The Fourteenth Banker Blog

November 22, 2010

Yves Smith on MERS Bailout – Not!

Filed under: Running Commentary — thefourteenthbanker @ 10:26 AM

In this Naked Capitalism piece, Yves expresses her opinion that despite last week’s reported attempts to reframe MERS and provide fig leaf cover for the allies of bank bailouts, this is unlikely to happen.

The industry is seeking legislation that would effectively affirm MERS’s legality and block any bill that would call into question what MERS does.

The latter bit, trying to block anti-MERS legislation, does have a shred of logic, given that the electronic database is coming under unfavorable scrutiny. Not only has Marcy Kaptur proposed legislation that would bar Fannie and Freddie from buying mortgages registered in MERS, but even Republican senator Richard Shelby, who once owned a title insurer, roughed up MERS president R.K. Arnold in hearings earlier this week.

But the idea of passing a Federal statue to solve MERS’ growing state-level problems is a huge stretch. As the latest report of the Congressional Oversight Panel noted,

In the absence of more guidance from state courts, it is difficult to ascertain the impact of the use of MERS on the foreclosure process. The uncertainty is compounded by the fact that the issue is rooted in state law and lies in the hands of 50 states judges and legislatures.

We’ve been told that Constitutional scholars have said that repeated Supreme Court decisions have found real estate transactions to be beyond the reach of Commerce clause, and hence not subject to Federal intervention. So the idea that MERS can be legitimated by Congress appears far-fetched.

She is probably right on this particular legislative idea. But I would not underestimate the power of the banks, and this is about the banks, not about MERS. The banks run the governments, as the selling out of the Irish people to save bankers and bondholders attests. Even Moody’s is explicit that the aid package from the EU shifts the burden of the banks to the Irish sovereign. Governments may fall, but institutional bondholders won’t.  In fact, the trans-national companies that went to Ireland to evade U.S. income taxes won’t help out either.  Several of these threatened to pull out if Ireland if their tax scheme is modified.




November 19, 2010

A Retroactive Bailout for MERS

Filed under: Running Commentary — thefourteenthbanker @ 6:29 PM

In this Washington Post article the strategy of major banks becomes clear. Reframe the issue, collect on IOUs from the campaign, demonstrate the revolving door promises for tomorrow.

The financial services industry has launched an aggressive campaign on Capitol Hill to bolster the legality of the way companies have turned mortgages into securities and traded them across the globe in recent years.

The companies have opened wide their wallets for lobbying and are flying top executives to Washington for one-on-one meetings with lawmakers. They are holding briefings for key staffers, including an event last week that drew more than 60 aides. And they are blanketing Congress with white papers, memos and other documents that lay out their arguments.

The industry is seeking legislation that would effectively affirm MERS’s legality and block any bill that would call into question what MERS does. MERS has spent more than $1 million in lobbying since fall 2008, when lower courts around the country began to rule against it. But MERS had kept its name under the radar until the recent uproar over foreclosures revealed broad problems in mortgage paperwork.

If successful on Capitol Hill, the industry could in one quick swoop make all lawsuits related to MERS across the country moot and remove one of the key uncertainties dangling over the mortgage industry. On the flip side, lawmakers could create a new federal registry, effectively killing MERS’s business and forcing the industry to submit to greater oversight.

Reframing efforts:

In the wake of such controversies, lobbyists for Reston-based Merscorp, which runs MERS, have been floating the idea of legislation that would establish the firm as the national registry to track the transfer of mortgages.

The MERS database “is a powerful tool that can be harnessed by the Congress and the industry to improve the mortgage finance system,” R.K. Arnold, Merscorp chief executive, told members of the Senate banking committee this week.

This reframing approach offers the fig leaf to congressmen that would support this backdoor bailout. A bill to eliminate liability for fraud, the high costs for legal remediation, and public accountability for misdeeds while intruding on the states abilities to safeguard property rights, would be colored instead as a measure to support efficient commerce.

Tom Deutsch, deputy executive director of the American Securitization Forum, an industry group that defended the validity of MERS in a recent paper being circulated on Capitol Hill, said establishing a centralized tracking system would resolve much of the confusion resulting from the patchwork of local laws governing mortgages and their transfer.

“There’s a lot of validity in the idea of a national mortgage registry that is complete and unambiguous about legal title to loans across all 50 states,” he said in an interview.

In its paper, the forum argued that although there have been “several minority decisions” in the courts that have taken issue with MERS, “not one of these decisions has challenged MERS’ ability to act as a central system to track changes in the ownership.”

Consumer advocates say such legislation would retroactively bless all mortgage transfers made through MERS – and eliminate one of the strongest legal arguments that homeowners in foreclosure are using to challenge their cases. There’s also concern among state officials that such a bill might permanently remove some of their power over property law and place it within federal jurisdiction.

Some of the advocates are referring to the idea as the “great MERS whitewash bill.”
“Fixing MERS on a federal level to give them a free pass from complying with what we have known as the law for many years because the banks screwed up is really a bad precedent,” said Ira Rheingold, executive director of the National Association of Consumer Advocates.

The compensation for politicians comes in two forms. Down payment made in campaign contributions. Big Bonus later in fancy high paying jobs.

Lobbyists working for MERS include people who were prominent legislators or federal officials: former U.S. representative Bob Livingston and his former chief of staff, Allen Martin; John M. Duncan, assistant secretary of the Treasury for legislative affairs in the George W. Bush administration; and Arnold Havens, a former general counsel at Treasury.

The revolving door into lucrative lobbying deals and high paying, low responsibility industry jobs is wide open.  Here is where one former Congressman landed.  Here is where a former Senator landed. Pretty good jobs. Do not for a minute think that the MERS bailout won’t result in some good work down the line for our public servants.



November 17, 2010

Unsafe At Any Speed

Filed under: Running Commentary — thefourteenthbanker @ 1:39 AM

When I first became aware of Ralph Nader, he was already considered a flake by the New Economic consensus that would shortly sweep Ronald Reagan into office. I would have laughed out loud if you had told me that 30 years later I would quote him. In the preface to his book, Unsafe At Any Speed, he says the following:

This country has not been entirely laggard in defining values relevant to new contexts of a technology laden with risks. The post-war years have witnessed a historic broadening, at least in the courts, of the procedural and substantive rights of the injured and the duties of manufacturers to produce a safe product. Judicial decisions throughout the fifty states have given living meaning to Walt Whitman’s dictum, “If anything is sacred, the human body is sacred.” Mr. Justice Jackson in 1953 defined the duty of the manufacturers by saying, “Where experiment or research is necessary to determine the presence or the degree of danger, the product must not be tried out on the public, nor must the public be expected to possess the facilities or the technical knowledge to learn for itself of inherent but latent dangers. The claim that a hazard was not foreseen is not available to one who did not use foresight appropriate to his enterprise.”

These words speak of legal and social developments in materials manufacturing going on 50 years ago. Yet it is striking that we have not achieved these most foundational values when it comes to another kind of manufacturing, the manufacture of financial products.

The clock has completed its cycle on the day in which the Congressional Oversight Panel released its report on Mortgage Irregularities and the consequences for financial stability.

In addition to documentation concerns, another problem has arisen with securitized mortgage loans that could also threaten financial stability. Investors in mortgage-backed securities typically demanded certain assurances about the quality of the loans they purchased: for instance, that the borrowers had certain minimum credit ratings and income, or that their homes had appraised for at least a minimum value. Allegations have surfaced that banks may have misrepresented the quality of many loans sold for securitization. Banks found to have provided misrepresentations could be required to repurchase any affected mortgages. Because millions of these mortgages are in default or foreclosure, the result could be extensive capital losses if such repurchase risk is not adequately reserved.

The dawn will soon break in Europe, where volcanoes erupt with regularity. Today’s volcano is the Irish Debt Crisis and an apparent impending bailout or series of bailouts, this time more painful. I give you this link, not to endorse it’s assessment because frankly I don’t know. But the very fact that such extremity can be considered plausible and be posted to a highly reputable blog (not mine, Calculated Risk’s) paints the picture rather well does it not?

So back to the quote from Ralph Nader’s preface. “Where experiment or research is necessary to determine the presence or the degree of danger, the product must not be tried out on the public, nor must the public be expected to possess the facilities or the technical knowledge to learn for itself of inherent but latent dangers. The claim that a hazard was not foreseen is not available to one who did not use foresight appropriate to his enterprise.”

