The Devils Are (Still) Here

Kyle Bass said it was a must read, and that was good enough for me. All the Devils Are Here, by Bethany McLean and Joe Nocera, offers a chronological account of how Wall Street executives created, and then abused, the instruments that led to the global financial crisis of 2008. The whole alphabet soup is explained--ABCP, CDO, RMBS, SIV, etc.--as well as the motivations of the chefs cooking this toxic brew.

The scary part is this. Time and again, smart men and women (O.K., men mostly) suspended their better judgment, allowing risk to metastasize. The dereliction was so pervasive as to appear inevitable. The story told here strongly suggests, furthermore, that the dereliction is ongoing. It comes from human nature. Character breeds success, which then undermines character.

So much for the villains. How 'bout them victims? There was a veritable tsunami of dumb money sloshing through global markets in the mid-aughts. There probably still is. We know that in August 2007 some of that dumb money, about $20 million worth, leaked from the State of Maine's Cash Pool into an SIV-Lite called MainSail II, which was heavily invested in residential mortgage-backed securities (RMBS). Maine bought at the exact top of the market for such securities--the very definition of "dumb money." Within weeks MainSail II was downgraded by Moody's from Prime-1 to junk, and the vehicle's assets were frozen. By the end of August, Maine could not be sure that it would get any of its money back.

According to UMaine's Richard Borgman (who gives the blow-by-blow account here), this was not a prudent investment by the Treasurer's office. For months defaults on home loans had been rising, home prices falling, and subprime lenders failing. In July 2010 (before Maine invested in MainSail II) Standard & Poor's and Moody's had each placed hundreds of tranches of RMBS on review for possible downgrade. The handwriting was on the wall, and Treasurer David Lemoine failed to see it. In Borgman's opinion, "there was a lack of understanding of the investment and an over-reliance on ratings and the broker." One year later Lemoine made a stick-save by putting the investment back to the broker, Merrill Lynch. But for a whole year the $20 million was dead money.

Fair question: if Maine's Treasurer was in over his head in 2007, are MainePERS fund managers, with their "passive" investment style, in over their heads now? If so, a lot more than $20 million is at risk.

Toward the end of their book, the Devils authors lift a trenchant passage from Alan "Ace" Greenberg's The Rise and Fall of Bear Stearns. Greenberg was formerly CEO (until 1993) and Chairman of the Board (until 2001) at Bear Stearns and was 80 years old when the firm that he helped build went belly up in 2008. Reading this, one cannot help but think that the money is getting ready to stop one more time:

The interdependent relationships between banks and brokerages and institutional investors strike most laymen as impenetrably complex, but a simple ingredient lubricates the engine: trust. Without reciprocal trust between the parties to any securities transaction, the money stops. Doubt fills the vacuum, and credit and liquidity are the chief casualties. Bad news, whether it derives from false rumor or verifiable fact, then has an alarming capacity to become contagious and self-perpetuating.

Quote for the Week, Dec. 25-31, 2011

Credit is suspicion asleep.
--William Gladstone

Queue It Up

"The Wind That Shakes the Barley"


The Emerald Isle seen shimmering.
And simmering.
Pragmatists debate fanatics in barroom brogues.
Andrea Corr sings the credits.
Trailer here.

Quote for the Week, Dec. 18-24, 2011

This is how government grows--by claiming to correct the mistakes it earlier created, all the while constantly shaking down the taxpayer.
--Congressman Ron Paul

The Beginning of the End

If you have not gotten enough of Kyle Bass about the capital flight from Europe, go here for an interview two days ago on CNBC.

Now speaks another voice, Michael Platt, founder of BlueCrest Capital Management, a $30 billion hedge fund. Over the past eleven years, BlueCrest has returned nearly 14% on an average annual basis and has never had a down year. John Paulson, eat your heart out! Platt tells Bloomberg [below] about the sovereign debt crisis and the serial insolvency of most European banks:

Late yesterday one of the Big Three ratings agencies, Fitch, issued downgrades for eight global banks, including our beloved Bank of America. BofA's Viability Rating was dropped from a- ("strong") to bbb ("good") and its long-term Issuer Default Rating from A+ to A, still a couple of notches above Johnny B (Goode). The calls follow similar moves from Standard and Poor's last month and Moody's in September, thus completing a tricky trifecta for BofA. Such downgrades can trigger collateral calls, reducing a firm's liquidity. In extreme cases a downgrade can put a company out of business (witness MF Global).

Go here for a refresher from Gary Shilling on why all these banks are such a miserable investment.

Fed Head MIA

Hilarious. From ZeroHedge.

