Is The Fed Responsible For The Great Financial Crisis?

"Recessions are a natural economic feature and their regular occurrence is healthy and indeed essential," is how Deutsche's Jim Reid introduces his investigation into post-Fed un-natural business cycles. Without them there is a serious danger of bubbles and the misallocation of resources as the further market participants detach themselves from the last downturn the more they tend to under-estimate risk. We,

Jim Reid, Deutsche Bank: The history of business cycles in the US

The chart below shows the duration of each economic expansion (i.e. between all US recessions) since the NBER started collating statistics from 1854. This highlights the fact that prior to the GFC the three preceding expansions were in the top five on record. We can also show that this cycle is now almost exactly average length through history.


If we re-order these cycles by duration we can show more clearly how this current US expansion compares to those through history.


We passed the median cycle length at the start of 2012 and we will be past the historical average point by the end of this month (September 2012). This expansion is now the 12th longest out of 34 since 1854.

There are those that suggest that the Fed's inception back in 1913 has allowed for longer business cycles and for those interested we have colour coded those cycles (above) that occurred after this point, and also those post WWII when overall economy debt seemed to start a YoY increase that continues to this day. Countering the argument for longer post-1913 cycles would be the view that without the Fed helping to elongate several recent cycles, the GFC we've just been through might not have been anywhere near this deep and we are therefore now left in a unique situation at what is at the likely end of a multi-decade leverage binge consisting of several artificially long cycles. We are also now arguably in a liquidity trap where the Fed are less potent that they have been before in their near 100 year history.

The three 'super-cycles' between 1982 and 2007 were the exception rather than the norm, one where Central Banks and Governments had almost total flexibility over policy. The conditions that allowed for these long cycles perhaps started a decade earlier with the already much talked about collapse of the Gold Standard.

Unfortunately the 25-30 year build up of excess that this facilitated led to the GFC being the worst crisis since the 1930s and we have now likely moved to an era where policymakers no longer have the flexibility that defined the previous 25-30 years. Most Developed World (DW) Governments are up against their fiscal limits and are actually being forced into economically damaging austerity. We also have interest rates across the Western World that remain close to zero with little room to be lowered further. While we do have money printing, we are close enough to a liquidity trap that flooding the market with printed money doesn't have the same immediate impact on the economy as a cut in interest rates did in the long leveraging stage of the super-cycle.

So not only are we battling with the huge structural problems that the post-credit crisis world brings, we are fighting it without much policy flexibility and are indeed being forced into a reversal of stimulus at arguably exactly the wrong time.

So it all adds up to a return to more normal length business cycles in our opinion. Indeed one could make an argument for shorter cycles than normal given the lack of policy flexibility relative to most of history.

We, like Jim, would argue that the reason the Great Financial Crisis was so deep was due to the authorities continued refusal to let the business cycle take its natural course.

Audit of the Federal Reserve Reveals $16 Trillion in Secret Bailouts

The first ever GAO (Government Accountability Office) audit of the Federal Reserve was carried out in the past few months due to the Ron Paul, Alan Grayson Amendment to the Dodd-Frank bill, which passed last year.

Jim DeMint, a Republican Senator, and Bernie Sanders, an independent Senator, led the charge for a Federal Reserve audit in the Senate, but watered down the original language of the house bill(HR1207), so that a complete audit would not be carried out.

Ben Bernanke (pictured to the right), Alan Greenspan, and various other bankers vehemently opposed the audit and lied to Congress about the effects an audit would have on markets.

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Nevertheless, the results of the first audit in the Federal Reserve’s nearly 100 year history were posted on Senator Sander’s webpage earlier this morning.

What was revealed in the audit was startling:

$16,000,000,000,000.00 had been secretly given out to US banks and corporations and foreign banks everywhere from France to Scotland.

From the period between December 2007 and June 2010, the Federal Reserve had secretly bailed out many of the world’s banks, corporations, and governments. The Federal Reserve likes to refer to these secret bailouts as an all-inclusive loan program, but virtually none of the money has been returned and it was loaned out at 0% interest.

Why the Federal Reserve had never been public about this or even informed the United States Congress about the $16 trillion dollar bailout is obvious – the American public would have been outraged to find out that the Federal Reserve bailed out foreign banks while Americans were struggling to find jobs.

To place $16 trillion into perspective, remember that GDP of the United States is only $14.12 trillion. The entire national debt of the United States government spanning its 200+ year history is “only” $14.5 trillion.

The budget that is being debated so heavily in Congress and the Senate is “only” $3.5 trillion. Take all of the outrage and debate over the $1.5 trillion deficit into consideration, and swallow this Red pill: There was no debate about whether $16,000,000,000,000 would be given to failing banks and failing corporations around the world.

In late 2008, the TARP Bailout bill was passed and loans of $800 billion were given to failing banks and companies. That was a blatant lie considering the fact that Goldman Sachs alone received 814 billion dollars.

As is turns out, the Federal Reserve donated $2.5 trillion to Citigroup, while Morgan Stanley received $2.04 trillion. The Royal Bank of Scotland and Deutsche Bank, a German bank, split about a trillion and numerous other banks received hefty chunks of the $16 trillion.

“This is a clear case of socialism for the rich and rugged, you’re-on-your-own individualism for everyone else.“- Bernie Sanders (I-VT)

When you have conservative Republican stalwarts like Jim DeMint(R-SC) and Ron Paul(R-TX) as well as self identified Democratic socialists like Bernie Sanders all fighting against the Federal Reserve, you know that it is no longer an issue of Right versus Left.

When you have every single member of the Republican Party in Congress and progressive Congressmen like Dennis Kucinich sponsoring a bill to audit the Federal Reserve, you realize that the Federal Reserve is an entity onto itself, which has no oversight and no accountability.

Americans should be swelled with anger and outrage at the abysmal state of affairs when an unelected group of bankers can create money out of thin air and give it out to megabanks and supercorporations like Halloween candy.

If the Federal Reserve and the bankers who control it believe that they can continue to devalue the savings of Americans and continue to destroy the US economy, they will have to face the realization that their trillion dollar printing presses will eventually plunder the world economy.

The list of institutions that received the most money from the Federal Reserve can be found on page 131of the GAO Audit and are as follows..

Citigroup: $2.5 trillion ($2,500,000,000,000)
Morgan Stanley: $2.04 trillion ($2,040,000,000,000)
Merrill Lynch: $1.949 trillion ($1,949,000,000,000)
Bank of America: $1.344 trillion ($1,344,000,000,000)
Barclays PLC (United Kingdom): $868 billion ($868,000,000,000)
Bear Sterns: $853 billion ($853,000,000,000)
Goldman Sachs: $814 billion ($814,000,000,000)
Royal Bank of Scotland (UK): $541 billion ($541,000,000,000)
JP Morgan Chase: $391 billion ($391,000,000,000)
Deutsche Bank (Germany): $354 billion ($354,000,000,000)
UBS (Switzerland): $287 billion ($287,000,000,000)
Credit Suisse (Switzerland): $262 billion ($262,000,000,000)
Lehman Brothers: $183 billion ($183,000,000,000)
Bank of Scotland (United Kingdom): $181 billion ($181,000,000,000)
BNP Paribas (France): $175 billion ($175,000,000,000)
and many many more including banks in Belgium of all places

View the 266-page GAO audit of the Federal Reserve (July 21st, 2011):

China Manufacturing PMI At Lowest Since March 2009; Market Response 'Bad Is Good' So Far

AUDJPY is getting smacked hard in this evening's admittedly thin trading given the US holiday. China's double-whammies of PMI data (both official and HSBC versions - with the latter revised lower from Flash to its lowest level since March 2009) and some weak Aussie retail sales data is weighing very heavily on the critical carry trade pair. S&P 500 futures traded down in line with AUDJPY from Friday's close but once the China PMI came as weak as it was so the 'Good is Bad', the PBoC have to do something crowd started buying and dragged ES up a few points. Juxtaposing these dismal macro data was a better than expected China Services PMI and Aussie manufacturing index - as the Schrodinger 'economy is good and bad' headlines continue to confound. For the 'bad-is-good' crowd who see stimulus as the solution, we offer two words 'Steel over-capacity'.

