Fin/Inv

There are a few corollaries that follow from the recent post on unstructured time and personality. I thought I'd highlight a few below:

* If we think of our unstructured time as a blank canvas, it isn't a far leap to the view that each of us is creating a work of art with how we fill that canvas. Do we create a masterpiece? A coherent work of art? Random scribbles? The noble life is one that creates a work of beauty from that blank canvas.

* One important facet of what we do with our unstructured time is who we choose to spend it with. We select our companions--friends and life partners--based upon our deepest interests, needs, and values. Who we select as a soulmate is the clearest window onto our souls.

* Some people frantically avoid unstructured time, making busy-ness their business. What painting to they create from their canvas--or do they run from the responsibility of holding the brush and taking the first strokes?

* Different version of the projective test: If you were to be stranded on an island for a year and could only bring one person and five possessions with you, who/what would you choose and why?

* How you would *least* like to spend your time is as informative as how you most prefer to use your time. We cannot value something strongly without responding strongly to threats to that value.

* A good relationship: when the person you love is also one you admire. Relationships transform us; good ones for the better.
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"Although the main interests of the Federal Reserve are macroeconomic in nature, well-functioning financial markets are ancillary to good economic performance. Conversely, financial instability can compromise economic growth and price stability. Because of this intimate connection with economic performance, the Federal Reserve has a clear interest in promoting the stability of financial markets."

 - Former Fed Governor Fred Mishkin, 2007

 

col·lat·er·al / k'lat'r'l; k'latr'l/ • n. 1. something pledged as security for repayment of a loan.

Recently, Zero Hedge presented a snapshot analysis of the various securities that made up the triparty repo agreement involving JPM, Lehman and the Fed. We uncovered numerous bankrupt companies' equities that were being pledged as collateral for what ultimately was taxpayer exposure. To our surprise, this discovery is not an exception, and in fact in the days immediately preceding the collapse of Bear Stearns first, and subsequently, Lehman Brothers, the Federal Reserve established and refined a program that permitted banks to pledge virtually any security as collateral, including not just investment grade bonds and higher ranked securities, but also stocks of companies, the riskiest investment possible, and a guaranteed way for taxpayer capital to evaporate in the context of a disintegrating financial system, all with the purpose of bailing out Wall Street's major institutions. On two occasions last year: on March 16, 2008, and subsequently on September 14, 2008, the Federal Reserve first established what is known as the Primary Dealer Credit Facility (PDCF), and subsequently amended it, so that the Fed, in becoming the lender of last resort, would allow any collateral, up to and including stocks, to be funded by the Federal Reserve's credit facility, in order to prevent the $4.5 trillion repo financing system from imploding. By doing so, the Federal Reserve effectively gave a Carte Blanche to primary dealers to purchase any and all equities they so desired, with such purchases immediately being funded by the US taxpayer, via the PDCF. In essence, this was equivalent to the Fed purchasing equities by itself through a Primary Dealer agent.

Readers who have been concerned with the moral hazard provided by the Fed's monetization of Treasury and Mortgage debt, should be doubly concerned by this Fed action which sent three key messages to Wall Street: i) it made sure that Primary Dealers would generate massive profits on risky assets as the Fed would provide the funding to acquire any and all stocks (keep in mind the cost of funding of the PDCF to primary dealers was negligible); ii) it tipped its hand as to the existence and modus operandi of the rumored "plunge protection team," iii) and it made clear that the much maligned, by none other than Chairman Bernanke, concept of "moral hazard" is the one and only systemically relevant doctrine as long as the Fed's Chairman is in control, and not subject to any auditing auspices. The fact that PDs used over $140 billion of taxpayer money within a few weeks of the program's expansion in September to fund what one can assume were exclusively equity purchases, demonstrates that the American financial system got the message.

The (Triparty) Repo System

Before we get into the details of the Fed's Primary Dealer Credit Facility, it is prudent to present the beating heart of the American financial system, more so than securitizations or money markets, all of which went into cardiac arrest on several occasions in 2008: the Triparty Repo system.

As the name implies, a triparty repo transaction involves three parties: a cash lender (the investor), a borrower that will provide collateral against the loan, and a triparty clearing bank. The triparty clearing bank provides cash and collateral custody accounts for parties to the repo deal and collateral management services. These services include ensuring that pledged collateral meets the cash lenders’ requirements, pricing collateral, ensuring collateral sufficiency, and moving cash and collateral between the parties’ accounts.

Both the investor and the borrower must have accounts at the clearing bank, and all three parties are bound by legal documentation called the triparty repo agreement. In the United States, there are two triparty clearing banks: the Bank of New York and J.P. Morgan Chase. One of the operational benefits of triparty repos is that, regardless of the term of the loan, the clearing bank unwinds the transaction each morning, returning the cash to the investor’s account and the collateral to the borrower’s account. Then at the end of the day, the borrower pledges qualifying collateral back to the deal, which once priced, determined as eligible, and deemed sufficient to meet the terms of the deal by the clearing bank, is moved to the investor’s account while the cash is placed in the borrower’s account. In this way, no specific collateral is committed for more than overnight. This arrangement allows borrowers to pledge whatever eligible collateral they have on hand each day, thus enabling them to manage their securities portfolios more effectively.

An important implication of this daily unwinding, however, is that the counterparty risk for the investor shifts from its repo counterparty to the triparty clearing bank, and the clearing bank becomes exposed to the borrower. Overnight, the cash investor has the borrower’s collateral in its account and the borrower has the cash. If the borrower defaults overnight— say, by filing for bankruptcy—the lender has the collateral in its account and thus is covered and the clearing bank is not affected. Once the collateral and cash are returned in the morning, however, the clearing bank, which has extended credit to the borrower to finance the original collateral purchase, becomes exposed to the borrower. Consequently, the clearing bank needs to determine each morning if it is comfortable accepting the exposure to the borrower that the reversal of the transaction will create.

As readers will recall, the reason why Jamie Dimon blew up in his letter to Barclay's John Varley and in fact threatened with litigation, is that the latter attempted to stuff JPMorgan, as the Lehman triparty clearing house, with about $7 billion in collateral for which Barclays had suddenly gotten buyers remorse and decided it had no desire for, after prices plunged in the days after the Lehman bankruptcy.

Triparty repos are a subset of the broader repo market. As the name implies, a repo is a simple transaction where the holder of a security obtains funds by selling that security to another market participant with the understanding that the security will be repurchased at a fixed price on some future date. Very much like a simple mortgage transaction, the seller is borrowing funds against the security, usually as a means of financing the original purchase of the security. The buyer is traditionally a pension fund, a money market mutual fund, or a bank, which makes what it assumes is a safe collateralized investment (using haircuts, more on that shortly), and in exchange it is paid a spread on the money forwarded. In today's economy most repos occur as triparty contracts, in which the clearing bank assesses the value of the collateral and imposes a haircut, or the difference between the estimated market value and a downside case for how much a lender can borrow. Logically, the size of the haircut reflects the collateral's riskiness. The following table which we presented previously discloses that haircuts determined by JPMorgan in the JPM/Lehman/Fed triparty repo. As one can see, the amount of haircut wiggle room is huge, and even when the taxpayer's money is on the hook for the full repo amount, the haircuts are still relatively tame. Yet if the fair value of the collateral is not properly determined for in a downside case, it pressures accelerated unwinds as banks are fully aware that what they have marked their securities making up their repos for an above FV. What results is a scramble for the exits as everyone attempts to unwind their repos first thereby causing a feedback loop where selling begets more selling, and the entire repo market grinds to a halt.

Why are haircuts an issue?

The repo market is huge. At its peak it was bigger than the Money Market. At the Bear Stearns collapse in March 2008, there was over $4.5 trillion in repos (contrast that to Money Markets which peaked at around $3.8 trillion), of which the bulk is in overnight repos (we will get into the maturity variation on repos in a second). The chart below indicates the phenomenal growth of the repo system, as the banking system glutted itself on free and excessive credit over the past decade. From 1997, through its peak just over ten years later, the amount of outstanding repos at Primary Dealers increased by over 400%!

A critical observation is that beginning in about 2005, the amount of overnight repos quickly overtook the term repo outstandings. Why is this relevant? As the share of overnight repos increased and hit nearly 75% in 2008, it created a significant duration funding risk.

The urgent shift to shorter term financing meant that much more of the Primary Dealers' funding had to be rolled each day, at terms satisfactory to the clearing bank. With loans coming due quickly, in a downward asset price spiral, dealers have to scramble to raise capital necessary to pay back creditors. Coupled with lenders tightening credit standards and suddenly imposing larger haircuts on loans (compare the Lehman to Fed haircuts above), and it become immediately obvious how the vicious cycle of deleveraging can accelerate without any natural breaking mechanism. In fact, a staggering $2 trillion worth of repos were extinguished in just over a year between the repo peak of $4.5 trillion in March 2008 and the latest reading of $2.5 trillion in July 2009.

A last side-effect of the credit bubble, was the increasing use of subpar and illiquid securities to make up the collateral of repo transactions. With only so many quality securities outstanding, banks found themselves scratching their heads how to legally continue the providing cheap credit against worse and worse assets. What resulted was an explosion in toxic junk backing repo agreements. In fact, according to estimates, "less liquid" collateral hit almost 60% of all repos at the peak in early 2009.

The deterioration in underlying collateral quality made the subsequent repo implosion a virtual certainty. Originally focused on the highest quality collateral - Treasurys and Agency debt (ironically, Agencies and MBS are not more shunned by the entire investing community than CCC-rated HY paper, compliments of the Fed's market intervention efforts), by 2008 repos were using junk bonds, whole loans, trust receipts and even equities for collateral purposes. A side effect of more distressed collateral is less liquidity, and of course, when one most needs access to liquidity, i.e., unwinds of distressed positions, is when the liquidity is gone: in the event of the guaranteed crisis which the Federal Reserve completely failed to anticipate, the selling of illiquid securities would take time and occur and major losses to lenders.