I heard a commenter recently say that in financial services, “complexity is fraud”.  I am becoming inclined to believe him.

November 12, 2010

Response to Goldman’s Threat – Simon Johnson vs Goldman Sachs

Filed under: Running Commentary — thefourteenthbanker @ 4:50 PM

In the near corner, wearing the red trunks, number one heavyweight contender Simon Johnsoooooooooon!

Johnson is known for his doggedness and determination. This slight man with a soft voice would hardly seem to be a threat. But he almost single-handedly saved financial reform from an ignominious death. Johnson is not done. Winning a round is not enough. Johnson is the new Great American Hope! Here is the champion of the little guy, the entrepreneur, the innovator, the jobs creator, ready to take on the most powerful of persons.

In the far corner, wearing the blue trunks with the GS emblem, despised financial markets champion Goldmaaaan Saaaaaachs!

Sachs is jumping up and down and is already glazed with a greasy sweat. Goldman’s Mel Gibson eyes are flashing angrily and froth and spittle alternately spew forth. This dangerous and unpredictable champion, like Hannibal Lecter, has a taste for sweetmeats and wants a piece of Johnson. Once worked into a frenzy by a monetary prize, Goldman will turn on anyone. Even those in his corner are not safe. Goldman once cannibalized his own cut man.

Let the bout begin.

Johnson strikes first. Quoting scholarship from Stanford Professor Anat Admati, Johnson challenges the very notion that requiring banks to be well capitalized is a danger to the economy. The false claim is this:

“Some claim that requiring more equity lowers the banks’ return on equity and increases their overall funding costs,” thus lowering economic growth, the professors write.

And the answer:


“This claim reflects a basic fallacy. Using more equity changes how risk and reward are divided between equity holders and debt holders, but does not by itself affect funding costs.”

They go on to say: “High leverage encourages risk taking and any guarantees exacerbate this problem. If banks use significantly more equity funding, there will be less risk-taking at the expense of creditors or governments.”

…capital requirements should be simplified and greatly increased — relative to what the Group of 20 leaders will congratulate themselves on.

“Lending decisions would be improved by higher and more appropriate equity requirements,” they say.

And they are also completely on target with regard to the political economy problem here: “Many bankers oppose increased equity requirements, possibly because of a vested interest in the current systems of subsidies and compensation. But the policy goal must be a healthier banking system, rather than high returns for banks’ shareholders and managers, with taxpayers picking up losses and economies suffering the fallout.”

Let me put another spin on it. Some say that requiring banks to have more of their own money at risk means they will put less total money at risk and therefore provide less support to the economy. Let’s see how Goldman strikes back. First, the left jab:

Requirements that banks hold more cash to prevent against economic downturns won’t just hurt the banks themselves, but also the companies they lend to, Goldman Sachs says in a new report.

Then the right cross!

“Small- and mid-sized” companies that have relied on bank financing will be hit hardest, the report says.

And finally, characteristically below the belt…

“These firms are likely to grow more slowly than the larger firms and multinationals that enjoy more flexibility in financing. Slower growth among smaller and mid-sized firms may act as an overhang on economic growth and the job creation that these firms traditionally propel. And because the adjustment to higher prices and constraints on credit availability is a dynamic process, the potential ongoing rise in capital requirements means that smaller firms are likely to bear the cost for some time to come, acting as a continuing drag on bank loan growth.”

Ouch! Goldman is standing up for Johnson’s little guy! What an unexpected blow! It turns out that Goldman must be the New American Hope! The crowd is confused! Goldman corner man Vikram Pandit spits on Johnson!

“There is a point beyond which more is not necessarily better. Hiking capital and liquidity requirements further could have significant negative impact on the banking system, on consumers and on the economy.”

Now the Goldman corner is on the side of consumers as well! What a turn of events!

Johnson staggers, then recovers, striking at Pandit:

Why then does he advance such obviously specious arguments in the pages of the Financial Times?

The answer is straightforward.

a)      He can get away with it.  Modern financial CEOs float in a cloud above the public discourse; they can spout nonsense without fear of being contradicted directly in the pages of a leading newspaper.

b)      Officials listen to bank CEOs and an op ed gets their attention.  Perhaps they think Mr. Pandit knows what he is talking about – or perhaps they know that these arguments are completely specious.  In any case, they are deferential.

c)      Mr. Pandit is communicating with other CEOs and, in this fashion, encouraging them to take recalcitrant positions.  There is an important element of collusion in their attempts to capture the minds of regulators, politicians, and readers of the financial press.

Mr. Pandit is engaged in lobbying, pure and simple.

14 here. I score this bout for Johnson, surprised? Goldman and Citigroup are “talking their book”. They are part of the old school that brought down the economy. They believe in a highly levered theory of finance where shareholders invest the minimum equity, maximize debt and thus try to generate more profit for themselves. Their concern for small business and the consumer is a subterfuge. Goldman, Citi, and the like have overseen the financialization of the economy. They have overseen the processes that consolidate power at the top of the economic structure, where large firms crush small ones. For them, consumers and small businesses are krill. Yes, they want them alive, so they can eat them.

They are speaking one truth though. Their model is based on leverage. If you change the leverage requirements, you threaten their standing. So in a universe where Goldman and Citi are the only hypothetical players, you would see a short term contraction in credit because of decisions they would make, because of who they are. Their choices would be to either raise new equity or to shrink their risk assets. Raising new equity would dilute the existing shareholders, reduce the metrics they use to justify their pay packages, and reduce the value of their own stock interests (common stock and stock options). So they would not choose to do that voluntarily, whether it is the right thing for the global economy or not. What their nature would require them to do is run off a portion of their assets, the least risky and profitable portion, double down on their most risky bets and try to make just as much money for shareholders with fewer assets deployed. That is not a reflection on some natural laws of business and economics. That is a reflection of their thought processes and models for doing business.

But here is the salvation, the Great American Hope. Nature fills a vacuum. The broken model of Wall Street would be filled by a new, more responsible, durable, and beneficial model. As Johnson says, the issue with the capital structure of firms is about how the returns are divided up, not about what the returns from business operations are. Wall Street confuses those issues, because their primary concern is with their returns.

Saving Wall Street at the expense of Main Street is the policy of our government. Enough is enough. Do not buy the baloney.

November 10, 2010

Bill Black Slam Dunks American Banker Columnist!

Filed under: Running Commentary — thefourteenthbanker @ 7:38 PM

In these two posts, Part 1 and Part 2, Bill Black mops the floor with American Banker columnist Andrew Kahr. In his column, Kahr had suggested that mortgage applicants be prosecuted to the full extent of the law including fines up to $1 million and up to 30 years in prison, if they gave false information in a mortgage application. Kahr is suggesting that banks comb their files and make criminal referrals to the U.S. Attorney in their jurisdiction.

Laws against bank fraud are of course necessary and appropriate. However, Black makes an amazing case that what has happened in general is widespread fraud by predatory lenders. He uses Kahr’s own words to convict him.

I find it incredible that with an abysmal record in regard to home mortgage origination, securitization, servicing, and foreclosure, a financial industry representative would recommend severe sanctions for clients. Yes, there are some who did intentionally commit fraud. But what is good for the goose is good for the gander. The U.S. Attorneys should start by prosecuting the fraudsters in the industry who knew what they were doing and did it for personal gain. Only then might there be some hope of an honest banking industry.


November 8, 2010

Watch Inside Job – The Movie | zero hedge

Filed under: Running Commentary — thefourteenthbanker @ 4:29 PM

Watch Inside Job – The Movie | zero hedge.

I endorse this as well. For those who follow alternative financial blogs, you will already know well the broad story line. But, seeing the images and hearing the voices has a value far greater than a couple hours and the price of a ticket. These are the things that steel your resolve.

The American Latvia

Filed under: Running Commentary — thefourteenthbanker @ 11:04 AM

These videos are of a speech Michael Hudson made several weeks ago to the American Monetary Institute. It is pretty engrossing. I hope you find time to watch it. Some of his examples are simplified to serve an explanatory purpose. I agree with much of his historical analysis and his description of the current problems of wealth distribution and political power. However, the financial system is complex and not all institutions or transactions are exactly as described in this speech. So let’s not quibble about that.

