naked capitalism

Enjoy!

Below is a related discussion by Ann Rutledge of R&R Consulting, another structured credit expert:

Rampant fraud in the mortgage industry has increased so sharply that the FBI warned Friday of an "epidemic" of financial crimes which, if not curtailed, could become "the next S&L crisis."

Assistant FBI Director Chris Swecker said the booming mortgage market, fueled by low interest rates and soaring home values, has attracted unscrupulous professionals and criminal groups whose fraudulent activities could cause multibillion-dollar losses to financial institutions.

"It has the potential to be an epidemic," said Swecker, who heads the Criminal Division at FBI headquarters in Washington. "We think we can prevent a problem that could have as much impact as the S&L crisis," he said.

In the 1980s, many Savings and Loans failed because of poor management, risky loans and investments, and in some cases, fraud. Taxpayers were left with a $132 billion tab to cover federal guarantees to S&L customers.

This is the headline and first four paragraphs of a CNN article from 17 September 2004.

Where are the investigations, perp walks, convictions? So what happened to all that fraud?

It’s still ongoing.

• Short sale fraud
• Mortgage fraud indictments result from media investigation

Here’s the only investigation of a leading insider that I know about:

• SEC Press Release on Mozilo’s fraud and insider trading

But, that was June of 2009. Have you heard anything about this?  I haven’t.

See Bill Black’s take on the fraud and the systemic response to it.  You should note that, while the FBI was concentrated on criminal gangs outside of financial institutions, Black believes the problem is the collusion of the financial institutions themselves in the frauds. Obviously, in an environment that relies largely on self-reporting by regulated institutions, there is no incentive to report, if much of the criminal activity is within those institutions.

The next four segments of the interview are available with this one here.

Sources

FBI: Mortgage fraud becoming an ‘epidemic’, 17 Sep 2004 – USA Today

Mortgage Fraud Operation "Quick Flip", 14 Dec 2005 – FBI

An American Epidemic: Mortgage Fraud–A Serious Business (book from 2005) – Amazon

Mortgage Fraud Epidemic: How the FBI Blew It and Why There’s No ‘Perp Walks’, 06 Apr 2009 – Tech Ticker

Mortgage fraud – Wikipedia

Epidemic Levels Of Mortgage Fraud Leading To Development Of Local Bubbles, 11 Feb 2010 – NuWire

Magnets ‘can modify our morality’ BBC

Bobcat Walks Into Home In Port Ludlow, Washington Through Open Front Door Huffington Post

Australia reveals prototype ‘bionic’ eye Raw Story (hat tip reader John D).

Department of “Huh?”: Default Discounts in U.S. Treasury Interest Rates????????? Edition Brad DeLong

Sex infection gonorrhea risks becoming “superbug” Reuters

A Samsung Robot In Every Home By 2020? h+ (hat tip reader David C)

Meat vs. Miles Columbia Journalism Review

James Lovelock: Humans are too stupid to prevent climate change Guardian (hat tip reader John D)

The True Causes Underlying the Moscow Metro Bombings OilPrice (hat tip reader Crocodile Chuck)

Helpless Beijing Watches The Housing Bubble Spreads To Rural China Clusterstock

Rent party Corrente

Obama warns of Iran threat to world economy Financial Times. The headline appears to represent Obama’s remarks accurately. So we want to avoid war in the Middle East….not because a lot of locals and US troops would die, no, it’s because a Middle Eastern war would be bad for the economy. Help me.

Irish banks face shortfall of €32bn Financial Times. The bank black hole is 20% of GDP

Why Germany cannot be a model for the eurozone Martin Wolf, Financial Times. This is pretty grim, even by his often dour standards.

Bill Black: To Own a Country, Rob a Bank New Deal 2.0

Antidote du jour:

By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

Wide swaths of families, businesses, investors, taxpayers, and others have had not just their net worth but their lives damaged by the recent financial crisis and its aftermath. Many are looking for an explanation. Many are content to attribute blame and much anger has been directed at Wall Street firms, the credit rating agencies and increasingly the Fed. However, I find ironic that the Fed is escaping criticism for egregious policy errors, while being blamed for decisions and actions that were precipitated by the failure of other agencies to shoulder their responsibilities.
Errors for which the Fed should be held accountable, but for which it has largely escaped criticism, include the following:

• The Fed managed to completely miss the housing bubble. It continues to argue that it should not be held accountable for missing the housing bubble because no one saw the housing bubble, when in fact many knowledgeable and well-respected analysts and policy makers, inside as well as outside the Fed, called attention to the bubble.

• The Fed adopted a macro-economic framework for policy analysis that systematically underestimated (i.e., ignored) the importance of financial markets and institutions to policy and economic performance. Not surprisingly, it ignored its supervisory regulatory responsibilities.

• The Fed allowed increased concentration in the financial services sector, which implied the growth of TBTF institutions, concentrations of market power, and informational asymmetries that are inconsistent with fair and well-functioning markets.

• The Fed publicly and repeatedly claimed credit for the great moderation. The view that it could produce trend growth in low inflation and interest rate environments, coupled with the low-and-slow-to-tighten interest rate policy contributed to an atmosphere in which financial institutions and households believed that there was no risk in highly leveraged positions.

• The Fed temporarily masked the costs of the decline of the tradable goods sector (in part a reflection of a dysfunctional exchange system) while at the same time ignoring its responsibility as the bank of issue of the world’s reserve currency.

