Fin/Inv

Doug Kass penned a column for TheStreet.com on Wednesday titled "The Earnings Season Racket." Kass argues that the earnings "beat" rate is so high this quarter because of lowered estimates, and that "companies almost always beat earnings forecasts even during rough economic periods." Below is a portion of his column: While it has been widely advertised by chest-thumping bulls in...

Still amazes me how little attention the Leading Economic Index from the Conference Board gets from the market. The Conference Board reported a September number with a 1% increase and a 5.7% 6 month growth rate. This forecasts huge growth in Q4 and Q1 but oddly the head of the Conference Board stills tells a cautious tale. With a 6 month rate at the highest since 1983, its difficult to see any

An apropos name
American United
We are all failed now.
by Soylent Green is People
From the FDIC:

American United Bank, Lawrenceville, Georgia, was closed today by the Georgia Department of Banking & Finance, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. ...

As of August 11, 2009, American United Bank had total assets of $111 million and total deposits of approximately $101 million. ...

The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $44 million. ... American United Bank is the 101st FDIC-insured institution to fail in the Nation this year, and the twentieth in Georgia. The last FDIC-insured institution closed in the state was Georgian Bank, Atlanta, on September 25, 2009.

The banks are small, but the loss ratios are high! Two down already ...

Special Wells Fargo Report on Gold

 

Attachment	Size
When Will Inflation Really Hit Us.pdf	21.79 KB

Yet another bank with more than 40% loss taken by the FDIC:

As of September 30, 2009, Partners Bank had total assets of $65.5 million.

....

The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $28.6 million.

Again, we see that the FDIC refused to step in and close this institution when the firm's Tier Capital Ratio (based on an actual market value for assets) went below 6%, 5%, 4%, 3%, 2%, 1% and flat.

Indeed, the FDIC not only allowed all of the firm's Tier Capital (that is, their EXCESS CAPITAL) to be wiped out, but then allowed the bank to continue to operate until it's asset base was destroyed to the tune of 43% of "face value" before stepping in and closing the institution.

Prompt Corrective Action - a LAW, not a suggestion - is supposed to prevent this outcome.  It is being wantonly and willfully ignored by the OTS, OCC, The FDIC and CONGRESS.

This level of loss is unconscionable and Sheila Bair, along with everyone involved in bank regulation at The Fed and the various Treasury departments (OTS, OCC and FDIC) must be held to account for their willful and intentional blindness.

"Mark to Myth" is not just a myth, it is a willful and intentional lie.

Again I ask:

What is the actual value of assets in our nation's banks - including the really big ones like Bank of America, Citibank, JP Morgan and Wells Fargo?

How can anyone possibly believe, given the overwhelming history of the last two years in this crisis, that the nation's banks are claiming and carrying their assets at anything close to their actual value when we continue to see, week after week, losses to the deposit insurance fund proving that close to half of the claimed "asset value" in these seized banks is a pure, unadulterated fiction?

Partners Bank in Naples, Florida is the 100th caller!

One Hundred, so far....
The pig still in the python
Working its way through.
by Soylent Green is People
FDIC Press Release:

Partners Bank, Naples, Florida, was closed today by the Office of Thrift Supervision, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. ...

As of September 30, 2009, Partners Bank had total assets of $65.5 million and total deposits of approximately $64.9 million. ...

The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $28.6 million. ... Partners Bank is the 100th FDIC-insured institution to fail in the Nation this year, and the seventh in Florida. The last FDIC-insured institution closed in the state was Community National Bank of Sarasota County, Venice, on August 7, 2009.

Just a minnow, but it counts.

Wie das Office for National Statistics heute in London mitteilte, fiel auch im 3. Quartal 2009 das Bruttoinlandprodukt in Großbritannien, um -0,4% zum Vorquartal (-0,6% in Q2), dass sechste Quartal in Folge! Dies ist die längste Schrumpfung seit Beginn der Datenerhebung im Jahr 1955. Erwartet wurde von Analysten und Ökonomen ein Wachstum von +0,2% zum Vorquartal.

> Im Vergleich zum Vorjahresmonat fiel das BIP um -5,2% (-5,5% in Q2 2009). <

Der BIP-Beitrag der Bauwirtschaft sank um -1,1% zum Vorquartal, die Industrieproduktion schrumpfte um -0,7% und der Beitrag des Dienstleistungssektors sank um -0,2%.

Im Vergleich zum Hoch in Q1 2008 schrumpfte die Bauwirtschaft um -14,7%, die Industrieproduktion sank zu Q4 2007 um kräftige -13,7% und der Dienstleistungssektor schrumpfte um -4,5% seit dem Hoch in Q2 2008.

Zum Hoch im 1. Quartal 2008 schrumpfte das gesamte UK-BIP bis zum 3. Quartal 2009 um -6,0%.

Trotz den niedrigsten Leitzinsen der Bank of England seit 1694, mit nur 0,5% und den aggressiven geldpolitischen Maßnahmen, der britischen Version von Quantitative Easing, tendiert der realwirtschaftliche positive Effekt daraus gegen Null! Dies ist eine Bankrotterklärung der Wirtschafts- und Finanzpolitik im Königreich.

Die Banken in Großbritannien haben sich besonders viel Kreditschrott aufgeladen. So z.B. die Lloyds Bank Group Plc, diese gibt ihre potentiell toxischen Vermögenswerte mit 260 Mrd. britischen Pfund an und verhandelt mit dem Finanzministerium über die Details eines weiteren möglichen Asset- Protection Program. Der Staat hält bereits 43% der Anteile an der Lloyds Bank. Die umfangreichen Stützungen des britischen Bankensystems lässt die Neuverschuldung des Staates explodieren. An der Royal Bank of Scotland und Lloyds, welche HBOS übernahm, flossen direkt 37 Mrd. Pfund durch Staatsbeteiligungen, weitere 200 Mrd. GBP flossen in Form von Liquiditätshilfen und insgesamt sagte die Regierung zu, für 585 Mrd. GBP an toxischen Vermögenswerte zu garantieren.

Im Fiskaljahr 2008/09, welches am 31. März 2009 endete, stieg die Neuverschuldung um 101,3 Mrd. GBP bzw. 7,1% des BIPs, nach 38,3 Mrd. GBP (2,1% des BIPs) im Fiskaljahr 2007/08! Für das Fiskaljahr 2009/10 bis Ende März 2010 geht das britische Finanzministerium von einer Neuverschuldung in Höhe von 175 Mrd. GBP bzw. 12,4% des BIPs aus!

Reloaded: "UK-Immobilienblase Reloaded", "UK-eine Bubbleökonomie", "Keine Green Shoots in UK", "UK - die höchsten Arbeitslosenzahlen seit 1996", "UK-BIP schmiert ab", "UK Arbeitslosigkeit explodiert", "UK-Häuserverkäufe fallen auf ein 30-Jahrestief", "UK Immobilien und Schuldenblase platzt", "Rekorddefizit in UK" (März 2007)


Quelle: PDF Statistics.gov.uk

Kontakt: info.querschuss@yahoo.de

Vice Chairman Donald L. Kohn

At the Federal Reserve Bank of Boston 54th Economic Conference, Chatham, Massachusetts
October 23, 2009

International Perspective on the Crisis and Response

I am pleased to participate in the conference discussion of the international dimensions of the recent financial crisis.¹ A striking feature of the crisis was its global character. With markets for financial assets increasingly integrated, often by the activities of globally active banks, no country escaped completely unaffected.

