Jackson Jambalaya

Mr. Denninger keeps asking questions regarding the financial crisis completely missed by the media. He is not some conspiracy theorist or a genius. He simply reads what is published and asks questions, something our money honeys seem unable to do as they blather about the rise and fall of the Dow Empire. He coins a new word in this post, fraudacity, as he discusses the phoniness of the Bacardi Bailout:
"John Mack yesterday in a CNBC interview said that the capital deployed by Treasury into the banks was going to rebuild their capital ratios - not be lent out. In other words, they intend to hoard it.
CNBC's Fast Money finally started talking about the outright fraud and lies last night. Dylan Ratigan was absolutely on fire about the fact that Paulson was in fact one of the executives lobbying hard for removal of leverage limits in 2004, just two years before he took the position at Treasury (and cashed out $500 million in Goldman Sachs stock tax free.)
I and a few others have been peppering the media with this, and finally, someone woke up to the fact that the very same people who made this mess now want we the taxpayers to pay for cleaning it up - after they ran off with all your money!.....
Nor does it stop there....."

Fraudacity Story

Anna Schwartz tells The Wall Street Journal that Bernanke is using the wrong tools to solve this problem. The hapless Fed Chairman defends his Maginot Line of Liquidity while the CDO Panzers outflank him through the forest of overleveraged balance sheets. Who is Ms. Schwartz? She is 92 years old and lived through the Great Depression. She co-authored with Milton Friedman "A Monetary History of the United States" in 1963, the leading treatise on how monetary policy "turned the stock market crash into the Great Depression". Since 1941, she has worked at National Bureau of Economic Research in New York. Her thoughts on the current crisis should be taken very seriously. Regular Readers of this blog will find her remarks sound very familiar.

"Ms. Schwartz thinks that our central bankers and our Treasury Department are getting it wrong again.
To understand why, one first has to understand the nature of the current "credit market disturbance," as Ms. Schwartz delicately calls it. We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.
This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."
So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue.".....
Today, the banks have a problem on the asset side of their ledgers -- "all these exotic securities that the market does not know how to value."
"Why are they 'toxic'?" Ms. Schwartz asks. "They're toxic because you cannot sell them, you don't know what they're worth, your balance sheet is not credible and the whole market freezes up. We don't know whom to lend to because we don't know who is sound. So if you could get rid of them, that would be an improvement." The only way to "get rid of them" is to sell them, which is why Ms. Schwartz thought that Treasury Secretary Hank Paulson's original proposal to buy these assets from the banks was "a step in the right direction."
The problem with that idea was, and is, how to price "toxic" assets that nobody wants. And lurking beneath that problem is another, stickier problem: If they are priced at current market levels, selling them would be a recipe for instant insolvency at many institutions......
Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job." http://online.wsj.com/article/SB122428279231046053.html

This is what Karl Denninger has been preaching on The Market Ticker and what he said on Kim Wade's show Monday. Most of the financial reporters don't have a clue or are using the wrong paradigm to analyze this problem. Its not liquidity, its not interest rates, its not the bailout and recapitalization. Its the transparency that is key. The freezing up of international shipping is merely a symptom although its a very serious one. The Fed and Treasury ostriches refuse to acknowledge they might have made a mistake in ignoring this issue. As Ms. Schwartz and others have stated, the problem is these CDO's were private deals and too often were kept off the balance sheets yet can very easily sink a company. Until these are acknowledged and valued properly (and how do you void mark to market if they were grossly overvalued in the first place?), banks will not lend to each other and the credit markets will stay frozen.