The crisis

The repo market hit an all time high days before Bear Stearns was expected to file for bankruptcy, and then froze. In the first week of March 2008, liquidity in the repo market became strained. Creditors were worried not just about extended counterparty risk, but also about the actual creditworthiness of the collateral posted in repos: for the first time ever the banking system was forced to look at not just its own balance sheet, but those of competitors, and recoiled at what it saw. An immediate escalation saw repo haircuts increase dramatically, with the one security impacted the most being mortgage-backed securities for obvious reasons, but even traditionally safe securities such as Treasurys saw their haircuts grow substantially.

As the spike in haircuts forced dealers to shun the repo market entirely, they turned to other sources of short-term funding, namely the Eurodollar market (LIBOR). While the LIBOR market did not become the go to conduit for short-term arrangements during the Bear debacle, following the bankruptcy of Lehman Brothers all repo bets were off and dealers scrambled to satisfy their near-terms funding needs using LIBOR. The Resulting spike in the LIBOR rate can be seen in the chart below. Once 3M LIBOR was at about 5%, even the Eurodollar market was no longer attractive, leaving the only other option: massive asset firesales.

And here is the liquidity crunch in its full flow-chart glory:

1. If can not obtain short-term (overnight or term) funding in repo market, go to Eurodollar market
2. If can not obtain short-term funding in Eurodollar market (LIBOR), go to asset sales
3. If asset sales are impossible due to lack bids, illiquid markets, and collateral consists of toxic MBS and CCC-rated junk bonds, yet margin calls are streaming and repo counterparties are demanding their cash back, go to bankruptcy
4. File for bankruptcy

This would be natural chain of events in a normal capitalist country. However, America in times of stress is anything but - which is why enter 3.5 (after 3 and before 4): the Federal Reserve. What the Fed did was to basically extend credit, first to Bear Stearns (through JP Morgan which ended up acquiring Bear's toxic asset mess, now better known as Maiden Lane as it continues to reside on the Fed's balance sheet), and second to Lehman Brothers (here JPMorgan was not the ultimate beneficiary of the "good bank," and instead it was merely the clearing agent of the triparty repo which had a very nervous Fed on one side, stuck with nearly $70 billion in worthless securities consisting of anything from defaulted CRE whole loans, to stock in hundreds of bankrupt companies.

Keep in mind this is not the first time the Fed has found itself in this situation: in 1998, when LTCM blew up, it was a dress rehearsal to the dot, along with the same feedback-loop driven evaporation of liquidity, as haircuts collapsed and nobody wanted to be on contingent to anyone else making rash decision. Yet there was one notable difference between 1998 and 2008: roughly $3.5 trillion (or 350% more) in outstanding repos: a number equally to about 30% of the US GDP, and a number sufficient to bring down the entire financial ponzi house of cards. Enter the Federal Reserve and the doctrine of encouraged moral hazard.

The Primary Dealer Credit Facility

On March 16, 2008, finding itself in a quandary as to how to unclog frozen repo markets, the Federal Reserve Board announced the Primary Dealer Credit Facility. Most notably from the press release is the disclosure on collateral: "Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities." Note: not junk bonds, equities or any other toxic trash. At least at this point the Fed, while acting to preserve liquidity, still retained some semblance of fiduciary responsibility to the U.S. taxpayer.

A formulaic definition of the PDCF is provided below:

The PDCF program is based on the triparty repo legal and operational infrastructure that the Federal Reserve uses to conduct its repo operations. To access the PDCF, primary dealers communicate a demand for overnight funding to their clearing banks, typically by 5 p.m. ET on business days. The clearing bank verifies that a sufficient amount of eligible collateral has been pledged to the loan by the primary dealer and notifies the Federal Reserve Bank of New York accordingly. Once the New York Fed receives notice that a sufficient amount of margin-adjusted eligible collateral has been assigned to its account, it transfers the amount of the loan to the clearing bank for credit to the primary dealer.

The pledged collateral is valued by the clearing banks using vendor pricing services. Loans are limited to the amount of margin-adjusted eligible collateral pledged by the dealer and assigned to the New York Fed’s account at the clearing bank. While loans under the PDCF are collateralized, they are loans made under recourse; thus, the primary dealer is responsible for repayment even if the collateral loses value overnight.

PDCF loans made to primary dealers increase the total supply of reserves in the banking system, in the same way that discount window loans do. When the Federal Reserve’s Open Market Trading Desk was targeting a non-zero federal funds rate, the reserve impact of PDCF loans was offset using a number of tools, including, but not necessarily limited to, reverse repurchase agreements, outright sales or redemptions of Treasury securities, a reduction in the size of conventional repo transactions, and use of the authority to pay interest on reserves. However, when the FOMC reduced the target fed funds rate to a range from zero to 25 basis points, there was no longer any need to offset or “sterilize” these loans.

As it does for loans made to depository institutions through the discount window, the Federal Reserve makes information on PDCF borrowing available each Thursday, generally at 4:30 p.m. ET, through its Statistical Release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.” The H.4.1 release reports the total amount of PDCF credit outstanding at the close of business on the previous business day as well as the average daily amount of credit outstanding for each week.

The legal authority to establish the PDCF is based on Section 13(3) of the Federal Reserve Act of 1913. Section 13(3), passed in 1932, allows the Federal Reserve to provide credit to individuals, partnerships, or corporations on an emergency basis. The central bank applied it to primary dealers for the purpose of establishing the PDCF.

So far so good: the Fed was concerned about maintaining liquidity and while one could find fault with some of its proposed haircuts on various security classes (see table above), overall due to the exclusion of risky assets, the Fed was mortgaging purchases of IG-rated collateral and above.

The twist

All through the spring and summer of 2008, the Fed was confident it had managed to glue the pieces together, and retain some semblance of stability. Then came that fateful weekend of September 13th about which so much has been written. In advance of the Lehman collapse, and what the Fed knew would quickly become a lock-up of not just money markets (which nearly occurred), but of the entire repo system, bringing practically all leveraged institutions to a halt and prompt liquidation, the Federal Reserve announced this little discussed amendment to the Primary Dealer Credit Facility:

For immediate release

The Federal Reserve Board on Sunday announced several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities.

"In close collaboration with the Treasury and the Securities and Exchange Commission, we have been in ongoing discussions with market participants, including through the weekend, to identify potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses," said Federal Reserve Board Chairman Ben S. Bernanke. "The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets."

"We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world," Chairman Bernanke said.

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.

Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion.

The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.

The bolded text is all you need to know to find the smoking gun for any and all allegations of "plunge protection" or however one wishes to frame the invisible market bid. On September 14th, 2008 the gloves cames off, when the Fed, stated in a press release no less, that it would provide virtually free taxpayer capital to banks so that they could go to the market and purchase equities! 

What was the response? In a word: astounding, as bank after bank rushed to purchase however many equities they needed, funded by the Federal Reserve, as PDCF lending skyrocketed from $0 to $150 in a matter of days (and $59.7 billion overnight on Wednesday, September 17th, a day before the Reserve Fund's breaking the buck caused a near-run on money market accounts). The demand for Fed backstopped equity purchasing was so large that borrowings under the costless PDCF promptly surpassed those of the Fed's actual Discount Window which did not go much higher than $100 billion in the days after the Lehman bankruptcy.

Implications

Gradually the use of the Primary Dealer Credit Facility moderated and around April of 2009 there were no additional borrowings on the program. However, by this time, none more were needed, as banks did not need to use the PDCF-intermediated mechanism for the Fed to purchase stocks. Beginning in March 2009, the Fed was now running the capital markets directly, by pushing prices of "riskless" assets ever higher through its $1.7 trillion Quantitative Easing program, thereby making it all too clear to PDs and other financial institutions that moral hazard was once again tolerated and encouraged, as the Fed in essence announced that banks should be acquiring risky assets, as it was the "purchaser of last resort" of riskless ones. Furthermore, by being a self-professed "lender of last resort" as well, providing a perpetual backstop for an indirect way to bid up equities at a 50 bps funding cost, the Federal Reserve has now managed to singlehandedly take over the entire capital market.

With regards to moral hazard, the Fed had this to say with respect to whether it was encouraging this phenomenon by the promotion of the PDCF:

"Concerns have been raised that the PDCF, by offering primary dealers a liquidity backstop, encourages risky behavior. In this view, the facility effectively invites primary dealers to delay raising equity because they can instead borrow from the Federal Reserve. These “moral hazard” issues are similar to those that arise in the context of emergency lending to banks. The countervailing view, however, is that the PDCF functions to protect prudently managed institutions from the damaging consequences of the risks taken by highly leveraged firms. In the period following the Bear Stearns crisis and again after the collapse of Lehman Brothers, the liquidity provided by the PDCF helped reduce the spillover of distress to more conservatively managed firms by enabling these firms to maintain their securities inventories and to fulfill their obligations to creditors and clients."

Alas, Mr. Bernanke, that has to be the weakest non-explanation explanation ever proffered by the Federal Reserve. Far from answering the question, it avoids it entirely by stating that the PDCF makes lives tolerable for those who, when the next credit implosion comes around, were not as greedy as the new Bears and the Lehmans of Credit Crunch v2. Yet in the meantime, PDs and banks should take full advantage of the Fed's market manipulating generosity courtesy of such middle-class devaluing constructs as Quantititve Easing, which all it does is kick the can down so the consequences of dealing with Wall Street's near collapse can be the next administration's problem, and the PDCF. We ask when, along with such other financial system crutches as TARP and TLGP, will the Fed finally eliminate the PDCF. After all the Fed has repeated many times that its sole purpose is to strengthen the US dollar and to work on behalf of America's hundreds of millions of taxpayers, not the thousands of kleptocrats working on Wall Street. It would be nice once in our lifetime to see the Fed actually put its (ironically, that would be our) money where its mouth is.