The way the problems in the U.S. subprime mortgage market spread illustrated the interconnections. Underwriting standards for U.S. subprime mortgages had weakened at the same time that non-U.S. investors, including many non-U.S. financial institutions, had eagerly invested in the subprime mortgage market by purchasing subprime-backed securities. When house prices leveled out and then began to decline, default rates on subprime mortgages started to rise rapidly. Both U.S. and foreign banks suffered losses, along with other investors.

Many of those losses affected asset-backed commercial paper (ABCP) conduits and similar structures that had invested in subprime-backed securities. Many of these conduits were sponsored by non-U.S. entities. The conduits had funded illiquid long-term assets with short-term liabilities, creating a substantial maturity mismatch. When a few of these conduits began to report subprime-related losses, investors ran from many conduits. The flight was broadly based because investors were uncertain about the incidence of losses and liquidity pressures arising from nontransparent and poorly understood exposures.

Integrated bank funding markets were an important source of contagion. Short-term funding markets in both the United States and Europe were disrupted when conduits drew on bank lines of credit to replace maturing ABCP, and banks turned to dollar-denominated money markets to raise the needed funds. As the financial crisis deepened, banks hoarded liquidity and became concerned about the exposure of their counterparties in the interbank market to losses from subprime mortgages. Spreads between the London interbank offered rate and the overnight index swap rate, a measure of interbank market stress, widened in dollars, euro, sterling, and other currencies.

To be sure, the mispricing of assets and risks was not confined to the U.S. subprime mortgage market. Many credit risk spreads across the globe were at historic lows in the period before the crisis, after several decades of mostly mild, infrequent recessions in the industrial economies. The broad incidence of narrow spreads in part reflected the activities of investors and intermediaries who were facing the same perceived incentives in many different markets. And asset prices–especially real estate prices–were unsustainably high in a number of countries.

Liquidity risk had also been mispriced. Investors had paid insufficient attention to the maturity mismatch present in a number of investment vehicles, including ABCP conduits and money funds. And both investors and intermediaries had assumed that the exceptionally liquid conditions in many markets of the pre-crisis period were a permanent part of the financial landscape. Again, with hindsight, we can see that these vehicles were vulnerable to runs once the crisis hit, and these runs did not stop at national borders.

Moreover, even countries where assets weren’t obviously mispriced felt the effects of the growing dislocations when global banks were forced to deleverage and conserve liquidity. Their pullback from lending was broad-based and eventually affected many emerging market economies. And the adverse feedback loop between world financial markets and the real economy was exacerbated by the greater global integration of markets for goods and services. Trade and industrial output plunged everywhere as consumers and businesses pulled back from spending.

Notably, although financial institutions in some countries seemed to be more resilient to the growing turmoil than in other countries, all were affected to a degree, and no particular type of regulatory or supervisory system proved itself clearly superior to other designs–either in the buildup or the crisis-response phase. Problems afflicted both the fragmented system of the United States and the unified systems of other countries. They cropped up where the central bank was deeply involved in regulation and where it played only a consultative role. And it occurred both in systems that were principles-based and those that had thick rule books. Clearly, the deficiencies in both private behavior and public oversight were widespread, and both needed to be addressed.

The Response to the Crisis Was Global
Given the global factors that helped spread the crisis, the response to the crisis needed to be global as well. And many of the responses were indeed global–or at least were quite similar across various jurisdictions. Everyone was reacting to the same types of problems, but the similarities also reflected a high degree of global consultation and collaboration.

We can see this in the actions of many central banks. Beginning in late 2007, central banks generally reacted to funding problems and incipient runs with similar expansions of their liquidity facilities. They lengthened lending maturities, in many cases broadened acceptable collateral, and in several instances initiated new auction techniques for distributing liquidity to overcome the inertia from stigma. Central banks were in constant contact through this period, although they arrived at many of these actions separately.

However, we did explicitly coordinate to address problems in dollar funding markets. The Federal Reserve entered into foreign exchange swaps with a number of other central banks to make dollar funding available to foreign banks in their own countries. By doing so, we reduced the pressure on dollar funding markets here at home.

Governments also reacted similarly when in late 2008 the turmoil deepened and many countries saw a need to provide broad support to their banking systems. The rescue plans in different countries contain similar elements: expanded deposit insurance, guarantees on nondeposit liabilities, and capital injections. Although most countries wound up in a similar place, the process was not well coordinated, with action by one country sometimes forcing responses by others.

Many countries also took measures to deal with financial distress at systemically important firms. Efforts in this area were much messier. The failure of Lehman Brothers highlighted the lack of a framework that would allow for the orderly resolution of a systemically important nonbank financial institution in the United States. Even where formal crisis-management frameworks existed, such as within the European Union, they were not always used in the heat of the crisis. The reality is that the resolution of failing firms is still a national responsibility, even for institutions that operate globally.

Early on in the crisis, authorities recognized that addressing the deficiencies made apparent by the crisis required an international effort. Many of those deficiencies–for example, in bank capital and liquidity requirements and in accounting systems–were embodied in internationally agreed regulations, standards, and codes of conduct. Addressing them would require working through global bodies of national and international standard setters and they would require broad agreement among national authorities. The Financial Stability Forum (now renamed the Financial Stability Board) brought central banks, regulators, and finance ministries together to identify the problems, suggest avenues for addressing those problems, and push for timely solutions.

What Remains to Be Done?
The process of addressing the problems is still at an early stage. Now that the crisis seems to be abating, we can better identify the causes of the crisis and work on finding the best solutions. Deficiencies must be fixed on a global basis to forestall gaps and regulatory arbitrage that could undermine the effectiveness of regulation. And countries need to have confidence that others are implementing tighter standards in a consistent way. But at the same time, regulations must be passed and implemented nationally. On one level, this type of action is simply what is required under existing legal structures. On another level, it reflects the reality that taxpayers in individual countries end up bearing much of the cost when home-country institutions need to be stabilized. I’ll highlight four of the many areas that require international coordination.

First, we need to identify the global risks that can affect local banks. One obvious issue is cross-border exposures, especially when banks in many countries have similar exposures. On a global level, international groups like the Financial Stability Board have an important role to play in looking for these kinds of vulnerabilities. For individual banks that operate across borders, supervisory colleges bring the key supervisors together and can improve the flow of information. These groups can also help raise supervisors’ awareness of the risks that occur when the business plans of local banks evolve and shift to take on more global exposures.

Of course, we shouldn’t expect too much from these exercises. In identifying risks, false positives will be common, and some mispricing of assets is inevitable as people attempt to evaluate the implications of broad economic trends and innovations. But looking in a focused way across markets and institutions may help to identify areas where greater supervisory attention could result in a more resilient system.

