Rating For Fun And Profit

Via Ezra Klein, James Surowiecki has a story about the nation's credit ratings agencies - Moody's, S&P, Fitch - who gave toxic waste sterling ratings that encouraged investors to buy them, leading to a collapse of the financial system. You can add to this the fact that the ratings agencies are funded by the banks, who have a compelling interest in having their crap be given triple-A ratings. But Surowiecki argues that government needs to take some of the blame for this as well.

[O]ver the years the government has made the agencies an increasingly important part of the financial system. Rating agencies have been around for a century, and their ratings have been used by regulators since the thirties. But in the seventies the S.E.C. dubbed the three biggest agencies — S. & P., Moody’s, and Fitch — Nationally Recognized Statistical Rating Organizations, effectively making them official arbiters of financial soundness. The decision had a certain logic: it was supposed to make it easier for investors to know that the money in their pension or money-market funds was going into safe and secure investments. But the new regulations also turned the agencies from opinion-givers into indispensable gatekeepers. If you want to sell a corporate bond, or package a bunch of mortgages together into a security, you pretty much need a rating from one of the agencies. And though the agencies are private companies, their opinions can effectively have the force of law. The ratings often dictate what institutions like banks, insurance companies, and money-market funds can and can’t do: money-market funds can’t have more than five per cent of their assets in low-rated commercial paper, there are limits on the percentage of non-investment-grade assets that banks can own, and so on.

The conventional explanation of what’s wrong with the rating agencies focusses on the fact that most of them are paid by the very people whose financial products they rate. That problem needs to be fixed, and last week the S.E.C. proposed new rules to address conflicts of interest. But there’s a much bigger problem, which is that, even though nearly everyone knows that the agencies are compromised and exert too much influence, the system makes it impossible not to rely on them.

Predictably, despite the ratings agencies' central role in the financial crash, nothing has changed with them, because the government has stamped them with authority and investors need their numbers to carry out deals, pretty much by law.

If government created this monster, they need to play a role in reversing it. In New York, inspectors with the state Insurance Department are considering dropping Moody's from its list of approved ratings agencies. The National Association of Insurance Commissioners (who collectively oversee an industry with $3 trillion in rated bonds) has proposed the same for the entire Big Three. And Jerry Brown has issued a subpoena to the Big Three agencies to investigate the ratings they gave to subprime mortgages. But ultimately, while this may keep the ratings agencies in line, you need to eliminate the official imprimatur from government and force the ratings agencies to compete on their own credibility. Further, the regulatory requirements actually force investors to sell downgraded securities quickly, leading to panic selling based on ratings that don't have a lot of backing behind them. That needs to be tweaked as well.

Surowiecki explains why this won't happen:

Oddly, the ratings system, broken as it is, remains attractive to many investors who have been burned by it. For one thing, it provides an easily comprehensible standard: without it, we’d need to come up with new ways of measuring risk. More insidiously, the ratings system provides a ready-made excuse for failure: as long as you’re buying AAA-rated assets, you can say you’re being responsible. After the housing crash, though, we know how illusory those AAA ratings can be. It’s time for investors to face reality: working with a fake safety net is more dangerous than working without any net at all.

I think, given the safety net under the bottoms of the major banks, that they'll take that fake one from the ratings agencies and live with it, thank you.

Health Insurance Companies Sucking Up Corporate Welfare

It's not a bad idea to look to how Wall Street reacts to the health care debate to determine winners and losers. After all, when you see insurance industry stock prices skyrocketing, you can safely say that investors believe whatever "reform" happens this year, if any, will not create a hardship for insurers, and more likely a windfall. Most of the major insurance companies are up 6-12% in the last month, far above the rise in the overall market. All of that is true.

However, we should note that these constant rises in the stock prices are most certainly not based on current fundamentals. Indeed, most insurance companies are losing market share.

But it turns out the current arrangement, through which employers are supposed to buy coverage from large insurance firms and enlist their employees to cover the costs, isn't working so well for the insurance industry, either. In fact, the system by which insurance coverage is tied to payroll jobs is a huge problem—especially in a period when Americans are less likely to have payroll jobs than they have been in the recent past and when employers are less likely to cover the costs of that insurance. A look at the earnings reports and stock prices of big insurance companies reveals that tying insurance to employment probably isn't a good idea, after all—unless the employer happens to be the government.

Since December 2007, the U.S. economy has lost 6.5 million payroll jobs, or about 4.7 percent of the total. The economy is likely to lose at least 1 million more by the end of this year. When people lose jobs, they frequently lose their insurance. (COBRA allows former employees to continue purchasing insurance for a period of time, but the costs are frequently prohibitive.) So large insurers have been losing millions of members. A chart in a recent Wall Street Journal article shows that seven large insurers have collectively lost 4.34 million members in their "commercial risk" plans since December 2007. ("Commercial risk" or "risk-based membership" generally refers to people whom insurance companies insure directly.)

Insurance company stocks have actually lagged behind the S&P 500 dating back from the beginning of the recession in December 2007. So why are they shooting up now, considering that job loss is continuing, which will erode their client base further? The answer is that insurance companies are actually being propped up by government money.

In fact, there's pretty good evidence that government spending is all that stands between the struggling insurers and complete disaster. Look through the insurers' earnings reports, and you'll see that a portion of the loss in commercial business has been offset by growth in Medicare and Medicaid programs. At UnitedHealth in the past year, for example, enrollment in its public programs rose from 6.185 million to 7.115 million.

The system of employer-provided health care coverage is crumbling before our eyes, and for more Americans—and for more American insurance companies—government-funded health care is all that separates them from financial disaster.

If investors are making a bet, they're assuming that government will continue to subsidize private industry, moving toward a model of quasi-nationalized health care, where private companies manage public programs, or get government to funnel direct payments through their customers to keep them covered. This is why two elements of reform are crucial - ending useless programs like Medicare Advantage, where private companies run public programs like Medicare for more money with no consequent increase in service; and instituting a public option, so that the government is not forced to bail out the insurance industry. With such shaky fundamentals based on the erosion of the employer market, insurers will be forced to change their practices or literally go out of business. But that's only if they aren't treated like corporate welfare cases, and injected with the cash they need to survive. Cash which often goes directly into the pockets of super-rich CEOs.

That's essentially the nature of the fight over the public option - should our tax dollars go to rescuing insurance companies which have added no value to the health care system, or should they go to treatment and care?

World's Stupidest CEO

They just built a giant Whole Foods right near me, on the border between Santa Monica and Venice, and it has been packed to the gills every night since. I would imagine that the clientele you would get from this area - liberal, generally well-off people who privilege healthy food - mirrors the locations of Whole Foods stores throughout the country. Therefore, CEO John Mackey attacking the notion of health care as a right is about as stupid a move as anyone who caters to progressives can make. It's like the head of Wal-Mart announcing that their stores will now be sanctuary cities for illegal immigrants. Mackey can say whatever he wants, but you would think the board of directors would react to such corporate malpractice.

Unsurprisingly, progressives initiated a boycott. The Facebook group has 15,000 members. The Washington Post and CNN have followed up with stories. And it's hitting the bottom line.

CNN is consistently neck and neck with MSNBC for largest online news audience. Not surprisingly, when the CNN story hit the web at 5 p.m., WFMI fell 0.59 during after hours trading, a more than 2% drop. It will be interesting to see what happens tomorrow. The stock is unlikely to go up if people read this trading advice column titled "Why Investors Should Cross Whole Foods Off Their Shopping Lists." Even Jim Cramer has noticed the boycott and is advising against the stock (for now) with an article called "Taking a Bite Out of Whole Foods."