Lastly, the bigger question is when will Gramm-Leach-Bliley finally be repealed. As long as commercial banks and dealers are allowed to commingle their balance sheets, and as long as firms like Goldman which have yet to open even one deposit branch exist and have a riskless balance sheet courtesy of the American taxpayer, nothing will ever change. The Gramm-Leach-Bliley act from 1999 was the precursor for the current symptom of Too Big To Fail. And the administration's response to date has been to make the firms at the top, even more systematically critical, when it should be focusing only on how to disintermediate them from the very fabric of America's capital markets.

The CPDF provides a glimpse into the Fed's, up to now speculative, and hereby confirmed, willingness to (in)directly manipulate equity markets via its Primary Dealer network. If there is no risk associated with borrowing practically free taxpayer money, it is obvious that banks will manipulate stock prices to the point where nobody but other Primary Dealers who enjoy the same Fed backstop benefits will remain in the market. As more and more American retail and institutional investors realize the magnitude of the scam, the risk that equity markets will remain an isolated bubble in perpetuity where Primary Dealers simply play around with the Fed's excess capital, becomes tangible. And as long as there is no regulatory reform to commence the split of TBTF institutions, as long as financial system crutches persist and as long as the opportunity cost of being wrong is zero (and borne only by US taxpayers), US equity markets will continue to be a scam. Therefore, Zero Hedge advises all readers to immediately remove all their capital from the stock market, until such time as proactive steps are taken to remedy these numerous concerns, or alternatively suffer the consequences of not only another Fed inflated market bubble, but the even sadder consequences of its unwind.

h/t Richard

Attachment	Size
An Overview Of The Fed's Intervention In Equity Markets Via The Primary Dealer Credit Facility.pdf	317.85 KB

Bruce Bartlett — yes THAT Bruce Bartlett — takes the usual suspects to school. He immolates the phony deficit hawks on the actual causes of the Federal shortfall (hint: Do unfunded tax cuts ring any bells?):

According to the Congressional Budget Office’s January 2009 estimate for fiscal year 2009, outlays were projected to be $3,543 billion and revenues were projected to be $2,357 billion, leaving a deficit of $1,186 billion. Keep in mind that these estimates were made before Obama took office, based on existing law and policy, and did not take into account any actions that Obama might implement.

Therefore, unless one thinks that McCain would have somehow or other raised taxes and cut spending (with a Democratic Congress), rather than enacting a stimulus of his own, then a deficit of $1.2 trillion was baked in the cake the day Obama took office. Any suggestion that McCain would have brought in a lower deficit is simply fanciful.

Now let’s fast forward to the end of fiscal year 2009, which ended on September 30. According to CBO, it ended with spending at $3,515 billion and revenues of $2,106 billion for a deficit of $1,409 billion.

To recap, the deficit came in $223 billion higher than projected, but spending was $28 billion and revenues were $251 billion less than expected. Thus we can conclude that more than 100 percent of the increase in the deficit since January is accounted for by lower revenues. Not one penny is due to higher spending.

Wow, when this guy burns bridges, he sure doesn’t fuck around!

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Hat tip Scotta!

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Source:
Why the Economy Needs Spending, Not Tax Cuts
Bruce Bartlett
Oct 24, 2009
http://capitalgainsandgames.com/blog/bruce-bartlett/1200/why-economy-needs-spending-not-tax-cuts

Die von der neuen Koalition vereinbarten erheblichen Steuersenkungen, vor allem fuer die Unternehmen und Besserverdiener, werden trotz der starken Staatsverschuldung mit der Erwartung gerechtfertigt, dass sie einen Boom ausloesen und so ueber steigende Steuereinnahmen die Absenkung kompensieren wuerden. Diese Rechnung wird wahrscheinlich nicht aufgehen, schon wegen gravierender Umstaende der derzeitigen schweren Krise.

By George Washington of Washington’s Blog.

What is the current American economy: capitalism, socialism or fascism?

Socialism

Initially, it is important to note that it is not just people on the streets who are calling the Bush and Obama administration’s approach to the economic crisis “socialism”. Economists and financial experts say the same thing.

For example, Nouriel Roubini writes in a recent essay:

This is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest…

The releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending.

Roubini has previously written:

We’re essentially continuing a system where profits are privatized and…losses socialized.

Nassim Nicholas Taleb says the same thing:

After finishing The Black Swan, I realized there was a cancer. The cancer was a huge buildup of risk-taking based on the lack of understanding of reality. The second problem is the hidden risk with new financial products. And the third is the interdependence among financial institutions.

[Interviewer]: But aren’t those the very problems we’re supposed to be fixing?

NT: They’re all still here. Today we still have the same amount of debt, but it belongs to governments. Normally debt would get destroyed and turn to air. Debt is a mistake between lender and borrower, and both should suffer. But the government is socializing all these losses by transforming them into liabilities for your children and grandchildren and great-grandchildren. What is the effect? The doctor has shown up and relieved the patient’s symptoms – and transformed the tumour into a metastatic tumour. We still have the same disease. We still have too much debt, too many big banks, too much state sponsorship of risk-taking. And now we have six million more Americans who are unemployed – a lot more than that if you count hidden unemployment.

[Interviewer]: Are you saying the U.S. shouldn’t have done all those bailouts? What was the alternative?

NT: Blood, sweat and tears. A lot of the growth of the past few years was fake growth from debt. So swallow the losses, be dignified and move on. Suck it up. I gather you’re not too impressed with the folks in Washington who are handling this crisis.

Ben Bernanke saved nothing! He shouldn’t be allowed in Washington. He’s like a doctor who misses the metastatic tumour and says the patient is doing very well.

Nobel prize winning economist Joseph Stiglitz calls it “socialism for the rich”.  So do many others.

Fascism?

Some, however, argue that the economy is more like fascism than socialism. For example, leading journalist Robert Scheer writes:

What is proposed is not the nationalization of private corporations but rather a corporate takeover of government. The marriage of highly concentrated corporate power with an authoritarian state that services the politico-economic elite at the expense of the people is more accurately referred to as “financial fascism” [than socialism]. After all, even Hitler never nationalized the Mercedes-Benz company but rather entered into a very profitable partnership with the current car company’s corporate ancestor, which made out quite well until Hitler’s bubble burst.

And Italian historian Gaetano Salvemini argued in 1936 that fascism makes taxpayers responsible to private enterprise, because “the State pays for the blunders of private enterprise… Profit is private and individual. Loss is public and social” (page 416).

This perfectly mirrors Roubini’s statement about the American government’s bailout plan.

Remember that one of the best definitions of fascism – the one used by Mussolini – is the “merger of state and corporate power“.

That could never happen in America, right?

Consider:

• The government has given trillions in bailout or other emergency funds to private companies, but is largely refusing to disclose to either the media, the American people or even Congress where the money went

• Congress has largely been bought and paid for, and two powerful congressmen have said that banks run Congress

• The head of the Federal Reserve Bank of Kansas City, the former Vice President of the Dallas Federal Reserve, and two top IMF officials have all said that we have – or are in danger of having – oligarchy in the U.S.

• Economist Dean Baker says that the real purpose of bank rescue plans was “A massive redistribution of wealth to the bank shareholders and their top executives”

• The big banks killed any real chance for financial reform months ago

Looting

As Examiner.com pointed out in May (it is worth quoting the essay at some length, as this is an important concept), looting has replaced free market capitalism:

Nobel prize-winning economist George Akerlof co-wrote a paper in 1993 describing the causes of the S&L crisis and other financial meltdowns. As summarized
by the New York Times:

In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer [co-author of the paper, and himself a leading expert on economic growth] said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

The Times does a good job of explaining the looting
dynamic:

The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greesnspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all…Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains…

What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.

In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it…Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

In fact, the big banks and sellers of exotic instruments pretended that the boom would last forever, siphoning off huge profits during the boom with the knowledge that – when the bust ultimately happened – the governments of the world would bail them out.

As Akerlof wrote in his paper:

[Looting is the] common thread [when] countries took on excessive
foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust…Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.  Indeed, Akerlof predicted in 1993 that the next form the looting dynamic would take was through credit default swaps – then a very-obscure financial instrument (indeed, one interpretation of why CDS have been so deadly is that they were the simply the favored instrument for the current round of looting).

Is Looting A Thing of the Past?

Now that Wall Street has been humbled by this financial crash, and the dangers of CDS are widely known, are we past the bad old days of looting?

Unfortunately, as the Times points out, the answer is no:

At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.

Bottom Line

So what do we really have: socialism-for-the-giants, fascism or an economy which calls itself “capitalism” but which allows looting?

Ultimately, it doesn’t matter. They are just different brand names for the same basic type of economy. All three systems allow giant businesses which are friendly to the government to keep enormous private profits but to pass the losses on to the government and ultimately the citizens.

Whether we use the terminology regarding socialism-for-the-giants (”socialized losses”), of fascism (”public and social losses”), or of looting (”left the government holding the bag for their eventual and predictable losses”), it amounts to the exact same thing.

Whatever we have, it isn’t free market capitalism.

Note: Yves Smith has called the financial services pay arrangement of “heads I win, tails you lose” looting, and has also argued that our form of capitalism is evolving into Mussolini style corpocracy, meaning fascism. But the label most often pinned on the Obama administration is socialism.

The bottom line is that I don’t put much stock in what socialists might label a system, any more than what fascists or corporate looters would label a system. Whatever you call it, if the giants get all the benefits and pawn all of the losses off on the public, it is a very dangerous system.