In the first segment he correctly points out at about the 3:30 mark that banks do not lend for productive purposes (in general). They lend on existing assets and cash flow streams. This is particularly the case with large banks that have much standardization and centralization of functions. As Amar Bhidé states in his book, “The financial system has been giving up, albeit unwittingly, on the decentralization of judgment and responsibility. Case-by-case judgments by many, widely dispersed financiers with the necessary ‘local knowledge’ have been banished to the edges, to activities such as venture capital, which accounts for a useful, but tiny proportion of financing activity.” Without this decentralized judgement and responsibility, banks are simply incapable of providing productive risk capital as Hudson describes. Instead, capital is consistently deployed to increase the values of existing assets, much like Bernanke proposes to do today.

All Tea Party supporters should watch this speech because it explains how America is becoming the new Latvia and how labor (90% of us) is and will continue to pay the freight. The greater public has been co-opted by a blind faith in the Neo-Classical economic paradigm. They believe that their angst, created by flat to decreasing real incomes for those still employed, high unemployment, and extreme volatility in perceived wealth, has been caused essentially by too much regulation and too much government. While I agree that inefficient or ineffective government is a problem, it pales relative to the effects of the power structures dividing up the wealth in a way the average citizen cannot grasp.

Further in the speech, Hudson refers to this increasingly debt based system and how all cash flow streams and assets are ultimately “capitalized”. In other words, debt is issued against them and profits are extracted by those able to do so. Perhaps you have seen this as we have more and more toll roads, red light cameras, and prisons run by private companies for profit. Those who outsource these things see one part of the picture, the part where government outlays are supposedly reduced. They do not see the part of the picture where those assets and cash flow streams are used to move wealth to the top of the social structure. Tea Party favorite Rand Paul unwittingly plays into this with his ideas on privatization. From an interview this weekend comes this quote:

When pressed on “This Week” about which programs the he would cut, Paul declined to identify individual programs. “All across the board,” the senator-elect said.

Amanpour challenged Paul, saying, “But you can’t just keep saying all across the board.” Still, the newly elected senator refused to budge. “No, I can. I’m going to look at every program, every program.” He later continued on the theme: “You need to ask of every program — and we take no program off the table. Can it be downsized? Can it be privatized? Can it be made smaller?”

This things that are privatized will then be leveraged and the profits will be extracted up front. Any change in the cash flow stream will then create future losses on that leverage and those losses will be allocated to taxpayers or the most unwary investors who bought the residuals after all the fees and equity dilutions for management have been stripped.

While John Hussman is writing on a different topic, the Bubble Crash cycle, his points tie in as well. After acknowledging that the markets already rose on the Fed action, Hussman effectively makes it clear that this has little to do with real wealth.

As a result of Bernanke’s actions, investors now own higher priced securities that can be expected to deliver commensurately lower long-term returns, leaving their lifetime “wealth” unaffected, but exposing them to enormous risk of price declines over the intermediate (2-5 year) horizon. This is not a basis on which consumers are likely to shift their spending patterns. What Bernanke doesn’t seem to absorb is that stocks are nothing but a claim on a long-term stream of cash flows that investors expect to be delivered over time. Propping up the price of stocks changes the distribution of long-term investment returns, but it doesn’t materially affect the cash flows. This reckless policy has done nothing but to promote further overvaluation of already overvalued assets. The current Shiller P/E above 22 has historically been associated with subsequent total returns in the S&P 500 of less than 5% annually, on average, over every investment horizon shorter than a decade.

With no permanent effect on wealth, and no ability to materially shift incentives for productive investment, research, development or infrastructure (as fiscal policy might), the economic impact of QE2 is likely to be weak or even counterproductive, because it doesn’t relax any constraints that are binding in the first place. Interest rates are already low. There is already well over a trillion in idle reserves in the banking system. Businesses and consumers, rationally, are trying to reduce their indebtedness rather than expand it, because the basis for their previous borrowing (the expectation of ever rising home prices and the hope of raising return on equity indefinitely through leverage) turned out to be misguided. The Fed can’t fix that, although Bernanke is clearly trying to promote a similarly misguided assessment of consumer “wealth.”

My final point before leaving you to this treasure trove of speechmaking is this. Today we have what we have. We cannot change it overnight. Evolutionary change is our only viable option until more dramatic shifts in our culture enable bolder political action. Right now the regulators are in the process of determining how to implement the provisions of Dodd-Frank. Simon Johnson penned a strong statement. It is essential to win these little battles on the regulatory front.

The Volcker Rule is not a panacea but if designed and implemented appropriately, it would constitute a major step in the right direction.  The effectiveness of our financial regulatory system declined steadily over the past 30 years; it is time to start the long process of rebuilding it.

Rebuilding the financial sector must be done a one step at a time. We must hope to rebuild it before we become the American Latvia and must sacrifice whole segments of our society to feed our parasite.

Please watch Professor Michael Hudson.

November 4, 2010

Bernanke Blows Bubbles

Filed under: Running Commentary — thefourteenthbanker @ 9:28 AM

Yesterday the Fed laid out the plan it had signaled months before. In an Op-Ed at the Washington Post, Bernanke laid out his reasoning and self-indictment of the Federal Reserve when it comes to economic influence. First, his philosophy:

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Bernanke’s view is that monetary policy, specifically expansionary monetary policy, can promote economic prosperity. The method he proposes is cheap borrowing costs and fictitious paper wealth in the form of an inflated stock bubble. In fact, according to the Op-Ed, this has already worked.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action.

Let me not mince words here. This policy has been a boon to the wealthy and the traders and has increased the disparity in wealth between the rich and the middle class. It has served to further the entrench the funding advantage of giant corporations and thus has reduced the opportunity for Small Business to drive economic performance. This is an “All-In” play on the philosophy of trickle down. But it is rife with risk and injustice.

You see, most Americans do not have huge bond portfolios or huge stock portfolios. In fact, while the market has been rising, average citizens have pulled money out of the stock market for 26 consecutive weeks. The stock market is now a traders playground and this policy will make them a lot of money. Please click on this link and look at the chart midway down that shows the performance of the stock market and flows into and out of domestic mutual funds. You will see that the average citizen buys high and sells low. Ben invites you to buy high again. Buy now and we can pump the Dow up a couple thousand points. They you will feel wealthy and buy a car.

In the meantime, Bernanke does not really explain the costs of this policy. He mentions that he wants to prevent the pernicious risk of deflation, but the truth is he has already stimulated consumer inflation though it barely shows in the backwards looking indexes. The Fed likes to use inflation rates that discount the “volatile” energy and food sectors, even though these sectors are among the most meaningful for middle and lower-income consumers. Look what is happening with energy commodity prices. Oil prices are up over 12% since the Fed signaled this policy in August. Look what is happening with food commodity prices. Farm products, processed foods and feeds are up 9.9% in 12 months. Grains are up 33%. Mild products are up 17%. You will see these hit your credit card bill very soon. You are asked to reinvest in the stock market and use your phantom earnings, which the Fed will attempt to guaranty, to cover your increased cost of living and spend more on discretionary items and hopefully houses. Good luck with that.

Ben does not discuss the injustice to savers, those anachronistic Americans that still have a little cash but not a lot. I have been searching for a place to earn more than 1% on my savings with something other than a promotional rate that will adjust downwards again in three months. Average Americans, savers, retired folks who cannot speculate in the markets, are getting creamed by low-income and rising prices while speculators, primary dealers, hedge fund managers and other front-runners are making a killing in trading ahead of the Fed. Savers will earn 1% on their money, pay 15% to 33% of that in Federal Income Tax, netting between 67 and 85 basis points. Then the Fed will hit you with a minimum of 2% inflation and will probably overshoot and give us much more. You lose again if you are not a speculator. This system rewards the entrenched financial power structure and penalizes the hard-working Americans who cannot play that game. It is a reverse Robin Hood subsidy to the rich and is unjust. Will it save all of us by saving the banks? Is that the real game being played? Not addressed by the Fed.

November 1, 2010

There Is No Thinking Like Systems Thinking

Filed under: Running Commentary — thefourteenthbanker @ 6:04 PM

How do we make sense of the ongoing mortgage and foreclosure fraud news flow and the attempts of the Fed and others to resuscitate the engines of job creation? About a week ago I re-posted an item from James Kwak at Baseline Scenario.

In this post, James discusses industrial food production and industrial finance. He refers to ideologies and how those are reflected in these industries. These industries are imprisoned in their ideologies.