If there's one thing Wall Street doesn't like it's controversy and uncertainty. Those two things pretty well describe Whole Foods in the current climate and I won't be surprised to see the stock sink lower in the days ahead. John Mackey, as noted previously, had the foresight to sell more than 1.39 million dollars worth of Whole Foods stock just days before he would have submitted his anti-Obama health care piece to the Wall Street Journal. The interesting thing about that sale is both the timing and that it dwarfed his previous sales of stock going back 2 years....the largest of which was less than $300,000. Happy coincidence?

Those who live in an area with a Whole Foods are pretty much the only people who have a range of options for healthy food close to them. The poor have to deal with the McDonald's around the corner in their food deserts. Whole Foods customers can go to Trader Joe's, or a farmer's market, or join a food cooperative or a CSA. These are people who associate pretty strongly with a brand, who integrate it into their lives. And they can just as easily integrate Whole Foods out.

This was about as obvious an outcome as you could imagine. If a CEO cannot get fired for this, they cannot get fired.

One Ha'penny, Please

Since the New York Times' story dropped last week about high-frequency trading, lots of people have been trying to wrap their heads around it. To me it just sounds like straight-up theft. Information is currency in the market, and Goldman Sachs and the other high-frequency traders are simply buying information low and cashing in high. It's a money machine, as K-Drum notes.

Fortunately, there's a simple and elegant fix that would allow Goldman or whoever to keep with their HFT while improving the federal budget situation and maybe, just maybe, voluntarily curbing the practice. Just tax individual financial transactions.

Dean Baker is probably the most aggressive advocate of this approach. But Larry Summers has promoted it in the past. And Britain actually has a version of it on the books. At base, it's simply a microtax on financial transactions. Say, one-half of one percent on stock transactions. The average investor would hardly notice it. Most investors would hardly notice it. But high-volume traders would notice it quite a bit. Baker estimates that the tax could raise more than $100 billion annually, even taking into account the resulting drop-off in high-volume trading. That's money the federal treasury desperately needs.

And it's money that's coming from something that the financial sector does not particularly need. I've not heard many analysts say that the problem with the financial market is that it's just too slow. Rather the opposite, in fact. If high-frequency trading is really worth something to these firms, they can pay the transactions tax, and the rest of us can have the guarantee that this financial innovation is actually helping the country. If it's not even worth a half of one percent, it's probably not something the market -- or the rest of us -- need all that much.

'Xactly. Free market in action and all that. We can try to site mainframe computers and come up with all sorts of regulatory hoops that HFTs can jump through (and over), or we can take half a penny on every trade. If the stock market is oh-so-valuable and important to our economic future, then they can gladly afford half a penny.

I even like this better than restricting CEO compensation, because the latter smacks of intervention in the marketplace and can also be easily subverted, while a simple tax on transactions, which are widely available as data, just cannot. To put this in context, a half-penny on every trade would, over the course of ten years, pay for the entire health care bill. If giant investment firms are going to gamble with our money, they can at least ensure that some of it returns to the taxpayer.

More Evidence Of Goldman Sachs' Blood Funnel

I saw Bill Maher offer Matt Taibbi some pushback last night about his Rolling Stone piece on Goldman Sachs. Maher wasn't willing to believe that Goldman has been uniquely positioned to profit from the breakdown of the financial system and the various bubbles created. Maher offered the predictable "why just Goldman" response, and Taibbi decided to talk about the many Goldman officials in high positions in the government. He could have just pointed to this story that leaped from Zero Hedge to the New York Times yesterday.

It is the hot new thing on Wall Street, a way for a handful of traders to master the stock market, peek at investors’ orders and, critics say, even subtly manipulate share prices.

It is called high-frequency trading — and it is suddenly one of the most talked-about and mysterious forces in the markets [...]

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

And when a former Goldman Sachs programmer was accused this month of stealing secret computer codes — software that a federal prosecutor said could “manipulate markets in unfair ways” — it only added to the mystery. Goldman acknowledges that it profits from high-frequency trading, but disputes that it has an unfair advantage.

Yet high-frequency specialists clearly have an edge over typical traders, let alone ordinary investors. The Securities and Exchange Commission says it is examining certain aspects of the strategy.

“This is where all the money is getting made,” said William H. Donaldson, former chairman and chief executive of the New York Stock Exchange and today an adviser to a big hedge fund. “If an individual investor doesn’t have the means to keep up, they’re at a huge disadvantage.”

They literally place their super-fast computers physically close to the machines that govern NYSE trades, to get the jump on competitors and make enough pennies off of the brief ups and downs of stocks to rake in mounds of cash. And in some cases, investors can buy access to buy and sell order information on certain exchanges that can be used to make these quick orders. When Chuck Schumer is calling for an investigation of Wall Street, you know something has gone horribly wrong.

No, Goldman Sachs is not the only organization profiting from this scheme, or any of the numerous others. But their name keeps surfacing among those that are, in pretty much every case. I don't know how much evidence it takes to understand their role in all of this. Taibbi may not have gotten every single solitary thing right in his very long piece, but he got enough right to make some very powerful people nervous. And rightly so.

We need to go further in determining what caused this financial crisis and what pitfalls remain. The new iteration of the Pecora Commission, a Depression-era panel that uncovered the origins of that crisis, can lead the way.

We, the undersigned, call on you to fulfill the responsibilities of your position by joining together in non-partisan cooperation to investigate the origins of the financial crisis in ways that lead to a full understanding of the institutions, people and practices that are responsible for our economic collapse.

In particular, we encourage the adoption of three guidelines that history has taught us are essential to an effective inquiry:

Appoint a single investigator. This individual must have a proven record of exposing fraudulent elites and institutions, and must provide a professional, non-political spirit to the investigation.

Afford no special treatment. No one is off-limits or gets special protection in the investigation.

Provide the tools to do the job. The investigator must be given ample budget and time, full subpoena authority, and the ability to hire and fire staff.

These principles were applied in the 1930s when Congress launched a formal inquiry into the causes of the Great Depression. That commission - led by Ferdinand Pecora - was willing to reach into the highest levels of Wall Street and finance to determine the causes of the economic collapse of 1929. The courage with which the commission greeted its task - and the revelations that courage ensured - inspired the sweeping banking and financial reforms that were the bedrock of our financial system for decades.

Building a new financial foundation requires us to begin on solid ground - the truth. It is only by illuminating the mistakes of the past that we will be able to meet the great challenges of the future.

And they can start by photocopying Matt Taibbi's notes.

Banksters Getting Money From Everyone

Cue the world's tiniest violin for the poor souls who just can't cut it for under $1 million a year on Wall Street.

There is an air of exodus on Wall Street — and not just among those being fired. As Washington cracks down on compensation and tightens regulation of banks, a brain drain is occurring at some of the biggest ones. They are some of the same banks blamed for setting off the worst downturn since the Depression.

Top bankers have been leaving Goldman Sachs, Morgan Stanley, Citigroup and others in rising numbers to join banks that do not face tighter regulation, including foreign banks, or start-up companies eager to build themselves into tomorrow’s financial powerhouses. Others are leaving because of culture clashes at merging companies, like Bank of America and Merrill Lynch, and still others are simply retiring early.

Yes, I'm awfully choked up about the assholes driven out of the big Wall Street firms.

