Market Based Solutions in a Messed Up Market

Senator Dean Heller (R-NV) and Representative Eric Cantor (R-VA) are fond of “market based solutions.”  Translation: A market based solution is simply the new GOP word for the discredited term PRIVATIZATION.  The market to which they refer is the financial market. When all features of American life are privatized, then the corporations offering the services (social security, Medicare, toll roads, prisons, police protection, etc.) will be successful, or not, according to the price of their shares in the Financial Markets.  It’s a lovely theory.  However, one of the problems with it is that The Financial Market is often irrational and sometimes incompetent.  Sometimes it’s hard to discern the difference.

Example:  JPMorganChase and the London Whale. After having been bailed out of the mess they made circa 2008, the bankers were ready to explain to the American public that they had learned their lessons about risky proprietary trading, and hence would be more responsible custodians of the nation’s financial wealth.  Surely, they said, we can now be trusted to regulate ourselves.  Not. So. Much. When CEO Jamie Dimon announced back in May 2012 that JPMorgan had lost $2 billion on a credit derivatives bet he was being rather optimistic — the losses are now estimated at some figure closer to the $6 billion to $9 billion range. [NYT Dealbook]

“More than profits are at stake. The growing fallout from the bank’s bad bet threatens to undercut the credibility of Mr. Dimon, who has been fighting major regulatory changes that could curtail the kind of risk-taking that led to the trading losses. The bank chief was considered a deft manager of risk after steering JPMorgan through the financial crisis in far better shape than its rivals.”  [NYT Dealbook]

In other words, the banking industry, as personified by Mr. Dimon, assured us that the provisions of the Dodd-Frank Act were unnecessary, and then proceeded to offer a classic living example of why they were.

Example: The Barclay Blunder.  Barclays Bank drew fire from members of the British Parliament and the FSA for manipulating the interest rates comprising the LIBOR.   The bank settled with officials, paying a $453 million fine.  The U.S. Department of Justice has offered that while the bank may not be the subject of criminal prosecution, such actions against individual bankers aren’t out of the question. [USAT]

The northern Atlantic Ocean isn’t going to protect us from the fall out from this blunder because also under investigation for the same financial ploys are Citigroup (USA), UBS (Switzerland), HSBC (UK), and the Royal Bank of Scotland.  [USAT]

Once again, we have the specter of a banker denigrating the necessity of banking regulation — “There was a period of remorse and apology for banks and I think that period needs to be over. We need our banks willing to take risks … so we can create jobs.” Bob Diamond Barclays CEO, 17 months ago. [Daily Mail] — and then providing a real world example of why more oversight is absolutely required.  One reaction:

“Just when you thought bankers could sink no lower in public regard, they’ve done it. News that Barclays has been found guilty of repeatedly falsifying the interbank rate – sometimes for the personal gain of traders, sometimes to make the bank itself seem more creditworthy than it really was – tops off another calamitous week in the seemingly never-ending litany of banking misdemeanours. ” [Telegraph]

The examples haven’t quite stopped coming.

Example:  The Interest Rate Swaps Sale.   Again, Barclays, HSBC, RBS, and Lloyds are facing official scrutiny for selling interest rate swaps to small business owners who were then “offered an umbrella and then when it stopped raining, the bank grabbed it back.” British authorities have been investigating these questionable deals for about two months:

“Poor sales tactics were uncovered including failing to provide sufficient information on the hefty exit costs involved, failure to gauge the customers’ understanding of risk and found rewards and incentives were a driver of these practices.” [Indpt]

Not to put too fine a point to it, but the polite paragraph above says that small business owners were sold financial products detrimental to their best interests because bankers wanted to earn better bonuses and compensation.   Worse still, business owners were threatened with a loss of credit if they didn’t participate in these swaps deals:

Aberconwy MP Guto Bebb claimed thousands of businesses lost large amounts of money after being mis-sold the complex products by their banks, and many were told that without signing up they risked being refused credit. He said many business people did not understand the deals but trusted their bank manager. In other cases, he said, businesses were offered only one product and the bank made no effort to provide a choice.