It might be helpful at this point to think in terms of “Systems“.  Tomorrow there is an election and it appears that the ideologies of the “Right” will win out. I’m not sure how those ideologies are going to help their supporters though. The vast majority of the Tea Party seems to share the angst of people on the right and the left who feel that we are losing our economic liberty. The ideology they are caught up in is the myth that we used to have free markets and now we don’t because there is too much government spending (even though the government does not bother to tax in order to spend), or too much regulation (even though neither Dodd Frank or the Health Care bill has done diddly squat yet).

Read this for a take on the state of the free market these days and where the threat comes from.

The CEOs I have talked to in recent years over drinks, overseas, and in private, are worried too. I have heard this comment at Davos far too many times to ignore: “I am as patriotic as anyone, but when I see where my corporation is investing, where it is doing R&D and especially where it is hiring, I worry about my country. It’s all going outside America. But what can I do?”

Or read this:

Democracy’s Death Spiral is a positive feedback loop between ever-greater concentrations of wealth and the ever-higher costs of retaining political power…

…In the U.S., the ever-greater concentrations of wealth gathered by an ascendant Financial Power Elite has entered a positive feedback loop with the costs of gaining or retaining political power. The costs of winning an election have skyrocketed to the point that fundraising is the key function of any politico who is not independently extremely wealthy.

This quantum leap up in the costs of gaining or retaining power has forced politicos to curry the favors of those few Elite groups which can give them millions of dollars.

Just as in an arms race, the amounts of money which can be spent on campaigns is essentially unlimited. The explosion of media now requires multi-million dollar campaigns on multiple fronts: broadcast TV, cable TV, mailed flyers, radio spots, promotion campaigns to influence the mainstream media coverage, adverts on the Web and social media campaigns–the list grows longer every year.

Here is the positive feedback loop. Candidate A gains the backing of a Power Elite group (a political action committee or other front) and collects $5 million. As a result of a media blitz, he/she wins.

Between elections, he/she amasses a “war chest” of $5 million from the same donors, guaranteeing that the final cost of the next election will be $10 million.

Potential rivals understand that victory against this well-funded incumbent, no matter how incompetent, will require $15 million. The only sources of that amount of cash are other Financial Power Elites and State-funded fiefdoms like teachers unions, and so each candidate sells their soul to the few “special interests” with deep enough pockets to harvest and contribute millions of dollars.

Back to “Systems” thinking. This is a complex topic but here are some basic elements of a system.

System concepts

Environment and boundaries
Systems theory views the world as a complex system of interconnected parts. We scope a system by defining its boundary; this means choosing which entities are inside the system and which are outside – part of the environment. We then make simplified representations (models) of the system in order to understand it and to predict or impact its future behavior. These models may define the structure and/or the behavior of the system.
Natural and man-made systems
There are natural and man-made (designed) systems. Natural systems may not have an apparent objective but their outputs can be interpreted as purposes. Man-made systems are made with purposes that are achieved by the delivery of outputs. Their parts must be related; they must be “designed to work as a coherent entity” – else they would be two or more distinct systems
Theoretical Framework
An open system exchanges matter and energy with its surroundings. Most systems are open systems; like a car, coffeemaker, or computer. A closed system exchanges energy, but not matter, with its environment; like Earth or the project Biosphere 2 or 3. An isolated system exchanges neither matter nor energy with its environment; a theoretical example of which would be the universe.
Process and transformation process
A system can also be viewed as a bounded transformation process, that is, a process or collection of processes that transforms inputs into outputs. Inputs are consumed; outputs are produced. The concept of input and output here is very broad. E.g., an output of a passenger ship is the movement of people from departure to destination.
subsystem is a set of elements, which is a system itself, and a component of a larger system.
System Model
A system comprises multiple views such as planning, requirement, design, implementation, deployment, operational, structurebehavior, input data, and output data views. A system model is required to describe and represent all these multiple views.
System Architecture
system architecture, using one single coalescence model for the description of multiple views such as planning, requirement, design, implementation, deployment, operational, structurebehavior, input data, and output data views, is a kind of system model.

All you have to do is read this description of “systems” and think of the news you read these days and you can see that we have dysfunctional systems. For example, there are concepts of exchange of matter and energy with surroundings. Implicit is that exchange is two way and beneficial. Exchange and extraction are not the same thing. There is a concept of transformation. Implicit is that stasis is not a measure of health of a system. The system must adapt. We do not see healthy adaptions in our system. A system must have a workable architecture. Does the inter-relationship between the Congress, the Fed, Wall Street, and Main Street feel like it has a workable architecture? Will leaving Congress, the Fed, and Wall Street unconstrained by any intentionality lead to a good outcome for Main Street?

Another word that you hear a lot these days is “Ecosystem.


The entire array of organisms inhabiting a particular ecosystem is called a community.[1] In a typical ecosystem, plants and other photosyntheticorganisms are the producers that provide the food.[1]Ecosystems can be permanent or temporary. Ecosystems usually form a number of food webs.[2]

Ecosystems are functional units consisting of living things in a given area, non-living chemical and physical factors of their environment, linked together through nutrient cycle and energy flow.[citation needed]

  1. Natural
    1. Terrestrial ecosystem
    2. Aquatic ecosystem
      1. Lentic, the ecosystem of a lake, pond or swamp.
      2. Lotic, the ecosystem of a river, stream or spring.
  2. Artificial, environments created by humans.

Central to the ecosystem concept is the idea that living organisms interact with every other element in their local environmentEugene Odum, a founder of ecology, stated: “Any unit that includes all of the organisms (ie: the “community”) in a given area interacting with the physical environment so that a flow of energy leads to clearly defined trophic structure, biotic diversity, and material cycles (i.e.: exchange of materials between living and nonliving parts) within the system is an ecosystem.”[3]

I am convinced that what is broken is the system. The system today is like a shattered mirror. The best that could be done with that mirror is all the hundreds of pieces could be put back together like a jigsaw puzzle, with great effort and cost, and then the mirror would only be partially functional.

The system is like the land. For 40 years we have used the land in a way that has depleted its productive capacity so that now all we can do to maintain industrial food production is engineer more synthetic fertilizers and engineer seeds that can withstand the ecological desert in which we plant them. We can’t get off this merry-go-round because if we did there would be nothing to eat. Then we would kill each other with our guns.

But we can recognize that the system we have is not optimal and begin to change it. Converting farmland back to organic takes a minimum of three years. During those three years the land can produce a little fodder for livestock or can product low yields of food crops. But it cannot produce much. During this time though, it can become healthy if the land, the soil, is nurtured properly. Organic content is increased. PH balance is restored. Microorganisms begin to return. The soil returns to life and living soil, properly managed with biodiversity, is productive soil and produces healthy food. Healthy food can improve quality of life and reduce health care costs and yes, even government expenditures. But we must invest in healthy food.

I recommend a book, Inquiries into the Nature of Slow Money, by Woody Tasch.

Quoting from the Forward:

We have to find a new form of economy, an economy that knows how to govern its limits, an economy that respects nature and acts at the service of man, a situation where political and humanistic choices govern the economy and not the other way around. We have to discover new economic relationships that respect the pace of nature. Lacking this respect, we have an economy that is speeding out of control, promoting unlimited consumption and always chasing after distant markets, with destructive consequences for local economies, communities, and all living things.

Quoting from Chapter One:

The problems we face with respect to soil fertility, biodiversity, food quality, and local economies are not primarily problems of technology. They are problems of finance. In a financial system organized to optimize the efficient use of capital, we should not be surprised to end up with cheapened food, millions of acres of Genetically Modified corn, billions of food miles, dying Main Streets, kids who think food comes from supermarkets, and obesity epidemics side by side with persistent hunger.

You see, the financial system is part of the food system and it is like the food system. There is no biodiversity in the financial system. It is largely monocultural. Monoculture breeds disease. Monoculture depletes the environment. Monoculture is standardized. Loan servicing is standardized. Monoculture is efficient. Outsourcing jobs is efficient. Monoculture is fragile. Too Big to Fail banks are fragile. Monoculture is about maximizing production. Biodiversity is about sustaining productive capacity without chemical infusions. Just as our monocultural agricultural processes require maximum synthetic inputs to produce crops, our monocultural financial system requires increasing infusions of monetary stimulus, fiscal stimulus, legislative protectionism, and public subsidy. We have a sick system. We need to quit protecting the sick system and build a healthy system.

Then we can have healthy communities.




