Stocks look to end the week in the black as the DOW has gained some 50 points or about ½% since Monday while the NASDAQ added 40 odd points or a bit less than 2%. The big jump in February retail sales +.3% as per the Census Bureau was the big headline. A number that benefited from a very easy year ago comparison, tax credits and a revised lower January figure, so while it is a good number its not as great as the headlines suggest. The ECRI Weekly Leading Index continues to slip, though at a slower rate, the smoothed annualized growth rate slipped to 13.1% last week the top line number increased to 130.6. The Fed’s latest Flow of Funds report is out, I’ll try and cover it on Monday.

Seems the Europeans are smart enough to block big US investment banks from sovereign debt underwriting following the parade of less than ethical behavior demonstrated by said banks of late. This pushed Goldman and JP Morgan Chase out of the top 10 though Morgan Stanley Managed to make the cut. Lack of ethical business standards leads to loss of business, something we need to see a lot more of.

What I really wanted to talk about today was the Lehman Brothers Bankruptcy Examiners Report, 2200 pages detailing the banks demise. A lot more material than I can cover here, a link to the report will be on my Blog if you’re interested. In a nutshell it is a parade of hubris, executive incompetence, accounting gimmicks, the use of derivatives to inflate the balance sheet, ala Greece and good old-fashioned greed and stupidity. Just like Enron, Worldcom and the other corporate frauds, the executives starting with the CEO Dick Fuld had no idea what was going on of course. The major accounting firms complicit in the previously mentioned corporate frauds played a central role in this one as well and like the credit ratings agencies, well frankly they can’t be trusted either particularly if you’re an investor. Once again the regulators demonstrated they couldn’t identify a duck even after it was dropped in their lap along with a complete description. The media prove once again that they are cheerleaders first and factual investigative news reporting outfits second, can’t alienate the nice folks on Wall Street that buy all that commercial airtime or to quote Rupert Murdoch who owns Fox News amongst other outfits “were all about ratings” as the courts agreed truthful reporting isn’t necessary. Of course we as taxpayers get to pay for this parade of what is increasingly looking like outright criminal behavior, but at this juncture frankly that isn’t all to surprising.

Sources:
JPMorgan, Citigroup Helped Cause Lehman Collapse, Report Says
Bloomberg | Linda Sandler, Bob Van Voris and Don Jeffrey

and

Wall Street Journal | Mike Spector, Susanne Craig, Peter Lattman
Examiner: Lehman Torpedoed Lehman

The report all 2200 Pages….
Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner’s Report

Stocks enter the final hour essentially unchanged after a volatile morning session. January’s trade balance fell to –37.3 billion. A large decline in autos and oil imports was the primary cause. Snapping a string of gains both imports and exports fell, again the culprits were largely autos and energy. Foreclosure activity slipped 2% in February as per RealtyTrac but was 6% higher than a year ago. There doesn’t seem to be a rush to blame this improvement on the snow by the media, perhaps its because the month was 3 days shorter.

The Congressional Oversight Panel’s report on the special treatment of GMAC delivers some harsh criticism of the 17.2 billion Dollar to date bailout. As an aside like the home mortgage market where Uncle Sam is by and large the only source of financing so to is GMAC with respect to auto financing as it now extends credit to Chrysler customers as well. This no doubt goes along way to explaining the preferential treatment, Fannie Mae and Freddie Mac etc. get similar deals and for much the same reasons as without the government sponsored finance these markets would largely disappear in the current environment and almost overnight, back to the report.

Chaired by Elizabeth Warren the panel finds that the avoidance of bankruptcy by GMAC in 2008 wasn’t a particularly good idea as an opportunity to shed less desirable loss producing business lines was missed. Amongst other items GMAC was very big player in the sub-prime mortgage market. The 17.2 billion dollar bailout to date gives the Fed 56.3% ownership in a company that the OMB figures will result in a 6.3 billion Dollar plus loss. Last but not least the panel is deeply disturbed at the lack of a clear business model or strategy designed to both return the company to a viable state and also repay the taxpayer.

