The (new) Financial Tsunami thread

[comokate]

Post 45)
There can be a resolution for a lot less than $10 or $15 trillion if it were applied to the proper spot in the proper way, but it will require detective work and a penetrating look into those mysterious or invisible books no one seems anxious to release for an evaluation. Accountants know how to do precisely that pretty darned effectively if you give them the missing pages and turn them loose.Nobody seems to want that!! Why doesn't Congress call for the pages? I believe because we would end up with a solution that might seem eerily similar to my prior proposal. The enriched folks would rather let the world's financial system slip down the drain before they'd put the money back on the table.As for the cancellations, settling of claims and balancing of accounts which would remove this sword Damocles from overhead , it's done every day in the banking industry all over the world, without mystery, without errors. It's a matter of basic banking business and a well known basic economic fact in monetary studies, clearing house process.

Post 46)

Basically, if we disregard the failure of the regulation and supervision of the dear folks who delivered us to this mess for the time being, we face a threat based on capital, liquidity and risk. It must be apparent to all that term commitments came due unexpectedly, before we were prepared to honor them, and the sudden demand by everyone trying to set their own accounts in order emptied the community pot too soon. If the risk managers had been alert or allowed to act on what might be considered normal impulses, they would have looked at the balance sheets and declared we were heading for a reckoning we could not meet.
There's an integrity among the bookkeepers that leads me to believe that someone who did not fully understand the consequences instructed them not to sound the alarm. Whether it was a matter of protecting what was left of their firm's integrity, or fearing a run on their resources, or the sheer embarrassment of being caught ignoring the inevitable, we'll never know. But once management started down that track, they couldn't change directions or momentum, or even switch lanes. They were committed. I doubt that a public flogging, the stockade or any other form of public humiliation would ever induce them to publicly confess to what was done, by whom and for what reason. They are committed to a universal and generic tight-lipped silence to a man, even though you can see guilt all over their faces when they appear on camera in Washington.
One thing is certain, there were accounting documents which could have been used as forensic evidence to retrace precisely what happened and when. Accountants and bookkeepers don't allow things like that to pass without noting it in their ledgers. Whether those pages still exist or went the way of the disappearing eighteen minutes of no longer recorded conversation, we're likely never to know.
Keeping those records is the function of accounting. People think of ledgers as numbers and detailing a condition, auditors and regulators think of books and ledgers as an history. Compliance, commitments, observing regulations (as well as organizational health) is found in all the ratios, entries and charts of accounts up and down the books. If they are not there, there is the obligatory memorandum and notation to explain. On the performing level, a qualified accountant, or even bookkeeper, would do no less. Eventually the books could be altered by someone else, but the entries would have been made. It's an obsessive compulsion on the part of bookkeepers.
This is mentioned not so much to say we should we turn the vaults upside down in a futile search for the incriminating records as it is to mention that if we intend to regulate the firms most likely to repeat the offense and again jeopardize the financial system, first regulations should be directed toward the accounting function to render it failsafe.
This is especial relevant in the case of those firms (be they still considered banks or brokerages, or whatever following the great redefinition forthcoming) who are large enough, with enough of a sphere of activity, who can exert the pressure, almost on their own, that would threaten to bring the system down. Since they're so powerful, they should more subject to the microscope than less capable institutions or enterprises.

[comokate]

Post 47, 48 )
Accounting standards will have to be stricter than ever before. The books need to be inspected more frequently, more thoroughly and questionable entries would have to be explained in excruciating detail to remove any and all doubt.
I'm not for "more transparency". I don't like the term. It's too indefinite. I'm in line with VL's insistence on FULL DISCLOSURE. (PERIOD). Get them to commit to more transparency, or even an unqualified transparency, they'll find a way around the terminology and you're inviting a repetition of the fiasco. Get them committed to full disclosure under penalties, and you're more likely to get the sun shining in the dark places again. You'll see some grim faces when they reappear before Congress, but their faces will reflect irritation at being forced to conform and cut off from the unlimited opportunities to fleece the world's financial systems, not guilt.
Once the books are ready to be setup and operate under the stricter standards, auditing should be required on a frequent basis. Not once or twice a year, the firms in question should be audited as often as necessary to make the audit a meaningful constraint by not losing track of what's transpiring.
So, soon after we issue the order to "Stop! Don't do that anymore"! and we get out of the "receivership" mode of strictly controlling operations of the offenders, (believe me, the people in Washington, the Fed, the FDIC, the SEC know who the offenders are) the birth of uncompromising integrity in the new era of bookkeeping will be in place and operating.
We need this!
There's yet more to come. This is not an easy task. The hole is deep and it's dark down here.

[comokate]

Post 49)
A slight nod to recent history might be in order here. Late summer in 2007, a Paul Krugman NYT column began:
Old-fashioned bank runs don't make sense these days. New-fashioned bank runs, on the other hand, do make sense -- and they're at the heart of the current financial crisis. The key to understanding what's happening is taking a broad view of what constitutes a bank. From an economic perspective, a bank is any institution that offers people liquidity -- the ability to convert their assets into cash on short notice -- while still using their money to make long-term investments.

Two things are notable. (1) Krugman, who is active on several international committees and entities serving banks and markets, describes the problem, or mechanism of the collapse, if you prefer, that did not become widely discussed until about nine months later, (the standard gestation period); and, (2) he, and a number of others in the international banking scene were well aware of the disastrous course we had been pushed onto by non-banks, meaning brokerages, their money funds, hedge funds, mutual funds and the like, back in the summer of 2007.

Knowing is one thing, being able to do something about it is another -- especially when the guilty parties do everything in their power to ignore, conceal and deny the path to disaster. It didn't help matters much by having a lot of folks not on the "inside" trying to hush those who could see the writing on the wall and were trying to forewarn people of the problems the world financial centers faced even when we were a couple of months into the now acknowledged recession.

In early September, 2007 the descriptive phrase, "non-bank bank run" escaped into the media and died a quick death. Whether the descriptive term was inappropriate, or suppressed, or conveniently ignored lest some skittish people become alarmed and cause a real run on banks (which then would be a "bank bank run" I'd suppose), it passed away quickly. Among others who knew of our developing situation was the President of the European Central Bank, M. Trichet, and some other rather important, experienced, well educated, European bankers. Perhaps, it was easier to see and discuss the truth from a distance. But, the point being that world bankers were already discussing what the pollyannic US financial sector hoped their tight-lipped, determined neglect would help disappear. It didn't. It simply exacerbated. Which could show how inept those in the position to do something were or how fright forced them into a defensive posture, something akin to the fetal position, a very reassuring note to the industry and to the US public .

And, we know what happened subsequently: we underwent a series of failures and takeovers that left the US financial scene in a shambles which promises to dog us for another four or five years. We're in the process of reinforcing the perception that we are unprepared and/or unwilling to take the necessary steps to treat the problem and take the path that would lead us out of the deep hole.

[comokate]

Post 50)
What does it mean when professionals elsewhere in the world can see industry problems and our experts cannot? Is it a matter of education? Different outlook? Or, simply the distance that allows the foreigners to be objective? If we don't have leaders who can be equally objective, we're in for a tough sled ride. Think, too, of the timing. I'm talking about publications at the beginning of September, 2007. US Economists acknowledged that the US "recession" began in December, 2007. And people in international banking circles were trying to deal with or least call attention to the slippery conditions bringing on the crisis months prior to that, while we had our heads safely buried in the sand.

[comokate]

Post 51)
When we were in the process of lowering our interest rates to zero in that inexorable march to nothingness, Europe was trying to hold the line on their interest rates, trying to fight the inflation they anticipated. And, we were fighting deflation, and still are! And, our household budgets, even if our income remains the same, are suffering. I believe our economists would benefit from economics courses at the University of Konstanz or the University of Siegen. We may then develop the insight to understand the leading indicators of financial collapse, or the courage to call a spade a spade.
If past performance is any indication of future policy, what I may now see as four or five years recovery period, may eventually stretch out to seven to ten years recovery. . . or, however much time it takes to change the leadership and find someone with the proper practical training and experience to address the underlying flaws in the system successfully.
What needs to be done?
We've already pointed out that the credit structure in US commercial banks is overwhelmed. By floating uncontrolled amounts of credit with no ties to reserves, we've not only nearly incapacitated the banking system, but we've introduced what amounts to a flood of American dollars throughout the world, inducing inflationary trends. Those countries who were not previously threatened with inflation are now putting inflationary controls in place. Also, banks are loaded with long term investments and have taken out short term loans loaded to the gunnels. That condition is called bankrupt. As fast as we pour money into the hole, it's used to cover the operating expenses, the reserves intended for that were used for the gamble. The boat analogy can be extended a little further by using the definition of a boat, "A big hole in the water into which you pour money".
What is the first order of business? Retire that funny money that banks and brokerages have circulated world wide. Stimulus won't do it. Bailouts won't do it. Accountants know the way out. What we need are some people willing to put their ear to the heartbeat of the world and listen to what's being said out there and heed advice. It's out there and it is circulating. Good advice is available.

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Post 52)
Second order of business is to chain the wild-eyed drunken cowboys to restrain their impetuosity. Then, provide strict regulations preventing them from issuing unsupported and unlimited fiduciary media; establish stringent reserve requirements; force off-book accounts onto the books (let's don't go on kidding ourselves about this serious matter, look it square in the eye like honorable people); make strict licensing requirements for upper echelon bank and brokerage management; train directors in the strategies crises can be dealt with (if they're uneducable, get rid of them!); enable agencies with the strong power to regulate effectively; (here's a tough one) regulate markets to prevent the contamination from spewing out again; communicate and coordinate our efforts as near as possible worldwide to prevent those "international entities" with branches worldwide from escaping local regulations too strong or restrictive for them to accept; if the amalgamated corporations are too big to be handled effectively during crises, break them up again; change the accounting standards (in particular for the larger institutions) to prevent them from putting the world system in jeopardy; establish ratios and benchmarks which flag danger points and have the institutions report on those standards on a regular basis; empower agencies to examine, more frequently and more thoroughly the status of the institutions unannounced; lay out a plan for support or shut down of banks that show weaknesses which if too pervasive and banks are too weak to manage their way out of their difficult, admit they are mismanaged and allow them to die; exercise strict risk management controls to prevent instruments like the derivatives from appearing again under any name or description; establish safe levels of minimum reserves and enforce them vigorously; every issue from any entity that popped up during the crisis should be addressed and assessed for any needed corrective action.
This is a big, project and it needs someone or some group with the expertise to decide what action can be taken immediately, what can be done short-term, mid-term, long-term, pretty much along the lines that the G20 has under consideration. and we should be hearing about in the beginning of April.
Through this all, I feel an urgency that the financial detectives apparently do not. They are just liable to put everything on a long-term timetable while we slip further down the incline.
Post 53)
What is unclear to me is by what path that "leadership" can reach this conclusion within a highly collusive and deceptive nexus of politics, the Federal Reserve and banking/non-banking sectors of our civilization.

Open the windows and let the smoke clear out.

Obama hinted in his speech this afternoon, that the banks are somewhere near the head of the line for the next corrective push. If so, it can't come too soon to please me.

To arrive at a point where we are prepared to adopt effective policies or programs, we've got to rid ourselves of the propaganda fantasies built on short misleading mottos: such as "Too Big to Fail". I'd prefer labeling them as too big to continue existence. There's no call for enterprises being so big that should they fail, the entire system goes down with them. Teddy Roosevelt was the last great champion of the idea that no one enterprise should be of such size that our existence, welfare or survival depends on them. I'm almost tempted to include the government in that picture frame.

Post 54)
In your strategy to unwind these huge corporations, are you suggesting that we separate the insurance companies and the brokerages from the banks. . . .

It's a kitchen countertop verity that putting an apple in a bowl with other fruit will ruin the apple post haste as well as prematurely endanger most of the rest of the fruit!

Insurance may be considered a kin to those apples. It's a far different species than banks in every conceivable way. First, management: supposedly the idea is to put aside reserves to cover not only catastrophic emergencies but normal failures of every day events and normal life cycles of whatever they underwrite; additionally, they are expected not to indulge in risk investments in order to conserve and protect funds; then, their expectations of disbursements are controlled by the trained and extremely reliable expertise of actuaries; next, their MO, which has been conceded complex enough to dissuade or discourage the IRS from exercising any meaningful control or counterarguments on disbursements thereby leaving insurance in the comfortable field of self-regulation; and finally, they are not regulated by the federal government but by state regulations (Or, if things have changed since I was active, at least, they were that way).

Now, suddenly, they are merged into the bank makeup. I had contacts with executives in Citi while I was active and have tried to get a grasp on how and by whom the Travelers functions are now regulated, generally without success. Of course, there's no hope of discussing the commingling of funds. If there's no description forthcoming, my curiosity and suspicions are aroused. I don't believe they belong together unless management wants to double operating and management expenses and conceal whether or not the insurance end is abiding by the "ethical" standards that served the industry since time immemorial.

In the 1980's there was an drastic upheaval in insurance which might not have been noticed by most of the public, but in business it was a severe blow. One committee on which I served, very complimentarily and flatteringly "elected" me head of the insurance committee seeking renewal of D & O (Directors and Officers) coverage. At that time, news coverage had headline stories of independent company owners declaring that the new schedule of premiums was so onerous, they'd elect to go bare and risk losing their company before succumbing to the unreasonable charges.

I discovered that where we had been able to get $15 million coverage for less than $3,000, we were now facing a maximum of $5 million coverage for a premium in excess of $6,000. A VP of Equitable was a close cousin. I pestered him about this fee and the reduced coverage to no avail. The people I approached were at the very top of blue chip insurance companies (you might recognize a name or two) and there wasn't a break in any of their proposals. My cousin had warned me that they would all resort to placing the policy with the same underwriter so there'd be practically no difference regardless of whom I contacted.