October 27, 2010

Electoral Nothingness

Filed under: Running Commentary — thefourteenthbanker @ 4:27 PM

As we move towards another Tuesday, election day, it is astounding that so few that stand for office “get it”. Get what, you ask? Get that our tired alliances no longer serve us. Politicians on both sides of the aisle, and those rolling in it, still genuflect to the all-powerful elites, the corporations, the money men, the public employee unions; the prophets of empire, militarism, moral superiority, fears of moral corruption; those allied to Keynes, Friedman or the new Austrians. Most of these races are actually about…. nothing. Two politicians in most cases racing for the bottom, running negative ads smearing the other, standing for nothing other than power accumulation, when it is power accumulation itself that is the problem.

In this recent post, Barry Ritholtz says it is Us versus the Corporations.n

This may not be a brilliant insight, but it is surely an overlooked one. It is now an Individual vs. Corporate debate – and the Humans are losing.


• Many of the regulations that govern energy and banking sector were written by Corporations;

• The biggest influence on legislative votes is often Corporate Lobbying;

• Corporate ability to extend copyright far beyond what original protections amounts to a taking of public works for private corporate usage;

• PAC and campaign finance by Corporations has supplanted individual donations to elections;

• The individuals’ right to seek redress in court has been under attack for decades, limiting their options.

• DRM and content protection undercuts the individual’s ability to use purchased content as they see fit;

• Patent protections are continually weakened. Deep pocketed corporations can usurp inventions almost at will;

• The Supreme Court has ruled that Corporations have Free Speech rights equivalent to people; (So much for original intent!)

None of these are Democrat/Republican conflicts, but rather, are corporate vs. individual issues.

For those of you who are stuck in the old Left/Right debate, you are missing the bigger picture. Consider this about the Bailouts: It was a right-winger who bailed out all of the big banks, Fannie Mae, and AIG in the first place; then his left winger successor continued to pour more money into the fire pit.

We are fighting the wrong battles. Both parties have spent money indiscriminately. Neither party is willing to sunset programs or laws that no longer serve a purpose because every program and every law has a constituent. Few are willing to say that killing two civilians for every enemy combatant is not patriotic and does not increase our security, or that 50 eyes for one eye is not justice in any moral system. Few are willing to put civil servants, private citizens, and uninjured veterans on the same retirement and health care programs.

I would add that political machines are on the side of the Corporation persons and not the Human persons.

Bill Black and Randall Wray make a case in two parts that could begin to rectify these power imbalances. At least someone is willing to speak up.

Part One

Part Two

Breaking the backs of entrenched power structures is unruly but it is not a zero sum game. From the ashes of these giants would emerge new young enterprises that would fill any void in the financial markets. What are the people getting from hanging onto these tenuous existing wealth and power structures? Very little. We are in the proverbial monkey trap. Our tiny little fists cannot get out of the trap because we won’t let go of what we think we have. Let it go.

October 25, 2010


Filed under: Running Commentary — thefourteenthbanker @ 7:24 AM

I am copying this entire post from Baseline Scenario.

Food and Finance

By James Kwak

I just read Michael Pollan’s book, In Defense of Food, and what struck me was the parallels between the evolution of food and the evolution of finance since the 1970s. This will only confirm my critics’ belief that I see the same thing everywhere, but bear with me for a minute.

Pollan’s account, grossly simplified, goes something like this. The dominant ideology of food in the United States is nutritionism: the idea that food should be thought of in terms of its component nutrients. Food science is devoted to identifying the nutrients in food that make us healthy or unhealthy, and encouraging us to consume more of the former and less of the latter. This is good for nutritional “science,” since you can write papers about omega-3 fatty acids, while it’s very hard to write papers about broccoli.

It’s especially good for the food industry, because nutritionism justifies even more intensive processing of food. Instead of making bread out of flour, yeast, water, and salt, Sara Lee makes “Soft & Smooth Whole Grain White Bread” out of “enriched bleached flour” (seven ingredients), water, “whole grains” (three ingredients), high fructose corn syrup, whey, wheat gluten, yeast, cellulose, honey, calcium sulfate, vegetable oil, salt, butter, dough conditioners (up to seven ingredients), guar gum, calcium propionate, distilled vinegar, yeast nutrients (three ingredients), corn starch, natural flavor [?], betacarotene, vitamin D3, soy lecithin, and soy flour (pp. 151-52). They add a modest amount of whole grains so they can call it “whole grain” bread, and then they add the sweeteners and the dough conditioners to make it taste more like Wonder Bread. Because processed foods sell at higher margins, we have an enormous food industry pushing highly processed food at us, very cheaply (because it’s mainly made out of highly-subsidized corn and soy), which despite its health claims (or perhaps because of them) is almost certainly bad for us, and bad for the environment as well. This has been abetted by the government, albeit perhaps reluctantly, which now allows labels like this on corn oil (pp. 155-56):

“Very limited and preliminary scientific evidence suggests that eating about one tablespoon (16 grams) of corn oil daily may reduce the risk of heart disease due to the unsaturated fat content in corn oil.”

With this fine print disclaimer:

“FDA concludes that there is little scientific evidence supporting this claim. To achieve this possible benefit, corn oil is to replace a similar amount of saturated fat and not increase the total number of calories you eat in a day.”

Unfortunately, nutritionism is pretty much bogus science. The major claim of nutritionism over the past thirty years–that fat is bad for you–turns out not to have any foundation at all.*

What does this all have to do with finance? Roughly speaking, read academic finance for nutritionism; the financial sector for the food industry; subprime loans, reverse convertibles, and CDOs for highly processed food claiming to improve your health but actually killing you; current disclosure laws for the FDA-approved health claims on corn oil; thirty-year fixed-rate mortgages and index funds for the neglected, unsubsidized, unadvertised fruits and vegetables in the produce section; the OCC and OTS for the FDA; and the long-term increase in obesity and diabetes for the long-term increase in household debt.

In both cases, you have an industry that earns profits by convincing people to do things that are not in their long-term interests; that, in the process, creates negative externalities for the rest of society; and that has cowed regulators into submission, if not outright cheerleading. In both cases, the industry defends itself from critics by saying that it is simply providing what customers want, and hence any new constraints (even, say, accurate organic labeling laws) constitute a paternalistic intrusion into people’s economic freedom. And in both cases, the industry claims that if it isn’t allowed to continue on its current course, the economy as a whole will suffer. (After all, our corn- and soy-based diet is what enables the industry to provide huge numbers of calories at low cost.)

One big difference is that when it comes to the food system, there is a fair amount you can do to protect yourself and your family from its unhealthy effects (if you have the money). With the financial system, it’s a bit harder.

* It’s a bit more complicated than that, so before you take this as advice, read Part I, Chapter 5.

So naturally I agree with this assessment. What you see is not what you get. The question is how do we make finance wholesome?  I rather like Bill Black’s idea for a starter but it mainly serves to deconstruct, not to construct.


October 22, 2010

Seeking Radical Solutions

Filed under: Running Commentary — thefourteenthbanker @ 12:22 PM

In this country we have real problems that need real solutions. They are too many to enumerate here but I will make a few generalities.

  • The middle class is under immense pressure. There has been no real wage growth for a decade or more. The second earner in most families in the workforce, is yet the real standard of living has not moved appreciably except that perhaps we have bigger houses, which is not necessarily a good thing in the long run.
  • We continue in the shadow of a boom bust cycle with unemployment and underemployment running somewhere in the 16-20% range.
  • Interest rates are at all time lows and yet the Fed can only think to stimulate the economy by further purchases of financial assets.
  • Markets are no longer trustworthy. In the stock market, program trading dominates volume. I heard recently that 70% of trade positions are held for an average of 11 seconds. These trading algorithms are in a cut throat competition to trade on information a fraction of a second before other computers. The retail investor is at the mercy of these traders and has lost confidence that the markets are fair. The bond markets are not fair either. The junk that makes up Commercial and Mortgage Backed Securities is subject to all kinds of risks. Rates are suppressed by the Fed and a rebound would burn bond investors. The rating agencies can’t be trusted. There is little retirement security. Low rates on bank deposits are suppressing income for savers.
  • The United States, state, and local governments are in a pickle and are looking to reduce spending, which will further suppress aggregate demand at a time when the economy is weak.
  • We are stuck in expensive foreign wars that appear to be endless.
  • The global economy favors developing nations and emerging markets. Labor cost differentials are suppressing middle class employment in the United States.
  • The nation is divided politically. Neither major party has much leeway to even implement their preferred policies.
  • Small business is struggling while economic power becomes more concentrated in the hands of mega corporations and the super wealthy.
  • The Fed’s efforts to stimulate policy by creating inflation appear to be creating inflation in the cost of living for families but not in the value of their assets. Food and energy costs are on the rise, yet the government excludes these from their core inflation measures. Health care costs continue to be out of control and the population is aging.

