MonkeyBusinessBlog

Maybe We're Just Not Very Smart.

You ever find yourself wondering how people or governments or businesses can make the same stupid mistakes over and over again?  Do you ever sit and wonder why YOU sometimes make the same stupid mistake over and over?  I know I do (Me not you!).  We certainly have gotten our share of examples in this latest financial debacle.  It used to take us a decade or two to repeat the same awful mistakes.  Now?  A couple of years?  A couple of months?

Anyway, I was thinking about this this morning while driving on the Hutchinson Parkway in New York. There is a radio station in New York, WRXP (101.9 on your FM dial!) that started up a little more than a year ago. They brought a programing concept that the terrestrial radio world has been dying for....forever!  Rather than call themselves a "Classic Rock" station and play the same 500 songs from bands that cut their last record twenty years or more ago, WRXP mixed in all the new great stuff being put out by new bands, "alternative" music that has been around for a while but never got the airplay on the big Rock n' Roll stations AND classic rock.  In fact, what is really refreshing about what WRXP did was, a lot of times when they play someone like The Stones, they play songs like "Winter" from the "Goats Head Soup" album as opposed to "Angie" for the 11 millionth time.

The station was lean and mean.  Between their programing and cheap, yet effective promotions, within a year they literally wiped out most of the other rock stations.  There's one big one left, WAXQ, which is fine because the listening area is big enough for both of them.  So I'm in the car listening to WRXP and I hear the disk jockey Matt Pinfield say, "So here we are, broadcasting live from London England!" and I say to myself, "WTF?  Why are you in England?"  Apparently, Matt and his partner are set up in London all week to celebrate "Beatles Day".  Tomorrow, the Beatles will release all their albums, remastered as well as launch the video game "Beatles Rock Band".  Tomorrow, the WRXP crew will be broadcasting from the Abbey Roads studio.  Meanwhile, Pinfield is telling us all about the super cool hotel he is staying at and all the celebrities he is seeing there.  Also, they happen to be interviewing guests, like they do every morning.  However, the guests are in the New York studio and Matt and his partner are in London!  That's cost effective.  I guess it could have been worse. WRXP could have flown the guests over to London to speak to Matt!

All I am thinking as I was listening was, "How much money is this costing??"  Did sponsors pay more to pop an advert during Pinfield's London broadcasts...in a depression?  I seriously doubt it and if anyone did they should be canned!  In one year, a tightly run business with a great plan and a tight budget is now spending Lord knows what so they can be in London, as if anyone give's a rat's ass!  Maybe Pinfield gets Paul McCartney on for an interview?  Who cares, the man gets interviewed in New York ALL THE TIME.  Ringo too!  These idiots are repeating probably all the mistakes the stations that have gone out of business have made, number one being spending enormous sums of money on sh*t no business person is going to pay them for.  Morons.

Oh, and as I was ranting traffic on the Hutch screeched to a halt.  The culprit?  A big 18 wheel tractor trailer got on the Hutch AGAIN. There's about a thousand warnings all over the parkway telling trucks they are not allowed on and if they get on they wont fit under the underpasses the parkway has every mile or so!  I was able to do some fancy rerouting and got around the disaster.  Trucker hauling onions hit the underpass and literally sheered off the roof of the trailer.  Onions EVERYWHERE.  The cab was fine so I am pretty sure the driver didn't get seriously hurt.  However, I am sure he won't have a job with his trucking company by tomorrow and I am sure the fine his company is going to get hit with, especially because Westchester County will have to spend hundreds of thousands of dollars to make sure the underpass he hit is structurally sound, may put them out of business or hit their insurance so bad that it may not get renewed.  This happens about once a month on New York's parkways.  Another fine example of people doing the same stupid thing over and over.

The White House Oval Office: October 2009.

The scene: The White House Oval Office

The Players: President Obama, David Axelrod, Rahm Emanuel, Tim Geithner, Larry Summers, Sheila Bair, Peter Orzag.

All to the President: "Congratulations sir!  The "2009 Health Insurance Reform Act" is a smashing success! 

Emanuel:  "Sir, thanks for finally letting me take the gloves off and crack some skulls.  I know you don't like or approve of the bare knuckle stuff, but it had to be done."

Axelrod: "Simply incredible sir.  The Clintons must be fuming with jealousy.  I bet you anything that Bubba's face is a dark shade of purple right now!  

