Posts Tagged ‘Federal Reserve Bank of New York’

Credits: The Price of Accountability

In Financial Engeneering, Financial Markets, Health and Environment, International Econnomic Politics, Law & Regulations, National Economic Politics, Views, commentaries and opinions on 24.10.10 at 00:21

Remember President Barack Obama’s pompous “BP-Will-Be-Held-Accountable”-speech? The president’s remarks on the oil spill dragged BP’s  share price right to the bottom and pushed the CDS’ straight through the roof. However, when The White House this week announced that US banks will be held accountable for any foreclosure violations, there was hardly any reaction in the financial markets at all.

“Whether investors chalked it up to part of mid-term election campaigning or simply could not discern the market impact is debatable.”

Otis Casey

Earlier this week, market price action seemed to suggest that investors were struggling to properly define the extent and impact of the potential foreclosure violations case. By the end of the week, however, I think they’ve started to see a more clear – not pretty – picture.

Bank of America, who had halted foreclosures in all 50 states, signalled on Tuesday that is was time to resume the foreclosure process. As for their process, CEO Brian Moynihan simply said; “Without question we’re doing it right.”

The day before Citigroup stated that their process was “sound”.

“While no one expected that the uncertainty in litigation risk could just disappear overnight, it at least appeared to be moderating a bit,” credit analyst Otis Casey writes in the weekly credit wrap from Markit Financial Information.

“There seemed to be a perception that the majority of the headlines would be read in the rear-view mirror – at least,” Otis Casey writes, but point out: “That sentiment was short-lived.”


Reminiscent of President Barack Obama’s “BP Will Be Held Accountable” speech, the White House announced this week that banks would be held accountable for any foreclosure violations.

This was not surprising, considering that a key part of the President’s communication strategy has been to side with “Main Street” against “Wall Street.”

“Whether investors chalked it up to part of mid-term election campaigning or simply could not discern the market impact is debatable, in any case the announcement did not have anywhere near the same market moving impact on CDS spreads the way that the BP speech did last spring on BP’s CDS spreads,” Casey notes.


“Then some of the biggest investors in the world decided to react like it was “Wall Street vs Wall Street” (nevermind
that PIMCO headquarters is in Newport Beach),” Casey goes on.

Reports surfaced that indicated PIMCO, BlackRock and the Federal Reserve Bank of New York are looking for a way to force  Bank of America to repurchase bad mortgages that is a part of some $47 billion in bonds, packaged by its Countrywide Financial unit.

Other investors are expected to join this group.

“Furthermore, the tactic is expected to be repeated in other cases where investors believe that the quality of mortgages may have been misrepresented,” Casey adds.

CDS spreads on the major mortgage lending banks widened significantly on the news and set a negative tone for the corporate credit markets generally.

However, by the week’s end, the CDS spreads for the major US banks were tighter than where they were a week ago.

Wells Fargo reported record earnings despite lower revenues.

While Bank of America reported a third quarter loss, adjusted results beat analysts’ estimates.

Earnings results in general have given support in the last two sessions, which has helped improve sentiment and again shifted focus away from the foreclosure issues – at least in the news headlines.


On the European side,  a bit more clarity emerged on the subordinated debt of Anglo Irish Bank.

The bank announced on Thursday that it was offering to exchange up to approximately 1.6 billion euro principal amount outstanding subordinated debt for new euro-denominated floating rate notes, due 2011, at an effective price of 20% of face value.

A separate offer for 300 million GBP, callable, subordinated notes at 5% of face value was also made.

“The exchange offers are “voluntary” but if holders choose not to participate, they could receive as little as 0.01 euro per 1,000 euro of principal amount,” Otis Casey writes.

The latest quotes are 10 points and 68 points upfront, for senior and subordinated protection, respectively.

Related by The Swapper:


The Dirty Little Secret Of The Dodd-Frank Legislation

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 10.08.10 at 00:01

“The dirty little secret of the Dodd-Frank legislation is that by failing to curtail the worst abuses of the OTC market in structured assets and derivatives, a financial ghetto that even today remains virtually unregulated, the Congress and the FED are effectively even encouraging securities firms to act as de facto exchanges and thereby commit financial fraud,” the Institutional Risk Analyst writes in its recent news letter.