The last time HSBC and Official Manufacturing PMIs were sub-50 was in Nov 11 - right before the last coordinated central bank intervention (but energy and food prices were dramatically different then). This is the lowest HSBC PMI since March 2009...


S&P 500 futures fell in line with AUDJPY's weakness but have diverged since China PMI printed so weak - now the market reprices on further central-planning help implied by the dismal data...


sigh...

With markets thin and no Treasury market 'police' to control the tom-foolery this evening, we can onlyt imagine where this ends but for now AUDJPY is our guide.

Perhaps this must-read story from Reuters will color those stimulus-hunters' opinion a little!!

China's banks are coming after the country's steel traders, hauling executives into court to chase down loans that some traders said they didn't initially need and can't now repay.

The heavy push to recover the loans is another sign of strain on China's financial system at a time when the country's leaders are contemplating another round of stimulus to boost the economy, and when banks are worried about bad debts piling up.

The battle between the banks and steel traders also exposes flaws in the 4 trillion ($629 billion) stimulus round in 2008, and offers a warning to those calling for pumping more money into the system. At that time, Chinese banks threw money at the steel trade - a crucial cog in supplying the country's massive construction and infrastructure growth.

But those steel loans, after offering a quick fix, became excessive, poorly managed, or a combination of the two. Government officials insisted more money was needed to prop up the industry. Steel executives said the money flow was too heavy, and they had to put the money to work in real estate and the stock market.

"After the financial crisis, when the government released its stimulus, banks begged us to borrow money we didn't need," Li Huanhan, the owner of Shanghai Shunze Steel Trading, told a judge at a recent hearing. "We had nothing to do with the money, so we turned to other investments, like real estate."

What To Expect From Bernanke At J-Hole

Expectations for tomorrow's J-Hole speech by the venerable Ben Bernanke vary from the mundane "things-we-can-still-do; monitoring-situation" to the exuberant "we'll-print-our-way-out-of-this-mess-no-matter-what-and-I've-got-your-back-for-anything-more-than-a-1%-drop-in-the-Russell". We suspect, like Morgan Stanley's Vince Reinhart that a lot of people are going to be grossly disappointed as the FOMC (C for Committee) meeting is so close and the election being just around the corner means playing-down any miracle-making. Instead we suspect it will be more of the same - disappointment in economic performance, could do better, closely monitoring, Fed-has-tools; i.e. a replay of most of his recent speeches in tone. Reinhart does see some room for surprise though - especially on conditional policy rules (and the potential problems with over-reaching their mandate).

Vincent Reinhart, Morgan Stanley: The Message from the Mountains

We have had low expectations for significant news from Chairman Bernanke’s Jackson Hole address for some time for two reasons.

•First, he respects that the Federal Open Market Committee is a committee. That is, monetary policy actions are group decisions and it is inappropriate to front run the outcome of a democratic process.
•Second, he wants to keep a relatively low profile during an election year when the Federal Reserve is already a hot-button campaign issue. His speeches and testimonies over the past few months—even his semi-annual report on monetary policy—have been short, factual, and uneventful.

What does he have to do? He has to convey that the Fed has been disappointed in the economy’s performance, that policymakers are inclined to provide additional accommodation soon unless there is a significant and sustained improvement, and that they will closely monitor the situation. Essentially, all he needs to do is repeat portions of the statement and minutes from the July-August meeting. Along the way, he will highlight that it is a beautiful venue for a conference, that they are about to hear interesting papers, and that many fiscal challenge remain unanswered.

The main possibility for surprise is if he addresses the ongoing work within the Fed on conditional policy rules. The last set of minutes referred several times to discussions of rules and more open-end policy commitments. Up to now, the Fed has been using its policy instruments in an unconditional way, in that it announces a program of fixed duration and fixed amount. Most academic work, as will be discussed in the formal program at Jackson Hole, suggests that a rule linking the policy instrument to economic outcomes or the outlook performs better.

The idea is that the Fed could agree, for instance, to keep the funds rate target at zero as long as they have an economic forecast that is short of their mission. The problem is that the mission at the heart of Fed policy-making is ambiguous. In the Federal Reserve Act, the Congress tells the Fed to foster maximum employment and stable prices but is silent on how to weigh deviations from the two objectives or how quickly those deviations should be eliminated. The monetary policymakers at the Fed are a diverse group of people who disagree on how to fill this silence. If they can come to terms with this issue, then they can offer more open-ended assurance to financial market participants and the public at large.

Chairman Bernanke is unlikely to offer a Solomonic solution, but his speech would be more interesting if he relayed where they are in the process.

Payoff in the Pit of the Plutocracy

Jeff Connaughton was a lobbyist, a Senate aide and a White House lawyer. He says he came to Washington, D.C. as a Democrat and left as a Plutocrat.

Now he’s written a book – The Payoff: Why Wall Street Always Wins (Prospecta Press, August 20, 2012.)

This book is about corporate crime – although that phrase doesn’t appear anywhere in its 288 pages.

It is in fact one of the best books on how corporate criminals manipulate the system to get away with their crimes.

One way is to enforce silence among the elites who know how the system works.

“Party cohesion and the desire to make a munificent living in DC go a long way to enforce silence,” Connaughton writes.

But Connaughton is silent no more.

“I’m willing to burn every bridge,” he writes. “Now that I’ve mutinied and fled to a remote place, I want to set flame to the ship that would take me back there.”

Connaughton says there have been no Wall Street prosecutions because the Obama Justice Department failed “to take a timely, targeted, all-in approach to the problem.”

“The truth is, the Justice Department never made investigating these actions a high priority,” he writes. “It never formed strike forces of investigators and lawyers that had sufficient resources and backing to doggedly pursue the obvious potential wrongdoers as long as it took to bring a fraud case.”

Prosecutors never used provisions in the Sarbanes-Oxley Act, which put in place tough criminal sanctions in the wake of Enron and other cases of massive corporate frauds, to indict those executives responsible for misleading financial reports.

“If Obama had appointed aggressive trial lawyers – and (Vice President Joe) Biden knew plenty of them – to these Justice Department positions and backed their efforts, there’s a good chance they would’ve hunted the worst Wall Street fraudsters relentlessly.”

“If the explanation for the inadequate effort is corruption (the administration could not afford to anger Wall Street contributors), the revolving door, or a belief that the health of the financial industry is more important than legal accountability, then we have an actual double standard. I don’t know the explanation, but in terms of faith in our institutions, it may not matter whether the double standard is real or apparent. That double standard has torn the social and moral fabric of our country in a way I find to be unforgivable.”

Connaughton says that two sources were telling him that Christine Varney, the assistant attorney general for the Antitrust Division, “was complaining to friends that Rahm Emanuel, then White House chief of staff, had sent her a message – in effect, throttle back on antitrust enforcement, because the top priority is economic recovery.”

“I was concerned that Attorney General Holder had gotten the same message about investigating Wall Street crime,” he writes.

Connaughton quotes Secretary of the Treasury Timothy Geithner as saying – “The stuff that seemed appealing in terms of…Old Testament justice…penalize the venal, would have been dramatically damaging to the basic strategy of putting out the panic, getting growth back, making people feel more confident in the future.”

“Geithner’s statement would seem to indicate that he believes utilitarian outcomes justify overlooking potentially criminal behavior by banks,” Connaughton writes.