Orzag: " Sir, you strong armed the big pharma guys into promising to not be greedy anymore AND to sponsor a nationwide run of "The Best of Rogers and Hammerstein" for the seniors in exchange for our promise that Medicare won't use its size as leverage to negotiate lower prices!"

Emanuel:  "Let's not forget the deal we rammed up the insurers asses!  In exchange for us dropping the public option the insurers promised to make their process more transparent and hold weekly lotteries for the poor.  The lucky winner gets a yearly $5,000 deductible, $10,000 max out of pocket health plan!  

Summers:  "I hope you realize the lottery was MY idea.  My research shows the poor LOVE lotteries."

President Obama: "Now now, take it easy fellas.  I had a lot of help from all you.  No way I get this landmark piece of legislation without you guys.  Ok, lets not revel in our successes.  There's still a lot of work to do.  Tim, you had something on General Motors you wanted to discuss?"

Geithner: "Yes Mr. President.  It seems General Motors Acceptance Corporation, GMAC needs about a $2 billion capital infusion."

Emanuel: "Jesus Tim, $2 billion?  Why don't you just come up here and ask the President of the United States to validate your parking?  

Orzag: "Seriously Tim.  Welcome to 2009.  If isn't at least $50 billion, handle that weak sh*t at your shop! Don't bring it up in here."

Summers:  "Listen you two neanderthals, the only one around here who gets to bitch-slap Tim is me!"

President Obama: "Alright fellas, take it easy.  Go ahead Tim. What is the story with GMAC?"

Geithner: "Well sir, remember Cash for Clunkers"?

Summers: "You mean the best stimulus idea since the Chinese built the Great Wall?  Duh, I think so!"

Geithner:  "Anyway sir, it seems that the 100,000 or so customers that participated in the program with GM essentially traded in a paid off vehicle for a new car."

Emanuel: "And.....?

Geithner:  "Well, essentially almost all these folks used the $4,500 Clunker Credit as a down-payment for the new vehicle and then borrowed the balance from GMAC at 0% for 72 months.  It appears that nearly 50% of those loans are already delinquent!"

President Obama: "Well that's bit odd isn't it?  It almost sounds like the subprime problem doesn't it David?"

Axelrod:  "It certainly does.  

Geithner: "You both are correct there.  It turns out that many of the borrowers are the same people.  Now the loans GMAC made to the Clunker borrowers are coming up delinquent.  And once these these folks go delinquent, they usually don't get things straightened out.

President Obama:  "Wow, who knew right?  Now, many of other car companies have been selling lots of vehicles.  Are they experiencing the same thing?"

Geithner:  "Yes Mr. President.  In fact, this is where it gets tricky.  See, remember all those neat lending facilities we set up with the Fed.......the Term Asset Backed Lending Facility or TALF?"  That is where we tried to help jump-start consumer financing by lending money at very generous terms to investors to buy the securities collateralized by things such as auto loans."

President Obama: "Okay..?

Geithner:  "Well the defaults on these Clunker loans are really starting to clobber those new securities that the Fed lent money on and the FDIC backstopped losses.  It looks like the FDIC may be taking some sizable losses as a result."  Additionally, a lot of this paper is ending up in money market mutual funds.  Last year we threw a government wrap on this market too.  So the FDIC may be on the hook for that as well.

President Obama: "Hmm, major bummer.  Sheila, what do you think?

Bair: "Umm, I suppose this isn't a good time to bring up that our FDIC reserve fund is out of money?"

President Obama: "I wonder if President Bush would let me clear some brush out at Crawford?"

 

F**king Banksters!

Alright, it's official.  There will be a day, and that day is coming soon when the banks in this country push enough people too far.  I just got off the phone with my bank, who I have banked with for the last five years, and I am so pissed off they have me walking around my "workspace" muttering like a mad man.

I have banked with JPM Chase for 5 years.  During those 5 wonderful years, because I like liquidity, I kept a nice balance in a savings account.  I also took out a line of credit with JPM Chase last year for a nice low rate to keep my liquidity in these uncertain times.  I know it cost a little something but late last spring I thought it best to be prepared.  Additionally, because I knew last year that banks like JPM Chase were giving people lines and then slashing the unused portion to free up potential balance sheet use, I took the whole line down the second after we signed the papers!