A survey by Bully Banks, which has been set up by alleged victims of swap mis-selling, found nearly three quarters of its members claim to have been forced to buy a swap by their lending bank as a condition of their loan.  [Indpt]

The British Bankers Association has issued the standard, “We Are Cooperating With The Investigation” press release.   Thus much for “creating jobs” and “benefiting small businesses,” amid the mess created by the “interest rate protection products” being hawked by the bankers.

It wouldn’t be amiss to ask if major banks in the United Kingdom and Germany are facing the wrath of small business owners and investors over the flogging of “interest rate protection products,” should American businesses and investors be looking to see if similar tactics were promoted by U.S. bankers?

Another reasonable question may have found an answer — Why do these scandals keep cropping up?

Why do we have such phenomena as the Flash Crash, May 6, 2010? Is all well now? Maybe not. [Forbes] Add to this the not soon to be forgotten failure of the Facebook IPO.   Sallie Krawcheck, former President of Merrill Lynch Wealth Management, may be on to something when she commented on the JPMorganChase mess:

“There’s no doubt,” said Krawcheck, “that these banks have taken more risk that we as a nation and we as an industry would like them to.” The amount of risk, she went on to say, is a problem because it seems no one can track it. “The size of the JP Morgan loss in some ways is no big deal, but the fact that they didn’t know about it…”  [BusInsider]

Let’s think about this statement for a minute.  For the sake of argument let’s assume that the Powers That Be at JPMorgan were unaware of some practices in the London offices.  That, in itself, is disturbing.  If we have “risk” in the financial structure no one can track, and management which doesn’t understand what is going on, then does that not describe a recipe for more problems?

This conclusion also raises the prospect that if the bankers (financialists) can’t chew what they’re already eating properly, then why should we give them more?

Deregulation Debacles: And, Heller Wants To Repeal Dodd Frank?

** Altogether too many Nevadans were happy to sign adjustable rate mortgages based on the COFI.    COFI is the Cost of Funds Index, i.e. a monthly weighted average interest paid on checking and savings accounts offered by financial institutions in California, Arizona, and Nevada.  [QNA]   It could have been worse, the loans could have been based on LIBOR,  the London Interbank Offered Rate.   Barclays Bank (as in Premier League) has now settled with U.S. and British financial authorities for $453 million. Why? “Barclays admitted to trying to make Libor look artificially low, to avoid signaling the bank’s distress to markets during the financial crisis. The bank also manipulated borrowing rates to benefit its trading positions.” [Reuters] (emphasis added)  Before anyone gets too comfortable about the shakeout from the financial meltdown of 2008, refer to Gradman’s Top Five RMBS Cases now winding their way through the courts.

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

** Meanwhile, the SEC has filed allegations that Philip Falcone, hedge fund manager of Harbinger Funds, manipulated the market, gave preferential treatment to Goldman-Sachs, and got a company loan to pay his taxes. [Bloomberg]

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

**  Then, we have MBIA v. Countrywide, Bank of America, in the NY Supreme Court.  “MBIA has been looking for just this type of smoking gun (documentation of knowledge, reliance on fraud)  since the beginning of their case, and it appears they believe they’ve found it, in the form of internal Countrywide documents relating to its fraud hotline and internal fraud investigations.  If Countrywide knew there was widespread fraud in its loan origination processes, and covered up that information, it could certainly form the foundation for a finding that it intentionally misled MBIA into providing insurance coverage.  And Countrywide has certainly acted like MBIA is knocking on the door of a treasure trove of damaging evidence, as it has fought like crazy to avoid producing these documents.”   [IGrad]

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

** The Securities and Exchange Commission opened a preliminary  investigation into the JPMorganChase “London Whale” debacle, “An important avenue for the S.E.C. investigation, the people said, is the firm’s accounting methods relating to the trades. Investigators could take a close look at a measure known as value-at-risk. The company disclosed earlier this year that it changed the way it calculates the metric, which may have masked some of the risk surrounding this trade.” [DealBook]

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

** The SEC is also looking into possible NASDAQ improprieties in the Facebook IPO.  [CNBC] “The S.E.C. is also examining whether some exchanges give undue priority to high-frequency trading firms and big institutional investors through its order types and data disclosure.” [DealBook]

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

** On June 7, 2012 the CFTC filed charges against a Florida “Wealth Management LLC; “ The U.S. Commodity Futures Trading Commission (CFTC) today announced that it filed a civil enforcement action against Jose S. Rubio (Rubio) and Rubio Wealth Management, LLC (RWM) of Surfside and Coral Gables, Fla., respectively. The CFTC complaint charges Rubio and RWM with defrauding investors in connection with operating a commodity pool to trade commodity futures and off-exchange foreign currency (forex) contracts. The CFTC complaint also charges Rubio with making false statements to pool participants, misappropriating pool funds, commingling investor funds with those of RWM, failing to register as a commodity pool operator, and failing to produce documents to the CFTC.”