Connaughton worked as chief of staff for Senator Ted Kaufman (D-Delaware.) Kaufman was appointed as Biden’s replacement and dedicated his two years in office to demanding accountability for Wall Street’s crimes.

During one meeting with Justice Department Criminal Division Chief Lanny Breuer, Breuer said the department was dependent on the “pipeline” to bring forward cases against Wall Street banks and their executives.

“That’s when I lost my temper,” Connaughton writes. “‘Lanny, you need to go down into your pipeline and make sure the FBI and U.S. attorney’s offices are making this a top priority. Organize and shake your pipeline hard and get it to bring you cases. Don’t just sit back and wait.’”

“I also couldn’t resist invoking our mutual history in the White House Counsel’s office and even exhorting him to emulate the tactics of our former antagonist,” he writes. “‘You need to be like Ken Starr. You need to target some of these guys like they were drug kingpins, just like Starr targeted Clinton, and squeeze every junior person around them until you can get one to flip and give evidence against the senior people.”

The scene at the Securities and Exchange Commission (SEC) was not much better.

SEC Enforcement Division Director Robert Khuzami, when asked about federal judges rebuking the SEC for paltry fines, said to Kaufman: “I’m not losing any sleep over them.”

And SEC chair Mary Schapiro wasn’t much more responsive.

“Near the end of the [October 2009] meeting [Kaufman] told [SEC Chairman Mary] Schapiro, ‘I don’t believe you’re going to do anything about high-frequency trading.’ Looking him straight in the eye, she replied, ‘You just watch.’”

“We watched for nearly three years,” Connaughton writes. “It wasn’t until July 2011 and June 2012 that the SEC approved minimalist rules that would force market participates to collect the data that would enable the SEC to begin – begin – the process of understanding HFT’s impact on markets. In effect, Ted and I and America are still watching and waiting for the SEC to take meaningful action.”

“If my tenure as Ted’s chief of staff taught me anything, it’s that the C in SEC doesn’t stand for the speed of light.”

Kaufman introduced legislation with Senator Sherrod Brown (D-Ohio) to break up the big banks.

But Brown-Kaufman could muster only 33 votes in the Senate.

“Senator Diane Feinstein – one of the most liberal members of the Senate – asked [Senator Dick] Durbin, the majority whip, ‘What’s this amendment?’ [referring to the Brown-Kaufman amendment to break up the mega-banks]. According to Durbin, he replied: ‘To break up the banks.’ Giving the thumbs-down sign, Feinstein said bemusedly: ‘This is still America, isn’t it?’

Connaughton and Senator Kaufman tried to get enforcement authorities to move aggressively against Wall Street criminality. They tried to break up the big banks. To no avail.

They were up against The Blob.

And The Blob won.

“The Blob – its really called that – refers to the government entities that regulate the finance industry – like the Banking Committee, Treasury Department, and SEC – and the army of Wall Street representatives and lobbyists that continuously surrounds and permeates them,” Connaughton writes. “The Blob moves together. Its members are in constant contact by e-mail and phone. They dine, drink, and take vacations together. Not surprisingly, they frequently intermarry. No lobbying restrictions yet promulgated can prevent pillow talk between Blob spouses.”

Connaughton holds out hope for reform – but not until there is another Wall Street crisis.

In the meantime, he says it’s time to “stop voting for the lesser of two evils” – and stand on principle.

He has burned his bridges.

And he wants you to burn yours, too.

The 'Euphoric' Economy And Why 'They' Didn't See It Coming

We are often asked for glossaries or background posts to help in the comprehension of how-we-got-here?, where-here-is?, and where-we-are-going? We hope that our posts, while diverse in nature, build upon one another and provide an educational platform for all levels of market/economy participant (active traders, passive investors, and working / non-working citizens alike) but as far as a succinct primer on how broken the status quo is and the 'euphoric' economy that very few could see through their Keynesian "debt doesn't matter" blinders, Steve Keen's introductory lecture at UWS is perhaps the most complete soup-to-nuts discussion we have seen recently. From the OECD's total ignorance to Bernanke's 'Great Moderation' miss; from economic 'religion' to science; and from Keynes to Minksy, Keen explains, in language even Chuck Schumer could understand, how more debt doesn't solve too much debt, how stability breeds instability, and why the US won't be finished deleveraging until 2025 (at this rate).

This brief lecture seems extremely apropos given we appear to be on the eve of yet another embarkation on the Keynesian 'stimulate' experiment - as everyone waits with baited breath for the next morsel of Fed/ECB/BoE/BoJ/PBOC juice...


Given the Australian audience, and the purpose of the clip, there is some 'selling' of his University course but quite frankly, his discussion of the various 'players' in the field of economics over time provides not just a 'reading' program but critically the concept that economics is not in equilibrium but is dynamic - as if common sense hadn't already persuaded you of this...

Spain's Economic Collapse Results In Whopping 5% Deposit Outflow In July

Yesterday, Spain was kind enough to advise those who track its economy, that things in 2010 and 2011 were in fact worse than had been reported, following an adjustment to both 2010 and 2011 GDP "historical" data. Today, we learn that Q2 data (also pending further downward adjustments), contracted by 0.4% sequentially in Q2, in line with expectations, but somehow, and we have to figure out the math on this, the drop on a Year over Year basis was far worse than expected, printing at -1.3% on expectations of just a -1.0% decline. However, while its economic collapse is well known by all, the surprise came in the deposits department which imploded by a whopping 5% in July, plunging to 1.509 trillion euros at end-July from 1.583 trillion in the previous month. Keep in mind this is after the June 29 European summit which supposedly fixed everything. Turns out it didn't, and the people are no longer stupid enough to believe anything Europe's pathological liar politicians spew.The good news: Greek deposits saw a dead cat bounce after collapsing by ridiculous amounts in the past several years: at this point anyone who puts their money in Greek banks must surely realize that the probability of getting even one cent back is equal odds with going to Vegas and at least having a good time while watching one's money burn.

Reuters first has some data on Spain's relentless depression:

Spain's economy shrank further in the second quarter of the year and a slump in domestic spending accelerated, signalling a protracted recession as the country presses on with efforts to slash its public deficit.

Gross domestic product fell by 0.4 percent in the second quarter of the year, according to final data that confirmed a preliminary reading. But on an annual basis it dropped by 1.3 percent, worse than initial estimates of 1.0 percent.

Spain's economy fell back into recession in the first quarter of the year, when output fell 0.3 percent, and government estimates show GDP will probably fall for this year and next year as it pushes through further measures aimed at slashing a bloated deficit.

The data came a day after Spain said its economy performed less well than expected in both of the last two years.

On Tuesday, the National Statistics Institute, INE, also revised down 2011 fourth quarter GDP to -0.5 percent from -0.3 percent.

Close to record high borrowing costs and an economy showing little sign of picking up any time soon is nudging Spain closer to calling for a European bailout, which analysts say is only a matter of time.

"With much more fiscal austerity in the pipeline and unemployment at astronomic highs, the risks are clearly tilted towards a more protracted recession," said Martin van Vliet, economist at ING.

He expected Spain to make a formal request for additional external financing in mid-September or October. Spain has already negotiated up to 100 billion euros in aid for its ailing banks.

Keep expecting buddy: as long as the ECB ponzi scheme allows Spanish banks to buy Spanish bonds, repo to the ECB, and pretend all is fine, keeping yields at or around 6%, Rajoy will never demand a bailout.

As for the deposits...

A rush by consumers and firms to pull their money out of Spanish banks intensified in July, with private sector deposits falling almost 5 percent as Spain was sucked into the centre of the euro zone debt crisis.

Private-sector deposits at Spanish banks fell to 1.509 trillion euros at end-July from 1.583 trillion in the previous month.

However, in a more positive sign, Greek banks stopped bleeding deposits in July after June elections decreased the worst fears of the country dropping out of the common currency bloc, European Central Bank data showed on Tuesday.