Now I am selling my house and renting because quite frankly, I am going to cry like a little girl if I'm still in my house a year from now and my equity stake declines by another 20-30% AND my real estate taxes go up.  So we got a good sale off and now we are going to rent and protect our equity.  Anyway, I call up Chase to get the payoff information on my line.  Low and behold, they are charging me a $1,000 fee because I'm "prepaying the line".  I said, "Are you guys kidding me?  You guys are cutting peoples lines left and right and I'm doing it for you.  Also, you got me at Prime minus 50 basis points!  I know your making a smidgen off me, but at the end of the day I'm one less NY real estate exposure that you have to worry about."

Now naturally, I am probably saying all this to a 25 year old girl in Mumbai but still!  Then I say, "Do you realize that I'm going to get a nice check when I close.  My FDIC limit was going to stay at your bank at some fabulous 13 month interest rate of .9%  I'm lending you money for practically nothing! 

You want me to walk over to your friends at Wells or BofA and give them the money?"  Of course all I get is, "I'm sorry sir."  Finally I just say, "Look, I'm sorry. I shouldn't take it out on you, but you have to admit it is a pretty bad business move.  Here's the number to fax to my attorney."  The nice Indian girl says, "Oh, we have a fax charge of $30!"    "What???  $30 bucks to type in a fax number and send the payoff!  Are you guys nuts??  "Oh, and sir, just so you know that the fax will probably get to your attorney in 24 hours."  I just started laughing and said, "Ok, did you just make that one up because I'm being an A-hole?"  She says, "Oh no sir, that's standard policy."  Then before hanging up she told me that I qualified for a high limit Visa card!  F**KING BANKSTAHS!

Banking System Drowning in Toxic Loans....Imagine That.

Bloomberg News has a piece today Toxic Loans Topping 5% May Push 150 Banks to Point of No Return 

More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival.

The number of banks exceeding the threshold more than doubled in the year through June, according to data compiled by Bloomberg, as real estate and credit-card defaults surged. Almost 300 reported 3 percent or more of their loans were nonperforming, a term for commercial and consumer debt that has stopped collecting interest or will no longer be paid in full.

Read on.  It is both horrifying and EXACTLY what we have been telling you on this blog for nearly a year! I worked through the S&L crisis of the late 1980's and I have stated since 2007 (when I was gainfully employed by a large Wall Street firm) that what we are going through now is the S&L crisis on steroids.  The loans are bad and they ain't getting any better with time.  That is a fact that the moronic green shooters as well as the Fed and Treasury Department (including Shelia Bair, who somehow obtained the moniker of "competent" throughout this mess) just haven't been able to get their heads around.  You can't have a recovery without a banking system and right now we don't have a banking system.  Here is a post from February 2009 that I hate to say, precisely lays out the road to Muddsville, our current local.

Not To Go On a Rant Here But......

The last couple of days I have been watching this insane play on words that has taken place between The Fed, Congress, The President, bank executives and investors.  "Will the U.S. Government nationalize the banking system?"  Somehow a picture was painted that the government was going to take control of the banking system and somehow run the entire thing from Washington D.C.  Our government has proved beyond a shadow of doubt that it is entirely incapable of running itself, let alone the banking system!  This idiotic spectacle has taken away from the main debate and problem.  What are we going to do with our LARGELY INSOLVENT BANKING SYSTEM?  The time our "leaders" spend jerking around with nuance, is time they need to focus like a laser on;

•  How do we pick the living from the dead? 
•  How do we strengthen the living?
•  How do we dispose of the dead? 

I appreciate that the government is going to run stress tests to determine who is well capitalized and who is not.  However, until we resolve the issue of how to move the $1 trillion or so toxic assets from bank books, the health of our major banks is shrouded in doubt....or worse.  Where is this freaking plan?  Customers with real capital are standing by waiting to purchase assets.  Treasury seems to be fixed on a misguided notion that creating another funding program like the TALF is going to juice up bids on these assets and save the bank's precious capital.  I call this misguided because I have seen this before when I worked at a bank that was trying to dispose of the very same assets we are talking about here.  We were specifically and correctly told;

"We are not interested in moving these assets to hedge funds who need financing to purchase the assets.  If we do that, all we are doing is changing troubled asset risk for hedge fund counterparty risk.  It does not reduce the balance sheet enough and if the asset prices deteriorate further, we may ended up having to take the assets back.  We would rather sell a bond to a "real money" investor at 65-00 than a hedge fund at 70-00.