Hoisted from comments:

I am a lawyer who has been involved in corporate finance for over 25 years. First, if you beleive that securitization offers benefits (cost reductions) to consumers then MERS is not per se a bad thing in that it reduces overall transation costs which should in part be passed on to the homeowner borrower. As you note, the problem is more a change in standards (perhaps ethics and morality) in the last ten years in the industry.

The problem is not MERs by itself but how the securitization industry has changed in recent years to the detriment of cosumers and investors in the banks and other companies that have blown up as a result of an important industry being turned into basically a circus. I can share my own expereince as a homeowner to demonstrate how crazy things have become.

I had a mortgage on my home that was originated over 15 years ago at a local bank. The mortgage had been sold (through five intervening transactions)over the years to Washington Mutual. Two years ago I decided to pay the loan off. At the end of a month, I sent in a check for the full balance of principal and interest on the loanand requested a deed release be filed. This was all in accordance with the terms of my promissory note and mortgage the legal agreement governing all parties.

Two weeks later I received my check back in the mail from WMU with a letter stating that the payoff was not in accordance with Washington Mutual policy. No one at Washington Mutual had bothered to read the mortgage agreement (the legal agreement binding the parties). Instead the letter stated that payoffs had to be preceeded by paying $75 for a “payoff quotation” and must be made by wire transfer and other terms which were obviously made to increase the profitablity to WMU which had no basis in the legal agreements.

Since WMU had no legal basis for its demands, I stopped paying my mortgage. Within three months my credit score had been lowered 300 points, all of my credit cards were canceled (I never kept a balance on any card) and I was receiving daily harrassing collection calls. Eventually, I sent a couple of letters to the WMU General Counsel’s office and began to work towards a class action lawsuit. Despite this, it took another three months to get someone’s attention at WMU who could put two and two together and I finally received a call and letter from a senior attorney who agreed to forgive thousands of dollars in interest, put a person full time on reestoring my FICO score etc etc. and fix the problems that never should have occured.

The point is that the securitization industry 5-10 years ago made a collective choice to ignore the terms of contracts, state and local laws and legal convesntions developed over hundreds of years. Why? Because they could. Our legal system and conventions were built on the assumption that most businesses would choose to follow them. Instead, the securitization industry simply developed a cost/benefit approach to following the law and adhering to contracts. It worked quite well becaseu most individuals just aren’t equipped to read and enforce their mortgage agreements or fully understand the law.

This is why the banks are fighting so hard against the Consumer Financil Protection Agency. The CFPA will have the ability to level the playig field and thus change the economics of banks simply ignoring laws, contracts and convention.

Note this mess got resolved only because the consumer in question was an attorney, and he still had to threaten a class action suit to get the servicer’s attention. And even then, it took months to clear matters up, and completely trashed his credit score in the meantime, resulting in the loss of ALL his credit cards.

How many people can afford that? Seriously. For instance, if you need to rent cars or stay in hotels in your line of work, and either your company does not provide you a corporate credit card, or you are self employed (business credit is based on your personal FICO), you’d be stuck. And if you were looking for a job, many employers pull a credit report and will not consider a candidate with a low FICO.

In other words, very few people are able to contest abusive behavior and overbilling by servicers due to the hard costs (attorney’s fees) and soft ones (damage to credit score).

Update 5:20 PM: Another sighting courtesy reader i on the ball patriot:

Bank of America and Countrywide Home Loans destroyed mortgage documents, and “recreate” them by “insert(ing) data as they see fit,” to cover up their own failure to keep records – or their fraud – according to a federal RICO class action.

Article continues here.
Update 9:30 PM: Further detail from the lawyer who provided the comment at the start of the post:

To clarify:

1. I sent WAMU a personal check for the full mortgage balance in accordance with the terms of my Promissory Note.

2. WAMU returned the check -not cashed- becasue I had not paid the additional fees that WAMU had unilaterally imposed as a precondition to paying off the mortgage. I stopped paying because I had a legal right to do so after tendering the correct payoff.

3. Yes, I was in a position that the vast majority of consumers are not – both as an attorney and being able to live without credit of any sort for an extended period. I’m old school and never borrowed except for home mortgages.

I beleive the fallout from the mass assignments (and re-assignments) is just starting from an administrative standpoint. I helped a friend this summer who had sold her house in Boston but was unable to close the sale because an earlier mortgage lender had failed to file a Deed of Release after being paid off with a refinancing a couple of years ago.

The prior lender had flipped the mortgage and had gone bankrupt. The payoff went to a lender three links down the chain and the attorney handling the refi never obtained copies of assignements or the Deed of Release from the parties. The immediate resolution was to close the current sale (a neceesity given the market) and hold all of the sale proceeds in escrow until a Deed of Release could be obtained. I spent two months tracking down a senior executive fromn the bankrupt lender who after weeks of cajoling and ultimately legal threats agreed to sign a Deed of Release which we filed. The ironic part of it is that the executive actually had no legal right to sign the Deed of Release becasue the bankrupt lender had sold the loan and had no right to sign the release.

Sounds like a nightmare right? It was and would have cost my friend probably $25K to get it resolved. I know because I spoke with a couple of attorneys who are are speacilizing in this kind of thing – a very recent specialization caused by the increasing frequency of problems associated with the caviler treatment of assignments by the industry.

Lastly,I would add that the reason for MERs existence is transitory. Electronic signatures are now valid in every state I beleive and deed registrys across the country are adopting electronic filings and records. I estimate 3-5 years before all the filings are done online.

Here is a question I will be asking my freshman seminar this week:

You are a utilitarian social planner. You have a limited number of H1N1 vaccines. How do you allocate them? Do you (A) give them to specific groups, such as high-risk populations, or (B) sell them to the highest bidder and rebate the revenue lump-sum to everyone? If you choose (A), do you allow those individuals allocated the vaccine to sell their dose to someone else? Be sure to specify the economic environment as carefully as possible. And remember: Your goal is to maximize total utility.

It will be a busy week ... a few coming highlights:

Tuesday: Case-Shiller Home Price Index for August (expect another increase).

Wednesday: Durable goods orders and New Home Sales.

Thursday: Q3 GDP (Consensus is 3.0%).

***************************************
A few articles and graphs from last week:

A comment: Existing Home Sales: More Activity, Little Achievement

From Dave Altig at Macroblog: The growing case for a jobless recovery

Freddie Mac: Delinquency Rate Rises to 3.33 Percent

Problem Bank List (Unofficial) Oct 23, 2009

From Tami Luhby at CNNMoney: 7,000 unemployed Americans lose their lifeline every day

***************************************
Click on graph for larger image in new window.

This graph shows the builder confidence index from the National Association of Home Builders (NAHB).

The housing market index (HMI) decreased to 18 in October from 19 in September. The record low was 8 set in January. Note that Traffic of Prospective Buyers declined sharply.

This is still very low - and this is what I've expected - a long period of builder depression.

From NAHB: Builder Confidence Decreases Slightly in October

***************************************
This graph shows a comparison of the Moodys/REAL Commercial Property Price Index (CPPI) and the Case-Shiller composite 20 index. CRE prices only go back to December 2000.

The Case-Shiller Composite 20 residential index is in blue (with Dec 2000 set to 1.0 to line up the indexes).

This shows residential leading CRE (although we usually talk about residential investment leading CRE investment, but in this case also for prices), and this also shows that prices tend to fall faster for CRE than for residential.

From Bloomberg: U.S. Commercial Property Values Fall 3% in August

The Moody’s/REAL Commercial Property Price Indices fell 3 percent in August from July, bringing the market’s decline to almost 41 percent since its peak in October 2007, Moody’s Investors Service said in a statement today.

From Moody’s: CRE Prices Off 41 Percent from Peak, Off 3% in August ***************************************
Total housing starts were at 590 thousand (SAAR) in September, up 0.5% from the revised August rate, and up sharply from the all time record low in April of 479 thousand (the lowest level since the Census Bureau began tracking housing starts in 1959). Starts had rebounded to 590 thousand in June, and have move sideways for four months.

Single-family starts were at 501 thousand (SAAR) in September, up 3.9% from the revised August rate, and 40 percent above the record low in January and February (357 thousand). Just like for total starts, single-family starts have been at this level for four months.

From Housing Starts in September: Moving Sideways

***************************************
This graph shows the Architecture Billings Index since 1996. The index has remained below 50, indicating falling demand, since January 2008.

Note: Nonresidential construction includes commercial and industrial facilities like hotels and office buildings, as well as schools, hospitals and other institutions.

Historically there is an "approximate nine to twelve month lag time between architecture billings and construction spending" on commercial real estate (CRE). This suggests further dramatic declines in CRE investment through most of 2010, if not longer.

From AIA: Architectural Billings Index Shows Contraction

***************************************
This graph shows existing home sales, on a Seasonally Adjusted Annual Rate (SAAR) basis since 1993.

Sales in Sept 2009 (5.57 million SAAR) were 9.4% higher than last month, and were 9.2% higher than Sept 2008 (5.1 million SAAR).

From Existing Home Sales Increase in September

***************************************
Here is a map of the three month change in the Philly Fed state coincident indicators. Forty one states are showing declining three month activity. The index increased in 7 states, and was unchanged in 2.

From Philly Fed State Coincident Indicators Show Widespread Weakness in September

***************************************

August CRE trends continued their downward trends, with a bevy of trackers of CMBS performance, Moody's, Fitch, Realpoint and TREPP seeing substantial deterioration in September. According To TREPP the August delinquency rate was up to 4.35% from 4.03. Legacy rating agencies Moody's and Fitch indicated a comparable acceleration in delinquency trends, with September 60-delinquencies at 3.64% and 3.58%, up from 3.04% and 3.23% respectively. New CRE NRSRO Realpoint had an even higher September reading at 4.15% up from 3.47% in the previous month.

