5 posts tagged “wall street”
The following article was printed today in the Wall Street Journal (August 7, 2007). It does an excellent job of describing what has happened to credit markets over the past decade as a result of decisions made by the Federal Reserve and Wall Street investment banks.
ASSETS: Gold certificate account 11,037 Special drawing rights certificate acct. 2,200 Coin 932 Securities, repos and loans 812,372 Securities held outright 790,439 U.S. Treasury 790,439 Bills 277,019 Notes and bonds 513,420 Repurchase agreements 21,000 Loans 933 Items in process of collection 4,524 Bank premises 2,036 Other assets 37,767 Total Assets 870,868 Analyzing the Federal Reserve's Balance Sheet reveals many interesting things: "Whoever controls the volume of money in any country is absolute master of all industry and commerce."(Paul Warburg, drafter of the Federal Reserve Act) "Permit me to issue and control the money of a nation and I care not who makes its laws."(Mayer Amschel Rothschild) By GREG IP and JON E. HILSENRATH An extraordinary credit boom that created many first-time homeowners and financed a wave of corporate takeovers seems to be waning. Home buyers with poor credit are having trouble borrowing. Institutional investors from Milwaukee to Düsseldorf to Sydney are reporting losses. Banks are stuck with corporate debt that investors won't buy. Stocks are on a roller coaster, with financial powerhouses like Bear Stearns Cos. and Blackstone Group coming under intense pressure. The origins of the boom and this unfolding reversal predate last year's mistakes. They trace to changes in the banking system provoked by the collapse of the savings-and-loan industry in the 1980s, the reaction of governments to the Asian financial crisis of the late 1990s, and the Federal Reserve's response to the 2000-01 bursting of the tech-stock bubble. When the Fed cut interest rates to the lowest level in a generation to avoid a severe downturn, then-Chairman Alan Greenspan anticipated that making short-term credit so cheap would have unintended consequences. "I don't know what it is, but we're doing some damage because this is not the way credit markets should operate," he and a colleague recall him saying at the time. Now the consequences of moves the Fed and others made are becoming clearer.
Fourth in a series • Page One: Mortgage Mess Shines Light on Brokers' Role • Page One: How Wall Street Stoked The Mortgage Meltdown Low interest rates engineered by central banks and reinforced by a tidal wave of overseas savings fueled home prices and leveraged buyouts. Pension funds and endowments, unhappy with skimpy returns, shoved cash at hedge funds and private-equity firms, which borrowed heavily to make big bets. The investments of choice were opaque financial instruments that shifted default risk from lenders to global investors. The question now: When the dust settles, will the world be better off? "These adverse periods are very painful, but they're inevitable if we choose to maintain a system in which people are free to take risks, a necessary condition for maximum sustainable economic growth," Mr. Greenspan says today. The evolving financial architecture is distributing risks away from highly leveraged banks toward investors better able to handle them, keeping the banks and economy more stable than in the past, he says. Economic growth, particularly outside the U.S., is strong, and even in the U.S., unemployment remains low. The financial system has absorbed the latest shock. So far. But credit problems once seen as isolated to a few subprime-mortgage lenders are beginning to propagate across markets and borders in unpredicted ways and degrees. A system designed to distribute and absorb risk might, instead, have bred it, by making it so easy for investors to buy complex securities they didn't fully understand. And the interconnectedness of markets could mean that a sudden change in sentiment by investors in all sorts of markets could destabilize the financial system and hurt economic growth. Side Effects of Deflation Fight When a technology stock and investment plunge and the Sept. 11 terrorist attacks pushed the economy into recession in 2001, the Fed slashed interest rates. But even by mid-2003, job creation and business investment were still anemic, and the inflation rate was slipping toward 1%. The Fed began to study Japan's unhappy bout with deflation -- generally declining prices -- which made it harder to repay debts and left the central bank seemingly powerless to stimulate growth. "Even though we perceive the risks [of deflation] as minor, the potential consequences are very substantial and could be quite negative," Mr. Greenspan said in May 2003. A month later, the Fed cut the target for its key federal-funds interest rate, a benchmark for all short-term rates, to 1%. It said the rate would stay there as long as necessary, figuring low rates would bolster housing and consumer spending until business investment and exports recovered. The rate stayed at 1% for a year. Mr. Greenspan raised vague fears with colleagues over the possibility this policy could create distortions in the economy, but he says today that such risks were an acceptable price for insuring against deflation. "Central banks cannot avoid taking risks. Such trade-offs are an integral part of policy. We were always confronted with choices." Fed officials who were there at the time generally maintain their policy was right, even in hindsight. The economy has grown steadily, avoiding both deflation and serious inflation. Yet some say they may have planted seeds of excess in the housing and subprime-loan markets. Robert Eisenbeis, retired research director at the Federal Reserve Bank of Atlanta, says the Fed overreacted to the threat of deflation and kept rates low for too long. As a result, it "overstimulated the housing market, and now we're dealing with the consequences." Edward Gramlich, a Fed governor in Washington from 1997 to 2005, says he failed to realize at the time that low rates were making it so easy for lenders to market subprime mortgages with low introductory rates. The Fed and other regulators could have prevented some of the resulting pain with more rigorous supervision of mortgage lenders besides banks, he says. "We didn't have that, and we're paying for it now." In June 2004, the Fed began to raise the short-term target rate, eventually taking it to 5.25%, where it has been for the past year. Such a boost usually leads to a rise, as well, in long-term rates, which are important to rates on 30-year conventional mortgages and corporate bonds. This time, it didn't. Mr. Greenspan expressed concern that investors were willing to accept low returns for taking on risk. "What they perceive as newly abundant liquidity can readily disappear," he said in August 2005, six months before retiring. "History has not dealt kindly with the aftermath of protracted periods of low risk premiums." Looking back, he says today: "We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed." Something besides Fed policy was at work. Both Mr. Greenspan and his successor, Ben Bernanke, point to an unanticipated surge in capital pouring into the U.S. from overseas. 'Global Saving Glut' In June 1998, U.S. Treasury officials made a plea to China that they would be reminded of repeatedly in the following years. Thailand had devalued its currency in 1997, touching off a crisis in the region that led other countries to devalue and in some cases default on foreign debt. The yen was sliding. Chinese officials, who pegged their currency to the U.S. dollar, "let it be known...that if things kept going this way they'd have no choice but to devalue," recalls Ted Truman, a Treasury official at the time. The U.S., fearing such a move would trigger another round of devaluations, urged the Chinese to hold their peg, and praised them when they did so. The Journal's Jon Hilsenrath discusses the origins of the credit boom and some of the lessons to be learned from its demise. But times changed. As recessions and depressed currencies held down imports and goosed exports in other Asian countries, the countries ran trade surpluses that replenished foreign-exchange reserves. Determined never to be so tied to the onerous conditions of the International Monetary Fund, they have kept those policies in place. Thai reserves, effectively exhausted in 1997, now stand at $73 billion. Long after the crisis passed, China's economic fundamentals suggested its currency should rise against the dollar. China let it rise only slowly, continuing to juice exports and produce trade surpluses that pushed China's foreign-exchange reserves above $1 trillion. When the U.S. pressed China to let its currency float, China reminded the U.S. of the fixed exchange rate's stabilizing role in 1998. China put much of its cash -- part of what Mr. Bernanke has called a "global saving glut" -- into U.S. Treasurys, helping hold down long-term U.S. interest rates. Chinese government entities also recently poured $3 billion into U.S. private-equity firm Blackstone. Mortgages for All Lou Barnes, co-owner of a small Colorado mortgage bank called Boulder West Inc., has been in the mortgage business since the late 1970s. For most of that time, a borrower had to fully document his income. Lenders offered the first no-documentation loans in the mid-1990s, but for no more than 70% of the value of the house being purchased. A few years back, he says, that began to change as Wall Street investment banks and wholesalers demanded ever more mortgages from even the least creditworthy -- or "subprime" -- customers. "All of us felt the suction from Wall Street. One day you would get an email saying, 'We will buy no-doc loans at 95% loan-to-value,' and an old-timer like me had never seen one," says Mr. Barnes. "It wasn't long before the no-doc emails said 100%." Until the late 1990s, the subprime market was dominated by home-equity lines used by borrowers to consolidate debt and by loans on mobile homes. But when the Fed held rates down after 2001, lenders could offer borrowers with sketchy credit histories adjustable-rate mortgages with introductory rates that seemed affordable. Mr. Barnes says customers were asking about "2/28" subprime loans. These offered a low starter rate for two years, then adjusted for the remaining 28 to a rate that was often three percentage points higher than a prime customer normally paid. Customers, he says, seldom appreciated how high that rate could be once the Fed returned rates to normal levels. Demand from consumers, on one side, and Wall Street and its customers on the other side prompted lenders to make more and more subprime loans. Originations rose to $600 billion or more in both 2005 and 2006 from $160 billion in 2001, according to Inside Mortgage Finance, an industry publication. At first, delinquencies were surprisingly low. As a result, the credit ratings for bonds backed by the mortgages assumed a modest default rate. Standards for getting a mortgage fell. About 45% of all subprime loans in 2006 went to borrowers who didn't fully document their income, making it easier for them to overstate their creditworthiness. The delinquency rate was a mirage: It was low mainly because home prices were rising so much that borrowers who fell behind could easily refinance. When home prices stopped rising in 2006, and fell in some regions, that game ended. Borrowers with subprime loans made in 2006 fell behind on monthly payments much more quickly than mortgages made a year or two earlier. When banks get in trouble, federal deposit insurance encourages depositors not to flee, and in extreme circumstances, banks can borrow directly from the Fed. But banks are no longer the dominant lenders. After the S&L crisis in the 1980s and early 1990s, regulators insisted banks and thrifts hold more capital against risky loans. This tipped the playing field in favor of unregulated lenders. They financed themselves not by deposits but by Wall Street credit lines and by "securitization" of their loans -- in effect, the sale of the loans to investors. The consequences proved painful. New Century Financial Corp., founded in 1995 by three former S&L executives, was the nation's second largest subprime lender by 2006. When its borrowers began falling behind, Wall Street cut off its lines of credit and forced it to buy back some of its poorly performing loans. New Century couldn't fall back on deposit insurance or the Fed. It filed for bankruptcy protection in April, wiping out shareholders and triggering market-wide fears about the health of the subprime business. LBO Boom Home buyers were not alone. In August 2002, Qwest Communications International Inc. -- heavily indebted, beaten down by the telecom bust and under investigation by the Securities and Exchange Commission -- decided to sell its Yellow Pages business. Private-equity firms Carlyle Group and Welsh, Carson, Anderson & Stowe agreed to buy it for $7 billion, about $5.5 billion of it borrowed. The business produced steady cash flow that could be used to pay down the debt. The buyers were worried they might not be able to borrow as much as they needed. "We were coming out of a pretty bad credit cycle," says Daniel Toscano, managing director at Deutsche Bank, which helped to manage the fund-raising. Instead, they tapped into a gusher. Within a year, Dex Media Inc., as the business became known, was back in the market. It borrowed $889 million to pay a dividend to Carlyle and Welsh Carson, and then $250 million more to pay another dividend. In just 15 months, the private-equity buyers made back most of their investment and still owned the company. By 2006, the volume of such leveraged buyouts was smashing records from the 1980s. Generous credit markets enabled private-equity firms to do larger deals and pay themselves bigger dividends. They boosted returns -- and attracted more investors, which enabled even bigger deals. As in subprime mortgages, lenders began to ease borrowing requirements. They agreed, for instance, to "covenant-lite debt," which dropped once-standard performance requirements, and "PIK-toggle" notes, which allowed borrowers to toggle interest payments on and off like a faucet. Bankers began marketing debt deals for companies that, unlike Yellow Pages, didn't have comfortable cash flow. There was Chrysler, burning cash rather than producing it. And there was First Data Corp., whose post-takeover cash flow would barely cover interest payments and capital spending, according to Standard & Poor's LCD, a unit of S&P which tracks the high-yield market. Last month, investors began to balk. Now many banks find themselves having committed to lend about $200 billion that they had intended to turn over to investors, but can't. Let's All Look Like Yale The subprime and LBO booms required willing lenders. The stock-market collapse and low interest rates of 2001 to 2004 nurtured a class of investors and products to fill that role. Managers of pension and endowment funds long had divided their assets among domestic stocks, bonds and cash. The funds saw their performance suffer when the stock market and then bond yields tumbled. A few endowments, most notably at Yale and Harvard, had for years been spreading their investments more broadly, going into hedge funds, real estate, foreign stocks, even timberland. The goal was holdings that wouldn't suffer in sync with stocks in a bear market. Sure enough, in 2000 and 2001, even as stocks tumbled, Harvard Management Co. earned returns of 32.2% and -2.7% respectively. Yale's returns were 41% and 9.2%. Other institutions wanted their money managed the same way, seeding a flood of hedge funds that bought other untraditional investments such as credit derivatives. University endowments poured roughly $40 billion into hedge funds between 2000 and 2006, according to Hedge Fund Intelligence, a newsletter. "I call it the 'Let's all look like Yale effect,'" says Jeremy Grantham, chairman of Boston money manager GMO LLC. Low interest rates made many investors willing to buy exotic securities in an effort to boost returns. Wall Street had just the vehicle: securitization, or turning loans that once sat quietly on banks' books into securities that can be sold in global markets. Securitization, long common in conventional mortgages, had been supercharged in the early 1990s when the federal Resolution Trust Corp. took over S&Ls that held more than $400 billion of assets. Though some thought it would take the RTC a century to unload them, it took only a few years. The agency successfully securitized new classes of assets, such as delinquent home loans or commercial loans. In the late 1990s, Wall Street went a step further, packaging bigger pools of securities into collateralized debt obligations, or CDOs, and carving them into "tranches," each with a different level of risk and return. Riskier tranches suffered the first losses if some underlying loans defaulted. Other tranches offered lower returns because riskier tranches would take the first hits if the business went sour. Because of the way they were structured, some CDO tranches got triple-A ratings from Moody's Investors Service and Standard & Poor's even though they contained subprime loans. That lured traditionally conservative investors such as commercial banks, insurance companies and pension funds. The upside was evident: Many borrowers got loans they wouldn't otherwise have had. The taxpayer-backed deposit fund was less likely to bear the cost of sloppy lending practices. Banks shifted risks to investors more willing to bear them -- leaving the banks able to make more loans. Investors could pick either more-risky or less-risky slices. And Wall Street middlemen made handsome profits. Now the downside, too, is painfully evident. Final investors were so many steps removed from the original loans that it became hard for them to know the true value and risk of securities they bought. Some were satisfied with a triple-A rating on a CDO -- seemingly as safe as a U.S. Treasury bond but with more yield. Yet as defaults ate through the cushion of lower-rated tranches with unexpected speed, rating agencies were forced to rethink their models -- and lower the ratings on many of these investments. Some structures were so opaque that markets couldn't value them. But ratings cuts sometimes forced an acknowledgment that securities owned weren't worth as much as thought. In May, Swiss bank UBS AG shut down a hedge fund after a $124 million loss. In June, two Bear Stearns hedge funds saw as much as $1.6 billion of investor capital wiped out by bad mortgage bets and pulled credit lines. The trouble spread to hedge funds in Sydney, Australia, a mortgage insurer in Milwaukee and a bank in Düsseldorf, Germany. Even Harvard has been hit. The university lost about $350 million through an investment in Sowood Capital Management, a hedge-fund firm founded by one of the university's former in-house money managers. Casino Night Recent events show that financial innovations meant to distribute risk can end up multiplying it instead, in ways neither regulators nor investors fully understand. Mr. Grantham, the Boston money manager, says his portfolios are behaving in ways he hadn't expected. Fed officials believe that even if their policies led to housing and debt bubbles, the strength of the overall economy shows that the policy was, on balance, the right one. Of course, that assumes the current problems don't culminate in a recession. Market veterans predict the most egregious underwriting practices and products will disappear, but the benefits of innovation will continue. Lessons have been learned -- the hard way. "The structures are here to stay," says Glenn Reynolds, chief executive of research firm CreditSights. "But you have to run it like a prudent risk-taking venture, not like it's casino night and you're on a bender." Write to Greg Ip at greg.ip@wsj.com and Jon E. Hilsenrath at jon.hilsenrath@wsj.com Wall St. Journal
It's obvious what is driving Wall Street - greed. Why else would you push mortgage companies for loans (that could be repackaged as securities) with no income documentation from the borrower that covered 100% of the purchase price? There has been no regard for the people who borrowed this money. No consideration of what would happen when these 'introductory' rates reset at higher interest rates. The only consideration was - how much money can I make? I'm sure that there were people within Wall Street who probably sounded an alarm - but it's obvious that any objections were silenced by the people at the top. What is the root of all evil?
We are led to believe that no one truly understands how our economy works (from the world's perspective) - it's simply too complicated. If you only listen to the media and economic ‘experts’ and never study economic and monetary policy yourself, you’ll never understand the truth of the economic system you rely on. I now believe that there are a few men in the world today who do understand and control much of the world’s economic activity. Because this certainly relates to Biblical end time events – we’ll review the truth of our monetary system in the next post.
We have many ways to measure our economy and economic growth, but what really causes periods of growth and periods of recession? What triggers a recession or a depression? If the leaders of our nation really understood our economy and really cared about our livelihood, we'd obviously never have recessions or depressions. Over the past few years, I've read many who believed we finally had it all figured out. Now, uncertainty reigns again. Derivatives, CLO's, CDO's & SIV’s supposedly spread risk around and protect investors....now it appears that everything is much more closely interconnected than anyone thought. Based on what we've learned about wealth from the Bible, do you really want to align yourself with such greed by investing in Wall Street? Take note of the section below entitled 'Casino Night'. Do you really want to place your life savings on black and have someone spin the wheel? At least in Vegas, you know your odds.
The actions of the Federal Reserve are more curious. Let's disregard for a moment that the Federal Reserve is a private corporation with private owners and take a quick look at their actions over the past few years. After Sept 11, 2001, the Fed reduced the Federal Funds Rate (rate charged to banks) to 1%. This is what has contributed to the 'easy money' or liquidity flowing throughout the world (see article below for details). As the economy has strengthened in recent years, the Federal Funds rate has steadily climbed to 5.25%. This, in effect, has raised the cost of everything in this country. The reason we are consistently given for this increase is that the Fed is concerned about inflation. We are always told that inflation is the enemy and must be contained at all costs. I agree, from an economic standpoint, inflation can destroy economic growth. But the question we must ask is this - is the Fed truly concerned about inflation?
Economists measure inflation in a couple of ways - the Consumer Price Index (CPI) and the Producer Price indexes (PPI) are two of the most prominent measures of inflation. Both measure the change in prices (for consumers and businesses) over time. What is something else that impacts the rate of inflation that doesn't get mentioned much in the media? The money supply. It stands to reason that as the supply of money in a nation increases, the chance of inflation increases. If you place more money in the hands of consumers and businesses, then there is a very high probability that everyone will buy more and invest more and drive up the prices of everything from consumer goods and services to stocks. Not sure whether this is an acceptable way to measure inflation? It used to be a very accurate measure of inflation – by the Federal Reserve. The following was taken from Wikipedia:
“In January 1987, with C.P.I. inflation down to only 1%, the Federal Reserve announced it was no longer going to use money supply aggregates, such as M2, as guidelines to control inflation, even though this method had been in use from 1979, apparently with great success. Previous to 1980, interest rates were used as guidelines; inflation was heavy. The Fed complained that the aggregates were confusing; Volcker was still chairman until August 1987, whereupon Alan Greenspan assumed the mantle, seven months after monetary aggregate policy had changed.”
Think about home equity loans. Low interest rates coupled with a hot housing market (again, this is inflation) has enabled many people to cash out equity in their homes. What have they done with this money? From what I've read, many have bought more stuff. This increases prices (supply and demand comes into play) and therefore, the rate of inflation increases.
So, does the Federal Reserve measure the overall money supply in the U.S.? It did until March 23, 2006. On this date, the Fed stopped publishing data on the M3 money supply (total measurement of our money supply). The following information was taken from Wikipedia:
"The most common measures are named M0 (narrowest), M1, M2, and M3. In the United States they are defined by the Federal Reserve as follows:
M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
M1: M0 - those portions of M0 held as reserves or vault cash + the amount in demand accounts ("checking" or "current" accounts).
M2: M1 + most savings accounts, money market accounts, small denomination time deposits and certificate of deposit accounts (CDs) of under $100,000.
M3: M2 + all other CDs, deposits of eurodollars and repurchase agreements.
As of March 23, 2006, information regarding M3 will no longer be published by the Federal Reserve, ostensibly because it costs a lot to collect the data but doesn't provide significantly useful data[1]. The other three money supply measures will continue to be provided in detail.
In an effort to reverse this change, Congressman Ron Paul introduced the now expired H.R.4892[2] on March 7th, 2006, and subsequently sponsored H.R.2754[3][4] on June 15th, 2007 which has been referred to the House Committee on Financial Services."
The Fed has said that M3 data is not significant. Really? Apparently, it was important from 1979 to 1987 when they used the money supply to measure inflation very effectively. Why is it now not important? By not publishing this data, we don't know how many dollars are in circulation throughout the world (coins, bills, checking accounts, foreign accounts, etc). Theoretically, you could estimate M3 from the other measures, but it would take alot of time and would only be an approximation. How much money are we talking about? At the time the Fed stopped publishing M3 data (March 2006), the total amount of our money supply equaled 10 trillion dollars. M3 data represented 3 trillion additional dollars in addition to M2. Not reporting 30% of our money supply is not significant? It is also interesting to note that the total value of our money supply has increased to 10 trillion dollars in 2006 from 4 trillion in 1990. So, our total 'supply' of dollars has more than doubled in only 16 years. Should it surprise us that the dollar is weakening against other currencies throughout the world? If the Fed was really concerned about inflation, why have they flooded the world's markets with dollars and stopped publishing this data?
The final question we need to ask is this - is the Federal Reserve acting in our best interests (the nation) or is it acting in the interests of its owners? Do private companies act in the best interests of everyone or do they act in the best interests of their shareholders? What if the shareholders of the Fed have another motive for their actions? Remember, we are not talking about Godly people. If you are still not convinced that the Federal Reserve system is privately controlled, the following was taken from Wikipedia:
“In Lewis v. United States, the United States Court of Appeals for the Ninth Circuit stated that "the Reserve Banks are not federal instrumentalities for purposes of the FTCA [the Federal Tort Claims Act], but are independent, privately owned and locally controlled corporations."”