Speculation about Greece possibly quitting the euro was intense in May when anti-bailout parties saw a strong showing in elections, but the Greek central bank said the process had reversed after the elections.

Then again, with both nations and banks now entirely reliant on central banks for funding, who needs deposits... or taxes?

New Real Estate Train Wreck Coming: Securitized Rentals

No matter how bad things get, it turns out they can always get worse. Wall Street is about to foist a new “innovation” on investors that even the ratings agencies won’t touch.

Greedy, reckless, and just plain lazy mortgage originators, servicers, and trustee took what was actually a not unreasonable idea, that of mortgage securitizations, and turned it into a loss-bomb. Remember, that movie did not have to end badly. First, participants in the private label mortgage securitization market did for the most part comply with the requirements of their contracts for the first decade plus of that product’s existence. It was their wanton disregard for their own products which have led to the chain of title mess and difficulties in foreclosing that still plagues that market. Second, securitization markets that developed later than the US market (most notably, in of all places Russia and Eastern Europe) and featured some improvements on the US template have not seen the abuses of borrowers and investors suffered here and got through the global downturn reasonably well. However, the sell side has completely refused to implement the sort of reforms necessary to make the product safe for investors. So the US mortgage is and is likely to remain on government life support for the next decade.

So what have the “innovators” decided to do? Foist an even worse product on hapless investors. Remember, mortgage securitizations in concept are a decent idea and with proper protections, fees, and incentives, can be a useful and attractive product. Securitizing rental income streams for a large number of single family homes is a completely different proposition. The concept is clearly still being fleshed out, since a story on it in Reuters was unclear as to whether the “bonds” would also be entitled to the proceeds of the eventual sale of the house. I imagine that the private equity investors who are targeting this market are pushing for that, since fobbing off the problem of the home sale to the securitized vehicle is tantamount to a full cashout. They’d get initial tenants in, no matter how good or bad, and effectively flip the house to the securitization.

The newly-found convervatism of the ratings agencies may (stress only may) put a damper on this market. The ratings agencies are not willing to rate the initial deals, and want to see some history before they hazard a rating. Even then, some regard this product as sufficiently risky so as not to merit high ratings even if it were to become established. From Reuters:

Over the past three months, Fitch, S&P, DBRS and Morningstar have each published initial assessments of the potential risks of the new asset class. But no agency has yet published official criteria for the product.

Fitch said that such transactions are unlikely to merit a rating above Single A — and even that would require sufficient historical rental-payment data or a solid record from the property’s operator/manager.

Moody’s issued its first report on the subject on Thursday, but said that since it had not seen a formal proposal yet, it was too early to tell exactly what rating it would assign a transaction. However, it noted that even extra credit enhancement would not mitigate a lack of historical rental-payment data, and therefore some transactions might not merit top grades.

“We would like to see the specific underwriting criteria that the operator is using to choose these tenants,” Kruti Muni, a Moody’s analyst, told IFR.

“Obviously the operators would rely on income information, the existence of security deposits, history of utility payments, etc. The diversity of the geography of the pools of homes is significant as well.”

Moody’s also said that before assigning a rating, it would need to know detailed information about the operator, and would conduct a review of the operator’s performance, its experience and its ability to perform its role in the transaction, which includes determining tenant default rates and re-leasing periods.

As Dave Dayen notes:

It’s simply incredible that, even with so many variables involved, Fitch would give these deals something even as high as single-A. You need data on default rates, vacancy periods, the impact of local economic forces on rentals, the various property managers and operators who would be handling the rental units in the deal, etc., etc…

There’s just no reason to believe that hedge funds and PE firms with no history of being landlords will be able to ensure a steady stream of revenue out of this. Moreover, one economic shock could blow up this market as easily as the housing bubble popped. We already know that the US economy is due to take a step back in 2013 at best, if not a full-blown recession as a result of the fiscal cliff. Add that into the mix with 9% unemployment or above (the expected range in the event of a recession), and suddenly hundreds of thousands if not millions of Americans fall behind on their rent. The securities start to sour. And this could become a full-blown financial crisis just like in 2007-2008.

To amplify Dayen’s concerns, this looks like an effort to fob risk off onto yield-despterate investors. Rental markets are tight now, precisely due to how many homes are behind held in REO inventories or have had the homeoweners leave, yet the servicer had not actually had the trust take title to the home. But those former owners need housing, so we have a real estate version of musical chairs, with families looking for rentals before the forecloses homes have been converted to rentals. Once the conversion process is further along, it isn’t hard to imagine that rent rates will be lower in many markets and vacancy periods will be longer. Similarly, some homeowners lost their houses due to financial stress. Some of them may not even be able to make their rent payments reliably. We saw how in the 2006-2007 period, mortgage were securitized even when the borrower had defaulted in the first three months. It isn’t hard to imagine that we will see equally weak tenant rental streams sold into these securitizations.

The other looming horrorshow is, if you think mortgage servicers were unresponsive, consider how bad rental securitization servicers are likely to be. Their incentives will be to delay in responding to tenant problems in the hope that the tenant will spend the time and money required. And God only knows what happens if they apply payments incorrectly, a not-infrequent problem. One difference here is that mismanaged rentals pose a threat to the home value of the neighbors, and here, the local community does have some recourse, in that it can impose minimum rental standards, which would provide tenants with some recourse. If some communities were to go that route, it might lead to enough uncertainty regarding rental costs and income so as to deter the ratings agencies from ever assigning ratigns, which would presumably limit the size of this product considerably.

As with mortgages, the impulse of the financial community is to find even more ways to skim fees off the top of income streams and leave investors holding the bag. And if investors are dumb enough to be fooled again, after the disaster of mortgage securitizations, they will have gotten what they deserve.

FDIC Sues Goldman, JPMorgan Over Mortgage-Backed Securities

Goldman Sachs & Co. and units of JPMorgan Chase & Co. (JPM) and Ally Financial Inc. overstated the quality of loans underlying mortgage-backed securities they sold to the failed Guaranty Bank in Austin, Texas, according to lawsuits brought by the FDIC as its receiver.

In three separate complaints filed in state court in Austin on Aug. 17, the Federal Deposit Insurance Corp. alleged those institutions and others sold about $5.4 billion worth of certificates to Guaranty Bank.

“The defendants made numerous statements of material fact about the certificates and, in particular, about the credit quality of the mortgage loans that backed them,” according to each of the FDIC complaints. “Many of those statements were untrue.”

Guaranty Bank, which had 103 branches in Texas and 59 in California, was closed by the Office of Thrift Supervision three years ago today. Its branches were acquired by BBVA Compass of Birmingham, Alabama, the FDIC said in a statement issued then.

BBVA Compass also acquired almost all of Guaranty’s $12 billion in deposits, the insurer said, while entering into a loss-share transaction with the FDIC on about $11 billion of the bank’s assets.

Claiming the certificate sellers breached Texas securities law by making misleading or untrue statements about loans backing those certificates, the FDIC said in one complaint that it seeks at least $900 million in damages from Goldman Sachs, Ally Financial’s Residential Funding Securities LLC and from units of Deutsche Bank AG and JPMorgan Chase.

Separate Complaint

A separate complaint seeks damages of more than $677 million in damages from JPMorgan Securities LLC, Bank of America (BAC) Corp.’s Merrill Lynch Pierce Fenner & Smith Inc. securities unit and a brokerage unit of Royal Bank of Scotland Group Plc.

Finally a third complaint seeks almost $560 million in damages from Bank of America, its Countrywide Securities unit and other defendants.

Thomas Kelly, a spokesman for JPMorgan Chase, declined to comment on the litigation. David Wells, a Goldman Sachs spokesman, also declined to comment. Both institutions are based in New York.