To the Times' credit, they go on to explain how this is a good thing, because it shrinks the size of the bigger banks and spreads the risk-taking. To their detriment, they fail to explain that the most likely reason for executives darting from the biggest banks is that they are insolvent. Sure, they're playing accounting games to keep up appearances, at the same time trying to raise billions in private money from investors. Simon Johnson explains all this.

How can the large banks persuade potential shareholders to put large amounts of new capital with them, given that their systems just failed massively, these systems have not been substantially changed, and - while there has been a bailout for insiders and creditors - shareholders were largely wiped out from mid 2007-end 2008?

It could, of course, be the case that shareholders see great upside. Anything that has fallen greatly may see some rebound. The large banks have demonstrated their political muscle, so that should help with other forms of government protection and “rents” (economics jargon for easy money from business that others aren’t allowed into). In the early stages of a recovery, perhaps the banks will be more generous to their shareholders; it could be that the excessive tunneling is a feature of a mad boom, and we seem some distance from having another of those.

But probably we are looking at a deeper market failure. Big money managers - including mutual funds, pension funds and insurance companies -have arguably failed in their fiduciary duty to ensure that major financial companies are run properly and in the interest of shareholders. These money managers have great resources, many years of experience, and real power vis-a-vis the companies. Why didn’t they push for stronger risk management? Why are they so eager to hand over our money again? Where exactly was or is their due diligence?

We're coming to a reckoning between the banksters and the regulators trying to rein them in. Shareholders really ought to know the risks at this point, and I weep little for them if they want to finance Goldman Sachs. What we cannot allow are the same people sucking the Treasury dry to then fleece their customers.

The committee overseeing federal banking-bailout programs is investigating the lending practices of institutions that received public funds, following a rash of complaints about increases in interest rates and fees.

Since the Troubled Asset Relief Program was launched last October, banks bolstered by capital infusions have boosted charges on a wide range of routine transactions, hiked rates on credit cards and continued making loans criticized as predatory by consumer advocates. The TARP funds are intended to open lending spigots and make it easier for people to borrow money.

Let me try to put this all together. The banks took billions from the government. They're offering stock sales to get billions from investors to pay some of the TARP money back (but they're balking at the interest rates the government is demanding). And they're bilking their customers for even more money.

No wonder they show good earnings.

No, The Economic Crisis Is Not Over

I guess all it took was one decent earnings forecast, and the collapse of the global financial system has been called off. Nothing to see here, everyone go home.

But, the great banking crisis of 2008 is over. It began last September 15 when Lehman Brothers filed for bankruptcy and bottomed when Citigroup (C) traded below $1 last month. Most analysts believe that mortgage-backed securities which included packages of subprime home loans failed when mortgage default rates went up and housing prices raced down. That is only partially true. Banks made a tremendous series of ill-advised loans to private equity firms, hedge funds, commercial real estate holders, and the average man with a credit card balance which he cannot pay.

When people look back on the near-collapse of the banking system they may say that the Congress and Henry Paulson threw enough money into the path of the oncoming failure of the credit system to slow it down so that the government could properly go through the process of guaranteeing parts of the balance sheets of firms including Citigroup (C) and Bank of America (BAC). The initial TARP may also have provided time for the new Administration to put together its widely hailed bank "stress test" program meant to determine which of the big financial institutions have dysentery and which do not. Finally, the hundreds of billions of dollars that went into the largest banks late last year allowed Secretary Geithner to produce his public/private partnership to buy toxic assets off of bank balance sheets.

The writer of this piece's tongue is halfway in cheek, and at the end he acknowledges the major changes bringing us to this so-called "resolution." But the cheery tone can be seen in other big panorama articles today, suggesting that the traditional media has as much of an attention-deficit disorder as a daytrader, and all the depth of an evening with the cast of Hee Haw. The wild swings in mood mirror the volatility in the markets, which actually doesn't portend well. Some context can be provided by Dean Baker:

In the case of bank profits, much of the profit was driven by a surge in mortgage refinancing which produces large fees for banks. This surge will continue for the near term, but before long most of the people who are able to refinance their mortgages will have done so. Banks have also opted not to declare large write-downs of bad loans in the current quarter. They have apparently decided, possibly for political reasons, to defer write-downs of bad debts for future quarters.

It is important to put reports on chain store retail sales in some context. First, the same store sales are higher relative to overall chain sales because the chains have opened fewer new stores over the last year and in some cases actually have fewer stores in March of 2009 than in March of 2008. More importantly, there will be some upward bias in the chain store sales overall since there are fewer alternatives stores in 2009 than in March 2008.

Many stores that might have provided competition for the chains in March of 2008 no longer exist in March of 2009. Therefore, we should expect to see an increase in chain store sales even if there had been no change whatsoever in overall retail sales.

The President was more circumspect today, announcing that he sees "glimmers of hope" but that "the economy is still under severe stress" and talk of the crisis lifting is easily mocked given the spectre of double-digit unemployment before the year is out. I'm sure that people who don't fear job loss can have no problem announcing an end to the crisis, but others are not so lucky.

I think Simon Johnson made an excellent point discussing this at the New York Times' website:

Some stock market rallies are reassuring. Others provide at least temporary respite. And a third kind, more commonly seen in emerging markets, actually expose deeper underlying problems and contribute to a further downturn.

We seem to be experiencing this third kind of rally in the U.S. right now. Equity prices are up sharply, but the debt market continues to indicate a high probability of default. In particular, the level and recent trajectory of credit default swap spreads suggest that, as the financial system as a whole stabilizes, market participants expect increasing odds of failure (and failed bailout attempts) for the very largest banks.

The fact that the Federal Reserve won't let the banks release the stress test results just doesn't augur well. And even if we escape without more bank failures and a period of stagnation until the economy kicks back in, the biggest potential problem would be to see the establishment wipe their brow, thank their lucky stars for the bailouts and go back to the same exact practices that got us into this mess. I don't think the White House will lack assertiveness and take their eye off of the problem, but I do think they will decline to fundamentally restructure the economy in such a way that the finance sector shrinks to a level that cannot harm the greater economy in a systemic way. Paul Krugman gets to the heart of this need for restructuring today, the idea that banking must become boring.

Much of the seeming success of the financial industry has now been revealed as an illusion. (Citigroup stock has lost more than 90 percent of its value since Mr. Weill congratulated himself.) Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry.

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

Krugman charts how we followed the exact same course in the period from 1920-1970; the bankers got rich, speculated madly, caused the Depression, and the tight regulations on the industry that followed reduced both the excitement of banking and the lucrative nature of it. "Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans," he concludes.

We're in that Second Gilded Age right now, and the return of banking to the staid reallocation of capital that is its core function must follow the hash that's been made of the economy. The banks had too much money to play with and ended up nearly gambling away the whole system. They bought the political process and it came relatively cheap compared to the largesse it allowed them to reap. The incentives created were perverse. The risks taken were unconscionable. And they cannot be repeated.

But by calling an early end to the crisis and not wrestling with the fundamental shift that is needed, we only set ourselves up for future failure. And the Bush-era retreads manning the TARP desk are not likely to recognize this or work toward such a solution. In fact, nobody in the political class is, unless we make them.

Tomorrow, A New Way Forward demonstrations will be held in over 70 cities across the country. I'm not sure a set of protests is necessarily the right thing to do to mass political pressure, but I do know that this is a genuine grassroots effort - unlike the Fox News-promoted, lobbyist-driven tea parties - and the message of structural change, not an exhale and relief that the crisis has lifted, is the exact message that our representatives need to hear right now.