“No more QE thank you please.¤

Institutional Risk Analyst

“With the passage of the Dodd-Frank Wall Street reform legislation, many financial analysts and members of the press believe that investment banking revenues and resulting earnings are in danger, but nothing is further from the truth,” the Institutional Risk Analyst writes.

The Volcker Rule and other limitations on the principal trading and investment activities of the largest universal banks do nothing to address the true cause of the crisis, namely the creation and sale of fraudulent securities and structured assets based on residential mortgages, toxic waste which was sold over-the-counter (OTC) as private placements and without SEC registration, according to the Institutional Risk Analyst, know for its regular publication of the IRA Bank Stress Monitor.

Here’ some more from the rather harsh commentary:

It is not own account trading but the derivatives sales desks of the largest BHCs whence the trouble lies.

Even as the big banks make a public show for the media of implementing the new Dodd-Frank law with respect to limits on own account trading and spinning off private equity investments, these same firms are busily creating the next investment bubble on Wall Street – this time focused on structured assets based upon corporate debt, Treasury bonds or nothing at all – that is, pure derivatives.

Like the subprime deals where residential mortgages provided the basis, these transactions are being sold to all manner of investors, both institutional and retail.

The Perverse Structure

It is the perverse structure of the OTC markets and not the particular collateral used to define these transactions that creates systemic and institution specific risk.

One risk manager close to the action describes how the securities affiliates of some of the most prominent and well-respected U.S.

BHCs are selling five-year structured transactions to retail investors.

These deals promise enhanced yields that go well into double digits, but like the subprime debt and auction rate securities which have already caused hundreds of billions of dollars in losses to bank shareholders, the FDIC and the U.S. taxpayer, these securities are completely illiquid and often come with only minimal disclosure.

The Dirty Secret

The dirty little secret of the Dodd-Frank legislation is that by failing to curtail the worst abuses of the OTC market in structured assets and derivatives, a financial ghetto that even today remains virtually unregulated, the Congress and the FED are effectively even encouraging securities firms to act as de facto exchanges and thereby commit financial fraud.

Allowing securities firms to originate complex structured securities without requiring SEC registration is a vast loophole that Senator Christopher Dodd (D-CT) and Rep. Barney Frank (D-MA) deliberately left open for their campaign contributors on Wall Street.

But it must be noted these same firms have a captive, client relationship with the FED and other regulators as well, thus a love triangle may be the most apt metaphor.

Of course retail investors love the higher yields on complex structured assets. Who can blame them for trying to get a higher yield than available on treasuries, while the FED keeps rates at historic lows to, among other things, re-capitalize the zombie banks.

The Only Trouble

The only trouble is that the firms originating these ersatz securities, as with the case of auction rate municipal securities, have no obligation to make markets in these OTC structured assets or even show clients a low-ball bid. And because of the bilateral nature of the OTC market, only the firm which originates the security will even provide an indicative valuation because the structures and models behind them are entirely opaque.

In fact, we already know of two hedge funds that are being established specifically to buy this crap from distressed retail investors as and when rates start to rise.

The sponsors expect to make returns in high double digits by making a market for the clients of large BHCs who want to get out of these illiquid assets. But the one thing that you can be sure of is that nobody at the FED or the other bank regulatory agencies knows anything about this new bubble.

As with the early warnings brought to the FED about private loan origination and securitization activities as early as 2005, the central bank and other regulators are so entirely compromised by the political pull of the large banks that they will do nothing to get ahead of this new problem.

Consider a specific example:

Shall We Reward Incompetence?  – The Case of Sarah Dahlgren and the FED of New York.

Read the rest at IRA’s homepage here.

Related by the Econotwist:

So, You Thought BP Was An OIL Company?

Webster Tarpley: The Financial Reform Is A Failure

Transantlantic Bailout Buddys Agree To Disagree

Civil And Criminal Probes Against JP Morgan For Silver Manipulation

Two Thirds of Americans Support Stricter Financial Regulations

Living In A Derivative World


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Mr. Rubin's Still Rockin' The House

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 30.06.10 at 00:04

It may come as a surprise to some that, despite the fiasco at Citigroup and his role in causing the subprime mess, former Goldman Sachs CEO Robert Rubin remains inside the circle at the White House. Nearly two decades after first migrating to Washington, he apparently is still calling the shots of U.S. financial and economic policy with the full support of President Barack Obama.

“Operating through trained surrogates such as Geithner, Summers and others, Robert Rubin is still pulling the economic and financial strings in Washington.”