This was the start of the melding of insurance and banking. And, this is what was promised for all insurance.

Post 55)
Among the results have been the infamous raiding of the pension funds of approximately 25 years ago, which resulted in people getting anywhere from 40% to 60% less than they had anticipated for retirement due to lack of "under-funding". It also is the result of their catastrophic funds running dry because they have a new temptation of watching funds lying fallow, waiting to be used. Despite the accuracy of the actuarial predictions, insurance companies are acting like brokerages in high risk areas or in long term lucrative investments that end up depriving them of funds when needed.

[comokate]

Post 56)
One of my favorite banking companies, stationed an annuity salesman in the lobby who made a pest of himself every time I walked in the door. I told him, and then the bank manager, I didn't want him anywhere near me or I'd find another bank. He desisted, but I couldn't tolerate the bank's attitude with the new alliance they had and decided it was not the company I cared to conduct business with. I imagine I was simply dismissed as a cranky old coot, but even cranky old coots are entitled to their privacy.
The three entities, banking, insurance, and brokering have different goals, are regulated differently, and should be managed separately. Regulation is impaired in trying to separate their operations and trying to keep the accounts straight. This, of course, is the principle reason for the merging. Now, insurance can disregard the actuaries and put the unguarded funds in their pocket at will and worry about coverage somewhere down the road, much the same way the brokerages have disregarded thoughts of regulations in their handling of derivatives. I have a sense that the insurance/banking merging was the trial forerunner of the derivatives venture. It's unconscionable as well as impractical.
do you think that companies like Goldman and JP Morgan should be able to maintain their status as "bank holding companies,"

NO! For reasons I mentioned in the above reply among others. In addition, regardless of whomever assumes the CEO position, he comes from one or the other function, banker or broker, is schooled in that mode of thought and could contaminate and inadequately serve the process of one or both of functions. I believe banking and brokering are too unlike both in operation and function to be merged. (But, I'm old fashioned.) One of the dangers we arrive at is the "Too big to fail" mode of thought which I believe is the stupidest non-justification ever expressed. If they're stupid enough to put themselves in the extremely vulnerable position to fail, they should be allowed to go all the way and wear the striped suit that goes along with the notoriety. Separated, we might be able to save all three of the entities in a catastrophe but as one they may be beyond even the Fed's resources to be considered salvageable. As a result, they'd cause more threat in what might not have as threatening a situation had they not been coupled.

Having brokerages in the Fed system (a status to which bank holding companies are obligated by law) places additional strain on the Federal Reserve System which by extension includes all member banks as well as the Reserve Banks themselves. In view of the vulnerability the system has subjected itself to at this time, I'd think it would be the last burden the Fed would consider taking on. Divesting brokerages and insurance companies is a simple thing. All the Fed need do is declare that they had proposed the union in order to salvage the financial system in a time of crisis and when the situation improves the Fed can acknowledge that the merging of the industries is too much of a risk and burden and banks can spin off the brokerages and insurance entities and return them to the proper size, status and regulatory authorities.

Post 57)
I believe they acted too hastily. The entire sequence seemed staged to me. Bear Stearns was assimilated and I posted a warning that the others would want in on the salvage work and the fees involved. They screamed "unfair" and the Fed went to work to spread the non-existent wealth throughout the industry, which, truthfully, was neither their responsibility nor obligation. Volcker saw fit to comment on the "extraordinary" move at the time, if you recall. Without justification or authorization, the Fed stepped into an open door with their storm trooper suit well-pressed and in evidence. That was not a role I pictured for them. I'd like to see them step back a bit and rethink what they've done, even though I picture an unavoidable larger role for them in the regulation function eventually.

Post 58)
. . . in the context of allowing the largest banks to simply fail, . . .



In re-reading my responses above, I seem to be coming through as a little Caesar. There are opposing instincts at work here.

A little lightness as an aside may be in order. More than ten years ago (I believe) I attended a meeting which Volcker moderated and he told this little anecdote to the assemblage:



When he was President of the NY Reserve Bank, a bank was threatened with failure and he thought it might be a good thing for the industry to see a failure take place. It might "teach them a lesson". Then, on further reflection, he said, "But, please, God, not in my District!"

Later when he went to Washington, there were other threatened bank failures and he thought again that it might be a good thing to have a good bank failure to teach the industry some restraint, but on further thought he said, "But, please, God, not in my country!"

After he'd left the Fed and Rubin and Greenspan were dealing with a disastrous situation south of the border (it may have been Mexico?) Volcker was thinking that Rubin and Greenspan were in Washington thinking it might be a good thing for the world's banking system to have a good country failure to teach them a lesson, but then he realized they were down there saying, "Please, God, not in my hemisphere!"



It may sound heartless to advise a cut and run situation, but many posters on JJ's threads have expressed pretty much what I believe.

My oldest son was an entrepreneur of sorts, He studied business administration and was privileged during his short life to have had a number of opportunities with some well-established companies and started up a couple of ventures on his own. We all know that nothing is guaranteed. He was with one company that was merged with another and was the victim of staff cutbacks, went with another and they went bankrupt, started up his own business in Texas, supplying oil fields, and the bottom dropped out of that industry, so he declared bankruptcy.

He was able to get another position, so he survived and, I thought, tolerated it well. But, later, we spent time talking about his experiences and once he asked me why my life went so smoothly and he had so much trouble. He never remembered our having any difficulties. For the first time, we discussed in great depth the depression, WWII, the struggle through the interrupted education process, then, first my turn to get an education, then his mother's turn, then the two of us for post graduate work. Included in this were a lot of the confrontations, I'd put out of my mind, that cost jobs or money, or both. The struggle to get my ideas down on paper, my alliances with publishers, agents, and co-authors. It was then that the both of us came to realize how much compromise life demands, how abrasive it is at times. So, he said something to the effect that my wife and I never talked about it, therefore, he had no idea what was going on.

[comokate]

Post 59)
If we enjoy living, we live. We enjoy the family, the people we deal with. There are situations to be enjoyed and others that impose on us. There's a certain satisfaction in overcoming adversity, so, even the worst situations have a satisfaction to them if you know you can beat the odds. I told my son, he was ahead of me in the game; he went bankrupt, that was one experience I never had. Bless him, he asked if I wanted to change places with him. I believe that was the final bond between us. We couldn't get any closer.
Post 60)
But, the point is that closing down an enterprise, a marriage, a business, whatever, is a challenge. What are we made of? What do we have that's so valuable we can't give it up? And hw do we know that the next opportunity may not be better than the last? The next bank that closes won't be the first or last. The next defunct insurance company or brokerage will not materially alter the world. And, then comes the question, do the people who brought this on themselves deserve to be saved. They ruined one enterprise, should they be allowed to continue until they drain the entire system? Or, do they have the fortitude to say, there were things learned and they can be put to better use, more efficiently?
On principle, I can't support a bank, an insurance company, or a broker who are lacking skills or training and slide into insolvency. If I exercise bad judgment, and I have at times, I don't expect to be supported for my indiscretions. How can a bank or insurance company with billions more resources than you and I have expect us to support them?
You failed, sir, sorry to see it happen. Pick a business you're better suited for next time. Goodbye.
I believe when it comes to senior debt, or any other debt for that matter, there was an element of risk at the outset. When I make an investment, I study the firm, the management, the industry and so on. I use tell tale ratios. I have enough training and experience that I can pick up a series of annual reports and determine the direction of a company from its past. A lot of people don't have this asset and suffer from their lack of investment analytical skills. If they prefer to continue investing, that's their choice. If they invest in an institution oI know three very, very serious investors who spend nearly every minute of their day, even at work, concentrating on what they can glean from every situation they encounter. They put it to use. They are relentless. They are very well to do. Even they get fooled once in a while. . . as you might suspect, not often! They put it out of their mind and go on. Senior debt? Except for scale, what's the difference? Take a few zeros off, divide by a thousand or whatever, put it in perspective. When it effects the innocent, non-participating general public, I get concerned; when it effects management and the investors, I do not.r an enterprise that slides into oblivion, that was their mistake.

[comokate]

Post 61)
"You would have to be very careful about imposing any loss on senior creditors of any bank taken under government control because it could impact the senior debt of all other banks,” he said. “This is a credit crisis and it is essential to preserve an anchor for the financing of the system. That anchor is the senior debt.”

Senior debt may be the anchor tostability, but he should be addressing the problem/

If we were able to deal with the derivatives and bundling issue, unwind it in a way it would no longer threaten banks, interested parties or depositors, neither nationalization nor senior debt would be under consideration, nor would counterparties be threatened. That would go a long way toward calming the situation.

Nationalization for a brief period with a strict, minimalized time limit may be a grudgingly acceptable alternative if the powers that be decide they do not care to get involved in straightening out the derivatives debacle. But, it's the coward's way out. Remember that I believe, essentially, it's the disparity between off-balance sheet items and balance sheet items that has caused this problem. If that is not disposed of (and I don't mean "mitigated" or "reduced" in its effect) it will come back to hit us again and again. The international community has to approach this off-balance sheet issue as the core of the problem. Had banks and brokers not allied themselves on this issue and infected the world currency and financial markets for the sake of the comparative pittance the fees represent, we would not have had the multi-trillion dollar problem dropped on us.

Off-balance sheet reporting has been of growing concern with increasingly frequent comments over the past fifteen or twenty years, I'd guess. More than one concerned and involved person has mentioned it. It's grown to the point now where something must be done!

With that hanging over us, how can we treat something else as a quintessential problem? It strikes me as little more than a diversion.

Nationalization is a poor idea for several reasons, but one of the foremost in my mind is the idea that it establishes precedent. From that moment on, banks can count on the taxpayers to bail them out every time they get the urge and behave imprudently.

I'll trust Greenspan's age when he assures us that this comes along every hundred years. I'm a little short of contesting his memory.



(Flashback! The meeting that Volcker moderated: one of the speakers referred to an economic situation in a couple of midwestern states before the Civil War and Volcker addressed the audience and said something like, "I trust nobody in the audience will question (the speaker's) historical analysis of the incident which took place before the Civil War.")

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Post 62)
I don't quite understand Greenspan's first sentence in the part I quoted above. I take it to mean, he would not like to see senior debt holders suffer while the bank was nationalized and under government protection. (?) Would he be equally concerned if the senior debt suffered while the bank was not in a "nationalized status"?
Old and gray, I feel certain he meant the former and only implied the latter.

Post 63)
Duff, you take my breath away!
The second thought. . . I'd better pay more attention to editing before posting.
Should I go on and address the issue of Credit Risk?

Post 64)
Please do. I hope you will keep all these posts in a word document because you are building the foundation of a new book. Perhaps you should keep two versions. One is the initial post and then you can edit the post later for the book. Its up to you but given the timeliness of the material and the volume you have already written, I would leave the possibility of a short book open.

I am hoping that you can do some of the rest of the posts as a socratic excercise in which you ask questions and provide questions for discussion so that we can get as many people involved as possible.
I'm looking forward to participating in this dialogue and hope many will join in.

Thanks.

Post 65)
This is the best expose of the situation our country is in I have read yet, and offers up the solutions that I wish the present administration were pursuing. I have to add though, that I don't think we will see that forthcoming.

Post 66)
Dave, I personally agree with each of your statements. None the less, the discussion of these principals is critical to keeping the the thoughts in the field of consciousness. As other means are tried and fail, there will be a natural migration to what is needed and I think much of that is currently outlined in this thread with detail to follow.

I plan on sending an edited synopsis of the ideas contained here in as well as a link to this thread to all of my representatives and to the contacts at www.whitehouse.gov.

Old and gray,

In discussing the issue of Credit Risk, I am hoping you will integrate a discussion of the credit rating agencies, the problems caused by their conflict of interests, their lack of realistic mathematical modeling and alternatives (both from a regulatory and new organizational standpoint) and as we evolve these concepts I believe some discussion of the various barriers to entry, including political, institutional and organizational factors would be round out the implementation side of the discussion.

Again, I hope one day you will publish a book (even if its only a free PDF book for download) and broadly disseminate your edited ideas.

Post 67)

Before continuing on the Credit Risk issue, it's worth noting that from late 2006 through mid 2007, it was no secret where the world economy was headed. IMF, the Bank of England and others issued "cautions" about the oncoming slide. (BIS might have been included in that group. They are always well informed.) Also, in the 1960s, another group of twenty countries formed the OECD (Organization for Economic Cooperation and Development). Their interest is basically corporate "governance". But, February 11, 2009, they published a study on "Lessons Learned" from the current crisis.

BIS has been concerned about Credit Risk for quite a long time. Since late 1990s, they published several papers about Principles for Credit Risk Management, Best Practices, Studies on Credit Risk Concentration and Principles for Sound Liquidity Risk Management AND Supervision. The last is concern for lax GOVERNMENTAL supervision in Credit Risk. The US had SIX representatives participating in that session, summer, 2008. Papers can be published ad infinitum, and management can assign the task of reading same to some minor intern, but until upper management takes the paper seriously and takes the first step in implementing the suggested principles or standards, they have no significance. Apparently, US banks needed no help in understanding the consequences of their behavior.

Today on CNBC, they had a couple of media airheads railing against the idea that bankers/brokers were doing something criminal or illegal when they dragged the world's economy into the pits. There are no laws broken, there are no laws written, therefore there can be nothing said against the players who "helped" the economies of the world. After that, they interviewed a major player and he essentially said the same thing, with pride.