Shirley Norton, a spokeswoman for Charlotte, North Carolina-based Bank of America, didn’t immediately reply to a voice-mail message seeking comment. Gina Proia, a spokeswoman for Ally Financial, didn’t immediately reply to an e-mail message seeking comment.

The cases are Federal Deposit Insurance Co. as receiver for Guaranty Bank v. Ally Securities LLC, D-1-GN-12-002522; FDIC v. Countrywide Securities Corp., D-1-GN-12-002516 and FDIC v. JPMorgan Securities Inc., D-1-GN-12-002517, Travis County, Texas, District Court (Austin).

Eric Sprott: The Financial System’s Death Knell?

On July 18th, 2012, the German government sold US$5.13 billion worth of 2-year bonds at an average yield of -0.06%. Please note the negative symbol in front of that yield number. What this means is that the German government was able to borrow money for less than nothing. When those specific bonds expire in two years’ time, the German government will pay back the original $5.13 billion minus 0.06%. Expressed another way, investors knowingly and willingly bid the German government $5.13 billion in exchange for bonds that will pay no interest and are guaranteed to lose them money on expiration.1 Welcome to the new status quo.

Germany is not alone. Over the past six months, the countries of Netherlands, Switzerland and France have also issued short-term government debt at negative yields. Like Germany, they’ve been able to do this because European bond investors are so shell shocked that they’d rather park money in a bond that’s guaranteed to only lose a miniscule amount rather than risk losing more in a PIIGS bond that actually pays some interest. In addition, many investors view German, French and Dutch bonds to be cheap options on the break-up of the Eurozone. If the EU currency union collapses, euro-denominated bonds issued by those specific countries may be paid back in re-issued deutschmarks, francs or guilders, which will be far more valuable than the euros that were spent to buy the bonds in the first place… or at least that’s the idea. As a result of this thinking, the bond market auctions for these select countries have seen overwhelming demand, making NIRP (Negative Interest Rate Policy) the new ZIRP (Zero Interest Rate Policy).

The NIRP acronym is misleading, however, because unlike ZIRP, NIRP isn’t actually an official “policy” per se, but rather a symptom of a broken financial system increasingly starved for good ‘collateral’. Aside from those speculating on a Eurozone currency collapse, a large portion of the bond investors participating in NIRP bond auctions are the banks. As the euro crisis has dragged on, banks in perceived “strong” countries like Germany and Switzerland have seen record inflows of deposits from banks in peripheral EU countries, like Spain. As most of these “strong country” banks have been hesitant to lend those deposits out (for obvious reasons), they are forced to park them in short-term government bonds. Moreover, new rules imposed by various regulators such as Basel III have forced all banks to hold a larger percentage of their balance sheet in government bonds, regardless of their country of domicile. The result has been a mad dash into the bond auctions of select “safe” countries just as the pool of available AAA-bonds has been drastically reduced. Banks are piling into NIRP bond auctions today because they have nowhere else to go. This is why nobody seems to be alarmed by the recent ubiquity of NIRP bond auctions – they are merely thought to be a short term phenomenon that will pass in time… just like zero-percent interest rates were supposed to be when they were widely introduced four years ago (sigh).

NIRP is different than ZIRP, however. NIRP causes outright financial destruction. Economies can hardly survive extended periods of ZIRP rates, let alone survive a long-term NIRP environment. It just doesn’t work. Institutional investors like pension plans and life insurance companies cannot earn enough “spread” to function properly. And many aren’t allowed to buy different asset classes that might produce a better “spread”, even if they wanted to. They are stuck holding the AAA government debt issuers – positive-yield, or not.

Negative rates also punish the individual investor. Try going online and using one of the banks’ retirement savings simulators and plugging in a negative expected return – you’ll break the program. The same also goes for the investment advisory business. When so-called safe-haven bonds start to consistently produce a negative return, try charging advisory fees to clients while recommending a 50% allocation to negative-yielding government debt. Advisors can try it for a while, but investors won’t put up with it for long.

The recent emergence of NIRP auctions are a signal that the relationship between governments, banks and investors has broken down. While the market still presumes that NIRP is a short-term phenomenon confined primarily to Europe, the dearth of AAA-assets coupled with banks’ captive bond purchasing suggests it may be structurally enforced for a long time to come. There’s even the potential for NIRP to emerge in the US bond market. As Bloomberg reports, the gap between US bank deposits and loans hit a record $1.77 trillion at the end of July 2012, representing an expansion of 15% since May.2 “Banks have already bought $136.4 billion in Treasury and government agency debt this year, more than double the $62.6 billion purchased in all of 2011, pushing their holdings to an all-time high of $1.84 trillion.”3 The current 2-year US Treasury bill is yielding a paltry 0.29%. If something exciting happens in Europe, what’s to stop the bond market’s typical knee-jerk move into US Treasuries from pushing that yield down past zero? Not much. We could be there before the end of the year, especially if the banks continue to gorge on ongoing US Treasury auctions in the meantime.

The question now is how well the financial system can cope in a relentless low-to-no yield environment for bonds. The last four years of low rates have already wreaked much damage to ‘spread’-dependent industries. One need only look at the insurers: In its latest Q2 report, after reporting an 88% drop in Q2 year-over-year earnings, Sun Life Financial stated that if current interest rates persist its profits for the period from 2013 to 2015 could be hurt by up to CAD$500 million.4 Manulife recently reported a Q2 loss of CAD$300 million, which was mainly attributed to a CAD$677 million charge it took to revalue long-term investment assumptions to account for falling bond yields.5

The pension plans are also deteriorating: According to recent reports from BNY Mellon and Mercer, the funded status of US corporate pension plans hit a record low in July 2012. Benefits Canada writes, “The average funded status dropped 2.9 percentage points to 68.7%… while the latest figures from Mercer show that the aggregate deficit in pension plans sponsored by S&P 1500 companies grew US$146 billion during July, to a record high of US$689 billion.”6 That’s a one-month increase of 27%.7 In the pension business, lower yields on long-term AAA bonds results in higher plan liabilities, plain and simple. As Reuters reporter Jim Saft writes, “To give an idea of exactly how powerful the effect of falling rates is on pension liabilities, consider that, according to Mercer, though US shares rose 1.4 percent in July, the 30-55 basis point fall in discount rates drove an increase in liability of between 3 and 11 percent. In a single month.”8

It’s even worse for the public pensions. According to the Washington Post, new pension accounting rules imposed by bond-rating firm Moody’s are expected to “triple the gap between what states and municipalities report they have in their funds and what they have promised to pay out retirees.”9 If implemented, that new public pension gap will balloon to $2.2 trillion. Michael Fletcher from the Washington Post writes, “Among other things, the new accounting rules from Moody’s and the Governmental Accounting Standards Board (GASB) limit the rate of return on future investments that pension funds can assume for accounting purposes. Most government pension funds assume a 7 percent to 8 percent return, which critics say overstates future investment income.”10 With the US 10-year bond now paying less than 2% a year, assuming a 7-8% return isn’t an overstatement, it’s a fantasy. Chart 1 shows how the last four years of low-to-no rates has impacted the average Canadian pension plan. Extend that trend another four years and we might as well redefine the entire purpose of pensions altogether.

CHART 1: THE SOLVENCY POSITION OF DEFINED-BENEFIT PENSION FUNDS IN CANADA IS AT AN ALL-TIME LOW Indexes (December 1998 = 100)

a. Solvency position is equal to assets divided by liabilities.
Source: Mercer (Canada) Limited. Last observation: May 2012.