• The Fed failed to learn from the LTCM crisis. In fact, the current crises can be accurately viewed as the LTCM crisis repeated on a nationwide scale.

• The Fed dismissed critics who charged that excess liquidity was fueling asset price bubbles, arguing that the liquidity was 1) a vague concept, 2) impossible to define, and 3) impossible to measure. In short, the Fed argued that liquidity could not be used as a policy tool. However, once the crisis broke, the Fed immediately made what had previously been indefinable the focus of policy. Furthermore, it knew how to allocate the liquidity by type of counterparty and collateral. Unfortunately, the problem of excess liquidity had already morphed in to a solvency crisis.

• Most importantly, the Fed failed to achieve the target it set for monetary. Starting in the mid-1990s, the Fed assured the public that it would use monetary policy to prevent the US from experiencing the problems that had beset Japan. Unfortunately, the US is repeating the Japanese experience: a stock market bubble, a real estate bubble, the collapse of the financial system, a recession (by many measures the worst since the Great Depression), unemployment, a ballooning of the fiscal deficit, and inflation low enough that the Fed was forced to adopt unconventional policies that resulted in its balance sheet doubling. (Short version: the Fed learned nothing from the Japanese experience.)

• The Fed has also exhibited a profound political naiveté. It allowed itself to become a political punching bag. This will compromise its ability to set policy with an eye to longer-run developments just when the political demands on the Fed will rise as the scale of the debt and deficits crimp fiscal policy.

The Fed role in the AIG fiasco straddles the fence. The Fed made a one decision that was a major blunder, but many of the criticisms directed at the Fed also reflect the errors and failures of others.

Post-Bear and the GSES, the Treasury should have prepared contingency plans to be used in the event of crises at systemically important firms, e.g. AIG and Lehman. Instead it simply waited until there was “blood in the street”. The Treasury abdicated its responsibilities.

The Fed had absolutely no business substituting itself for the executive and legislative branches of government by “bailing out” AIG. Making a loan based on acquiring a 79.9% ownership interest in the borrower is not a loan—I don’t care what the Fed lawyers opined at the time any more than I care about what E&Y opines about Lehman’s 105 repos. The Fed assuming indirect operational control of any company, especially an insolvent one, was a bridge too far. Assuming a bailout was necessary, the de facto nationalization or resolution of AIG should have been accomplished de jure under terms and conditions approved by Congress and the President, as was the case with the GSEs and the auto makers.

Given the speed of developments, it may have been incumbent on the Fed:

1. to have temporarily financed Treasury’s acquisition of AIG while Treasury sought the enabling legislation; or

2. to have lent Treasury the funds to meet AIG liquidity needs contingent on Congressional approval and funding of a resolution vehicle; or

3. to have taken steps to relieve the pressure on AIG while Congress and the President established the legal framework to nationalize and or unwind AIG.

However, the Fed should never have agreed to take an ownership interest in (even if placed in a Trust) and exercised any degree of management control over AIG.

If the Fed had limited its role to the temporary financing of the AIG bailout (much as it provided financing until Congress created the GSEs conservatorships), then decisions made about AIG, including treatment of its various creditors and the payment of bonuses would have been in the hands of the Executive and Legislative branches of government where they belonged.

The Fed was and is not a bankruptcy court. Congress or an entity explicitly authorized and appropriately empowered by the Congress should have been designated to deal with AIG and the issues such as the payment of bonuses and payouts by the clearly insolvent AIGFP. The Fed had no business adjudicating claims or arbitrarily imposing haircuts on AIGFP’s creditors, counterparties, or other claimants. If senior status was to be granted to investors in AIGFP’s GIAs relative to CDS counterparties or other claimants, it is up to Congress to decide and the courts to enforce. Note that AIG is the only company that the Fed is “resolving”. The Fed wasn’t chosen as the conservator of the GSEs. The Fed wasn’t chosen as the vehicle to revive GM and Chrysler. The Fed doesn’t even unwind failed banks.

The Fed should never have put itself in a position where it could be called upon to use public money to make any of a bankrupt firm’s creditors whole without authorization and appropriation from the Congress.

The Fed made a series of errors, but they were precipitated by the failure the Treasury to act and presumably the inability of Congress to make a decision in a timely fashion. The Fed should have had the backbone to just say NO to the then-Secretary of the Treasury Paulson when it was asked to bail out and assume control of AIG. Treasury had stepped up and bailed out the GSEs (with temporary Fed-supplied financing). The Treasury also arranged guarantees for money market funds. Why was it the job of the Fed to bail out and unwind an insolvent insurance holding company and assorted subsidiaries?

If the Treasury and the Congress had been up to their responsibilities, the Fed would not have had to abandon its lending function whereby it makes overly collateralized recourse loans to solvent firms.

In short, the Fed should be criticized and admonished for foolishly exceeding its legal authority. The Fed made decisions and some of them have proved to be unpopular. However, two-plus years after Bear we still do not have a law providing a framework for resolving financially impaired systemically important firms. What kinds of decisions, if any, would the Congress have made in the middle of the AIG crisis? We know that Treasury was incapable of planning a response to a crisis and ducked responsibility for difficult and potentially politically costly decisions. The Fed should have stepped aside, but instead it stepped up and made some decisions which have proven to be unpopular. Would Paulson have made better decisions? Could Congress have made a decision?

