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This REALLY Gets Rid Of Too Big To Fail

Posted by Karl Denninger

Bill Black Calls It As It Is

Posted by Karl Denninger

An amazing set of written testimony was given to the panel on Lehman’s collapse that you all need to read has been filed by Bill Black.

Read this:

Lehman’s principal source of (fictional) income and real losses was making (and selling) what the trade accurately called “liar’s loans” through its subsidiary, Aurora. (The bland euphemism for liar’s loans was “Alt-A.”) Liar’s loans are “criminogenic” (they create epidemics of mortgage fraud) because they create strong incentives to provide false information on loan applications. The FBI began warning publicly about the epidemic of mortgage fraud in 2004 (CNN). Liar’s loans also produce intense “adverse selection” – even the borrowers who are not fraudulent will tend to be the least creditworthy. The combination of these two perverse incentives means that liar’s loans, in economics jargon, have a deeply “negative expected value” to the lender. In English, that means that the average dollar lent on a liar’s loan creates a loss ranging from 50 – 85 cents.

The value of Lehman’s Alt-A mortgage holdings fell 60 percent during the past six months to $5.9 billion, the firm reported last week.1

Gambling against the casino creates a negative expected value, but making liar’s loans creates inevitable, catastrophic losses.

Is it over?  Oh hell no.

That loss, however, may not be recognized for many years – particularly if the liar’s loans become so large that they help hyper-inflate a financial bubble. In the near-term, making massive amounts of liar’s losses loans creates a mathematical guarantee of producing record (albeit fictional) accounting income. (As long as the bubble inflates, the liar’s loans can be refinanced – creating additional fictional income and delaying (but increasing) the eventual loss.

And what are we doing right now with our still existing banks?

We have issued official guidance that they do not need to mark their commercial real estate exposures to the market so long as they are receiving income from them, even if the lies (valuation) are known. 

This is EXACTLY IDENTICAL to making liar’s loans to buy houses “which are perfectly ok so long as the people can make the (initial) payments”!

It gets better:

It was a painful, as a former regulator, to read the Valukas report’s discussion of the FRBNY staff’s open disdain for working cooperatively with the SEC to protect the public. The Valukas report exposes the sick relationship between the country’s main regulatory bodies and the systemically dangerous institutions (SDIs) they are supposed to be policing. The FRBNY, led by President Geithner, had a clear statutory mission — promote the safety and soundness of the banking system and compliance with the law – stood by while Lehman deceived the public through a scheme that FRBNY officials likened to a “three card monte routine” (p. 1470).

And what are we doing right now with so-called “disclosure”?  Mark to fantasy accounting for commercial real estate loans and HELOCs, hundreds of billions of dollars of off-balance sheet “vehicles” that are being carried by all major financial institutions without any capital behind them at all since they are not counted in the firm’s “capital ratios” and explicit direction by the FDIC to examiners to not require banks to hold more capital against underwater real estate loans so long as rents are being paid?

Meanwhile we continue to see disclosures from the ratings agencies and others that CMBS (commercial mortgage backed security) delinquency/default rates continue to rise, with FITCH now saying that defaults will exceed 11% of all outstanding securitizations in their rated deals by the end of the year.

Yet the banks are being explicitly allowed to fail to reserve against these predictable and expected losses by both current policy and explicit direction from the so-called “risk managers” in the FDIC (that is, bank examiners) and others in the regulatory apparatus.

Translation: The FRBNY knew that Lehman was engaged in fraud designed to overstate its liquidity and, therefore, was unwilling to loan as much money to Lehman. The FRBNY did not, however, inform the SEC, the public, or the OTS (which regulated an S&L that Lehman owned) of the fraud. The Fed official doesn’t even make a pretense that the Fed believes it is supposed to protect the public. The FRBNY remained willing to lend to a fraudulent systemically dangerous institution (SDI). This is an egregious violation of the public trust, and the regulatory perpetrators must be held accountable. The Fed wanted to maintain a fiction that toxic mortgage product were simply misunderstood assets, so it allowed Lehman to keep dealing the three card monte scam.