Quote for the Week, Dec. 11-17, 2011

He knows nothing; and he thinks he knows everything. That points clearly to a political career.
--George Bernard Shaw

Now You See It, Now You Don't

"I simply do not know where the money is."

This is what former MF Global CEO Jon Corzine will tell the House Agriculture Committee on Capitol Hill in his testimony today. Corzine was forced to resign last month amid allegations that his firm improperly commingled clients' funds with its own investment capital. All the money went out the door in some highly leveraged speculation. And never came back.

How can this happen? Reuters correspondent Christopher Elias describes how in a must-read article, MF Global and the Great Wall Street Re-hypothecation Scandal. Now, if "re-hypothecation" sounds to you like something sinister and best not tried at home, you would be absolutely right. But the big banks and brokers do it all the time. In fact MF Global, before it collapsed, warned its customers in its Customer Agreement as follows (and where you see the world "collateral," think anything of yours with cash value):

7. Consent To Loan Or Pledge

You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control.

In other words, Mr. Client, we are going to pledge to someone else what rightfully belongs to you. And you can't opt out. If you want to do business with us, you have to play along. The problem, explains Elias, is that the same collateral gets pledged over and over, from one counterparty to the next:

With collateral being re-hypothecated to a factor of four (according to IMF estimates), the actual capital backing banks' re-hypothecation transactions may be as little as 25%. This churning of collateral means that re-hypothecation transactions have been creating enormous amounts of liquidity, much of which has no real asset backing...Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold, then a Eurozone sovereign default could be apocalyptic. [emphasis mine]

Expounding on the Elias piece, Zero Hedge uses a familiar metaphor to describe the risk to the global economy:

The collapse of the weakest link in the daisy-chain sets off a house of cards that eventually will crash even the biggest entity due to exponentially soaring counterparty risk: an escalation best comparable to an avalanche - where one simple snowflake can result in a deadly tsunami of snow that wipes out everything in its path. Only this time it is not something as innocuous as snow: it is the compounded effect of trillions and trillions of insolvent banks all collapsing at the same time, and wiping out the developed world and the associated 150 years of the welfare state as we know it.

Hyperbole? We shall see.

What's That Smell?

I love the smell of napalm in the morning, says Robert Duvall's character in Apocalypse Now. We are getting a whiff of that on the morning after this CBS 60 Minutes piece on alleged fraud at Countrywide Financial (now a division of Bank of America):

Now, none of this is really news. If you have been following this blog, you know that Bank of America is freighted with huge successor liabilities inherited not just from Countrywide, but from Merrill Lynch as well. Consumer fraud, investor fraud, breach of fiduciary duty, obstruction of justice--you name it. That the Obama Administration has done so little to hold these companies accountable is a sure sign of whose shed has the biggest Tool.

Maybe, if the feds don't do it, the states will. The Attorneys General of the fifty states have been trying for a year or more to reach a settlement with BofA and other Wall Street lenders over foreclosure abuses. But the dollar figure being floated around for the industry to buy immunity is, in the eyes of at least one AG, too small. So last week Martha Coakley of Massachusetts announced that her office is striking off on its own and suing BofA, Wells Fargo, JP Morgan Chase, Citigroup, and GMAC. To her chagrin, Martha will be forever remembered as the heavily favored Senatorial candidate who lost Ted Kennedy's seat to a little-known Republican runt, Scott Brown. But she has been a crackerjack AG, going after some of the big banks in 2008 when few others did.

The news flow on Bank of America continues to, um, reek. Aside from this latest legal attack, there was the credit downgrade announced by Standard & Poor's late Tuesday of BofA and 36 other global banks. Indeed, the share price of BAC common was headed for a toilet spin until a gang of central banks injected a stiff dose of monetary heroin the very next morning. And how's business, you ask? BAC's share of mortgage loan originations in the U.S. has declined from about 25% to around 10% in Q3 2011. That's in a market that is expected to soften by 25% in 2012. Hmm, wonder what that combo is going to do to revenues.

But faithful shareholder MainePERS is hanging tough, I tell ya. HANGING TOUGH!

[update, 12-07-11--]

Mississippi PERS just reached a settlement with BofA, recovering $315 million from a soured investment in toxic mortgage-backed securities peddled by Merrill Lynch in 2006 and 2007. The settlement awaits approval by Federal District Judge Jed Rakoff. Yup, that Judge Rakoff.

Quote for the Week, Dec. 4-10, 2011

Long ago I proposed that unsuccessful candidates for the Presidency be quietly hanged, as a matter of public sanitation and decorum. The sight of their grief must have a very evil effect upon the young.
--H.L. Mencken