Audit the auditors? » New Jersey CFO

Let Them Eat Credit

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Aug 292010

By most counts, the U.S. economy started growing in the middle of last year. For many Americans, though, it does not feel as if the Great Recession has ended—unemployment and underemployment are still alarmingly high, and job growth is weak. Many causes have been suggested for both the economic collapse and mediocre recovery, but one that is hardly ever mentioned is income inequality. This is a mistake. Growing income inequality in the United States and the policy responses it has spawned have done tremendous damage to our economy. And because we continue to ignore this underlying problem, the risks of our policies leading to another calamity will not go away, no matter what we do to reform the financial sector.

Since 1968, income inequality has been steadily increasing in the United States. I am not referring to the Croesus-like income of a John Paulsen, the hedge fund manager who in 2008 netted over $3 billion, about 75,000 times the average household income. I refer to a more worrying everyday phenomenon that confronts most Americans, the disparity in income growth rates between a manager at the local supermarket and the typical factory worker or office assistant. Since the 1970s, the wages of the former, typically workers at the 90th percentile of the wage distribution in the United States, have grown much faster than the wages of the latter, the typical median worker. Or consider the table below, which shows that the wages of occupation groups that are paid more than the national average in 2002 have grown much faster since then than the wages of occupation groups below the average:

The Inequality Gap Is Ruining the American Economy—and Bernanke Is Just Making it Worse Raghuram G. Rajan

Does It Make Sense to Resurrect the Glass-Steagall Act?

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Feb 202010

In the present system, the more unrestricted the banks are, the more money they can generate “out of thin air,” and the more damage they can inflict upon the wealth-generation process. FULL ARTICLE by Frank Shostak

What they knew and when they knew it

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Jan 312010

“I have to think this train is probably going to leave the station soon and we need to focus our efforts on explaining the story as best we can. There were too many people involved in the deals — too many counterparties, too many lawyers and advisors, too many people from AIG — to keep a determined Congress from the information.” James P. Bergin, NY Fed, in an email to his Fed colleagues

‘Though it is hard to divine much understanding from the unredacted filing, it has become clear that Goldman had more involvement than previously believed: In addition to the credit default swaps it bought from AIG, the filing shows that Goldman Sachs also originated many of the underlying assets that AIG and the New York Fed bought back from Société Générale.

The American people have the right to know how their tax dollars were spent and who benefited most from this back-door bailout,” said Kurt Bardella, spokesman for Issa. “Now that it’s public, let’s see if the sky really does fall as the New York Fed said it would to justify its coverup.”

Other lawmakers believed that the New York Fed was trying to hide its ties to Goldman Sachs.’ AIG Reveals the Story – CNN

“Wednesday’s hearing described a secretive group deploying billions of dollars to favored banks, operating with little oversight by the public or elected officials.

We’re talking about the Federal Reserve Bank of New York, whose role as the most influential part of the federal-reserve system — apart from the matter of AIG’s bailout — deserves further congressional scrutiny…

By pursuing this line of inquiry, the hearing revealed some of the inner workings of the New York Fed and the outsized role it plays in banking. This insight is especially valuable given that the New York Fed is a quasi-governmental institution that isn’t subject to citizen intrusions such as freedom of information requests, unlike the Federal Reserve.

This impenetrability comes in handy since the bank is the preferred vehicle for many of the Fed’s bailout programs. It’s as though the New York Fed was a black-ops outfit for the nation’s central bank…

New York Fed staff and outside lawyers from Davis Polk & Wardell edited AIG communications to investors and intervened with the Securities and Exchange Commission to shield details about the buyout transactions, according to a report by Issa.

That the New York Fed, a quasi-governmental body, was able to push around the SEC, an executive-branch agency, deserves a congressional hearing all by itself.” Secret Banking Cabal Emerges From AIG Shadows – Reilly – Bloomberg

Hat Tip to : Jesse

NY Fed Conspired to Hide Details of AIG Bailouts from Public and Congress

The Banking System Is Still Broken

Analysis & Commentary, Audit the auditors?, Banks - Crisis Discussion No Responses »

Oct 172009

From the Wall Street Journal:

Borrow from the Federal Reserve at zero and lend to Treasury for a profit. That’s some racket.

Treasury Secretary Tim Geithner and Federal Reserve Chairman Ben Bernanke have announced that the recession is over. Now that the Dow Jones Industrial Average has broken the 10,000 mark, we’ll surely be hearing assurances that economic growth is here to stay. But the credit markets are in much worse shape than some indicators suggest.