Far worse than what happened with Lehman in this regard it is still the ongoing policy of all of these agencies to do the same damn thing with the still-existing banks and bank-holding companies!

Or, in plain English, the Fed didn’t want Lehman and other SDIs to sell their toxic assets because the sales prices would reveal that the values Lehman (and all the other SDIs) placed on their toxic assets (the “marks”) were inflated with worthless hot air.

AND STILL IS – the entire point of “extend and pretend”, that is, a formal and written policy crammed down FASB’s throat at literal gunpoint by the US Congress and implemented by current FDIC examiners with regard to both underwater commercial real estate loans and HELOCs behind underwater, delinquent first mortgages is to prevent the liquidation of these products into the market, thereby preserving the ability to make willfully and intentionally fraudulent claims of value that does not exist.

The FRBNY has vastly greater leverage than the FHLBSF ever had and in the context of the Lehman crisis it had the leverage to force any change it believed was necessary, including an immediate conversion of Lehman to a bank holding company and a commercial bank.

Of course it did.  The entire point of the scam was to prevent the recognition of the true value of any of these assets, lest they force a mark-to-market by all other system participants.  That would have been catastrophic (and still will be) but the market cannot clear until it happens.

Fifth, the Fed is addicted to opaqueness and its senior ranks believe the bankers when they claim that the people must never be allowed to learn the truth about asset losses. One of the conflicts of interest that a banking regulator must never succumb to is the temptation to encourage or allow the regulated entity to lie about its financial condition for the purported purpose of preventing a run on the bank.

Like, for example, claiming that the big banks all passed “stress tests” that were orchestrated to be impossible-to-fail because they were predicated on forcing FASB to allow these same institutions to carry underwater and unrecoverable paper at par?

What Bill Black has documented is not only how and why Lehman blew sky high, but that nothing has, in fact, changed – other than the fact that we have now effectively backstopped this activity among the current survivors by sweeping the truth under the rug!

If we do not stop it now the system will blow sky-high – again – and this time there won’t be enough money or credit available to the United States Government (or any other government) to stop it.

If We’re Dismantling Too Big To Fail…

Posted by Karl Denninger

Derivatives Exposure Among US Commercial Banks

I have not looked at this in some time. The amounts are still quite impressive and highly concentrated in a handful of the TBTF banks.

As in the case of LTCM, leverage is a source of income, the higher the leverage, the greater the profits from which you can claim and take your salaries and bonuses.

Here is how things looked in the middle of 2008 Derivates Report June 30, 2008

When Did Hoenig Grow A Brain?

Posted by Karl Denninger

Wall Street and Washington Hope You Are Gullible: Disappoint Them

By Janet Tavakoli President, Tavakoli Structured Finance, Inc.

If a high-on-crack driver crashed his speeding rental car into your house and killed your spouse, you would be outraged if law enforcers took bribes and gave the driver a pass on a blood test. If the judge then merely fined the killer and ordered you to pay it, you would appeal, wondering what happened to justice. If the government then handed the crack-driver keys to a bigger rental car and presented you with the rental bill, you would certainly protest.

How is it, then, that you have remained largely silent in the face of the same sort of behavior by Wall Street and Washington? Bonus-seeking bankers careened off the right path and ran Ponzi schemes that nearly ruined our economy. Bureaucrats and elected officials bailed them out without demanding consequences. Bankers are revving their engines again.

Bankers Get Bonuses, the USA Gets the Great Recession

Taxpayers are asked to believe that over-borrowing by U.S. consumers created a global financial crisis. This myth aids and abets Wall Street. The economy was nearly destroyed because banks borrowed massively, and they borrowed many multiples more than they could afford. Wall Street pumped the Fed’s cheap money through financial meth labs, and deceptive financial vehicles ran over securities laws at top speed.

More than 20% of mortgage loans–including originally sound loans–are underwater, meaning the borrower owes more than the home is worth. Official unemployment numbers hover at around 10%. If you include underemployment, it is around 18%. In depressed areas where the nation’s poorest–chiefly minorities–have been hurt the most, unemployment has soared past 30%. For this destitute group, unemployment combined with underemployment exceeds 50%.