July, 1999, BIS, in a "Consultative paper. . ." entitled "Principles For the Management of Credit Risk", the Appendix, entitled "Common Sources of Major Credit Problems" opens with this statement:

Most major banking problems have been either explicitly or indirectly caused by weaknesses in credit risk management. In supervisors' experience, certain key problems tend to recur. Severe credit losses in a banking system usually reflect simultaneous problems in several areas, such as concentrations, failures of due diligence and inadequate monitoring. This appendix summarizes some of the most common problems related to the broad areas of concentrations, credit processing, and market- and liquidity-sensitive credit exposures.



It was sometime around the middle of 2007 that the former CEO of Citi, Prince, made a comment to the effect that he was aware of the danger that confronted banks. Judging from his failure to acknowledge the caution fully and alter the bank's direction, he wasn't willing to retract and leave the field open to his competitors. He probably also felt that he had everything under control, an error in assessment that eventually led to his demise and the eventual slide of Citi from $237 billion to $10.5 billion as of Feb, 2009 as Happy Days pointed out. Banks still have not deceased from issuing poisoned paper inasmuch as Happy Days also posted that FDIC Reports show an increase in derivatives to over $200 trillion at year's end, 2008. All in all, the banking think tanks foresaw banking's future at least two years in advance and possibly as much as ten years. But, the party was too much fun to shut down and it was carried over the brink.

Now they want us to forgive them and pay their way out of jail.

This is the lead in to the Credit Risk fiasco.

[comokate]

Post 68)
Believe it or not, Duff, the role (and failures) of credit agencies have been addressed by international groups, committed to writing pointedly, and should have been recognized by literate people in the domestic banking industry. There's no excuse for their having misled us into the entanglements we suffer.

Post 69)
a couple of media airheads railing against the idea that bankers/brokers were doing something criminal or illegal when they dragged the world's economy into the pits. There are no laws broken, there are no laws written, therefore there can be nothing said against the players who "helped" the economies of the world. After that, they interviewed a major player and he essentially said the same thing, with pride.

Of course there were no laws or regulations on the books. The lobbies for these organizations made sure of it with the various legislation to undo previous laws. Gram Leach Bliley and failure to pass derivatives regulation were all part of the "end of big government" and "markets in place of democracy" arguments that were put forward by Greenspan and Robert Rubin (of Goldman Sachs and Citi fame).

Post 70)

a couple of media airheads railing against the idea that bankers/brokers were doing something criminal or illegal when they dragged the world's economy into the pits. There are no laws broken, there are no laws written, therefore there can be nothing said against the players who "helped" the economies of the world. After that, they interviewed a major player and he essentially said the same thing, with pride.
A followup to this comment is a thread to which I've referred to before having to do with how Greenspan and Rubin came to Clinton shortly after he won his first bid for President and told him that he needed to abandon his campaign promises of national health care and better conditions for the middle class and so on and move to a market based economy and hence the announcement of the "the end of big government". This was really a continuation of the Reagan/Bush push towards greater and greater deregulation which resulted ultimately in the existence of nearly 1/2 Quardillion (and growing) unregulated derivatives and the amalgemations of banks, brokers, insurance companies and hedge funds into the incredibly complex opaque mega corporations we have today. Its written by Robert Reich and only skims the surface of the C change but I think its an imperative footnote to the cause and effect chain of history.

moneycentral.msn.com/community/message/thread.asp?board=PoliticsandtheMarket​s&threadid=979645&boardname=Hide&header=SearchOnly&footer=Show&linktarget=_parent&pagestyle=money1

Here are excerpts from an article by Robert Reich which I think speak eloquently to the subject. (2 Pages). I recommend reading the entire article here:
robertreich.blogspot.com/2008/12/greenspan-and-democracy.html



"… Alan Greenspan, writing in the current issue of the Economist, argues that in the future banks will need more of a capital cushion than they needed before the crisis because holders of bank liabilities will require them to hold more capital. "Today, fearful investors clearly require a far larger capital cushion to lend" to financial intermediaries. In other words, there's no need for additional regulations requiring banks to have more capital. The financial market will take care of itself. Greenspan has learned nothing at all….



"… He had supposed that the interplay of millions of self-seeking individuals would make government regulation unnecessary – except to prevent outright fraud or theft. To Greenspan and others like him, the global financial market represented the almost perfect form of the free market, because buyers and sellers were could gather almost unlimited information about one another, at almost instantaneous speed, at very low cost. Not only would the financial market be self-correcting, but it would automatically give us everything we might reasonably wish from it.

Greenspan’s real failure of imagination was his inability to believe there are useful market rules beyond those that protect private property and prevent outright fraud. This, presumably, was why he kept insisting for so long that government be held at bay…."



"… But now the United States has chosen to deal with the financial crisis by buying up a significant fraction of the shares of the nation’s major banks and its largest insurance company, underwriting the loans of a large portion of the nation’s home-lending industry, and is on the verge of underwriting the nation’s largest automobile makers. Yet little if any of this largesse has found its way to the broader public – to homeowners in danger of defaulting on their mortgages and losing their homes, small businesses close to insolvency, state and local governments cutting public services because of budget shortfalls, families unable to afford health insurance, or young people unable to obtain loans to finance university tuition…."

"…

"...The ideology of a perfectly self-correctly free market has given way to what might be described as a raid by America’s biggest banks and corporations on the public purse, supposedly justified by benefits to the broader public which seem nev

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Post 71 and 72)
Ideas travel faster than we anticipate. . . or, they proliferate in predictable fashion. The first interviewee on CNBC duplicated or simultaneously generated the idea of "Too big to Fail" not being the operative word, choosing instead to suggest, if the entity is too big to fail it should be broken up.

He was in San Diego, Wednesday afternoon EST, at the time of interview. Soft spoken about the matter but apparently convinced.

Encouraging! Let's hope the thought gathers steam and spreads faster in a movement that would impress Bernanke and others with the fact that it is not only a viable alternative, but a necessity. Simply put, we are not capable of managing supersized corporate entities. If they don't fail now, they will further down the road and lead to an unmanageable catastrophe.

First thought of a consultant is to bring the problem into manageable perspective. First time I heard that cry was expressed as, "Break up the A's!!!" Now we need a wide-spread movement to "Break up the banks!"

The CNBC crew seems on edge, slightly more contentious, moving toward confrontational, a normal state of affairs when someone is unsure of the path they've been following and are about to shift positions into another mode or follow another line of reasoning. Miracle of miracles? Larry Krudlow may be waking up and changing his position. . . He's feinted off toward unorthodox (for him) thoughts before, uncharacteristic for his blind, hard line support of whatever Wall Street chooses to do. But, then, he returns to the unyielding support before anything positive is accomplished. So, not too much hope for change there.

This could all be imagination rather than hope being satisfied.

Keep the faith!

[comokate]

Post 73)
I think it might be helpful to bring some of the concepts discussed into a case study or two. I can suggest that we discuss the topic of disintermediation in regard to counter parties and derivatives and also discussing how GE's involvement in derivatives is yet another example of how "derivatives creep" has sent its tentacles through industries we not normally think of as being heavily connected to exotic financial engineering. Here is an excerpt (which while fairly dire in its opinion of the situation) and peraps a bit dramatic, is one of the few articles I can find on what seems a most important situation, the disintermediation of derivatives and deals with two strong examples of how derivatives are conintuing to reek destruction.

If this seems distraction, I don't mind being pulled back on topic. I'd like to know, what if anything our policy makers plan to do to replace the current credit ratings system with something that is resposible.

Here are the excerpts:

"...What is occuring at JPM, and in all the major financial institutions, is disintermedation (according to my plugged-in savvy sources who clued us in to the JPM mess debacle way back when). Counterparties are pulling out of MANY bank/financial firm deals because they have have no faith they will get there money on those deals. And who has the MOST counterparties of all with their hundreds of trillions of derivatives? JP Morgan Chase! Their disintermediation problem is mounting. Result:

It is called PANIC! and then there is

*GE, a small fry compared to JPM, but a mega American name and an increasing embarrassment to The Muppets and CNBC. They are in the hunt in the race to zero for former elite American firms. Their share price sank another 32 cents to $6.69, after making a $5.72 low. It is the same case here as JPM. Had the DOW not charged higher, GE was dead meat today. Both might be tomorrow! No wonder President Obama was out beating the drums.

Both JPM and GE are are loaded with toxic derivatives. Meanwhile, the ridiculous AIG coninues to lead the way to zero, finishing the day flat at a pitiful 43 cents. To view these stinko charts…

www.stockwatch.com/utilit/utilit_snapsh_result.aspxDave from Denver with the scoop…

GE credit defaulty swap is 17% bid 19% offered

Good morning Jack Welch!

acrossthecurve.com/?p=3577This bond trader heard that CDS buyers want 20% up front, but as he points out, he has not seen a trade like that actually "print." Let's look at the quoted "bid" side of 17%. That essentially means the market is saying that GE debt should be rated triple-C. It also implies a very high probability of bankruptcy. GE is so complex and has so much off-balance-sheet crapola, that we might not get so see until GE is in receivership, that I would just as soon stay away from GE as an investment altogether. There's probably some value left to shorting the stock… more later…

re: the 20% cost to insure GE debt against default

In my experience as a bond trader, and especially junk bonds, I found the bond market to be much more efficient at pricing in risk and forecasting future problems with a company. Bond investors tend to do a lot more thorough investigation of a company's "credit" quality, something the ratings agencies have been failing miserably on. The bond investors also often get a peek at the information bank debt investors have access to (even though technically they should not - my bond desk was right next to the bank trading desk). If GE credit default protection costs 20% up front now, a GE restructuring of some sort is coming soon to a theatre near you. Certainly today's stock price action in GE is starting to discount these facts. Be nice if burned investors start filing lawsuits against GE and CNBC….

GE on the hook for $8 billion in credit default payments

if they get downgraded:

zerohedge.blogspot.com/2009/03/ges-8-
billion-downgrade-time-bomb.htmlGiven the players involved behind the scenes at GE - e.g. Warren Buffet, Wall St, etc - I would imagine a lot of pressure is being put on the rating agencies to maintain GE's ratings.

Post 74)
Today's market is getting really heavy. There are days I wish I didn't know anything about all this. Its really awful to look at your country being hurt so badly by the greed of a few thousand people and the corruption of great institutions. We'll need help from a higher power to pull through here but I guess that isn't anything new.

[comokate]

Post 75)
To maintain order and abide by sequence indicated in the above posted analysis and developed corrective program, it may better serve our purpose to continue by reviewing Credit Risk and the banking failures that resulted from inadequate policies and programs due to the lack of attention to what should have been Generally Accepted Banking Principles and Practices (GABPP - my acronym) in all of banking.
It's been hinted above that banking is a huge undertaking. It's not something you start up with $10 million and, since leveraging is ideal at a 9.5 ration, in three years you'll have a $95 million going concern. That's no more likely to happen than a fully qualified engineer, accountant or physician is rocketed into success directly out of high school. Any one of those three and many more disciplines require study, training, reading and more reading all with a mind to understanding what is required to move earth and pile bricks in a sound building or probe inside a living body looking for the cause of a disease. Not only is there initial study to overcome the inertia of ignorance, but there's a career long continuing education to keep abreast of ever-changing media and new techniques.
It's the same with banking.

I doubt seriously that there is any banker around with the speed reading skills to allow him to pour through banking laws, read all the printed banking literature aimed at helping him attend to his bank and do all the things demanded of him during the course of a day's worth of banking business.

We've already mentioned that a bank has two principle functions: issuing loans backed by depositors' money and issuing loans on fiduciary media basis. Overlooked in that simplistic explanation is the principle purpose of any business. . . show a profit. In the process of seeking a profit, the temptations are great to employ any means available, and when dealing with money the means available are tempting. One need look no further than Mr. Madoff to see how easy it is to go astray. (He was after all, not a broker but a banker! The only problem was that his pocket and personal wants served as the bank vault!)

To better serve their depositors, bankers can consult several sources dedicated to studying banking problems, setting up banking programs and generally helping the industry to coordinate efforts so that nothing like the derivatives contagion harms the international banking community. There's the BIS (Bank for International Settlements), The Basel Committee on Banking Supervision (a working committee of the BIS), the OECD (Organisation for Economic Co-operation and Development, Paris) dedicated to "codifying" corporate governance, sovereign laws in most countries dealing with their domestic banking systems along with regulators and supervisors, and countless private consultants well versed in providing developed programs and systems. Each one has its own merit and each one burdens the busy senior banker with more reading, learning and implementing systems and controls.

Beyond this, we have the individual bank systems which are more complex the bigger the banks. At the top of the organization we have a board of directors responsible for everything meaning they need to be well informed on every bit of banking business since they are ultimately responsible for seeing the bank observes laws, implements programs, charges senior management with their responsibilities, and on and on.

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Post 76)
The fly in the ointment? Some directors believe they have a sinecure on the board and if they show up at all, it's with an attitude that serves the bank poorly when they consider the laws a nuisance; regulators and supervisors, a threat to making a profit; and the international banking organizations, a millstone. That's why a prior post (above) mentioned the "uneducable" among them should be rousted. They have a serious job to do. When it's not done conscientiously, it's not a small matter, moreso when it is an international bank with tentacles reaching around the world and embracing many countries too small and unable to deal with such a massive entity.
All of this is a build-up for a charge that in view of all the literature and consultative help out there, with the BIS publishing all the desirable constructs in bank programs and systems, with guidelines, principles and practices carefully detailed in depth, the banks had no excuse for not doing their job. . . Except!!
It may be that the big banks are too big to be managed and this has been proven by their failure. The performances demanded of the board and the senior managers may be beyond anyone's capabilities. I know bankers and board members who burn the midnight oil in an attempt, sometimes near desperation, to keep up with developments effecting banks which are considered tiny in comparison with the top ten. Everything is magnified in the larger banks. They have larger regions to cover; more laws to comply with; social, political and economic conditions small domestic banks do not have to cope with. If the process of managing was getting away from those in the important positions in the critical, larger banks, this fact should have been acknowledged. If they had no idea what was expected of them, someone made the wrong choice in appointing them to the board or not informing them of their responsibilities.
Simply put in summary: everything got away from management and ran out of control.
Now, the question is, what should they have been doing and what did they not do?