So does anyone have any ideas? Here is one. Let’s create a wave of entrepreneurship that begins to rectify some of these imbalances. How can we do that? There is tremendous talent and knowledge locked up in our biggest corporations, those that are prospering while giving paltry wage increases, passing more health care costs back to their employees, moving many jobs to other nations, paying massive bonuses to executives. Why should the people support this?

A little over a century ago, the foundations of corporate power were laid with a series of legal decisions that weakened the position of the skilled employee vis a vis the corporation. This paper by Duke University professor Catherine Fisk examines these legal decisions. Here is the Abstract:

A legal ideology emerged in the 1870s that celebrated contract as the body of law with the particular purpose of facilitating the formation of productive exchanges that would enrich the parties to the contract and, therefore, society as a whole. Across the spectrum of intellectual property, courts used the legal fiction of implied contract, and a version of it particularly emphasizing liberty of contract, to shift control of workplace knowledge from skilled employees to firms while suggesting that the emergence of hierarchical control and loss of entrepreneurial opportunity for creative workers was consistent with the free labor ideology that dominated American thinking on the subject of work.

Today, corporations own virtually all intellectual property. They choose to develop and market some products and ideas, and others lie fallow for lack of attention and frankly motivation among increasingly disenfranchised corporate workers. The lack of any wave of major new innovation that can carry employment and personal income levels higher is exacerbating all the problems listed above. The government’s efforts to solve economic problems only serve to entrench existing corporate interests. They pass stimulus efforts through the financial markets, supporting “systemically important” institutions by shielding them from the consequences of their actions and pumping up the value of assets that are primarily institutionally and corporately held. All this is supposed to trickle down to the benefit of the employees. I can tell you, it is a trickle.

This suggestion is radical. The whole legal basis of company/labor relations would be challenged. But is not a shaking up of the status quo what is needed in order to get change of any magnitude? Well intentioned as they may be, are efforts to make change without actually hurting entrenched interests having any material effect? Take the health care bill. By building a coalition of the existing entrenched interests, the bill does little to affect cost. Cost is the problem my friends. If you want stimulus, cut health care costs back to 10% of GNP! That means some companies go under. So what? The prosperity that would result would dwarf these effects. But, then no campaign contributions, no?

Here is an issue for the Tea Party. Free the worker! Free market for intellectual capital! Decentralization of power! Pro Small Business!

Perhaps some of this intellectual capital would be used to revolutionize our health care. Perhaps some would be used for experimentation with new agricultural techniques. Perhaps some would be used in the energy business. The only problem is that the tables would be turned on the poor corporations, with their rising stock prices and billion-dollar war chests.

Anyone have any other ideas?

Of course, to get these businesses going we would need banks with decentralized judgment based decision-making. Good luck with that.

October 21, 2010

Petty “Truthiness” Issues at Bank of America

Filed under: Running Commentary — thefourteenthbanker @ 2:40 PM

Bank of America is in the news these days for humongous foreclosure fraud issues, mortgage securitization fraud allegations, etc.  Perhaps as revealing to me is that they refuse to be truthful and transparent in even the most mundane matters.  B of A put out two information releases this week and neither one made sense to me. The big one was the earnings release in which they announced a write off of $10.4 Billion (with a “B”) in Goodwill. Goodwill is an accounting concept which attempts to capture “value” related to some sort of acquisition or transaction that cannot be properly assigned somewhere else. For example, if you buy a business for $1 million and the actual assets of the business (real estate, equipment, inventory, etc.) are only worth $700,000, the other $300,000 still has to be put on your financial statements and if it represents the intangible value of the business as a going concern, it can be booked as goodwill.

So back to this earnings release. What Bank of America said is:

We recorded a goodwill impairment charge. The $10.4 Billion non-cash charge does not impact regulatory capital ratios or liquidity. The charge is the result of recent legislation and expected impact on debit card business. Future debit card profitability is diminished.

So I wonder, how do you have $10.4 Billion in an asset account for “future debit card profitability”. I could not answer this question from their financial statements. But, the answer must be one of these two things. They either bought a business and paid way too much for it or, they have been booking future income from debit cards all in one lump sum when a revenue stream from debit cards is somehow “acquired”. In either case, they should not be downplaying it as basically nothing and should admit that it is a $10 Billion mistake or misrepresentation. In fact, if they had been transparent and explained how the goodwill came to be there in the first place, I would not have put the word “misrepresentation” into this post. But when you dissemble that is what you get. Neither the Merrill nor the Countrywide acquisitions should have resulted in a humongous booking of future debit card revenue, so I suspect there is funny bookkeeping going on. Probably legal, but still misleading.

The second petty truthiness issue has to do with this press release. Bank of America is announcing the hiring of 1000 Small Business Bankers. This should be a good thing. We need more effort on Small Business. So why do they have to let their marketing people put number into the release which misrepresents what Bank of America is doing in Small Business? What they said in their press release is that:

In the first half of 2010, Bank of America has provided $45.4 billion in credit to small and medium-sized companies and is expected to meet or exceed its pledge to increase lending to those businesses by $5 billion in 2010.

In Bank of America’s actual financial statements they break out Small Business Lending totals. In December, 2008 they had a total of $19.1 billion outstanding. In December, 2009 it had shrunk to $17.5 billion. In their earnings report for September, 1010 it had shrunk to $15.2 billion. Since these figures represent the gross loans outstanding, the $45.4 billion in supposed credit extended in the first half of the year really tells you that the vast majority of their lending is to medium-sized businesses, which are probably those with over $25 million in sales, and that they are hiding the small business credit production numbers in this big number. They are losing ground in small business lending. A further little snippet in the fine print says that “commercial credit extensions include a significant number of credit renewals”. In other words, they have told us nothing! These production number include credit renewals, which are not new loans at all.

Transparency? Apparently that is against policy. Come on guys, just tell us the truth and what you intend to do about it.

October 17, 2010

How Do We Judge the Homeowner?

Filed under: Running Commentary — thefourteenthbanker @ 8:21 AM

In the rush to foreclosure, the banks and even government officials have been taking the position that the borrower/homeowners are fully to blame for the situations they find themselves in and that the paperwork technicalities just need to be worked out in order for there to be a just outcome, which is to say, a foreclosure.

Industry executives note that few, if any, borrowers in the foreclosure process dispute the fact that they’re not paying their mortgages. “We’re not evicting people who deserve to stay in their house,” James Dimon, J.P. Morgan chief executive, told analysts Wednesday.

Okay. This seems simple enough. The contract between the bank and the borrower says that the borrower will make their payments and that if they don’t, the bank can foreclose. Assuming the bank did everything right, it can.

We live under the free market paradigm and that is simple free market and contract law cause and effect.

But, what if the borrower was defrauded in either a legal sense or a moral sense at the inception of the contract? That may not make the contract unenforceable, but does it make the enforcement inequitable? Does it erode this moral high ground that lenders are claiming?

Perhaps we need to be more discriminating here.  Some time ago I posted on asymmetrical information in regard to one type of transaction. But suppose that there was asymmetrical information at the time the mortgage was originated? According to Dealbroker, Jamie decided on October 2006 to get J.P. Morgan out of Subprime. According to the article, the JPM team decided that quality control had slipped at the originator level. What might this mean? I suspect “quality control” is a euphemism for rampant fraud. So lets just say that October, 2006 is “Day Zero”

It used to be said that a business person needed a good banker, a good accountant, and a good lawyer. (Now it might be said that a banker needs a good lawyer)  Implied in this is that there is a professional relationship and that the customer depends on the advice of these professionals. Bankers have until recently seen themselves as professionals. In the less heady days of local banking, the President and senior officers of the bank made the loan decisions. One of them generally had a relationship with the borrower. They knew the borrower and had their interest in mind along with the interest of the bank. There was a certain implied fairness at work. The judgement of the banker often accrued to the benefit of the borrower. If the banker though something was a bad deal, they said so. If they thought the borrower was making a bad investment either in general or in relation to their specific circumstances (knowledge, skills, income, liquidity, time horizons…) they would tell them that.

The mechanistic finance models took that away.