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

On June 25, 2012 the SEC announced a settlement with Ayuda Equity Funding:   “According to the SEC’s complaint, Ayuda and AmeriFund reaped more than $3.2 million of illegal gains on loans to public company officers and directors who put up stock as collateral. Although some borrowers received written and oral assurances that the stock would not be sold as long as they did not default on their loan payments, Ayuda and AmeriFund sold the shares before or soon after making the loans, the SEC alleged.”

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

On June 26, 2012, the Securities and Exchange Commission filed a civil injunctive action in the United States District Court for the Southern District of New York charging Tai Nguyen, the owner of the California-based equity research firm Insight Research, with insider trading.  The charges stem from the SEC’s ongoing investigation of insider trading involving so-called “expert networks” that provide specialized information to investment firms.”

And, Senator Heller (R-NV) believes we should repeal the Dodd Frank Act which sought to reform financial sector regulation.  [GovTrack]

Enough Said?

Unsolicited Questions for the Press Corps

There was a post like this a while back, but after listening to the President’s remarks this morning and then sitting through some rather inane inquiries from the White House Press Gaggle — how about this:  We put a moratorium on questions that begin, “Mr. President… The _____ are saying that ____ and how would you respond?“

First, this makes the person asking the question sound lazy.  The easiest question in the world is something someone else writes for you.  A right wing bloviator of some infamy writes — “The president had control of both houses of Congress during his first two years, and the economy didn’t bounce back.” And, then the intrepid reporter asks, “How do you respond?”

Step two, now the reporter sounds uninformed.  The President’s party had control of the House, and titular control of the Senate.  A majority is sufficient to establish Committee appointments in the Senate, BUT it is insufficient to overcome 137 Republican filibusters.  [Senate]   The question also indicates that somehow we were supposed to rebound enthusiastically from the worse Crash since 1929, all while some $50 trillion of global wealth was erased by the Wall Street casino.  Not to mention the $7 trillion lost in U.S. equity wealth, and another $6 trillion lost in the housing debacle. [CBS]

Thus, in the interest of assisting a more energetic, more informed, Fourth Estate, here’s a humble offering of possible questions:

#1.  Background: In 2006 JPMorganChase hired a trading manager who rescinded the company’s guidance that traders exit any position in which there were $20 million in losses, and in February 2012 the firm adopted an index comprised of 125 credit default swaps on investment grade entities.   By April 5, 2012 the London Whale was involved in position so large that he was moving prices in the $10 trillion credit market.  As of May 18, 2012 JPMorgan’s losses were calculated at $3 billion and rising.

Question:  What actions have the SEC, CFTC and other regulators taken which might control the gambling in credit markets exemplified by JPMorgan? And, are U.S. capital requirements sufficient to protect American investors from fall out?

Question: What progress has been made by the CFTC and other regulators to assure the investing public that credit default swaps (and the indices based thereon) are transparent enough so that risk can be properly assessed and debacles like the one at JPMorgan avoided?

#2. Background:  From the Bureau of Economic Analysis, “the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 1.9 percent in the first quarter of 2012 (that is, from the fourth quarter to the first quarter), according to the “second” estimate released by the Bureau of Economic Analysis. In the fourth quarter of 2011, real GDP increased 3.0 percent. ” (May 31, 2012)

Question: If public sector hiring has decreased of late, and the Department of Labor is predicting, “Slower population growth and a decreasing overall labor force participation rate are expected to lead to slower civilian labor force growth from 2010 to 2020: 0.7 percent annually, compared with 0.8 percent for 2000-10, and 1.3 percent for 1990-2000. The projected 0.7 percent growth rate will lead to a civilian labor force increase of 10.5 million by 2020. (See table 1.)” Then, what role does public sector hiring play in the full recovery of our consumer based economy?