Hans-Joachim Dübel

“Most recently Mr. Rubin managed the defense of Wall Street following the great crisis. No matter what Treasury Secretary Geithner says, or when he says it in public, you can be sure that those utterances have the full knowledge and approval of his handler Larry Summers and their common political owner and sponsor, Robert Rubin,” the founder of Finpolconsult, Hans-Joachim Dübel, writes.

Hans-Joacim (Achim) Dübel describes the famous former Goldman Sachs CEO, Robert Rubin, as a modern day colossus, who “effortlessly bestrides the worlds of political and finance, and mostly without leaving a trail of slime that often betrays the average political operator.”


Rubin stood at the right hand of Alan Greenspan on the famous February 1999 Time cover entitled: “The Committee to Save the World.”

He’s not an entrepreneur like Pierpont Morgan; Rubin is a mixture of banker, politician and global technocrat, a super fixer of sorts, but with a proper sense for public-private partnership.

Case in point: The famous letter from Rubin to Goldman Sachs clients when he first went to the Clinton White House saying that just because he was in Washington didn’t mean he wouldn’t be looking after them.


Here’s Mr. Dübel’s commentary:

Mr. Rubin Goes To Washington

President Bill Clinton famously called Rubin the “greatest Secretary of the Treasury since Alexander Hamilton,” yet another example of the former President’s generosity.

There’s probably a couple of dozen names on the list of the less than 100 Treasury chiefs who’ve served since the inception of the U.S. we’d put in front of Rubin. How about Albert Gallatin, Salmon Chase, Carter Glass, William McAdoo, Andrew Mellon and Henry Morgenthau to start?

In fact, reasonable people might call Robert Rubin the chief architect of the financial crisis and also of Wall Street’s grand strategy to minimize the political damage from the subprime crisis.

From his mismanagement of the U.S. Treasury’s dollar policy in the mid-1990s to his bailout for Mexico (for Goldman Sachs and other Wall Street dealers), to the rescue of Citigroup and AIG in 2008, Rubin has met or exceeded the most demanding expectations for duplicity from our public servants.

Recall the comment by former Fed Chairman Alan Greenspan about “cringing” when Rubin spoke about the need for a strong dollar and you get the idea. Yves Smith has a great summary of this period of Rubin’s career in her book Econned, BTW, in the last Rubin hit in the index.

Emboldened by the cash surpluses from Social Security contributions pouring into the Treasury and the related silly talk about the US redeeming all outstanding public debt, in the 1990s Rubin transformed himself into a deficit hawk. And using the considerable network of connections and money that is the chief asset of Goldman Sachs, Rubin became part of the permanent government that still runs Washington today.

Rubin worked first at the White House as economic policy boss, then after the abortive 1994 election sweep by the Republicans, at the Treasury.

He oversaw the bailout of Mexico in December 1994, thereby bailing out Goldman Sachs and the other banks which held Mexican exposure.

Then was forged the core gang of Rubin, Larry Summers and Timothy Geithner which comprises the Rubin political tendency today. Summers was the chief minion in those days and ran political interference for Wall Street after Rubin’s departure in 1999.

Lesser minions of Rubin today in the Obama White House include Jason Furman, a deputy to Summers on the National Economic Council and likely candidate to be the next head of the Office of Management and Budget. He would replace yet another Rubin protege, Peter R. Orszag.

Larry Summers - Timothy Geithner

Larry Summers - Timothy Geithner

Through eight years of George W. Bush and two decidedly non-Wall Street Treasury chiefs in Paul O’Neill and John Snow, the Rubin machine worked opportunities on Wall Street and groomed its new front-man, Timothy Geithner.

Geithner served as Under Secretary of the Treasury for International Affairs from 1998 to 2001 under Secretaries Rubin and Summers, where he was “a principal adviser and member of the executive branch’s senior team.”

Geithner then spent a couple of years at the IMF gaining credibility (and dodging his personal income taxes) before being made President of the Federal Reserve Bank of New York in October of 2003.

Geithner was chosen for the key Fed job by that subset of the Council on Foreign Relations which seemingly controls the Fed of New York board, a fact that the latest financial reform legislation leaves undisturbed.

The selection of Geithner was made by a search committee headed by Pete Peterson, senior chairman and co-founder of The Blackstone Group, who fortunately did not need to look far. Rubin, Summers and Fred Bergsten all reportedly “advised” Peterson on the selection of Geithner, according to the FRBNY.