So is there any difference in the way we should look at someone who purchased a house on Day Zero minus One versus Day Zero plus One?  Perhaps before Day Zero, the general conditions in the market were that everyone was wrong. Everyone thought prices would continue to rise. Everyone thought the rising prices would mitigate the imprudent loan processes and structures, the no-doc loans, the 97% loans or 120% home equity loans. At Day Zero plus One, that changed. The caution light should have come on and the relationship of the professional banker to the client should have included caveats about the investments that were being made. This is idealistic, I admit.

But, someone should investigate when JP Morgan and every other bank changed their policies in regard to loan to value, income verification, product recommendations to customers, instructions to bankers, incentives to bankers, etc. If banks knew in the Executive suite or the research department that the fundamentals were turning ugly, and still kept making loans and shoving them into government guarantee programs or selling them to investors, then there is no moral high ground. The information asymmetry was used to make more money. In a moral sensibility, the contract should be looked at what it was, a gamble by both parties. If at this point in time the stupidity of the lender has allowed the contract to become unenforceable, then that is the lender’s problem. Too bad, so sad.

Now, none of this absolves the borrower of responsibility for their decision. It just puts the borrower and the lender on a level moral ground and perhaps they find themselves on level legal grounds. If that is the case, the lenders should get off their high horse and negotiate modifications that share the losses between two equally culpable parties.

October 14, 2010

What Did They Know? When Did They Know It?

Filed under: Running Commentary — thefourteenthbanker @ 8:36 PM

The markets finally woke up to the mortgage fraud debacle. JP Morgan, a day after beating earnings expectations, is off 4.18% for the high water mark of 48 hours ago. Bank of America is off 11.9% and Wells Fargo is off 5.9%.

Even CNBC is acknowledging the fears that are sweeping the marketplace. Today they reported that there are fears that earnings could be impacted more than expected, perhaps way more than expected.

With perhaps a tiny bit of understatement, David Fabor states that:

It appears the mortgage content of many of those pools—created when the banks were dominating the mortgage securitization market in 2005, 2006 and 2007—may have been misrepresented.


Yet perhaps most interesting is admission by JPM that they ceased using MERS on some transactions two years ago. One wonders why? The answer from spokesman Tom Kelly was vague,

So I asked Kelly why they dropped MERS. First he said, “In truth some courts won’t accept MERS for foreclosures.” But then he said it was “a matter of policy.” I’m sure they don’t want to come right out and say, well, we’re not exactly sure MERS is all that legal.

Oh, and something I noticed in the earnings … JP Morgan upped its reserves for “litigation and repurchase.” Repurchase refers to when the bank is forced to buy back loans (called “putbacks”) from the investor or security due to some problem with the origination. They have the biggest reserves of all the banks, according to experts.

This is not a new crisis. This is a continuation of the crisis that surfaced three years ago but began years before that. The many individual stories of homeowners who were wrongly evicted, or had their homes broken into, or had false documents created and presented to the courts are all pointers to the rot, the toxicity of the assets in question.

So the questions above are addressed both to the CEOs of the major banks and to the primary architects and defenders of the bailouts. See, despite all the assurances by Geithner and Bernanke, all is not well with the bailout. Instead, the government and the mega banks are in collusion to deceive the broad public, the investing community, (which keeps getting smaller) and international private and public economic players. It appears JP Morgan has known that all is not well but has been acting as if it were.

This post addresses much more thoroughly what I alluded to a few days ago. The Fed owns this crap and that puts the government in bed with the bankers. I will just pull out one section.

The free-market, let the banks do what they do mentality was what allowed them to create a $14 trillion mountain of securities backed by precarious mortgages to begin with. Don’t look at what they’re doing, that might hurt the boom. Don’t ask them for anything in return for bailouts — that might clog the system. Don’t stop them from churning foreclosed properties — that might stop the recovery.

But the real reason for Geithner’s reluctance about a foreclosure moratorium is that he’s scared stiff about those securities – because even if he won’t admit it, he knows that the bailout wasn’t just about TARP and Bernanke isn’t just an economic savior.

The government owns or is backing trillions of dollars worth of assets predicated on the same or similar suspicious loans that defaulted during the 2008 crisis period, which they did nothing to stop (or force banks to restructure).

I believe the intent of Geithner has been to deceive for political purposes and to protect the markets, which is really to protect the existing wealth distribution and power structure.

It is time for an investigation of banks, the executive branch, and the Fed to answer the questions, what did they know and when did they know it?

October 10, 2010

Foreclosure Fraud Parody

Filed under: Running Commentary — thefourteenthbanker @ 6:33 PM

Hat tip Z/H

Auto Repairs and The Financial Crisis

Filed under: Running Commentary — thefourteenthbanker @ 2:26 PM

The other day my vehicle was making a rubbing/grinding noise that was noticeable on low-speed turns. From prior experience, I knew it was probably wheel bearings, power steering, cv boots, axles or some such. As you can tell, I did not know much, just what I had paid for in previous experiences with similar symptoms.

I received a recommendation for a local auto service place and decided to try them out. After leaving the car with them a few hours, the actual mechanic called me back. Note, it was not a “service advisor” or the intake person. The mechanic told me that the power steering fluid was a little low but he could not detect a leak. He said he topped off the fluid and suggested we just drive the car awhile and see if there is some very slow leak that is undetectable. He also told me that the last person to change the power steering fluid might have just left it a little low. When he paused, my response was “that’s it?”  Yes. I asked if he inspected the front end and he said that he had and there was a cracked CV boot but no wear as yet. He did not recommend changing it because I could drive it awhile and repair the whole thing later, including the axle, for about the same money.

Then he put the business owner on and I asked him how much it would be. “Nothing”, he said. No service fee, no charge for time, no charge for fluid. I told him he had a customer for life.

The business itself appeared to be quite successful. While not on a main street, there were two nice new buildings and plenty of apparent work, which could only come from word of mouth. This place had zero street visibility.

As I was pondering this later, it occurred to me that the staff must not be under “metrics” and “goals”. Rather, they had an innate desire to provide a quality customer experience and to do the right thing for the client. They had a faith that if they did so, they would have a loyal customer that would come back to them when a real repair needed to be done. Do you know what, they are right. I will only go to a new car dealership in the future for a complex problem that only they have the diagnostics to fix, after these guys tell me then cannot handle it. And I trust that they will tell me that if it is the case.

I did a quick internet search and quickly found a site that discussed metrics for Service Advisors. The terminology that began to jump out at me reminds me of that we find at large banks and corporations of every stripe. There are lots of metrics and the article discusses how if you compare individuals on the metrics the measures go up. Apparently in the auto repair business, metrics are such things as:

  • Average up-sell per advisor
  • Additional recommendations per Repair Order
  • Additional average Customer Pay per Repair Order
  • Warranty to Customer Pay conversion

Customer declining of these additional up-sells are seen as a problem, so the industry has developed tools and techniques to overcome objections. They have found that if the advisor walks the customer through each recommended repair and “prioritizes” its importance, the customer pays for more repairs. They can use printed reports to help with this. The Recommended Action Plan can itemize all the suggested work and highlights in color (presumably red), those that are most urgent.

Now I have had some experience with this process. I use a variety of places to service my auto based on convenience. If I am out at one office and there is a quick lube next door and I need an oil change, I will just get it done. I may even flush the radiator, rotate the tires, or do something else. Once at a new car dealership, a service advisor gave me this long list of work that he recommended and I asked where did he get this from? He told me that it was basically the list of everything that had to be done at certain intervals. If for example, my car had 80,000 miles on it, he might recommend a timing belt, even though I had someone else change the timing belt six months before. If I was not paying attention or did not remember what I had done, which is more likely the older one gets, I might just authorize the work. It had nothing to do with the condition of the vehicle.

I am not against using metrics. They are important tools for accountability and to compare performance. But they go horribly awry when the metrics are wrong, there is little subjectivity, the compensation is tied to the metrics, the interests of the employee and the firm are elevated above the customer’s interest, the numbers are easily gamed by ethical lapse or cheating, etc. There are also many important work products that cannot be captured by metrics. I would love to see a metric in an auto shop that measures what my mechanic did. We could call it, “Sending The Customer Home Without Charging Them Anything. It might actually be the most important metric of all.