The failure of Lehman is in the headlines once again. Not surprisingly, the Fed is in the cross hairs of numerous commentators. I am not surprised. The free ride given to the SEC does surprise me. The SEC failed in regard to Bear. It failed in regard to Merrill. It failed in regard to Madoff. It failed in regard to Lehman. The SEC was Lehman’s regulator. While on the SEC’s watch, Lehman became a large, complex, grossly overleveraged securities firm with a concentration of illiquid under-performing assets and dodgy bookkeeping.

Where is the outrage at the SEC? The only mention of the SEC in the summaries of the Dodd financial reform bill that I read was funding for the SEC independent of Congressional appropriation. It seems the only thing that the SEC succeeded at was lowering its performance bar to the point that a snake would trip over it. On the other hand, the Fed is portrayed by many critics as an omniscient, omnipotent, Machiavellian operative responsible for all that is less than optimal. (This is in stark contrast to some at the Fed who believe the Fed to financial market version of a comic book super hero: incapable of doing evil, i.e. Fed policy cannot possibly have unwanted unintended negative side effects and undesirable outcomes must be somebody else’s fault.)

Critics charge that the Fed should have made public the fact that Lehman was insolvent. Given that the Treasury had decided not to develop or propose a means to deal with failures of systemically important non-banks until after a crisis had occurred, any such announcement would have precipitated the crisis we all rue. Historically, the bank regulators have acted to minimize both potential market disruptions and the cost to the insurance fund/taxpayers. This was the modus operandi behind the JPMorgan/Bear and BOA/Merrill mergers. The fact that the Fed and the SEC said nothing while Lehman continued to shop itself should not be newsworthy.

Many charge that the Fed should have also independently taken steps to avoid the disorderly unwind of Lehman, but many of the same critics take issue with decisions and choices made at AIG even though Lehman would have been AIGFP in spades.
A frequently cited reason for Fed involvement in AIG is that Congress could not have put together a rescue plan in a timely fashion as it did for the GSEs; however that is really an additional reason for the Fed to have refrained from getting involved in AIG. The Fed is not empowered to substitute its judgment for that of the President and the Congress.

It is inconsistent and hypocritical to charge the Fed with being undemocratic while requiring it or expecting to take actions outside its legal mandate. If the Fed is to be a democratic institution, it must constrained by its legal mandate at all times. It cannot violate its mandate simply because it deems it expeditious; it cannot assume the role of a bankruptcy judge; it cannot usurp the role of the Congress by distributing public monies. On the other hand, if you want or approve of the Fed exceeding its mandate and taking extra-legal actions by performing functions mandated to other agencies, or the courts, or the taking it upon itself action to fill loopholes in legislation on-the-fly, then you must cede that the Fed will be anti-democratic.

Criticize the Fed for failing to deliver financial and economic stability. Criticize the Fed for failing to discharge its responsibilities as a regulator. Criticize the Fed for foolishly exceeding its mandate. Criticize the Fed for assuming responsibilities for which it was not designed and ill-prepared. Criticize the Fed for permitting itself to be turned into an off balance sheet Treasury Department SIV. Criticize the Fed for charging in to a political mine field. The Fed deserves it
Limit criticism of the Fed for not being what it was never designed to be: a means to unwind/resolve financially troubled, systemically important firms.
Don’t criticize the Fed for having exceeded it legal mandate in the case of AIG and then criticize it for not exceeding its legal mandate in the case of Lehman (or vice versa).

Criticize the Fed for its role in AIG, but keep it in perspective. Whatever the costs to society and the taxpayer of the mistakes the Fed may have made in the AIG fiasco, they are small change compared to the cost of the Fed’s inappropriate monetary policy, the Fed’s ignoring its regulatory responsibilities, etc. In addition, compare the cost to society of any Fed errors at AIG with the costs of Treasury and Congressional inaction and/or their hasty decisions if the Fed had not assumed control of AIG.

Criticize the Fed, but keep in mind the relative costs of all the mistakes and failures to act by all the participants.

By Marshall Auerback, a fund manager and investment strategist and Rob Parenteau, CFA, sole proprietor of MacroStrategy Edge, editor of The Richebacher Letter, and a research associate of The Levy Economics Institute

Who funds our budget deficit? It is a question taking on increasing significance, given the recent back up on longer-dated bond yields, which has been explained by many as a “buyers’ strike” in response to growing government profligacy. We think this argument displays a seriously lagging understanding of how much modern money has changed since Nixon changed finance forever by closing the gold window in 1973. Now that we’re off the gold standard, neither our international creditors, nor the so-called “bond market vigilantes”, “fund” anything, contrary to the completely false & misguided scare stories one reads almost daily in the press.

In his usually effective fashion, Bill Mitchell debunks the notion that “the markets” determine our interest rate structure, as opposed to the central banks. Mitchell discusses this in the context of his analysis of a BIS paper, “The Future of Public Debt: Prospects and Implications”, which raises the old canard about a potential “bond market buyers’ strike” as a consequence of rising public debt.” “[T]he debt ratio will explode in the absence of a sufficiently large primary surplus”, argues the author of the BIS paper.

From which – Mitchell deduces- “the governments [should] either stop allowing the bond markets to determine yields – that is, use their capacity to control the yield curve or, better still, abandon the practice of issuing debt.”