Banks are also suffering from NIRP and ZIRP, as evidenced by the performance of Wall Street’s five biggest banks thus far in 2012. Bloomberg writes, “JPMorgan Chase & Co. (JPM), Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley had combined first-half revenue of $161 billion, down 4.5 percent from 2011 and the lowest since $135 billion in 2008. The firms blamed the decline on low interest rates and a drop in trading and deal-making.”11 (Emphasis ours.) Banks make money on the spread between the interest they charge on loans and the interest they pay on our deposits (this is called the net-interest margin). Chart 2 shows the impact low rates have had on the net-interest margin for the Big 6 Canadian banks, and how tightly correlated their profits are to bond yields themselves. The average net-interest margin for the Big 6 was 2.55% in fiscal Q2 2012, while the average yield on the Canadian 5-year Treasury bond was 1.54%. According to our calculations, for every 100 basis point decline in the 5-year Treasury yield, the Banks’ net-interest margin will fall roughly 20 basis points. All else equal, a 1% drop in 5-year bond yields will result in a -15.6% impact on the banks’ net income. Like the insurers, the persistence of low bond yields hurts their profit margins… and the more deposits the banks take on, the more they are inadvertently forced to participate in short-term bond auctions – thereby supporting the very market causing the margin compression in the first place. It’s a vicious catch-22.

Source: Bloomberg, Big 6 Canadian Banks’ Financial Reports.

From a government perspective – especially governments like Germany who currently issue short-term debt for less than nothing, the current abundance of NIRP and ZIRP bond auctions represent a sweet irony. Here we are, on the interminable verge of collapse in Europe, and at a time when Western governments have never been more indebted, and bond investors are lining up to pay for the pleasure of owning their bond paper! It’s actually quite ridiculous. But no matter how much pain the current low-to-no yield environment causes the rest of the financial industry, governments will not do anything to change their current set-up. No government is incentivized to proactively raise their bond auction yields for the sake of savers, and barring the surprise emergence of major inflation, no central bank would ever raise interest rates and risk curtailing their expensive efforts to foster growth through money-printing. The banks’ continuing need for safe “collateral” means they’ll buy government bonds at virtually any price, leaving the governments with a “captive” buyer for their bonds. It’s almost perfect for the governments… and as it now stands, unless the banking system diversifies into different forms of AAA-collateral (like gold), or until we experience a default or major inflation – both clearly negative events, investors will be forced to survive with a AAA-bond market that pays absolutely nothing, just like Japanese investors have suffered through for the past twenty years.

Under widespread NIRP, pensions, annuities, insurers, banks and ultimately all savers will suffer a slow but steady decline in real wealth over time. Just as ZIRP has stuck around since the early 2000’s, NIRP may be here to stay for many years to come. Looking back at how much widespread damage ZIRP has caused since its introduction back in 2002, it’s hard not to expect that negative interest rates will cause even more harm, and at a faster clip. In our view, NIRP represents the death knell for the financial system as we know it today. There are simply too many working parts of the financial industry that are directly impacted by negative rates, and as long as NIRP persists, they will be helplessly stuck suffering from its ill-effects.

Although it’s been a quiet summer for “hard assets” like gold and silver, this low-to-no rate environment should prove to be beneficial for them over time. The tide is definitely turning in their favour. Various bond commentators have recently come out in support of hard assets, including PIMCO’s Bill Gross, who opined in his August month-end letter that, “Unfair as it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.”12 NIRP and ZIRP are critical components of that solution, and are here to stay until something unpredictable disrupts the current relationship between the banks and government bond auctions. In our view, the factors that have led to the emergence of NIRP bond auctions are the same factors that will drive demand for physical gold in the coming months: savers have nowhere to go for a “safe” return. It’s only a matter of time before they realize they’ve overlooked a unique financial asset that would perfectly suit their needs. When they do, we would strongly advise them to take delivery.

a. Solvency position is equal to assets divided by liabilities.
Source: Mercer (Canada) Limited. Last observation: May 2012.

What Jules Kroll Is Not Saying About Ratings Agencies

Time and again, the traditional agencies' analyses have lacked any foresight, even after the lessons of the subprime mortgage debacle. It's hard to trust companies that have repeatedly gotten it so wrong. A year after S&P downgraded long-term U.S. Treasuries, investors are still buying them up, and little else has changed: Interest rates remain low, and Dow Jones industrials are high. Then, take Greece. In 2009, Moody's said that fears about Greece's financing were "misplaced," according to the New York Times, only to go on to downgrade Greece's debt. We all know the fallout from that. These were the same firms that gave Enron an "investment grade" rating back in 2001, just before it filed for bankruptcy. And lest you've forgotten by now, they also gave Lehman Brothers a favorable rating before its collapse. – Reuters

Dominant Social Theme: What American ratings agencies need is transparency, accountability and more numerative substance.

Free-Market Analysis: Jules Kroll is back in town. The man, who is really a myth, single-handedly invented private, white collar, corporate investigations. Now he wants to reinvent the US ratings agency industry.

Standard and Poor's, Moody's and Fitch Ratings ran into trouble after the earthshattering financial crash of 2008. All three were busily providing ratings for lots of money right up until the West's economy virtually shattered overnight.

In fact, there really wasn't much the big three could do or say. Unlike many other market participants, their job was uniquely focused on predicting risk and, given what occurred, it probably wasn't possible to formulate an adequate defense.

They've been trying to brazen it out ever since but one assumes their position is eroding. Brussels is beginning to investigate whether the agencies have the resources and plain competence to evaluate risk. This is actually a fair question to ask.

But beyond this, the agencies are in a bind because their business is essentially an artful one. It deals with a gray area that goes well beyond the numbers. And as such, the agencies are lightening rods for resentment and irritation. A downgrade costs money and can kill a business deal.

When the agencies were seen as in a sense infallible, such power was granted simply because the agencies acted like a force of nature. They existed, and there was no real recourse.

But now, given that virtually every entity large or small in the Western world would have probably unraveled without what is by now US$50 TRILLION in loans and outright giveaways by the world's central banks, there isn't much of a defense to muster.

Kroll is right to perceive a new business opportunity, given the fundamental injury the business has received. What is less clear is why Kroll believes he has invented a better mousetrap.

He is, nonetheless, and in this Reuters editorial he explains it. But first, a little more about the man – who would be a formidable entrant in any industry. Here, from Wikipedia:

Jules B. Kroll invented the modern corporate investigations industry when he founded Kroll, Inc. in 1972. Kroll Inc. was ultimately sold to Marsh & McClennan Companies for $1.9b in 2004. In 2009, Kroll founded two successor firms, Kroll Bond Rating Agency and K2 Intelligence. KBRA is the first independent bond rating agency formed since the credit crisis in 2008.

Kroll intends to offer "clear and transparent" ratings and to restore "trust" in an industry badly in need of some. In the editorial, which is engagingly part opinion and part promotion, Kroll lays out the problem that the current crop of US ratings agencies have and then proposes his solution. Here's how he positions it:

Credit rating agencies should adopt a new business model that includes transparency, accountability and strong analytics as its cornerstones. When my firm employed this model, our average report produced anywhere from 30 to 50 percent more content than a firm like Moody's. We are able to routinely provide timely, forward-looking research so investors and the public can make more informed decisions. If a rating turns out to be wrong, we will say so.

This new approach will work. Markets don't trust the old model, not just because it's been wrong so often but also because it is conducted in a vacuum. Traditional rating agencies go into a back room and come out with a letter grade that increasingly appears to be chosen out of thin air. But a model that includes full and public disclosure of the methodology used to reach the rating, and long-term accountability for whether the rating was right or wrong, will restore confidence. It won't happen overnight, but little by little, it will happen.

With due respect to Mr. Kroll, who's been extraordinarily successful, this strikes us as a somewhat simplistic approach to resuscitating the ratings business.

He does make good points in the editorial about the persistent problems that the big three US agencies face. Interestingly, he uses the market itself as his touchstone, pointing out that the agencies are becoming irrelevant not because they are right or wrong but because investors aren't listening anymore.