Question: If private sector worker compensation costs (wages and benefits) increased by 2.1% YOY, and public sector worker compensation costs increased 1.5% YOY,  [DoL] and if this trend continues will this constitute a drag on consumer spending?

#3. Background:  As of January 2007, the GAO reported that our national transportation infrastructure were at risk in terms of financing and capacity, and that funding sources were eroding  just as investment was needed to expand capacity.

Question:  What inroads into this imbalance might have been made by ARRA projects?  What employment advances might be made if funding was available for contracts to improve air traffic and transportation facilities? For highway improvements?

Question: In terms of our national parks, the GAO reported in 2006:  “Each of the 12 park units reported their daily operations allocations were not sufficient to address increases in operating costs, such as salaries and new Park Service requirements. In response, officials reported that they either eliminated or reduced services, or relied on other authorized sources to pay operating expenses that have historically been paid with allocations for daily operations.”   What should Congress and the Administration do to prevent this trend from continuing, and what might the economic benefits be in the private sector if sufficient funding were available for the operation of our national parks?

#4. Background: “During the 2011 legislative sessions, states across the country passed measures to make it harder for Americans – particularly African-Americans, the elderly, students and people with disabilities – to exercise their fundamental right to cast a ballot. Over thirty states considered laws that would require voters to present government-issued photo ID in order to vote. Studies suggest that up to 11 percent of American citizens lack such ID, and would be required to navigate the administrative burdens to obtain it or forego the right to vote entirely.” [ACLU]

Question:  What actions are currently being taken by the Department of Justice to confirm every eligible American citizen’s right to vote?

Thank you.  You’re welcome.

If You’re So Rich Why Aren’t You Smart?

The FDIC recently reported that bank profits were at the highest level since 2007 in its latest quarterly profile.  [BizJ] [FDIC link]

“FDIC-insured commercial banks and savings institutions reported $35.3 billion in net income for first quarter 2012. This represents a $6.6 billion (22.9 percent) improvement over first quarter 2011 results, and is the highest quarterly net income reported by the industry since second quarter 2007. The average return on assets (ROA) rose above the 1 percent threshold for only the second time since second quarter 2007 (third quarter 2011 ROA was 1.03 percent). Quarterly net income has now improved year over year for 11 consecutive quarters. More than two-thirds of all institutions (67.5 percent) reported year-over-year improvement in their quarterly earnings, and only 10.3 percent were unprofitable, the lowest level since second quarter 2007.” [FDIC]

The investment banking sector doesn’t seem to be doing too badly either, as the following two charts from the Wall Street Journal would indicate.

There’s even happy news in the mergers and acquisitions for middle-markets:

“The market for Mergers & Acquisitions (M&A) is clearly improving in valuations, financing availability, and deal volume and will continue to do so throughout 2012 according to a survey conducted by MBA students and Professor Kevin J. Mulvaney at Babson College in collaboration with members of The Association for Corporate Growth and Exit Planning Exchange.

Looming clouds on the horizon may include variations in the capital gains rate, estate changes, and uncertainty about economic growth and the effect of world events on the global economy. This is the 4th year of the Babson survey which has delivered “extremely accurate” projections in its previous years said Mulvaney.

Findings That Impact Business Owners
The environment for exit continues to improve. Valuations are rising and are projected to continue to rise. The market to sell a business or restructure capital is very good. Key is getting the company’s revenue growth and EBITDA (earnings before interest, taxes, depreciation, and amortization) to acceptable standards vs. the industry average and the expectations of the buyer.”  [PRNewswire]

Note that one of the things that troubles the people engaging in the M&A trade is how much they might have to pay in capital gains taxes — let’s be clear — you don’t worry about capital gains taxation levels unless you stand to earn beaucoup bucks in investment banking.

So, if the commercial banks are experiencing the best profits since things on Wall Street started to unravel in 2007, and the mergers and acquisitions are doing nicely thank you very much — then why have the Financialists been so far behind the curve?