Mitchell then poses the question: “Why will yields spike dangerously so that real interest rates exceed real output growth rates? There is no answer to this question provided.”

There is no answer provided because, as a point of economic logic, Bill’s critique of the BIS is (as usual) unassailable. BUT as any regular observer of the markets can tell you, bonds have begun to rise again over the past few weeks, notably in the US. This might have occurred for the dumbest reasons imaginable (one person foolishly tried to link the rise in US yields to Portugal’s downgrade by the benighted ratings agencies).

On the other hand, one of the great insights of George Soros was the notion that markets could act on incorrect or imperfect information and thereby create a new kind of economic reality. It might well be that very few understand MMT or basic public reserve accounting, but that doesn’t alter the reality that bond yields have risen 20 basis points in the past week or so. And a central bank which is underpinned by a market fundamentalist ideology, coupled with a bunch of “big swinging dicks” in the trading pits is a potentially toxic combination. The Fed follows the price action at the long end of bond market. Long bond investors often try to force Fed’s hand. Around and around they go,dog chasing tail style.

There’s a power dynamic here – who’s really in control: Big Swinging Dick Finanzkapital (BSDF) or policy geeks who understand basic public reserve accounting?

The Fed clearly has a dilemma. It needs to finesse expectations management for BOTH Treasury bond and equity investors. Bond investors need to know they are not going to get screwed by inflation, so they want the fed funds rate renormalized. Equity investors want the “extended period” of ZIRP to last for, well, an extended period. Free money is good for specs.

So what’s a central banker like Bernanke to do?

How about a modern version of “Operation Twist”, which was implemented originally by the Fed in 1961 to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. It was only marginally successful back then.

So why should it work better today?

Well, the Fed has more tools in its policy box, thanks in part to its policy of paying interest on excess reserves (IOER). Scott Fullwiler has an excellent paper on this (“Paying Interest on Reserve Balances: It’s More Significant than You Think”), in which he demonstrates that this change in Fed policy has severed the relationship between the policy rate target and the level of reserves outstanding (if there ever was one – some indications in recent years were that all Fed had to do was announce new fed funds rate target, and primary dealers would take it there, knowing Fed had capacity to change reserves outstanding – all of which meant Fed did not have to change reserves, since they had a credible threat they could, making the textbook story about Fed ops even more outdated and incorrect).

So the Fed can tell everybody that they are renormalizing the fed funds rate and take the IOER up to 100bps. Note, the Fed does not need to remove any reserves to do this – they can just do it administratively. That’s how the IOER works – it severs the link between reserves in the system and the target policy rate, right?

Then, if the bond gods don’t rally Treasuries on the Fed’s efforts to renormalize the policy rate, Mr Bernanke calls up Bill Dudley (President at the NY Fed) and gives him instruction to buy all the 10 year UST on offer until the 10 year UST yield is down to, oh, say 3.5%. It is an open market operation, which the Fed performs all the time. They won’t have to call it QE, but it is in effect the same thing.

Then, every time some big swinging dick bond trader tries to push it above 3.5% by shorting Treasuries, the Fed slams their face into the concrete by having the open market desk buy the hell out of UST until the 10 year yield is back to 3.5%. Burn Fido enough times, yank his chain enough times, and like the Dog Whisperer, he gets it and stops.

No less than one of the leading “bond market vigilantes” has conceded this point. In his October 2003 Fed Focus, PIMCO’s Paul McCulley has acknowledged that “any market induced—foreign or domestic-driven—upward pressure on U. S. intermediate or long-term interest rates would/will be limited by the leash of the Fed’s . . . anchoring of the Fed funds rate . . . . Put differently, there is a limit to how steep the yield curve can get, if the Fed just says no—again and again!—to the tightening path implicit in a steep yield curve”.

What happens if the 10 year bond breaks out of the 3.5% to 4% range significantly even with no changes in expectations regarding the Fed? Could that happen, or is there some arbitrage mechanism that brings it back? Of course, there will always be smart bond traders (such as our friend, Warren Mosler), who will understand the potential arbitrage opportunity at hand and react accordingly, but a signal from the Fed that it desires a certain rate level or term structure for rates will facilitate the process.

Operation Twist, Part Deux, then? It strikes us as the optimal way to finesse the expectations management dilemma.

It seems to us that we are now approaching a very critical juncture in terms of potentially settling the debate between those who think that central banks establish the rate structure versus those who believe that this is done by the markets (such as the usual band of deficit hawks, and the writer of the BIS report critiqued by Bill Mitchell). Of course, like most MMT adherents, we feel that the whole debate would become less relevant if the US Treasury responded to today’s environment through sensible proactive fiscal expenditure, but it’s hard to sustain political support for that amidst sock puppet politicians who dole out goodies to their corporate contributors, and an Administration which genuinely believes we’re “running out of money”.

That places an unnecessarily large burden on the Fed, hardly an appealing prospect, given Mr Bernanke’s own neo-classical economics framework. Keynes himself was quite explicit about the importance of investor portfolio preferences in determining interest rates specifically. Indeed, Ch. 12 of “The General Theory” is all about the beauty contest aspect of asset price determination in the face of fundamental uncertainty and asset markets organized to optimize liquidity for existing holders. Does the Fed understand this? It may well not happen, but no question an aggressive move to counter short term portfolio preference shifts on the part of private investors could do much to resolve this “who determines rates” question once and for all.