Probably the single largest factor that caused the market meltdown was the 2004 SEC rule change that removed leverage limits. The New York Times reported:
"On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.
They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments. ......
Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measurement of how much the firm was borrowing compared to its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratios at the other firms also rose significantly. ...... "(Kingfish note: The limit had been 12:1 before the SEC action) http://www.nytimes.com/2008/10/03/business/03sec.html?pagewanted=1&_r=1

Want to guess who spearheaded the effort by the investment banks to get the SEC to change the rules? "The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary. "

Anyone questioning the leadership of the Treasury Department as it bailed out Bear Stearns, AIG, Fannie Mae, Freddie Mac, the nine largest banks while each time promising that particular step would solve the crisis as the SAME leadership caused this debacle to happen in the first place in the private sector. Skeptical? Ask Secretary Paulson when he is going to force the banks and other financial institutions to put these CDO's and other off-balance sheet assets or losses on their balance sheets so we can finally have an accurate picture of our financial health? Why does he insist on throwing money at the problem while avoiding the issue of transparency? Sixty Minutes recently reported the credit default swap market could be as large as $60 TRILLION dollars but no one knows for sure because they are not regulated or registered, yet we are assured by the Secretary and Federal Reserve Chairman that spending $700 billion on the banks will fix the problem.

Tic..tic..tic.. that is the sound of invisible off-sheet swaps and balance sheets waiting to explode.

Read it and weep:
"The bill The Senate intends to try to ramrod down your throat is neither about Main Street or really even about Wall Street.
You are going to get VERY angry. Sit down before you read further.
""Hundreds of billions of dollars are going to bail out FOREIGN INVESTORS. They know it, they demanded it, and the bill has been carefully written to make sure that can happen." - Brad Sherman , D-California"
That's right folks. You are going to have $700 billion - about 25% of the total federal budget - put on your personal credit card (via taxes forever) in order to bail out foreign investors.
Oh, and the best part of it is that the underlying assets involved do not even have to be in the United States!
Here is the definition of a "troubled asset", right from the bill:
"(9) TROUBLED ASSETS.—The term ‘‘troubled assets’’ means— (A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress."
Notice that conspicuously missing from the definition is the requirement that the asset's underlying thing (that is, the property that was mortgaged, etc) lies within the United States. Also note that Treasury must tell Congress if they add "new types" of debt, but that Congress has no right of review or censure.
That is, it is perfectly legitimate under the bill for a foreign bank to sell or swap any "crap sandwich" it may hold (irrespective of how or where it originated, so long as a mortgage is the basis for it somewhere) with a bank domiciled in the United States, and said bank may then "PUT" it into the TARP.
Note also that Representative Sherman said on Kudlow last night that when this was raised with Secretary Paulson he was told that if Congress tried to restrict the ability of the Secretary to purchase assets "laundered" in this fashion from foreigners, that the bill would be vetoed...." http://market-ticker.denninger.net/

Watch the video if you have time. One thing I noticed was the phrase "ANY OTHER ASSET". Understand what that means? Secretary is given the permission to buy up any bad debt NOT related to mortgages from lenders that want to get rid of their bad paper. Let that thought percolate in your head awhile.

Note: Watch yesterday's video if you get a chance. Interesting stuff.

The Naked Capitalist website reports on a secret conference call Treasury had with financial analysts last night.
"Various readers wrote us, and it was confirmed by a detailed report on the call at DealBreaker, that the Treasury Department held a conference call this evening for analysts on the bailout bill. A memo was evidently sent to SIFMA members; others may have been contacted by other means. But the report I got from one person who was on the call was the the questions came from financial services industry members. In other words, this was most assuredly not intended to be a call open to the public at large. If anyone from the media or other member of the great unwashed was listening in, it was by accident......."
http://www.nakedcapitalism.com/2008/09/mussolini-style-corporatism-in-action.html

Here is a live blog of the call. You need to read this and give our Congressional delegation hell today. Emailing or calling the David Hampton and Sid Salter wouldn't' be a bad idea as well. This is garbage. As I wrote last night, this bill is loaded with bad things for Americans that have nothing to do with restoring confidence in the markets.
http://dealbreaker.com/2008/09/live-blogging-the-treasury-cal.php#more

Here is a recording of the call. Bob Hoyt works for Treasury.
http://thepiratebay.org/torrent/4418763

Note: Good comment below from someone who listened to the audio recording.