Geithner has been effectively an operating asset of Rubin for the past two decades and especially after the former Treasury Secretary left Washington in 1999 to join the board at Citigroup.

As we reported prior to Geithner’s nomination as Treasury Secretary, during his tenure at the Federal Reserve Bank of New York Geithner would often speak to Robert Rubin on the telephone for hours at a time, a practice we are told by a reliable source inside continues even to this day.

What are they talking about?

The Citigroup Bailout

During the period when Secretary Geithner headed the Fed of New York, Rubin was on the board of Citigroup, a bank that would eventually be rescued at great cost to the taxpayer and C shareholders.

Robert Rubin

Robert Rubin

But what is frequently missed is that Rubin and the board knew or should have known about operational problems at Citigroup as early as 2003.

Not even two years after Rubin arrived on the board of Citigroup as a senior adviser to Chairman Sanford Weill, the largest subprime lender in the U.S. almost cratered.

During the 2001-2003 mini recession, Citigroup’s credit loss experience skewed almost a standard deviation higher than the large bank per group and stayed there until the end of 2005. As it turns out, this large loss event in terms of the bank’s credit experience was a hint of things to come.

That is, Rubin and the Citigroup board should have known in 2002 onward that there was a problem at the bank. But Rubin seemingly was too busy with other matters to know or to care. Users of the professional version of The IRA Bank Monitor may view the default series for C’s subsidiary banks by clicking here. The chart illustrates that for Citigroup, the subprime crisis began in 2002.

But where was Bob Rubin?

From 2003 through 2007, Rubin encouraged Citigroup to increase leverage and risk during the subprime boom, this while spending a great deal of time pursuing an agenda of global diplomacy that was largely unrelated to the bank’s operations.

Where were the Fed and the OCC while Rubin was AWOL from his role as board chairman? “You were either pulling the levers or asleep at the switch,” Philip N. Angelides told him during hearings on the Citigroup bailout, but Rubin refused to take personal responsibility for what occurred at Citigroup or in the larger economy, according to the New York Times.

Angelides, a former California state treasurer and a fellow Democrat, did not buy Rubin’s excuses. “You were not a garden-variety board member,” Angelides said. “I think to most people chairman of the executive committee of the board of directors implies leadership.

Certainly $15 million a year guaranteed implies leadership and responsibility.” And of course Rubin was and is exercising leadership, just not the kind that is generally understood.

When Citigroup was nearing collapse in 2008, Rubin then orchestrated the bailout of the bank in order to hide the effects of his lack of attention to the bank’s operational problems. During a series of telephone conversations with his former partner and another former Goldman Sachs CEO, Treasury Secretary Hank Paulson, the Citigroup bailout was agreed.

Rubin’s intervention saved the proverbial bacon for Rubin and the other members of the Citigroup board of directors. But also remember that Paulson’s arrival at the Treasury, in and of itself, was a sign that another financial crisis was brewing on Wall Street.

Rubin remained at Citigroup through January 2009, long enough to see the bank through the most difficult part of the crisis and bailout. He was aided by his dutiful minion Geithner, who was now at Treasury but operating under careful supervision of Summers and Rubin.

Geithner also facilitated the bailout of American International Group, again to the advantage of Goldman Sachs and other Wall Street dealers. Rubin then departed from the board of the badly damaged banking group and ascended into heaven.

Next Crisis: The Dollar

The end result of financial reform is inconvenience for the financial services industry and more expense for the taxpayer and the consumer.

Hans-Joachim Dübel

Hans-Joachim Dübel

But it should be noted that, once again, Wall Street has managed to blunt the worst effects of public anger at the industry’s collective malfeasance. The banks can now start to focus their financial firepower on winning back hearts and minds on Capitol Hill. All it takes is money.

Notwithstanding anything said or done by the Congress this year, operating through trained surrogates such as Geithner, Summers and others, Robert Rubin is still pulling the economic and financial strings in Washington.

The fact that there is a Democrat in the White House almost does not seem to matter. President Obama arguably has a subordinate position to Rubin because of considerations of money.

If you differ, then ask yourself if Barack Obama could seek the presidency in 2012 without the support of Bob Rubin and the folks at Goldman Sachs. Case closed.