Additionally, if the government starts handing out cheap term financing to any Tom, Dick or Harry hedge fund, we will sell the first 10% of the assets in question at better than current market prices (and there are market prices....I know this) and then the real money buyers who have real capital to put to work are going to balk at the new, higher levels.  There's already too much uncertainty around the new housing plan, potential bankruptcy or modification cramdown risk, and another other rule changes the government  might execute at a moments notice.  Real capital will bid a bond to get double digit returns in a severe bad case scenario to account for this risk and uncertainty that they cannot control.  If that return goes to zero or negative in that severe bad case scenario because the bonds got bid up too high, they will walk away and we will be left with just the leveraged players who require tremendous amounts of government balance sheet and risk allocation, not to mention man-power and expertise that the government does not have.  We will only get a clearer picture of where we really stand after we start liquidating assets to real money accounts.

I've also been hearing certain congressmen and women from "The Heartland" crowing how their little banks are just fine...they don't need the government.  It's just the big New York banks that got themselves into trouble.  Really?  Have your banks done a lot of commercial real estate lending?  Sure they have.  I've been hearing from good sources that the last couple of years, medium to small size lenders have been throwing money into all kinds of local commercial real estate ventures.  And when they ran out of local lending they branched out into not so local ventures.  I've also been told that the underwriting standards on these loans were about as good as they were the last time they went on a commercial real estate lending binge....the S&L crisis of the 1980's.  A few months ago, Bloomberg published an article saying that the FDIC needed at least $150 billion of new funds to handle the oncoming failures.  And this was BEFORE they raised deposit insurance from $100,000 to $250,000.  At the time (late September) Bloomberg was essentially accused of treason for publishing this.  Now?  You notice that among all the monster headlines you seem to see a few "small" banks going toes up every week?  Unfortunately this will be a flood in the near future.  We can stick our heads in the sand all we want but "The Heartland" is going to need as much money as the big boys are going to need.  You heard it here second!

So call it whatever you want, Nationalization, Short-term nationalization, Recapitalization, Socialization...etc.  Many banks are going to go bye bye and the survivors are going need massive amounts of capital to operate effectively.  None of that is good news for common shareholders for banks.

The last couple of days I have been watching this insane play on words that has taken place between The Fed, Congress, The President, bank executives and investors.  "Will the U.S. Government nationalize the banking system?"  Somehow a picture was painted that the government was going to take control of the banking system and somehow run the entire thing from Washington D.C.  Our government has proved beyond a shadow of doubt that it is entirely incapable of running itself, let alone the banking system!  This idiotic spectacle has taken away from the main debate and problem.  What are we going to do with our LARGELY INSOLVENT BANKING SYSTEM?  The time our "leaders" spend jerking around with nuance, is time they need to focus like a laser on;

•  How do we pick the living from the dead? 
•  How do we strengthen the living?
•  How do we dispose of the dead? 

I appreciate that the government is going to run stress tests to determine who is well capitalized and who is not.  However, until we resolve the issue of how to move the $1 trillion or so toxic assets from bank books, the health of our major banks is shrouded in doubt....or worse.  Where is this freaking plan?  Customers with real capital are standing by waiting to purchase assets.  Treasury seems to be fixed on a misguided notion that creating another funding program like the TALF is going to juice up bids on these assets and save the bank's precious capital.  I call this misguided because I have seen this before when I worked at a bank that was trying to dispose of the very same assets we are talking about here.  We were specifically and correctly told;

"We are not interested in moving these assets to hedge funds who need financing to purchase the assets.  If we do that, all we are doing is changing troubled asset risk for hedge fund counterparty risk.  It does not reduce the balance sheet enough and if the asset prices deteriorate further, we may ended up having to take the assets back.  We would rather sell a bond to a "real money" investor at 65-00 than a hedge fund at 70-00.