There’s a power dimension here. Does the Fed really want to be led around by the nose by the very same people who created today’s economic disaster?

Hyena laughs and giggles decoded BBC

Beyond ACTA: Proposed EU – Canada Trade Agreement Intellectual Property Chapter Leaks Michael Geist. What does sovereignity mean when you are bullied like this?

RNC investigating money spent at L.A. bondage nightclub The Hill (hat tip Jim in MN). Now we know why Palin has been dressing like a domme….

Judge Invalidates Human Gene Patent New York Times. About time.

The Rio Tinto Case and China’s Rule of Law Wall Street Journal. Reader Crocodile Chuck said this piece did a good job of highlighting the underlying issues.

Greeks, Romans, and The Permanent Committee to Save the World Forever Bill Mike Konczal

Elizabeth Warren: Half of commercial RE mortgages to be underwater Bubble Meter

The Ballad of GM James Kwak

Study: Chapter 13 bankruptcy little help in saving homes PhysOrg

HAMP = Foreclosure Loan Fraud Investigations (h/t Mortgage Implode-o-Meter)

Declining Progressivity in US Taxes Linda Beale

Krugman as Failure Archein

By Marshall Auerback, a fund manager and investment strategist who writes for New Deal 2.0.

Arthur Conan Doyle’s literary creation, Sherlock Holmes, once solved a murder by noting the dog that didn’t bark. It doesn’t take Holmes’s ingenuity to see that the plan on offer for Greece is clearly a rescue package which doesn’t rescue. It’s a dog’s breakfast.

Greece indeed is being offered a financial aid package of around 22 billion euro, but no funding will be made available until the country fails to find funding elsewhere, entirely obviating the point of the bailout. Greece, like all borrowers, simply offers securities at ever higher rates until it finds the needed buyers. Failure, in theory, is defined as the rate reaching infinity with no buyers. At that time, the euro members would step in with a loan offer at a non concessional rate which would then presumably be infinity. As George Friedman of Stratfor has noted, “That is akin to offering a homeowner, who is about to default on a mortgage, a refinancing offer that equals or increases his mortgage rates above the rate he already cannot pay.”

This makes no sense at all, of course. In reality, it’s a statement that says Greece is on its own. It means that the EMU nations will stand by without taking action as observers of the standard market default process of Greek funding rates going into double and then triple digits as happens to all failed borrowers of externally managed currencies, including nations with fixed exchange rates.

So much for European solidarity. Even worse, German Chancellor, Angela Merkel has managed to secure the backing of France for her proposal for a joint International Monetary Fund and bilateral aid package from euro-zone countries should Greece need help, which is a shame, given that recent remarks by French Finance Minister Christine Lagarde suggested that Paris better understood the nature of the current crisis.

An interesting question which has hitherto been unanswered by the mainstream media: why did the Greek debt crisis erupt with such sudden ferocity in the past month or so? As many observers have noted, if these countries had their own national currencies, they could allow their currencies to float, which would potentially allow some stimulus via the external sector. More significantly, they are unable to use the expansionary fiscal policies that would help pull their economies out of recession. Of course, both France and Germany also violated these rules and were never punished for their transgressions. Indeed, the selective applications of the rule in EMU have made it more apparent that this is nothing more than a liquidationist gambit on the part of Berlin and now, it appears, Paris.

A liquidationist gambit is the removal, by power, of government from the society. Liquidation occurs when society has ceased to be a center of power, and has become a center of weakness. It therefore becomes far more prone to corporate predation. It does not mean that government becomes either smaller or less intrusive, but that government’s traditional role of mobilizing resources for broader public purpose is impaired. These are some of the instruments which are characteristic of liquidation gambits:

1. Looting
2. Corporatism and cartelization
3. Brow-beating (societal interest above self interest, power as power, cooptation and betrayal) particularly via manufactured bankrupcties
4. Shams and accounting frauds

The unseemly side of the Franco-German power play came to the fore last week: ECB President Jean-Claude Trichet ostensibly took some pressure off Greece by extending emergency lending rules, saying its bonds won’t be cut off from ECB refinancing operations next year in case Moody’s Investors Service lowers its rating to a level comparable with other companies. Of course, this occurred only after the Greeks cried “Uncle”.

Why were these lending rules threatened to be removed in the first place? This has never been adequately explored. Trichet’s statements marked a reversal for the ECB, which said in January that it wouldn’t soften its collateral policy for the sake of a single country. The bank was scheduled to reintroduce pre-crisis rules at the end of 2010.

This basically confirmed my earlier suspicions that this entire crisis was triggered by the ECB at the behest of the Germans. The ECB closed the lending window to Greece, which had been dealing with the inherent operational constraints of the EMU by buying Greek government debt, repo-ing it to ECB, and then taking the reserves from that and buying more government debt. The Germans surely took offense to that, since it is Weimar 2.0 from their paranoid perspective. Ireland has also been using this loophole. Of course, that Germany and France were serial violators of these EMU imposed constraints (when they routinely ran budget deficits in excess of 3% of GDP) never seemed exorcise the President of the ECB to the same degree.

Given the loss of Greece’s independent currency creating function, the repo mechanism was likely the only way to get “vertical money” into Greece, once ECB stopped expanding its balance sheet as the crisis died down. So various European central bankers started mentioning in front of microphones that ECB rule waiver would be up at year end, (the one that lets ECB hold and repo lower quality rated euro zone government debt) and, presto, a fully-fledged crisis emerges in Greece.