For America’s creditors and allies, the key question is whether the Democrats around Rubin are willing to embrace fiscal discipline at a time when deflation in the US is accelerating. That roaring sound you hear is the approaching waterfall of the double dip.

With the US at the moment eschewing anything remotely like fiscal restraint and the rest of the world going in the opposite direction, to us the next crisis probably involves U.S. interest rates and the dollar.

Judging by Rubin’s performance in the past, when he talked first of a strong dollar, then a weak dollar policy, and fudged the issue regarding fiscal deficits, we could be in for quite a ride.

But at some point the Obama Administration should acknowledge that this particular former CEO of Goldman Sachs is still driving the policy bus.

If the Republicans are in control of the Congress come next January, maybe they should subpoena Rubin to appear periodically. At least then we all can hear directly to the person who is actually making national economic policy.

By Hans-Joachim Dübel


FINPOLCONSULT the financial and real estate sector specialist. The company offers independent economic, market and legal-regulatory analysis and advice at the intersection of both sectors – especially in mortgage capital markets, mortgage lending and insurance, and housing policy.nd housing policy.

Original post at the Institutional Risk Analysis.

Related by the Econotwist:

JPMorgan’s “Poison Pill” Strategy

Webster Tarpley: The Financial Reform Is A Failure

Citigroup: Euro Zone No Longer A Single Economy

Goldman Sachs: Good Morning Europe!

6 U.S. Banks Collects 93% Of Industry’s Trading Revenue

Bank Protest Sponsored By Banks

Transantlantic Bailout Buddys Agree To Disagree

Banks Face Multi-Hundred-Million Dollar Settlements

The Truth, Some Truth And Something Like The Truth

Goldman-Boss Questioned By Congress – Watch It LIVE Now

Goldman Sachs Charged With Fraud – Here’s The SEC filing


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Big Banks Block OTC Clearing in “Proxy War”

In High Frequency Trading, Law & Regulations, Quantitative Finance on 15.06.10 at 23:45

Wall Street’s largest banks are blocking smaller firms from using over-the-counter derivatives clearinghouses as a “proxy war” to protect the money they make from trading swaps, according to a brokers’ association.

“The effort to protect clearing, however, is actually a proxy war to limit competition to the incumbent dealers’ $100 billion in profits for derivatives execution.”

Mike Hisler

Rules intended to lessen the risk of a systemwide failure are “working to restrict access to only the incumbent dealers,” the Swaps and Derivatives Market Association said in a statement sent Tuesday  to Theo Lubke, senior vice president at the Federal Reserve Bank of New York.

According to Bloomberg News, the group of more than 20 brokers including Jefferies & Co., Imperial Capital LLC and Newedge USA LLC formed in February to lobby Congress and regulators for access to derivatives clearing.

Intercontinental Exchange Inc., CME Group Inc. and other companies that operate clearinghouses for the $615 trillion privately negotiated derivatives markets enforce capital requirements and trading rules intended to bolster the ability of the clearinghouses to withstand losses.

Those requirements, though, prevent all but the world’s largest banks, including Goldman Sachs Group Inc., JPMorgan Chase & Co and Barclays Plc, from sending trades to the clearinghouses, according to the statement by the brokers group.

“The effort to protect clearing, however, is actually a proxy war to limit competition to the incumbent dealers’ $100 billion in profits for derivatives execution,” the brokers group said. Mike Hisler, a spokesman for the association, and Ray Zorovich, the group’s policy assistant, are listed as contacts on the statement.

Hisler also is a partner at New York- based Hexagon Securities LLC, a member of the association.

“Economic Self-Interest”

Clearinghouses should want to offer clearing to as many qualified users as possible to maximize profits, according to the statement.

“However, the clearinghouses are not acting in their own self-interest; they are influenced by the incumbent dealers and are thus acting in the dealers’ economic self- interest.”

Goldman Sachs spokesman Michael DuVally and Barclays spokesman Brandon Ashcraft declined to comment.

JPMorgan spokesman Justin Perras didn’t immediately return a telephone call, Bloomberg writes.

The debate about access takes place as Congress seeks to empower regulators to dismantle failing financial firms deemed to pose a systemic threat to the economy. Limiting the number and types of firms that can join derivatives clearinghouses concentrates too much risk there, the excluded firms say.

At stake is access to the privately negotiated derivatives markets that generated an estimated $28 billion in revenue last year for the five biggest U.S. dealers, Goldman Sachs, JPMorgan, Morgan Stanley, Bank of America Corp. and Citigroup Inc., according to company reports collected by the Federal Reserve and people familiar with banks’ income sources.