This deterioration is in line with the Moody's Real CRE Index, which showed continued decline in apartment value, at 131.9 in June, down 24.4% from a year ago, when TREPP had apartment delinquencies at just 1.72%, and has now risen to 7.05%. Additionally, it sees hotel delinquencies at 6.72%. Practically put, this means that over $8 billion of apartment loans and $5 billion of hotel loans are more than 30 days late. Look for both of these numbers to decline significantly.

The apartment delinquency rate is set to have a step-wise deterioration any second, as the rate does not include $3 billion in securitized debt associated with the Stuy Town which is about to have much bigger problems than mere delinquency, as the $650 million in initial reserves run out in December as Zero Hedge discussed previously. When Stuy Town becomes delinquent, the apartment delinquency rate will finally surpass 10%.

And for a real-life example of the merciless deterioration in CRE, this week's shining example is the 566,000 sq. foot office building at 550 South Hope Street in Los Angeles, which last month was reappraised at a stunning $121 million: a whole $114 million less than its 2007 appraisal value. That was the time when a $165 million mortgage on the property was securitized. As the CMBS deal will now be hit with interest shortfall payments, CMBS investors can not be happy, especially the junior tranches. The way interest shortfall are effected is that master servicers advance payments to bondholders on loans that are delinquent until loans are reappraised. Once appraised, the amount of advances gets reduced by the new collateral value, with the resulting delta called an appraisal subordinate entitlement reduction (ASER) and, as expected, results in a shortfall of interest payments that first impacts the most junior CMBS tranches then goes up the deal.

The other notable thing about the deal is that the CMBS deal securitizing the property, GS Mortgage Securities Corp., II, 2007-GG10, is one of the largest CMBS deals ever issued and is very widely held. The property was part of a major $3 billion portfolio acquisition by near-defunct Maguire Properties, which bought 550 South Hope and several other assets from Blackstone. MPG which earlier this year was on the verge of bankruptcy, stated it would stop subsidizing six properties and work with loan services to dispose of collateral in an orderly fashion. In addition to GG10, MPG also owns $103.5 MM of debt on 500 Orange Tower in Orange, CA., famous for being next door to the Anaheim Angels stadium. This loan is likely to be impaired quickly once MPG's guaranteed payments expire in December, and as expected market-rate lease rolls have failed to materialize, thus putting the expected $11.9 million in needed net cash flow annually in jeopardy.

Via CRE Direct, h/t Bankster

What is the current American economy: capitalism, socialism or fascism?

Socialism

Many people call the Bush and Obama administration's approach to the economic crisis "socialism".

Are they right?

Well, Nouriel Roubini writes in a recent essay:

This is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest...

The releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending.

Roubini has previously written:

We're essentially continuing a system where profits are privatized and...losses socialized.

Nassim Nicholas Taleb says the same thing:

After finishing The Black Swan, I realized there was a cancer. The cancer was a huge buildup of risk-taking based on the lack of understanding of reality. The second problem is the hidden risk with new financial products. And the third is the interdependence among financial institutions.

[Interviewer]: But aren't those the very problems we're supposed to be fixing?

NT: They're all still here. Today we still have the same amount of debt, but it belongs to governments. Normally debt would get destroyed and turn to air. Debt is a mistake between lender and borrower, and both should suffer. But the government is socializing all these losses by transforming them into liabilities for your children and grandchildren and great-grandchildren. What is the effect? The doctor has shown up and relieved the patient's symptoms – and transformed the tumour into a metastatic tumour. We still have the same disease. We still have too much debt, too many big banks, too much state sponsorship of risk-taking. And now we have six million more Americans who are unemployed – a lot more than that if you count hidden unemployment.

[Interviewer]: Are you saying the U.S. shouldn't have done all those bailouts? What was the alternative?

NT: Blood, sweat and tears. A lot of the growth of the past few years was fake growth from debt. So swallow the losses, be dignified and move on. Suck it up. I gather you're not too impressed with the folks in Washington who are handling this crisis.

Ben Bernanke saved nothing! He shouldn't be allowed in Washington. He's like a doctor who misses the metastatic tumour and says the patient is doing very well.

Nobel prize winning economist Joseph Stiglitz calls it "socialism for the rich". So do many others.

Fascism?

Some, however, argue that the economy is more like fascism than socialism. For example, leading journalist Robert Scheer writes:

What is proposed is not the nationalization of private corporations but rather a corporate takeover of government. The marriage of highly concentrated corporate power with an authoritarian state that services the politico-economic elite at the expense of the people is more accurately referred to as "financial fascism" [than socialism]. After all, even Hitler never nationalized the Mercedes-Benz company but rather entered into a very profitable partnership with the current car company's corporate ancestor, which made out quite well until Hitler's bubble burst.

And Italian historian Gaetano Salvemini argued in 1936 that fascism makes taxpayers responsible to private enterprise, because "the State pays for the blunders of private enterprise... Profit is private and individual. Loss is public and social" (page 416).

This perfectly mirrors Roubini's statement about the American government's bailout plan.

Remember that one of the best definitions of fascism - the one used by Mussolini - is the "merger of state and corporate power".

That could never happen in America, right?

Consider:

• The government has given trillions in bailout or other emergency funds to private companies, but is largely refusing to disclose to either the media, the American people or even Congress where the money went

• Congress has largely been bought and paid for, and two powerful congressmen have said that banks run Congress

• The head of the Federal Reserve Bank of Kansas City, the former Vice President of the Dallas Federal Reserve, and two top IMF officials have all said that we have - or are in danger of having - oligarchy in the U.S.

• Economist Dean Baker says that the real purpose of bank rescue plans was "A massive redistribution of wealth to the bank shareholders and their top executives"

• The big banks killed any real chance for financial reform months ago

Looting

As Examiner.com pointed out in May (it is worth quoting the essay at some length, as this is an important concept), looting has replaced free market capitalism:

Nobel prize-winning economist George Akerlof co-wrote a paper in 1993 describing
the causes of the S&L crisis and other financial meltdowns. As summarized
by the New York Times:

In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer [co-author of the paper, and himself a leading expert on economic growth] said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

The Times does a good job of explaining the looting
dynamic:

The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greesnspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all...Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains...

What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.

In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it...Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

In fact, the big banks and sellers of exotic instruments pretended that the boom would last forever, siphoning off huge profits during the boom with the knowledge that - when the bust ultimately happened - the governments of the world would bail them out.

As Akerlof wrote in his paper:

[Looting is the] common thread [when] countries took on excessive
foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust...Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Indeed, Akerlof predicted in 1993 that the next form the looting dynamic would take was through credit default swaps - then a very-obscure financial instrument (indeed, one interpretation of why CDS have been so deadly is that they were the simply the favored instrument for the current round of looting).

Is Looting A Thing of the Past?

Now that Wall Street has been humbled by this financial crash, and the dangers of CDS are widely known, are we past the bad old days of looting?

Unfortunately, as the Times points out, the answer is no:

At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.

Bottom Line

So what do we really have: socialism-for-the-giants, fascism or an economy which calls itself "capitalism" but which allows looting?

Ultimately, it doesn't matter. They are just different brand names for the same basic type of economy. All three systems allow giant businesses which are friendly to the government to keep enormous private profits but to pass the losses on to the government and ultimately the citizens.

Whether we use the terminology regarding socialism-for-the-giants ("socialized losses"), of fascism ("public and social losses"), or of looting ("left the government holding the bag for their eventual and predictable losses"), it amounts to the exact same thing.

Whatever we have, it isn't free market capitalism.

Note: Yves Smith has called the financial services pay arrangement of "heads I win, tails you lose" looting, and has also argued that our form of capitalism is evolving into Mussolini style corpocracy, meaning fascism. But the label most often pinned on the Obama administration is socialism.

The bottom line is that I don't put much stock in what socialists might label a system, any more than what fascists or corporate looters would label a system. Whatever you call it, if the giants get all the benefits and pawn all of the losses off on the public, it is a very dangerous system.

Freddy King, known as "The Texas Cannonball", was one of the most influential yet unknown blues artists of the 1960's and early 1970's. Unfortunately, he died at the age of 42 of heart failure. King inspired many young white guitarists around the world including Eric Clapton and Peter Green (Fleetwood Mac).

"The only bubble I see developing in the world right now is in long-term government bonds in the United States. The idea that somebody would lend money to the United States for 30 years in U.S. dollars at 4 or 5 or 6 percent interest is incomprehensible to me. I'm not short bonds right now because the government keeps driving them up—I don't know how long they're going to do it—but I do suspect and hope that sometime in the next year or two, I'll be shorting U.S. government bonds, because that's the only bubble I see developing."

Related assets: ProShares UltraShort 20+ Year Trea (ETF), NYSE: TBT

Timothy R. Homan, writing for Bloomberg says GDP Probably Grew as Stimulus Took Hold

The economy in the U.S. probably grew in the third quarter at the fastest pace in two years as government stimulus helped bring an end to the worst recession since the 1930s, economists said before reports this week.

The world’s largest economy grew at a 3.2 percent pace from July through September after shrinking the previous four quarters, according to the median estimate of 65 economists surveyed by Bloomberg News. Other reports may show sales of new homes and orders for long-lasting goods increased.

Americans flocked to auto showrooms and real-estate offices last quarter to take advantage of government programs such as “cash-for-clunkers” and tax credits for first-time homebuyers. Growing demand caused stockpiles to keep falling, which will prompt companies to rev up assembly lines and help sustain the recovery into 2010 even as unemployment climbs.

“The recovery is off to a decent but unspectacular start,” said Joe Brusuelas, a director at Moody’s Economy.com in West Chester, Pennsylvania. “While another large drawdown in inventories will be a drag on third-quarter growth, it sets the stage for a longer and stronger upturn in manufacturing.”