Post 77)
A gentleman for whom I have the greatest respect, Prof. Axel A. Weber. President of Deutsche Bundesbank addressed a conference in Frankfurt am Main, December 11, 2008. He addressed the issue of transferring Credit Risk (CRT). The following are excerpts which, with forbearance, I hope he will allow.
When analysing an economic event such as the current financial crisis, it is usually very helpful to consult some economic theory. In the case of CRT general economic theory tells us that CRT is, in principal, beneficial.
First, it may lead to a better risk allocation as it disconnects the originator of a risky asset from the ultimate risk taker. Second, referring to a result of the model by Hakenes and Schnabel presented at this conference, better risk allocation provides scope for socially beneficial projects that, otherwise, would not have been financed. Finally, as the Basel Committee on Banking Supervision points out in The Joint Forum on Credit Risk Transfer (2008), "CRT has made the market pricing of credit risk more liquid and transparent".
However, in the current financial crisis different methods of CRT applied by financial institutions have made for negative headlines in the newspapers:
Securitisation - Financial institutions . . . that were engaged in the American mortgage market through financial products such as RMBS suffered major unexpected losses when house prices in the US started to decline.
Credit Default Swaps (CDS) - Some insurance companies and other financial institutions are involved in insuring structured products linked to the US mortgage market in the form of CDS. Some of them experienced large losses and had to be rescued by the government (for example, AIG). The bankruptcy of a big credit risk insurer threatens the insured financial institutions, which often undervalue counterparty risk. The crisis may be exacerbated in this way.
Off-balance-sheet vehicles - Banks have transferred their credit risk to off-balance-sheet vehicles, such as SIVs and conduits, in order to save capital costs. The business model of these vehicles built on maturity transformation broke down leading to liquidity problems of the SIVs and conduits. Owing to reputation concerns, the banks took the suffering SIVs and Embargo conduits back on to their balance sheet. This transferred the credit and liquidity risk back to the banks and triggered the loss of confidence in the money market.
All these examples show that we are experiencing severe problems with CRT. I would there-fore like to pose two questions. What are the weaknesses in CRT markets? How can we change the institutional framework in order to profit from the social benefits of CRT?
: 11 December 2008, 8.30 pm CET Page 4 of 8 Deutsche Bundesbank • Communications Department • Wilhelm-Epstein-Strasse 14 • 60431 Frankfurt am Main • Germany www.bundesbank.de • E-mail: [e-mail] • Tel: [phone]/3512 • Fax: [phone] Reproduction permitted only if source is stated

The only exception to theabove, taken for personal comfort (not theory), is that relieving the originator of the responsibility and transferring that to the ultimate "risk taker" does not bode well for ethical originator behavior. Our experience demonstrated that much more was originated than could be covered by any combination of entities where nominal value was concerned. When the market faltered, the house of cards collapsed. Theory may have been sound, but temptation of the moment surrendered in order to bypass prudence.

What it did display was the practice "originate-to-retain" had been replaced by "originate-to-distribute". The fox was looking at the grapes in his reflection and wanted more.

[comokate]

Post 78, 79)
This Credit Risk Transfer, CRT and the impact of perception and the volume and acceleration of requisite information mastery and cognition as well as questions of manageability of organizations that cross certain thresholds of size and degrees of amalgemation seems to portend questions that fall into yet other disciplines, such as Learning Organizations and the need to have a lot more reflection and perhaps ultimately an evolution in how human minds communicate.

We've seen how mathematics has become too big for any one scholar to be a master of all disciplines regardless of their genius. I would think the practice and theory of banking has risen to the same levels. I also believe that its not so much the sheer size of an organization which makes an organization un-manageable but the diversity of overlapping and underlinking businesses such as we've seen organizations such as citi. It is also in the merging of the business paradigms and the incentives that motivate the operations of the seperate and now integrated businesses that has caused a lapse in organizational judgment, leaning towards quick profit without the boundries normally imposed over a banking business, where risk management has classically been very strong.

I think it will take teams of highly experienced bankers, each taking mastery in various areas of regulation and theory, different regional focuses and the management infrastructure ( a learning and collaboration culture) to develop more net cognitive capacity at the executive level. While this is slower than having a small group of top decision makers, the outcomes are likely to be based on a firmer objective understanding of what is best for everyone, depositers, investors, borrowers, and the nation. There is so much we could go into on the topics that you have mentioned that each could result in its own complete thesis paper x 20.

Post 80)
I understand that CDS and and other derivatives serve as Transfer of Risk Instruments and that a large part of the problem is in opaqueness of the nature and credit viability of all the counter parties. I also understand that the mass consolidation and amalgamation of multiple fianncial industries (insurance, hedge funds, brokerages and investment banks, commercial banks and bank holding companies) into single corporate entities has resulted in the blurring of appropriate decision making and I'd guess likely the way incentives serve to motivate executives at the tops of these corporations.

On the other hand I'd like to really get a handle on the strengths, weaknessess, opportunities and threats (SWOT) of the current credit system via some sort of comparable metaphor for sake of all of us non-experts. I was wondering if CDS were in some ways like the "carbon credits" in the so called environmental health plans that use "emission trading."

If we shift the risk, (carbon credits) around, the net carbon emission may be reduced by concentrations of actual carbon emission may become more concentrated and thus cause a breakdown in key systemic aspects of the aggregate environment, in fact being substantially worse to the health of the overall system that would otherwise be experienced if in fact we dealt with pollution (risk) more directly? Here is a link on Carbon credits so that you can familiarize yourself with the paradigm if you are not familiar with it: en.wikipedia.org/wiki/Carbon_credit

Post 81)

On the other hand I'd like to really get a handle on the strengths, weaknessess, opportunities and threats (SWOT) of the current credit system via some sort of comparable metaphor for sake of all of us non-experts.

Again you read my mind, Duff. This is precisely what I intend to do. But, for those readers who may feel the entire horizon is covered with a veiled mush that has no substance, I'd like to proceed in a manner which builds from top down. Specifically, in order to have adequate analysis of credit risk, a competent management must be in place. This was the reason for my mentioning The Board and Directors and Senior management in messages #75 and #76. It may have seemed premature, but had these people handled their jobs properly, there would have been no collapse any where near the magnitude we've suffered. I took the liberty because papers and reports generally begin with an "executive summary" of sorts. That's to save the busy executive from digging through material he may be thoroughly familiar with, and to provide some road signs. Now, we know where we're headed, we have to start up the engines.

I returned to edit my message #77 by highlighting two terms, highly important to an intermediate goal somewhere down the road. Those two phrases: "originate-to-retain" and "originate-to-distribute" are probably well familiar to someone like VL, not in a friendly way either, I'd guess. That was the start of the fall. Your mention of shifting the risk around is precisely what was done when banks moved from originate-to-retain to originate-to-distribute. The risk, as Prof. Weber addressed and I editorially pointed out, was not merely shifted, it was, in effect, dispensed with. Had it been shifted, it would have returned to the point of origin when the rot was discovered. We now know the risk was so thoroughly concealed no one could tell what risk was assumed and where it originated. That was the purpose of the bundles. Swaps, derivatives, mortgages. . any kind of a loan they for which they could find a counter-party were bundled and shipped out. Out of sight; out of mind; off the balance sheet

About five years ago, perhaps more, I read that banks were reducing the number of loans kept with a target somewhere in the low single digits, percentagewise! Just as money disappeared from circulation, banks tried to climb out from under the burden of risk by passing it on in the anonymity of "opacity" We'll return to this thought later.

A few other terms were dropped casually back a ways: fiduciary responsibility and risk which has a wide ranging application, many parts of which are overlooked, but both of these concepts essential if a bank (as well as other corporations) is to show a profit. Risk is present every time we handle money in our personal lives. We never think about it until it pops up, but when we do something as innocent as take a dollar bill out of one pocket and put it in another we run the risk of dropping the dollar and then the risk of not discovering it until too late. Net result, we're a dollar shorter. We run a risk in handing our children cash to go down to the store to buy something: he also accepts fiduciary responsibility; every time we mail a payment in; every time we purchase something over the 'net; every time we loan five dollars to a friend and expect it back by next Friday because we'll have a bill to pay and it will be toward the end of pay period. Banks are faced with the same problem from the word go. They're counting on their depositors bringing in more funds on a timely basis so they can meet their obligations. This is short term funding covering long term obligations. If it doesn't happen as expected and is dragged on too long, the inevitability is bankruptcy. . cash flow problem. It turns out to be a severe risk they took that certainly didn't pay off.

[comokate]

Post 82) deleted
Post 83)
VL, has mentioned countless times about the vetting of borrowers, something that is exhaustively thorough if done right. One of the first requirements in processing a loan is taking an (1) arm's length attitude toward the transaction. No matter how well you know the borrower (or counterparty), when a loan is processed, the analyst must be detached and objective. What was true of the borrower's situation last month or even yesterday, may no longer be true. The lender must know the borrower's purpose for the loan, how he'll use it, how he'll repay it, whether he knows what he's doing or going into a new venture for which he has no expertise, whether he's involved in a legal venture, whether he has the right to become involved as the principal if he so represents himself. Has he been on time (Time is money! The bank has obligations and late payments may incur cost for the bank.) and repaid all his loans? What are the prospects for the financial future or the economic stability? Is there a sound outlook? Is this a commitment or venture that's sound in view of anticipated conditions? Business loans should be subject to even more rigorous analysis than personal loans. If he fails how does the lender recover the principal? Collateral? A co-signer guarantee? When a bank sets up its Credit-granting risk policy, all of these and a few more must be taken into consideration. Some banks have the equivalent of actuaries, those people dealing with the profound concept of "What is the probablility of failure or success?" Every one of the above mentioned considerations are built into the process.
Post 84)
Duff,
I understand and agree with everything that you have said.I think I probably fall somewhere in between you and your son, in age. I remember when I was very young, the early 60's being a very difficult time for my family with the lingering financial strain of the late 50's deep recession still having hold. I remember wearing hand-me-downs that did not quite fit, never going to restaurants or movie theatres, and having a pretty bland diet. We were a one car family and the one car was a beater...

I was a young teen during the next deep recession, in the early 1970's. My father lost employment for a time in a rust belt city, and it was still fairly unusal for married women with chidlren to work outside the home.We moved around several differant places during that time, and I remember the humiliation of standing in the grocery line while my parents used food stamps to get by. Both of my parents were Great Depression era kids and I was told as bad as it seemed to me, it was nothing compared to what they lived through. I listened. Our area never did fully recover from that 70's era recession and so I , as many of my fellow classmates, moved far away after high school graduation.

I married and had my first child 25 years ago, during the next recession...and I think the financial strain of that time is part of the reason that marriage did not last. It is sometimes easy to forget the human suffering involved when simply looking at numbers, statistics, or "history". I worked my way through college as a single mom, selling plasma as needed to make up the differance, borrowing student loans on an as needed for tuition only basis, and picking the less wanted, but more affordable college. I made do with what I had.

Interest rates spiked for homes, and credit card interest was no longer tax deductable ( no one ever brings that up anymore, do they?). I had one card for emergencies only and bought a house when the rates went "down" to 12% ( !!) thinking that if I waited, I'd never have the opportunity again ( and so I was told...). I was also told I shold be putting as much income as possible into mutual funds, to buy and hold for the long term, that historically the market always went up, and mutual funds would spread out my risk...and then our world went a little crazy.

I saw people purchasing homes with high school educations, that I could not afford being a a degreed, licensed health care provider. I saw people buying expensive cars, eating dinner out at restaurants several times a week, taking extravagant vacations, buying their 16 year old unemployed children new cars and cell phones...

I thought to myself, what am I doing wrong? I asked questions and looked around more. People were many tens of thousands of dollars in credit card debt. Homes were refinanced multiple times for non-durable goods. People expected the highs to go higher and never drop down...

Having a few bitter recessions already under my belt, I trusted my own experiences and instincts more.