A second area that is likely to involve international collaboration is the development of a more macroprudential approach to supervision and regulation. One aspect of such an approach is higher standards for systemically important institutions; another is supervisory and regulatory measures to offset procyclical tendencies of the financial sector. Formulating higher standards for systemically important, globally active institutions will require international coordination to avoid uneven playing fields. And, offsetting procyclical tendencies presents a difficult question: Should authorities aim at damping such tendencies at a global level or at the level of an individual country? If only global risks are addressed, vulnerabilities will persist at the local level; however efforts to address local problems could disadvantage domestic banks relative to those headquartered abroad.

Third, we need to improve our ability to resolve systemically important institutions without generating spillovers that spread systemic risk across firms or across borders. Clearly, each country should have the legal authority to wind down a systemically important institution in an orderly way, taking account of the international dimensions. Beyond this, there is not yet a consensus on exactly what to do, but a range of promising proposals have been suggested to facilitate orderly resolutions. One is for supervisors to press firms to strengthen their ability to quickly provide the information on exposures, funding, and counterparties that would be needed for crisis management. Another would have supervisors recommend changes to simplify the organizational structures of systemically important firms to make it easier to deal with their failure. A related proposal would require firms to maintain a so-called living will, a written contingency plan that provides for an orderly wind-down should severe financial distress lead to failure.

Fourth, we need to address home-host issues that arise in the supervision of cross-border firms. For example, some global banks can expose a host country to a withdrawal of risk-taking caused by problems outside its own borders. This exposure understandably makes host countries uncomfortable with the traditional division of responsibility that restricts a host-country to supervising only the activity of a global bank within its own country. One possible response here would be more information sharing from home to host, to better enable host countries to protect themselves. Another response would be restrictions by host countries on cross-border operations of global banks, perhaps going so far as requiring global banks to operate through separately capitalized subsidiaries. However, this requirement, in addition to imposing costs on the banks, might also impede the ability of the global financial system to channel capital to where it is most likely to enhance productivity and growth.

Conclusion
I’ve touched on only a few of the international aspects of the crisis. We face a difficult set of decisions regarding how best to reform our national regulatory and supervisory frameworks in response to the lessons we have learned. But perhaps chief among the lessons learned from the past two years is that in an integrated global financial system we cannot make those decisions in isolation; we must collaborate internationally if we are to build a more resilient financial system for the future.

---

Footnotes

1. Michael Gibson of the Board’s staff contributed to these remarks. The views expressed are my own and not necessarily those of other members of the Board of Governors. Return to text

Return to top

Bank of America is really unable to catch a break. The latest kick in the groin comes courtesy of the Chairman of the House Oversight Committee Edolphus Towns, who has announced he will launch a subpoena into whether Countrywide gave "favored terms to lawmakers and other VIPs." Concurrently, a panel is evaluating predatory lending practices at a variety of different banks. Some of the firms that will be told to provide information include Wells Fargo, JP Morgan, Citigroup, US Bank and GMAC.

In a letter dated October 23 to the banks, Towns asked for data on VIP-type programs, foreclosures, marketing strategies, and potential anti-trust behavior.

The letter asks for information on whether attempts were made by lenders to identify whether loan applicants had regulatory authority over them. It also asks for details on the types of mortgages offered and sold. Also, it asks whether the companies helped draft legislation or regulatory language to propose to federal or state officials.

"The actions of mortgage lenders contributing to the foreclosure and financial crisis are of serious concern to many Americans and to the members of this committee," Towns said.

Ironically, Towns himself may well have been the recipient of Angelo Mozilo's preferential generosity (if not Agent Orange-strength tanning lotion), after having received two loans from the lender. Previously it was rumored that certain politicians were stalling this inquiry for fear of what may be uncovered. Towns had previously "rebuffed calls by the top Republican on the panel, Darrell Issa, to demand documents from Countrywide."

The pending receipt of disclosure is the reason why yesterday's hearing with Bank Of America Directors and Mary Schapiro has been delayed indefinitely: a surprising development in light of all the information that is expected to be revealed.

For more perspectives on this matter read the following by Karl Denninger.

h/t Geoffrey Batt

I took profits on my short position late today; it was definitely one of those gut feel decisions that may or may not come back to haunt me. The stock indexes were weak today; there's no denying that. As we approached the Wednesday and Thursday lows, however, I noticed that we only had a little over 500 NYSE, NASDAQ, and ASE registering 20-day lows. That was about the same as Wednesday's level and below Thursday's.

In addition, as you can see from the Futures Heatmap from Barchart, intermarket themes were not providing as many bearish cues as I would have expected to see if we were going to sustain a break to new weekly lows. We didn't see unusual strength in the U.S. dollar, and we didn't see unusual commodity weakness--particularly from the metals.

In short, we were weak; just not outstandingly so. Discretion the better part of valor, I cashed in my chips.

When we get to the top or bottom of a distinct range, there's always a judgment call to be made for discretionary traders as to whether we trade for a breakout or fade for a move back into the range. And, sometimes, when the evidence is mixed, it's best to take the chips off the table and wait for a clear signal. Success doesn't require being involved in all market moves; it just requires that the market move your way when you do get involved.
.

Submitted by Terry Coxon of The Case Report

 

While we wait for the 100th bank failure of 2009 ...

Click on graph for larger image in new window.

From Doug Short of dshort.com (financial planner).

Note that the Great Depression crash is based on the DOW; the three others are for the S&P 500.

The S&P was off 1.2% today. The index is up about 60% from the bottom (and off 31% from the peak).

Two different views on CIT:

From Bloomberg: CIT Sees Recovery as Low as 6 Cents in Bankruptcy

CIT said in a regulatory filing today that if its reorganization plan fails, it “will likely face bankruptcy” and that those claims would fetch recoveries between 6 cents and 37 cents a dollar.

And from MarketWatch: Icahn urges bondholders not to accept CIT plan

Icahn said if assets on the comapny's balance sheet are "run off" in a controlled way, CIT bonds will be worth at least 80 cents to 85 cents on the dollar.

A few CRE stories:

Yesterday from the NY Times: Court Deals Blow to Owners of Apartment Complex

And more Tishman troubles, from Bloomberg: Tishman Speyer Office Park in L.A. Faces Foreclosure (ht Brian)

A Tishman Speyer Properties LP office park in California ... is the subject of a foreclosure lawsuit saying the owners failed to repay $154 million in debt due in July.

Tishman Speyer and Walton Street Capital LLC bought the Campus at Playa Vista at the top of the U.S. real estate boom in 2007. KeyBank National Association sued to foreclose against limited partnerships controlling the Los Angeles property ... The Los Angeles Business Journal reported Oct. 19 that a mortgage on the property was up for sale for $50 million.

If that LA Business Journal story is correct, the lenders were trying to sell the $150 million note for $50 million. Ouch.

And from Bloomberg: NYC Tower Buyers Wrestle Towering Vacancy Dilemma (ht Mike In Long Island, others!)

... Worldwide Plaza [is 40% vacant]. It’s one ... George Comfort & Sons Inc., was able to buy the ... in July for $590 million, two years after it sold for almost three times as much.

The purchase price may allow Duncan to undercut the rents competitors charge as he leases his 709,000 square feet. Manhattan has 59 million feet of available offices, according to brokerage Colliers ABR, the most since June 1996, and rents for the best space are down more than 30 percent from their peak last year.