Consumer spending last quarter probably jumped at a 3.1 percent annual rate from the previous three months, the biggest gain since the first quarter of 2007, the GDP report is also projected to show.

September readings on household purchases, due from the Commerce Department on Oct. 30, may show the quarter ended on a soft note after the Obama administration’s car incentive expired the month before. Spending probably fell 0.5 percent last month as car sales slowed after jumping 1.3 percent in August, the biggest gain since 2001.

The so-called cash-for-clunkers program offered buyers discounts of as much as $4,500 to trade in older cars and trucks for new, more fuel-efficient vehicles. The plan boosted sales by about 700,000 vehicles, according to a Transportation Department estimate.

Homebuyer Credit

The administration’s $787 billion stimulus package, signed into law in February, included an $8,000 tax credit for first- time homebuyers that expires at the end of November.

Take Hold Of What?

If the government gave everyone $4,500 I am sure we would see a fine increase in spending. However, I am equally sure nothing would "take hold" except that the dollar would go into a free-fall, which of course is the opposite of take hold.

Cash for clunkers ended, pushing demand forward. Now what?

Uncle Sam Adds 5% to Prices of Homes

Goldman Sachs says Uncle Sam Adds 5% to Prices of Homes.

Uncle Sam’s interventions in the housing market have pushed home prices 5% higher on a national average than they would have been otherwise, Goldman Sachs estimates in a report released late Friday.

The government over the past year has slowed the pace of foreclosures through moratoria and the drive to modify mortgage terms to keep more borrowers in their homes. It also has pumped up demand for housing by giving tax credits to many first-time home buyers and by driving down mortgage interest rates. As a result, home prices in some areas have risen in recent months, particularly for homes that appeal to investors and first-time buyers. Bidding wars for the more attractive bank-owned homes have become common.

But these artificial props won’t last forever and may have created a false bottom in the market. “The risk of renewed home-price declines remains significant,” Goldman economist Alec Phillips writes in the report, “and our working assumption is a further 5% to 10% decline by mid-2010.”

False Bottom Indeed

I am and have been in the "false bottom" camp (even calling for a false bottom in advance). The fact remains, homes are still not affordable and inventories are high, yet artificially low. How can that be? Easy. There is a huge amount of shadow inventory as noted in Zombie Subdivisions and "Pig In The Python" Shadow Inventory.

That shadow inventory is poised to come out of the woodwork in the next decline as the pool of early fools dries up. Granted, there are way more bargains than three years ago when there were no bargains at all, but most are jumping the gun and this insane $8,000 tax credit is not helping anything in the long run.

Unfortunately, the tax credit is temporarily inflating home prices that are still out of line with wage and job growth. Once the stimulus ends, prices will resume deflating. Moreover, even if the stimulus does not end, prices will resume deflating (it will just take longer).

Shrinking Pool Of Greater Fools

Once everyone who wants a house and can afford a house has one, price appreciation will stall or go into reverse. The difference between now and 2006 is people are not buying 3 houses and a vacation home. Nor are lenders willing to finance three houses and a vacation home. Nor are lenders willing to do liar loans, pay option ARMs or other toxic financing. Thus, the pool of greater fools is far smaller than in 2006.

UK Stimulus Dies On Vine

Across the Atlantic, things are not looking so hot in the UK. Please consider BOE More Likely to Expand Bond Purchases After GDP Slump.

Britain’s failure to escape the worst recession since World War II may force the Bank of England to increase its bond-purchase plan next month, economists said.

Seven months after Governor Mervyn King’s central bank started a 175 billion-pound ($286 billion) program to rescue the economy, the Office for National Statistics said yesterday gross domestic product unexpectedly shrank 0.4 percent in the third quarter. None of the 33 economists surveyed by Bloomberg predicted a contraction.

The GDP figures “reopen a serious possibility that the Monetary Policy Committee increases its QE target,” said Philip Shaw, chief economist at Investec Securities in London, in a note titled “Champagne Corks Go Back Into Bottles.”

“It seems to me inconceivable that the recession is deepening and the housing market is recovering,” said Steven Bell, chief economist at London-based hedge fund GLC Ltd. and a former U.K. Treasury official. “The last refuge of the failed forecaster is to challenge the statistics, but that’s what I’m left with.”

Illusion of Stimulus

Here is a snip worth rereading from U.S. Faces Second Lost Decade "Because" of Misguided Stimulus written by my friend "HB"

I know Romer best for her misinterpretation of what happened in 1937-38. She believes that the fallback into full-scale depression from 'depression light' (as evidenced by unemployment in 1938 almost returning to the highest levels of the depression trough 32/33) is proof that it was a mistake to tighten policy (fiscal and monetary) too early.

In other words, according to her, if the Fed had continued pumping as furiously as possible, then everything would have been alright.

In reality, the entire inflationary mini-boomlet-within-the-depression was simply an illusion. 'GDP growth' that is bought with monetary pumping and feckless fiscal spending only misdirects and ultimately consumes even more scarce capital.

Fiscal stimulus may temporarily give the impression of a recovery, but it is not a genuine recovery. It makes things worse. The moment the pumping is abandoned, the true state of affairs is simply unmasked. That is what happened in 37/38 - a slight tightening of monetary policy revealed the fact that the mini-boomlet was as unsound as its predecessor boom in the years prior to the '29 crash.

It would not have been possible to hide this reality forever. There is nothing, absolutely nothing, that government intervention can achieve in terms of 'fixing' the economy. The choice was in either abandoning the unsound policy and the unsound investments it produced, or careen toward a complete destruction of the currency system.

Once again, I stand amazed at how people can look at this, and look at Japan, and look at the housing bubble/bust sequence, and still believe that monetary pumping and deficit spending are viable tools of economic policy when a bust occurs. It really boggles the mind, reminding me of Einstein's definition of insanity, 'doing the same thing over and over again and expecting a different result'.

Champagne Corks To Go Back Into Bottles

The hard reality of an "L" shaped recovery or a string of "WWs" looms large, leading indicators be damned. Please see A Look at ECRI's Recession Predicting Track Record for details.

Any celebrating in the US (or Canada, or China, or Australia, or anywhere else) is simply premature.

In the coming months, expect to see more comments like “The last refuge of the failed forecaster is to challenge the statistics, but that’s what I’m left with.”

By the way, that is how the term "stagflation" came about. Under misguided Keynesian logic it was impossible to have a recession and inflation at the same time. We all know how that worked out.

In the US and globally we are in uncharted territory. Odds are we will see many things we have never seen before as stimulus after stimulus fails to produce desired results. Actual results, as in the examples above may very well be unbelievable to all the Keynesian and Monetarist clowns.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

by Rebecca

Policymakers across Latin America are announcing measures to stem currency appreciation against the $US. Since March 2009, the $US depreciated 25% against the Colombian peso, 28% against the Brazilian real, 14% against the Mexican peso, 12% against the Peruvian nuevo sol, and 11% against the Chilean peso.

Much of the $US's lost value is due to a renewed risk appetite as the "flight to (US) quality" unwinds somewhat. Even so, emerging market policymakers are worried; and governments across the region are stepping up to halt the appreciation either directly (Peru) or with quasi-capital controls (Brazil).

The Brazilian government announced a 2% tax on foreign capital flows into the domestic fixed income and equity markets. And to Brazil's northwest, the Colombian central bank on Friday announced plans for direct intervention in the foreign exchange market to the tune of 3 trillion pesos (only after lesser and indirect measures announced the previous week proved only transiently effective). And Peru's central bank has been purchasing $US on a regular basis since September 2009.

As the chart above illustrates, the Banco Central de Reserva del Perú has been very successful in stemming the appreciation. Colombia's initial efforts (like halting the repatriation of foreign dollar holdings) were successful but only to a point - the peso fell almost 4% against the $US; but since then, the peso has settled to around 1917 Peso/$US. Brazil's efforts, however, did little to break the trend of the real: the $US appreciated roughly 2% in the wake of the capital tax announcement, but the BRL (the real) gained back every bit of value that it lost in about 2.5 days. As one of my colleagues said, "you can't submerge a beach ball".

I suspect that Colombia's direct intervention announced on Friday will successfully drive down the value of the peso, as the foreign capital inflows are primarily from $US-denominated government bond issues (little equity flows). It's kind of interesting that the government is concerned about the appreciation of the peso but issuing debt denominated in $US.......

Brazil's capital markets are too big and too enticing to foreigners right now (see charts below) - more direct measures are needed to stop the BRL's appreciation. We will see if the Banco Central do Brasil goes there - Asia's certainly doing it!















Text added: The charts illustrate the EXTERNAL bond and equity issuance by country as a share of total issuance in Latin America from the IMF Global Financial Stability Report.

Rebecca Wilder

I guess if you look at starts in a certain way — and ignore the obvious seasonality — they may appear to be up, but . . .

>

Hat tip Rob

The Rydex market timers are all in again.

From Carolyn Lochhead at the San Francisco Chronicle: Experts see rebounding economy shedding jobs

Forget a jobless recovery. The economy may be entering a recovery with job losses.
...
"It's not even a jobless recovery; it's a recovery with more job losses," said UCLA economist Lee Ohanian. "The idea of having essentially no net job creation after a remarkably severe recession is a real pathology for the U.S. economy."
...
Alarms are ringing at the White House and in Congress. But with a mind-boggling $1.4 trillion deficit this year, Democrats have used up their bullets. The word stimulus has such a bad connotation that the term has been banished from new efforts to goose the economy and help workers, such as extending unemployment benefits, sending $250 checks to seniors and a program the White House announced to help small businesses get loans.

As I noted earlier this week, so far the current recovery is even worse than "jobless"; it is a "job-loss" recovery.

This will be hot topic over next couple of months. Maybe the forecasts will be too pessimistic, but without jobs, it isn't much of a recovery.