Post 85)
I began to get nervous with what I was seeing. How was this all supposed to work out? A nation that no longer produces much of anything, a people embroiled in heavy debt with no real savings ? I felt we were in for one heck of a financial Tsunami. I contacted friends in Sweden to find out information about getting a savings account there. They contacted three banks for me and all told them they could not take any more "American customers". This was new. It was also alarming. When I inquired further as to why, I was given information about the high risks US banks were involved in that the Swedish banks did not want to become party to. They have a healthy aversion for high levels of risk...
I heard that big wave coming. I cashed out my 401 K stocks into money market accounts and IRA CD's. I did this the summer of 2008. I had wanted to do it the summer of 2007 but it took a year of self talk to follow my own instincts and not what the masses , or media at that time, were saying.
Those younger than me have not had the wisdom that comes from the crashes of hard recessions. They have grown up with creature comforts unknown to mankind. Instant microwave food, instant cable/internet recreation, instant profits from stocks not really worth anything...they simply do not understand or have the life experience to know these years of "prosperity" have in fact been an enormous aberration.
Post 86)
And so we see posts speaking of the "end-of-the world". That "all politicians are crooks and liars" ( like this is new? just do a little history reading starting with the Roman Empire...). There are posts from people planning to bunker down in hills and forests with guns and talk of shooting people. They just don't know....Nothing in our lives , even life itself, has ever been guaranteed. If you want to live, you will eventually have to work, and sometimes you will have to work for much less than what your work is really worth. You save for lean times. And you survive. Hopefully we can prevent panic amongst the younger folks. They need to hear the survival stories. They need to understand that what was up, has come crashing down. But once down, we will again go up. Even Tsunami waves receed back into the ocean and life goes back to normal. It has always been that way throughout history, and it will always be that way as long as humans walk the earth. Learn to value the people, the things, that will be there for you no matter what part of the cycle you find yourself in. Don't let yourself drown in gloom and panic. Learn to find the happiness and joy in life that does not depend on your financial worth. If you can do that, you will survive anything.
Post 87)
If I had to take a broader stab at the whole dilemma, I'd say that we have sheered away all other aspects expect the debt and those who stand to lose when the debt collapses the global economy completely. The evidence is all around us, instead of admitting a bad investment course, the hoarders are willing to realize massive "other" collateral damage rather than call it quits. I have said repeatedly, where is the money? $2.2 Trillion of it is in Swiss bank accounts. There isn't enough in circulation here any longer to fund an ice cream social, much less a recovery. The sole reason why the printing presses are running full tilt yet none of it gets to Main Street is that the overhead on dysfunctional derivative obligation is absorbing it. Have you looked up the stock prices on the Fed banks? All are under $20, half are under $5, three have flirted with $1 this week. It seems obvious that we will see some fail around 6,500. I'm not sure what happens after that. No historical reference.
Post 88)
ComoKate,
I hope you realize that my goal is, first, to analyze the situation and then propose a way out of the quagmire. Most of the posters here want a five second remedy. That won't happen with a problem over fifty years in development. Therefore, I've taken the long road, hoping that people will see what's been done, how it's been done and what needs doing to unravel it.
I hope you realize that my goal is, first, to analyze the situation and then propose a way out of the quagmire. Most of the posters here want a five second remedy. That won't happen with a problem over fifty years in development. Therefore, I've taken the long road, hoping that people will see what's been done, how it's been done and what needs doing to unravel it.
I had my sister and brother over for more than a week just recently. Both of them have advanced degrees: my brother was in academia and my sister is a program consultant (community programs for every conceivable situation). My brother, as always was calmly inquisitive about the economic situation and we spent a great deal of time discussing it until my sister was near tears asking us to stop talking about it. We come from the same family, same upbringing, half of us were in finance and money matters; the other less than half, not. All educated.
I grew up and worked during the depression. When I came home from work to what he referred to as the "castle" (asking if I'd drawn the moat and locked the gate), at the dinner table my stepfather asked what we'd heard "out in the real world" and the family would be off discussing the serious situation we faced. That never changed.

Until the past week, I believed this prepared the entire family to face up to adversity. Apparently not. The specter of another depression probably plagues my sister more than my brother and I realized.

I believe the younger people want to know what's going on in the world, how we got into something and how to get out. At least those in my family by far, have that inquisitiveness. I encourage them, as I was encouraged in my turn, to discuss things openly; that being aware of events can prepare us for not only the expected but the unexpected. I believe that there are many people out there with the same outlook. Tell me, Be honest. Don't treat me like a child. And, they grow up as adults ready to face the world.

I don't see panic among my children or their children, and yet my sister, who grew up in an atmosphere of political and economic openness, who also has five well-informed, alert and intelligent children, finds discussing what we see as reality depressing.

I think a better purpose is served when we set the example of riding confidently to meet a fate we understand than trying to live in the dark. I see the former as a healthy example, something the young people will be discussing long after I'm gone, and something much more beneficial than shunning the subject. I know I respect my stepfather for the confidence that allowed him to raise seven children through the depression.

I have respect for you, ComoKate. I truly believe you've lived a noble life, and I'm sorry that a woman of your quality has to put up with less than desirable events. I'd judge that you've come through it in sound shape.

And, you are absolutely correct in those last three sentences. My wife, my anchor, my rock, my life, never allowed me to forget about the essential things, just by her presence. . . . And, from what I've witnessed of your thoughts, you certainly know what they are.

[comokate]

Post 89 and 90 )

(To follow message # 83)
Once you have the criteria established, staff has to be trained to do as the process requires. This is the responsibility of the board, Senior Management and the management chain. It’s not an haphazard process where personnel is concerned.
Now, the board’s responsibilities come into play again. They decide what kind of market to serve and whether the bank has the resources to engage in those markets. They also establish limits: dollar amounts, industries to be served, types of loans to offered. All such considerations describe what kind of credit portfolio (meaning all the loans the bank issues) the bank will have.
The ideal situation from the viewpoint of producing manageable or comprehensible risk factors is to have all loans of the same size. Of course, the ideal never is served. So there are loans that are of large denominations as well as small. When there are a minimum number of loans, ten or twenty, a large loan in the portfolio can do a lot of damage. The risk factor is high and the drag on the bank’s resources is strong.
Such a loan in a large bank might pose no risk in its portfolio of 2,000 or 5,000 loans. To a small bank, it’s threatening. If the bank were to successfully survive the risk while it grew and its portfolio expanded, just in numbers alone, the large loan would be increasingly less of a risk.
This is a normal credit-granting procedure.
Notice! There is risk capital required for sound credit-granting procedure. The board must consider factors of risk and the available capital at their disposal when they establish the limits of the portfolio. There will be failure; but, it will be predictable! Under normal circumstances, with normal credit-granting procedure, an alert banking system (which includes all levels of personnel), even if it is a small bank where managers are not loan experts and have the responsibility to see that adequately trained loan officers observe the criteria and the limits of the bank’s procedure, the system will be more than adequate and the bank will survive any trial.
Of course, there is more. The system must be reviewed periodically as events change, new customers arrive, economic situations change, new technology evolves, and so on. Management (however big or small it may be) has the responsibility to see that the criteria are observed, they are adequate, the staff has competently handled their job, and, in general, the system is serving its purpose and the bank is sound in its opera
There’s need for internal controls, external supervision (regulators), banks have to work with supervisors to make certain that both sides are working with the same understanding. The portfolio needs review, economic conditions bring change and the credit-granting could come to a standstill, as banks have in the current crisis. I’m sure as they discovered that they don’t have the capital coverage they needed for the circumstances, word came down in a loud call to stop and desist. If this happened, then the board and the managers did not do their job along the way. That’s why I began the credit risk issue as I did.

Things creep up on us when we least expect them. BUT, NOT IF WE KEEP OUR EYE ON THE DOUGHNUT!!

Banks have the markets, liquidity, what is referred to as concentration as well as internal credit process problems. So, you need a well-informed Board and Senior management constantly in touch with the banks internal capital balance and the external economic and industry circumstances. Must have your finger on the pulse and know what your competitors or associates are doing. In the current case, circumstances didn’t creep up on them in the dead of night, they all fell into a narcotic stupor fed by overconfidence that it could go on forever. And, since they haven’t taken any visible step to correct the situation, I’d venture that they still haven’t gotten over that self-deception, or, they’re still making too much money to desist.

[comokate]

Post 91)
Now, notice, everything I’ve described is what normally occurs in a bank granting credit with the intent to retain loans to maturity. This is the old-fashioned way. It’s still done this way in small, somewhat isolated communities. This is the orginate-to-retain mode of credit-granting.
Once the bank begins to lay off loans to counterparties (originate-to-distribute), obviously things change. Suddenly you must be aware of the strength and capabilities of the counterparty, just as he is wary of your strength and capability. Pick the wrong partner and the originator can find himself in deep trouble when his portfolio, which may be near filled, suddenly is over-filled, the unexpected additional expense of servicing something thought long gone, with several unanticipated price tags coming due and insufficient capital to handle the obligation. The responsibilities could easily double in scope and importance!
Sound familiar? Somebody was sleeping while they thought everything was in perfect working order; or, the job was beyond their capabilities; or, the concept or limits of the operation escaped them!
Post 92)
It must be increasingly difficult to keep a pulse on the balance sheet of the company when there are vast numbers of bundled securities, which given the opacity of OTC derivatives, can not be valued in any consistent way. It also seems that there are so many areas of specialization in lending that mega bank holding companies of today simply have too much complexity and sometimes conflicts of interest to governed by the modern top down management systems. I wonder why the ideal situation is that all loans be of the same size. Is this purely a mathematical phenomenon related to risk probabilities and management?
Post 93)
Duff,
This would bring us to the end of the expose before an appropriate time, because without the full explanation of the evidence and the indicators, it's impossible to make a case that sticks.
It circles back to a problem we noted elsewhere which forces me to regard it as a systemic problem.
Given the difficulties experienced in South America, then the migration to Malaysia and thence to Japan in the '90s, followed by Mother Russia with her problems in 2004 (which are not yet resolved) and eventually to the US, which then infected a relatively stable Germany and the EU, and then England, this plague will continue to recirculate and bother us for at least a decade before someone stumbles onto the solution in a sincere, involved, concerned way.
Without a full case laid out, the conclusion will be dismissed as superficial and meaningless.
Eventually, I'll get around to some esoteric labels: market-sensitive, liquidity-sensitive, concentration (which I've already alluded to without definition in order to avoid introducing language obstacles, and I'll side-step it here for the same reason) and process issues, as well as disclosure. I don't want to introduce them at this inopportune time.
Loans being the same size is part of a concept labeled "granularity", as in grains of sand. As far as the loans being the same size, math is applied to determine the degree of risk in a theoretical sense, to make a comparative case to drive home how much more risk is involved in a gradation of cases, such as the one I mentioned above. Numbers are really not as important as realizing it is quite a burden. And, the more loans you have in your portfolio, the less the risk, and the inverse is true as well.
But, granularity is a matter of a priori reasoning. It can be proven this way:
If, as a bank, I hold a thousand loans and my capital reserve for loan failures is a mere 5% of the total loans' value, should one of them fail, given my capital reserve, it would be of no consequence. Should a dozen of them fail, that's still barely more than 1%. Should fifty of them fail besides using up all my reserve to cover the loss, I haven't done my homework and I deserve what I get. . . delivered to the brink of bankruptcy.
On the other hand, should I have one failing loan that requires a reserve equal to more than 50 of my small, equally sized loans, with the same sized reserve, I'm in trouble! I won't be able to cover the loss and that's over the edge bankruptcy.
And, of course what you have in your first sentence is the nub of the problem we face.

Your second sentence, I don't consider an important issue except for how it points out the carelessness in which bank management indulged. If they were on top of it, they should have recognized their deficiency before they embarked on the mad slide to the bottom. It was pointed out to them very specifically. They should have had insider foreknowledge that the rest of the world was watching, from before GLB was promulgated.(And, I'll deal with that charge at the appropriate time.)

Bank management, if they did not understand the nature of the swaps and derivatives business (which I suspect is the case), should not have been in it. They were careful to see that supervisors were not allowed anywhere near the pit where business was conducted because, as it turned out, they didn't know what they were doing themselves. With the protection offered by GLB of 1999, they could then bundle their poison and get it out of the way as quickly as possible. Evidence gone, no crime, no guilt, no punishment, beaucoup riches! They thought! Except, the contagion waited for them in the wings and eventually came back to infect them with the disease they thought they'd shipped off to another world. And, you and I and all the rest here will pay for it for a good part of the next ten years unless a fire is lit under the people who should be untangling the mess.

[comokate]

Post 94)
Make no mistake about two things: (1) It is a serious problem; and (2) I don't think the people in a position to do something are ready to take the drastic steps needed to repair the damage. They might arrive at a point where they can understand what needs repairing to prevent recurrence, but, it's not our current problem and a great deal of courage will be required to repair the harm done. I don't see that in evidence where it should be found. And, face up to this, as much admiration as we may be able to muster for Obama, this is not his field of expertise and the crowd surrounding him, whispering in his ear, is too inexperienced in the disciplines required.
I need my sleep now. Good night, Duff.

Post 95)

There's an entrepreneurial spirit among ambitious people and there's managerial talent among others. Some folks get confused about the value or the proper time to employ either. As a result you have leaders of entities who believe their job is done once they've opened the door and shown the pathway to others, then all they expect is homage and a fat paycheck.
In that vein, too many banks believe that once they have extended credit, the lender's job is done. Far from it. What the newly orchestrated loan does to the portfolio needs to be reviewed. What happens to the life of the loan can't go unnoticed. Continuing monitoring is called for by someone with enough expertise to know what they are looking at during that process. Routine updating on the borrower's (or counterparty's)condition is necessary. Conditions in the marketplace, the industry the borrower is competing with and whoever he is servicing or supplying need to be assessed periodically. Threats perceived have a direct bearing on the health of the borrower and on the lender. By keeping tabs on the borrower or counterparty, the lender is protecting his interests. Should either of these falter, the originating lender is in jeopardy. Which means that neglecting a commitment after extending credit is bad business.
Yet, once the large domestic banks passed on the bundled mortgages, the CDSs, and the derivatives, that's precisely what they did. . to their eventual detriment. What were the consequences of this shoddy work? Let's return to the speech of Dr. Weber December 11, 2008 in which he mentions three items we have introduced prior to this.