Let’s take a look at the Federal Reserve’s balance sheet. This information is taken from Wikipedia. The dollar amounts are in millions.
So, the Federal Reserve has over $870 Billion dollars in assets.
The following analysis is also taken from Wikipedia. The figure that stands out to me is the amount of money the Federal Government (that’s you and me included) owes the Federal Reserve banking system. At the time this article was written (June 2007), the United States Government owes the Federal Reserve $790 Billion dollars. This represents 9% of our national debt. That’s the price we pay to the Fed to create our currency and manage the banking system. When the media discusses our national debt, why is this never mentioned? People in high places would prefer that we didn’t know.
The question becomes – should the United States Government pay a private corporation to manage its money? I believe what we have all forgotten is that our money has no real value. Since 1971, our money is no longer, in any way, tied to the value of gold. So, our paper money is only good to use as long as everyone accepts it as money. If the dollar crashes on world markets, what will happen to our banking system? It won’t be good.
Starting to feel uncomfortable?
What if the private owners of the Federal Reserve are the same people who control much of our government behind the scenes? If you study all of the events of 9/11/2001, you will find that there were many suspicious financial transactions taking place before the event. Many 'puts' (bets that a stock will fall) were placed on airline stocks (including Boeing). The number of puts placed before the attacks were many times higher than the norm. Harddrives were recovered from ground zero that showed many millions of dollars in financial transactions related to the event that someone apparently thought would be 'covered up' and destroyed. Where are the billions of dollars worth of gold that was stored in the vaults of the World Trade Center? It seems to have vanished. Why doesn't our mainstream media investigate these things? Whether you want to believe it or not, many people had prior knowledge of this event. It's hard to believe, but it's the truth.
So, what if this event was planned as a 'false flag' operation that would be used against us in order to slowly remove our freedoms in the name of the 'war on terror'? Whether you want to believe it, this is exactly what is happening (Patriot and Military Commissions Act, the various 'executive orders' from President Bush). Don't forget, we are dealing with very intelligent, deceptive people who place no value on your life or mine - they use our patriotism against us. What if, in connection with this event, the Federal Reserve lowered interest rates for a long time to give the appearance that they were helping us, but were, in effect, setting up the world for a major financial crisis? Is it a coincidence that at a time we are worrying about a future terrorist event, financial markets are experiencing a very high level of volatility? It's as if we have been directed to the edge of a cliff, but we think that there's no way we're going over. It won't happen - we're America after all! We think we're invincible. We're being setup on many fronts - but are spiritually blind and can't see our enemy. The world is going to tell us who can save us from these 'terrorists'. The world will tell us who can restore financial stability. As Jesus told us - the father of lies is ruler of this world. Don't trust the world. Place your faith in God and His truth.
Also keep in mind that President Bush has signed many executive orders that give him what amounts to dictatorship powers in the event of another 'terrorist' event. I wonder why mainstream media never reports on these things? Do you see where this is going? This 'event' will trigger not only the loss of our freedom, but could very well be the trigger for a worldwide financial collapse. Based on what is at stake, who do you think will be behind this event? What do you think will emerge from this event? There are people walking around today that could tell you exactly what is planned.
Still not convinced? What do some of the men who helped created the Federal Reserve have to say on the subject?
It's time to stop focusing on our pursuit of worldly things. God is giving us signs everywhere - we're simply not paying any attention. This is going to change.
__________________________________________________
How Credit Got So Easy
And Why It's Tightening
August 7, 2007; Page A1
7/5/07
6/27/07
I wrote the articles on ‘wealth and the Bible’ sometime in early to mid 2007. At the time, it appeared that the sub-prime housing market was heading for some serious trouble. It also seemed like there was a lot of lying, cheating and stealing going on – from the information I could find. I also posed a question at one point – how long will God allow this to continue? How long will He allow a small group of wealthy men – to continue to take advantage of us? The answer – it turns out – was less than a year.
Today is November 13, 2008. Over the past 2 months, we’ve watched the world’s economy seize up – prices for everything (stocks, bonds, commodities, etc) are plummeting. As bad as things are – they’re going to get worse. As I have mentioned multiple times before – when our wealth is gone – which path will we take? We’ve watched where the world’s path takes us – destruction. Will we choose a different path this time?
The article below sums up what really goes on in Wall St. firms and describes how greed drove the housing market to ruin. It’s always best to learn the truth of what happened from someone who has been in the game. If you have purchased stocks, bonds, CDO’s – whatever – from Wall St. – this will explain exactly what you purchased – a lie.
jg
The End
by Michael Lewis Nov 11 2008
The era that defined Wall Street is finally, officially over. Michael Lewis, who chronicled its excess in Liar’s Poker, returns to his old haunt to figure out what went wrong.
Photoillustration by: Ji Lee
To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue.
I’d never taken an accounting course, never run a business, never even had savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous—which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people’s money, would be expelled from finance.When I sat down to write my account of the experience in 1989—Liar’s Poker, it was called—it was in the spirit of a young man who thought he was getting out while the getting was good. I was merely scribbling down a message on my way out and stuffing it into a bottle for those who would pass through these parts in the far distant future.
Unless some insider got all of this down on paper, I figured, no future human would believe that it happened.
I thought I was writing a period piece about the 1980s in America. Not for a moment did I suspect that the financial 1980s would last two full decades longer or that the difference in degree between Wall Street and ordinary life would swell into a difference in kind. I expected readers of the future to be outraged that back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid $3.1 million; I expected them to gape in horror when I reported that one of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost $250 million; I assumed they’d be shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the risks his traders were running. What I didn’t expect was that any future reader would look on my experience and say, “How quaint.”
I had no great agenda, apart from telling what I took to be a remarkable tale, but if you got a few drinks in me and then asked what effect I thought my book would have on the world, I might have said something like, “I hope that college students trying to figure out what to do with their lives will read it and decide that it’s silly to phony it up and abandon their passions to become financiers.” I hoped that some bright kid at, say, Ohio State University who really wanted to be an oceanographer would read my book, spurn the offer from Morgan Stanley, and set out to sea.
Somehow that message failed to come across. Six months after Liar’s Poker was published, I was knee-deep in letters from students at Ohio State who wanted to know if I had any other secrets to share about Wall Street. They’d read my book as a how-to manual.
In the two decades since then, I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces?
At some point, I gave up waiting for the end. There was no scandal or reversal, I assumed, that could sink the system.
Then came Meredith Whitney with news. Whitney was an obscure analyst of financial firms for Oppenheimer Securities who, on October 31, 2007, ceased to be obscure. On that day, she predicted that Citigroup had so mismanaged its affairs that it would need to slash its dividend or go bust. It’s never entirely clear on any given day what causes what in the stock market, but it was pretty obvious that on October 31, Meredith Whitney caused the market in financial stocks to crash. By the end of the trading day, a woman whom basically no one had ever heard of had shaved $369 billion off the value of financial firms in the market. Four days later, Citigroup’s C.E.O., Chuck Prince, resigned. In January, Citigroup slashed its dividend.
From that moment, Whitney became E.F. Hutton: When she spoke, people listened. Her message was clear. If you want to know what these Wall Street firms are really worth, take a hard look at the crappy assets they bought with huge sums of borrowed money, and imagine what they’d fetch in a fire sale. The vast assemblages of highly paid people inside the firms were essentially worth nothing. For better than a year now, Whitney has responded to the claims by bankers and brokers that they had put their problems behind them with this write-down or that capital raise with a claim of her own: You’re wrong. You’re still not facing up to how badly you have mismanaged your business. Rivals accused Whitney of being overrated; bloggers accused her of being lucky. What she was, mainly, was right. But it’s true that she was, in part, guessing. There was no way she could have known what was going to happen to these Wall Street firms. The C.E.O.’s themselves didn’t know. Now, obviously, Meredith Whitney didn’t sink Wall Street. She just expressed most clearly and loudly a view that was, in retrospect, far more seditious to the financial order than, say, Eliot Spitzer’s campaign against Wall Street corruption. If mere scandal could have destroyed the big Wall Street investment banks, they’d have vanished long ago. This woman wasn’t saying that Wall Street bankers were corrupt. She was saying they were stupid. These people whose job it was to allocate capital apparently didn’t even know how to manage their own.At some point, I could no longer contain myself: I called Whitney. This was back in March, when Wall Street’s fate still hung in the balance. I thought, If she’s right, then this really could be the end of Wall Street as we’ve known it. I was curious to see if she made sense but also to know where this young woman who was crashing the stock market with her every utterance had come from.
It turned out that she made a great deal of sense and that she’d arrived on Wall Street in 1993, from the Brown University history department. “I got to New York, and I didn’t even know research existed,” she says. She’d wound up at Oppenheimer and had the most incredible piece of luck: to be trained by a man who helped her establish not merely a career but a worldview. His name, she says, was Steve Eisman.
Eisman had moved on, but they kept in touch. “After I made the Citi call,” she says, “one of the best things that happened was when Steve called and told me how proud he was of me.”
Having never heard of Eisman, I didn’t think anything of this. But a few months later, I called Whitney again and asked her, as I was asking others, whom she knew who had anticipated the cataclysm and set themselves up to make a fortune from it. There’s a long list of people who now say they saw it coming all along but a far shorter one of people who actually did. Of those, even fewer had the nerve to bet on their vision. It’s not easy to stand apart from mass hysteria—to believe that most of what’s in the financial news is wrong or distorted, to believe that most important financial people are either lying or deluded—without actually being insane. A handful of people had been inside the black box, understood how it worked, and bet on it blowing up. Whitney rattled off a list with a half-dozen names on it. At the top was Steve Eisman.
Steve Eisman entered finance about the time I exited it. He’d grown up in New York City and gone to a Jewish day school, the University of Pennsylvania, and Harvard Law School. In 1991, he was a 30-year-old corporate lawyer. “I hated it,” he says. “I hated being a lawyer. My parents worked as brokers at Oppenheimer. They managed to finagle me a job. It’s not pretty, but that’s what happened.”
He was hired as a junior equity analyst, a helpmate who didn’t actually offer his opinions. That changed in December 1991, less than a year into his new job, when a subprime mortgage lender called Ames Financial went public and no one at Oppenheimer particularly cared to express an opinion about it. One of Oppenheimer’s investment bankers stomped around the research department looking for anyone who knew anything about the mortgage business. Recalls Eisman: “I’m a junior analyst and just trying to figure out which end is up, but I told him that as a lawyer I’d worked on a deal for the Money Store.” He was promptly appointed the lead analyst for Ames Financial. “What I didn’t tell him was that my job had been to proofread the documents and that I hadn’t understood a word of the [obscenity deleted] things.”
Ames Financial belonged to a category of firms known as nonbank financial institutions. The category didn’t include J.P. Morgan, but it did encompass many little-known companies that one way or another were involved in the early-1990s boom in subprime mortgage lending—the lower class of American finance.
