, of the old school, said he would approve the deal when his desk was clear. Fuld pushed off the papers on Kaplan’s desk and told Kaplan his desk was clear. Kaplan died in 2003, and afterwards, there were fewer restraints on Fuld’s bullying style for pushing deals through. Coincidentally, subprime securitizations took off in a big way the next year. Tibman believes that as much as anything, what killed Lehman was Fuld's emasculation of the risk management function, which served as a moral compass.

Wall Street Conspiracy Theories: Which Are The Most Plausible?

2009-11-13T15:04:54Z

So here's a field guide to the five most prevalent Wall Street conspiracy theories, with each one graded on scope, durability, crowd appeal, and plausibility and each graded on a sliding scale from 1 to 5, with 1 being "fugetaboutit" and 5 being "damn right."

Janet Tavakoli: Ralph Cioffi: Off the Hook for a Long Time Pattern of Behavior

2009-11-11T15:31:14Z

The following is an excerpt from my book, Dear Mr. Buffett, What an Investor Learns 1,269 Miles from Wall Street, in response to the acquittal Tuesday of Bear Stearns Asset Management heads Ralph Cioffi and Matthew Tannin.

****

I worked at Bear Stearns in the late 1980s and remembered amiable newcomer Ralph Cioffi to be Bear Stearns' most talented and successful salesman of mortgage-backed securities. He was usually even tempered, always hard working, and thoughtful. I headed marketing for the quantitative group run by both Stanley Diller, one of the original Wall Street "quants," and Ed Rappa (now CEO of R.W. Pressprich & Co, Inc.), a managing partner. Ralph was a popular salesman with my colleagues and a heavy user of our quantitative research. In gratitude for analytical work that helped him make sales, Ralph presented our group with an $800 portable bond calculator purchased out of his own pocket. When I was lured away from Bear Stearns by Goldman Sachs, Ralph Cioffi tried to persuade me to stay, matching the offer. Around 20 years had passed and since then we occasionally stayed in touch, but we were not close friends.

Among other hedge funds, Bear Stearns Asset Management (BSAM) managed the Bear Stearns High Grade Structured Credit Strategies fund. By August 2006, the fund had a couple of years of double-digit returns. BSAM launched the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage fund taking advantage of the first fund's "success."

Both funds managed by BSAM included CDO and CDO-squared tranches backed in part by subprime loans and other securitizations (collateralized loan obligations) backed by corporate loans and leveraged corporate loans. In August 2006 when BSAM was setting up the Enhanced Leverage fund, other hedge fund managers (like John Paulson), shorted subprime-backed investments.

Investors in the two funds managed by BSAM had been getting double digit annualized returns on high-grade debt at a time when treasuries were yielding less than 5 percent. In fixed income investments, that usually means investors are taking risk.

Ralph seemed to have similar views to mine on CPDOs, the leveraged product that I had said did not deserve a AAA rating. Ralph told me he thought the AAA rating could "lull the unsophisticated investor to sleep," and that for the purposes of his hedge funds, if he liked an investment-grade-rated trade he could have the same trade without paying fees and: "easily lever up ... fifteen times." To paraphrase Warren Buffett, if the price of your investments drops, leverage will compound your misery.

On May 9, 2007, Matt Goldstein called and asked me if I had a chance to look at the registration statement for a new initial public stock offering (IPO) called Everquest Financial, Ltd (Everquest). Everquest is a private company formed in September 2006, and the registration statement was a required filing in preparation for its going public. The shares were held by private equity investors, but the IPO would make shares available to the general public.

Everquest was jointly managed by Bear Stearns Asset Management Inc, and Stone Tower Debt Advisors LLC, an affiliate of Stone Tower Capital LLC. I was curious, but I was swamped. I told him no, I was very busy and had not even had a chance to glance at it. He called again asking if I had seen it, and again I said no, "Go away." The next morning I ignored Matt's voice mails, but finally took his call the afternoon of Thursday May 10 telling him that I still had not looked at the registration statement and had no plans to do so that day. My first call on the morning of Friday, May 11, 2007, was again from Matt Goldstein. He thought the IPO might be important.

I went to the SEC's website, and as I scanned the document I thought to myself: Has Bear Stearns Asset Management completely lost its mind? There is a difference between being clever and being intelligent. As I printed out the document to read it more thoroughly, I put aside the rest of my work and said: "Matt, you are right; this is important." I was surprised to read that funds managed by BSAM invested in the unrated first loss risk (equity) of CDOs. In my view, the underlying assets were neither suitable nor appropriate investments for the retail market. I did not have time for a thorough review, so I picked a CDO investment underwritten by Citigroup in March 2007 bearing in mind that if the Everquest IPO came to market, some of the proceeds would pay down Citigroup's $200 million credit line. Everquest held the "first loss" risk, usually the riskiest of all of the CDO tranches (unless you do a "constellation" type deal with CDO hawala), and it was obvious to me that even the investors in the supposedly safe AAA tranches were in trouble. Time proved my concerns warranted, since the CDO triggered an event of default in February 2008, at which time Standard & Poor's downgraded even the original safest AAA tranche to junk.

The equity is the investment with the most leverage, the highest nominal return, and is the most difficult to accurately price. The CDO equity investments were from CDOs underwritten by UBS, Citigroup, Merrill, and other investment banks.

Based on what I read, Everquest's original assets had significant exposure to subprime mortgage loans, and the document disclosed it, "a substantial majority of the [asset-backed] CDOs in which we hold equity have invested primarily in [residential mortgage-backed securities] backed by collateral pools of subprime residential mortgages." Based on my rough estimates, it was as high as 40 percent to 50 percent.

I explained my concerns to Matt in a general way. Among other concerns: (1) money from the IPO would pay down Everquest's $200 million line of credit to Citigroup; (2) the loan helped Everquest buy some of its assets including CDOs and a CDO-squared from two hedge funds managed by BSAM, namely the Bear Stearns High-Grade Structured Credit Strategies Fund that had been founded in 2003 and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund ("Enhanced Leverage Fund") launched in August 2006; and (3) the assets appeared to include substantial subprime exposure.

Matt Goldstein posted his story on Business Week's site later that day. Initially it was called: "The Everquest IPO: Buyer Beware," but after protests from Bear Stearns Asset Management, Business Week changed the title to Bear Stearns' Subprime IPO. I hardly think that pleased Bear Stearns more.