After my recent post political stability and the middle class, some distubing items have appeared:

• The debtors' revolt continues. A story in the New York Times reports that the courts are taking a dim view of lenders who try to foreclose without proper documentation. If this trend continues, chaos will ensue.
• There is more backlash against Wall Street. Speaking about bankers' bonuses, the vice-chairman at Goldman Sachs stated that the public must "tolerate the inequality as a way to achieve greater prosperity for all" - an unfortunate remark picked up by The Guardian. Meanwhile, a headline in the alternative press reads After the Billionaires Plundered Alabama Town, Troops Were Called in ... Illegally.

Watch out for the pitchforks. Down that road is turmoil, political disintegration, and chaos.

Simon Johnson is proving to be prescient. These stories sound like the sorts of things that might happen in an emerging market country in financial trouble. Is there any wonder why there is downward pressure on the US Dollar?

Fujisan here.

As the earnings season is winding down, we are going to see the change of the season of the equity market.  I found that it's much easier to spot the intermediate tops of the individual stocks than the major indices.  I am going to discuss the option strategies after the earnings season. 

Before I get into my weekly option topics, here are some updates on the general market:

SPX and EUR/USD Update:

Here is an updated comparison of the current and 1975 SPX charts.  Once again, our trader friend, ZigZag, kindly agreed to share his work.  Thank, ZZ!

Here is my updated SPY chart.

Here is my EUR/USD chart update.  My target has not changed since the formation of the bull flag back in July.  We are getting very close to the price projection.

As many of you know, I trade GOOG up, down, and sideways.  A couple of weeks ago, I discussed the option strategies to take advantage of the earnings, and now, after the party is over, GOOG is going through a consolidation phase.

The beauty of trading the options is that you can trade the sideway movements.  Yes, that's right.  You can make money on a sideway movement if you could define the price range and apply the proper strategy. Let's go through a couple of examples. 

GOOG

As you can see, GOOG goes through a very narrow range of consolidation after the earnings - typically in the range of $40 up and down.  In addition, I don't see any divergences between the price movement and Oscillator, so GOOG is not ready to roll over just yet.

When you see a very narrow range of consolidation like this, you can apply "income" strategies like ATM (at the money) butterfly, ATM iron condor, double diagonal, double calendar, etc. and still have a chance to have a very high yield on your investment over the life of the options.

Income strategies typically employs delta neutral position (meaning you don't make money on the price movement) with positive theta (meaning you collect option premium on a daily basis instead of losing it),

Here is an example of ATM iron condor.  This position basically covers that $40 estimated movement of the underlying, which is between $535 and $575.  As long as GOOG is within this price range, you could double your money by the next OPX.

What if it breaks out of the range? - Even if it breaks out of this range, my risk is only $50~$80 over the estimated profit of $545.  Risk/reward is just too good not to take this trade.  All I have to do is to close out the legs that were broken, and keep the other legs which is still making money.  This is a Win-Win strategy!

If you have a particular bias as to which way the underlying is going to break out, you could simply put on one side of the legs instead of both sides.  This is called a "credit spread".

Here is an example of 570/580 credit spread.  This spread is to buy 580 Nov Call and sell 570 Nov Call.  The other side of the spread is 530/540 credit spread, and these two credit spreads make my ATM iron condor as illustrated above.

GS

Here is another wonderful example of the range-bound stock.  As I illustrated last week, GS is forming the world infamous H&S pattern with a very defined support and resistance levels.  As long as the underlying is trading within this range, you can apply the same income strategies to take advantage of the sideway move.

Here is an example of 165/170/185/190 Iron Condor.  This is a combination of 165/170 bull put spread and 185/190 bear call spread.

The risk that I see here is that GS could come back and retest the recent high and form M pattern instead of H&S pattern.  As we are getting close to the major support line, you could put on the bull put spread first at the neckline, and then put on the bear call spread once GS gets to the shoulder level in order to complete the Iron Condor.  If this sounds too complicated, simply put this thing on altogether.

For those who like to take more of an intermediate term position, here is December 190/170 bear put spread.

IBM

Similar price action as GS with H&S pattern formation. 

Here is an example of Iron Condor.  I was able to put it in at a very good price and I'm already in a money.  Risk/reward is not as good as GS or GOOG example.  If you are planning to put it on, please wait for a good entry point.

If you don't want to deal with the other side of the credit spread, here is more of an intermediate term position of December 115/125 bear put spread.

Ok, this should be enough charts for the weekend. I hope everyone has a wonderful weekend!

Submitted by Edward harrison of Credit Writedowns

Yves covered this in an earlier post overnight. Here’s my take. This is probably my fourth post on the tangled web woven by securitization, which puts a considerable distance between home owners and mortgagees which own a mortgage.  The issue is causing huge problems in bankruptcy and foreclosure in courts around the U.S. 

Update: I now see Barry Ritholtz has a piece out on this as well.

This morning, Gretchen Morgenson has another good piece out describing how a judge nixed all claims by mortgagee which refused to modify a home owner’s mortgage.

The debtors’ revolt is on.

For decades, when troubled homeowners and banks battled over delinquent mortgages, it wasn’t a contest. Homes went into foreclosure, and lenders took control of the property.

On top of that, courts rubber-stamped the array of foreclosure charges that lenders heaped onto borrowers and took banks at their word when the lenders said they owned the mortgage notes underlying troubled properties.

In other words, with lenders in the driver’s seat, borrowers were run over, more often than not…

But some judges are starting to scrutinize the rules-don’t-matter methods used by lenders and their lawyers in the recent foreclosure wave. On occasion, lenders are even getting slapped around a bit.

One surprising smackdown occurred on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

I see this as a watershed case in jurisprudence surrounding mortgage-related bankruptcies and foreclosures.  The reason this is huge is that it echoes the case in Kansas I have written about in two previous posts:

• “Why mortgages aren’t modified and what a ruling stopping foreclosures means”
• “What are the legal rights of lenders and homeowners in foreclosure?”)

At issue is the question of what legal rights do lenders or their agents have in foreclosure in the new byzantine world of securitized mortgages.  In the New York case the judge nixed the entire claim as the mortgagee could not prove it had legal claim to the mortgage note. With the mortgagee unable to show ownership, the homeowner might even be able to stay in his home mortgage-free, Morgenson attests. That’s huge – and we should definitely expect an appeal.

In the Kansas case, MERS, a mortgage registrar, and a second-mortgage mortgagee were not informed of the homeowners bankruptcy and disposition of assets and claims before judgment was made. Nevertheless, the district court, the appeals court AND the Kansas supreme court all upheld the original summary judgment arguing that MERS was not contingently necessary.  While I would expect this case to be appealed because of the precedent it could set, I don’t see how it can be overturned after affirmation in every court – that is except through a politicization of the verdict.

Notice how PHH and MERS, the two lender agents in each cases, are not the actual owners of the mortgages. They are the agents of the mortgagees. This is why these cases have a lot to do with securitization

See also: How much money is Wells Fargo really making? for how some of this affects earnings at money center banks.

Morgenson had another article of merit on this topic last week. See her piece The Mortgage Machine Backfires.  This could get interesting.

Oh, and in an unrelated case, but also involving bank customers successfuly contesting big finance, Citibank Belgium is being held liable by state prosecutors for duping its savers into taking safe money out of their savings account and investing it in Lehman Brothers. When Lehman went bust, 128 million euros of their savings money went poof. See my story here. Agence France Press has covered it, but don’t expect it to get huge coverage in the U.S. Mish thinks Citigroup is in “serious trouble” globally. So do I. Let the backlash against reckless finance begin.

Projective testing has a long history within psychology. The basic idea is simple: people look at ambiguous images (inkblots, in the case of the Rorschach test; pictures of people doing things in the Thematic Apperception Test) and explain what they see. What we project into the pictures is believed to say something about our ways of seeing the world; it also says something about how we organize our perceptions and thoughts.

Consider the Rorschach image above, which I pulled from the Web. When I first took the test as a graduate student, I saw two things:

1) The bottom left and right were "two seahorses, turning from each other in a bashful way."

2) Turning the card upside down, I said that it looked like "two African native women cooking over a kettle, maybe as part of a ceremony".

All in all, those are responses you might expect from a psychologist-to-be: largely harmonious images of people (or animals-as-people) interacting with each other. The form of the responses dominated the use of shading or color, which is also typical for me--a more intellectual than emotional style of responding to the world.

In reality, we don't need cards to assess people in a projective manner. Anytime we face a relatively blank or ambiguous situation, we tend to respond with our own needs, values, and feelings.

Time may be the best projective test of all. What do people do when they don't have anything that they *need* to do? Unstructured time gives us no cues: we have to create activity--and what we create says something about who we are.

After a long work week, I knew that I would have unstructured time on Saturday. The thought of relaxing for a day never entered my head. I knew my daughter (who has some diagnosed learning problems) was having some problems in a couple of her college courses, so I drove to her campus and we spent the afternoon studying--just as we had in high school. For another person, driving two hours after a long work week and taking on large reading assignments would be overwhelming and most unappealing. For me, it was fun. It was a chance to be there for someone I care about. I could never have spent the time on a golf course or socializing with neighbors; to me, that would have seemed frivolous.

On other recent occasions of unstructured time, Margie and I have traveled to areas where we've never visited, including an ethnic neighborhood where we seemed to be the only native English speakers. On still other occasions, I've spent a long morning researching new market indicators and how they work with different money management strategies.

What I almost never do in unstructured time: go to parties, watch TV, get together with other couples, relax at home or on vacation, work in the yard, anything artistic, play sports for reasons other than fitness development. What I often do: read books, research markets, write, travel, go out to eat to new/different places, visit family members, surf the Web for news.