Hier zunächst die Lagebeurteilung der deutschen Unternehmen, wie sie vom Ifo-Institut erfragt und heute veröffentlicht wurde: Ein Krebsen im kellertiefen Bereich und im Oktober kaum noch eine Verbesserung

When George first spotted this triangle on Friday, it was a neutral symmetrical triangle. But by the end of the day, it degraded, and is now looking more like a bearish descending triangle (click chart to enlarge):

The height of the triangle, the dotted linen between “A” and “B”, gives us the projection if the triangle breaks to the downside from this point. The blue line below the triangle is the same length as the dotted line, so “Target” is calculated as somewhere down in the 1050’s.

Ironically, that level is where another triangle formed on October 6th-7th.

Another wave up to the top line of the triangle might be a dream scenario for bears.

Today's market action has been essentially one-way wholesale selling of every dollar-denominated asset class (except allegedly Kindles, which are now accepted as Fed discount window collateral (until HR 1207 passes we won't really know), and are rumored to soon have a direct brokerage feed allowing readers to buy (but not sell) Amazon stock). Stocks and bonds (entire curve affected, not just the far end) are both getting pounded, with the VIX climbing almost 10%, as the dollar has been rising all day. Either this is another headfake, this time without a Dick Bove scapegoat, or a dollar renaissance could finally be in the making, with a subsequent drubbing of all dollar-denominated assets. Once again the question is does the world, in its ongoing duel against the US federal reserve, finally feel lucky?

Submitted by Credit Trader

The Buy-Write or covered-call strategy has become increasingly popular and I suspect is dramatically responsible for the "surprising" rally in stocks and compression in vol of the last month or so. The covered write (long underlying stock and selling in-the-money calls against it) supposedly allowing investors to benefit from the enhanced return offered by the option premium.

However, the synthetic equivalent of the position is a short put (think about the payoff profiles) and I wonder just how comfortable these home-gamers would be with the strategy of naked option writing. "Covered Call" just sounds so much better.

Anyway, the point is that while this strategy may be 'ok' for widows and orphans who will never be selling their stocks and are perpetual buy-and-holders. However, to most as the position is working out profitably, the cheap out-of-the-money put that is created will reach a point when it is not worth holding onto any longer (i.e. becomes very rich to the equivalent put or greek speed picks up). This is the point at which the position should be rolled to optimize the income enhancement process.

The issue is that just as during the 1980s and specifically the lead up to 1987, the covered-call creates more positions that need to be liquidated or require more hedging which helps to exaggerate or create selling pressure in any downturn.

The covered-call in fact offers limited protection in a severe sell-off as the hedge is in fact nothing like as linear as many would hope. The synthetic equivalent of the covered-call necessarily puts upward pressure on stock prices and downward pressure on vol - exactly what we have seen in the last few months and saw in 1987.

The charts attached show normalized vol and S&P for the 1987 period and same 2009 period. Look at the similarities! However, the moth of October has been very interesting, we have seen credit markets start to stall, the dollar tanking and TSY yields pick up and at the same time the S&P has burst higher as vol has dropped dramatically.

The regime since the March lows has been of credit leading equities (up and down) and the stalling of the credit rally recently while stocks push divergently higher (and vol lower) has been very conspicuous! A look at the vol term structure (VIX/VXV for a simple example) shows that short-dated vol (the most likely to be used for covered-writes) is exceptionally low (with the term structure steep).

We feel the possibility for a very much self-fulfilling drop in stocks and rise in vol is at hand and the last few days massively schizophrenic behavior is perhaps the first signal that cracks are appearing.

More companies are set to report earnings next week than this week, but the big names have already come and gone. There are a lot of second-tier reports to focus on next week, however, and below we provide a list of the names that investors will be following most. As shown, Corning (GLW) and Verizon (VZ) kick off the week...

Chairman Ben S. Bernanke

At the Federal Reserve Bank of Boston 54th Economic Conference, Chatham, Massachusetts
October 23, 2009

Financial Regulation and Supervision after the Crisis: The Role of the Federal Reserve

The theme of the Federal Reserve Bank of Boston’s Economic Conference this year–reevaluating regulatory, supervisory, and central banking policies in the wake of the crisis–is certainly timely. Not much more than a year ago, we and our international counterparts faced the most severe financial crisis since the Great Depression. Fortunately, forceful and coordinated policy actions averted a global financial collapse, and since then, aided by a range of government programs, financial conditions have improved considerably. However, even though we avoided the worst financial and economic outcomes, the fallout from the crisis has nonetheless been very severe, as reflected in the depth of the global recession and the deep declines in employment both here and abroad. With the financial turmoil abating, now is the time for policymakers to take action to reduce the probability and severity of any future crises.

Although the crisis was an extraordinarily complex event with multiple causes, weaknesses in the risk-management practices of many financial firms, together with insufficient buffers of capital and liquidity, were clearly an important factor. Unfortunately, regulators and supervisors did not identify and remedy many of those weaknesses in a timely way.¹ Accordingly, all financial regulators, including of course the Federal Reserve, must take a hard look at the experience of the past two years, correct identified shortcomings, and improve future performance.

Supervisors in the United States and abroad are now actively reviewing prudential standards and supervisory approaches to incorporate the lessons of the crisis. For our part, the Federal Reserve is participating in a range of joint efforts to ensure that large, systemically critical financial institutions hold more and higher-quality capital, improve their risk-management practices, have more robust liquidity management, employ compensation structures that provide appropriate performance and risk-taking incentives, and deal fairly with consumers. On the supervisory front, we are taking steps to strengthen oversight and enforcement, particularly at the firmwide level, and we are augmenting our traditional microprudential, or firm-specific, methods of oversight with a more macroprudential, or systemwide, approach that should help us better anticipate and mitigate broader threats to financial stability.

Although regulators can do a great deal on their own to improve financial regulation and oversight, the Congress also must act. We have seen numerous instances when weaknesses and gaps in the regulatory structure itself contributed to the crisis, many of which can only be addressed by statutory change. Notably, to promote financial stability and to address the extremely serious problem posed by firms perceived as “too big to fail,” legislative action is needed to create new mechanisms for oversight of the financial system as a whole; to ensure that all systemically important financial firms are subject to effective consolidated supervision; and to establish procedures for winding down a failing, systemically critical institution without seriously damaging the financial system and the economy. In the rest of my remarks, I will elaborate on each of these areas.