Ralph Cioffi contacted me about the Business Week article. He said that dozens of IPOs like Everquest had been done--mostly offshore so as not to deal with the SEC. According to Ralph, BSAM's hedge funds and Stone Tower's private equity funds would own about 70 percent of Everquest stock shares (equity), and they had no plans to sell "a single share at the IPO date." They planned to use the IPO proceeds to pay down the Citigroup credit line and possibly buy out unaffiliated private equity investors.

I responded that verbal assurances that there are no plans to sell a share at the IPO date are meaningless. Publicly traded shares can be sold anytime. But even if the funds kept their controlling shares, it was not good news. Retail investors would have only a minority interest which would be a disadvantage if they had a dispute with the managers.

Ralph claimed that subprime was "actually a very small percent of Everquest's assets." He reasoned that on a market value basis the exposure to subprime was actually negative because Everquest hedged its risk. Technically, Ralph might have been correct--but the registration statement for the Everquest IPO itself suggested otherwise: "The hedges will not cover all of our exposure to [securitizations] backed primarily by subprime mortgage loans."

It is fine to talk about net exposure (left over after you protect yourself with a hedge), but one usually also discusses the gross exposure (of the assets you originally bought). Hedges cost money, so they can reduce returns.

Ralph Cioffi said CDO equity is "freely traded and easily managed." I countered that CDO equity may be easy for Ralph to value, but investment banks and forensic departments of accounting firms told me they have trouble doing it. I told him that if this were a CDO private placement, it would have to be sold to sophisticated investors and meet suitability requirements, but since it is in a corporation, it can be issued as an initial public offering (IPO) to the general public. It seemed to be a way around SEC regulations for fixed income securities, and it was not suitable for retail investors in my view.

Ralph said he would talk to his lawyers about changing the IPO's registration statement to add a line about third party valuations. We seemed to be talking at cross purposes, since the registration statement already said that third party valuation would occur at the time of underwriting. The problem with that was that the assumptions for pricing would be provided by a conflicted manager, and assumptions are critical in determining value. Moreover, on an ongoing basis, one had to rely on a conflicted management's assumptions for pricing.

Ralph did not seem to want to end the discussion, so I asked him if there was something he wanted me to do. He said it would be great if I issued a comment saying I was quoted "out of context," that my being quoted in Business Week lent credibility to the article and was not helping me, and that I would be "better served" writing my own commentary. I ignored what I perceived to be a thinly veiled threat. I told him that if he wanted me to write a commentary, I would do a thorough job of raising all of the objections I had just raised with him. Ralph seemed unhappy but my thinking he was a hedge fund manager from Night of the Living Dead was the least of his problems.

Excerpted with permission from the publisher, John Wiley & Sons, from Dear Mr. Buffett, What an Investor Learns 1,269 Miles from Wall Street , by Janet Tavakoli. © 2009 by Janet Tavakoli.

Tom Gregory: The Lloyd's Prayer

2009-11-11T03:25:09Z

THE LLOYD's Prayer

Our Chairman,
Who Art At Goldman,
Blankfein Be Thy Name.
The Rally's Come. God's Work Be Done
On Earth As There's No Fear Of Correction.

Give Us This Day Our Daily Gains,
And Bankrupt Our Competitors
As You Taught Lehman and Bear Their Lessons.
And Bring Us Not Under Indictment.
For Thine Is The Treasury,
The House And The Senate
Forever and Ever.

Goldman.

Ralph Cioffi, Matthew Tannin Verdict: Ex-Bear Stearns Hedge Fund Managers NOT GUILTY On All Fraud Charges

2009-11-10T15:30:40Z

NEW YORK — Two Bear Stearns executives who ran hedge funds that collapsed after betting heavily on the shaky subprime mortgage market were acquitted Tuesday of lying to investors – a defeat in the government's bid to punish fraud exposed by the financial crisis.

A jury in federal court in Brooklyn deliberated about eight hours over two days before finding Ralph Cioffi and Matthew Tannin not guilty of conspiracy and other charges in an alleged scheme that cost 300 investors about $1.6 billion and nearly caused the demise of Bear Stearns itself. The firm avoided bankruptcy in a rescue buyout by JPMorgan Chase & Co.

Charles Gasparino: Goldman Sachs Doing "God's Work"?

2009-11-09T14:32:34Z

The only thing worse than Goldman Sachs amassing close to $20 billion
in bonus money for its executives based on various government
subsidies and bailout measures is listening to senior executives there
trying to explain it all away. The spin job has been coming from an
unlikely source: The normally media shy Goldman CEO Lloyd Blankfein
has been making the rounds lately, talking to selective reporters,
including William Cohan, who recently wrote a book about the fall of
Bear Stearns and now has the firm's complete cooperation as to write
something on Goldman Sachs, the most prestigious of the Wall Street
firms, even if it needed a bailout to survive last year's financial
crisis..

Cohan's Bear book, the first of many financial crisis tomes (including
my own) wasn't exactly a puff piece, but trading access for
information is a time honored journalistic practice, and it's human
nature to be nicer to someone who gives you information. So presumably
we'll all find out from Cohan how, in the throes of the financial
crisis, Goldman really didn't need the $10 billion in bailout money it received
from the federal government as its stock cratered; that it was forced
to take the cash from then-Treasury Secretary (and former Goldman CEO)
Hank Paulson, or how despite its exposure to troubled insurance giant
AIG, Goldman was miraculously "hedged," against losses, meaning that
the fed's AIG's bailout last year didn't really help Goldman survive
last year's panic. No, Goldman survived because it was built for
survival.

Forget the absurdity of such claims, Blankfein has been on a roll of
late, repeating them time and again, not just presumably to Cohan, but
to a growing number of credulous journalists who will stomach just
about anything to get a few minutes with the CEO of the Great Goldman
Sachs, even if its greatness was put to the test last year.

Blankfein's spinning is reaching epic proportions. Several recent
stories about Goldman have cast the firm as the Great Satan of the
securities markets, or as Rolling Stone's Matt Taibbi put it, the "great vampire
squid wrapped around the face of humanity, relentlessly jamming its
blood funnel into anything that smells like money." No longer is
Blankfein simply trying tell the world Goldman isn't the root of all
evil; rather, old Lloyd is informing us all that Goldman is a source of
goodness in the world. The exact quote, from the Times of London has
Blankfein professing that as CEO of the vampire squid he's actually
"doing God's work," simply by doing what banks get paid to do: Raising
money for clients and investing in businesses.