Additionally, if the government starts handing out cheap term financing to any Tom, Dick or Harry hedge fund, we will sell the first 10% of the assets in question at better than current market prices (and there are market prices....I know this) and then the real money buyers who have real capital to put to work are going to balk at the new, higher levels.  There's already too much uncertainty around the new housing plan, potential bankruptcy or modification cramdown risk, and another other rule changes the government  might execute at a moments notice.  Real capital will bid a bond to get double digit returns in a severe bad case scenario to account for this risk and uncertainty that they cannot control.  If that return goes to zero or negative in that severe bad case scenario because the bonds got bid up too high, they will walk away and we will be left with just the leveraged players who require tremendous amounts of government balance sheet and risk allocation, not to mention man-power and expertise that the government does not have.  We will only get a clearer picture of where we really stand after we start liquidating assets to real money accounts.

I've also been hearing certain congressmen and women from "The Heartland" crowing how their little banks are just fine...they don't need the government.  It's just the big New York banks that got themselves into trouble.  Really?  Have your banks done a lot of commercial real estate lending?  Sure they have.  I've been hearing from good sources that the last couple of years, medium to small size lenders have been throwing money into all kinds of local commercial real estate ventures.  And when they ran out of local lending they branched out into not so local ventures.  I've also been told that the underwriting standards on these loans were about as good as they were the last time they went on a commercial real estate lending binge....the S&L crisis of the 1980's.  A few months ago, Bloomberg published an article saying that the FDIC needed at least $150 billion of new funds to handle the oncoming failures.  And this was BEFORE they raised deposit insurance from $100,000 to $250,000.  At the time (late September) Bloomberg was essentially accused of treason for publishing this.  Now?  You notice that among all the monster headlines you seem to see a few "small" banks going toes up every week?  Unfortunately this will be a flood in the near future.  We can stick our heads in the sand all we want but "The Heartland" is going to need as much money as the big boys are going to need.  You heard it here second!

So call it whatever you want, Nationalization, Short-term nationalization, Recapitalization, Socialization...etc.  Many banks are going to go bye bye and the survivors are going need massive amounts of capital to operate effectively.  None of that is good news for common shareholders for banks.

Timmy Blows a Gasket!

Wow.  It has been written in the Wall Street Journal today Geithner Vents at Regulators as Overhaul Stumbles.  that Treasury Secretary Tim Geithner blew up at his chief regulators last week in a;

expletive-laced critique last Friday as frustration grows over the Obama administration's faltering plan to overhaul U.S. financial regulation, according to people familiar with the meeting. 

About time he blew up at something.  This whole regulatory overhaul issue really pisses me off.  First of all, I love how it seems every answer to improving financial regulation is to give more authority to the Fed.  Just what exactly did the Fed do this decade, officially or unofficially, to safeguard the system?  Zilch. Nada. Nichts.  Absolutely nothing.  

Geithner, the former President of the New York Fed from 2003, sat there and watched about $1 trillion of asset backed commercial paper , paper backed by AAA rated MBS and CDOs, get created and never asked where $1 trillion of this crap came from.  

Greenspan, and Bernanke?  They sat in the catbird seat and never seemed to question just how the hell savings rates could go negative, incomes could stay relatively flat and somehow the American consumer could keep buying piles of crap every year.

These ass clowns can say all they want but the bottom line is that all the rest of the regulatory agencies take their cue from the Fed and the cue was to not rock the boat.

Anyway, I continue to believe that we do not need a year long power, ass-grabbing, turf battle to give us better financial regulation.  What we need is regulation, free from Congressional and White House meddling, by folks who actually "know stuff".  We need to stop recycling the same 100 or so people that have seemed to get all the top posts for the past two decades.  They, for the most part, have proven that they either lack the knowledge or courage to intelligently regulate their jurisdictions.  And sprinkling in some "new blood" in the form of a few "financial professionals" that managed to run their institutions into the ground the last few years isn't the answer either.  

You want my regulatory framework?  Here's something I wrote in March.  We need about ten to fifteen guys and gals to float about, ask questions to whoever they please and then direct the various regulatory bodies to deal with any "issues".  I call them "Common Sense Czars";

One of the many things going on in Washington is financial system regulatory reform.  I have a suggestion that I have brought up before on this blog.  How about a guy like Paul Volcker or Henry Kaufman gets nominated as the "Common Sense Czar"?  I used to read about how Henry Kaufman used to walk the floors of Salomon Brothers, poking his head in to different trading desks and saying things like, "Hi,I see you guys are up a lot so far this year.  Are those gains realized, or are we still holding risk?  Who's buying the bonds you're selling?  Who are we buying our hedges from?"  Mr. Kaufman was like the "Czar of Common Sense."  He would collect a bunch of this information and figure out if the firm was over-exposed to anything.