Size Requirements

Only firms with a net worth of at least $5 billion are allowed to be members of the largest credit-default swap clearinghouse, Intercontinental Exchange’s ICE Trust. At CME Group’s venture, that requirement is $500 million.

Both demand expertise in the market, including swaps-trading desks that can provide prices for the contracts at the end of the day. Those prices are used to determine margin payments to the clearinghouse.

Smaller brokers should be able to partner with independent dealers to provide end-of-day prices, according to the statement.

Clearinghouses should want to offer clearing to as many qualified users as possible to maximize profits, the group said. “However, the clearinghouses are not acting in their own self‐interest; they are influenced by the incumbent dealers and are thus acting in the dealers’ economic self‐interest.”

“The dealers’ have a circular argument because an actionable pricing requirement only exists because of the lack of an exchange and is merely a temporary solution under the current bilateral OTC market that the dealers themselves are trying to preserve,” the group said.

“Once price transparency is achieved, volumes will migrate to price transparent products and actionable pricing requirements will no longer be needed.”

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Greece, Lehman And Geithner

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 14.04.10 at 09:29

We live in an age of unprecedented bailouts.  The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.

“The financial crisis wasn’t so bad; no depression resulted and bonuses stayed high, so why do we need to change anything at all?”

Financial Times

“The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures,”  Simon Johnson at The Baseline Scenario writes.

Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?

But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).

The sharp decline in market confidence last week – marked by the jump in Greek yields – scared the main European banks, and also showed there could be a real run on Greek banks; other Europeans are trying to stop it all from getting out of hand.  But there is no new program that would bring order to Greece’s troubled public finances.

It’s money for nothing – with no change in the incentive and belief system that brought Greece to this point, very much like the way big banks were saved in the US last year.

If anything, incentives are worse after these bailouts – Greece and other weaker European countries on the one hand, and big US banks on the other hand, know now for sure that in their respective contexts they are too big to fail.

This is “moral hazard” – put simply, it is clear a country/big bank can get a package of support if needed, and this gives less incentive to be careful.  Fiscal management for countries will not improve; and risk management for banks will remain prone to weakening when asset prices rise.

If a country hits a problem, the incentive is to wait and see if things get better – perhaps the world economy will improve and Greece can grow out of its difficulties.  If such delay means that the problems actually worsen, Greece can just ask Germany for a bigger bailout.

Similarly, if a too-big-to-fail bank hits trouble, the incentive is to hide problems, hoping that financial conditions will improve.  Essentially the management finds ways to “prop up” the bank; on modern Wall Street this is done with undisclosed accounting manipulation (in some other countries, it is done with cash).  If this means the ultimate collapse is that much more damaging, it’s not the bank executives’ problem any way – their downside is limited, if it exists at all.

The Greeks will now:

  1. Lobby for a large multi-year program from the IMF.  They’ll want a path for fiscal policy that is easy in the first year and then gets tougher.
  2. When they reach the tough stage, can’t deliver on the budget, and are about to default, the Greek government will call for another rapid agreement under pressure – with future promises of reform.  The euro zone will again accept because it feels the spillovers otherwise would be too negative.
  3. The Greek hope is that the global economy recovers enough to get out, but more realistically, they will start revealing a set of negative “surprises” that mean they miss targets.  If the surprises add to the feeling of crisis and further potential bad consequences, that just helps to get a bailout.
  4. The Greek authorities will add a ground game against the European Central Bank, saying things like:  “the ECB is too tight, so we need more funds”.  We’ll see how that divides the eurozone.

In their space, big US banks will continue to load up on risk as the cycle turns – while hiding that fact.  Serious problems will never be revealed in good time – and the authorities will again have good reason (from their perspective) to agree to the hiding of issues until they get out of control, just as the Federal Reserve did for Lehman Brothers.  Moral hazard not only ruins incentives, it also massively distorts the available and disclosed information.

As for Mr. Geithner – head of the New York Fed in 2008 and Secretary of the Treasury in 2009 – those who cannot remember the bailout are condemned to repeat it.

By Simon Johnson

The Baseline Scenario

Related by the Econotwist:

Germany Forced To Accept Greek Bailout

Greece: Here’s The Deal (Well, sort of…)

Who’s Hiding In The Sherwood Forrest?