What does this have to do with the financial crisis? There are two competing models here. One model is about extraction and consumption. Extract as much as you can so you can consume as much as you can. The other model is about preservation and investment. My new mechanic believes in preserving my money and investing in the relationship. In so doing, he also preserves his time, does not wear out his equipment, and perhaps provides faster service to other customers. With the time he is not spending doing unnecessary repairs on my vehicle, perhaps he is working on another vehicle, helping his spouse, or playing with his kids. There is a benefit to both of us that cannot be measured in currency.

The current mortgage foreclosure crisis is a result of “extract and consume” thinking. How many tales are there of borrowers that bought more house than they could afford on false “stated income”. The mortgage originators must have been hitting some great metrics and getting big payouts. What about the lenders that made so many loans they did not have time to process the paperwork afterwards. Great metrics. Big payouts. What about the investment bankers that packaged these deals up and sold them to unwitting investors? Great metrics. Huge millions in payouts. What about the banks that loaded up on this stuff, many of them knowing the shortcomings but also knowing that they could get short-term results and that hopefully home prices would rise forever and everything would be fine? Great metrics and fantastic bonuses. What about the Federal Reserve that now owns much of this crap? Oh, never mind.


October 9, 2010

Mortgages 101

Filed under: Running Commentary — thefourteenthbanker @ 2:56 AM

Here is a good primer with graphics on the basics of mortgages and Residential Mortgage Backed Securities (RMBS)


October 7, 2010

CNBC Article Wants Banks to Skate on Foreclosure Mess

Filed under: Running Commentary — thefourteenthbanker @ 1:38 PM

CNBC has this article up this morning decrying the politics of foreclosure. Yes, it is political. But look at the nonsense of his argument.

Yes, the process is flawed because the banks clearly aren’t equipped to handle the numbers.

Yes, there may be some loans that could have been saved, but the vast majority can’t.

Still lawmakers want to freeze all foreclosures to make sure all of them are fair because, as Speaker Pelosi writes, “People in our districts are hurting.”

The question is, how much would a foreclosure freeze hurt the greater housing market?

What do these questions have to do with it? Either there is a legal process and the banks spend the money to follow it, or they bear the consequences. That is free market capitalism. So far, no one has proposed a new law or regulation. They are just asking the banks to follow the laws that were in place when these mortgages were originated and sliced and diced into securitized assets. If it now costs more to process the risks that were in those portfolios, the folks that made the bets should pay the costs. Simple and elegant.

I asked some mortgage mavens and got the following responses:

Josh Rosner, Graham-Fisher: With REO sales being a large part of supply we would see home prices artificially and unsustainably rise, foreclosure volumes paint a false picture of stability and investors in MBS would be further harmed as their losses grow. Once the moratorium ended prices would fall and foreclosures would skyrocket. But, it would paint a prettier picture than reality heading into mid-term elections.  14 here. This is nonsense. Nothing much will change before the mid term elections. Red Herring.

Guy Cecala, Inside Mortgage Finance: Instead of having a ton of mortgage borrowers who haven’t made any payments in at least a year, we would have a ton who haven’t made a payment in a year-and-half. Keep in mind we will have new problem loans entering the system throughout any moratorium whether we acknowledge them or not. Do we seriously believe that a foreclosure moratorium can change the outcome of potentially 5 million or more homeowners losing their homes over the next two years? Ultimately, if we don’t do something to handle distressed properties more efficiently (and faster), the housing market is going to remain stuck in limbo with no recovery in sight.  14 here. So we trample legal rights to process distressed assets efficiently? That is a slippery slope.

Janet Tavakoli, Tavakoli Structured Finance: Banks are vulnerable to lawsuits from investors in the [securitization] trusts. This problem could cost the banks significantly more money, which could mean TARP II.

Is this really so bad that we will need TARP II?  That seems like fear mongering. The lawsuits will drag out for years and will not cause a sudden collapse of banks unless people figure out the banks are not solvent anyway, in which case we need to clear the banking market the way they suggest we clear the real estate market. Then we can capitalize a new banking sector. If $700 Billion were put into capitalizing new banks, we would not need to old banks at all. Let them wind down.




October 6, 2010

Mortgage Mess Battle Lines Being Drawn

Filed under: Running Commentary — thefourteenthbanker @ 10:52 AM

Two new posts today articulate where the battle lines are beginning to take shape in the Mortgage Foreclosure Fraud mess. Because few mortgages are held on bank balance sheets, having been sold into Mortgage Trusts which support Mortgage Backed securities (MBS), there are parties who may find themselves at cross purposes. Then again, mortgage investor coalitions may try to hang together, lest they all hand separately. Regardless of the extent to which groups of investors do or do not become antagonistic, individual renegades will doubtlessly stir the pot.

So this Zero Hedge post points out, while referencing the WSJ, that three of the parties involved in the typical deal form a sort of triangle. I guess this is like a love triangle, after the lovin’? They are connected to one another but also opposed to one another. The mortgages are held in a Mortgage Trust. Cash flow from the Trust is paid out to the various classes of bondholders. There are always Senior bondholders and Junior bondholders. Much of the paper referred to as “toxic” is that held by Junior bondholders. They take the first loss. With the declines in real estate values and large numbers of defaults, the first losses are quite large and may in some cases be 100% for some Junior classes. But, while the Mortgage Trust still lives, the loan Servicer must advance moneys to make the interest payments on the bonds. So the longer the Trust is alive, the more payments the Junior bondholders get. The Senior bondholders don’t like this. In seeking their recovery, they would like the Trust to unwind as quickly as possible and the recoveries to be credited to them. They do not want to trade time for cash flow, because some of that cash flow goes to other creditor classes. Because these classes are at cross purposes, the likelihood of litigation is very high.

To wit: junior bondholders will rejoice as they will receive payments for the duration of the halt/moratorium (these would and should cease upon an act of foreclosure), while senior bondholders will suffer, as the deficiency money will come out of the total “reserve” in the pooling and servicing agreement set up by the servicers. As for the servicers themselves, they should be “reimbursed by funds in the trust for all costs related to litigation and extra processing of foreclosures, provided they follow standard industry practices.” In other words, it will now become “every man, sorry, banker for themselves” as each party attempts to preserve as much capital as possible given the new development: juniors will push for an indefinite foreclosure halt, seniors will seek an immediate resumption of the status quo, while the servicers stand to get stuck with billion dollar legal and deficiency fees if it is found that “standard industry practices” were not followed. Alas, it would appears that the servicers have by far the weakest case, and the impact to the banks, whose sloppy standards brought this whole situation on, will be in the tens if not billions of dollars. Oh, and suddenly both junior and senior classes will be embroiled in very vicious, painful, and extended litigation with the servicers. Lots of litigation.

As you can see, the litigation will doubtlessly be directed at the loan servicers who created this next generation of destruction. If it can be proven that the loan servicers did not follow the proper servicing procedures, they will be liable for damages. We are talking billions of dollars in damages.

Naked Capitalism raises additional issues around the jockeying that is taking place. The servicers are mostly large banks and Ally Financial. Three of these have suspended foreclosures while the do document reviews to determine the extent of the problem, and to buy time for lawyers and lobbyists to cast about for solutions like the Ringwraiths.

Per Naked Cap:

Yves here. This development reveals how this battle is likely to play out. Now that judges in some states are starting to take these dubious, potentially fraudulent measures seriously, the next line of attack is to get the more bought and paid for Federal government to intercede on behalf of the banks. As the e-mail by the Ohio Secretary shows, this is a state versus Federal rights issue. And the problem is that these solutions will be depicted as “efficient,” just as securitizations and other “innovations” were.

And while efficiency in theory is a good thing, it must always be kept secondary to the overall integrity of the system, otherwise, you run the risk of breakdown. Using dubious arguments to overturn well settled law to get the banking industry out of a monster mess it created is a Faustian bargain. It makes it abundantly clear what is really at stake here, which is the rule of law. Banks that were quick to defend unjustifiable pay deals by invoking “sanctity of contract” have no inhibition about ignoring their own contracts to pad their bottom line, and ultimately, the wallets of top executives.

Rather than deal with the considerable consequences of these abuses, the banks are prepared to bulldoze well settled state laws to give them an easy way out. And I’m not basing my view on this story alone; I had a conversation yesterday with a Congressional staffer who matter-of-factly said (but with little understanding of the underlying issues) that Congress would intervene on behalf of the industry, via its authority over national banks.

The “document reviews” are being done internally and any report on the findings should be taken with several grains of salt. The interest of the banks is to minimize their culpability.

A referee will be needed to sort this out. Perhaps Sheriff Elizabeth Warren will step into the gap.

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