We’re learning more about the debacle at JPMorganChase, enough to know that their $2 billion and climbing blunder stemmed from a failure to learn some of the lessons of 2007.  One lesson unlearned appears to be that price doesn’t always equate to value, and all the accounting treatments in the world won’t help you if one unit isn’t sharing accurate information with the others.  To wit:

The JPMorgan Chase & Co. (JPM) unit responsible for at least $2 billion in losses on credit derivatives was valuing some of its trades at prices that differed from those of its investment bank, according to people familiar with the matter. [Bloomberg]

Recall, if you will, it was not so long ago the CEO of JPMorganChase, Jamie Dimon, was moaning loudly about the capital requirements under new regulatory regimes.   In September 2011, Dimon “exploded” during an IMF conference about “growth killing capital requirements.”  [BusInsider] This wasn’t Dimon’s first confrontation.  He questioned Federal Reserve Chairman Bernanke about capital requirements in June 2011:

“The substantive issue that seems to be bothering Dimon is capital requirements, and particularly the news that the Fed is leaning toward making large banks, such as JPMorgan, hold a 3 percent capital “surcharge” (a complete misnomer; the requirement for more equity financing relative to debt would be a buffer against losses, and not a tax.)”  [Bloomberg]

Lo and behold — what would have prevented the Balaenoptera musculus* sized losses at JPMorganChase?   Reliance on larger capital reserves against risks.

“Those bets, which led to $2 billion of losses, wouldn’t have been necessary if JPMorgan did what banks once did: rely on bigger capital buffers rather than credit-default swaps to hedge against souring loans. One hundred years ago the equity of U.S. lenders was about 20 percent of total assets, compared with 9 percent now, according to data compiled by the Federal Reserve. For JPMorgan, it was 7 percent last quarter.”  [Bloomberg]

One finance professor summed up the problem: “Only equity capital is the true protection against losses, whether from loans or other risks,” said Admati, who has written about bank capital. “Dimon and other bank CEOs lobby against rules that would force them to reduce leverage. Then they try to hide risks through derivatives that offer more ways to borrow and speculate.” [Bloomberg] (emphasis added)

Quick translation: Dimon and other bankers are lobbying against rules that would require their banks to maintain more capital reserves, and rely less on borrowing.  Instead, they played in the Wall Street Casino hoping to cover potential losses in ways that would generate more revenue.  It didn’t work.   All it took was one London Whale to create a multiple billion dollar mess.

All the king’s Quants and all the king’s computer models couldn’t accurately value the risk JPMorgan was taking and without an accurate account of the risk, and without adequate capital reserves which would have obviated the need for the swaps dealing, the London Whale sank the bank to the tune of at least a tidy $2 billion.  There’s nothing like a little obscurity to enhance the chances of exotic deals blowing up.

“The source of JPMorgan’s problems is an obscure group of indexes that track the performance of corporate bonds. One of the indexes, the Markit CDX NA IG Series 9 maturing in 2017, is essentially a portfolio of credit default swaps – basically contracts that protect against default by a borrower.  This particular index is tied to the credit quality of 121 North American investment-grade bond issuers, including such names as Kraft Foods and Wal-Mart Stores .  JPMorgan used that index, and others, to bet that credit markets would strengthen. Because that position is widely known on Wall Street, many traders are betting the opposite way in the hope of profiting as the bank’s losses increase. The index has been moving against JPMorgan in recent days.”  [Guardian]

Surprise?  If memory serves it was trading in exotic swaps that got several large financial institutions on Wall St. in a bit of trouble in 2008?  And, why were they trading in exotic swaps until their wasn’t a single stand-alone investment bank left on Wall Street?  Because they chose to hedge possible losses with swaps rather than maintaining higher capital reserves.

The merger & acquisition crowd may moan to the moon that such things as increased capital requirements are “growth killing,” BUT what really kills growth are investment banking practices which reward engaging in swaps dealing rather than more conservative practices like keep the piggy bank sufficiently filled to hedge against potential sour deals.   Additionally, if we want another look at what’s really “growth killing” all we need is another Wall Street investment banking fiasco generated by banks that aren’t accurately calculating their risks and aren’t doing such a hot job of hedging them either.

In short, if they’re so rich — why aren’t they smart?

*Blue Whale