So you get the idea: the unstructured time test shows that I value intellectual and interpersonal activity that is more instrumental than expressive and that is focused on intimate/close relationships rather than purely social ones. If an activity doesn't have a goal/purpose and if it doesn't bring me close to someone I care about, it strikes me as a waste of time.

Other people, of course, structure their free time in very different ways and might value expressive and social activity (sharing with friends, arranging flowers) and pure relaxation (a day at the beach, watching TV of an evening). There's no right or wrong here, just a relatively blank canvas of time that we fill with what we most treasure.

The ultimate blank canvas is retirement. I'm convinced that how people structure their time in retirement is one of the best windows on their souls. With children having left the nest and the end of career work, retirement leaves most time unstructured. How do people use that time? For intellectual stimulation? For productive activity? For social time with family? For travel? All say something about who we are and how we view ourselves and the world.

One retired couple moves to an area to live a country club lifestyle; one couple moves to be closer to their children and grandchildren; still another couple stays in their home community and goes to work building a charitable foundation. By retirement age, when time is not structured by school or work, life itself becomes a grand projective test.

So if you want to know someone, don't ask for their self-descriptions: just look at what they're doing when they don't have to be doing anything.

And if you want to know a trader, don't ask for a self-assessment: just look at what he or she does outside of market hours.

(written during free time of a Sunday morning)

.

What happens when mortgage lenders lose proof of a mortgage?

That question gets addressed in a must read article in the Sunday NYT by Gretchen Morgenson:  If Lenders Say ‘The Dog Ate Your Mortgage’.

Gretchen begins with a little history: Over the past decades, the banks and their lawyers have held the cards in litigation. Even with the institutional advantages they held, Banks were given the benefit of the doubt against the “deadbeat mortgage delinquents.”

More recently, we have learned that the bank was undeserving of that. And, we have also learned that a goodly percentage of the “deadbeats” had been defrauded — by mortgage brokers, by real estate agents, and by extension, the banks themselves.

Throw in the securitization process, rife with legal shortcuts that made attempts by good faith borrowers to work out of their delinquency problems all but impossible. Hence, you end up with a judiciary that has become increasingly infuriated with bankers.

There is usually the tendency for judges to have a hands off approach to business issues, and to leave things to the legislature to either modify or pass new laws to resolve dramatic injustices.

At a certain point, the Judiciary will act as a check against excesses and insane outcomes, and “in the furtherance of Justice” step in to correct absurdities. After a few years, a few million foreclosures, and some truly insane claims by securitized investors, courts are now forcing lenders to demonstrate they actually own the mortgages they claim in foreclsoure actions.

The bankers’ benefit of the doubt has been lost, and hilarity ensued:

“Even so, banks and borrowers still do battle over foreclosures on an unlevel playing field that exists in far too many courtrooms. But some judges are starting to scrutinize the rules-don’t-matter methods used by lenders and their lawyers in the recent foreclosure wave. On occasion, lenders are even getting slapped around a bit.

One surprising smackdown occurred on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

So the ruling may put a new dynamic in play in the foreclosure mess: If the lender can’t come forward with proof of ownership, and judges don’t look kindly on that, then borrowers may have a stronger hand to play in court and, apparently, may even be able to stay in their homes mortgage-free.

The reason that notes have gone missing is the huge mass of mortgage securitizations that occurred during the housing boom. Securitizations allowed for large pools of bank loans to be bundled and sold to legions of investors, but some of the nuts and bolts of the mortgage game — notes, for example — were never adequately tracked or recorded during the boom. In some cases, that means nobody truly knows who owns what.

In the case discussed above, the lawyer for the homeowner filed bankruptcy hoping to “persuade PHH to modify his client’s loan.” But after PHH jerked him around for a few months, he got pissed, and asked for proof of PHH’s standing in the case. They failed to produce it, and the judge kicked their asses to the curb.

There is an obvious unjust enrichment claim by the homeowner — If I were the bank, I would offer to reissue a new $200k mortgage to the owner, remove any marks on their credit record, and move forward. Otherwise, a precedent gets set that the banks and securitizers will rue.

The last of the “landed gentry” in America are trial judges — smart litigants learn never to piss them off . . .

>

Previously:
Mortgage Electronic Registration Systems Loses Legal Shield (September 23rd, 2009)
http://www.ritholtz.com/blog/2009/09/mortgage-electronic-registration-systems-loses-legal-shield/

The Mortgage Netherworld (April 2009)
http://www.ritholtz.com/blog/2009/04/the-mortgage-netherworld

Source:
If Lenders Say ‘The Dog Ate Your Mortgage’
Gretchen Morgenson
NYT, October 24, 2009
http://www.nytimes.com/2009/10/25/business/economy/25gret.html

Cash for Clunkers, although the Obama Administration will hail it as the "savior" of the automobile business, and it did infuse many a dealership with traffic, and paperwork- it was a disaster in the making.  Some would have called it "controlled chaos" but, that's anything involving the public on any mass scale, and on another note...  That's the car business and politics pure and simple.  

But as I read about how junk piles are overstocked with CARS trade-ins, with "C4C" written on the soon-to-be cracked-up windshields, with breakers and recyclers unable to keep-up with the paces of parting, sorting, crushing and shredding- recycling for the betterment of our world; really, there's more garbage to come- Cash for Appliances.

The South Carolina Budget and Control Board's State Energy Office announced this past Thursday that it will use some $3.9 million, their share of $300 million federal stimulus funds for new appliance rebates according to an article written by TheItem.com, a Sumpter, South Carolina-based publication. 

The "Energy Efficient Appliance Program" is expected to launch soon (though more official state sites say by Christmas) and will give $50 to $500 in rebates to customers willing to trade-in old appliances for newer, more efficient ones.  Sure, more spending and consumership in the name of the environment.  After all, it's "green" and it obviously works, right?

In an article written by Annabelle Robertson, a staff writer at The Item, John Clark, Director of the South Carolina Energy Office is quoted as saying "This is a great opportunity for South Carolinians to save money at the store and every month when they open their utility bill;" don't you love it when politicians and State officials get involved in sales?  Hey, at least it's a trade for them to fallback on, right?

For small appliance items that can be bought and carried-out of the store, the rebate will be instant.  Larger appliances that have to be professionally installed, will have their rebates withheld via an online database until forms are filled-out and mailed back- they'll be tracked electronically.

The idea is to get consumers to buy new, efficient Energy Star(tm) compliant models- which is basically most new appliances, but I stand to be corrected on this.  Shit, if my 46" Bravia is- just about anything is these days. 

Rebates are based-on cost differences between standard and Energy Star(tm) models, for more on the Energy Star(tm) designation- logon to www.energystar.gov.

South Carolina customers will get rebates from stores who participate in the program and must turn-in their old, inefficient appliances to be recycled.

Yes, there will be more garbage to recycle. 

It will be interesting to see if any lessons were learned in the Cash for Clunkers program, and how they will apply to Cash for Appliances.  Paperwork backlogs, delays in compensation, etc, etc, could wreak havoc on the appliance store floor- another arena of controlled chaos if you've ever shopped a new household appliance. 

Rebates range anywhere from $50 for dishwashers and refrigerators to $100 for clothes washers to up to $500 for a new furnace.  For a complete rundown on the South Carolina Cash for Appliances program, logon to www.energy.sc.gov for details. 

Since each state will be administering its own program, they're free to select which appliances to include, and the respective rebates to put on them.  Also, trading-in old appliances for recycling may or may not be mandatory according to state. 

States had until just last week, October 15, 2009 to submit their application for funding and plans to the Department of Energy (DOE), which hopes to have monies available by November 30- just in time for the Christmas shopping season.

So, as Washington hails Cash for Clunkers as the program that "saved the automobile business," putting hundreds of thousands of new "green" vehicles on the road, Cash for Appliances just may very well be "the program that saved Christmas."  Just wait- it's coming.

And the real beauty of the program- all those empty refrigerator boxes make great houses for those struggling to make ends meet- as unemployment mounts, soaring past 10% by Christmas, for sure.  Makeshift Hoovervilles for the 21st Century- but let's call them Obamatowns.

But the Obama Administration will have to spin that one too.  I mean, look at all the low-cost housing they will be creating?  Relax, I'm not totally "hating," just a little skeptical, for sure.  

That's politics.  And that's sales.  "You Got It...  Obama."

From Drew DeSilver at the Seattle Times: Reckless strategies doomed WaMu

This is the first of two parts. Here is a section on loose lending:

"The big saying was 'A skinny file is a good file,' " said Nancy Erken, a WaMu loan consultant in Seattle. She recalled helping credit-challenged borrowers collect canceled checks, explanatory letters and other documentation that they could afford their loans.

"I'd take the files over to the processing center in Bellevue and they'd tell me 'Nancy, why do you have all this stuff in here? We're just going to take this stuff and throw it out,' " she said.

In time, WaMu even began allowing low- or no-documentation option ARMs, piling risk on risk. The loose standards spread through the company like a flu virus.

And on risk management:

In an internal newsletter dated Oct. 31, 2005, and obtained by The Seattle Times, risk managers were told they needed to "shift (their) ways of thinking" away from acting as a "regulatory burden" on the company's lending operations and toward being a "customer service" that supported WaMu's five-year growth plan.

Risk managers were to rely less on examining borrowers' documentation individually and more on automated processes, Melissa Martinez, WaMu's chief compliance and risk oversight officer, wrote in the memo.
...
"The whole tone it set was that 'Maybe the next file I review I should pull back, hold off on downgrading (a loan), not take a sharp pencil to what production was doing,' " [Dale George, a former senior credit-risk officer in Irvine, Calif.] said.

"They weren't going to have risk management get in the way of what they wanted to do, which was basically lend the customers more money."

Ouch. There is much more in the article - on Option ARMs, switching to originate-to-sell and more ... WaMu was definitely "doomed".