How convenient, especially as it finally gave Berlin the leverage to fully impose its version of hair shirt economics on those allegedly lazy southern Mediterranean scroungers. Left conveniently unstated is the idea that the longer the PIIGS are forced to wallow in stagnant growth, the more persistent will be the very budget deficits and the larger the public debt to GDP ratios for which they are now being punished. It’s akin to someone having a high temperature because he/she is suffering from influenza and therefore denying that person medicine on those grounds. Trying to work against the automatic stabilizers with austerity programs will be futile unless you start dismantling some of the automatic capacity, which gives rise to these stabilizers.
Which is exactly what is happening at present. As Bill Mitchell has noted:

European countries have stronger automatic stabilisers than most other nations because they have historically given better protection to their workers and retirees etc. The push for austerity is seeking to undermine these provisions in part and in my view that is one of the hidden agendas in all of this.

We would agree with Mitchell and go further by noting the hypocritical nature of the cuts demanded here. As is the case in the US, fiscal austerity seems only to apply when dealing with “wasteful” social spending, because at the same time France and Germany were imposing harsh austerity conditions on the Greeks in exchange for their “support”, Berlin and Paris are using the leverage created by the debt crisis to force Athens to buy their weaponry and warplanes even as they urge those “profligate” Greeks to cut public spending and curb its budget deficit. France is pushing to sell six frigates, 15 helicopters and up to 40 top-of-the-range Rafale fighter aircraft. Greek and French officials said President Nicolas Sarkozy was personally involved and had broached the matter when Papandreou visited France last month to seek support in the financial crisis, according to The Economic Times.

Talk about gunboat “diplomacy”! The Germans like to argue that nations such as Greece, Portugal, Spain, Ireland and Italy blew the opportunity that interest rates converging down gave them to get labor productivity up with new investment. In Berlin’s eyes, it is all their fault they can’t “achtung baby” and get their lazy work forces in line, with lower unit labor costs, like the Germans themselves managed after 7 years of deflating their own country into the ground following on from reunification (of course, this conveniently in the days before the creation of the Stability and Growth Pact).

Surely there was a better way? Rather than the austerity cold bath to break the back of labor and induce a private income deflation with a decidedly Fisherian debt deflation cast to it, would it not be better for current account countries to reinvest the surpluses in the deficit nations in the form of direct foreign investment, or PIIGS government bonds directed solely at public investment that will improve productivity in periphery and have ripple effects on private investment, or run it through the European Investment Bank?

Or the creation of a supranational authority, but not one which replicates the austerity ethos embodied in the Stability and Growth Pact — rather one which emphasizes the principle that the only fiscally sustainable policy is one that promotes full employment. As we’ve said before, this could be done via a Government Job Guarantee program. We would need a supranational authority which is geared toward a full employment goal. Such a program would potentially be even more attractive in Europe, given that minimum wages and income support packages are far more generous in than in the US, consequently leaving less scope to use the JG program as a means to replace a strong social welfare benefits model with some form of indentured slavery, which is something one could potentially envisage developing in the US.

Acknowledging that crony capitalist politicians do have this proclivity toward supporting corporate predation and wasteful spending and giving goodies to their campaign contributors, a genuine Job Guarantee Program that automatically adjusts to insure the private sector can actually realize its desired net nominal savings position largely frees the system from political parasites while increasing the freedom of the private sector to achieve its goals. And it is consistent with the idea of re-employng the country via, say, green tech initiatives.

If the Franco-German axis proves resistant to this idea, then it might be time for the Greeks, Portuguese, Italians, Spanish, Irish, etc., to send a different message to Chancellor Angela Merkel. To quote those noted political philosophers, Keith Richards and Mick Jagger, “Angie…ain’t it time to say goodbye?”

An exit from the euro zone would clearly create a short term problem because the PIIGS nations that wanted to exit would have to deal with a foreign currency debt burden. It is unclear how the transfers back into the central banking system from the ECB noted above would serve to offset the “euro exposure” upon exit. And there is also likely to be collateral damage within the remaining EMU nations’ banking systems, given the amount of PIIGS debt that they likely hold. But ultimately as part of a painful adjustment process it might require the nation to default which could manifest as a negotiated settlement where the creditors accepted the local currency (or nothing). It would be painful and messy. But a long, drawn-out process of wage cutting is the other way and that will have to be a decade-long adjustment. Far more costly, other words, in the long run. And, as Keynes, noted insightfully, in the long run, we’re all dead.

→ Washington’s Blog

On March 3rd, Richard Fisher – President of the Federal Reserve Bank of Dallas – told the Council on Foreign Relations:

A truly effective restructuring of our regulatory regime will have to neutralize what I consider to be the greatest threat to our financial system’s stability—the so-called too-big-to-fail, or TBTF, banks. In the past two decades, the biggest banks have grown significantly bigger. In 1990, the 10 largest U.S. banks had almost 25 percent of the industry’s assets. Their share grew to 44 percent in 2000 and almost 60 percent in 2009.