Strengthening Regulations and Guidance
First, I would like to report on changes already under way to strengthen the regulatory standards that limit the risks taken by financial firms and establish the capital and liquidity buffers that they must hold. Through the course of the crisis, it became increasingly clear that many firms lacked adequate capital and liquidity to protect themselves as well as the financial system as a whole. These problems became apparent not just in the United States but around the world, necessitating an internationally coordinated response. The Federal Reserve has played a key part in the international effort, working through organizations such as the Basel Committee on Bank Supervision and the Financial Stability Board. For example, we were extensively involved in the Basel Committee’s recent decisions to strengthen capital requirements for trading activities and securitizations, and we continue to work with domestic and foreign supervisors to raise capital requirements for other types of on- and off-balance-sheet exposures.²

By conducting the Supervisory Capital Assessment Program, popularly known as the stress test, U.S. supervisors took a significant step toward ensuring that our banks hold adequate levels of high-quality capital.³ Led by the Federal Reserve, the program evaluated the capital needs of 19 of the largest U.S. banking organizations by estimating their expected losses and earnings capacity through the end of 2010 under a more-adverse-than-expected macroeconomic scenario. Firms that were not projected to have enough high-quality capital under this scenario were required to raise additional capital within six months. The release of the assessment results last spring increased investor confidence in the banking system and helped open the public equity markets to these institutions. Since January 1, the 19 participating firms have raised more than $150 billion of incremental Tier 1 common equity, primarily through share issuances, exchanges, and asset sales, increasing their average Tier 1 Common ratios from 5.3 percent at the end of last year to 7.5 percent on June 30 of this year.⁴ As one indication of improved market confidence in those firms, their subordinated debt spreads have fallen by nearly one-half since the completion of the assessment.

Additional steps are necessary to ensure that all banking organizations hold adequate capital. Internationally, the Financial Stability Board has called for significantly stronger capital standards, and the Group of Twenty has committed to develop rules to improve both the quantity and quality of bank capital.⁵ The Federal Reserve supports these initiatives. The structure of capital requirements should also be reviewed. For example, to reduce the tendency of current capital requirements to promote credit growth in booms and to restrict credit during downturns, the Federal Reserve has supported international efforts to develop capital standards that would be countercyclical. Countercyclical standards would require firms to build larger capital buffers in good times and allow them to be drawn down–but not below prudent levels–during more-stressed periods. We also are working with our domestic and international counterparts to develop capital and prudential requirements that take account of the systemic importance of large, complex firms whose failure would pose a significant threat to overall financial stability. Options under consideration include assessing a capital surcharge on these institutions or requiring that a greater share of their capital be in the form of common equity. For additional protection, systemically important institutions could be required to issue contingent capital, such as debt-like securities that convert to common equity in times of macroeconomic stress or when losses erode the institution’s capital base.

The crisis also highlighted weaknesses in liquidity management by major firms. Short-term secured funding of long-term, potentially illiquid assets–through repurchase agreements and asset-backed commercial paper conduits, for example–became unavailable or prohibitively costly during the worst phases of the crisis, both here and abroad. In response, the Federal Reserve helped lead the Basel Committee’s development of revised principles for sound liquidity risk management, which in the United States are being incorporated into new interagency guidance that reemphasizes the importance of rigorous stress testing to determine adequate liquidity buffers.⁶ Together with our domestic and international counterparts, we are also considering quantitative standards for liquidity exposures similar to those for capital adequacy, with the goal of ensuring that internationally active firms can fund themselves even during periods of severe market instability. With supervisory encouragement, large banking organizations have, for the most part, already significantly increased their liquidity buffers and are strengthening their management of liquidity risk.

In addition to insufficient capital and inadequate liquidity risk management, flawed compensation practices at financial institutions also contributed to the crisis. Compensation, not only at the top but throughout a banking organization, should appropriately link pay to performance and provide sound incentives. In particular, compensation plans that encourage, even inadvertently, excessive risk-taking can pose a threat to safety and soundness. The Federal Reserve has just issued proposed guidance that would require banking organizations to review their compensation practices to ensure they do not encourage excessive risk-taking, are subject to effective controls and risk management, and are supported by strong corporate governance including board-level oversight.⁷

A fundamental element of effective financial regulation is protecting consumers from unfair and deceptive practices. The recent crisis clearly illustrated the links between consumer protection and the safety and soundness of financial institutions. We have seen that flawed financial instruments can both harm families and impair financial stability. Strong consumer protection helps to preserve household savings and to provide families access to credit on terms that are fair and well matched with their financial needs and resources. At the same time, effective consumer protection promotes healthy competition in the financial marketplace, supports sound lending practices, and increases confidence in the financial system as a whole.

The Federal Reserve has taken several important steps to strengthen the protections provided consumers and ensure that these protections effectively respond to market changes and emerging risks. As well-informed consumers are better able to make decisions in their own best interest, effective disclosures are the first line of defense against improper lending. The Federal Reserve has pioneered the use of extensive consumer testing to improve the clarity of disclosures, notably for mortgages and credit cards. However, we have learned that even the best disclosures may not always sufficiently protect consumers from unfair practices. Accordingly, we have written rules providing strong substantive protections for mortgage borrowers and credit card users. For example, last year the Board adopted new regulations under the Home Ownership and Equity Protection Act to better protect consumers with higher-priced mortgages. These rules strengthen underwriting, restrict prepayment penalties, and require escrow accounts for property taxes and insurance. The rules also address deceptive mortgage advertisements and unfair practices related to real estate appraisals and mortgage servicing. More recently, the Board adopted new credit card rules to increase transparency and protect consumers from a variety of unfair and deceptive acts and practices, rules that were largely incorporated into subsequent legislation. We are currently working on rulemakings in the areas of overdraft protection, reverse mortgages, and gift cards.

Making Supervision More Effective
Let me turn from regulation (the development of rules and standards that govern banks’ practices) to supervision (ongoing oversight and enforcement to ensure that the rules are being followed). As I noted earlier, the events of the past two years revealed serious failures in risk management at regulated financial firms that, in turn, underscored the need for supervisors to identify weaknesses in a more timely way and to more effectively ensure financial institutions remedy the problems. The nature and causes of these failures have been outlined in reports issued by a variety of domestic and international groups in which we participate.⁸ As a complement to those efforts, we at the Federal Reserve set up a number of working groups, drawing on expertise from throughout the Federal Reserve System, to evaluate all aspects of our oversight of banking organizations and to develop strategies to improve the quality of our supervision.

Two important themes have emerged from these efforts. First, they have reaffirmed the importance of effective consolidated supervision, particularly at large, complex organizations, so that supervisors can properly understand risks and exposures that cross legal entities and business lines. Second, we must combine a systemwide, or macroprudential, perspective with firm-specific risk analysis to better anticipate problems that may arise from the interactions of firms and markets. To support these approaches, we are strengthening our supervisory processes to include analyses that draw on multiple disciplines, updated surveillance tools, and more timely information so that supervisors can identify emerging risks sooner and respond more effectively. I will address each of these themes in turn.

First, recent experience confirms the value of supervision of financial holding companies–especially the largest, most complex, and systemically critical institutions–on a consolidated basis, supplementing the supervision that takes place at the level of the holding company’s subsidiaries. Large financial institutions manage their businesses in an integrated manner with little regard for the corporate or national boundaries that define the jurisdictions of functional supervisors in the United States and abroad. For example, a nonbank subsidiary of a financial holding company may originate a mortgage loan, sell it to an investment banking affiliate to be packaged and distributed as a security, which in turn may be purchased by an investment vehicle supported by a liquidity facility from a bank affiliate. Because financial, operational, and reputational linkages span large and complex financial firms, the risks borne by such firms cannot be adequately evaluated through supervision focused on individual subsidiaries alone. Instead, effective supervision must involve greater coordination among consolidated and functional supervisors and an integrated assessment of risks across the holding company and its subsidiaries.