However, in the current financial crisis different methods of CRT applied by financial institutions have made for negative headlines in the newspapers:
Securitisation - Financial institutions (for example, IKB) that were engaged in the American mortgage market through financial products such as RMBS suffered major unexpected losses when house prices in the US started to decline.
Credit Default Swaps (CDS) - Some insurance companies and other financial institutions are involved in insuring structured products linked to the US mortgage market in the form of CDS. Some of them experienced large losses and had to be rescued by the government (for example, AIG). The bankruptcy of a big credit risk insurer threatens the insured financial in-stitutions, which often undervalue counterparty risk. The crisis may be exacerbated in this way.
Off-balance-sheet vehicles - Banks have transferred their credit risk to off-balance-sheet vehicles, such as SIVs and conduits, in order to save capital costs. The business model of these vehicles built on maturity transformation broke down leading to liquidity problems of the SIVs and conduits. Owing to reputation concerns, the banks took the suffering SIVs and conduits back on to their balance sheet. This transferred the credit and liquidity risk back to the banks and triggered the loss of confidence in the money market.
All these examples show that we are experiencing severe problems with CRT. I would there-fore like to pose two questions. What are the weaknesses in CRT markets? How can we change the institutional framework in order to profit from the social benefits of CRT?
Embargo: 11 December 2008, 8.30 pm CET Page 4 of 8 Deutsche Bundesbank • Communications Department • Wilhelm-Epstein-Strasse 14 • 60431 Frankfurt am Main • Germany www.bundesbank.de • E-mail: [e-mail] • Tel: [phone]/3512 • Fax: [phone] Reproduction permitted only if source is stated

[comokate]

Post 96)
Securitization is a situation in which collateral no longer has sufficient value to support the loan amount.
CDS? Cynicism might prompt the addition to Dr. Weber's remarks of one word, a temptation I can't resist. . . Where he mentions "insured structured products" I would preface that with the word flimsy. It was an incomplete, hastily constructed product that was released on the world's banking community with insufficient analysis and vetting. Unfortunately it was accepted with the same zealotry. So someone could offer a twisted defense that, if these instruments were flawed or defective, the world market should not have accepted them.
Off balance sheet vehicles were the means for entering and refining the grey area of "shadow banking".
SIVs are Structured Investment Vehicles. The concept was to issue short-term paper in different amounts, collect all the contributions into a large fund and invest in long term instruments at a higher rate and pocket the difference or distribute it to participants. (Born 1988 @ Citibank)
The other end of the barely legal banking world were the conduits, a bastardization of a once perfectly legitimate device of setting up an entity to handle investments or fund distribution for clients without having the operation entered on the balance sheet. The large banks discovered that they could handle much more business in the shadow world and therefore avoid disclosure and accountability, a failed strategy you and I now are asked to subsidize after the fact. Enron may have introduced the "shadowy" aspect of the once legitimate device.
None of these investment vehicles were designed to help the economy. The truth probably lies in the weakness our economy has been suffering through since the early seventies when we seemed to have lost our way and have searched for a stability which is no longer there and riches from quarters that are pretty much dried up. Among the posters that have witnessed the lack of balance we've suffered are neohguy who finds it difficult to let go of the fact we no longer earn our way with products distributed to the world, the true "economic" wealth of any nation. Turning raw materials into finished products adds value to the raw material and enriches the nation. We've substituted guile and deception for that trait.
VL, periodically, has noted the change in the ethics of the lending profession. Slipshod methods whose only intent is to deceive the next receiver in line just long enough to pocket the cash and leave the register barren so there's nothing to refund when the demand comes. Quick returns, artificially high values, soaring indices and everybody has instant gratification. Forget the hick piper. He's in another county over the hill, out of ear shot.
So, after the dance is finished and the band has packed it in, now is the time to face the moral hazard, issues of transparency, or disclosure, and the bookkeeping.

[comokate]

Post 97,98
Post 98)
To Duffminster and Old and Gray;
thank you for taking your own personal the time to try to inform people with relevant, intelligent and insightful information. You can't control how people react when they hear information, or even whether they even want the information to begin with ( we are a society that loves quick fixes, superficiality, and instant gratification)...but you are getting it out there and some will take the time to read and understand. Red rose
Post 99)
Hopefully, the common Joe/Joanne has learned their lesson now, (but unfortunately I fear they have not)...the only "investing" that should be done with money that you can't afford to lose, is with CD type instruments...let the "pros" gamble with their money, and not yours, or as we all have seen, we know what can and will happen.Of course one of the biggest consequences of this all, long term, will be the long lasting moral implications...some of the biggest crooks being seen by everyone as getting away with some of the biggest rewards...besides the gigantic debt we're leaving them, we're also leaving the next generation with that as a sick lesson for all of them to see...after all it really seems to me that that's what America is really all about right now...like the poster said above, grab what you can, and then you can laugh (all the way to the Swiss Bank) about how you beat all the other poor suckers out of it......
Post 100)
Duff,
It occurred to me that I have not responded to your query on disintermediation. I addressed it indirectly when I introduced conduits which, in effect, is disintermediation controlled wholly in house, and, if not a WMD, is a tool. Rest assured the big boys want to cut out all the overhead they can and pocket whatever is gained.
This off-balance-sheet marketing tool is one of the strategies that needs supervisor attention. It's unregulated, part of the new e-banking system, and could be viewed as an out-of-control source of the new fiduciary media based e-money. (BTW, England has a clever name for their e-money bailout. . . "Quantitative easing"! Translated into "more money to reduce stress"? . . . Now, there's imagination at work. I wonder if the Brits feel any more comforted for the euphemism. It's alarming more than calming to me. What's next?)
Getting back to the issue, outside the wholly controlled conduits in the banking industry, I don't believe disintermediation displays the vigor necessary to be a market force at this time. E-trade, the company, is slowly gaining a name for itself, but it's in the low billions range, (which seems a cavalier dismissal, doesn't it) not a large enough force to be of concern when we're looking at hundreds of trillions. Madoff can do better than that all by himself.
As for conduits proper, I don't think we've finished with that aspect yet.

[comokate]

Post 101)
HeyJoe. .
The moral aspect bothers me the most. It's that amoral attitude that has nearly led us down the tubes. We're at the entry to the big slide and those most able to repair the damage are still too busy picking up the loose change that spilled over to attend to their obligations to the rest of the world. . using something called ethics.

Post 102)
Duffminister & O&G -
At risk of sounding repetitive and sycophantic, your sharing the insightful & in-depth observations contained in these threads has been like honey to me. Thanks to technology and willing participants even those without access to higher level education can learn from and enjoy higher level critical thinking from those whom have been blessed by being born intelligent and then had those innate gifts honed by what appears to have been good educations, likely in the home and then beyond.
As a footnote not meant in any way to change HeyJoeIsTheName



Of course one of the biggest consequences of this all, long term, will be the long lasting moral implications...some of the biggest crooks being seen by everyone as getting away with some of the biggest rewards...besides the gigantic debt we're leaving them, we're also leaving the next generation with that as a sick lesson for all of them to see...after all it really seems to me that that's what America is really all about right now...

In this era of moral relativism with its 'survival of the fittest' mindset and diminished perception of the value of human life it does not take a prophet to foresee that coming generations, those subjected to the fuller brunt of the selfish and short sighted implementations of today's manipulative princes of money, will require but few brain cycles to conclude that those ‘so last generation’ #$!&@*'s who enslaved ‘me and mine’ to perpetual indebtedness (so that ‘they’ would not have to endure the consequences of their actions) might logically conclude that for the greater good of ‘our more enlightened generation’, that the piggish, consumptive, and have had their shot at it life forms that got us into this mess should be euthanized post haste.



It is befuddling that the aforementioned manipulators and princes of money, who are apparently even to this day lost in the self delusion that they might have somehow benefitted anyone but themselves, remain so proud and caviler about their poisonous policies which

[comokate]

Post 103, 104)
The problem is that some people have been misled about the purpose. They started to believe the critics of their profession who thought evil or the destruction of the masses was the rule to their survival. This is not the truth. The masses were often kept in dark because it was felt that they would not be able to accept the truth and as a result they would act irrational. This in turn would cause problems as selfish masses, not knowing what is in their best interest, to over do things, such as, overspend or buy unaffordable homes which would ultimately lead to the destruction of their plots. The true purpose of our great organizations is to take care of the masses or the weak, this is why we elect people to public or private offices, with a fiduciary duty, to take care of and protect us in our interactions with people who don't mean us well. This is what the strong people do.



The regulatory system also broke down here. The concept of securitization of mortgages was a good idea but the rules or constrains to the system were flawed, this is what caused the problems. The industry manipulators got around every law or rule that was designed to prevent these current problems.



In the final analysis, the people who should have benefited from this got caught with over priced homes, less disposal incomes and loss of jobs in some cases. But this does not mean that they are weak, for money or material things do not make them strong, it is their hearts, minds and ability to overcome adversities which make them strong and their belief in something greater than themselves.



No matter who we are there will be someone who is doing worse or better than us. In both cases it is always better to be loved by someone.

Post 105)
Great thread Duffminster and Old and gray. Very complex situation indeed. A couple of spokes have been put in place on our broken wheel. At least we may now get a truer picture of the extent of the damage. The ICE Trust news may be a market positive(?), as this partial solution has been long in the tooth coming and now may be perceived as "finally some action"?
I know you two are well above the market (with regards to whether the market goes up or down, we have larger problems then that at the moment), and I see a real effort here to offer up solutions. Thank You!


www.dtcc.com/news/press/releases/2009/cds_data_transparenc​y.php

Excerpt:

DTCC to Expand CDS Data Released from Trade Information Warehouse

New York, January 15, 2009 – The Depository Trust & Clearing Corporation (DTCC) announced today that, in its ongoing efforts to enhance transparency in the market for over-the-counter (OTC) credit derivatives, it is expanding the data its DTCC Deriv/SERV unit publishes on credit default swaps (CDS) registered in its Trade Information Warehouse (Warehouse) to show additional detail on weekly transaction activity. The Warehouse is the market’s only central trade registry and industry-recognized infrastructure for credit derivatives trades.


ir.theice.com/releases.cfm

Excerpt:


Clearing to Bring Unprecedented Transparency and Risk Management to Global CDS Markets -- Acquisition of TCC Complete -- SEC Exemption Received March 6; Fed Approval Received March 4 -- Agreement in Place with Markit to Produce Daily Settlement Prices
NEW YORK, March 6, 2009 /PRNewswire-FirstCall via COMTEX News Network/ -- IntercontinentalExch​ange(R) (NYSE: ICE), a leading operator of regulated global futures exchanges and over-the-counter (OTC) markets, today announced that ICE US Trust, LLC (ICE Trust), a New York limited liability trust company, will begin processing and clearing credit default swap (CDS) index transactions on March 9, 2009. Clearing of North American Markit CDX indexes is expected to be followed by liquid single-name CDS in the following months. ICE Trust has entered into an agreement with Markit to produce daily settlement prices required for mark-to-market pricing, margining and clearing

[comokate]

Post 106)
Thank you, cYbird2.



The timeline is interesting, January 15th and March 6. Duff opened this discussion on Feb 2. That means the DTCC was at work before the thread inception. Apparently, we brought nothing new to the table except a reprise. They were beating us to the punch without announcement.

The next question is, how effective have they been? Is the DTCC operating at this time? I'll have to take a look.

To this point, I hadn't seen anything in the papers. Had I been in office, or in any position to broadcast a little calming news like this, to show the forces were at work trying to resolve some issues, I would have done so! Wouldn't that have demonstrated a willingness to attack a problem?

ICE Trust is doing exactly what we have been discussing for the derivatives! Well, Good! We weren't first and that is reassuring to me. Maybe those windowless rooms do have well-intentioned people at work in something other than a vacuum!



www.dtcc.com/mews/press/releases/2009/cds_data_transparenc​y.php



I'll repost the address. For some reason your link doesn't activate on my screen. Thank you for that post.

Post 107)
I checked the site out and discovered once more that someone else carrying the magic key has arrived at the golden gate before me. Elsewhere, I admitted to never heading a parade; the only time I lead a parade is when I cross the street before the main event arrives.

Checking the News room on the DTCC site, I discovered that the EuroCCP was in existence in January of 2009. (CCP stands for Central Counterparty, which in turn implies matching beneficiary and guarantor of the toxic papers. This is followed up by cancelling out obligations and the remaining balance is settled. Let's hope it has the beneficial effect we all seek.

Good! Next step is determining how far they'll carry the process to reduce the spread of the mess by means of this clearing process.

Whatever they do should bring immediate relief to the financial stress by reducing the floating garbage in the world's banking systems.

That is very good news, cYbird2! Heartening!

Post 108)
This is also worth a peek.
It remains to see how effective they will be in reducing the clutter of obligations and counter obligations.



ir.theice.com/releases.cfm



Any contribution would be a step forward. But with over $600 trillion of derivatives floating through the global financial systems, there's a long row to hoe. . . . and still no word on how the banking systems intend to attack the matter of credit risk, disclosure and the accounting changes needed.



At this point, I don't see anything to discourage continuation of the analysis of the situation or remedies needed. There's more contributing to the problem than is immediately obvious.

We'll pick it up tomorrow.

[comokate]

Post 109)
Gramm Leach Bliley Act clearly gave the FED the responsibility to regulate and control the "Risk" the criminals on Wall Street have now clearly criminally evaded. The cost was shifted to the Consumer / Taxpayer. Risk of allowing criminals to run Banks and Brokers and Insurers on "Wall Street" was clearly cost shifted to "Main Street"
Our Government is corrupt and so is Wall Street - end of story.
www4.law.cornell.edu/uscode/15/usc_sec_15_00006716----000-.html
TITLE 15 > CHAPTER 93 > SUBCHAPTER I > § 6716

It is the intention of the Congress that the Board of Governors of the Federal Reserve System, as the umbrella supervisor for financial holding companies, and the State insurance regulators, as the functional regulators of companies engaged in insurance activities, coordinate efforts to supervise companies that control both a depository institution and a company engaged in insurance activities regulated under State law. In particular, Congress believes that the Board and the State insurance regulators should share, on a confidential basis, information relevant to the supervision of companies that control both a depository institution and a company engaged in insurance activities, including information regarding the financial health of the consolidated organization and information regarding transactions and relationships between insurance companies and affiliated depository institutions. The appropriate Federal banking agencies for depository institutions should also share, on a confidential basis, information with the relevant State insurance regulators regarding transactions and relationships between depository institutions and affiliated companies engaged in insurance activities. The purpose of this section is to encourage this coordination and confidential sharing of information, and to thereby improve both the efficiency and the quality of the supervision of financial holding companies and their affiliated depository institutions and companies engaged in insurance activities.