Securitization was maddeningly complex. Mandated transparency is the only solution.

Audit the auditors?, Bank Failures, Cash Flow, Deleveraging, Did they ever hear of GAAP?, Lending Crisis, Negative Cash Flow, No Bank Is Indispensable, Our phony middle class, Patience is a virtue...Delusion is a vice, Political Chaos No Responses »

Jul 212009

With so much complexity, and uncertainty about future performance, it is not surprising that the securities are difficult to price and that trading dried up. Without market prices, valuation on the books of banks is suspect and counterparties are reluctant to deal with each other.

The policy response to this problem has been circuitous. The Federal Reserve originally saw the problem as a lack of liquidity in the banking system, and beginning in late 2007 flooded the market with liquidity through new lending facilities. It had very limited success, as banks were still disinclined to buy or trade such securities or take them as collateral. Credit spreads remained higher than normal. In September 2008 credit spreads skyrocketed and credit markets froze. By then it was clear that the problem was not liquidity, but rather the insolvency risks of counterparties with large holdings of toxic assets on their books.

The federal government then decided to buy the toxic assets. The Troubled Asset Relief Program (TARP) was enacted in October 2008 with $700 billion in funding. But that was not how the TARP funds were used. The Treasury concluded that the valuation problem seemed insurmountable, so it attacked the risk issue by bolstering bank capital, buying preferred stock.

But those toxic assets are still there. The latest disposal scheme is the Public-Private Investment Program (PPIP). The concept is that private asset managers would create investment funds of half private and half Treasury (TARP) capital, which would bid on packages of toxic assets that banks offered for sale. The responsibility for valuation is thus shifted to the private sector. But the pricing difficulty remains and this program too may amount to little.

The fundamental problem has remained untouched: insufficient information to permit estimated prices that both buyers and sellers find credible. Why is the information so hard to obtain? While the original MBS pools were often Securities and Exchange Commission (SEC) registered public offerings with considerable detail, CDOs were sold in private placements with confidentiality agreements. Moreover, the nature of the securitization process has made it extremely difficult to determine and follow losses and increasing risk from one tranche and pool to another, and to reach the information about the original borrowers that is needed to estimate future cash flows and price.

This account makes it clear why transparency is so important. To deal with the problem, issuers of asset-backed securities should provide extensive detail in a uniform format about the composition of the original pools and their subsequent structure and performance, whether they were sold as SEC-registered offerings or private placements. By creating a centralized database with this information, the pricing process for the toxic assets becomes possible. Making such a database a reality will restart private securitization markets and will do more for the recovery of the economy than yet another redesign of administrative agency structures. If issuers are not forthcoming, then they should be required to file the information publicly with the SEC.

Mr. Scott is a professor of securities and corporate law at Stanford University and a research fellow at the Hoover Institution. Mr. Taylor, an economics professor at Stanford and senior fellow at the Hoover Institution, is the author of “Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis” (Hoover Press, 2009).

Why Toxic Assets Are So Hard to Scrub – Kenneth Scott & John Taylor, WSJ

Bilkers, suckers and Wall Street atrocities – Is Madoff Really Worse Than Fuld?

Audit the auditors?, Back to the basics, Madoff Scam, Patience is a virtue...Delusion is a vice, The Financial Elite, The Importance of Strategic Planning No Responses »

Jul 062009

Somewhere back around 1946 or 1947, Nick Etten–by now a pretty much forgotten first baseman for the Yankees–signed a one-year contract in the amount of $15,100. This sum struck many observers as an odd number, but not one canny New York baseball writer, possibly Red Smith. “The $100,” he wrote, “is for fielding.”

That pretty much sums up my reaction to the 150-year prison sentence handed out to Bernard Madoff. As I assay the punishment-to-crime ratio implicit in the judge’s decision, I attribute 25 years as penal recompense for Madoff’s particular peculations–his swindling of a few thousand institutions and individuals–and the balance of 125 years as society’s get-even for Wall Street’s recent crimes against humanity, for which Madoff can stand as an almost perfect symbol.

We cannot get at Stanley O’Neal, or Jimmy Cayne, or Joseph Cassano and his merry band of AIG rogues, or Dick Fuld–men whose actions and recklessness ultimately led to the destruction of trillions of dollars of personal wealth and the hopes and necessities that wealth was intended to underwrite and secure.