After Moody's downgraded the ratings of 15 global banks, he explains, US bank stocks actually went up. "When the sovereign debt of Germany, the Netherlands and Luxembourg were downgraded on July 23, U.S. stocks remained largely unchanged."

Just look at the US Treasury bond market following Standard & Poor's downgrade of the United States: "Investors are making key investment decisions using their own analysis."

Horrors!

From our point of view (admittedly not Kroll's), the problems that the ratings agencies face simply stem from their unwillingness to adopt an Austrian, free-market economic model.

It would be interesting to press the agencies on the economic model they DO follow. Probably you'd get the old runaround. You'd be told that your rating was linked to your financial position, business prospects, etc. But if you persisted in asking them how they DEFINED the money they're evaluating, you'd probably get nowhere fast.

Even Kroll doesn't get into it. He talks about a deeper level of evaluation but we'd bet this merely entails more number-crunching and more "transparency."

Ask Kroll whether there is a danger in government printing too much money and he might say yes. Ask him how much is too much, and if he's telling the truth he'd have to admit that he doesn't know. The ratings agency business, in the end, is "smoke and mirrors." It was issuing healthy ratings to bankrupt businesses and country's right up to the collapse.

Kroll's idea that more intensive statistical analysis will make a difference doesn't address the fundamental problem at all. The problem has to do with monopoly fiat central banking. Until the agencies, Kroll's included, are willing to forthrightly state that every ten years or so excessive money printing will cause a crash and drive numerous firms out of business, their models will be flawed.

But it will never happen because we live in an era of faux-economics. The power elite that has set up this mad and miserable system intends for it to do exactly what it's done. Those at the top could care less about the current ratings system or those agencies that purvey it. Not really.

Kroll ends this way:

The solution is not to banish credit ratings to the scrap heap of history. Nor to eliminate an important tool for valuing debt and keeping capital markets solvent. What we really need is a new model to restore credibility to the industry once again. Put simply, ratings are too important to not be trusted.

Credit rating agencies can offer an important assessment of public-sector institutions, the structured finance sector and other market conditions more broadly. When these analyses are conducted thoroughly and independently, they are valuable. For example, if demand for a state's general obligation bonds - which credit agencies rate - exceeds the bonds available, a state can reduce interest rates and potentially save millions over the life of the bonds.

Conclusion: God help us.

Corrupt banks engaged in ‘organized LIBOR’

Visiting British friends reminded me that all summer, the press has occa­sionally covered the “LIBOR Scandal,” but many stories have been a lot of “inside-baseball”-style financial confusion. Actually, the situ­ation affects regular working people much more than has been noted.

Besides making a mockery of the “free market,” LIBOR – specif­i­cally, manip­u­lating LIBOR – costs us money in many ways. LIBOR – London Interbank Offered Rate – is supposed to gauge the average interest rate banks charge when they lend to each other. Ideally a measure of banks’ trust in their solvency, LIBOR is used as a foun­dation for other rates, like adjustable-rate mort­gages or complex financial deriv­a­tives. But: Big Banks don’t use data based on veri­fiable facts; there’s no check or balance.

So that ideal dissolved in June, when Britain’s Barclays bank admitted that it had routinely and repeatedly under­stated the rate for years. They did so in two ways. First, Big Banks conspired to move LIBOR levels (up or down) to benefit banks’ invest­ments, not customers. Next, during the 2008 financial crisis, Big Banks appear to have under­re­ported LIBOR to seem stronger.

LIBOR affects us because it changes the cost of money, whether personal or commercial borrowing. It influ­ences credit cards, student loans, mort­gages and more. Interest rates that banks charge are usually figured as LIBOR plus an addi­tional amount.

Barclays’ CEO resigned, and it’ll pay $453 million in fines to settle charges of LIBOR manip­u­lation as far back as 2005. More banks will probably be impli­cated. About 20 Big Banks contributed to LIBOR – including three giant U.S. outfits: Bank of America, Citi­group and JPMorgan Chase – at least some­times involving them­selves in the scheme, as well as possibly the Bank of England, the U.S. Federal Reserve, and the U.K. government, according to material Barclay’s disclosed.

“This is a very, very signif­icant event,” said Gary Gensler, chair of the U.S. Commodity Futures Trading Commission (CFTC), one of the regu­lators inves­ti­gating the scandal, in Time magazine. “LIBOR is the mother of all financial indices, and it’s at the heart of the consumer-lending markets. There have been winners and losers on both sides [of the LIBOR deals], but collec­tively we all lose if the market isn’t perceived to be honest.”

However, the CFTC neither charged Barclays with a crime nor required resti­tution to victims. Still, Barclays’ activ­ities may be felonies under federal RICO statutes. The Rack­eteer Influ­enced and Corrupt Orga­ni­za­tions Act autho­rizes victims to recover triple damages.

Another gigantic conse­quence of the banks’ manip­u­lation is that it hid 2008’s financial crisis for months. The scandal repre­sents a financial system that remains secret and under-regulated – four years after that crisis – further eroding people’s under­standable distrust of Big Banks.

Econ­omist, author and former Labor Secretary Robert Reich said, “Just when you thought Wall Street couldn’t sink any lower – when its myriad abuses of public trust have already spread a miasma of cynicism over the entire economic system, giving birth to Tea Partiers and Occu­piers and all manner of conspiracy theories; when its excesses have already wrought havoc with the lives of millions of Amer­icans, causing taxpayers to shell out billions (of which only a portion has been repaid) even as its top exec­u­tives are back to making more money than ever; when its vast political power (via campaign contri­bu­tions) has already evis­cerated much of the Dodd-Frank law that was supposed to rein it in, including the so-called ‘Volker’ Rule that was sold as a milder version of the old Glass-Steagall Act that used to separate investment from commercial banking – yes, just when you thought the Street had hit bottom, an even deeper level of public-be-damned greed and corruption is revealed.”

The extent of the fraud and its conse­quences is incredible.

Attorney Ellen Brown, chair of the Public Banking Institute and author of Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free, said, “The losers have been local govern­ments, hospitals, univer­sities, and other nonprofits. For more than a decade, banks and insurance companies convinced them that interest-rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools.”

Heather Slavkin writing for AFL-CIO Now said, “Around $10 trillion in loans is indexed to LIBOR [and] when you add in all types of financial products including complex instru­ments like deriv­a­tives, LIBOR is the index for around $800 trillion in financial instruments.”

That $800 trillion is 11 times the Gross Domestic Products of every nation on Earth, according to 2011 figures from the Inter­na­tional Monetary Fund.

Again, Big Banks could face criminal pros­e­cution, civil lawsuits and regu­latory penalties, but how did it happen for so many years? Were regu­lators them­selves – admit­tedly dealing with weaker laws than decades past – incom­petent or corrupt? Further, will pros­e­cutors do their job and go after such corporate ille­gality? After this inter­na­tional cartel?

Attorney For Goldman Sachs CEO Is Eric Holder's 'Best Friend'

The crony connections just keep on coming over at Eric Holder’s Department of Justice.

Last week, the Justice Department announced that it will not prosecute Goldman Sachs or any of its employees in a financial probe.

Could that be because the attorney for Goldman Sachs CEO Lloyd Blankfein was none other than Attorney General Eric Holder’s “best friend” and former personal attorney, Reid Weingarten?

Or because in 2008, Goldman Sachs employees donated $1,013,091 to Barack Obama?

Or because Goldman Sachs is the former client of Eric Holder’s and Assistant Attorney General Lanny Breuer’s law firm, Covington & Burling?

The conflicts of interest and cronyism at Holder’s Department of Justice are so many that it took a 27-page report by the Government Accountability Institute to catalog them all.

And lest one forget: Holder's best friend Reid Weingarten--who previously represented child rapist Roman Polanski--is also the lawyer for former MF Global treasurer Edith O’Brien. On Thursday, the New York Times reported that Holder's Justice Department will not be criminally charging Jon Corzine or any MF Global executives in that case either.