Think about how a Common Sense Czar would have approached our current crisis BEFORE it fully developed.  Let's use the year 2006.  If we snuffed out the growing disaster then, we still would have had a disaster, but not life threatening.  Anyway, lets fantasize!

1. First the Czar visits the folks making tons of money "guaranteeing things".  Guys like AIG and Ambac and MBIA and asks the question, "Hi, how are you making your money?"  They would say, "We have this great business where we get paid to use our AAA rating to guarantee bonds that ARE ALREADY RATED AAA!  In fact sometimes we guarantee bonds by writing credit default swaps against bonds that ALREADY have another AAA rated company guaranteeing them!  It's like taking candy from babies!"  The Czar of Common sense does some quick math versus those firm's capital positions and says, "Wow, I guess as long as you don't take a 10-15% loss against this portfolio you don't die.  Still, if the losses ever become significant won't you get downgraded?  If you lose your AAA don't you lose your franchise?"  The guarantors say, "?". 
2. The Common Sense Czar then goes to Freddie and Fannie and asks them, "Hi, how are you making your money?" Freddie and Fannie say that they are a combined mortgage insurance shop and leveraged mortgage investment portfolio.  For the insurance they have private mortgage insurers to mitigate risk (especially the sub prime credit they have guaranteed) and with regard to investments they are in a AAA position on the dodgy credits so they are more than fine too.  The Common Sense Czar does some quick math on Freddie and Fannie's combined $3.5 trillion guarantor book and $1.5 trillion retained portfolio  and says, "Wow, if you take a 2% loss on your mortgage insurance portfolio you lose $70 billion?  You have that kind of capital?"  Freddie and Fannie pick up the phone and call Barney Frank and Chris Dodd!
3. Now the Common Sense Czar has similar calls with the private mortgage insurers and they essentially say the same thing that Freddie, Fannie, AIG, MBIA, Ambac, etc have said.  The Czar of Common Sense does the same quick calculations and arrives at similar conclusions, a small percentage loss on a BIG number wipes these guys out too.
4. The Czar of Common Sense pauses and says, "Man, all these guys with pretty thin levels of capital are relying that these mortgage bonds can't lose money because the ratings companies rated them AAA or AA- at worst.  I need to go visit those guys but before I do that I am going to drop in on Bear Stearns and Lehman Brothers since they are the two biggest underwriters of these bonds.
5. The Czar goes to Bear and Lehman and says, "Hi, how are you making your money?"  The two investment banks tell the Czar that they make their real money from originating their OWN dodgy loans, structuring them and selling them to a variety of investors for a much higher price.  The Czar asks, "How is this possible?"  Bear and Lehman say that through the magic of diversification, they are able to create a very large percentage of AAA bonds that sell for a much higher price than the subprime loans backing them would.  The Czar says, "Hmm, that is interesting.  It all seems to come back to these rating companies.  Oh, by the way, do you guys ever get stuck holding some of these bonds?"  Bear and Lehman say, "Well, we certainly wouldn't call it 'getting stuck'!  But yes, we each have about $50 billion laying around earning us GREAT carry."  The Czar says, "Wow!  How do you guys finance that?  After all, you aren't banks so you don't have retail deposits."  Bear and Lehman tell the Czar, "Oh contraire, we have hedge fund prime brokerage cash.  That money is stickier than the best mom & pop retail deposits.  Besides that, our commercial paper programs are over-subscribed every month!  The last thing we are worried about is funding! The Czar says, "Commerical Paper?  You guys issue CP backed by this stuff?"  "Oh sure, but we don't do THAT much.  You should go talk to Citigroup.  They are doing hundreds of billions, UBS too!"  The Czar makes a note to ask New York Fed President Tim Geithner about this.  Surely he is on top of it.
6. Now the Czar takes a trip out to California to see the subprime giants Ameriquest and New Century.  The Czar says, "Hi, how are you making your money?"  The subprime guys say, "We have thousands and thousands of loan brokers prowling the countryside making the loans that give folks a chance to have things they never had AND make loans that the boys at the Wall Street shops say they need.  We get paid a premium for the loans and we make a lot of fees." The Czar says, "The subprime sector used to be pretty small.  Now suddenly it is very big.  How did that happen?"  The subprime originators say "?".  The Czar asks for a sample of the loans and sees they look pretty horrible.  He then asks the subprime originators, "By the way, what happens if these loans go bad early on.  Don't you guys have to buy them back?  How much capital do you have?"  The subprime guys say, "Oh we have some capital, but not to worry because if guys default we just sell the property and no one takes a loss.  After all, real estate only goes up!"  The Czar says, "Well yeah, but lets just pretend real estate goes down and a lot of these borrowers, especially the ones who are speculators shrug their shoulders and default.  Wouldn't you have to buy all these bad loans back at par?  Do you have enough capital to do that?  Oh, and who regulates you guys?"  The subprime originators answer those two questions by saying, "?" and "?".
7. Now the Czar is a little worried.  It seems like the entire financial system is betting that somehow these loans were magically transfigured from garbage to riskless assets.  It's time to visit S&P and Moody's.  The Czar says, "Hi, how do you make your money?"  The ratings companies say, "Oh, we make lots of money rating all these structured securities.  We are having record earnings every year!"  The Czar says, "Who pays you?"  The ratings companies say, "Why, the issuers of course!"  The Czar is now pale.  He gulps a drink of water and says, "How is it possible to take $1 billion of subprime loans and create $800 million AAA rated bonds?"  The ratings companies say, "Well, diversification of course.  All real estate is local and all economies are local. Real estate prices can never go down NATIONALLY at the same time as we are having a recession and folks are losing their jobs.  Anyway, even if we do have a recession, economies are local and diversified too.  And even if they are not, if we have a recession and the dollar falls, the Arabs, Europeans and Asians will just come in and support real estate prices.  It's all covered see?"
8. The Czar call the President and says, "Houston....we have a problem!"