Our plan: Real structural change of Wall Street

Any bank that's "too big to fail" means that it's too big for a free market to function. The financial corporations that caused this mess must be broken up and sold back to the private market with strong, new regulatory and antitrust rules in place -- new banks, managed by new people. An independent regulatory body must protect consumers from predatory practices.

As Wall St. corporations grew bigger and bigger until they were “too big to fail,” they also became so politically powerful that they led to distorted and unfair policies that served companies, not citizens.

Its not enough to try to patch up the current system. We demand serious reform that fixes the root problems in our political and economic system: excessive influence of banks, dangerous compensation systems, and massive consolidation. And we demand that the reform happen in an open and transparent manner.

I've been banging this drum quite a bit, but I urge you to join these protests or at least get connected with what this group is trying to do. I really hope for it to be a beginning point and not an end point. Because until the financial sector has been fully decentralized, re-regulated and restructured, we're just going to go through this again and again.

Problem Solved, The Banksters Get To Lie Again!

Today, the Financial Accounting Standards Board approved a change to mark-to-market accounting that will allow banks to pretend they're still solvent, which apparently will end the crisis in their minds.

A once-obscure accounting rule that infuriated banks, who blamed it for worsening the financial crisis, was changed Thursday to give banks more discretion in reporting the value of mortgage securities.

The change seems likely to allow banks to report higher profits by assuming that the securities are worth more than anyone is now willing to pay for them. But critics objected that the change could further damage the credibility of financial institutions by enabling them to avoid recognizing losses from bad loans they have made.

Critics also said that since the rules were changed under heavy political pressure, the move compromised the independence of the organization that did it, the Financial Accounting Standards Board.

During the financial crisis, the market prices of many securities, particularly those backed by subprime home mortgages, have plunged to fractions of their original prices. That has forced banks to report hundreds of billions of dollars in losses over the last year, because some of those securities must be reported at market value each three months, with the bank showing a profit or loss based on the change.

Bankers bitterly complained that the current market prices were the result of distressed sales and that they should be allowed to ignore those prices and value the securities instead at their value in a normal market. At first FASB, pronounced FAS-bee, resisted making changes, but that changed within a few days of a Congressional hearing at which legislators from both parties demanded the board act.

Shorter banking industry: We should be able to price worthless crap at whatever dollar amount we want! We want a goddamn pony!

What will happen is that the banks will put this into their accounting statements and puff up their earnings reports for the first quarter, then making jazz hands at the market and singing "Let's put on another show, kids!" It won't work this time, as James Kwak explains.

Investors and regulators are not idiots. They know what the accounting rules are. If banks claim they were forced to mark their assets down to “fire-sale” prices, investors can look at the facts themselves and apply any upward corrections they want. Now that banks will be able to mark their assets up to prices based solely on their own models, investors will make the downward corrections they want. It’s a little like what happened when companies were forced to account for stock option compensation as expenses; nothing happened to stock prices, because anyone who wanted to could already read the footnotes and do the calculations himself.

However, the situation is not symmetrical, and the change is bad for two reasons. First, fair market value (”mark to market”) has the benefit of being a clear rule that everyone has to conform to. So from the investor’s perspective, you have one fact to go on. The new rule makes asset prices dependent on banks’ internal judgment, and each bank may apply different criteria. So from the investor’s perspective, now you have zero facts to go on. It’s as if auto companies were allowed to replace EPA fuel efficiency estimates with their own estimates using their own tests. We all know the EPA estimates are not realistic, but we can find out exactly how they were obtained and make whatever adjustments we want. If each auto company can use its own criteria, then we have no information at all.

Second, this takes away the bank’s incentive to disclose information. Under the old rule, if a bank had to show market prices but thought they were unfairly low, it would have to show some evidence in order to convince investors of its position. Under the new rule, a bank can simply report the results of its internal models and has no incentive to provide any more information.

So what we get is less information and more uncertainty. That was all reason number one.

Read the whole thing. Didn't bad accounting standards get us INTO this mess, in some ways (I'm referring to Enron and the various scandals of 2001-2002)?

The banksters want to live in an alternate reality, and will be tempted to raise less capital because of the magic numbers on their books, leaving them even more vulnerable than before. You know it's a problem when the SEC Commissioners under Bill Clinton AND George Bush denounce it.

The vote drew condemnation from an organization called the Investors Working Group, and the two former S.E.C. chairman who lead it — William H. Donaldson, appointed by the second President Bush, and Arthur Levitt Jr., who served in the Clinton administration.

“In order to create high-quality accounting standards, it is critical that the process be independent and free from political pressure,” the group said in a statement. “This will ensure that such standards are neutral and faithfully represent economic reality. To the extent that these new FASB proposals reduce the free flow of transparent and reliable financial information, they undermine investor interests and weaken their ability to make sound investment decisions.”

This is absurd. And Kevin G. Hall notes that this is EXACTLY what happened during the S&L crisis.

"Why should all assets be treated as if they're really for sale?" asked Bert Ely, a banking expert who gained wide recognition during the savings and loan crisis of the late 1980s.

During the S&L crisis, government regulators initially eased federal accounting rules for troubled S&Ls, which hid their negative worth and allowed them to make even worse decisions that led to their collapse and an expensive federal rescue.

Could it happen again?

"That concern does come up with this situation," Ely said. "At what point in time do we move from improved accounting to manipulation?"

Pension Guarantee Money Set Ablaze On Wall Street

From the Boston Globe, a terrifying report about how the Pension Benefit Guaranty Corporation, the agency that insures retirement funds, decided to play in the stock market at precisely the wrong time:

WASHINGTON - Just months before the start of last year's stock market collapse, the federal agency that insures the retirement funds of 44 million Americans departed from its conservative investment strategy and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such as stocks in emerging foreign markets, real estate, and private equity funds.

The agency refused to say how much of the new investment strategy has been implemented or how the fund has fared during the downturn. The agency would only say that its fund was down 6.5 percent - and all of its stock-related investments were down 23 percent - as of last Sept. 30, the end of its fiscal year. But that was before most of the recent stock market decline and just before the investment switch was scheduled to begin in earnest.

The PBGC is a backstop against major losses by private pension funds and the parent companies slipping into bankruptcy. Especially at this time, with the economy struggling, the PBGC could be called on more than ever to help protect pensioners. Just as an example, a structured bankruptcy by GM or Chrysler would mean that huge liabilities would be passed on to this agency. Which apparently gambled and lost tons of money. That's exactly the opposite investment strategy that should be taken by what amounts to an insurer.

David Kurtz is blunt and right on the money.

A finance professor who had previously advised the agency not to make the switch away from bonds compared the move to an insurance company writing policies to cover hurricane damage and then investing the premiums in beachfront property.

Bush was able to do for the PBGC what he tried and failed to do for Social Security.

Josh Marshall concurs. These were Bush Administration officials who, in the wake of losing their battle to privatize Social Security, had this big pot of money - close to $64 billion - that they sunk into stocks, providing more money to Wall Street for them to keep pushing asset values higher. The timing of it happening just at the time before the market began to crash suggests that the Administration viewed this as perhaps a last-ditch effort to prop up Wall Street. The director of the PBGC, who advised and directed this strategy, is Charles E.F. Millard, a former managing director at LEHMAN BROTHERS, just to give you some more assurance. In the article he practically admits that he was just taking a whirl at the casino with public money:

He said the previous strategy of relying mostly on bonds would never garner enough money to eliminate the agency's deficit. "The prior policy virtually guaranteed that some day a multibillion-dollar bailout would be required from Congress," Millard said.