We cannot get at Goldman Sachs, which seems about to report as profitable a quarter as any in its history, a fact which, under the circumstances, will rank, if true, with the greatest moral obscenities and perversions of process I have witnessed in what is now starting to feel like quite a long life.

But we can get at Bernard Madoff, and if he must stand proxy for the fury we feel at Wall Street, and for our frustration that the real malefactors not only seem beyond adequate punishment, but are being rewarded with non-dues-paying membership in a tight little club of taxpayer-financed vulture finance, then so be it: 150 years and every penny for Madoff, not a nickel nor a month from the real bad guys.

This is not to say I don’t feel Madoff’s victims’ pain. Not possibly, not to that extent, to be sure. I am not bankrupt. But every morning now, when I arise, the first thing I do is some simple arithmetic that suggests I no longer have resources adequate to get me to my grave, assuming the actuarial tables are correct. Until last December, I never heard the name “Madoff.” I owned good stocks. The people who advised me never for one second showed themselves deficient in intelligence or good faith. And yet here I am.

Is Bernie Madoff Really Worse Than Dick Fuld? – Michael Thomas, Forbes

The Danger Of Greed and Short Term Focus

Audit the auditors?, Back to the basics, Integrity and Responsibility No Responses »

May 252009

An important question at Custerstock:

Are activist investors to blame for horrible corporate balance sheets? (Clusterstock)

On Squawk Box this morning, DealBook maven Andrew Ross Sorkin made some comments about the role investor activism played in getting companies to lever up their balance sheets during the boom times.

That this happened is indisputable, as conservative boards and executives were constantly getting pilloried for taking on too-little debt, paying out too low of a dividend or not executing stock buybacks rapidly enough.

The converse to this idea is that more entrenched, conservative boards, impervious to investor activists would’ve been more likely to resist the temptation of leverage. (If there’s any academic literature on this question, please let us know.)

Perhaps the most striking thing, though, is not just that companies and investors levered up during the boom times (that’s obvious, people always think that they’ll last forever) but that calls for more buybacks and debt were occurring very late into 2007, early 2008. We remember going to media industry banking-sponsored in early 2008, when it seemed pretty obvious that the writing should be on the wall, and yet investors would barrage management with requests for more buybacks. As we wrote, elsewhere, companies frequently complied.

Too bad more boards didn’t have the spine to stick with common sense.

Phony Accounting

Audit the auditors?, Did they ever hear of GAAP?, Those Quarky Accounting Rules No Responses »

May 142009

Stanford Law Review has a great interview with Warren Buffett’s longstanding partner, Charlie Munger. Munger offers much less corn pone and more direct opinion than Buffett does.

The entire piece is very much worth reading, but I wanted to hone in on some key topics. One is the neglect of the role of what amounts to accounting fraud in this mess. Much of this is technically not fraud under the current regime but would be if the standards of 20 years ago were still in place. We now live in a world where everyone knows that the authorities simply will not take down any of the Big Four. Four is now deemed to be the minimum number of big accounting firms permissible. So we de facto have accounting firms “too big to fail”, which means “too big to be asked to eat much liability, not matter how indefensible their conduct.” So if they do something bad, they might have to fire a few partners and pay a moderate fine.

So effectively, we live in a world that echoes the Nixon Presidency. If the Big Four does it, it must be legal.

From the Stanford Law Review (hat tip reader Hubert):

As we look at the current situation, how much of the responsibility would you lay at the feet of the accounting profession?

I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting. They are way too liberal in providing the kind of accounting the financial promoters want. They’ve sold out, and they do not even realize that they’ve sold out.

Would you give an example of a particular accounting practice you find problematic?

Take derivative trading with mark-to-market accounting, which degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large profit from the same trade.

And they can’t both be right. But both of them are following the rules.

Yes, and nobody is even bothered by the folly. It violates the most elemental principles of common sense. And the reasons they do it are: (1) there’s a demand for it from the financial promoters, (2) fixing the system is hard work, and (3) they are afraid that a sensible fix might create new responsibilities that cause new litigation risks for accountants….

Very few people realize how much we’ve screwed up. Even in leading law schools and business schools very few people realize that the mess at Enron never could have happened if accounting customs hadn’t been changed. What we have now is a bigger, more widespread Enron.

Munger also has some interesting observations about the decay in values:

Read the entire article at Naked Capitalism: http://www.nakedcapitalism.com/2009/05/munger-on-phony-accounting-cultural.html