Oh really, Lloyd? My brother is a doctor who works in the intensive care
unit of an inner city hospital; he could have a cushy lucrative
practice here in New York, but he likes helping people, and yet he has
never once told me he's doing God's work even after he explained one
afternoon how he had just saved a homeless man's life by massaging his
heart.

Believe it or not, I happen not to fall into the camp of Goldman
haters, where people believe the firm is behind every scandal and
conspiracy and may have even created the swine flu virus so it could
corner the market for drug stocks. (Though Goldman and several other
firms did seem to have no problem obtaining for their employees the
swine-flu vaccine, which is in short supply.) Indeed, as I show in my
new book The Sellout, when it came to risk-taking over the last 30
years on Wall Street, Goldman did it better than any other firm on the
Street. The folly that was found at a firm like Bear Stearns, with its
CEO caring more about playing bridge and golf (and allegedly smoking
marijuana) than tending to the firm's balance sheet, would never
happen at Goldman Sachs.

But there is something truly unsettling about the new message coming
from the firm, honed I hear from a phalanx of image consultants who
are literally trying to re-write history as the firm gets ready to
dole out its enormous bonus pool. And that's what all this spinning is
about. For the record Goldman Sachs didn't take down the financial
system last year -- Citigroup, Merrill, Lehman or Bear are much more
responsible for that. And for the record every firm spins -- its called
public relations, and Goldman will need all the PR it can muster as it
decides in the coming weeks how much of the $20 billion it will hand
out to its executives. My sources at Goldman say Blankfein won't be
stingy because he needs to prevent top producers from bolting to hedge
funds and private equity.

What makes Goldman so contemptible is that its level of spin has
almost no basis in reality. We are supposed to believe Goldman wasn't
bailed out; it didn't need the government's money when big investors
where yanking funds from the firm and its stock was plummeting and now
the firm is doing "God's work," even as government bureaucrats
continue to subsidize how the firm makes most of its money -- through
risk taking and bond trading, all on the backs of the US taxpayer.

Goldman, in case you haven't heard, has been classified as a
commercial bank, meaning it can borrow cheaply to finance its risk
taking, and can borrow from the Federal Reserve in a pinch. That's why
it's amassing such massive profits. And yet not a penny of its massive
bonus pool will be lent out to funding-starved small businesses. Think
about that: The Federal Government run by the most Liberal
Administration in years, is subsidizing big business at the expense to
small business.

How did this bizarre scenario develop? Who knows, but it should come
as no surprise that Wall Street -- Goldman in particular -- funneled far
more money to president Obama than it did to his Republican
challenger, John McCain. Maybe that's why the president has been
eerily silent on the Goldman Sachs subsidy, even as Lloyd Blankfein
tells the world he's doing "God's work."

Steve Begleiter, Former Bear Stearns Exec, Wins $1.6 MILLION In World Series Of Poker Final

2009-11-05T08:00:01Z

UPDATED:
Bloomberg reports that Steve Begleiter, the former head of corporate strategy at Bear Stearns, has finished sixth in the 2009 World Series of Poker. Though, Begleiter did not win the coveted $8.55 million top prize, he did walk away with $1.26 million in tournament winnings. Check out the rest of the story here.

ORIGINAL POST:
Former Bear Stearns executive Steven Begleiter is set to compete in the final table at the Main Event at the World Series of Poker starting on Saturday in Las Vegas.

Begleiter qualified for the final round in the July preliminaries -- since 2008, the final table has been delayed until November -- where he finished among the top nine out of 6,494 entrants and took home $1.26 million in prize money. This month, he'll play for the top payout of $7.2 million.

Until 2008, Begleiter was head of corporate strategy at Bear Stearns, where executives were known more for their regard for bridge than poker. When Bear was sold to J.P. Morgan, Begleiter helped transition the firm before moving to the private equity group Flexpoint Ford. Begleiter told The New York Times that despite the "populist nonsense going on right now," he's still "very proud" of his time at Bear.

Time reports that, Begleiter will be up against several very skilled professional poker players -- including Phil Ivey, who many consider to be the game's top professional -- but it appears he appreciates the challenge: "It's not about the money, really, I just like to compete," he said.

WATCH: Begleiter talks about being in the "November Nine" below:

Meet the WSOP November Nine -- Steven Begleiter - Click here for more free videos

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New "Too Big To Fail" Bill Gives Feds Power To Freeze Derivatives Contracts

2009-11-03T13:46:49Z

The "Too Big To Fail" legislation currently being debated by a House committee has been widely criticized as toothless. But one provision gives the federal government a powerful mechanism to prevent another implosion like the one that launched the current financial crisis.

The bill, which would give the Federal Deposit Insurance Corporation the power to take over failing firms that pose a risk to the entire financial system, gives the FDIC the authority to repudiate the firm's derivatives contracts, pay the parties less than what they're owed, or transfer the contracts to another, healthy financial firm.

Perhaps most importantly, the FDIC would have the authority to delay the parties from closing out their contracts and taking their money with them. That's part of the reason why the Lehman Brothers bankruptcy announcement caused the financial markets to crash, and it's what helped bring about the demise of the 158-year-old investment firm -- everyone wanted to get their money out before it was too late.

The FDIC already has this power when it comes to failed banks. But its authority is strictly limited to insured depositories. So the FDIC can take over a Citibank, for example, but not all the operations of a Citigroup. It's an important difference, and part of the reason why the administration and House Financial Services Committee Chairman Barney Frank are proposing to give the FDIC this expanded authority.

Here's how it works:

These days, when the FDIC takes control of a bank, it can liquidate it (receivership) or take it over in preparation for a sale (conservatorship). Receivership is the most common approach. In those cases, the FDIC will sell off a bank's assets, or it can open a temporary bank in order to minimize the disruption that would come from immediately selling off all of a bank's assets.

In derivatives contracts, a firm's failure or bankruptcy often triggers a clause that calls for the contract to be immediately closed out.

From Michael Krimminger, special advisor for policy at the FDIC, before a House committee in October:

Under both the Bankruptcy Code and bank insolvency law, the counterparties to insolvent firms can terminate and net out derivatives and sell any pledged collateral to pay off the resulting net claim. During periods of market instability -- such as during the fall of 2008 -- the exercise of these netting and collateral rights can increase systemic risks. At such times, the resulting fire sale of collateral can depress prices, freeze market liquidity as investors pull back, and create risks of collapse for many other firms.