Karl Denninger of The Market Ticker blog read the bailout bill and gives his sober analysis. I read all 102 pages of the bill myself this morning and can say that he is on the money in his remarks. Sickening. Here are some highlights of his epistle today:

Section 3(9) – This permits the purchase of CDOs, CLOs, and credit default
swaps! ALL forms of derivatives have a potential zero value and credit default swaps have a potential negative value; that is, they can result in an obligation greater than their purchase consideration – in fact, they can result in obligations of 100 times or more their purchase consideration! This is outrageous and must not be allowed.... "

(Kingfish note: That is exactly what this section of the bill says. The Secretary can purchase " residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages..." That includes Credit Default Swaps. Notice the commercial mortgage provision. Is this a new crisis or a favor to the banks?)

Section 101(e) – Specifically allows Treasury to pay up to 100% of the original acquisition cost of an asset, irrespective of its current value in the marketplace, and such determination is nonreviewable.
None of these “troubled assets” are currently priced or valued there, or they
wouldn’t be “troubled.” There is no threshold to prevent the Treasury from overpaying for
these assets nor to keep sellers from gaming the system for acquisition! (Did you get that? Can we say kickback?)

(Kingfish note: Bill says (Secretary shall take steps) "preventing the sale of a troubled asset to the Secretary at a higher price than what the seller paid to purchase the asset." In my opinion the bill is poorly worded in this section and shows an intent to keep firms from profiteering off of the sale of assets. However, Denninger is correct in that the Secretary could buy the assets for their original purchase price, not current market value. One can see the opportunities for financial mischief here. Remember, under the proposed judicial review provisions, any injunctive relief is AUTOMATICALLY STAYED until the Secretary can appeal.

The taxpayers will undoubtedly get ripped off because of this provision. The government will purchase mortgages that are based on overvalued appraisals. Lenders such as Countrywide OWNED the appraisal companies used for their mortgages, creating an egregious conflict of interest as it led to the widespread problem of these lender-employed appraisers creating fraudulent or bogus appraisals. Even worse, Fannie Mae had a program for several years that WAIVED appraisals altogether. Unfortunately, that is not the end of it as there is the second mortgage market that has completely collapsed. Second mortgages usually did not depend on appraisals at all or if they did, the lender relied on a "drive-by appraisal". Citi originated stated income second mortgages. GMAC underwrote 125% second mortgages, i.e. an unsecured loan based on an overvalued property. The Secretary could thus be forced to buy most of the second mortgages that are toxic while the lender actually gets full value for the bad debt. Nice deal if you can get it. This section is bad news for Americans. Period. Banks will take advantage of this clause to dump bad or fraudulent mortgages on the government, leaving it to figure out how to modify the mortgage or help the homeowner.)

Section 119 – This is an absolute travesty. Full protection under the law must be provided
to shareholders and bondholders. Absent this you will precipitate capital flight from these
instruments and institutions – guaranteed. This section is tremendously DESTABILIZING.

(Kingfish note: You REALLY need to read the entire section. He is not kidding one damn bit. The bill states:
INJUNCTION.—No injunction or other form of equitable relief shall be issued against the Secretary for actions pursuant to section 101, 102, 106, and 109, other than to remedy
a violation of the Constitution.....
(3) LIMITATION ON ACTIONS BY PARTICIPATING COMPANIES.—No action or claims may be brought against the Secretary by any person that divests its assets with respect to its participation in a program under this Act.... (Get government aid, surrender all legal rights to defend yourself )
(4) STAYS.—Any injunction or other form of equitable relief issued against the Secretary for actions pursuant to section 101, 102, 106, and 109, shall be automatically stayed. The stay shall be lifted unless the Secretary seeks a stay from a higher court within 3 calendar days after the date on which the relief is issued.....)

Section 128 – This is touted by Bernanke as accelerating his ability to pay interest on reserves; that is not of particular concern. The problem with this section is that it also allows Bernanke to set the reserve requirement for banks to zero if he so chooses. Such an event would have a catastrophic outcome for our banking system. This section MUST NOT STAND AS WRITTEN AS IT RISKS OUR ENTIRE BANKING SYSTEM......"

Read the rest of Mr. Denninger's thoughts at http://www.denninger.net/letters/you-r-nuts.pdf. The address for the home page of The Market Ticker is http://market-ticker.denninger.net/.

Here is a link to the text of the bill itself: http://banking.senate.gov/public/_files/AYO08C04_xml2.pdf