With criminals in charge all ignoring the LAW, "Change" is not possible.

Post 110)
An inside look into Negative Basis Trading.
www.acredittrader.com/

Excerpt:

What is a negative basis trade?
In a nutshell, if a bond is trading cheaper than the CDS you buy the bond and buy CDS protection to lock in “risk-free” carry. In other words, say there is a 5y bond in the market trading at 500bps spread while a 5y CDS is trading at 480bps. Putting on this trade gives you a carry of 20bps, which if you lever it up 25x + provides you with carry of 5%+.

The reason this is called “risk-free” is because you don’t care (caveats coming) if the name defaults since what you lose on the bond you make back from the short risk position in the CDS.





Referenced Bloomberg Article

www.bloomberg.com/apps/news?pid=20601109&sid=aaCZXj5ScUlo&refer=home



Excerpt:

Darth Wall Street Thwarting Debtors With Credit Swaps (Update2)



By employing a so-called negative-basis trade, investors could buy Six Flags bonds at 20.5 cents on the dollar and credit- default swaps at 71 cents. If the New York-based chain defaults, the creditors would receive the face value of the debt, minus costs. In a Feb. 27 note, Citigroup Inc.’s high-yield strategists put that profit at 6 percentage points, or $600,000 on a $10 million purchase.

Investors who bet on the collapse of a company are pitting themselves against traditional debt holders at a time when Moody’s Investors Service projects defaults will more than triple this year to the worst level since the Great Depression. The clash may stall restructuring efforts to prevent bankruptcies, as basis traders may be less inclined to participate in distressed debt exchanges, said Matthew Eagan, an investment manager at Boston-based Loomis Sayles & Co., with $7 billion in high-yield assets.

“Before, you really had to worry mostly about where you were in the” company’s capital structure, he said. “Now, you have to consider the possibility that you might have this large holder of CDS incentivized to see it go into bankruptcy. It’s something that’s going to come up more and more.”


Man o man, this is some really deep doo doo! I am ulcerated!

Post 111)
Thanks Old and Gray. I've just read through the new material. I'm beginning to think we should have a parallel glossary thread to this thread in which terms are easily referenced over 20 or so pages. This subject has a language all its own and it would be nice to print out a glossary.

Post 112)
This series of posts will run several panels. I can't predict how many.



Defined Quality; Re whether change is possible. . .



I don’t believe we should consider if it’s possible, but whether it’s demanded by circumstances. E-money and e-banks have altered a lot of precepts in the banking industry and until we come to grips with the issues raised, we won’t be able to properly assess cause and effect, or adequately regulate the industry.

If my memory isn’t failing, you posted this previously, didn’t you?

Post 113)
To continue with the analysis of our banking problems:
In addition to credit risk, banks face another pair of inter-related risk problems: market-risk and liquidity-risk, often addressed as market-sensitivity and liquidity-sensitivity. Banks have an ever-present problem when they extend credit by means of their two methods, depositors’-money-backed-loans and fiduciary-backed-loans and that problem is the long-term commitment to loans covered by short-term depositors’ funds.

Once the bank’s loan department commits to the long term loans or investments, liquidity becomes an issue and the depositors’ accounts must be used not only for running operating expenses but to provide a cushion in the form of loss reserves. Unexpected devaluation such as that we experienced in the mortgage securitization trap when market forces developed into more than just a simple threat when they produced suddenly unanticipated un-securitized loans, placed a demand for additional reserves for basic bank operation. Low reserve levels results in scraping for funds just to open the doors.

Considering the highly leveraged situations brought on by extending loans through leveraging to the maximum on depositors’ funds, and then, beyond that, extending loans on a fiduciary media basis (with "no-money" backing), it’s easy to understand how liquidity reserve requirements can be strained. Add to this the convenience of running off-balance sheet conduits and off-balance-sheet activities, and we understand how tempting it might be to temporarily gamble with the idea that since it’s not visibly accounted for, we can ignore reserve requirements today and make up for it tomorrow (that immediate profit is so tempting!) or, next week. Since Congress conveniently hid the transactions from regulators, who’s to know? In common parlance we now refer to this situation as cash flow problems, in banking terminology, it’s liquidity risk.

With the multiplier effect of derivatives, swaps, MBSs and the like, and the temptation and ease of computerized dispersal through conduits at the speed of electricity, comfortable liquidity levels can be forgotten or overlooked quickly and the global system can be overwhelmed before originators are aware of it. The nature of liquidity and keeping abreast of the threat falls within the purview of Probability studies. Those studies aside, it just hasn’t worked out the way it should have, has it?

Post 114)
Referring back to Paul Krugman’s article of late summer 2007 and the "non-bank bank run", we’re forced to acknowledge we’ve been beset by problems since around mid-2007, a full year and a half ago. We’re nowhere near solving that problem yet. I’m not sure we’ve yet acknowledged it. A combination of market overload and the developed shortfall of securitization, proved just how damaging ignored liquidity-sensitivity can be. The low-level high speed flight banks were enjoying was abruptly ended when we smacked into the unyielding problem of a rapidly coagulating, resistive market. The impact must have been silent or they tried to conceal it. Yet, some alert observers saw it. Then, the once gushing stream suddenly evaporated and we suffered a belly landing on a dry river bed.
Money markets, hedge funds and banks were in trouble, but still anxious not to show signs of the trouble fearful of bank runs. There was the near miss of 2007 and the one in September, 2008 that was quickly shut down. The former had little effect on the market, the second forced market recognition.
In 2007, banks realized they were remiss in attending to Liquidity Risk from both management and supervisory view points. In retrospect, it’s a marvel that so many informed people were so oblivious to the consequences of their actions.
Plainly stated, the situation was one in which bankers simply did not have the assets required to back up their market activity when the abrupt market shifts fell out of the blue and hammered them.
Just as Credit Risk imposed a string of conditions on banks for safety’s sake, there is a list of equally strong controls required to anticipate and offset liquidity risk. Basically, even if they followed the same kind of top down procedure instituted for credit risk, the banks’ tolerance for liquidity risk would have been served. . . not entirely, but a mechanism would have been in place. As it became obvious, nothing had been addressed or prepared.
So banks weren’t prepared, the onslaught too swift, and bankers could not respond with the reflex necessary to counter the devastation that descended on them at the speed of electricity. The fact that not only the large banks but medium-sized banks seized up and stopped, demonstrated how little attention was devoted to the well known, potential problem of liquidity risk. Banks behaved as though the carousel was in perpetual motion mode and no further attention or concern was necessary. . . or, so they believed.
If they had been forced into disclosure, if not to the depositors or the supervisors, certainly to the market they were dealing with, that alone might have forced them to adopt a more reasonable, balanced stance. Explanation demands attention. But, instead, in the blissfully ignorant state they all enjoyed, bank personnel, management and bank supervisors saw no end to the spree.

Better still, had there been a Central Counter Party ( CCP) active during that time (mid-2007 to mid-2008), the stressed situation had a better chance of being detected and the tribulations averted.

The Basel Committee issued "Sound Practices for Managing Liquidity in Banking Organisations" in 2000. "Liquidity Risk and Management and Supervisory Challenges" was published Feb, 2008. The latter was a little late to expect timely installation of an adequate program which would implement and monitor liquidity procedures. But, at least the former publication was available well in advanced of the critical period beginning in mid-2007.

Too much money and profit for bankers to interrupt their enjoyment in order to work out a back up plan in the event of failure . . or, perhaps, they thought, "What failure? Are you sick?"

[comokate]

Post 115)
At this point, in partial defense of bankers, not to excuse the oversight and apparent negligence, I’d restate that banking is a complex, ever-changing enterprise. The effect of internal and external forces, industry and market challenges, and local and global influences and fluctuations in constant play must be considered. Yet, on the other hand, with so much at stake, care and determination to avoid serious consequences are not too much to ask of the folks in the driver’s seat. That it could be anticipated and handled is proven by the fact that many more banks weathered the storm in good shape than did not. If some could, why not all? Particularly the critical, sophisticated, heavily leveraged institutions. Their performance was worst of all.
Were they too big, too misdirected, mis-managed, or was the situation mis-understood?
Had they been properly setup and if the staff did what they should have, could they have prevented the collapse from happening?

Would the leaders have done so? Would they have limited their activity? The Fed must have had some idea of what was going on. If not the Fed, then the FDIC – the keeper of the SDI statistics. But, then, we saw what the establishment did to the woman, Brooksly Born who blew the whistle on the scam back in 1997, before it got under way. She suffered the equivalent of being hoisted on a rail, being tarred and feathered and ran out of town by folks who did not want their game disturbed.
What to do to correct the situation?
Russia’s experience, which began in 1997 and peaked in 2004, resulted in approximately 265 of 1,165 banks being shut down. Their reserve resources were inadequate for the liquidity support required by weak, or no, market activity. To add to the stressed situation, foreign capital flowed out of the system. Support resources for liquidity proved inadequate and various strategies had been tried unsuccessfully. Despite best efforts of the Central Bank of Russia (CBR), sufficient funds could not (and still cannot) be mustered to service the problem. The realities forced retractions and culled out the less favored small banks based on policy decision addressing the lesser of evils. Larger Russian banks were still able to rely on infusion of some helpful foreign capital when the CBR discovered enough assets (by auctioning off pension plans, apparently the only assets they held of any marketable value) to seed support to the select group, which then, in turn, allowed the banks to extend credit. The test of time will prove the value of this strategy.
Regulation and confidence are key issues to restoring the Russian banking system. They are also, as are our banks to a degree, concerned about reputation and the effect of the debacle on their image. Market response has still not been assuring. This is something American banks have not seen fit to yet consider in depth. They are too busy trying to get their feet under them at the moment. At any rate the US banks would probably insist that the Russian experience is not related to US conditions in any way despite their both tackling the same issues. In addition, should the derivatives which they’ve been dabbling in begin to draw further on their resources, the smaller Russian banks would be troubled and would need more help to support liquidity. After eleven years, foreign market response has been at less than helpful levels while the Russian state bank is struggling to retain over 40% of their total of inadequate available funds for its own stability
.
Post 116)
All this might be an object lesson to the US system when we see that overall, Russia’s growth is severely hampered and is less than half of what’s needed for the nation’s economic recovery. Whether we dismiss it as a system too different from ours or not, the same market forces are at work in Russia as in the US. There must be a lesson there. Should they concentrate on servicing the corporate sector alone, none but the largest Russian banks would be able to participate effectively, a problem also similar to ours. To add to the weight of the Russian problem, the Japanese economy has been struggling to regain the zip it lost back in the early 1990s to little avail. The same concerns, credit and liquidity and recalcitrant markets were responsible for the problems in South America and Malaysia where obligations could not be met because credit had been stretched beyond limits of available liquidity. Some may argue that circumstances were different, but the basics were and remain the same.
Another observation which should prove useful in improving the US banking situation: is that issues delaying corrective action in the Russian system have been deciding which of the additional small banks should be merged, and matched with whom during the inevitable contraction. The acquisition process may be important in the US as well, along with technology demanding retraining, a slow process and an item we have yet to address in analyzing the US system. In today’s banking systems, if performance is not up to the task, market potential is meaningless. Banks must be fast, lean, and precise in dealing with modern currency concepts, recognizing opportunities and execution. The more we analyze, the more we discover we are the exact opposite.
Our current focus is on the large auto industries, as is Russia’s on their large corporations. In both cases, flagging consumer demands and participation is, if not a black cloud, then, less than encouraging. Alternate markets are scarce and global competition is fierce so market-sensitivity might even be of more importance than is liquidity-sensitivity.
cYbird2 pointed out the emerging development of CCP activity, the clearinghouse cancellation process directed toward cleaning up the swaps, derivatives, etc., a start-up process which, if it were to begin tomorrow is too slow to suit me. It has been in the works for at least two months or so, and is still coming to the rescue. The day we see the off balance sheet activity diminished without putting the entire banking system in the red, we’ll learn the value of it’s contribution. Such a result would certainly increase liquidity. That would be followed by improving market conditions and an increase in the flow of credit. This may not be noticeable for at least two quarters, and if the pace of canceling out counter parties is disappointing, recovery could stretch out for a couple of years before it has an ameliorative effect. But, we will shortly have the counter balance of CCP activity in Europe as well as the US, which would be helpful.
Between the two entities values could be established to replace the out-of-the-blue guessing at pricing which does nothing to restore confidence with everyone holding their breath, afraid to make a mistake in either direction, over- or under-valuing. This contributes nothing to re-instating faith in banks liquidity.
The mechanics of reports and publishing data is also working against a swift analysis and timely assurance that we are on the right path to recovery. Roughly, 8500 banks report for the FDIC-SDI (Statistics on Depository Institutions). There is at least a two step delay, one at the bank level, and one at the FDIC level, in gathering, verifying and publishing the data, so that by the time it’s released for analysis, it is already more than two months old. So, those looking for immediate verification that conditions are improving in response to the work now in progress, and those soon to be introduced, will find the delays frustrating.
Post 117)

Now that we’ve explored the difficulty in some detail, the question remains. What additional steps can help us climb out of the current doldrums to prepare for the recovery ahead? We’ve already hinted at them above. And, also, why were we blind-sided by the "shadow banking" and what needs attention in that approach? That’s next.


A side note:

It has occurred to me (and, I’m sure, others) that this couldn’t have been better orchestrated to disable the nation and the world if terrorists had been at the helm and forced this ingenious plan into operation to disable our financial system. Does this prove we are our own worst enemy at times?

Post 118)
Duff,
In RE your message #111 and an accompanying glossary:

You're probably correct in the implied value of a glossary. However, I lack the time and energy to devote to it.