In effect, financial firms are more prone to sudden market runs because of the cycle of increasing collateral demands before a firm fails and collateral dumping after it fails. Their counterparties have every interest to demand more collateral and sell it as quickly as possible before market prices decline. This can become a self-fulfilling prophecy -- and mimics the depositor runs of the past.

This is what happened to Lehman Brothers and another Wall Street firm no longer standing, Bear Stearns.

"Rumors about Lehman's liquidity problems, and the subsequent bankruptcy filing, triggered asset fire sales and destroyed the liquidity of a large numbers of claims held by Lehman's direct counterparties as well as of claims held by counterparties several steps removed from those having claims directly against Lehman itself," Krimminger said. "This led to an abrupt collapse of liquidity as the ability of parties throughout the market to complete settlements was placed into doubt."

While the FDIC can now stem the tide for banks, it can't for investment firms such as Goldman Sachs or Morgan Stanley. The draft of the Financial Stability Improvement Act of 2009 -- first proposed by the administration and introduced in the House Financial Services Committee last week -- would give the agency that ability.

It's not going to be easy, though. With derivatives, under both its current and proposed authority, the FDIC only has until 5 p.m. on the business day following its appointment as a receiver to dispose of the problems. The rationale behind the one-business day turnaround is that the value of derivatives is tied closely to a company's relationship with others in the market and its need for immediate and continuous access to liquidity.

According to a summary of the administration's regularly reform framework by the international law firm Gibson, Dunn & Crutcher, which represents banks and other financial firms, the FDIC would have the "power to repudiate 'burdensome' contracts and leases and is liable only for 'actual direct compensatory damages' and no damages for profits or lost opportunity or pain and suffering or punitive damages...[and it would be able to] enforce contracts despite default, termination, or acceleration clauses."

The proposal has its critics. The International Swaps and Derivatives Association, a global trade group representing the over-the-counter derivatives industry, is concerned that the bill wouldn't allow firms to immediately net-out and end their contracts.

"In general, our main concern about any wind-down authority would be to ensure that potential legislation recognizes the importance of the enforceability of close-out netting to the derivatives markets and the counterparty risk management benefits this brings," the group said in a statement.

To put the provision into context, let's imagine that AIG had been taken over by the FDIC. Rather than the troubled insurer paying Goldman Sachs $12.9 billion for its disastrous credit-default swaps (a type of derivative contract) -- a sum paid in full per the contracts -- the FDIC could have mandated a lesser payment. In the real world, however, the New York Fed chose to make AIG pay all of its debts in full. Per Jonathan Weil of Bloomberg:

AIG wound up paying $32.5 billion to retire the swaps, $13 billion more than if it had paid, say, 60 cents on the dollar. The New York Fed also arranged to pay the banks $29.6 billion for collateralized-debt obligations backed by subprime mortgages and other loans, a tad less than half their face value. (The swaps were side bets by the banks that rose in value as the CDOs fell.)

It probably made sense for the counterparties to reject AIG's initial settlement offers. They had their own investors to look after. And once the government took control of AIG, it couldn't credibly threaten to force the company into bankruptcy proceedings. The premise of the government's seizure, after all, was that AIG was too big to fail.

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Robert Reich: Breaking Up the Big Banks, and Why Congress Won't Do It

2009-10-26T21:49:41Z

And now there are five -- five Wall Street behemoths, bigger than they were before the Great Meltdown, paying fatter salaries and bonuses to retain their so-called"talent," and raking in huge profits. The biggest difference between now and last October is these biggies didn't know then that they were too big to fail and the government would bail them out if they got into trouble. Now they do. And like a giant, gawking adolescent who's just discovered he can crash the Lexus convertible his rich dad gave him and the next morning have a new one waiting in his driveway courtesy of a dad who can't say no, the biggies will drive even faster now, taking even bigger risks.

What to do? Two ideas are floating around Washington, but only one is supported by the Treasury and the White House. Unfortunately, it's the wrong one.

The right idea is to break up the giant banks. I don't often agree with Alan Greenspan but he was right when he said last week that "[i]f they're too big to fail, they're too big." Greenspan noted that the government broke up Standard Oil in 1911, and what happened? "The individual parts became more valuable than the whole. Maybe that's what we need to do." (Historic footnote: Had Greenspan not supported in 1999 Congress's repeal of the Glass Steagall Act, which separated investment from commercial banking, we wouldn't be in the soup we're in to begin with.)

Former Fed Chair Paul Volcker, whose only problem is he's much too tall, last week told the New York Times he'd like to see the restoration of the Glass-Steagall Act provisions that would separate the financial giants' deposit-taking activities from their investment and trading businesses. If this separation went into effect, JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. And Goldman Sachs could no longer be a bank holding company.

But the Obama Administration doesn't agree with either Greenspan or Volcker. While it says it doesn't want another bank bailout, its solution to the 'too big to fail' problem doesn't go nearly far enough. In fact, it doesn't really go anywhere. The Administration would wait until a giant bank was in danger of failing and then put it into a process akin to bankruptcy. The bank's assets would be sold off to pay its creditors, and its shareholders would likely walk off with nothing. The Treasury would determine when such a "resolution" process was needed, and appoint a receiver, such as the FDIC, to wind down the bank's operations.

There should be an orderly process for putting big failing banks out of business. But this isn't nearly enough. By the time a truly big bank gets into trouble -- one that poses a "systemic risk" to the entire economy -- it's too late. Other banks, competing like mad for the same talent and profits, will already have adopted many of the excessively-risky banks' techniques. And the pending failure will already have rocked the entire financial sector.

Worse yet, the Administration's plan gives the big failing bank an escape hatch: The receiver might decide that the bank doesn't need to go out of business after all -- that all it needs is some government money to tide it over until the crisis passes. So the Treasury would also have the authority to provide the bank with financial assistance in the form of loans or guarantees. In other words, back to bailout. (Historical footnote: Summers and Geithner, along with Bob Rubin, while at Treasury in 1999, joined Greenspan in urging Congress to repeal Glass-Steagall. The four of them -- Greenspan, Summers, Rubin and Geithner also refused to regulate derivatives, and pushed Congress to stop the Commodity Futures Trading Corporation from doing so.)

Congress is cooking up a variation on the "resolution" idea that would give the Federal Deposit Insurance Corporation authority to trigger and handle the winding-down of big banks in trouble, without Treasury involvement, and without an escape hatch.