The second company for which Eisman was given sole responsibility was Lomas Financial, which had just emerged from bankruptcy. “I put a sell rating on the thing because it was a piece of [obscenity deleted],” Eisman says. “I didn’t know that you weren’t supposed to put a sell rating on companies. I thought there were three boxes—buy, hold, sell—and you could pick the one you thought you should.” He was pressured generally to be a bit more upbeat, but upbeat wasn’t Steve Eisman’s style. Upbeat and Eisman didn’t occupy the same planet. A hedge fund manager who counts Eisman as a friend set out to explain him to me but quit a minute into it. After describing how Eisman exposed various important people as either liars or idiots, the hedge fund manager started to laugh. “He’s sort of a [obscenity deleted] in a way, but he’s smart and honest and fearless.”
“A lot of people don’t get Steve,” Whitney says. “But the people who get him love him.” Eisman stuck to his sell rating on Lomas Financial, even after the company announced that investors needn’t worry about its financial condition, as it had hedged its market risk. “The single greatest line I ever wrote as an analyst,” says Eisman, “was after Lomas said they were hedged.” He recited the line from memory: “ ‘The Lomas Financial Corp. is a perfectly hedged financial institution: It loses money in every conceivable interest-rate environment.’ I enjoyed writing that sentence more than any sentence I ever wrote.” A few months after he’d delivered that line in his report, Lomas Financial returned to bankruptcy.
Eisman wasn’t, in short, an analyst with a sunny disposition who expected the best of his fellow financial man and the companies he created. “You have to understand,” Eisman says in his defense, “I did subprime first. I lived with the worst first. These guys lied to infinity. What I learned from that experience was that Wall Street didn’t give a [obscenity deleted] what it sold.”Harboring suspicions about people’s morals and telling investors that companies don’t deserve their capital wasn’t, in the 1990s or at any other time, the fast track to success on Wall Street. Eisman quit Oppenheimer in 2001 to work as an analyst at a hedge fund, but what he really wanted to do was run money. FrontPoint Partners, another hedge fund, hired him in 2004 to invest in financial stocks. Eisman’s brief was to evaluate Wall Street banks, homebuilders, mortgage originators, and any company (General Electric or General Motors, for instance) with a big financial-services division—anyone who touched American finance. An insurance company backed him with $50 million, a paltry sum. “Basically, we tried to raise money and didn't really do it,” Eisman says.
Instead of money, he attracted people whose worldviews were as shaded as his own—Vincent Daniel, for instance, who became a partner and an analyst in charge of the mortgage sector. Now 36, Daniel grew up a lower-middle-class kid in Queens. One of his first jobs, as a junior accountant at Arthur Andersen, was to audit Salomon Brothers’ books. “It was shocking,” he says. “No one could explain to me what they were doing.” He left accounting in the middle of the internet boom to become a research analyst, looking at companies that made subprime loans. “I was the only guy I knew covering companies that were all going to go bust,” he says. “I saw how the sausage was made in the economy, and it was really freaky.”
Danny Moses, who became Eisman’s head trader, was another who shared his perspective. Raised in Georgia, Moses, the son of a finance professor, was a bit less fatalistic than Daniel or Eisman, but he nevertheless shared a general sense that bad things can and do happen. When a Wall Street firm helped him get into a trade that seemed perfect in every way, he said to the salesman, “I appreciate this, but I just want to know one thing: How are you going to screw me?”
Heh heh heh, c’mon. We’d never do that, the trader started to say, but Moses was politely insistent: We both know that unadulterated good things like this trade don’t just happen between little hedge funds and big Wall Street firms. I’ll do it, but only after you explain to me how you are going to screw me. And the salesman explained how he was going to screw him. And Moses did the trade.
Both Daniel and Moses enjoyed, immensely, working with Steve Eisman. He put a fine point on the absurdity they saw everywhere around them. “Steve’s fun to take to any Wall Street meeting,” Daniel says. “Because he’ll say ‘Explain that to me’ 30 different times. Or ‘Could you explain that more, in English?’ Because once you do that, there’s a few things you learn. For a start, you figure out if they even know what they’re talking about. And a lot of times, they don’t!”
At the end of 2004, Eisman, Moses, and Daniel shared a sense that unhealthy things were going on in the U.S. housing market: Lots of firms were lending money to people who shouldn’t have been borrowing it. They thought Alan Greenspan’s decision after the internet bust to lower interest rates to 1 percent was a travesty that would lead to some terrible day of reckoning. Neither of these insights was entirely original. Ivy Zelman, at the time the housing-market analyst at Credit Suisse, had seen the bubble forming very early on. There’s a simple measure of sanity in housing prices: the ratio of median home price to income. Historically, it runs around 3 to 1; by late 2004, it had risen nationally to 4 to 1. “All these people were saying it was nearly as high in some other countries,” Zelman says. “But the problem wasn’t just that it was 4 to 1. In Los Angeles, it was 10 to 1, and in Miami, 8.5 to 1. And then you coupled that with the buyers. They weren’t real buyers. They were speculators.” Zelman alienated clients with her pessimism, but she couldn’t pretend everything was good. “It wasn’t that hard in hindsight to see it,” she says. “It was very hard to know when it would stop.” Zelman spoke occasionally with Eisman and always left these conversations feeling better about her views and worse about the world. “You needed the occasional assurance that you weren’t nuts,” she says. She wasn’t nuts. The world was.
By the spring of 2005, FrontPoint was fairly convinced that something was very screwed up not merely in a handful of companies but in the financial underpinnings of the entire U.S. mortgage market. In 2000, there had been $130 billion in subprime mortgage lending, with $55 billion of that repackaged as mortgage bonds. But in 2005, there was $625 billion in subprime mortgage loans, $507 billion of which found its way into mortgage bonds. Eisman couldn’t understand who was making all these loans or why. He had a from-the-ground-up understanding of both the U.S. housing market and Wall Street. But he’d spent his life in the stock market, and it was clear that the stock market was, in this story, largely irrelevant. “What most people don’t realize is that the fixed-income world dwarfs the equity world,” he says. “The equity world is like a [obscenity deleted] zit compared with the bond market.” He shorted companies that originated subprime loans, like New Century and Indy Mac, and companies that built the houses bought with the loans, such as Toll Brothers. Smart as these trades proved to be, they weren’t entirely satisfying. These companies paid high dividends, and their shares were often expensive to borrow; selling them short was a costly proposition.
Enter Greg Lippman, a mortgage-bond trader at Deutsche Bank. He arrived at FrontPoint bearing a 66-page presentation that described a better way for the fund to put its view of both Wall Street and the U.S. housing market into action. The smart trade, Lippman argued, was to sell short not New Century’s stock but its bonds that were backed by the subprime loans it had made. Eisman hadn’t known this was even possible—because until recently, it hadn’t been. But Lippman, along with traders at other Wall Street investment banks, had created a way to short the subprime bond market with precision.
Here’s where financial technology became suddenly, urgently relevant. The typical mortgage bond was still structured in much the same way it had been when I worked at Salomon Brothers. The loans went into a trust that was designed to pay off its investors not all at once but according to their rankings. The investors in the top tranche, rated AAA, received the first payment from the trust and, because their investment was the least risky, received the lowest interest rate on their money. The investors who held the trusts’ BBB tranche got the last payments—and bore the brunt of the first defaults. Because they were taking the most risk, they received the highest return. Eisman wanted to bet that some subprime borrowers would default, causing the trust to suffer losses. The way to express this view was to short the BBB tranche. The trouble was that the BBB tranche was only a tiny slice of the deal.But the scarcity of truly crappy subprime-mortgage bonds no longer mattered. The big Wall Street firms had just made it possible to short even the tiniest and most obscure subprime-mortgage-backed bond by creating, in effect, a market of side bets. Instead of shorting the actual BBB bond, you could now enter into an agreement for a credit-default swap with Deutsche Bank or Goldman Sachs. It cost money to make this side bet, but nothing like what it cost to short the stocks, and the upside was far greater.
The arrangement bore the same relation to actual finance as fantasy football bears to the N.F.L. Eisman was perplexed in particular about why Wall Street firms would be coming to him and asking him to sell short. “What Lippman did, to his credit, was he came around several times to me and said, ‘Short this market,’ ” Eisman says. “In my entire life, I never saw a sell-side guy come in and say, ‘Short my market.’ ”
And short Eisman did—then he tried to get his mind around what he’d just done so he could do it better. He’d call over to a big firm and ask for a list of mortgage bonds from all over the country. The juiciest shorts—the bonds ultimately backed by the mortgages most likely to default—had several characteristics. They’d be in what Wall Street people were now calling the sand states: Arizona, California, Florida, Nevada. The loans would have been made by one of the more dubious mortgage lenders; Long Beach Financial, wholly owned by Washington Mutual, was a great example. Long Beach Financial was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking homeowners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000.
More generally, the subprime market tapped a tranche of the American public that did not typically have anything to do with Wall Street. Lenders were making loans to people who, based on their credit ratings, were less creditworthy than 71 percent of the population. Eisman knew some of these people. One day, his housekeeper, a South American woman, told him that she was planning to buy a townhouse in Queens. “The price was absurd, and they were giving her a low-down-payment option-ARM,” says Eisman, who talked her into taking out a conventional fixed-rate mortgage. Next, the baby nurse he’d hired back in 1997 to take care of his newborn twin daughters phoned him. “She was this lovely woman from Jamaica,” he says. “One day she calls me and says she and her sister own five townhouses in Queens. I said, ‘How did that happen?’ ” It happened because after they bought the first one and its value rose, the lenders came and suggested they refinance and take out $250,000, which they used to buy another one. Then the price of that one rose too, and they repeated the experiment. “By the time they were done,” Eisman says, “they owned five of them, the market was falling, and they couldn’t make any of the payments.”
In retrospect, pretty much all of the riskiest subprime-backed bonds were worth betting against; they would all one day be worth zero. But at the time Eisman began to do it, in the fall of 2006, that wasn’t clear. He and his team set out to find the smelliest pile of loans they could so that they could make side bets against them with Goldman Sachs or Deutsche Bank. What they were doing, oddly enough, was the analysis of subprime lending that should have been done before the loans were made: Which poor Americans were likely to jump which way with their finances? How much did home prices need to fall for these loans to blow up? (It turned out they didn’t have to fall; they merely needed to stay flat.) The default rate in Georgia was five times higher than that in Florida even though the two states had the same unemployment rate. Why? Indiana had a 25 percent default rate; California’s was only 5 percent. Why?
Moses actually flew down to Miami and wandered around neighborhoods built with subprime loans to see how bad things were. “He’d call me and say, ‘Oh my God, this is a calamity here,’ ” recalls Eisman. All that was required for the BBB bonds to go to zero was for the default rate on the underlying loans to reach 14 percent. Eisman thought that, in certain sections of the country, it would go far, far higher.The funny thing, looking back on it, is how long it took for even someone who predicted the disaster to grasp its root causes. They were learning about this on the fly, shorting the bonds and then trying to figure out what they had done. Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.
But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.
As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”
“With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”
This wasn’t Fitch or even S&P. This was Moody’s, the aristocrats of the rating business, 20 percent owned by Warren Buffett. And the company’s C.E.O. was being told he was either a fool or a crook by one Vincent Daniel, from Queens.