The existing rules and oversight are not up to the acute regulatory challenge imposed by the biggest banks. First, they are sprawling and complex—so vast that their own management teams may not fully understand their own risk exposures. If that is so, it would be futile to expect that their regulators and creditors could untangle all the threads, especially under rapidly changing market conditions. Second, big banks may believe they can act recklessly without fear of paying the ultimate penalty. They and many of their creditors assume the Fed and other government agencies will cushion the fall and assume the damages, even if their troubles stem from negligence or trickery. They have only to look to recent experience to confirm that assumption.

Some argue that bigness is not bad, per se. Many ask how the U.S. can keep its competitive edge on the global stage if we cede LFI territory to other nations—an argument I consider hollow given the experience of the Japanese and others who came to regret seeking the distinction of having the world’s biggest financial institutions. I know this much: Big banks interact with the economy and financial markets in a multitude of ways, creating connections that transcend the limits of industry and geography. Because of their deep and wide connections to other banks and financial institutions, a few really big banks can send tidal waves of troubles through the financial system if they falter, leading to a downward spiral of bad loans and contracting credit that destroys many jobs and many businesses.

The dangers posed by TBTF banks are too great. To be sure, having a clearly articulated “resolution regime” would represent steps forward, though I fear they might provide false comfort in that a special resolution treatment for large firms might be viewed favorably by creditors, continuing the government-sponsored advantage bestowed upon them. Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size—more manageable for both the executives of these institutions and their regulatory supervisors. I align myself closer to Paul Volcker in this argument and would say that if we have to do this unilaterally, we should. I know that will hardly endear me to an audience in New York, but that’s how I see it. Winston Churchill said that “in finance, everything that is agreeable is unsound and everything that is sound is disagreeable.” I think the disagreeable but sound thing to do regarding institutions that are TBTF is to dismantle them over time into institutions that can be prudently managed and regulated across borders. And this should be done before the next financial crisis, because it surely cannot be done in the middle of a crisis.

Fisher joints many other top economists and financial experts believe that the economy cannot recover unless the big, insolvent banks are broken up in an orderly fashion, including:

• Nobel prize-winning economist, Joseph Stiglitz

• Nobel prize-winning economist, Ed Prescott

• Former chairman of the Federal Reserve, Alan Greenspan

• Former chairman of the Federal Reserve, Paul Volcker

• Dean and professor of finance and economics at Columbia Business School, and chairman of the Council of Economic Advisers under President George W. Bush, R. Glenn Hubbard

• Simon Johnson (and see this)

• President of the Federal Reserve Bank of Kansas City, Thomas Hoenig (and see this)

• Deputy Treasury Secretary, Neal S. Wolin

• The President of the Independent Community Bankers of America, a Washington-based trade group with about 5,000 members, Camden R. Fine

• The Congressional panel overseeing the bailout (and see this)

• The head of the FDIC, Sheila Bair

• The head of the Bank of England, Mervyn King

• The leading monetary economist and co-author with Milton Friedman of the leading treatise on the Great Depression, Anna Schwartz

• Economics professor and senior regulator during the S & L crisis, William K. Black

• Economics professor, Nouriel Roubini

• Economist, Marc Faber

• Professor of entrepreneurship and finance at the Chicago Booth School of Business, Luigi Zingales

• Economics professor, Thomas F. Cooley

• Former investment banker, Philip Augar

• Chairman of the Commons Treasury, John McFall

Even the Bank of International Settlements – the “Central Banks’ Central Bank” – has slammed too big to fail. As summarized by the Financial Times:

The report was particularly scathing in its assessment of governments’ attempts to clean up their banks. “The reluctance of officials to quickly clean up the banks, many of which are now owned in large part by governments, may well delay recovery,” it said, adding that government interventions had ingrained the belief that some banks were too big or too interconnected to fail.

This was dangerous because it reinforced the risks of moral hazard which might lead to an even bigger financial crisis in future.

Senators Ted Kaufman, Maria Cantwell, John McCain and others are also demanding that the too big to fails be broken up.

But Senator Dodd is trying to push through a financial “reform” which bill won’t do anything to break up the too big to fails, or do much of anything at all.   It’s got a reassuring name and a nice, sugary taste … but there’s no real medicine in it.

For example, Dodd’s bill:

• Won’t break up or reduce the size of too big to fail banks

• Won’t remove the massive government guarantees to the giant banks

• And won’t even increase liquidity requirements to prevent future meltdowns

As Senator Ted Kaufman points out:

What walls will this bill erect? None.

***

Just this week, a Moody’s report stated: “…the proposed regulatory framework doesn’t appear to be significantly different from what exists today.”

***

In sum, little in these reforms is really new and nothing in these reforms will change the size of these mega-banks.

Our economy is really sick, and the cure is well-known.  But Dodd is offering nothing but a placebo.

The Financial Times reports that the SEC has launched a probe into whether other financial firms used repos to engage in what amounted to financial fraud (as in fraudulent financial reporting), although perilous few are using the “F” word.

From the Financial Times:

US regulators on Monday asked more than 20 financial groups whether they engaged in transactions along the lines of “Repo 105” – an accounting device that helped Lehman Brothers conceal its high leverage ratio during the financial crisis.

The corporate finance division of the Securities and Exchange Commission wrote to chief financial officers of “close to two dozen” large foreign and domestic banks and insurers, demanding details of repurchase agreement deals.

The SEC probe includes whether companies booked repos as asset sales for accounting purposes over the past three years, and whether these deals were concentrated with certain counterparties or certain countries. Regulators also asked companies to quantify the amount of repos that were disclosed as asset sales and to explain the “business reasons” for use of these structures.