Needless to say, Wall Street favors the Administration's approach -- which is why the Administration chose it to begin with. If I were less charitable I'd say Geithner and Summers continue to bend over bankwards to make Wall Street happy, and in doing so continue to risk the credibility of the president, as well as the long-term financial stability of the system.

Wall Street could live with the slightly less delectable variation that Congress is coming up with. But Congress won't go as far as to unleash the antitrust laws on the big banks or resurrect the Glass-Steagall Act. After all, the Street is a major benefactor of Congress and the Street's lobbyists and lackeys are all over Capitol Hill.

The Street obviously detests the notion that its behemoths should be broken up. That's why the idea isn't even on the table. But it should be. No important public interest is served by allowing giant banks to grow too big to fail. Winding them down after they get into trouble is no answer. By then the damage will already have been done.

Whether it's using the antitrust laws or enacting a new Glass-Steagall Act, the Wall Street giants should be split up -- and soon.

Cross-posted from Robert Reich's Blog.

Joseph A. Palermo: Wall Street Is More of a Threat to Obama's Domestic Agenda than Afghanistan

2009-10-20T15:02:29Z

"Deficits don't matter." When Vice President Dick Cheney uttered this famous line he was making a political judgment, not an economic one. In 2001, when the newly selected President George W. Bush and his posse rode into Washington they immediately began in earnest the chicanery, lying and recklessness that we came to expect throughout the subsequent eight years. They promised there'd be great benefits for our nation if the Republican Congress passed a massive tax cut aimed at Bush's wealthy friends, corporations, and campaign donors.

This call for fiscal abandon came after years where we heard squawking about the danger of budget deficits from Newt Gingrich and other Republicans, as well as from conservative pundits and Blue Dog Democrats. And one of the loudest voices decrying budget deficits in the pre-Bush years was the Chair of the Federal Reserve Alan Greenspan. The proposal coming from the Republican president and the Republican Congress was a tax giveaway to the wealthiest Americans and corporations that was certain to blow a hole in the federal budget and add $1.7 trillion to the national debt.

As head of the Federal Reserve it was Alan Greenspan's job to tell the Bush gang that after the sacrifices made to pay down the debt a new round of Reagan-style tax giveaways to the rich and corporations would be a bad idea. That line would have been the "conservative" position to take. Instead, as the high priest of all things economic, Greenspan testified to Congress giving his imprimatur to the Bush administration's kleptomania.

Greenspan's easy money policies aided and abetted Wall Street's pumping up "the mother of all bubbles." And along with the federal budget deficit he encouraged (and the Republicans' drunken spending spree that followed) the money ordinary Americans circulate was buried under a mountain of new debt and new claims on the money supply from Wall Street. By 2006, Wall Street was throwing around 7.5 times as much money ($10.299 trillion) than was being spent by Main Street ($1.367 trillion). Greenspan also sat back and watched when an exemption to the "net capital rule" was passed in 2004 that allowed investment banks to exceed the maximum debt to equity ratio of 12 to 1. Soon Bear Stearns' debt to equity ratio jumped to 33 to 1 and Merrill Lynch's ballooned to 40 to 1. And a lot of this leveraged debt was wrapped up in collateralized debt obligations (CDOs) and other toxic derivative sludge.

We all know how the story plays out: In October 2008 the Congress, with a gun to its head from Wall Street titans and in the middle of an election season, forked over $810 billion of the taxpayers' money to bailout some of the greediest and most short-sighted market players ever to exist in the history of capitalism.

Today, just over a year later, with Goldman Sachs and other bailed out financial institutions turning big profits and paying out bonuses to their luckiest gamblers we continue to see the "real economy" in free fall. There are about $70 billion in crappy mortgages due to be "reset" in the next eighteen months, so there's no end in sight to Americans being thrown out of their homes. Unemployment continues to climb (albeit at a slower rate) but the deep hole that needs to be filled to replace the jobs lost will take many years of robust economic growth. The Congress, always in hawk to Wall Street, is dragging its feet in passing anything near the sweeping regulatory restructuring that is needed if we are to prevent Goldman Sachs and the rest of the gang from exploiting their "moral hazard" by using the federal treasury as the mother of all "credit default swaps." We can't even get the Democratic Congress to create a Pecora Commission with subpoena power to explore the extent of the criminality that led to the current crisis with the aim of modernizing the Securities and Exchange Commission to challenge the kleptocracy.

At some point, as the journalist Matt Taibbi and others have pointed out, our nation's Treasury seems to have been usurped by the former Goldman Sachs CEOs and other executives who both Bill Clinton and George W. Bush thought would make great Treasury Secretaries.

President Barack Obama's economic team headed by Treasury Secretary Tim Geithner and presidential adviser Larry Summers, like Alan Greenspan, are the wrong people doing the wrong job at the wrong time. They are catering to the whims of Wall Street when they should be mad as hell and representing the interests of Main Street. When FDR tapped Joseph P. Kennedy to be the first chair of the SEC he did so because Kennedy understood the swindles that needed to be policed because he had practiced them himself. Geithner and Summers understand the problems but so far they have not shown the will or desire to do anything about them.

There is currently a lot of hand wringing about the possibility of the war in Afghanistan, as costs rise and public support wanes, destroying President Obama's domestic agenda just as the Vietnam War brought down Lyndon Johnson. But whatever Obama decides to do in Afghanistan is of little consequence compared to Wall Street's ongoing "plutonomy." Either President Obama and the Congress tame and bring under control the white collar criminals who run Goldman Sachs and other "too big to fail" institutions or else there isn't going to be a "domestic agenda."

Wall Street Donating Little To Obama

2009-10-20T03:37:35Z

The Wall Street giants that received a financial lifeline from Washington may have no compunction about paying big bonuses to their dealmakers and traders. But their willingness to deliver "thank you" gifts to President Obama and the Democrats is another question altogether.

Congressional Committees Quietly Kill Portion Of Derivatives Bill; No One Watching For Systemic Risk

2009-10-17T16:23:06Z

Two congressional committees in charge of drafting legislation to regulate derivatives have quietly killed a provision that would allow the Federal Reserve to police the complicated financial transactions. The kind of derivatives that many blame for the near-collapse of the American financial system have never been regulated.