A full nine months earlier, Daniel and Moses had flown to Orlando for an industry conference. It had a grand title—the American Securitization Forum—but it was essentially a trade show for the subprime-mortgage business: the people who originated subprime mortgages, the Wall Street firms that packaged and sold subprime mortgages, the fund managers who invested in nothing but subprime-mortgage-backed bonds, the agencies that rated subprime-mortgage bonds, the lawyers who did whatever the lawyers did. Daniel and Moses thought they were paying a courtesy call on a cottage industry, but the cottage had become a castle. “There were like 6,000 people there,” Daniel says. “There were so many people being fed by this industry. The entire fixed-income department of each brokerage firm is built on this. Everyone there was the long side of the trade. The wrong side of the trade. And then there was us. That’s when the picture really started to become clearer, and we started to get more cynical, if that was possible. We went back home and said to Steve, ‘You gotta see this.’ ”
Eisman, Daniel, and Moses then flew out to Las Vegas for an even bigger subprime conference. By now, Eisman knew everything he needed to know about the quality of the loans being made. He still didn’t fully understand how the apparatus worked, but he knew that Wall Street had built a doomsday machine. He was at once opportunistic and outraged.
Their first stop was a speech given by the C.E.O. of Option One, the mortgage originator owned by H&R Block. When the guy got to the part of his speech about Option One’s subprime-loan portfolio, he claimed to be expecting a modest default rate of 5 percent. Eisman raised his hand. Moses and Daniel sank into their chairs. “It wasn’t a Q&A,” says Moses. “The guy was giving a speech. He sees Steve’s hand and says, ‘Yes?’”
“Would you say that 5 percent is a probability or a possibility?” Eisman asked.
A probability, said the C.E.O., and he continued his speech.
Eisman had his hand up in the air again, waving it around. Oh, no, Moses thought. “The one thing Steve always says,” Daniel explains, “is you must assume they are lying to you. They will always lie to you.” Moses and Daniel both knew what Eisman thought of these subprime lenders but didn’t see the need for him to express it here in this manner. For Eisman wasn’t raising his hand to ask a question. He had his thumb and index finger in a big circle. He was using his fingers to speak on his behalf. Zero! they said.
“Yes?” the C.E.O. said, obviously irritated. “Is that another question?”“No,” said Eisman. “It’s a zero. There is zero probability that your default rate will be 5 percent.” The losses on subprime loans would be much, much greater. Before the guy could reply, Eisman’s cell phone rang. Instead of shutting it off, Eisman reached into his pocket and answered it. “Excuse me,” he said, standing up. “But I need to take this call.” And with that, he walked out.
Eisman’s willingness to be abrasive in order to get to the heart of the matter was obvious to all; what was harder to see was his credulity: He actually wanted to believe in the system. As quick as he was to cry [obscenity deleted] when he saw it, he was still shocked by bad behavior. That night in Vegas, he was seated at dinner beside a really nice guy who invested in mortgage C.D.O.’s—collateralized debt obligations. By then, Eisman thought he knew what he needed to know about C.D.O.’s. He didn’t, it turned out.
Later, when I sit down with Eisman, the very first thing he wants to explain is the importance of the mezzanine C.D.O. What you notice first about Eisman is his lips. He holds them pursed, waiting to speak. The second thing you notice is his short, light hair, cropped in a manner that suggests he cut it himself while thinking about something else. “You have to understand this,” he says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot [obscenity deleted] believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.
His dinner companion in Las Vegas ran a fund of about $15 billion and managed C.D.O.’s backed by the BBB tranche of a mortgage bond, or as Eisman puts it, “the equivalent of three levels of dog [obscenity deleted] lower than the original bonds.”
FrontPoint had spent a lot of time digging around in the dog [obscenity deleted] and knew that the default rates were already sufficient to wipe out this guy’s entire portfolio. “God, you must be having a hard time,” Eisman told his dinner companion.
“No,” the guy said, “I’ve sold everything out.”
After taking a fee, he passed them on to other investors. His job was to be the C.D.O. “expert,” but he actually didn’t spend any time at all thinking about what was in the C.D.O.’s. “He managed the C.D.O.’s,” says Eisman, “but managed what? I was just appalled. People would pay up to have someone manage their C.D.O.’s—as if this moron was helping you. I thought, You [obscenity deleted], you don’t give a [obscenity deleted] about the investors in this thing.”
Whatever rising anger Eisman felt was offset by the man’s genial disposition. Not only did he not mind that Eisman took a dim view of his C.D.O.’s; he saw it as a basis for friendship. “Then he said something that blew my mind,” Eisman tells me. “He says, ‘I love guys like you who short my market. Without you, I don’t have anything to buy.’ ”
That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with [obscenity deleted] credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?”
This particular dinner was hosted by Deutsche Bank, whose head trader, Greg Lippman, was the fellow who had introduced Eisman to the subprime bond market. Eisman went and found Lippman, pointed back to his own dinner companion, and said, “I want to short him.” Lippman thought he was joking; he wasn’t. “Greg, I want to short his paper,” Eisman repeated. “Sight unseen.”Eisman started out running a $60 million equity fund but was now short around $600 million of various subprime-related securities. In the spring of 2007, the market strengthened. But, says Eisman, “credit quality always gets better in March and April. And the reason it always gets better in March and April is that people get their tax refunds. You would think people in the securitization world would know this. We just thought that was moronic.”
He was already short the stocks of mortgage originators and the homebuilders. Now he took short positions in the rating agencies—“they were making 10 times more rating C.D.O.’s than they were rating G.M. bonds, and it was all going to end”—and, finally, the biggest Wall Street firms because of their exposure to C.D.O.’s. He wasn’t allowed to short Morgan Stanley because it owned a stake in his fund. But he shorted UBS, Lehman Brothers, and a few others. Not long after that, FrontPoint had a visit from Sanford C. Bernstein’s Brad Hintz, a prominent analyst who covered Wall Street firms. Hintz wanted to know what Eisman was up to. “We just shorted Merrill Lynch,” Eisman told him.
“Why?” asked Hintz.
“We have a simple thesis,” Eisman explained. “There is going to be a calamity, and whenever there is a calamity, Merrill is there.” When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman’s logic—the logic of Wall Street’s pecking order. Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things. The game, as Eisman saw it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place at the end of the chain.
There was only one thing that bothered Eisman, and it continued to trouble him as late as May 2007. “The thing we couldn’t figure out is: It’s so obvious. Why hasn’t everyone else figured out that the machine is done?” Eisman had long subscribed to Grant’s Interest Rate Observer, a newsletter famous in Wall Street circles and obscure outside them. Jim Grant, its editor, had been prophesying doom ever since the great debt cycle began, in the mid-1980s. In late 2006, he decided to investigate these things called C.D.O.’s. Or rather, he had asked his young assistant, Dan Gertner, a chemical engineer with an M.B.A., to see if he could understand them. Gertner went off with the documents that purported to explain C.D.O.’s to potential investors and for several days sweated and groaned and heaved and suffered. “Then he came back,” says Grant, “and said, ‘I can’t figure this thing out.’ And I said, ‘I think we have our story.’ ”
Eisman read Grant’s piece as independent confirmation of what he knew in his bones about the C.D.O.’s he had shorted. “When I read it, I thought, Oh my God. This is like owning a gold mine. When I read that, I was the only guy in the equity world who almost had an [obscenity deleted].”
On July 19, 2007, the same day that Federal Reserve Chairman Ben Bernanke told the U.S. Senate that he anticipated as much as $100 billion in losses in the subprime-mortgage market, FrontPoint did something unusual: It hosted its own conference call. It had had calls with its tiny population of investors, but this time FrontPoint opened it up. Steve Eisman had become a poorly kept secret. Five hundred people called in to hear what he had to say, and another 500 logged on afterward to listen to a recording of it. He explained the strange alchemy of the C.D.O. and said that he expected losses of up to $300 billion from this sliver of the market alone. To evaluate the situation, he urged his audience to “just throw your model in the garbage can. The models are all backward-looking.
The models don’t have any idea of what this world has become…. For the first time in their lives, people in the asset-backed-securitization world are actually having to think.” He explained that the rating agencies were morally bankrupt and living in fear of becoming actually bankrupt. “The rating agencies are scared to death,” he said. “They’re scared to death about doing nothing because they’ll look like fools if they do nothing.”On September 18, 2008, Danny Moses came to work as usual at 6:30 a.m. Earlier that week, Lehman Brothers had filed for bankruptcy. The day before, the Dow had fallen 449 points to its lowest level in four years. Overnight, European governments announced a ban on short-selling, but that served as faint warning for what happened next.
At the market opening in the U.S., everything—every financial asset—went into free fall. “All hell was breaking loose in a way I had never seen in my career,” Moses says. FrontPoint was net short the market, so this total collapse should have given Moses pleasure. He might have been forgiven if he stood up and cheered. After all, he’d been betting for two years that this sort of thing could happen, and now it was, more dramatically than he had ever imagined. Instead, he felt this terrifying shudder run through him. He had maybe 100 trades on, and he worked hard to keep a handle on them all. “I spent my morning trying to control all this energy and all this information,” he says, “and I lost control. I looked at the screens. I was staring into the abyss. The end. I felt this shooting pain in my head. I don’t get headaches. At first, I thought I was having an aneurysm.”
Moses stood up, wobbled, then turned to Daniel and said, “I gotta leave. Get out of here. Now.” Daniel thought about calling an ambulance but instead took Moses out for a walk.
Outside it was gorgeous, the blue sky reaching down through the tall buildings and warming the soul. Eisman was at a Goldman Sachs conference for hedge fund managers, raising capital. Moses and Daniel got him on the phone, and he left the conference and met them on the steps of St. Patrick’s Cathedral. “We just sat there,” Moses says. “Watching the people pass.”
This was what they had been waiting for: total collapse. “The investment-banking industry is [obscenity deleted],” Eisman had told me a few weeks earlier. “These guys are only beginning to understand how [obscenity deleted] they are. It’s like being a Scholastic, prior to Newton. Newton comes along, and one morning you wake up: ‘Holy [obscenity deleted], I’m wrong!’ ” Now Lehman Brothers had vanished, Merrill had surrendered, and Goldman Sachs and Morgan Stanley were just a week away from ceasing to be investment banks. The investment banks were not just [obscenity deleted]; they were extinct.
Not so for hedge fund managers who had seen it coming. “As we sat there, we were weirdly calm,” Moses says. “We felt insulated from the whole market reality. It was an out-of-body experience. We just sat and watched the people pass and talked about what might happen next. How many of these people were going to lose their jobs. Who was going to rent these buildings after all the Wall Street firms collapsed.” Eisman was appalled. “Look,” he said. “I’m short. I don’t want the country to go into a depression. I just want it to [obscenity deleted] deleverage.” He had tried a thousand times in a thousand ways to explain how screwed up the business was, and no one wanted to hear it. “That Wall Street has gone down because of this is justice,” he says. “They [obscenity deleted] people. They built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience.”
Truth to tell, there wasn’t a whole lot of hand-wringing inside FrontPoint either. The only one among them who wrestled a bit with his conscience was Daniel. “Vinny, being from Queens, needs to see the dark side of everything,” Eisman says. To which Daniel replies, “The way we thought about it was, ‘By shorting this market we’re creating the liquidity to keep the market going.’ ”
“It was like feeding the monster,” Eisman says of the market for subprime bonds. “We fed the monster until it blew up.”