In recognition of these points, the Federal Reserve Board issued guidance a year ago that updated our approach to consolidated supervision, tying it more explicitly to the systemic significance of individual holding companies and their business lines, such as core clearing and settlement activities and activities in critical financial markets.⁹ Strengthened consolidated supervision also supports improved oversight of institutions’ compliance with consumer protections. Indeed, building on a pilot project we launched in 2007, we recently announced a consumer compliance examination program for nonbank subsidiaries of bank holding companies, as well as of foreign banking organizations.¹⁰

Second, our supervisory approach should better reflect our mission, as a central bank, to promote financial stability. The extraordinary pressure on financial firms last fall underscored how profoundly interconnected firms and markets are in our complex, global financial system. Thus, any effort to address systemic risks will require a more systemwide, or macroprudential, approach to the supervision of systemically critical firms. More generally, supervisors must go beyond their traditional focus on individual firms and markets to try to identify possible channels of financial contagion and other risks to the system as a whole.

To improve consolidated supervision and increase the macroprudential focus of our oversight, we are improving existing supervisory tools and developing new ones. For example, drawing on our experience with the recent capital assessment program, we have increased our emphasis on horizontal reviews, which focus on particular risks or activities across a group of banking organizations. Although we have conducted horizontal reviews before, the Supervisory Capital Assessment Program of the past spring was both broader in scope and conducted differently than many previous horizontal reviews. It involved a broad simultaneous review of several types of risk exposures at the included banking organizations, covering a majority of the assets of the U.S. banking system. Examiners applied the same stress parameters to each firm, highlighting the relative strengths and weaknesses among them. Because we simultaneously evaluated potential credit exposures across all the firms, we were also better able to consider the systemic implications of financial stress under adverse economic scenarios. Building on the success of this initiative, we will conduct more frequent, broader, and more comprehensive horizontal examinations, evaluating both the overall risk profiles of institutions as well as specific risks and risk-management issues.

The increased complexity of the firms we supervise and the need to consider the systemic implications of problems at individual firms underscore the importance of increased collaboration within the Federal Reserve System itself among examiners and other specialists. The Federal Reserve’s ability to draw on expertise from a range of disciplines was essential to the success of the Supervisory Capital Assessment Program, and it will be a central feature of our supervision in the future. For example, we are using a multidisciplinary approach to develop an enhanced quantitative surveillance program for systemically critical institutions. This program will incorporate supervisory information, firm-specific data analysis, and market-based indicators to identify developing strains and imbalances that may affect multiple institutions, as well as specific firms. Our economic and market researchers will work in concert with examiners, market operations specialists, and other experts within the Federal Reserve System. Their efforts will incorporate periodic scenario analysis so we can better understand the consequences of economic shocks for both individual firms and the financial system. Off-site quantitative analysis will complement our traditional on-site supervision, but will be independently conducted to provide an alternative perspective to traditional examination findings.

To support and complement these initiatives, we are working with the other federal banking agencies to develop more-comprehensive information-reporting requirements for the largest firms. Traditional bank regulatory reports have not been sufficiently complete or timely to support continuous monitoring and analysis of the dynamic and diverse business activities of the largest, most complex organizations. These firms should report systematic, frequent, and consistent information on material firm-wide exposures, funding and liquidity profiles, and operating performance. Enhanced reporting requirements should not only help supervisors identify potential vulnerabilities at individual institutions and in the banking sector more broadly, but should also prompt institutions to better track their own risks.

When risk-management shortcomings are identified, even if losses have not yet materialized, supervisors must hold management accountable and make sure that weaknesses receive proper attention at senior levels and are resolved promptly. We will ensure that important supervisory concerns are communicated promptly and at a high level, with more frequent involvement of senior bank management and boards of directors and senior Federal Reserve officials. This approach proved especially effective during the recent Supervisory Capital Assessment Program and in other circumstances where clear expectations for prompt remediation were forcefully communicated to large banking organizations. Of course, we will use the full range of enforcement tools at our disposal as necessary to achieve important supervisory objectives.

Need for Legislative Action
Though the Federal Reserve and other supervisors in the United States and abroad are strengthening the existing regulatory and supervisory framework, it remains critical for the Congress to close regulatory gaps and provide supervisors with additional tools for anticipating and managing systemic risks. The recent financial crisis clearly demonstrated that risks to the financial system can arise not only from banks, but also from other financial firms–such as investment banks or insurance companies–that traditionally have not been subject to the type of regulation and consolidated supervision applied to bank holding companies. To close this gap, the Congress should ensure that all systemically important financial institutions are subject to a robust regime for consolidated prudential supervision. Large, complex financial firms that do not own a bank, but that nonetheless pose risks to the overall financial system, must not be permitted to avoid comprehensive and effective supervisory oversight. Consolidated supervision of systemically important institutions, together with tougher capital, liquidity, and risk-management requirements for those firms, is needed not only to protect the firms’ stability and the stability of the financial system as a whole, but also to reduce firms’ incentive to grow very large in order to be perceived as too big to fail.

To further ameliorate the too-big-to-fail problem, the Congress should create a new set of authorities to facilitate the orderly resolution of failing, systemically important financial firms. In most cases, federal bankruptcy laws work appropriately for the resolution of nonbank financial institutions. However, the bankruptcy code does not always protect the public’s strong interest in avoiding the disorderly collapse of a nonbank financial firm that could destabilize the financial system and damage the economy. In light of the experience of the past year, it is clear that we need an option other than bankruptcy or bailout for such firms.

A new resolution regime for nonbanks, analogous to the regime currently used by the Federal Deposit Insurance Corporation for banks, would permit the government to wind down a failing systemically important firm in a way that reduces the risks to financial stability and the economy. Importantly, to restore a meaningful degree of market discipline and to address the too-big-to-fail problem, it is essential that there be a credible process for imposing losses on the shareholders and creditors of the firm. Any resolution costs incurred by the government should be paid through an assessment on the financial industry and not borne by the taxpayers.

Beyond strengthening and extending consolidated supervision and making provisions for the safe unwinding of failing, systemically important firms, there remains the broader objective of monitoring and addressing emerging systemic risks. Because of the size, diversity, and complexity of our financial system, that task may exceed the capacity of any individual supervisor. The Federal Reserve supports the creation of a systemic oversight council, made up of the principal financial regulators. By combining the expertise and information of all the relevant agencies and departments, the council would be in the best position to identify developments that threaten the stability of the system as a whole. The council could be charged, among other things, with monitoring risk exposures that cut across firms and markets; analyzing potential spillovers among financial firms or between firms and markets that could lead to financial contagion; identifying regulatory gaps; coordinating the responses of its member agencies to emerging systemic risks; identifying systemically important firms; and periodically reporting to the Congress and the public about emerging systemic risks and recommended approaches for dealing with those risks. In addition, to further encourage a more comprehensive and holistic approach to financial oversight, all federal financial supervisors and regulators–not just the Federal Reserve–should be directed and empowered to take account of risks to the broader financial system as part of their normal oversight responsibilities.