Weingarten, who calls himself a “hard-core child of the ‘60s,” apparently has a soft spot for Wall Street fat cats. "I feel like I'm in the French Revolution, defending the nobility against the howling mob," Weingarten told Bloomberg in 2002.

So, to recap, Goldman Sachs, which donated $1,013,091 to Barack Obama in 2008 and whose CEO is represented by Holder's best friend, will not face prosecution.

Nor will Obama bundler Jon Corzine, who raised at least $500,000 for Barack Obama.

Indeed, Eric Holder’s Department of Justice has not charged, prosecuted, or convicted a single top Wall Street executive.

Alas, pay-to-play justice and the Chicago Way are alive and well.

Spain Out of Options

Yves here. We’ve flagged in earlier posts how the Spanish banking crisis has the potential to become destabilizing politically, as if Spain wasn’t already at considerable risk of upheaval. Spanish depositors were pushed to convert their deposits into preference shares, which they were told were just as safe. This was a simple desperation move by the banks to save their own skins, customers be damned, by raising equity from the most unsophisticated source to which they had access. And now that that gambit failed, these shareholders are due to have those investments wiped out unless the Spanish authorities can cut a deal to spare them. Don’t hold your breath.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness

I mentioned back in early July that Spain had a serious political problem brewing because the draft Memorandum of Understanding for the Spanish banking system clearly stated that:

Banks and their shareholders will take losses before State aid measures are granted and ensure loss absorption of equity and hybrid capital instruments to the full extent possible.

From a market perspective this is absolutely the correct thing to do. Equity is a risky business. You take a punt, the banks falls over, your money it gone, fair enough. But in Spain it’s not that simple because of something I commented on in April:

The key in a banking crisis is to keep the confidence of depositors. But while many countries relied on capital injections and government guarantees, Spanish banks have added a unique twist of effectively turning some depositors into equity holders. That puts customers on the front line.

Some banks started by persuading depositors to switch from low, interest-bearing accounts into preference shares, which paid a fixed, higher interest rate. The benefit for the banks was that these securities counted as core capital under banking rules. UBS says Spanish banks issued €32 billion ($42.7 billion) of such instruments from 2007 to 2010.

But as the crisis deepened, these instruments became illiquid, trading at deep discounts. At the same time, they ceased to count as core capital under new rules known as Basel III. So banks have encouraged investors to convert preference shares into either common stock or mandatory convertible notes, which pay a high initial yield before later converting into stock.

And so now, under the watchful eye of the Spanish regulators, depositors in Spanish banks had been converted into equity holders and these same people were about to see their savings eaten up by the first stages of a banking bailout.

Although there are other factors involved, I think this is one of the primary reasons Mariano Rajoy has been so hesitant to move forward with any bailout, and it comes as no surprise that he is now attempting to negotiate a way out for these people:

The Spanish government is in talks with Brussels to allow tens of thousands of retail clients who bought risky savings products from now nationalized lenders to avoid losing their investments as part of Spain’s bank bailout.

In place of inflicting large losses on small savers who purchased savings products linked to preference shares in in the lenders known as cajas, the Spanish government is negotiating a compromise where they will suffer an instant haircut, and then be repaid in full over time by their banks, people familiar with the talks said.

The decision to inflict losses on holders of high interest preference shares and subordinated debt in rescued savings banks has been highly controversial in Spain, with the terms of the country’s bank rescue not distinguishing between professional and retail investors.

Apart from the obvious question of whether they will actually get a deal, the other question is will the banks be in any position to make those payments in the future. As WSJ reports, the banking system looks increasingly flakey as deposits continue to leave the country and the hole is filled by ECB:

Spanish banks borrowed a record amount from the European Central Bank in July, as other sources of funding evaporated further in the weeks following the announcement of a €100 billion ($123 billion) bailout for the country’s financial industry.

Bank of Spain data indicated that net ECB borrowing rose to €375.55 billion from €337.21 billion in June. It was the 10th straight month of increases, highlighting how the country’s lenders are having more and more difficulty financing themselves through private investors.

Spain’s traditional funding sources have been dwindling as the economy sinks deeper into a downturn. During the Spanish construction boom of the past decade, German and other European banks were more than willing to fund the rapid expansion of the Spanish banking system, inflating the country’s credit bubble.

And the latest report from Tinsa makes it very clear that the bubble’s deflation is far from over:

The IMIE General index registered a year-on-year decline of 11.2% in July, pushing the index down to 1577 points. The cumulative decline in house prices since the market peaked in December 2007 is 31%.

In terms of the cumulative decline in house prices by region since peak prices, there was a 37.2% fall in July for the “Mediterranean Coast”; followed by 33.5% for “Capitals and Major Cities”, 32.1% for “Metropolitan Areas”, 29.2% for the “Balearic and Canary Islands” and 25.9% for “Other Municipalities”, which comprises the remainder.


Mariano Rajoy is expected to meet Herman Van Rompuy, Angela Merkel, Mario Monti and Finland’s President, Sauli Niinistoe, over the next few weeks in order to discuss his country’s future. It is, however, increasingly obvious that he will have little choice to accept whatever he is given, and I have to question again exactly how long he has left in politics.

Marcy Wheeler: Standard Chartered Bank Admits Promontory’s Estimates of Its Iran Business Were Wrong

Yves here. A few quick comments on the New York state settlement. Some readers are unhappy that there wasn’t a prosecution. First, as we’ve written before, criminal prosecutions of big financial firms put them out of business (tons of customers are forbidden to do business with them) so they settle pronto (prosecuting individuals is another matter completely). Second, Lawsky is only a banking regulator and does not have prosecutorial powers. To do that, he would have needed Eric Schneiderman’s cooperation. But Lawksy’s boss, Andrew Cuomo and Schneiderman are rivals. And Schneiderman has thrown his lot in with the Obama Administration, which has been ferociously trying to undermine Lawsky. As Neil Barofksy noted in a Bloomberg story:

“I can’t think of another case where there has been such uniformity among federal regulators undercutting an enforcement case”

Marcy’s observation below is very important, and is being glossed over or even denied in the mainstream media. The Wall Street Journal has one of its all too common alternative reality editorial page pieces. Key snippet:

Of the $250 billion of transactions at issue, it now appears that $249 billion and change were legal at the time they occurred.

In a word, no.

By Marcy Wheeler. Cross posted from emptywheel

Standard Chartered just settled with NY’s Superintendent of Financial Services. The settlement–for $340 million and a monitor of SFS’ choosing–is less than some reports said the settlement might have been.

But here’s the detail I’m most interested in:

The New York State Department of Financial Services (“DFS”) and Standard Chartered Bank (“Bank”) have reached an agreement to settle the matters raised in the DFS Order dated August 6, 2012. The parties have agreed that the conduct at issue involved transactions of at least $250 billion. [my emphasis]

Just .1% fine, so not that big. But an admission that the scope of the fraud and the Iran business really did amount to $250 billion.

I find that interesting for two reasons. First, because it’s going to cause all kinds of headaches for the folks at Treasury who would like to let SCB off easy but ordinarily base settlements on the amount of the underlying activity.

More importantly, for me, because it demonstrates what a sham the Get Out of Jail Free industry is. A former OCC head and his minions at Promontory Financial Group claimed to have added it all up and determined that SCB only hid $14 million of transactions from Iran. SCB now says that Promontory was wrong.

By orders of magnitude.

Granted, SCB–and most of the people who pay Promontory to soft-pedal their crimes and risk–tried not to admit it had gotten that estimate from Promontory. Going forward, I expect we’ll see Promontory’s clients hide their involvement even more.

Still, this is a useful demonstration of how corrupt the Get Out of Jail Free industry is.