About the time they were sitting on the steps of the midtown cathedral, I sat in a booth in a restaurant on the East Side, waiting for John Gutfreund to arrive for lunch, and wondered, among other things, why any restaurant would seat side by side two men without the slightest interest in touching each other.
There was an umbilical cord running from the belly of the exploded beast back to the financial 1980s. A friend of mine created the first mortgage derivative in 1986, a year after we left the Salomon Brothers trading program. (“The problem isn’t the tools,” he likes to say. “It’s who is using the tools. Derivatives are like guns.”)
When I published my book, the 1980s were supposed to be ending. I received a lot of undeserved credit for my timing. The social disruption caused by the collapse of the savings-and-loan industry and the rise of hostile takeovers and leveraged buyouts had given way to a brief period of recriminations. Just as most students at Ohio State read Liar’s Poker as a manual, most TV and radio interviewers regarded me as a whistleblower. (The big exception was Geraldo Rivera. He put me on a show called “People Who Succeed Too Early in Life” along with some child actors who’d gone on to become drug addicts.) Anti-Wall Street feeling ran high—high enough for Rudy Giuliani to float a political career on it—but the result felt more like a witch hunt than an honest reappraisal of the financial order. The public lynchings of Gutfreund and junk-bond king Michael Milken were excuses not to deal with the disturbing forces underpinning their rise. Ditto the cleaning up of Wall Street’s trading culture. The surface rippled, but down below, in the depths, the bonus pool remained undisturbed. Wall Street firms would soon be frowning upon profanity, firing traders for so much as glancing at a stripper, and forcing male employees to treat women almost as equals. Lehman Brothers circa 2008 more closely resembled a normal corporation with solid American values than did any Wall Street firm circa 1985.
The changes were camouflage. They helped distract outsiders from the truly profane event: the growing misalignment of interests between the people who trafficked in financial risk and the wider culture.
I’d not seen Gutfreund since I quit Wall Street. I’d met him, nervously, a couple of times on the trading floor. A few months before I left, my bosses asked me to explain to Gutfreund what at the time seemed like exotic trades in derivatives I’d done with a European hedge fund. I tried. He claimed not to be smart enough to understand any of it, and I assumed that was how a Wall Street C.E.O. showed he was the boss, by rising above the details. There was no reason for him to remember any of these encounters, and he didn’t: When my book came out and became a public-relations nuisance to him, he told reporters we’d never met.
Over the years, I’d heard bits and pieces about Gutfreund. I knew that after he’d been forced to resign from Salomon Brothers he’d fallen on harder times. I heard later that a few years ago he’d sat on a panel about Wall Street at Columbia Business School. When his turn came to speak, he advised students to find something more meaningful to do with their lives. As he began to describe his career, he broke down and wept.When I emailed him to invite him to lunch, he could not have been more polite or more gracious. That attitude persisted as he was escorted to the table, made chitchat with the owner, and ordered his food. He’d lost a half-step and was more deliberate in his movements, but otherwise he was completely recognizable. The same veneer of denatured courtliness masked the same animal need to see the world as it was, rather than as it should be.
We spent 20 minutes or so determining that our presence at the same lunch table was not going to cause the earth to explode. We discovered we had a mutual acquaintance in New Orleans. We agreed that the Wall Street C.E.O. had no real ability to keep track of the frantic innovation occurring inside his firm. (“I didn’t understand all the product lines, and they don’t either,” he said.) We agreed, further, that the chief of the Wall Street investment bank had little control over his subordinates. (“They’re buttering you up and then doing whatever the [obscenity deleted] they want to do.”) He thought the cause of the financial crisis was “simple. Greed on both sides—greed of investors and the greed of the bankers.” I thought it was more complicated. Greed on Wall Street was a given—almost an obligation. The problem was the system of incentives that channeled the greed.
But I didn’t argue with him. For just as you revert to being about nine years old when you visit your parents, you revert to total subordination when you are in the presence of your former C.E.O. John Gutfreund was still the King of Wall Street, and I was still a geek. He spoke in declarative statements; I spoke in questions.
But as he spoke, my eyes kept drifting to his hands. His alarmingly thick and meaty hands. They weren’t the hands of a soft Wall Street banker but of a boxer. I looked up. The boxer was smiling—though it was less a smile than a placeholder expression. And he was saying, very deliberately, “Your…[obscenity deleted]…book.”
I smiled back, though it wasn’t quite a smile.
“Your [obscenity deleted] book destroyed my career, and it made yours,” he said.
I didn’t think of it that way and said so, sort of.
“Why did you ask me to lunch?” he asked, though pleasantly. He was genuinely curious.
You can’t really tell someone that you asked him to lunch to let him know that you don’t think of him as evil. Nor can you tell him that you asked him to lunch because you thought that you could trace the biggest financial crisis in the history of the world back to a decision he had made. John Gutfreund did violence to the Wall Street social order—and got himself dubbed the King of Wall Street—when he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation. He ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of the firm’s founder, who had made Gutfreund C.E.O. only after he’d promised never to sell the firm, had told me.) He lifted a giant middle finger at the moral disapproval of his fellow Wall Street C.E.O.’s. And he seized the day. He and the other partners not only made a quick killing; they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be worth 2.26 shares of Citigroup today—market value: $27.) But it made fantastic sense for the investment bankers.
From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.
No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.
No partnership, for that matter, would have hired me or anyone remotely like me. Was there ever any correlation between the ability to get in and out of Princeton and a talent for taking financial risk?
Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of the other Wall Street firms—all said what an awful thing it was to go public and how could you do such a thing. But when the temptation arose, they all gave in to it.” He agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep [obscenity deleted],” he said, with a half chuckle. He was out of the game.
It was now all someone else’s fault.
He watched me curiously as I scribbled down his words. “What’s this for?” he asked.
I told him I thought it might be worth revisiting the world I’d described in Liar’s Poker, now that it was finally dying. Maybe bring out a 20th-anniversary edition.
“That’s nauseating,” he said.
Hard as it was for him to enjoy my company, it was harder for me not to enjoy his. He was still tough, as straight and blunt as a butcher. He’d helped create a monster, but he still had in him a lot of the old Wall Street, where people said things like “A man’s word is his bond.” On that Wall Street, people didn’t walk out of their firms and cause trouble for their former bosses by writing books about them. “No,” he said, “I think we can agree about this: Your [obscenity deleted] book destroyed my career, and it made yours.” With that, the former king of a former Wall Street lifted the plate that held his appetizer and asked sweetly, “Would you like a deviled egg?”
Until that moment, I hadn’t paid much attention to what he’d been eating. Now I saw he’d ordered the best thing in the house, this gorgeous frothy confection of an earlier age. Who ever dreamed up the deviled egg? Who knew that a simple egg could be made so complicated and yet so appealing? I reached over and took one. Something for nothing. It never loses its charm.
If you stop and think about it – Wall St. is a lot like a school of piranhas. Piranhas swim and hunt together – but it is an uneasy alliance. Together – they are a potent killing machine – devouring their prey. The problem (if you happen to be a piranha) is that if you become injured or weakened in some manner – you are transformed from the predator to the prey in the blink of an eye. All of your so-called ‘friends’ – suddenly turn on you – and you are devoured. I imagine that if a fish could think and reason – being a piranha would be a very stressful existence.
The same dynamic has always been present on Wall St. There has been an uneasy alliance among Wall St. investment banks. Remain strong – and you can continue playing the game – chasing after profits in whatever manner you can get away with. The problem is – just like with piranhas – once you show any type of weakness – your ‘friends’ begin circling. Instead of eating you for breakfast like piranhas – they begin scheming. How can we profit from this weakness? Their pursuit of profits – at your expense – weakens you further – until you are out of the game – purchased or bankrupt.
There are now only two major Wall St. investment banks left – Morgan Stanley and Goldman Sachs. Bear Stearns was ‘bailed out’ at around $10/share. Lehman Brothers was allowed to fail and file for bankruptcy. Merrill Lynch was bought by Bank of America for a fraction of what they were worth just one year ago. We heard many of the leaders of these institutions cry foul on the way down – because they felt that their Wall St. brethren were accelerating their demise. This was coming from people who focused their entire lives on the pursuit of money – above all else. Should it surprise anyone that other people – just like themselves – would want to profit from their misfortune? This is a prime example of worldly people being surprised at how the world treats them. When you are strong and times are good – come and join the party. When you are in a position of weakness and times are not so good – the world begins to circle you. How can we profit from this person’s (or institution’s) weakness? There is no compassion – no thought to how people are treated – there is only the pursuit of money, power and glory at all costs. Do I need to tell you again where this is coming from?
The world doesn’t care about you – it only cares about what it can gain from you. It wants to profit from your power, your wealth, your beauty – but if you lose these things – then the world casts you aside. How many Hollywood actors have seen their careers vanish? How many Wall St. titans have lost everything? How many corporate leaders have lost their wealth and power? What do worldly people have when their world is taken from them? Nothing – no hope. I’ll say it again – this is why Jesus told us not to build our lives on this world – because it is full of deception and lies – it’s constantly shifting. Just when you think you’ve got it all figured out – someone pulls the rug out from under you. If you build your life on God’s promise, however, and live according to His ways – the world may shift – but your life is built on a solid foundation. The world will not move you.
God’s promise does not change – because He does not change. His laws do not change and His character does not change. When you are born again and follow Him – your morals will not change and your faith will not change. This is what Jesus was referring to – a rock solid belief that God has promised us something greater than this fallen world.
What got me thinking about this was Citigroup’s demise last week. Their stock plunged below $5 – and the CEO began speaking about the evils of short selling. Apparently, according to the CEO, Citigroup’s demise has very little to do with the billions of dollars of Level III assets (CDO’s, etc.) – toxic securities on their books – and has everything to do with other institutions and traders ‘shorting’ their stock. Let’s get everyone to forget that Citigroup got greedy (like so many other banks, insurance companies, etc.) and began buying ridiculous securities based on unsustainable mortgages – and focus everyone on the current credit ‘crisis’ and short selling. When is anyone going to tell the truth?
You’ll notice in the article below that Citigroup was one of the largest institutions placing huge bets that Morgan Stanley would fall in September – using credit default swaps and ‘short’ selling. It appears that short selling is A-OK – as long as no one is ‘shorting’ your stock. It amazes me that Wall St. has lasted as long as it has. The problem now is that everyone is injured and trying to stay afloat – while the really big shark circles the carnage.
If you’ve ever wondered what short selling is – here’s a simple example. A short seller ‘borrows’ a share at $50 from someone willing to lend - and sells the share. The stock then declines and the short-seller buys a share at $40. He then returns the borrowed share to the lender and pockets the $10 difference. You can also see why short selling is risky. If the stock rises – the short seller will have to buy the stock at a higher price than he sold it for – resulting in a loss. Last month we watched many hedge funds lose billions because they had ‘shorted’ Volkswagen stock – only to see the stock skyrocket when Porsche announced that it had secretly bought a controlling stake in the company. Short sellers scrambled to buy enough shares to ‘cover’ their positions – driving the stock even higher. It’s easy to see how crazy this is – it’s nothing more than high stakes gambling.