Yves here. While this is a welcome move, the open question is whether the SEC has sufficient reach to be effective. Repo 105 provides a template for one sort of violation, but how many other balance-sheet flattering games, involving God-knows-what jurisdictions, might have taken place? The SEC regulates broker-dealers, so for commercial banks with broker-dealer operations, its authority extends only to the US broker dealer operations. Even for the former investment banks, the SEC’s authority over the holding companies was tenuous. Per an earlier post:

The SEC did not have statutory authority over Lehman’s holding company. Its authority was “voluntary”, a sort of regulatory default. The lack of statutory authority creates ambiguity as to its basis for action (for instance, it cannot use statutory violations as a basis for action, nor can it threaten to revoke a license, since it does not have licensing authority. The examiner’s report is definitive upon this point (p. 1484):

The Gramm‐Leach‐Bliley Act of 1999 had created a void in the regulation of systemically important large investment bank holding companies. Neither the SEC nor any other agency was given statutory authority to regulate such entities.

In keeping, to induce the US LIBHCs to participate in an toothless regulatory scheme, the SEC weakened net capital requirements, an action that many experts see as having played a direct role in the crisis (as it is allowed investment banks to attain higher levels of leverage). Moreover, note the implicit limits on the SEC’s authority. From Report 466-A, published September 25, 2008:

The CSE program is a voluntary program that was created in 2004 by the Commission pursuant to rule amendments under the Securities Exchange Act of 1934. This program allows the Commission to supervise these broker-dealer holding companies on a consolidated basis. In this capacity, Commission supervision extends beyond the registered broker-dealer to the unregulated affiliates of the broker-dealer to the holding company itself. The CSE program was designed to allow the·Commission to monitor for financial or operational weakness in a CSE holding company or its unregulated affiliates that might place United States regulated broker-dealers and other regulated entities at risk.

Yves here. Did you catch that? While the SEC can supervise the holding company and unregulated entities, its scope of action is limited to preserving the health of regulated entities only.

The CSE program focused on liquidity, NOT solvency.

Back to the current post. So for the former investment banks, the SEC presumably has some history in supervising their “unregulated entities” but it can’t really force them to comply. Now these firms don’t want to appear to be obstructionist, but I would not be surprised to see any queries answered as narrowly as possible.

And how far can the SEC get, say, with a US or foreign bank with US broker dealer operations? It can presumably demand that the US broker dealer explain any suspect looking end of reporting period transactions, but the SEC’s ability to demand documents from the entity on the other side of the trade (even if it is another affiliate) would seem to be limited.

That is a long-winded way of saying that it is not a good sign that the SEC appears to be conducting this investigation without the support of other regulators, both in the US and overseas. Perhaps some will throw their weight behind it, but the lack of coordinated action does not bode well for reform.

Two reasons that many people went along with the Obama administration’s health care reform proposal was that it was purported to extend coverage to the uninsured and would eliminate the ability of insurers to deny coverage (including rescind existing policies) for pre-existing conditions.

The latter claim was false (more on that shortly) and some gaps have already come to light. Consider this story from the New York Times, “Coverage Now for Sick Children? Check Fine Print.” Here was the sales talk:

Mr. Obama, speaking at a health care rally in northern Virginia on March 19, said, “Starting this year, insurance companies will be banned forever from denying coverage to children with pre-existing conditions.”

Here’s the reality:

William G. Schiffbauer, a lawyer whose clients include employers and insurance companies, said: “The fine print differs from the larger political message. If a company sells insurance, it will have to cover pre-existing conditions for children covered by the policy. But it does not have to sell to somebody with a pre-existing condition. And the insurer could increase premiums to cover the additional cost.” …

But, insurers say, until 2014, the law does not require them to write insurance at all for the child or the family. In the language of insurance, the law does not include a “guaranteed issue” requirement before then…

Starting in January 2014, health plans will be required to accept everyone who applies for coverage.

Yves here. So that means everything is hunky dory starting in 2014, right? Don’t assume that.

The way pre-existing conditions often come into play now is that a patient has an expensive ailment, and the insurer looks for a way to deny coverage. So they go through the patient’s medical history and find something, anything they failed to tell the insurer about, and use that as an excuse to deny coverage. And it doesn’t matter that the condition you failed to report was inconsequential, or that you failed to report it because your doctor diagnosed it late (for instance, you got Lyme disease before you got a policy, but no one diagnosed it until it was advanced Lyme disease, after you were covered).

Why can insurers use these weak excuses to cancel coverage? Because they have been able to argue successfully, that these omissions are “fraud and intentional mispresentation”.

Guess what? The draft bill preserved the “fraud and misrepresentation” out, and I have seen nothing to indicate that this language was revised. The executive director of a 150,000 member nursing organization, which opposed the bill, noted:

Insurers may continue to rescind policies for “fraud or intentional misrepresentation” – the main pretext insurance companies now use to cancel coverage.

So when will voters find out the full extent of the bait and switch? In 2014, when Obama hopes to have been voted in for his second term.

Update 3/30/10: Per reader Nimrod, it looks as if the hue and cry over the poor drafting of the language regarding child coverage has led to a climbdown by the industry. No openly crossing Obama during his momentary resurgence. But I am not holding my breath that other ambiguities in the bill will be so readily resolved in the public’s favor.