As U.S. soldiers fought wars in Iraq and Afghanistan, Wall Street flattened Main Street. Our foreign wars drag on, while the U.S. battles a crippling recession at home.

Global Ponzi Scheme

Fraud by borrowers, fraud on borrowers, and speculation by people who thought home prices would rise forever have all tarnished mortgage lending. Yet this pales compared to the epidemic of predatory lending.

Predatory snipers committed financial murder as deliberately as British soldiers sold smallpox contaminated blankets to Native Americans. Honest homeowners were systematically targeted and actively misled into bad mortgage products. Loans were presented as gifts, but these Trojan horse loans hid destructive risk. “Disclosures” were acts of malice.

When Wall Street packaged these loans and sold deceptive “investments,” documents did not specifically disclose that credit ratings were misleading. If you know or should know a car’s gas tank will blow up, you cannot use a misleading third-party consumer report as an excuse. Yet bonus-seeking bankers used this sort of excuse to get through a few more highly-paid bonus cycles, before it all fell apart. Only the elite crowd of insiders prospered.*

This was the most massive Ponzi scheme in the history of the global capital markets. U.S. taxpayers became unwilling unsophisticated investors when we bailed out the financial system. We must hold Wall Street accountable for its fraud.

More Bonuses for Bankers, a Deeper Recession for the USA

Banks that contributed to our economic distress are heralded as geniuses at risk management, after taxpayers saved them from ruin. Wall Street escaped prosecution (so far), and Congress gave it a faster and more powerful car.

Paul Volcker suggested reforms, and special interest groups successfully lobbied to make them meaningless. His proposal to limit “proprietary” trading–a small step in the right direction–has been thwarted by banks claiming they engage in high risk trades on behalf of customers. Washington seems to have already forgotten that AIG nearly went bankrupt–and nearly took the entire financial system down with it–because of Wall Street’s “customer” trades. Wall Street and AIG insiders grew rich on bonuses based on a myth, and taxpayers funded AIG’s $180 billion bailout.

Wall Street now makes most of its “profits” from high-risk trading, and rewards risk with huge bonuses. It has unfettered access to more U.S. taxpayer money than in the history of the United States. Traditional banking suffers; it cannot generate enough revenue to “justify” massive bonuses. Bankers get billions in bonuses based on a myth, and U.S. taxpayers get a deeper recession and more risk.

Reform Starts with the President and Congress

Congress has protected Wall Street and passed on the costs to hard-working taxpayers. “Too-big-to-fail” financial institutions are too big to exist, and it is past time to break them up. They currently enjoy around $13 trillion of taxpayer-funded support, including tens of billions of FDIC debt guarantees for each of the too-big-to-fail banks and more than $2 trillion in nearly zero-cost funding from the Fed.

President Obama has not yet condemned Wall Street’s massive fraud, and Congress’s bailout methods rewarded Wall Street’s malicious mischief. The House just passed a bigger bailout bill that will give too-big-to-fail Wall Street banks access to $4 trillion dollars the next time they crash the economy.

Congress must start again from scratch, and give us real reform. Washington needs to get back in the driver’s seat, and voters need to make Congress steer straight this time by calling and writing representatives and senators.

* In a control fraud, only insider agents prosper. The losers are financial institutions’ shareholders and debtors, investors, borrowers, and the U.S. taxpayer. Banks covered-up indefensible lending–enabled by complicit rating agencies, “creative” accounting at related mortgage lenders, crooked CDO “managers,” venal hedge funds, crony accountants, and captured regulators. They parked the risk on their own balance sheets, on the balance sheets of Fannie Mae or Freddie Mac, in off-shore vehicles, or on unwary investors around the globe. Sometimes banks “transferred” risk with credit derivatives backed by phony securities that harmed “sophisticated” insurers like AIG, Ambac, MBIA, FGIC, and ACA–all of which were either bankrupted or damaged.