AIG: What Did FED Bail Out and Why?

Obama’s Consumer Protection Agency: “A Joke”

The Bailout Package Under The Christmas Tree

2010 Analysis: Collapse of Credit


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AIG: What Did FED Bail Out and Why?

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 22.03.10 at 17:21

Why did the Fed let itself be put in the position where it became expected to act as a bankruptcy court and a supplier of capital to private insurance concerns? And why did we bail out the operating and capital deficits of AIG, deficits which suggest the same type of questionable accounting maneuvers and regulatory arbitrage as was seen in the Lehman Brothers collapse. If a bailout of AIG was better than bankruptcy, how would we know?

“Sadly, that key question about AIG – how did we get here – does not seem likely to be answered.”

Richard Alford

“While the popular accounts and analyses of the crisis at AIG have largely focused AIG Financial Product’s (AIGFP) book of credit default swaps, the problems at AIGFP involve more than the CDS book. AIG’s financial difficulties overall reflected problems at the insurance subs as well as on the derivatives book,” former economist at Federal Reserve Bank of New York, Richard Alford, writes.

American International Group (AIG) is back in the news yet again as it has finally negotiated the sale of two significant operating units, the domestic underwriter ALICO and the Asia business operated under AIA. The length of time it took for AIG to find buyers for the two subsidiaries and the terms of the deals as presented in the newspapers are both telling.

While the popular accounts and analyses of the crisis at AIG have largely focused AIG Financial Product’s (AIGFP) book of credit default swaps, the problems at AIGFP involve more than the CDS book. AIG’s financial difficulties overall reflected problems at the insurance subs as well as on the derivatives book.

The problems at the insurance subsidiaries were not larger or more serious than the problems in AIGFP. However, some of the insurance subsidiaries would have experienced serious problems continuing as going concerns even under state conservatorship had the parent and AIGFP been allowed to fail. Given the fragility of the market post Lehman and the difficulties at Primary Reserve Fund during this same time frame, it is probable that the market would not have distinguished between the sound and unsound subsidiaries of AIG.

But the problems at the insurance units have received far too little attention and, in turn, suggest motives for the rescue of AIG that are not commonly understood.

A quick examination of how the bailout money was used supports the view that serious problems were more endemic than the popular accounts suggest. The $22.4 billion of bailout funds were used to make payments to AIGFP’s CDS counterparties.

However, AIGFP had significant losses other than in the CDS book.

A total of $24.6 billion was used to make payments to meet non-CDS linked AIGFP obligations, e, g. $12.5 billion was used to retire maturing debt and $12.1 billion was used to make whole participants in Guaranteed Investment Agreements (GIAs) -largely municipality sponsored tax-advantaged employee savings plans. These numbers do not reflect fully reflect the losses from the various activities that AIGFP was engaged in, but rather are presented to make it clear that AIGFP incurred sizable losses in areas other than the CDS book.

The non AIGFP parts of the AIG family, including the insurance subsidiaries, received $29.4 billion of bailout funds-less than the $52 billion AIGFP received- but still a considerable amount of aid. Of that $29.4 billion, $20.9 was reported as “Capital Contribution to Life Insurance Cos.” If the life insurance companies were financial sound, then the scandal ought to be the needless transfer of $20.9 billion to the life insurers.

As The IRA has noted in the past, the bailout of AIG was the first federal rescue of an insolvent insurer in modern times.

Unfortunately, there are good reasons to believe that the transfer was necessary. The reported uses of the bailout funds indicate that a securities lending operation had cost AIG life insurers dearly.

Were these transactions arm’s length and were they suitable for a regulated insurer such as AIG?

Which dealers were involved in these transactions?

Some of the life insurers attempted to enhance returns by lending securities they held and then investing the collateral posted with them in residential mortgage-backed securities (RMBS) in effect leveraging up and running a maturity mismatch. As the RMBS they held declined in value, and securities lending counterparties return the borrowed securities for the cash they had placed with the life insurers, losses mounted and liquidity evaporated.

The realized losses stemming from the securities lending operations were large relative to the surplus (surplus = assets-liabilities) of some of the life insurance subsidiaries. This has been brought to light by research of David J. Merkel of Finacorp Securities and the author of The Aleph Blog in a paper titled “To What Degree Were AIG’s Operating Insurance Subsidiaries Sound?” Merkel based his analysis and conclusions on a review of regulatory filings made by AIG life insurance subsidiaries.