In July, the Obama administration sent a proposed bill to Congress requesting that the Federal Reserve be given authority to oversee those aspects of the financial system that posed "systemic risk" -- in short the kind of firms and activities that could bring down the entire financial system. It would be up to the Fed and other federal regulators to determine what constituted "systemic risk." The trading of derivatives, essentially contracts that can act as insurance against a future event or as just a simple bet, were part of the package.

Derivatives brought down the Wall Street investment banks Lehman Brothers and Bear Stearns and nearly caused insurance giant AIG to go belly up. The reason why they nearly brought down the entire financial system is because every major financial firm and bank were tied to them through derivatives deals. They were all interconnected. But there wasn't a single regulator looking at that. Rather, individual government regulators -- both state and federal -- were overseeing their own individual part of the pie, instead of the whole thing. Obama's plan is an attempt to change that.

But late Friday afternoon, the House Agriculture Committee quietly posted to its Web site a revised version of the Obama administration-proposed legislation. The Committee, which has jurisdiction over one of the two federal regulators of derivatives trading -- the Commodity Futures Trading Commission (CFTC) -- deleted the portion of Obama's bill that gives the Federal Reserve a say in those derivatives activities that pose a risk to the financial system. Specifically, the Fed would have been given the power to oversee new rules set up by the exchanges and clearinghouses where derivatives trading takes place. The previous version of the Agriculture committee's bill, released Oct. 9, included that passage. The current bill places that power solely in the hands of the CFTC.

A spokesman for House Agriculture Committee Chairman Rep. Collin Peterson, a Democrat from Minnesota, could not be reached for comment late Friday.

The move follows that of the House Financial Services Committee, where Rep. Judy Biggert, an Illinois Republican, offered an amendment striking the same provision in their version of the bill with the agreement of Committee Chairman Rep. Barney Frank (D-Mass.). The original version of the Financial Services bill, though, was a bit stronger than the Agriculture bill (at least in this aspect) because it included all of the language originally put forward by the administration regarding systemic risk. Specifically, the administration's proposal gave the Fed authority over not only new rules governing derivatives trading that threatened the system, but also over new derivatives and how the trading of them would be processed.

Frank allowed Biggert's amendment to pass without debate, punting the issue to the Agriculture committee. His spokesman says the Financial Services Committee lacks jurisdiction in this area, thus calling the committee's move "irrelevant." However, Frank and the rest of the committee did impose additional regulation on other aspects of derivatives trading that fall under Agriculture's jurisdiction.

In its white paper announcing its detailed plans to overhaul financial regulation, the administration explained how derivatives led to the economy's near-collapse, and why the Federal Reserve would need additional power over them:

"Through credit derivatives, banks could transfer much of their credit exposure to third parties without selling the underlying loans. This distribution of risk was widely perceived to reduce systemic risk, to promote efficiency, and to contribute to a better allocation of resources," the administration said.

"However, instead of appropriately distributing risks, this process often concentrated risk in opaque and complex ways. Innovations occurred too rapidly...for the nation's financial supervisors.

"The build-up of risk in the over-the-counter (OTC) derivatives markets, which were thought to disperse risk to those most able to bear it, became a major source of contagion through the financial sector during the crisis," the administration said. "We propose to enhance the Federal Reserve's authority over market infrastructure to reduce the potential for contagion among financial firms and markets."

Derivatives, the administration said in its draft legislation, "may also concentrate and create new risks and thus must be well designed and operated in a safe and sound manner. Enhancements to the regulation and supervision of systemically important financial market utilities and the conduct of systemically important...activities by financial institutions are necessary to provide consistency, to promote robust risk management and safety and soundness, to reduce systemic risks, and to support the stability of the broader financial system."

Thus, "responsibility and authority for ensuring consistent oversight of all systemically important...activities should be assigned to the Federal Reserve," the administration said.

Officials from the Federal Reserve also have lobbied for the added role, arguing that it's best suited to minimize destabilizing threats to the financial system.

"The [Federal Reserve] Board believes that all systemically critical firms should have a consolidated supervisor, as well as be subject to the oversight of any systemic regulator that might be created," said Patricia White, associate director of the Fed's division of research and statistics, in June during testimony before the U.S. Senate. "The scope of a firm's activities in the OTC derivatives market will likely be an important factor in making that assessment."

Fed Chairman Ben Bernanke echoed those remarks the next month during testimony before Barney Frank's Financial Services Committee.

"It is critical that systemically important systems and activities be subject to strong and consistent prudential standards designed to ensure the identification and sound management of credit, liquidity, and operational risks," Bernanke said. "The Federal Reserve also would expect to carefully monitor and address, either individually or in conjunction with other supervisors and regulators, the potential for additional spillover effects...For example, the failure of one firm may lead to deposit or liability runs at other firms that are seen by investors as similarly situated or that have exposures to such firms. In the recent financial crisis, exactly this sort of spillover resulted from the failure of Lehman Brothers, which led to heightened pressures on other investment banks."

Thus, in explaining why the Fed would need additional police power over things like derivatives trading, Bernanke brought up the failure of Lehman Brothers, the largest bankruptcy filing in U.S. history. At the time of its demise, the storied Wall Street investment bank listed more than $613 billion in debt.

But as it stands, the Fed won't be getting that power from the two derivatives bills currently snaking through congressional committees. Rather, it will be fragmented across an array of federal and private regulators -- just what the Obama administration warned against.

The Treasury Department declined to comment.

The Entire Financial Crisis In 7 Minutes: iHeartWallStreet (VIDEO)

2009-10-16T16:26:24Z

Clusterstock points us to a new video by iHeartWallStreet, which attempts to distill the entire financial crisis in seven minutes and 15 seconds.

There are some hilarious clips of Jim Cramer in this piece, which melds together some of his worst calls of the crisis. There's one particular damning piece from TheStreet.com in which Cramer claims that, if the entire subprime loan market collapsed, the world would hardly notice. Ouch.

His words: "It has no relevance whatsoever...no one entity is going to be hurt, except for the one guy who ran Bear Stearns." Double ouch.

Watch the entire thing:

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New Bear Stearns Email Reveals Early Fear of "Blow-Up Risk"

2009-10-09T17:35:09Z

NEW YORK (Reuters) - One of two former Bear Stearns managers indicted for fraud over the collapse of hedge funds in 2007 feared a "blow up risk" to investors as early as November 2006, according to an email released on Thursday.