Not to pick on the City of Detroit but their latest offer of muni bonds, underwritten by Goldman Sachs of course contains the following glaring items in the offering statements. The possibility that the municipality will file bankruptcy, the most recent financial statements from the city are dated June 2008, a pledge of state sales tax revenue as backing to maintain an investment grade rating on the offering so that Detroit can keep its head above water a little longer.

A number of takeaways on this one, the continued borrowing by a municipality at ever more onerous terms is all but guaranteed to end badly as per the disclosure about bankruptcy. The credit ratings agencies are just as suspect as ever. Goldman Sachs having been instrumental in helping to precipitate this crisis made a fortune setting everyone up for failure. Another fortune when they failed and here we have a Goldman special, extend the offer of help, if you can call it that, profit handsomely from the syndication of the bond issue and then buy every CDS they can get their hands on to “hedge” their position in the event of default. Which given Detroit’s precarious financial position is highly likely, ala the bankruptcy disclosure.

Rapacious transactions similar to this have been engineered by the banks on a global scale, cites, counties, school boards, pension plans, states and nations have been victimized wholesale. The taxpayer has the privilege of paying to clean up the mess through bailouts that run into the trillions and yet our elected representatives 2-years after the fact still have not come up with effective regulation to reign in, let alone prevent these types of abuses or address the issue of “to big to fail”.

The politician’s failure to act speaks volumes about the effectiveness of financial industry lobbying largess and the true loyalties of our elected representatives who seem quite content to sell America, its citizenry and the ideals that formed this great nation down the river in the name of bank profits. It’s long past time to demand accountability and if we don’t who will.

The money quote: “Wall Street thrives and makes money in inefficient markets”. Or in plain English if they put all the cards on the table and made full, complete and fair disclosure as there supposed to do they couldn’t make so much money as their marks/customers would realize that they are being taken for a ride…..

The proposals championed by Mr. Gensler, if adopted by Congress, would substantially alter what is now a largely unregulated market in over-the-counter derivatives, financial instruments used by companies and investors to protect themselves and bet on moves in variables, like interest rates or currencies, and to speculate.

“The question is how much is legitimate hedging by corporations” as opposed to speculative trading, said Don M. Chance, a finance professor at Louisiana State University. “You have to be careful you don’t punish companies that want to use swaps in a productive, safe manner.”
“Wall Street’s interest is not always the same as the public’s interest,” he says now. “Wall Street thrives and makes money in inefficient markets, and I am creating efficiencies in the market.”

The Commodity Futures Modernization Act of 2000, backed by the likes of Mr. Rubin, sidelined the trading commission even more than before. If Congress agrees to reverse many of the measures contained in that law, Mr. Gensler says he intends to rebuild the commission by increasing its staff to about 1,000, from 600 today, and by increasing the computing power at its disposal to try to keep up with Wall Street’s traders.

“I disagree with anyone who says derivatives did not play a part in the crisis,” he said in defense of more oversight. He added: “Like San Francisco after the earthquake, we had a calamity, and now we need building codes.”

Consider for example these characteristics of most financial instruments:

-They trade on an exchange;
-Participants have sufficient capital to engage in trading;
-Counter-parties disclosure is known (at the least to the exchange)
-Potential future payments require capital reserves to meet obligations;
-The full amount of traded instruments is transparently disclosed;
-There is a regulator in charge of insuring the above rules are followed.

Derivatives had none of those. Indeed, the CFMA specifically exempted derivatives not only from these items, but added they were exempt from state insurance regulators.
Let’s not over-complicate this: We need to do 3 things to rein in the worst aspects of derivatives, and dramatically reduce the systemic risk they present, while retaining their ability to be a valid financial instrument for hedging risk:

1. Repeal the Commodity Futures Act of 2000
2. Treat Derivatives like all other financial instruments: All of the above elements need to be derivative requirements;
3. Give the Commodity Futures Trading Commission full oversight and the teeth to enforce the rules.