He said he believed the new policy - which includes such potentially higher-growth investments as foreign stocks and private real estate - would lessen, but not eliminate, the possibility that a bailout is needed.

Asked whether the strategy was a mistake, given the subsequent declines in stocks and real estate, Millard said, "Ask me in 20 years. The question is whether policymakers will have the fortitude to stick with it."

I don't think policymakers will be sticking with it, because there's probably almost no money left in that portfolio. Money that was designed to insure pensions.

This is a crime.

The Stock Market Is Not The Economy

Well, Tim Geithner released his plan to buy up Big Shitpile today (a better article explaining the details is here), and the market responded with a 300-point rally, because I imagine investors quite like getting free tapayer money with no downside risk. Predictably, Drudgico connects the wrong dots.

It was bound to happen sooner or later.

Treasury Secretary Timothy Geithner – who hasn’t had many winning days in his short tenure on Pennsylvania Avenue – scored a big political victory Monday, as Wall Street traders breathed new life into his career with a stock market rally of more than 300 points.

I mean, good grief. This notion that the stock market is any kind of predictor of economic policy should have been tossed out long ago. It doesn't take a genius to realize the existence of a very visible hand at work - the biggest money in the market wants a bailout, and a bailout they're getting, essentially.

In addition, there's a media movement to ghetto-ize the critiques of the plan by the likes of Paul Krugman, painting him as a reflexively shrill hater who sees red at anything Obama proposes. There is of course no effort to actually engage with the material of his critique. I know these media stars aren't economists, but this actually isn't all that hard to understand. Heck, even Eric Cantor can come up with a Cliffs Notes version of Krugman's basic argument, which is below.

The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn’t be in trouble.

And so the plan is to use taxpayer funds to drive the prices of bad assets up to “fair” levels. Mr. Paulson proposed having the government buy the assets directly. Mr. Geithner instead proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the stuff. The idea, says Mr. Obama’s top economic adviser, is to use “the expertise of the market” to set the value of toxic assets.

But the Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. So this isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.

What's more, plenty of smart people actually have engaged Krugman and other liberal economists on their critiques. Christina Romer of the Council of Economic Advisors says that the Administration merely seeks to use the market to effectively price the bad assets (I'm sorry, legacy loans) and the taxpayer is protected by sharing in the rewards. I don't agree, mainly because all the subsidies artificially inflate the price in the market, but those two could easily have it out. So could Krugman and Brad DeLong, who is mildly bullish on the plan.

Q: Why isn't this just a massive giveaway to yet another set of financiers?

A: The private managers put in $30 billion and the government puts in $970 billion. If we were investing in a normal hedge fund, we would have to pay the managers 2% of the capital and 20% of the profits every year. In this case, the private managers' returns can be thought of as (a) a share of the portfolio's total return proportional to their 3% contribution, plus (b) a "management incentive fee" of (i) 0% of the capital value and (ii) between 0% (if the portfolio returns 3% per year) and 9% (if the portfolio returns 10% per year)--much less than hedge-fund managers typically charge [...]

Q: So the Treasury is doing this to make money?

A: No: making money is a sidelight. The Treasury is doing this to reduce unemployment.

Q: How does having the U.S. government invest $1 trillion in the world's largest hedge fund operations reduce unemployment?

A: At the moment, those businesses that ought to be expanding and hiring cannot profitably expand and hire because the terms on which they can finance expansion are so lousy. The terms on which they can finance expansion are so lazy because existing financial asset prices are so low. Existing financial asset prices are so low because risk and information discounts have soared. Risk and information discounts have collapsed because the supply of assets is high and the tolerance of financial intermediaries for holding assets that are risky or that might have information-revelation problems are low.

Krugman responded to DeLong, and DeLong responded back. And though all that I did discern a case that COULD plausibly be made for this plan. Even if the assets are artificially priced, at least they'll be priced at all. And then the banks will truly have to put up or shut up, either selling the assets or holding out because the spread between their imagined value and what investors are willing to pay will reveal them to be insolvent. I agree with DeLong that Swedish-style nationalization would certainly be an option should this fail, and while I prefer going ahead with taking over the insolvent banks now, that's not free, and so we cannot with certainty say what option represents the biggest tax giveaway. And the downside of screwing up receivership hasn't been priced at all (though the FDIC's facility with the practice shows that to be a somewhat low risk).

I remain dubious, but the blogospheric debate enhanced my knowledge of the issue. A task that modern media never rises to perform.

...Atrios sez everyone's overthinking it:

The Geithner plan will:

1) Funnel more government money to the banksters.
2) Allow the banksters to pretend for a bit longer that their hunks of big shitpile aren't quite as shitty as we thought by using the bullshit price that this process comes up with, allowing too big to fail businesses to stay in business for a bit longer.

This might make sense if you truly believe the magic market you believe in fervently is genuinely incorrectly pricing the assets, perhaps because you genuinely believe that if you could turn around the economy fast enough that you could massively reduce expected foreclosures.

But if you genuinely believe that, I don't think you've been paying too much attention to just what's been going on in the housing market. I don't think you paid too much attention 3 years ago when you didn't realize that it didn't quite make sense that so many people could afford $700,000+ homes in Orange County. I don't think you paid too much attention to the degree of speculation and outright fraud that was happening in parts of the country.

Of course, the Administration has several programs to mitigate foreclosures, which would mean people still making mortgage payments, which would mean that these securities aren't worthless, because every payment adds to their value. But nothing thus far has succeeded on that front.

Tiny Bubbles

The very good Joe Nocera has an interesting piece in the New York Times, which may read as a little cruel to some. His basic premise is that Bernard Madoff had accomplices in his crime, and they were also his victims.

At a panel a month ago, put together by Portfolio magazine, Mr. Wiesel expressed, better than I’ve ever heard it, why people gave Mr. Madoff their money. “I remember that it was a myth that he created around him,” Mr. Wiesel said, “that everything was so special, so unique, that it had to be secret. It was like a mystical mythology that nobody could understand.” Mr. Wiesel added: “He gave the impression that maybe 100 people belonged to the club. Now we know thousands of them were cheated by him.”

And yet, just about anybody who actually took the time to kick the tires of Mr. Madoff’s operation tended to run in the other direction. James R. Hedges IV, who runs an advisory firm called LJH Global Investments, says that in 1997 he spent two hours asking Mr. Madoff basic questions about his operation. “The explanation of his strategy, the consistency of his returns, the way he withheld information — it was a very clear set of warning signs,” said Mr. Hedges. When you look at the list of Madoff victims, it contains a lot of high-profile names — but almost no serious institutional investors or endowments. They insist on knowing the kind of information Mr. Madoff refused to supply.

I suppose you could argue that most of Mr. Madoff’s direct investors lacked the ability or the financial sophistication of someone like Mr. Hedges. But it shouldn’t have mattered. Isn’t the first lesson of personal finance that you should never put all your money with one person or one fund? Even if you think your money manager is “God”? Diversification has many virtues; one of them is that you won’t lose everything if one of your money managers turns out to be a crook.

There's no question that the SEC failed in a core function to protect the investor from fraud. But did anybody really want them to step in? The market was overheated for so long that investors felt entitled to unrealistic returns. Those who trusted in Madoff didn't want to know how the decisions were made or where the money was coming from. They were investing in another part of the shadow banking system, one that turned out to be as fraudulent as the supposedly regulated system of credit default swaps and collateralized debt obligations.

