Financial Reform: Other Testimony

Financial Reform: Other Testimony

The Market Ticker

I know I keep talking about pieces of this (and in fact posted an earlier Ticker related to Sheila Bair), but I believe it is important to piece it all together.

First, the financial regulatory hearing had one of the most outrageous pieces of testimony that I have heard in a long time from the ABA:

It is critical that banks remain committed to the long-term. For banks to provide long-term loans to, and investment in, businesses, communities, and consumers’ futures, banks must not have their loans and investments marked to prices set in markets that are panicked or are over-exuberant. These are long-term investments, not day-to-day trades. Simply put, if FASB continues its effort regarding mark-to-market, the lesson learned from this financial disaster will be that long-term loans and investments will have their valuations destroyed, and therefore the bank will be destroyed, by mark-to-market accounting during financial panics.

Panics only happen when you first have financial bubbles caused by loose lending policies.

This is the worst sort of complaint from an arsonist who has managed to accidentally burn down his own house! "But the fire was so unfair!" he protests, while hiding his own gasoline can - which he spread liberally around the neighborhood!

SIFMA also ignores the 900lb Gorilla in the room, refusing to accept their member's responsibility for creating the bubbles in the first place, then bleating about "fair value" in a panic of their own creation. But the gist of the issue we now face is in fact that "fair value" is in fact zero for many of the instruments currently being held at or near "par". As just one of many examples we have the HELOC exposure on all of the major banks - 70% of the dollar value is in the bubble states and by law these are subordinate loans - if the first mortgage balance is higher than market value this is an unsecured credit line and has zero recovery value in the event of default, yet there is absolutely no accounting recognition of this fact that I can find in quarterly reports over the last two years.

Interestingly enough the AFL/CIO has a very critical piece submitted to the panel; among their comments was this nugget:

These arrangements may explain why the Federal Reserve has never given any account of how it allowed bank holding companies like Citigroup and Bank of America to arrive at a point where they required tens of billions of dollars of direct equity infusions from the public purse to avoid bankruptcy.

Is there an explanation required? Willful blindness is obvious in this instance. So is the willful blindness that has trashed AFL/CIO (and other) pension plans who were investing in securities that ultimately were proved to be worth far less than represented (and in some extreme cases actually worthless) - all through a process of intentional obfuscation that was known to The Federal Reserve system and yet not only left alone but actively encouraged under Alan Greenspan's tenure, and ignored during Bernanke's.

The fact of the matter is that while "mark-to-market" may be imperfect, published, market prices are superior to all others, in that there is a reference - what a willing buyer will give you for a given asset right here and now.

The function of the banking system is not, as often believed, to allow certain "favored sons" to get wealthy while everyone else gets screwed.

I have repeatedly documented that many of these so-called "securitzations" were the financial equivalent of claiming to have spun flax into gold, in that it is not possible to return more, in aggregate, on a risk-adjusted basis than was present in the original lending transaction. Since nobody works for free the all-in return on any securitization must mathematically be significantly less than would be the case for the same basket of single loans held by the originators. The primary means by which such "flax-spinning" occurred was by hiding risks - not clearly documenting, for example, that percentage of the loans in the pool had no documentation of income or assets, and that HUD had found that those who took "stated income" loans tended to overstate their incomes by 50% or more. By this bit of omission these securities were thought of as "safe", when in fact nothing was further from the truth.

The fact remains that until we force the schemes, intentional mis-valuations and lies out into the open, enforce existing law that makes fraudulent conduct illegal and start locking up the scammers up the down the line trust cannot return to the economy.

What the AFL/CIO needs to understand, along with the rest of America, is that these losses did not happen due to bad luck or a "bubble bursting" - they happened due to lies, intentional obfuscation and even fraudulent misconduct that resulted in the bubble's growth in the first instance, all fueled by making loans - creating credit growth - that the originators of said loans either knew or should have known could not, in aggregate and in the fullness of time, be paid back.

I continue to return to the mathematics because the math is never wrong and can never be debated. Again, the GDP and Credit Growth chart:

From The Fed's own Z1 data the Compound Annual Growth Rate of debt since modern records have been kept (early 1950s) is 8.77%, while GDP has grown at 6.82%, a difference of 1.95%.

Since 1990 Debt has grown at a compound rate of 7.91%, while GDP has grown at 5.39%, a difference of 2.52%.

Since 2000 debt has grown at a compound rate of 8.49%, while GDP has grown at 5.22%, a difference of 3.27%.

The "spread" is and has been increasing and it is a mathematical fact that such cannot be maintained in perpetuity.

Yet the merchants of debt, including Bernanke and The US Congress, continue to refuse to deal with the mathematics - even when it screws major constituencies such as the AFL/CIO.