Wall Street and the banks will fight this tooth and nail, as they are reaping billions in derivative trading profits. Never mind that whole 2008-09 meltdown thingie — that’s ancient history.

Source: Graham Bowley | New York Times
Goldman Deal-Maker Now Advocates Regulation
Published: March 10, 2010

and

Barry Ritholz | The Big Picture
Time to Regulate Derivatives (like every other financial instrument)

Our tax Dollars go down the rat hole to prop up failed institutions that engage in creative accounting rendering the whole idea of transparency laughable.

2-Years after the meltdown we still don’t have real financial reform and for the banks its business as usual.

The collusion between Wall Street and Washington DC must end or they will periodically create financial disaster as they did in the Great Depression and as they are doing so today.

Frank Portnoy provides a great lesson in modern and historical finance!

Frank Partnoy on Off-Balance Sheet Transactions (MMBM) from Roosevelt Institute on Vimeo.

Source:
Frank Portnoy | Roosevelt Institute

Stocks enter the final hour with small gains. The regional and state unemployment survey showed 30 states and the District of Columbia increasing their unemployment rate, 9 states saw a decrease in the unemployment rate and the rest no change. From a year ago no state recorded and increase in employment. The top 5 unemployment rates by state are, Michigan 14.3%, Nevada 13%, Rhode Island 12.7%, South Carolina 12.6% and California 12.5%. South Carolina and California both set new series highs in January, as did 3 other states and the District of Columbia. Like the monthly employment report labor markets remain distressed that said Census hiring should produce a nice jump in the employment figures for March and April, while temporary the cheerleaders are already pushing this for all its worth and will no doubt have a field day with it when the reports come out.

Mortgage apps increased fractionally last week as per the latest MBA survey. The 30-year contract rate was 5.01% about where it has been for a year or so. The sharp plunge in sales activity seen with the expiration of the original home buyer tax credit seems permanent, as the recent plunge in potential home buyer traffic suggests. The HAMP trial modification process has been completed by about 1/3 of applicants giving those a chance at permanent modification. The actual numbers will out late next week. While another step in the right direction there remains many, many steps to go.

The bank bailouts have no shortage of critics myself included. But there are many that argue the cost will be mitigated and that the deficits don’t matter, we just need the right tools. Pundits cite the TARP program, it’s profits and that it will lose little if any money come its conclusion. They conveniently omit the data from TALF that swelled the Fed’s balance sheet dramatically with the swapping of various impaired assets, some junk, for Treasuries. Additionally the deficit spending from the stimulus programs themselves has been substantial. For those that claim deficits don’t matter, eventually they do as too much debt leads to default and worse as many a citizen has found out the hard way of late and many more will before it is all over. As for the right tools to clean up these fiascoes, a better plan would be to simply enforce existing regulations in the first place so that we don’t have to clean up the mess, when did an “ounce of prevention is worth a pound of cure” go out of fashion?

More fun with creative accounting…

Some excerpts below:

A letter written by Barney Farnak head of the Financial Services Committee to the 4 largest banks contained the following two paragraphs.

Many investors in first-lien mortgages have indicated that they are willing to accept the fact of significant losses on those investments in order to move on and use their money for other purposes, rather than having it locked in underwater mortgages with a high and growing likelihood of foreclosure. With the interests of homeowners and investors aligned in this way, it should follow that large numbers of principal-reduction modifications could be made relatively quickly. That is not happening. According to investors, Administration officials, and other experts I have consulted, holders of second-lien mortgages are now a principal obstacle to many modifications. The problem of second-lien mortgages standing in the way of successful principal reduction modifications has reached a critical stage and requires immediate attention from your institutions.

Large numbers of these second liens have no real economic value – the first liens are well underwater, and the prospect for any real return on the seconds is negligible. Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans, which would allow willing first lien holders to reduce principal and keep borrowers in their homes.