What Madoff did was a crime and the fact that he pulled it off for close to twenty years is an act of regulatory malpractice, but in the end, nobody - not least of which the investors themselves - wanted to pop the bubble anywhere on Wall Street. If it wasn't ever-larger stock prices for the Pets.com sock puppet it was more mortgages to slice and dice into securities and sell everywhere. They made a fortune off of a phantom, and they certainly didn't want anyone telling them it wasn't real.

In another interesting perspective, Chadwick Matlin calls Bernie Madoff a hero, because he focused anger on an individual on Wall Street, as well as exposing the SEC and the whole regulatory apparatus. I don't know if I totally agree with that, but what Madoff has done is uncover the danger of bubbles, and of endless belief in the power of small men who are mythologized into Masters of the Universe. It has made plain that when wealth is rewarded instead of work, when the economy tips out of balance and moving money becomes a growth industry, when free market fundamentalism reigns, greed takes over, and the endless desire for growth makes fools of us all. What Madoff has accomplished is to give recognition that we need what is being called at the highest levels a post-bubble economy.

The last point that I'd make -- and I made this point to the Business Roundtable yesterday -- it is very important, even as we're focused on the financial system and the credit markets, that we are laying the foundation for what I'm calling a post-bubble economic growth market. The days when we are going to be able to grow this economy just on an overheated housing market or people spending -- maxing out on their credit cards, those days are over. What we need to do is go back to fundamentals, and that means driving our health care costs down. It means improving our education system so our children are prepared and we're innovative in science and technology. And it means that we're making this transition to the clean energy economy. Those are the priorities reflected in our budget, and that is part and parcel with the short-term steps that we're taking to make sure that the economy gets back on its feet.

In politics you sometimes need villains, and so calling out Bernie Madoff or the bankster CEOs is fine. It's what they represent - an unsustainable bubble economy, based on cheap credit and over-leveraging and the illusion of wealth and prosperity - that is the real culprit, that took in all of us in one way or another. There's no floor under our feet in such an economy, and so we have to rebuild that floor out of something heavier than air. It's not going to happen quickly. But it has to happen now, with the necessary investments to get it going. This is why fixing what's broken is not enough, and reinflating bubbles will only lead to them bursting larger.

Let Me Get This Straight

A report released today says the unemployment rate will stay above 9% all year and probably wouldn't rebound until 2011. The five largest banks are on the hook for at least $587 billion in derivatives, just at the moment, with no sign of recouping any of that if the economic climate worsens. There hasn't been a positive economic number in weeks, if not months.

And yet Vikram Pandit can write an internal memo saying his own business is doing fine, the way CEOs have done approximately forever (name the last time you heard a CEO ever say "We're in the toilet. I suck"), and that's all it takes to send the stock market up?

These are the days where I question everyone on Wall Street's sanity.

Media-Financial Complex

CNBC decided to respond to the righteous Jon Stewart rant against them on a Friday so he couldn't talk about it on that night's show. Their claim is that Stewart is "bizarrely obsessed" with their network, and Stewart was repeatedly calling Rick Santelli to come on the show. That's, um, called BOOKING A GUEST. Maybe CNBC doesn't do much of that, they just have a "CEO room" in Manhattan and just put the camera on whoever shows up there. It's not like they ask much of a variance of questions: "How great is your company doing? Is it awesome to be rich?"

Meanwhile, the network and other right-wing market populists continue to push the idea that Obama is responsible for the Dow's fall since Inauguration Day. I guess the business climate and the job loss has nothing to do with it.

The argument that Obama is somehow responsible for the collapse of Wall Street is absurd. First, every major policy that led to this collapse occurred under George W.'s watch (or, more accurately, his failure to watch). The housing and financial bubbles were created under Bush and exploded under Bush. The stock market began to collapse under Bush.

Second, it's inevitable that stocks, led by the bloated financial sector, would lose their remaining hot air as the new administration begins "stress-testing" the big banks, many of which are technically insolvent. After all, their share prices were built on a tissue of lies and dreams. Other sectors whose values were similarly distorted and distended by years of financial deception and regulatory disregard, such as housing and insurance, will also have to return to the real world before they can recover. Which could mean more stock losses.

Finally, none of the financial wizards who are now charging Obama with leading America into the abyss have offered an alternative plan for getting us out of the mess that, not incidentally, many of these same wizards happily led us into. For years, the Wall Street Journal editorial page and the financial gurus of cable news cheered as Wall Street leveraged its way into oblivion.

Obviously, Wall Street rage is aimed at getting the biggest banks paid off and the shareholders made whole so that only taxpayers will bear the burden of the collapse. There may be a very good reason, however, for outlets like CNBC, in particular Jim Cramer, to claim that Obama is responsible for the fall of the market. It deflects the blame from themselves. The story of Deep Capture is epic and needs to be read in full by the investigators who followed it for years to really understand. But TocqueDeville at Daily Kos does a pretty decent summarizing job.

This rabbit hole involves the thugs surrounding Jim Cramer and some of the top financial "journalists" from the New York Times, WSJ, Fortune magazine and BusinessWeek, top hedge funds, the Mafia, and the DTCC. It also includes "blackmail, smear campaigns, espionage, fraud, harassment, extortion, bribery, rumor-mongering, sabotage, off-shore money laundering, political cronyism, frivolous lawsuits, witness tampering, biased financial research, false identities, bogus credit ratings, bribery, libelous blogs, bad science, forgery, wiretapping, counterfeiting, collusion, lying, cheating, threats and theft."

And if that wasn't fun enough, it may be the underlying story of what collapsed the entire, global banking system or at least served as the catalyst for the collapse.

We're talking about financial journalists using the power of their megaphone to trash a stock, or even tout it at the last minute, and then, through naked short-selling, earn millions while destroying public companies. And Jim Cramer is perhaps the greatest offender.

I have analyzed well over a thousand stories written by this clique of journalists. The vast majority of them were sourced from a small group of short-sellers who are also friends of Cramer. Other popular sources for this group of journalists include convicted felons, mobsters, dubious private investigators, crooked lawyers, hired stock bashers, and gun-toting goons - most of whom are tied to the Cramer constellation of short-sellers.

Some of the stories written by these reporters are accurate enough. But many are not. The journalists misconstrue data with seemingly purposeful intent. They exaggerate and obfuscate. They publish innuendo or merely repeat, Deus Optimus Maximus, the words of their hedge fund and criminal friends. A single negative story by one of these reporter-thugs can send a company’s stock tumbling by more than 50% — pure profit for their hedge fund sources, who of course sell the company short (often right before the articles are published). Meanwhile, an overwhelming majority of the companies targeted by these journalists will also be the victims of phantom stock selling and other shenanigans. The journalists do not mention this in their stories, and in fact go out of their way to deny that phantom stock exists.

Anyone who says otherwise is subjected to a vicious media smear.

It doesn't take much these days to persuade you that anyone on Wall Street is a crook. But Mark Mitchell had the goods. Cramer understood the value of information, like any inside trader. Then he got the power, through his own TV show, to control that information. And the method that Cramer and his cronies apparently preferred, naked short-selling, has been brought up as a possible culprit in the fall of Bear Stearns. Sen. Jon Tester even brought it up in a hearing with then-SEC chair Christopher Cox in April 2008.