There are two big reasons why banks/companies hate to be a ‘target’ of short sellers. If a large number of people are ‘shorting’ the stock – large numbers of borrowed shares are being sold – which could obviously drive the price lower. The biggest problem is the most obvious one – if many people are ‘shorting’ the stock – it’s probably because there are rumors the firm is in trouble – and people are trying to profit from this. We’ve seen this happen time and again this year. Rumors get started, a panic ensues – and the stock tanks. The firm’s stock decline becomes a self-fulfilling prophecy. If enough people believe the rumors – and start acting on this belief that the firm is in trouble – a somewhat stable stock suddenly becomes highly volatile.
It’s not easy watching our nation destroy itself – because this is exactly what is happening. We are a nation divided politically and financially – and what does the Bible say about a house divided? It will fall.
"Every kingdom divided against itself will be ruined, and every city or household divided against itself will not stand.” (Matthew 12:25)
jg – Nov 24, 2008
NOVEMBER 24, 2008
Anatomy of the Morgan Stanley Panic
Trading Records Tell Tale of How Rivals' Bearish Bets Pounded Stock in September
Two days after Lehman Brothers Holdings Inc. sought bankruptcy protection, an explosive rumor spread that another big Wall Street firm, Morgan Stanley, was on the brink of failure. The chatter on trading desks that Sept. 17 was that Deutsche Bank AG had yanked a $25 billion credit line to the firm.
That wasn't true, but it helped trigger a cascade of bearish bets against Morgan Stanley. Chief Executive Officer John Mack complained bitterly that profit-hungry traders were sowing panic. Yet he lacked a critical piece of information: Who exactly was behind those damaging trades?
Trading records reviewed by The Wall Street Journal now provide a partial answer. It turns out that some of the biggest names on Wall Street -- Merrill Lynch & Co., Citigroup Inc., Deutsche Bank and UBS AG -- were placing large bets against Morgan Stanley, the records indicate. They did so using complicated financial instruments called credit-default swaps, a form of insurance against losses on loans and bonds.
A close examination by the Journal of that trading also reveals that the swaps played a critical role in magnifying bearish sentiment about Morgan Stanley, in turn prompting traders to bet against the firm's stock by selling it short. The interplay between swaps trading and short selling accelerated the firm's downward spiral.
This account was pieced together from the trading documents and more than six dozen interviews with Wall Street executives, traders, brokers, hedge-fund managers, regulators and investigators.
For years, sales of credit-default swaps were a profit gold mine for Wall Street. But ironically, during those tumultuous few days in mid-September, the swaps market turned on Morgan Stanley like a financial Frankenstein. The market became a highly visible barometer of the Panic of 2008, fueling the crisis that ultimately prompted the government to intervene.
Other firms also were trading Morgan Stanley swaps on Sept. 17: Royal Bank of Canada, Swiss Re, and hedge funds including King Street Capital Management LLC and Owl Creek Asset Management LP.
Pressure also mounted on another front. There was a surge in "short sales" -- bets against the price of Morgan Stanley's stock -- by large hedge funds including Third Point LLC. By day's end, Morgan Stanley's shares were down 24%, fanning fears among regulators that predatory investors were targeting investment banks.
That pattern of trading, which previously had battered securities firms Bear Stearns Cos. and Lehman, now is dogging Citigroup, whose stock fell 60% last week to a 16-year low.
Investigators are attempting to unravel what produced the market mayhem in mid-September, and whether Morgan Stanley swaps or shares were traded improperly. New York Attorney General Andrew Cuomo, the U.S. Attorney's office in Manhattan and the Securities and Exchange Commission are looking into whether traders manipulated markets by intentionally disseminating false rumors in order to profit on their bets. The investigations also are examining whether traders bought swaps at high prices to spark fear about Morgan Stanley's stability in order to profit on other trading positions, and whether trading involved bogus price quotes and sham trades, people familiar with the probes say.
No evidence has emerged publicly that any firm trading in Morgan Stanley stock or credit-default swaps did anything wrong. Most of the firms say they purchased the credit-default swaps simply to protect themselves against potential losses on various types of business they were doing with Morgan Stanley. Some say their swap wagers were small, relative to all such trading that was done that day.
Proving that prices of any security have been manipulated is extraordinarily difficult. The swaps market is opaque: Trading is done by phone and email between dealers, without public price quotes.
Erik Sirri, the SEC's director of trading and markets, contends that the swaps market is vulnerable to manipulation. "Very small trades in a relatively thin market can be used to … suggest that a credit is viewed by the market as weak," he said in congressional testimony last month. He said the SEC was concerned that swaps trading was triggering bearish bets against stocks.
Morgan Stanley had entered September in pretty good shape. It made money during its first two fiscal quarters, which ended May 31. It didn't have as much exposure to bad residential-mortgage assets as Lehman did, although it was exposed to commercial-real-estate and leveraged-loan markets. Mr. Mack knew that third-quarter earnings were going to be stronger than expected.
On Sept. 14, as Lehman was preparing to file for bankruptcy protection, Mr. Mack told employees in an internal memo that Morgan Stanley was "uniquely positioned to succeed in this challenging environment." The following day, the firm picked up some new hedge-fund clients who had fled Lehman.
But rumors were flying as traders worried which Wall Street firm could fall next. The chatter among hedge funds was that Morgan Stanley had $200 billion at risk as a trading partner with American International Group Inc., the big insurer on the brink of a bankruptcy filing, according to traders. That wasn't true. Morgan reported in an SEC filing that its exposure to AIG was "immaterial."
Some brokers at rival J.P. Morgan Chase & Co. were suggesting to Morgan Stanley clients it was risky to keep accounts at that firm, people familiar with the matter say. Mr. Mack complained to J.P. Morgan Chief Executive James Dimon, who put an end to the talk, these people say. Deutsche Bank, UBS and Credit Suisse also marketed to Morgan Stanley's hedge-fund clients, people familiar with the pitches say.
On Sept. 16, Morgan Stanley's stock fell sharply during the day, although it rebounded late. Some hedge funds yanked assets from the firm, worried that Morgan might follow Lehman into bankruptcy court, potentially tying up client assets. In an effort to quell concerns, Morgan Stanley released its earnings that afternoon at 4:10 p.m., one day early.
"It's very important to get some sanity back into the market," said Colm Kelleher, Morgan's chief financial officer, in a conference call with investors. "Things are frankly getting out of hand, and ridiculous rumors are being repeated."
UBS analyst Glenn Schorr asked Mr. Kelleher about the soaring cost of buying insurance in the swaps market against a Morgan Stanley debt default. Protection for $10 million of Morgan Stanley debt had risen to $727,900 a year, from $221,000 on September 10, according to CMA DataVision, a pricing service.
"Certain people are focusing on CDS as an excuse to look at the equity," Mr. Kelleher responded, implying that traders betting on swaps were also shorting Morgan Stanley shares, betting that the stock price would fall.
It's impossible to know for sure what was motivating buyers of Morgan Stanley credit-default swaps. The swap buyers stood to receive payments if Morgan Stanley defaulted on bonds and loans. Some buyers, no doubt, owned the firm's debt and were simply trying to protect themselves against defaults.
But swaps were also a good way to speculate for traders who didn't own the debt. Swap values rise on the fear of default. So traders who believed that fears about Morgan Stanley were likely to intensify could use swaps to try to turn a fast profit.
Amid the uncertainty that Sept. 16, Millennium Partners LP, a hedge fund with $13.5 billion in assets, asked to pull out $800 million of the more than $1 billion of assets it kept at Morgan Stanley, according to people familiar with the withdrawals. Separately, Millennium had also shorted Morgan Stanley's stock, part of a series of bearish bets on financial firms, said one of these people. In addition, the hedge fund bought "puts," which gave it the right to sell Morgan shares at a set price in the future.
"Listen, we have to protect our assets," Israel Englander, Millennium's head, told a Morgan Stanley executive, according to one person familiar with the conversation. "This is not a personal thing."
Those bearish bets, small compared to Millennium's overall size, rose in value as Morgan Stanley shares fell.
That same day, Sept. 16, Third Point LLC, a $5 billion hedge-fund firm run by Daniel Loeb, began to move $500 million in assets out of Morgan Stanley. The following day, Sept. 17, Third Point, after seeing the surge in swaps prices, made a substantial bearish bet, selling short about 100,000 Morgan Stanley shares, trading records indicate. Third Point quickly closed out that position for a profit of less than $10 million, says one person familiar with the trading.
Around the same time, hedge fund Owl Creek began asking to withdraw its assets, and ultimately took out more than $1 billion.
On the morning of Sept. 17, David "Tiger" Williams, head of Williams Trading LLC, which offers trading services to hedge funds, heard from one of his traders that a fund had moved an $800 million trading account from Morgan Stanley to a rival. His trader, who was on the phone with the fund manager who moved the money, asked why. Morgan Stanley was going bankrupt, his client responded.
Pressed for details, the fund manager repeated the rumor about Deutsche Bank yanking a $25 billion credit line. Mr. Williams hit the phones. His market sources told him they thought the rumor false.
But damage already was being done. By 7:10 that morning, a Deutsche Bank trader was quoting a price of $750,000 to buy protection on $10 million of Morgan Stanley debt. At 10 a.m., Citigroup and other dealers were quoting prices of $890,000.
As the rumor about Deutsche spread, Morgan shares fell sharply, from about $26 at 10 a.m. to near $16 at 11:30 a.m.
Before noon, swaps dealers began quoting the cost of insurance on Morgan in "points upfront" -- Wall Street lingo for transactions where buyers must pay at least $1 million upfront, plus an annual premium, to insure $10 million of debt. In Morgan Stanley's case, some dealers were demanding more than $2 million upfront.
Bearish Signal
Firms making trades protecting against a Morgan Stanley default during Sept. 17 and 18, 2008
|
Firm |
Net Purchase+ |
Comment |
|
Merrill Lynch |
$149.2 |
Doesn't comment on trades |
|
King Street |
110.0 |
Hedging |
|
Royal Bank of Canada |
69.0 |
Replacing Lehman swaps |
|
Citigroup |
55.7 |
Hedging, customers |
|
Deutsche Bank* |
50.6 |
Hedging, customers |
|
Swiss Re* |
40.0 |
No comment |
|
Societe Generale** |
37.5 |
No comment |
|
Owl Creek* |
35.5 |
Insuring collateral held at Morgan Stanley |
|
UBS* |
35.0 |
No comment |
|
Liberty Harbor Master Fund** |
30.0 |
Hedging |
|
ACM Global Credit Fund |
28.0 |
Hedging |
|
Bank of America** |
27.0 |
No comment |
|
Castlerigg** |
25.0 |
No comment |
|
Barclays** |
21.0 |
No comment |
|
Cyrus Opportunity Fund** |
20.0 |
No comment |
+ Morgan Stanley debt covered by credit default swaps.
* Trading on Sept. 17
** Trading on Sept. 18
Source: Trading records, Wall Street Journal research
During the day, Merrill bought swaps covering $106.2 million in Morgan Stanley debt, according to the trading documents. King Street bought swaps covering $79.3 million; Deutsche Bank, $50.6 million; Swiss Re, $40 million; Owl Creek, $35.5 million; UBS and Citigroup, $35 million each; Royal Bank of Canada, $33 million; and ACM Global Credit, an investment fund operated by AllianceBernstein Holding, $28 million, according to the documents.