Conclusion
As we work together to build on the progress already made toward securing a sustained economic recovery, we cannot lose sight of the need to reorient our supervisory approach and to strengthen our regulatory and legal framework to help prevent a recurrence of the events of the past two years. As I have described today, the Federal Reserve has been actively engaged in this process. We are working with our domestic and international counterparts to strengthen the standards governing bank capital, liquidity, risk management, incentive compensation, and consumer protection, among other areas. We are also improving supervision, and giving it a greater macroprudential focus, through enhanced consolidated supervision and through the development of new supervisory tools–including comprehensive horizontal reviews, off-site quantitative evaluations, and more extensive information gathering. We are moving quickly to bring unresolved issues to the attention of senior management and requiring prompt responses.

Regulators and supervisors can do a great deal, but comprehensive financial reform requires action by the Congress. Strengthening consolidated supervision, setting up a mechanism (such as a systemic oversight council) to identify and monitor risks to financial stability, and creating a framework that allows for the safe unwinding of failing, systemically critical firms are among the essential ingredients of a new system that will reduce the probability of future crises and greatly mitigate the severity of any that occur. We at the Federal Reserve look forward to working closely with the Congress as the legislative process evolves.

---

Footnotes

1. Numerous studies confirm these points. See, for example, Group of Thirty (2009), Financial Reform: A Framework for Financial Stability (520 KB PDF) (Washington: Group of Thirty, January); Markus Brunnermeier, Andrew Crockett, Charles Goodhart, Avinash D. Persaud, and Hyun Shin (2009), “The Fundamental Principles of Financial Regulation (1.8 MB PDF),”  Geneva Reports on the World Economy–Preliminary Conference Draft (Geneva: International Center for Monetary and Banking Studies, January); The de Larosière Group (2009), The High-Level Group on Financial Supervision in the EU (443 KB PDF) (Brussels: European Commission, February); Financial Services Authority (2009), The Turner Review: A Regulatory Response to the Global Banking Crisis (1.2 MB PDF) (London: FSA, March); International Monetary Fund (2009), Global Financial Stability Report: Responding to the Financial Crisis and Measuring Systemic Risks (Washington: IMF, April); and U.K. Parliament, House of Lords, Select Committee on Economic Affairs (2009), Banking Supervision and Regulation,  H.L. Paper 101-I and H.L. Paper 101-II, session 2008-09 (London: The Stationary Office Limited, June). Return to text

2. See Bank for International Settlements (2009), “Basel II Capital Framework Enhancements Announced by the Basel Committee,” press release, July 13; and Basel Committee on Banking Supervision (2009), Enhancements to the Basel II Framework (188 KB PDF) (Basel, Switzerland: Bank for International Settlements, July). Return to text

3. For more on the Supervisory Capital Assessment Program, see Ben S. Bernanke (2009), “The Supervisory Capital Assessment Program,” speech delivered at the Federal Reserve Bank of Atlanta 2009 Financial Markets Conference, held in Jekyll Island, Ga., May 11. Return to text

4. The average Tier 1 Common ratio as of June 30, 2009, has been adjusted to reflect the completion of Citigroup’s exchange offer in September 2009. Return to text

5. See Group of Twenty (2009), “Leader’s Statement: The Pittsburgh Summit,”  press release, September 25. Return to text

6. See Basel Committee on Banking Supervision (2008), Principles for Sound Liquidity Risk Management and Supervision (153 KB PDF) (Basel, Switzerland: Bank for International Settlements, September); and Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of Thrift Supervision, and National Credit Union Administration (2009), “Agencies Seek Comment on Proposed Interagency Guidance on Funding and Liquidity Risk Management,” joint press release, June 30. Return to text

7. See Board of Governors of the Federal Reserve System (2009), “Federal Reserve Issues Proposed Guidance on Incentive Compensation,” press release, October 22. Return to text

8. See, for example, the President’s Working Group on Financial Markets (2008), “Policy Statement on Financial Market Developments (1.36 MB PDF),” policy statement (Washington: U.S. Department of the Treasury, March 13); Financial Stability Forum (2008), Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience (399 KB PDF) (Basel, Switzerland: FSF, April 7); and Senior Supervisors Group (2008), Observations on Risk Management Practices during the Recent Market Turbulence (373 KB PDF) (Basel, Switzerland: Bank for International Settlements, March 6). Return to text

9. See Board of Governors of the Federal Reserve System, Division of Banking Supervision and Regulation and Division of Consumer and Community Affairs (2008), “Consolidated Supervision of Bank Holding Companies and the Combined U.S. Operations of Foreign Banking Organizations,” Supervision and Regulation Letter SR 08-9 / CA 08-12 (October 16). Return to text

10. See Board of Governors of the Federal Reserve System, Division of Consumer and Community Affairs (2009), “Consumer Compliance Supervision Policy for Nonbank Subsidiaries of Bank Holding Companies and Foreign Banking Organizations,” Consumer Affairs Letter CA 09-8 (September 14). Return to text

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The ugly truth is that Mole might have fallen for a nice head fake which retraced exactly to the 78.6% fib line:

If we breach today’s highs we will make new highs - if we drop through yesterday’s lows we are most likely looking at more downside going forward.

Here’s the zoomed in view:

Of course don’t expect to see this resolve today - the resolution will occur via a gap overnight or over the weekend, so that retail traders have no chance to get in or out where necessary.

Yes, this tape looks like it’s topping but we have been fooled - how many times now? You come back on Monday and suddenly the ‘nature’ of the tape completely changes as if a new roster of traders has taken over with a completely different game plan.

If you were still short from yesterday’s lows chances are you sold out during the spike up - unless of course you were stubborn as hell - as I was in the past. Of course that’s when the tape kept running - this time I didn’t want to take this chance and the tape dropped. I thought of that possibility last afternoon but was not ready to take on that type of risk again - and I’m pretty sure the entire game was primed against that prior experience. Nothing like conditioning players that something will happen at a particular stage and then to do the exact opposite. This is one big poker game at this point - and the only difference is that the big cats can see my cards and I am flying blind. What I have is my wave count but at the current stage the odds are completely open. A year or so ago I would have stayed short and added positions today. But I have seen a drop like today’s recover too often to take any more risks like that.

So, the only ugly alternative now is to wait for this trend to officially fail - which means 1070 and then 1040 need to be taken out. VIX is going to be higher then and premium won’t be as cheap but it sure beats this losing game.

Public Service Announcement:

Effective today I will not post a Program Trading Update anymore - I will however continue to post the Zero chart when I find the time. This is mainly due to unjustified accusations by one unhappy Geronimo subscriber who suggested that both me and Eric were lying - something which in my mind is simply inexcusable as we both have been bending over backwards to be as fair and transparent as possible.

I will also reduce my participation on this blog as this outlash today has shocked and disappointed me deeply. Quite frankly I also do not believe that I have much to contribute these days - and I’m sure that most of you are sick and tired of hearing me bitch about this erratic gyrations - this is not very productive. I also wonder if it makes sense to continue catering geronimo to retail traders as some of you obviously are unfit to accept the occasional losses - if this is what we get after one or two down days then I don’t want to know what will happen after a bad week or month. Eric and I are considering to scale out of the current subscription model and to solely work with funds and CTAs.

Enjoy your weekend.