This financial meltdown isn't entirely due to the people who made money on the way down. But the corroded relationship between the Masters of the Universe and the subjects who cover them - the Media-Financial Complex - is absolutely a part of this tale. And the phantom stock - invented wealth that can appear and disappear - is just another of the exotic financial instruments created by people who push paper and add zeroes to their balance sheets and call it work, paper and securities that are then leveraged and bet upon and sliced and diced until nobody understands them and just doesn't want to get left holding them when the organ stops playing and the big dance ends.

Read the story of Deep Capture. It's a through-the-looking-glass experience. Anyway, I can think of a guest for Stewart's next show...

The Man Who Still Rules Their World

This is really a jump the shark moment for Matt Drudge, who is only relevant to the Gang of 500, anyway.

The markets opened this morning with a sustained decline, which Reuters attributed to a new “report showing yet more deterioration in the housing market.” Matt Drudge, however, wanted to blame it on President Obama, so he posted an auto updating graph of the Dow Jones Industrial average. Under that, in large block letters, Drudge asked, WAS IT SOMETHING HE SAID? But as the day passed, the market rebounded, and Drudge was left suggesting that Obama was responsible for the rally. Drudge couldn’t let that stand so, several minutes later, he changed the headline: MARKET REBOUNDS. But then, shortly before the closing at 4:00 PM, the market declined again. What did Drudge do? He hurriedly changed it back, typos and all: WAS IT SOMETHING HE SAID?">WAS IT SOMETHING HE SAID?

We all know that every minute of market activity is dictated entirely by the utterances of whoever is President at that time, so Drudge is surely on solid footing here. So I'm sure this embarrassment is just a temporary setback for him. After all, markets rarely fluctuate over the course of a day.

I'm also fairly certain this will cause approximately no member of the chattering class to reassess their reliance on headlines and news stories hand-picked by someone who today revealed himself to be a complete idiot.

The Mystery Of The Banking Solution

President Obama was deliberately vague on the subject of how to deal with insolvent banks - I believe the phrase used was that he would "make the necessary adjustments." It's probably a good idea until he determines how to best sell temporary nationalization, which looks to be a question of words:

With all eyes on the possibility of increased U.S. government ownership of embattled bank Citibank, and with increased discussion of the need for a government takeover of other major banks, a new USA Today/Gallup poll indicates that Americans' reactions to these prospects vary significantly, depending on how the process is described to them. A majority of Americans (54%) favor a temporary government "takeover" of major U.S. banks, but a much lower minority (37%) favor a temporary "nationalization" of the banks.

There's probably another phrase (pre-privatization?) that works even better. And anyway, because of the customary panic of the markets, this is an issue where you have to hold your cards right up until the moment you make the decision, and then you work quickly. The WaPo seems to think that the Administration has cleared the way for a temporary takeover (hey, I read the polls, I know what words to use), and yet the ability for the government to purchase common stock in the banks doesn't really make a lot of sense.

What we want to do is clean up the bank’s balance sheet, so that it no longer has to be a ward of the state. When the FDIC confronts a bank like this, it seizes the thing, cleans out the stockholders, pays off some of the debt, and reprivatizes.

What Treasury now seems to be proposing is converting some of the green equity to blue equity — converting preferred to common. It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt?

I just don’t get it. And my sinking feeling that the administration plan is to rearrange the deck chairs and hope the iceberg melts just keeps getting stronger.

In fact, the move only makes sense if it's a prelude to temporary takeover. Perhaps the stress tests will make that clear, but those are shrouded in mystery as well (which is probably also as it should be, as a transparent process could cause runs on the banks if they are found to be struggling). Some say the vagaries of the process is causing market uncertainty, but a specific process could be even worse.

Whatever the case, the Administration needs to make its move fast. The banks are dying, and may not be able to hold out without a plan that everyone can understand and accept.

Stocks And The Citi

Today kicks off the stress tests administered by the Treasury Department for the nation's banks. I don't expect the results to be completely transparent until the moment any bank is found to be insolvent, because the chaos that would ensue from a minute-by-minute reading of the stress test would sink the financial system. But we're already learning that Citigroup wants the feds to get more involved in their operations:

In yet another sign of distress for the banks, Citigroup officials were in active talks with federal regulators on Sunday night about plans for the government to take a bigger ownership stake in the bank, according to a person close to the talks.

Citigroup approached the regulators with a plan that would allow them to convert a large amount of the government’s $45 billion of preferred shares, which is treated as debt, into common stock, this person said. The government owns a stake of roughly 8 percent, but that could grow to as much as 40 percent.

Converting the preferred shares while also issuing more common shares would bring Citigroup closer to the mix of equity that the government is likely to demand when it introduces the stress test. But that would severely dilute the value of shares held by existing Citigroup stockholders.

This sounds like the taxpayers would get a real stake in Citi, and the shareholders would face reductions. Which is good, right? Well...

In exchange for its investments, the government required the banks to issue preferred shares that pay interest and are designed to encourage repayment after a few years. Under the changes announced this morning, companies instead can give the government preferred shares that can be converted into shares of the company's common stock [...]

Companies that convert the government's investment to common shares can reduce required dividend payments and ease repayment pressure for the banks. The change could encourage more people to invest alongside the government. And there is a significant but technical accounting benefit. The swap would significantly improve banks' performance on a measure of health used by financial analysts called tangible common equity, which basically judges a bank's reserves against future losses.

We're not getting full value for our investment as taxpayers. We're overpaying without getting a return for perhaps years. You just have to do the math.

Citigroup's common equity is currently worth $10 billion. If the US were to convert all $45 billion of its preferred at the current stock price, it should end up with 80% of the company, not 40%.

For the US to convert $45 billion of preferred to common and only get 40% of the company, Citigroup's existing common equity would have to be valued at $65 billion, not $10 billion, and the conversion price would have to be about $10 a share. Or the US would only be able to convert $4 billion of its $45 billion, which wouldn't help Citigroup's tangible equity ratio much.

So is that what Citigroup is trying to do here? Persuade the US goverment to convert to common stock at a price miles above the current trading price, screwing the US taxpayer yet again?

It's a black bag job. Elites have such a stranglehold on this government that I couldn't see us getting out of this without at least some handout, but the fact that such a simple math equation can be used to prove it makes me think that we have stupid elites, too. Of course, the handling of the economy over the past few years proved that.

Penthouse Arrest

I actually watched a good bit of the replay of yesterday's incredible House hearings with Madoff scandal whistleblower Harry Markopolos and the SEC (yes, it was a rockin' Wednesday night), and they really are amazing. The extent to which government protects the rich and powerful was really on full display. Here are two clips that should be widely distributed.

We now know that Bernie Madoff was running a Ponzi scheme that defrauded investors out of tens of billions of dollars. We know that the SEC had everything it needed to stop the fraud years in advance and did nothing. And yet today, Bernie Madoff is still living in a fabulous New York penthouse instead of a jail cell, with a security detail that he pays for. As Markopolos says in this clip, "He's under penthouse arrest [...] He is leading a life of luxury. He does have serious complaints; he's not allowed to go out for his nosh."



More amazing altogether is the behavior of the SEC officials, who actually tried to assert executive privilege in refusing to discuss their failure in the Madoff case or of any resposible oversight of the financial industry at all.



Go Gary Ackerman. I think we've become so inured to random government officials using "executive privilege" as a get out of jail free card that we don't understand how extraordinary this is. We pay the salaries of these people. Every one of them should be fired.

Meanwhile, Emperor Paulson stole your money in the bailout.