The filings indicate that the realized security lending losses at six life insurance subsidiaries exceeded their reported surpluses.

The average realized loss at twelve subsidiaries was 76% of the surpluses of those subsidiaries. The scale of the losses is also reflected in the fact that AIG used $36.7 billion of the bailout finds it received to pay securities lending counterparties.

Merkel also makes it clear that there were other problems at AIG’s life insurance subsidiaries, including the interlacing of the capital of the subsidiaries which allowed for greater leverage and cross guarantees as well as losses from investments apart from the securities lending operations, etc.

For example, Sun American Life held securities of affiliated companies equal to 107% of its 2008 year end surplus. These cross holding of securities gave rise to unrealized capital losses. For example, ALICO reported unrealized capital losses of $3.9 billion as of year end 2008. Merkel dug a little deeper:

“I found something unusual at ALICO. At the end of 2007, almost the entirety of their surplus assets were composed of AIG common stock. For those less aware, holding affiliated stock of the subsidiary is capital stacking which raises leverage, but owning holding company stock is creating capital out of thin air.”

Merkel’s analysis of the regulatory filings also revealed that in some cases the realized capital losses-excluding those arising from securities lending operations were substantial fractions of the subsidiary’s surplus.

These realized capital losses arose from investments in corporate bonds (including junk bonds), CMBS and nonconforming RMBS.

Barofsky, of SIGTARP, charged that the Fed failed because it did not have a contingency plan in place deal with a problem at AIG (and presumably a contingency plan to deal with a failure at every other systemically important firm). This assumes, of course, that bailing out a financial firm is even a proper role for the central bank.

I beg to differ. William Dudley, President of the Federal Reserve Bank of New York offered the best rebuttal when he said: the Fed was the contingency plan. Treasury, the other regulators, the President and Congress all avoided so much as proposing a plan to deal with failure of a large non-bank post Bear and the GSEs. The Fed picked up the financial and political tab.

But why should we have expected the Treasury to make difficult decisions before a crisis, when the Fed could buy time to react after the crisis when the political cost to the DC crowd – but not the economic costs to society – would be lower.

Why did the Fed let itself be put in the position where it became expected to act as a bankruptcy court and a supplier of capital to private insurance concerns? And why did we bail out the operating and capital deficits of AIG, deficits which suggest the same type of questionable accounting maneuvers and regulatory arbitrage as was seen in the Lehman Brothers collapse.

If a bailout of AIG was better than bankruptcy, how would we know?

AIG has negotiated the sales of ALICO to MetLife and AIA to Prudential UK. In both cases the Fed will receive partial payment in stock of the acquirer.

Richard Alford

In other words, the Fed and the US taxpayers are still providing capital and taking risk to support the business activities of insurance subsidiaries of financially sound parent companies,) operating abroad, a year and a half after the crisis hit.

If the life insurance subsidiaries of AIG were financially sound, how did we get here?

Sadly, that key question about AIG – how did we get here – does not seem likely to be answered.

By Richard Alford.

Here’s a copy of the research report by David Merkel.

This article was first published by the Institutional Risk Analytics.

Related by the Econotwist:

Bad Debt: More, But Less Bad

Obama’s Consumer Protection Agency: “A Joke”

Bernanke’s Testimony (Full Transcript)

AIG Planning Another Round of Bonuses

“Geithnergate” Is A Reality

Ordnung muss sein

The Bailout Package Under The Christmas Tree

Organizing Financial Rebellion

“An Embarrassing Report”

Crisis In A New Light

Wall Street: “God’s Work”

Wall Street – unplugged

Gullringenes Herre

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"Geithnergate" Is A Reality

In Financial Markets, International Econnomic Politics, National Economic Politics on 28.01.10 at 07:23

The scandal surrounding Federal Reserve New York and now Treasury Secretary Timothy Geithner has now reached porpotions that might be equal the Watergater scandal in the 70’s that led to president Nixon‘s resignation. The latest report from SIGTARP concludes that someone is lying, and that federal laws was violated in the process of bailing out AIG.

“The Backdoor Bailout”

“In times when the truth is so valuable, it has to be protected with a bodyguard of lies.”

(Winston Churchill)

The Conclusion

Here’s the full statement.

And there you are; signed, sealed, delivered…

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