Georges Ugeux: Time to Stop the Regulatory Circus and to Steer the Ship to Safe Ground

2009-10-08T10:50:46Z

Writing from Istanbul October 6, 2009

After the G 20, the annual assembly of the International Monetary Fund and the World Bank in Istanbul has been a theater (in the true sense of the word) of the most confusing and disparate cacophony of opinions on the issues of the day. The world's financial regulators and Ministers of Finance need to stop their internal competitions and find a different way to reform financial regulation, make the economy grow, ensure that the systemic risk is eliminated and define an exit strategy.

Last year, this same assembly was starting to realize the magnitude of the disaster created by the bankruptcy of Lehman Brothers, the rescue of Bear Stearns and Merrill Lynch, the transformation of Goldman Sachs and Morgan Stanley into a bank, and of course the bloodbath of AIG. This week's meeting in Istanbul is the first assembly after three G 20 meetings, loads of summits and meetings around the world.

Foreign delegations were not amazed to hear, read or see the cacophony of opinions emanating from the U.S. administration and its focus on short term measures, completely missing the global and long-term perspectives. Emerging markets in particular had a field-day explaining that they coped very well with the crisis, did not suffer from a collapse of their financial institutions and were not plagued by greed as the Western Hemisphere has been.

However, this is not an excuse to continue business as usual. Somebody has to rein in the various parties and call them to focus on the work at hand. Yes, they can congratulate each other for the way they managed to stop what could have been a true financial earthquake, but the current landscape is not exactly pretty and it is urgent to make some sense of the current disorder of financial markets. On top of that, they should not ignore their own responsibilities in the crisis.

While all of this is happening, the derivative market's gross exposure is approaching its pre-crisis levels or in the words of NYU Professor, Nouriel Rubini, it is nearly ten times the world's Gross Domestic Product. With $ 1.5 trillion, the fixed income markets (and related bonuses) are at record levels.

The real issue for regulators around the globe is a serious definition of the financial world we want to live in. The current focus nearly exclusively on the banking sector, could cause authorities to miss the broader picture: the non-banking financial sector and global capital markets. By adding charges and equity requirements to the banks' balance sheet and cash flows, we are substantially shrinking the ability of banks to keep loans on their balance sheets and setting up the potential for days of scarce and expensive credit that could threaten the fragile economic growth we currently enjoy.

The United States has demonstrated that unless it reorganizes its regulatory apparatus to make it coherent and to give the Federal Reserve a coordinating role at the Federal and State levels, it will have no credibility. Only president Obama can empower the Federal Reserve Bank to play an essential leadership role, since it has the financial means to act and oversee the systemic financial risks.

Creating a special regime for financial institutions representing a systemic risk could effectively giving them control of banks to the public sector and creating a scenario where institutions that are "too big to fail" will enjoy quasi-Government guaranteed funding.

At international level, three institutions have the credibility to tackle these issues, provided that they closely cooperate: the International Monetary Fund for macro imbalances, the Financial Stability Board (acting effectively for the G 20) and the Bank for International Settlements where central banks coordinate their actions and clear funds between them. The time has come to stop talking and holding high level meetings. Let us see what these institutions will propose. In the mean time, the banks do not remain idle. They already are well under way in their restructuring, even at compensation level.

Now is time to identify a captain to steer this ship to safe ground by giving this person or institution the powers needed to implement a coherent new financial architecture and define the financial world in which we want to live.

Dan Solin: The Big Secret Wealthy Investors Don't Want You to Know

2009-10-06T20:57:44Z

Wealthy investors are different from you and me. They have a secret they don't want anyone to know.

They are bigger suckers.

How can this this be?

They qualify as "accredited investors" who can invest in deals exempted from SEC registration. Without SEC registration, the sponsors of these deals can avoid troublesome filing requirements that require detailed disclosures about transparency, limitations on fees and liquidity.

This means they can be enticed to buy "alternative investments" like hedge funds and private equity deals.

How is that working for them?

Not well.

According to a web site that tracks hedge fund performance, since late 2006, 117 hedge funds at 71 fund families have "imploded." The fund mangers don't include just miscreants like Bernie Madoff. Carlyle Capital, Bear Stearns, Dillon Read (run by UBS) and JPM Partners all made the list.

The news was not bad for everyone. The sponsors of these funds did just fine. For example, the UBS-run Dillon Read Capital Management hedge fund closed after losing $124 million in the first quarter of 2007. When UBS closed its hedge fund group, it incurred costs of $300 million.

Where did that money go?

According to the New York Times, "...$200 million went to severance payments and other costs for the hedge fund manager and his team."

Now I understand.

The investors get clobbered. The fund manager and his "team" get rewarded.

Here's the ultimate irony.

When wealthy investors seek legal redress against the firms that put them into these deals, they are confronted with the defense that they are "sophisticated investors" who should have known better. It usually works.

The rest of us can learn a valuable lesson from the foibles of the rich.

They are no match for the securities industry.

We aren't either.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

Diane Tucker: Who Duped Rolling Stone Gonzo Reporter Matt Taibbi?

2009-10-06T12:35:37Z

It's starting to look like basketball-player-turned-political-reporter-turned-overnight-authority-on-Wall-Street Matt Taibbi may have fallen for a stock-trading ruse. Heaven knows he's an easy mark. "I can't even balance my checkbook," he told radio talk show host Don Imus.

Taibbi, Rolling Stone magazine's teen heartthrob, became a sensation last month after calling Goldman Sachs "a giant vampire squid wrapped around the face of humanity." His piece contained as many errors as facts, but few of us minded because the imaginative writer memorably captured the national zeitgeist.

Taibbi knows you're only as popular as your latest record, so in this month's issue of Rolling Stone he takes on short selling, a controversial Wall Street stock trading practice. His report offers the usual cocktail of half-truths, which you can read about at Business Insider, Economic Policy Journal, Fraud Files Blog, The Atlantic, New York Times DealBook, and Investment News.

To tell you the truth, I haven't lost any sleep worrying about Taibbi's sloppy reporting or his obscene language. He's colorful, he's cute, he admits he'd rather be writing fiction ... oh, fiddle dee dee.

But I am intrigued by the video Taibbi posted on YouTube to make his point about short selling. People who know about these things say the video is a fake ... a hoax. Taibbi claimed the video showed a Penson Financial Services trading platform transaction, but today Penson dashed off a fast letter to the U.S. Securities and Exchange Commission, alerting them that the trading platform identified in each of Taibbi's posts is not Penson's. "While we are uncertain whether Taibbi's article is the result of a hoax or something more deliberate, we are contemplating sharing our concerns with YouTube and the blogger directly," wrote Penson's associate general counsel, in a two-page letter to the SEC that was made available to the Huffington Post.