The U.S. Treasury may have significantly overpaid for its investments in financial institutions, a government watchdog said Thursday, as criticism of the $700 billion financial rescue continues to build.

"Treasury paid substantially more for the assets it purchased under the [ Troubled Asset Relief Program] than their then-current market value," Harvard Law School professor Elizabeth Warren told the U.S. Senate Banking Committee.

Warren, who chairs a five-person congressional oversight panel overseeing the Wall Street rescue plan, said a report being released Friday by the group includes an analysis of 10 TARP transactions. Extrapolating that analysis for all of the purchases made by the Treasury in 2008 suggests Treasury paid $254 billion for assets worth approximately $176 billion, a shortfall of $78 billion.

"They did not price for risk, that's what markets do," Warren said, suggesting the Treasury's lack of consistency had made the government funds a better deal for some institutions.

And they're getting ready, under "new leadership" at Treasury in name only, to do it again. More on that in a different post.

It's a wonder that pitchfork and torch sales aren't through the roof.

They Wouldn't Be Able To Find First Base."

There is a rather remarkable hearing playing out right now on Capitol Hill. Harry Markopolos, the whistleblower in the Bernie Madoff scandal, is testifying to a House Committee, and he's basically calling out the SEC for its total incompetence - over a period of several years - in failing to identify the Madoff Ponzi scheme and put a stop to it. Markopolos, who went to the SEC in May 2000, when the Madoff scheme was only about $5 billion, is getting off line after line ripping the SEC a new one. TPM Muckraker has all the details. Some highlights:

• "If you flew the entire SEC staff to Boston, and sat them in Fenway Park, they wouldn't be able to find first base."

• Markopolos discusses Madoff's mob ties: "When you're that big and you're that secrective, you're going to attract a lot of organized crime money, and which we now know came from the Russian mob and the Latin American drug cartel, and when you are zeroing out mobsters, you have a lot to fear. And he could not afford to get caught, because once he was caught. And if he would've known my name and knew he had a team tracking him, I didn't think I was long for this world."

• Markopolos offered to go undercover wearing a disguise to catch Madoff.

• Perhaps the most telling statement: "They (the SEC) were a captive regulator. Mr. Madoff was too big," he just told Congress. "They looked at Madoff and said: 'he's a big firm, we dont attack big firms.'"

That really says it all. The real difference between Madoff's scheme and the rest of Wall Street was that Madoff was more explicitly criminal. But that's it. And the SEC's inability to go after anything substantive on Wall Street turned the place into a deregulated casino.

There is a populist uprising going on in the country right now, as more and more stories like this come out. Which is why Obama's limit on executive pay this morning was significant and important. But the stimulus is being caught in the crossfire, as anything from a position of power is becoming infected with all the talk of theft of taxpayer dollars. The Republicans are being very sanguine, and if they do derail the stimulus or render it ineffective, the next few years will be really terrible and people will just get angrier.

50,000 More Lucky Duckies

Somehow, the Dow is up today on news of corporate mergers being financed with bank lending, with investors hoping for an end to the credit crunch. That's comforting for Wall Streeters, but outside the fantasy economy, thousands of layoffs punctuated the deepening recession.

It's already been a lousy year for workers less than a month into 2009 and there's no relief in sight. Tens of thousands of fresh layoffs were announced Monday and more companies are expected to cut payrolls in the months ahead.

A new survey by the National Association for Business Economics depicts the worst business conditions in the U.S. since the report's inception in 1982.

Thousands more jobs cuts were announced Monday. Pharmaceutical giant Pfizer Inc., which is buying rival drugmaker Wyeth in a $68 billion deal, and Sprint Nextel Corp., the country's third-largest wireless provider, said they each will slash 8,000 jobs. Home Depot Inc., the biggest home improvement retailer in the U.S., will get rid of 7,000 jobs, and General Motors Corp. said it will cut 2,000 jobs at plants in Michigan and Ohio due to slow sales.

Caterpillar Inc., the world's largest maker of mining and construction equipment, announced 5,000 new layoffs on top of several earlier actions. The latest cuts of support and management employees will be made globally by the end of March. An additional 2,500 workers already have accepted buyout offers, and ties have been severed with about 8,000 contract workers worldwide. In addition, about 4,000 full-time factory workers already have been let go.

Just last week, Microsoft Corp. said it will slash up to 5,000 jobs over the next 18 months. Intel Corp. said it will cut up to 6,000 manufacturing jobs and United Airlines parent UAL Corp. said it would get rid of 1,000 jobs, on top of 1,500 axed late last year.

Home Depot is eliminating jobs by closing their Expo stores. I was just in one of those over the weekend. Everyone working in that store is going to be out of a job before long.

All these people idling with no tangible help could get as ugly as the global financial unrest we're seeing in places like Latvia and Iceland. This is why it's so important to get that stimulus package signed into law as soon as possible. The American economy cannot run with all this record job loss - it's too dependent on consumer spending. We will spiral into depression.

Back To Reality

The stock market provided perhaps the right punctuation to this Inauguration Day, reminding everyone that the economy won't magically repair itself because of the change in occupancy at the White House. In fact, given the deterioration in the banking sector this past week, I'd say we got off easy with just a 4% drop.

NEW YORK (AP) -- Fear that the global banking crisis is worsening sent financial stocks plunging Tuesday, with many companies' shares down by double-digit percentages and Citigroup Inc. diving to a 17-year low.

Disheartening news came from U.S. and British banks: They are still suffering losses from loans and are warning that those losses will not subside anytime soon. Regional banks as well as the big money center banks are struggling [...]

Evidence that the banking crisis is worsening overseas also rattled investors. On Monday, the Royal Bank of Scotland forecast a loss of $41.3 billion in 2008. That led the British government to increase its stake in RBS to nearly 70 percent, essentially nationalizing the bank. Separately, the British government announced a new round of bailouts for the country's troubled banking industry.

Bank stocks also dropped in the aftermath of multibillion losses announced Friday by Citigroup Inc. and Bank of America Corp.

15-20% losses were the NORM for a lot of banks today. The UK banks are getting a very generous bailout, with guarantees made against their losses in mortgage-backed securities, instead of allowing the shareholders to bear the brunt of the pain. Gordon Brown may want to clean up the balance sheets but he's really just sinking massive amounts of money into the system. Meanwhile, the US is considering building a "bad bank" where the toxic waste would all flow to, paying off banks for ridding themselves of their own self-created problems. Paul Krugman had a good piece on this yesterday; basically, we're using an artificial respirator to keep the banks alive. They are completely dependent on the government, and yet we are unwilling to do the cheaper and more sensible thing and just nationalize them.

Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, recently tried to describe how this would work: “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent because the alleged $400 billion of toxic waste on its books is actually worth only $200 billion. The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth: “We don’t have really any rational pricing right now for some of these asset categories,” Ms. Bair says. But should the government be in the business of declaring that it knows better than the market what assets are worth? And is it really likely that paying “fair value,” whatever that means, would be enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense, disguised as “fair value” purchases of toxic assets.

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. The truth is that Gothamgroup and its sister institutions are already wards of the state, utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

There are very real consequences to this. We've already lost something like $64 billion dollars from the initial TARP release (remember when that was called an "investment" and we were all assured we would get the money back?). Everybody's tiptoeing around the solution. England owns 70% of the Royal Bank of Scotland and won't nationalize it.

Without President Obama (yay, I get to write that!) leveling with the American people, we will continue to waste more money propping up an insolvent set of banks.