Read the paragraphs from Barney Frank’s letter again. In order to write down the first principal of a mortgage, the second needs to be destroyed. However the second mortgages are on the books of the largest banks, and they are on their books for a high value even though they are worthless.

I’m going to isolate the four largest banks Frank questioned about second-liens, along with their losses as they’ve legally sworn to being accurate during the stress test:

Again, this is data as reported to the government by the major banks during the stress test of 2009. So what’s going on here? The four major banks have about $477 billion in junior liens, either in the form of a second mortgage or a home equity line of credit. If you go to the Fed Funds data online, you’d see that there’s about a trillion dollars of 2nd/Juniors out there, so the four major players have about half the market.

The four major players each report that they expect to have a 13-14% loss on these items under an “adverse scenario”, with Citi reporting a 20% loss under an adverse scenario. That means of the $477bn, $68.4 bn is junk that’ll never be collected on. This, combined with all the other expected losses (see the link to the stress test for the rest), meant that the four biggest players needed around $53bn to be raised.

Notice how Frank’s letter, and pretty much anyone you’d speak to who isn’t working for the four largest banks, assume that second liens in the country aren’t worth 86% of their value (for a 14% loss). You see in Frank’s letter “no economic value.” Huh. Well, that’s a problem.

Principal Writedowns and the Fake Stress Test

Source: Seeking Alpha | Mike Konczal March 09, 2010

Stocks managed modest gains into the final hour on little real news. The one-year anniversary of the stocks markets rally from 12 year lows occurs this week. From the peak set in October of 2007 the Dow fell 54.4%, the S&P 500 shed 57.7% and the NASDAQ plunged 55.8% hitting their lows in March of last year. Since that time the DOW has surged 63.3%, the S&P 500 jumped 70.8% while the NASDAQ has rocketed 83.8% so at least on a percentage basis it appears that all is right in the world again.

Looked at from a Dollar perspective using a theoretical $100,000 portfolio and the previously mentioned percentages and the picture becomes a lot less dramatic as the DOW turned $100,000 into $74,464, the S&P 500 reduced the same $100,000 to $72,248 while the NASDAQ with an 80+% gain reduced $100,000 to $81,239. All of which serves to illustrate the validity of Warren Buffet’s 2 rules of investing; Rule #1 Don’t lose money; Rule #2 Don’t forget about Rule #1, as losses cut deeper on the way down, simple mathematical fact.

Unlike us and most other nations, perhaps all, that currently have a banking crises the good people of Iceland told their government and the banksters to take a hike when it comes to the citizens tax money being used to pay for their losses. Each citizen was looking at a bill equivalent to $16,400. Despite an overwhelming 93% majority of Icelanders voting down the latest settlement with the banksters the government is actually working on settlement #3 of all things.

At least the citizenry of Iceland has the courage to tell the banksters where to get off. The Argentinians did the same several years back, the mainstream media predicted it would be the end of the world and financial Armageddon for Argentina, yet they came out of the crises quite well after a relatively short period of struggle.

Perverting capitalism in a manner that socializes losses whilst profits remain private is contrary to Adam Smith’s dream, smacks of socialism or worse and is downright un-American. Perhaps we need to follow the example set by the good people of Iceland, demand accountability and inform the banksters that if they require government assistance it can be found at their local unemployment office.

Our huge socialist experiment attempting to prevent true price discovery and by implication real affordability through taxpayer funded market manipulation in an attempt to save the banksters from their own folly continues….

Some excerpts below.

House Financial Services Committee Chairman Barney Frank wrote, “To save homes on a large scale, we must move past temporary modifications in interest rates or terms and focus on permanent principal reductions that result in truly sustainable mortgages.”

The problem is prices. Home prices have fallen so far in the hardest hit areas, the areas where the bulk of the troubled loans are, that banks would have to write down principal 30 to 50 percent to put borrowers back in the green. Accounting rules require that banks write down the value of those loans on their books, and experts tell me that if banks really accounted for all the losses in the home loan market, they’d all be insolvent.