Federal Reserve Gets Slammed by "Low Latency Trading"!!

There has been tremendous focus on program or "high latency trading" as of late.  This type of trading takes place in the equity markets.  The definition of latency is the amount of time a package of data takes to move across a network from one computer to another.  Major Wall Street firms and hedge funds who deploy high latency trading programs are accused by many of using their super fast computers and algorithms to figure out what large trade orders are coming and get in front of those trades milliseconds before they are made and scalp a penny or two.  Done a few trillion times and you are talking about some real money!

The focus this morning however, is something one of our favorite readers describes as "Low Latency Trading."  Since we are making this term up, here is our definition;

"Low Latency Trading occurs when a gigantic counterparty announces to the known capitalist world that it will be a size buyer of a certain mortgage backed security or Treasury note.  The low latency trader will normally announce his intentions days in advance, allowing time for dealers, hedge funds and money managers to "set up" for the low latency traders order, thus allowing for large profits at the low latency trader's expense."

Check this out from the Financial Times Wall Street Profits From Fed Role

Wall Street banks are reaping outsized profits by trading with the Federal Reserve, raising questions about whether the central bank is driving hard enough bargains in its dealings with private sector counterparties, officials and industry executives say.

The Fed has emerged as one of Wall Street’s biggest customers during the financial crisis, buying massive amounts of securities to help stabilise the markets. In some cases, such as the market for mortgage-backed securities, the Fed buys more bonds than any other party.

However, the Fed is not a typical market player. In the interests of transparency, it often announces its intention to buy particular securities in advance. A former Fed official said this strategy enables banks to sell these securities to the Fed at an inflated price.

The resulting profits represent a relatively hidden form of support for banks, and Wall Street has geared up to take advantage.Barclays, for example, e-mails clients with news on the Fed’s balance sheet, detailing the share of the market in particular securities held by the Fed.

“You can make big money trading with the government,” said an executive at one leading investment management firm. “The government is a huge buyer and seller and Wall Street has all the pricing power.”

A former official of the US Treasury and the Fed said the situation had reached the point that “everyone games them. Their transparency hurts them. Everyone picks their pocket.”

Imagine that!  I spent a lot of my time on Wall Street in the agency mortgage backed securities market.  One of the most important things that I, along with my clients, traders and research departments would do would be to gage the supply and demand technicals of each particular Fannie Mae and Freddie Mac coupon.  For example, we would try to figure out how many 5% Fannie Mae MBS (FN 5%) would being made by originators, how many were currently in the hands of accounts who do not lend them out (Asian central banks as an example), what big accounts, who normally lend out huge amounts of FN5%, might suddenly not re-lend all or a portion of the bonds, etc.  This covered the supply part of the technicals. Essentially, you were trying to find MBS that might get "squeezed". Then on the demand side, we would try to figure out who wanted or needed these FN5%'s.  If you got your technicals right there were all kinds of ways to trade and make money. However, it is important to note that all of this was educated guesswork. You could guess wrong and lose.