If all these folks are right, it begs a few questions:

-- How did "short selling" happen to catch Taibbi's attention?
-- Who slipped Taibbi the fake video?
-- For what purpose?

Well, Matt? Who's screwin' with ya? We're waiting ...

* * *

For more details on this story I recommend business writers John Carney, Dan Jamieson, Megan McArdle, Gary Weiss, and Robert Wenzel. You can also read fraud examiner Tracy Coenen. If you think this is all a bunch of silly nonsense, you might enjoy satirist William K. Wolfrum's hilarious Taibbi video.

David Paul: Regulating Systemic Risk and Banker Compensation Will Not Fix What Is Broken on Wall Street

2009-10-03T12:18:15Z

Thirty years ago, Salomon Brothers and Goldman Sachs were two of the "bulge bracket" underwriting firms that dominated Wall Street. Both firms with partnerships with trading cultures that characterized their organizations. It was a time when Wall Street firms were looking far and wide for ways to increase their access to capital. Trading firms make money by making bets. More capital meant bigger bets. Bigger bets meant more money.

In 1980, in pursuit of a bigger balance sheet, Salomon CEO John Gutfreund negotiated the sale of his firm to Philipp Brothers, then the largest commodity trading firm in the world. The sale was not without controversy. Within Salomon, bond traders--led by Salomon family member William Salomon--opposed the sale. How, they asked, would traders be paid their due in the event the new firm lost money in other far-flung commodity businesses? As partners, they had a reason to be concerned by over-expansion into business lines that they neither understood nor controlled. They did not yet appreciate the benefits of trading with Other People's Money.

But the sale of Salomon went through--John Gutfreund pocketed his $30 million bonus--and over the next few years, the new firm, Phibro-Salomon was acquired by Travelers Insurance. Travelers, in turn, was acquired by Citibank, to create the financial supermarket that was supposed to give American banking a global dominance to match the well-capitalized Asian and European counterparts.

The Salomon story was part of the evolution of Wall Street over the past thirty years, as the storied Wall Street firms succumbed to the lure of capital to give up their partnership status and merge into commercial banks and to become publicly traded corporations. And while these firms did achieve their goals of increasing their access to capital--and ultimately won back their access to the massive pools of depositor money insured by the FDIC--the cost to the rest of us has been significant.

Where, after all, was William Salomon when Lehman Brothers decided to bet the ranch on collateralized mortgage securities that would ultimately bankrupt the firm. Where was William Salomon when Bear Stearns increased its leverage to thirty times, based on financial models that few in the firm really understood. And where was William Salomon when Joseph Cassano, the head of AIG Financial Products took the insurance giant headlong into the credit default swap business.

There was a moment when Cassano made his case to the AIG Board of Directors. The credit default swap contracts that AIGFP was providing to financial giants such as Goldman Sachs had no risk to AIGFP, argued Cassano, and therefore all of the annual receipts paid to AIGFP under those credit default swap contracts could be taken as current income--and used to pay very large bonuses--rather than held as reserves against future risk. CDS contracts are essentially insurance contracts provided to guarantee against defaults on corporate bonds, but Cassano argued that the bonds were so strong that there was no credit risk, and therefore the money paid to AIGFP was essentially free money.

But there was no William Salomon on the AIG Board of Directors. Unlike the old Wall Street partnerships, directors of corporations are largely insulated from the financial consequences of their decisions. Had AIG been a partnership like the old Salomon Brothers, a William Salomon would likely have asked the logical question of Joseph Cassano:

Goldman Sachs is paying us tens of millions of dollars a year, but you are telling us there is zero risk. One of us is wrong. This is a game of poker, and there is an idiot at the table. And you are telling me that Goldman Sachs is the idiot? I don't think so. I think we are the idiots at this table. If Goldman Sachs is paying us tens of millions of dollars a year, we are taking risk, and we sure better know what that risk is, because we are betting our future on it.

But, of course, AIG was not a partnership, and the rest is history.

But the Phibro-Salomon story had one chapter left. This summer, Citibank--the failed financial supermarket that is now a ward of the State--sought approval from the US Treasury to pay bonuses in order to keep a group of highly profitable traders from leaving the bank. The bonuses--the most famous being the $100 million for Andrew Hall--were to be for traders in its Phibro commodity trading subsidiary.

William Salomon saw the writing on the wall. The partnership trading culture that was critical to Salomon Brothers success--a culture that combined incentives and accountability--would not survive an evolution into a corporate model. What we have learned is that the incentives to make big bets and take big risks has survived, but without the accountability. Andrew Hall made $2 billion for Citigroup placing energy bets, and was due to be paid $100 million. But what of those whose bets lost Citigroup $2 billion? They have not even lost their jobs.

The trading firms gained the access to the capital that they sought in the 1980s, and they found the joy of playing with Other People's Money. And for twenty years, the game has gone on.

Heads I win, tails you lose. Or in David Einhorn's more elegant formulation, Private Profits, Socialized Risk.

Today, the US Treasury and the Fed are trying to hold the pieces together. AIG. Citi. Bank of America. GMAC. Fannie Mae. CIT Financial. But why? Where is the evidence that large financial corporations are more efficient at allocating capital than smaller banks? Surely, they have not been sound custodians of depositor funds or of the public trust. Neither have they proven they can deliver more predictable returns on shareholder equity than smaller, more nimble financial institutions, who themselves are increasingly disadvantaged by each bailout. Whose interest has conglomeration served but that of insiders seeking greater compensation with less risk?

One central question to all of this is whether the fundamental corporate model is not central to the problem. Today, absent prosecution for fraud, the CEOs and directors of all of these failed firms will walk away with much of their wealth intact, insulated from the consequences of the decisions they made. For years now, they have been playing with our money.

New regulatory regimes will not be adequate to control this systemic risk. Controlling banker compensation might have a populist appeal, but no one should imagine it constitutes systemic reform. Regulatory bureaucracies cannot control systemic risk in massive financial corporations, because the systemic risk is the massive financial corporation.

Thirty years ago. William Salomon was suggesting a simple truth: Sound decision-making, incentives and accountability require that those who are making decisions and placing bets have their own capital at risk.