Having been exposed to your energy and curiosity, I know you are anxious to be thorough, consolidate terms, ascertain that our language is synchronized, something essential to thorough understanding of position once the digging into dark areas begins, especially those shrouded in technology or "not-so-obvious", or "not-of-the-everyday-variety" of interests.

A while back I mentioned that continental interpretation of "transparency" differs from our meaning. As might be expected, almost every term in the financial world has more than one meaning, in the "shadow banking" world more so than elsewhere.

As an additional example, a while back, I made a quick explanation of "securitization", aligning it with collateralization. Several people I correspond with use the term with that meaning. Some others use it to denote the bundling process of distribution that has been so widely vilified and is now, I'd venture, generally considered one of the roots of our global financial problems. Depending on the users leaning, it could mean other things as well. Or, an analyst can go back a sentence or two and take up the argument that no way could the process be considered a "root cause" of our foundering and, we're off on another excursion entirely.

I'll beg off on that task. Too late for me to turn to lexicology. I'll try to be as lucid as possible while under way; but, to fall back on a simile I used previously, I don't want to use up my time studying knots in loose threads instead of enjoying the fabric.

Post 119)
I couldn't agree more. I wish to thank you personally DUFF for bringing clarity by way of OLD AND GRAY along with your own insights into this mess. I cannot avoid the anger that sweeps over me when I hear everybody talking in circles about the problem in lieu of telling the american people exactly what happened. How MOODYS stamped nodoc loans as AAA investment securities when they HAD to know they were lead and not gold. My fondest wish is for ALL those responsible to pay dearly along with the "whiz kids" that created the programs they based their entire deregulated dreams on.

Post 120)
I don’t believe we should consider if it’s possible, but whether it’s demanded by circumstances.

Change is clearly evident for all who can think. BUT.....not gonna happen!!!!!!!!!

Repeal of Glass Steagall set off one huge transfer of wealth by the RICO enterprise it created which was made up of Banks, Insurance Companies and Investment Bankers. Its existence would not be possible without Corruption as the Defining Quality of the highest levels of Government. $Trillions upon $Trillions of other peoples money and life's savings have been stolen from countless innocent investors and home owners World Wide. Many lives will be lost to starvation and disease before this all plays out over the next 20 years.

The reason why change is not possible is quite simple. The criminals that passed Gramm Leach Bliley Act are still in charge. What needs to happen will never happen period.

Everyone currently in the House and Senate who voted to repeal Glass Steagall should be Impeached and then imprisoned and have all their personal wealth stripped. The criminals on Wall Street who used GLBA to Securitize / Collateralize Risk through private OTC contracts to evade Insurance Regulations and Capital Reserve Requirements for banks and insurance companies, should likewise be prosecuted and have all their assets stripped.

The OTC market in Derivatives is was and will continue to be one giant Ponzi Scheme designed to Evade Insurance Regulations and the LAW - period. It was not some big technological breakthrough, and it was clearly not legal and it was clearly not Regulated by anybody charged with the duty to act. One huge circle jerk for the financial pleasure of the power elite.
If my memory isn’t failing, you posted this previously, didn’t you?
Your memory is good. Everyone gets it but no one can do anything about it.

[Aman A.K.A. Ahamburger]

(O&G) Post 121)
Change is clearly evident for all who can think. BUT.....not gonna happen!!!!!!!!!

Well, if it doesn't happen, it won't because I gave up! I'm a little less that 6 weeks shy of 88 and whether I finish it from this or the other side of the Great Divide, it'll be finished, no matter how much longer the pathway.

So! Back to work!

(O&G) Post 122)
This lull might provide the opportunity to spotlight the rating systems issues.

The erisk.com site I linked previously had more than a passing reference to the problems created, namely conflicts of interest and the modeling they use for generating their evaluations. OECD included Credit Rating Agencies in one of their studies. I have a preliminary draft of one of them: "The Fundamental Principles of Financial Regulation". Third paragraph and beginning of the fourth is quoted below. They devote only one page to Credit Rating Agencies.

Rather than accusing CRAs of sharp practice, our view is rather that the CRAs failed to appreciate the likelihood that US housing prices might decline across the board, and the extent that probabilities of default could migrate upwards in that event. Most forecasters have had poor, checquered records over the last two years. CRAs are just another group of forecasters, and they have done just as badly.

Anyhow, whether the CRAs were knaves (conflict of interest) or fools (poor forecasters, like most other forecasters), the question is what to do about their role in the general conduct of regulation. . .

Their conclusion was that they have already been placed in the center of Basel II Standardised Approach and placing them at the centre may have added to their fallibility.
So, there you are. Shine the spotlight on them and they perform more poorly!

Conflicts of interest always exist. Most economists are hired to represent a company or an entity and are expected to develop support for a point of view. Their personal thoughts may not coincide with the employers view so there's an air of equivocation about the work that results. It can be annoying, especially on occasions when the finished work avoids the obvious path to which some of the contentions lead us. It wouldn't serve the employer's end to have the slightest suggestion of a contrary view. In such a case, everyone knows what's happening and nobody is satisfied. How dependent the economist is on that employer determines how much of his independence or integrity he/she is willing to compromise.

The alternative to having a rating firm handling data operating on a for hire basis is having the government undertake the effort. Anyone who's ever heard of John Williams and shadow stats knows the problem with government stats. Anyone who has looked at the US government's year end Financial Report realizes how unreliable the bottom line is. (We're running on a known hundreds of billions deficit and they show half that, because they omit half of it purposefully!) Anyone who's ever looked at the Bureau of Labor stats realizes there's room for suspicion. The local paper carried a report that government claims there is an 8.1% unemployment rate and in this state, currently, 10.2% are collecting unemployment. Take your pick for reliability. I might have been three or four years of age when I first heard, "Figures don't lie, but liars figure."

Yes, it is a shame that the ratings agencies develop figures only for those who pay them and the results are suspect. But, that acknowledgement should provide us with a built-in caveat. Take what they offer with a grain of salt.

Math has a constant problem dealing with projections, principally because we don't know what the future brings and how that will effect our lives, our choices, our functioning. If WWII hadn't come along, I might have spent my entire life in another part of the world, doing something entirely different among exotic people with strange customs. As it is, I'm living in the US among strange people with exotic customs, very much like me and my family. No projections prior to the actual events could have predicted what happened to me during that time or since, yet this is what we expect of ratings companies.

[Aman A.K.A. Ahamburger]

(O&G) Post 123)

They produce a rating and set it aside for the next scheduled publication date or a delivery date to a client, and the circumstances of the entity they evaluated change drastically in response to an unforeseen event in the interim. The service doesn't catch it and what they release or convey to the client a week or so later it totally invalid. The alternative is to hire an untested "expert" and have him/her conduct the study and rely on the results. This is a much riskier proposition, that I'd avoid like a plague even though there have been times that I've undertaken such a task myself. Since there were no other data compilations or sources to compare to my conclusions, I couldn't measure the reliability. The figures worked, but I always pointedly warned the client ahead of time and never had repercussions.

The Preliminary Draft I quoted above finished with the choice between two possibilities: that CRAs and their ratings should be removed "as far as possible from the structure of formal regulation altogether". But, that investment managers and bankers should take responsibility for their own decisions, and they (and their regulators) should no more be allowed to hide behind CRA forecasts. . ." Or, the second "approach is to register and to regulate the CRAs, but to leave them with a central role in the regulatory process." I admit I don't understand how registering and regulating the CRAs will improve their reliability.

With the questionable degree of reliability we find in Government reports, I wouldn't see any great advantage in putting government statisticians in charge of the CRAs. Anyone who's tried to reconcile the Government's Annual Financial Report or read John Williams Shadowstats, might find that a tough choice to make. The Federal government has as dull an axe to grind as anyone else.

I see no chance for improvement.

(Duff)Post 124)
As an additional example, a while back, I made a quick explanation of "securitization", aligning it with collateralization. Several people I correspond with use the term with that meaning. Some others use it to denote the bundling process of distribution that has been so widely vilified and is now, I'd venture, generally considered one of the roots of our global financial problems. Depending on the users leaning, it could mean other things as well. Or, an analyst can go back a sentence or two and take up the argument that no way could the process be considered a "root cause" of our foundering and, we're off on another excursion entirely.

Perhaps the semantics of derivatives and its seemingly fuzzy lexicology are part of the problem of opaqueness. Complexity in and of itself serves to create seeming ambiguity and opaqueness and makes "Full Disclosure" easier to hide behind the excuse of "for experts only" and complexity. I've also been preoccupied the last few days. I hope to read more of the links and perhaps locate the best existing links for a glossary. I hope to take that upon myself in the coming weeks.

(O&G)Post 125)
Had some additional thoughts on the CRAs.

Among the factors included in the model evaluating vehicles is history. It occurred to me that some of the vehicles HAD NO HISTORY. If they did not alter the models used (which I suspect they could not), or were not able to do so and comply with a pressured request from the client, the results would have been skewed. If they had been supplied inaccurate data, historical or otherwise, already the analysis is in trouble.

Another question: how was the market at the time? Was there anything reliable the CRA could use?

Of course the results they received could have been verified through the financial Institutions internal verification process. . . if they had one. There's no excuse for skipping this step. Many houses do this, some don't. It's my understanding that those who did confirm the CRA's work fared better in the market than those who didn't.

Then, too, some firms asked the CRAs to advise them on how they might split their tranches and head them off for distribution. CRAs complied. But my focus is on, how does anyone know that all those bundled off were evaluated after being assembled?? Being in a hurry to distribute a couple of trillion (even several billion) dollars worth of bundled, questionable assets, is there enough time or patience to wait for the CRAs to analyze your product? CRAs are under considerable pressure to meet the needs of the clients and they must respond quickly. If they bungle the job, blame it on the CRA, documentation or no.

In the far reaches of my mind is the memory of someone mentioning some institutions misused the information obtained from CRAs.

I'm not sure of that, but it's always a possibility. This probably prompted these thoughts.
At any rate the criteria for CRAs still remains integrity in analysis and advice, try to use arm's length attitudes, and provide all relevant information.

In the end it's humans in action, and, like everything else, caveat emptor.

[Aman A.K.A. Ahamburger]

(O&G)Post 126)
Perhaps the semantics of derivatives and its seemingly fuzzy lexicology are part of the problem of opaqueness.

We haven't really treated derivatives in great depth. There's so much to the strategy, marketing and distribution clouded by the off-balance sheet nature and the terms. I understand that Citi distributed some vehicles, which may or may not have been all derivatives, that had a proviso for returning them to the originator and Citi became the surprised recipient of a mass of instruments with a request for a refund. All of which forced them to put the instruments back on their balance sheet, which in turn, caused a demand for increased reserves. A totally unexpected crunch at a time they were experiencing difficulty encouraging new deposits to handle other liquidity problems. That was a considerable shock.

The opaqueness problem is due in large part to the accounting procedure and the off-balance sheet treatment. Derivatives were nested in the conduits and there were time constraints as to how long most of those vehicles could remain there before being moved back onto the balance sheet.

(Duff) Post 127)
Old and Gray,

Returning to an earlier statement you made in regard to the CRA's,


Conflicts of interest always exist. Most economists are hired to represent a company or an entity and are expected to develop support for a point of view. Their personal thoughts may not coincide with the employers view so there's an air of equivocation about the work that results. It can be annoying, especially on occasions when the finished work avoids the obvious path to which some of the contentions lead us. It wouldn't serve the employer's end to have the slightest suggestion of a contrary view. In such a case, everyone knows what's happening and nobody is satisfied. How dependent the economist is on that employer determines how much of his independence or integrity he/she is willing to compromise.

The alternative to having a rating firm handling data operating on a for hire basis is having the government undertake the effort. Anyone who's ever heard of John Williams and shadow stats knows the problem with government stats. Anyone who has looked at the US government's year end Financial Report realizes how unreliable the bottom line is. (We're running on a known hundreds of billions deficit and they show half that, because they omit half of it purposefully!) Anyone who's ever looked at the Bureau of Labor stats realizes there's room for suspicion. The local paper carried a report that government claims there is an 8.1% unemployment rate and in this state, currently, 10.2% are collecting unemployment. Take your pick for reliability. I might have been three or four years of age when I first heard, "Figures don't lie, but liars figure.

I wonder how one manages to create an objective reporting system that provides truthful and the most accurate possible reporting outside of government or corporations that have a clear and dangerous conflict of interest in their business paradigms, both rating debt and providing a paid service to the debt issuer?

(O&G)Post 128)
Departing from the status quo is a risk we're unwilling to take at this time. You and I know of disciplines which are reliable, impartial and accepted as such. First thing that pops into my mind are court reporters, basically stenographers with specialized training in court protocol and legalese, with integrity, trusted and accepted by the people who employ them. Notaries are licensed by the state, One of my sons is a Professional Geologist, certified by the state and he is extremely careful and conscientious about applying his apostille. Those and more are trustworthy people for hire to do a job, guarding their attestations carefully.

There is a professional organization named "Global Association of Risk Professionals" (GARP). I suspect employees of Moody's and S&P are members. Garp provides updated information, updates training, might even provide CPEs or CPUs.

There are independent and extremely reliable actuaries. Why not individual, certified Credit Raters? If there is a market for them, they might be out there now. Independent, contracting Credit Raters. If you were a landlord with a sizeable rental unit, you'd know of a credit rating agency to track your prospective tenants.

Moody's works with committees of employees and officers convened when the occasion arises. The experience required renders evaluation beyond the scope of a one person process. An independent would need staff to present a credible appearance at the outset and then would have to prove him/herself before attracting the larger entities and building an impressive clientele.

But, most direct answer to your question, for investment vehicles, we have what has evolved to service the market needs.


Must redirect myself toward the conclusion of the analysis or this might drag out for longer than I can tolerate