Now however, we have the Fed as the largest buyer of mortgage backed securities.  Not only do we know that the Fed is a buyer (long only), but they are telling the dealer community what they want to buy in advance.  Because the Fed does not lend those securities back out and because they are not selling the securities anytime soon, even if dealers weren't front running, the price of what the Fed wants to buy will spike ahead of their purchase.  However, because the Fed's program is designed around keeping keeping primary mortgage rates below 5%, it's pretty easy to figure out when the Fed is going to be a buyer and what coupons they can buy.  It's like shooting fish in a barrel.  Check out this quote from Barney Frank (also from the FT);

Barney Frank, chairman of the House financial services committee, said the potential profiteering may be part of the price for stabilising the financial system. “You can’t rescue the credit system without benefiting some of the people in it.” Still, Mr Frank said Congress would be watching. “We don’t want the Fed to drive the hardest possible bargain, but we don’t want them to get ripped off.”

Crystal clear Barney!  We told you back in December Will Anybody at Treasury of The Fed EVER Learn How the Secondary Mortgage Market Works? last year that the Fed might easily lose more money on these programs than the country makes through artificially low mortgage rates. Between the MBS and Treasury notes and bonds they have bought, un hedged, the Fed probably has duration exposure of about $500,000,000 per basis point (one-hundredth of one percent)! That's a lot of risk no?  Add to that irresistible front running/guessing on the part of dealers and it seems like another moronic program that puts our central bank at huge risk (which isn't a good thing when the credibility of a central bank is supposed to be unquestioned) and transfers more money from taxpayer pockets to major Wall Street banks.

You Really Really Can't Make This Sh*t Up!

They really must want to see how much they can push the envelope before we have riots in the streets!  From Bloomberg News Fed Intends to Hire Lobbyist In Campaign to Buttress Its Image.

The Federal Reserve intends to hire a veteran lobbyist as it seeks to counter skepticism in Congress about the central bank’s growing power over the U.S. financial system, people familiar with the matter said.

Linda Robertson currently handles government, community and public affairs at Johns Hopkins University in Baltimore, and headed the Washington lobbying office of Enron Corp., the energy trading company that collapsed in 2002 after an accounting scandal. She was also an adviser to all three of the Clinton administration’s Treasury secretaries.

Robertson would help the Fed manage relations with lawmakers seeking greater oversight of a central bank that has used emergency powers to prevent Wall Street’s demise. While she wasn’t tied to Enron’s fraud, her association with the firm may raise questions, analysts said.

“Some members of Congress think there are votes in attacking the Fed” after it “unnecessarily and unwisely entangled monetary policy with fiscal policy,” said former St. Louis Fed President William Poole. “The Fed is going to have a tricky time of unwinding what has been done” and will need to “keep in touch with members of Congress more thoroughly,” said Poole, now senior fellow with the Cato Institute in Washington.

Robertson served under Treasury Secretaries Lawrence Summers, Robert Rubin and Lloyd Bentsen. She didn’t return calls seeking comment.

Enron!!  Well at least she didn't work for Goldman Sachs.  However she worked for Summers and Rubin so...yeah, she kind of worked there too!  Oh, and if you aren't mad enough....they were considering her for a senior Treasury post but the Adminstration stopped it because she's a lobbyist.

I feel like I'm living in a banana republic.....with no bananas!!

Apparently Mayor Bloomberg Didn't Get the Memo Either

"Yeah, listen ummm, we're gonna do a little photo-op okay?  Right, were gonna fly a jumbo jet straight at lower Manhattan with an F-16 in hot pursuit okay?  We're gonna do it say....10'ish....What's that?  It's already 11:30 and we did it?  Ooops, our bad."

All that's missing from this picture so far is President Obama doing his own version of, "Your'e doing a heck of a job Brownie." to someone in his Defense Department and FAA.  Here is Mayor Bloomberg. Really starting to wish he ran in 2008.