Mole

A few interesting items

• Elizabeth Warren for President (True Slant)

• Fed weighs its words on ending near-zero interest rate (FT)

• The New $1 Million Bill (Bloomberg)

• Uh-oh: Taking It To The Street(.com) (Zerohedge)

• Systemic Risk in the Financial System: Insights from Network Science (PEW)

• Mona Lisa’s smile a mystery no more (New Scientist)

Anything catch your collective eye?

While certainly no Medallion (in anything but iambic pentameter), it appears that recently notorious and soon defunct hedge fund Galleon has been dabbling, among other things, in statistical arbitrage. One wonders if Moody's has been instrumental in providing the firm with any good VWAP "hot tips." Oddly, the firm's stat arb fund has performed an impressive 18% YTD, and had recorded just one down month in the past year. Perhaps the Feds should take a quick look at this particular strategy and discover how it has generated 64% since inception on a Jim Simons drool-inducing 0.96 sharpe, especially with such broad M/N indices as the HSKAX and HFRXEMN about to wiped out with impunity due to constituent underperformance.

A full description of the rocket science behind this holy grail of Profit generation is provided straight from the horse's mouth:

The Galleon Quantitative Statistical Arbitrage Fund (“GQSA”) returned +2.29% net for the month, bringing the year to date return to +18.10% net. The Galleon investment strategy, which integrates mean reversion and momentum price based models in a global portfolio, was profitable in each geographic region. In recent months, the multi-factor approach to price based trading has yielded the strongest returns in the European and Asian portfolios; in September the equity markets continued to exhibit good momentum and mean reversion opportunities throughout many markets. However, the multiple proprietary filters used to control leverage of the individual trading models remained cautious for most of the month. The gross exposure largely stayed low, approximately 180% (90 cents per side). Net exposure was approximately +7% and VaR averaged 55bps. In terms of sector attribution, the GQSA Fund was profitable in every sector in aggregate, with Industrials, Consumer Discretionary and Financials being the most profitable sectors across the global portfolio.

AFP reports:

The Federal Reserve will expand its so-called stress tests of the banking system to ensure they have enough capital during difficult periods, Fed chairman Ben Bernanke said Friday.

Bernanke highlighted the positive impact of stress tests conducted earlier this year on major banks, a move aimed at ensuring their financial health and building confidence.

"Building on the success of this initiative, we will conduct more frequent, broader, and more comprehensive horizontal examinations, evaluating both the overall risk profiles of institutions as well as specific risks and risk-management issues," Bernanke told a conference organized by the Boston Federal Reserve.

The highly publicized stress tests conducted earlier this year focused on 19 major banks, and indicated 10 needed additional capital.

Bernanke said the Fed would step up efforts to review bank capital requirements to avoid a recurrence of the credit crisis that has spread around the world.

"Additional steps are necessary to ensure that all banking organizations hold adequate capital," he said.

He noted that the Financial Stability Board -- a global watchdog made up of senior representatives of national financial authorities -- had called for "significantly stronger capital standards," and that the Group of 20 "has committed to develop rules to improve both the quantity and quality of bank capital."

"The Federal Reserve supports these initiatives. The structure of capital requirements should also be reviewed," Bernanke said.

Should we be reassured by the new round of stress tests?

Well, let's take a look:

• Time Magazine called the previous stress tests a "confidence game" and Geithner a "con man" for running them deceptively

• Paul Krugman called the stress tests a mere "self-esteem class" for banks that no bank would be allowed to fail

• Nouriel Roubini said the stress tests "fail the basic criterion of a reality check"

• William K. Black called them "a complete sham"

• FDIC head Sheila Bair didn't believe they were credible
  

• The stress tests were a P.R. stunt devised by the banks themselves
  

• The government has more or less admitted that the stress tests were meaningless (see this and this)

In addition, AFP quotes Bernanke as saying:

"For example, to reduce the tendency of current capital requirements to promote credit growth in booms and to restrict credit during downturns, the Federal Reserve has supported international efforts to develop capital standards that would be countercyclical," or require firms to build larger capital buffers in good times and allow them to be drawn down in times of stress.

But as I have previously noted:

One of the Fed's main justification has been that it can provide a "counter-cyclical" balance. In other words, during boom times it can put on the brakes ("take the punch bowl away right as the party gets started"), and during busts it can get things moving again. But as economist Jane D'Arista has shown, the Fed has failed miserably at that task:

Jane D'Arista, a reform-minded economist and retired professor with a deep conceptual understanding of money and credit [has a] devastating critique of the central bank. The Federal Reserve, she explains, has failed in its most essential function: to serve as the balance wheel that keeps economic cycles from going too far. It is supposed to be a moderating force in American capitalism on the upside and on the downside, the role popularly described as "leaning against the wind." By applying its leverage on the available supply of credit, the Fed can slow down a boom that is dangerously overwrought or, likewise, stimulate the economy if it is sinking into recession. The Fed's job, a former chairman once joked, is "to take away the punch bowl just when the party gets going." Economists know this function as "counter-cyclical policy."

The Fed not only lost control, D'Arista asserts, but its policy actions have unintentionally become "pro-cyclical"--encouraging financial excesses instead of countering the extremes. "The pattern that has developed over the last two decades," she wrote in 2008, "suggests that relying on changes in interest rates as the primary tool of monetary policy can set off pro-cyclical foreign capital flows that tend to reverse the intended result of the action taken. As a result, monetary policy can no longer reliably perform its counter-cyclical function--its raison d'être--and its attempts to do so may exacerbate instability."...

The new stress tests will be a meaningless P.R. stunt, just like the originals. The Fed largely caused the financial crash, and shouldn't even be given an electric razor, let alone financial or economic oversight.

Some Mutual Assured Destruction, Friday edition, courtesy of CIT: $35 billion in estimated General Unsecured Claims recovering between $2 and $13 billion if company is "forced" to file for bankruptcy.

Without an approved restructuring plan, the Company will likely file for bankruptcy without the benefit of a plan of reorganization and stakeholders will lose significant value.

 

Impacts include:

• Substantial damage to the franchise
• Inability to insulate valuable operating businesses from the proceedings
• Increased risk of seizure of CIT Bank
• Uncertainty and constraints with respect to liquidity
• Significant bankruptcy related expenses
• Lengthy process in court
• Estimated recovery value for general unsecured claims in a accelerated liquidation is  between 6 - 37 cents per $1.00

Full CIT Management presentation below:

 

Guess who said the following:

Far from turning around the [George] Bush legacy of deficits and debt, [US president Barack] Obama has made it worse. It has got all the hallmarks of a financial collapse about to happen in America...

The US dollar is almost becoming like junk bonds.

A senior Senator from Australia.

Leading Australian paper The Age adds:

The Nationals Senate leader Barnaby Joyce is openly canvassing an economic upheaval that would dwarf the current global financial crisis, triggered by the US defaulting on its sovereign debt within the next few years.

In unusually pessimistic comments for a senior political figure, Senator Joyce said the US Government was running such large deficits and building up so much debt that it was in a similar position to Iceland or Germany before World War II.

On a related note, in the for-what-it's-worth department, Peter Schiff has issued an urgent warning to get out of the dollar:

However, some smart people think the dollar will rally at the next stock market crash.