I stole that shell game idea from housing consultant Howard Glaser: “We’re spending tens of billions of dollars on a tax credit to get people to purchase homes, we’re spending federal money to keep them in their homes through the modification program, and now we’re going to pay them to move out of their homes. This is not a sustainable system for the housing market. It’s a shell game. Bernie Madoff could have created this system,” Glaser told me today.

As for the borrowers, the rental market is ripe. Rent rates are low, vacancies are high, and the hit to personal credit isn’t going to matter as much a few years from now when banks are desperate once again sell mortgages.

Mortgage Principal Writedown Won’t Save Housing

Source: Diana Olick | CNBC
Monday, 8 Mar 2010

Stocks enter the final hour about even. Another 4-banks went to the receivers Friday bringing the total for 2010 to 26. Consumer Credit snapped a string of 12 consecutive declines to increase 5 billion in January as consumers spent more on non-revolving purchases like cars. Credit card or revolving debt continued to slip.

The FDIC holds a growing asset collection from all of the bank closures and the process of liquidating these assets in the open market is likely to promote further bank losses and write downs as it will provide for price discovery of impaired assets, a.k.a. toxic assets. Of course the banks are less than happy that their regulator would expose them to further losses, then again when you play games with asset value accounting and avoid mark to market and instead mark to fantasy or the banks opinion of what something is worth, what did they expect. It should be noted that various regulators not only encouraged but also promoted the use of creative accounting by the banks.

Which brings us to the looming crises with mortgage modifications, a program that just isn’t working. Still the need to cure the related bad debts remains hence the growing push to facilitate short sales. Hopefully this strategy will meet with more success as if all parties can agree, the big problem is junior, primarily second, lien holders as they frequently get nothing in a short sale. Nonetheless the primary lender and mortgage holder usually suffer lower loss rates and other negative consequences, primarily credit score related for the borrower and asset value preservation for the lender, with a successful short sale as compared to an actual foreclosure.

California recently revised its job loss figures for 2009 increasing the total by 338,400 to a little less than a million. Reading between the lines and that means the original number was roughly 600,000 but grew to nearly a million meaning that the job loss figures statewide were revised upward by some 50%. I complain about the BLS and there shoddy national jobs reporting, perhaps I should be quiet as California’s data is just plain terrible and it is no wonder the budget is such a disaster. As 50% more people than originally figured, didn’t earn money or pay taxes in 2009 and that is a lot of aggregate economic activity. Which serves to highlight growing problems with the reliability and accuracy of economic data as the fudging of numbers has become extensive.

There has been substantial debate on the Fed’s role in the current credit bust, some claim it is simply regulatory imprudence, essentially weak rules that allowed this fiasco to develop. Others figure it was a failure to regulate or enforce existing regulations, commonly known as nonfeasance or a failure to do ones job effectively. Clearly at this juncture it was a failure to enforce existing regulations or nonfeasance because the job just was not done effectively, there were plenty of regulations.

Which brings me back to California’s 50% upward revision to 2009 employment losses and growing problems with other economic data sets. Revisions to the numbers are to be expected and required in the interest of accuracy and reporting but when the methodology is retuning data that is grossly inaccurate as shown through substantial revision or considerable anecdotal data suggesting otherwise. It is either deliberate policy to further an agenda or nonfeasance in the data collection process, analysis or reporting.

As always Elizabeth Warren does a great job of explaining things in plain English, touching on the Fed’s failure to regulate thereby allowing the bubble to grow and collapse. The usury nature of bank lending agreements and related “revenue enhancers” and the problems faced by the commercial real estate sector and legacy toxic asset issues facing the banks amongst other subjects.

Charlie Rose Interviews Elizabeth Warren TARP Special Investigator

Source:
Charlie Rose | Elizabeth Warren