The following day, Sept. 18, some of those same names were back in the market. Merrill bought protection on another $43 million of Morgan Stanley debt; Royal Bank of Canada, $36 million; King Street, $30.7 million; and Citigroup, $20.7 million, the trading records indicate.
None of the firms will comment on how much they paid for the swaps, or whether they profited on the trades.
"The protection we bought was a simple hedge, not based on any negative view of Morgan Stanley," says John Meyers, a spokesman for AllianceBernstein. A Royal Bank of Canada spokesman says the bank bought the swaps to manage its Morgan Stanley "credit risk," and was not "betting against Morgan Stanley and conducted no bearish trades on its stock."
King Street, a $16.5 billion hedge fund, bought the swaps to hedge its exposure to Morgan Stanley, which included bond holdings, according to a person familiar with the fund. The fund didn't hold a short position in the stock, this person says.
Spokespeople for Deutsche Bank and Citigroup say their trading was relatively small and meant to protect against losses on other investments with Morgan, and to handle client orders. An Owl Creek spokesman says it bought the swaps "to insure collateral we had at Morgan Stanley at the time," and that it continues to do business with the firm.
Merrill, UBS and Swiss Re declined to comment on the trading.
As Morgan Stanley's stock tumbled, the number of shares sold short by bearish investors soared to 39 million on Sept. 17, nine times the daily average this year, adding to the 31 million shares shorted in the prior two days, according to trading records.
Mr. Mack sent a memo to employees on Sept. 17. "I know all of you are watching our stock price today, and so am I.… We're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down."
The stock and swaps trading were feeding on each other. That afternoon, Mr. Schorr, the UBS analyst, wrote: "Stop the insanity -- we need a time out." In an interview that day, he said "the negative feedback loop of stocks and CDS making each other crazy shouldn't be able to destroy the value of companies."
Scrambling to stop the crisis of confidence, Mr. Mack phoned Paul Calello, investment-banking chief at Credit Suisse, and asked whether he knew what was driving the cost of the swaps up so quickly, say people familiar with the call. Mr. Calello said he didn't.
Morgan Stanley's chief legal officer, Gary Lynch, once the SEC's enforcement chief, called New York Stock Exchange regulatory head Richard Ketchum. He said he was suspicious about manipulation of Morgan Stanley securities, and asked whether the NYSE would support a temporary ban on short selling, according to people familiar with the call.
Mr. Mack called SEC Chairman Christopher Cox, Treasury Secretary Henry Paulson and others. Trading in Morgan Stanley securities, he groused, was irrational and "outrageous," and "there's nothing to warrant this kind of reaction," says a person familiar with the calls. The steps already taken by the SEC to prevent certain types of abusive short selling, he argued, didn't go far enough.
In his memo to employees that day, Mr. Mack had made it clear that he intended to press regulators to rein in short sellers. When word about that got out, hedge-fund managers were up in arms. Some yanked business from Morgan Stanley, moving it to rivals including Credit Suisse, Deutsche Bank and J.P. Morgan. They said the trading represented legitimate protection and speculation.
Hedge-fund veteran Julian Robertson Jr. and James Chanos, a well-known short seller, both longtime Morgan Stanley clients, were both angry. Mr. Chanos says he "hit the roof" when he heard about Mr. Mack's memo.
After the stock market closed that day, Mr. Chanos decided that his hedge fund, Kynikos Associates, would pull more than $1 billion of its money from a Morgan Stanley account.
"It's one thing to complain, but another to put out a memo blaming your clients," says Mr. Chanos, who adds that the development all but ended a more-than-20-year relationship with Morgan Stanley. He says his fund hadn't bought any Morgan Stanley swaps or sold short its stock.
Other Wall Street executives, concerned about their stocks, were also calling regulators. At about 8:15 that night, the SEC said it would require more disclosure of short selling. Late the following day, Sept. 18, the SEC moved to temporarily ban short selling in financial stocks.
Mr. Mack contacted hedge-fund clients to tell them he hadn't single-handedly brought on the ban, and that he was primarily interested in giving the market a temporary "time out" from the volatile mix of rumors and trading.
But within days, more than three-quarters of Morgan Stanley's roughly 1,100 hedge-fund clients had put in requests to pull some or all of their assets from the firm, according to a person familiar with the operation. Even though most kept some money at the firm, Morgan Stanley couldn't process all the withdrawal requests at once, adding to market fear.
Morgan Stanley was in a precarious position. During the Sept. 17 trading frenzy, Mr. Mack had begun merger talks with Wachovia Corp. Four days later, Morgan Stanley shifted course, becoming a bank-holding company and gaining wider access to government funds. Last month, after raising $9 billion from a Japanese bank, it received a $10 billion capital injection from the federal government.
Morgan Stanley must now revise its business strategy to contend with a more risk-averse environment and the more stringent government oversight that comes with being a bank-holding company. Earlier this month, it announced it would fire about 2,300, or 5%, of its employees.
The cost of insuring its debt has come back down from its peak, but its stock remains in the doldrums. On Friday, it was trading at $10.05 a share in 4 p.m. composite trading on the New York Stock Exchange -- less than half of the $21.75 close on Sept. 17.
A month after the mayhem, Mr. Mack said in an interview that he had all but given up trying to get to the bottom of what was driving the trading in his firm's securities during those chaotic days in mid-September. "It's difficult to say what's rumor and what's fact," he said.
Write to Susan Pulliam at susan.pulliam@wsj.com, Liz Rappaport at liz.rappaport@wsj.com, Aaron Lucchetti at aaron.lucchetti@wsj.com and Jenny Strasburg at jenny.strasburg@wsj.com
It doesn’t appear that we’ve learned any lessons over the past few months - greed continues on Wall Street.
As Chris mentions below – a Wall St. trader who wins 60% of the time is considered an excellent trader. What did Goldman do in the last quarter? Their daily win/loss ratio was 97 to 3. What do you think would happen if you won 97 out of 100 blackjack hands in Vegas? My guess is that the pit bosses would become very interested in your methods. There’s luck – then there’s defying all laws of probability to the point that everyone knows you’re cheating.
Not surprisingly, there is a lead story on the Wall Street Journal this afternoon regarding a Justice Department investigation into Goldman Sachs’ trading ‘practices’.
If you were gaming the system to increase your trading profits – wouldn’t you at least ‘lose’ a few trades to make it more realistic to everyone?
This level of greed and arrogance is amazing.
jg
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Goldman Sachs' Incredible Trading Returns are Literally Unbelievable
Wednesday, August 5, 2009, 10:49 am, by cmartenson
A long while ago (September 2008), I wrote an article entitled " The Greatest Looting Operation in History" and followed it up with another entitled "America is Being Looted."
What shocked me at the time was how brazen the perpetrators were being in their efforts, almost as if they had no fear of being exposed or being asked any hard questions.
In an article that came out today, this was confirmed to an extraordinary degree.
Goldman Sachs $100 Million Trading Days Reach Record in Quarter
By Christine Harper
Aug. 5 (Bloomberg) -- Goldman Sachs Group Inc. made more than $100 million in trading revenue on a record 46 separate days during the second quarter, breaking the previous high of 34 set in the prior three months.
Trading losses occurred on two days during the months of April, May and June, compared with eight days in the first quarter, the New York-based bank said today in a filing with the U.S. Securities and Exchange Commission.
There is no possible way in a free market system where everyone has the same advantages and information for Goldman Sachs to sport a win-to-loss ratio of 46-to-2. Ergo, Goldman Sachs is running a gigantic scam at everyone's expense while the SEC, the Fed and everyone else politely looks the other way.
There are mountains of evidence pointing to the fact that markets trade in inherently unpredictable ways.
Because of this, really extraordinary traders are those that can keep their noses slightly, but consistently, above water. Turning in a win-loss ratio of 60/40 is considered extremely good. Getting to 70/30? Best to stop now and write a "trading guru" newsletter selling your system while it still works. But 80/20? Now you are just on a lucky tear that will soon be reversed in a humbling way. Given this, what would we say about a 96.9 to 3.1 ratio? (Thanks DavidC for the correct figures here).
That's what Goldman Sachs' daily win-loss ratio works out to and it speaks of something other than "being good" or "being lucky." This is just comparing Goldman Sachs' $100 million "win" days against their total number of losing days and I admit I have no idea what their actual win/loss ratio looks like on a trade-by-trade basis. But on a daily basis alone, this sort of performance cannot be chalked up to anything but an unfair advantage.
Anybody with even a minor appreciation of statistics knows that this represents something other than "being good." This represents an unfair advantage to a degree that is truly mind-boggling.
If this seems esoteric and therefore perhaps unimportant to you, I would like to point out that when it comes to trading, someone's win is somebody else's loss. Trading is a zero sum game.
Money is not created through the act of trading. It would be a mistake to think that Goldman Sachs somehow created this money through the act of their trading genius. For Goldman Sachs to win $100 million in a day of trading means that somebody else lost $100 million. Most likely a huge collection of somebody elses.
I would suggest that the most probable source of these funds, the ultimate loser, is the taxpayer.
This means that as Goldman wins, you lose, I lose, and our future gets diminished so that a pathetically small number of already obscenely rich individuals can continue to game a rigged system to their obvious and magnificent advantage. While I am sure that somebody, somewhere has convinced themselves that it is a good thing to allow Goldman Sachs to recapitalize itself in this way, obviously rigged markets are not a good idea for a country that depends on the willing flow of foreign funds, and they are also certain to misallocate capital.
Moving along, one thing I truly despise is when unfounded statements or opinions are inserted into an article and presented as fact such as this example.
Goldman Sachs’s trading results reflected the firm’s willingness to take on more risk during the period.
No, the results do not reflect "the firm's willingness to take risk." This is more likely than not a direct quote from the Goldman Sachs PR department.
If all a firm needed to do to enjoy outlandish trading results was to "take on more risk" then they'd all do it and - presto! - everyone would have higher trading profits!
That's just not how things work, unfortunately. Anybody who is turning in a ratio of winning-to-losing trading days of 46-to-2 is not trading in a fair and competitive manner.
Instead we might reasonably conclude, knowing what we know about how equities markets are supposed to work, that 46-to-2 reflects an unfair advantage, not a taste for risk, as the scribe put it. One could reasonably re-write that sentence to read:
"Goldman Sachs’s trading results reflected the firm’s clever use of lobbying funds and influence to skirt the rules that everyone else abides by. Their gain was your loss. "
What these trading results tell us, as clearly as one could ever hope in this day and age, is that Goldman Sachs (and likely other major recipients of bailout money) is gaming the system to their benefit and everybody else's loss.
I suppose it would be even clearer if we received individual, hand engraved notices informing us of this fact, but, for me, the presence of only 2 days of trading losses in an entire quarter is more than sufficient.
America, you are being looted, and the pirate's name is Goldman Sachs.
I’ve been searching for what could possibly cause the value of the dollar to remain somewhat steady (and even increase in value) – when everything in the market is telling us that the value of the dollar should be declining (Fed actions resulting in trillions of new dollars, massive U.S. budget deficits, U.S. account balance, etc.).
I think Chris Martenson has found the answer…….
jg – September 25, 2009
Currency Swaps, the Dollar, and a Tilted Playing Field
Friday, September 25, 2009, 9:48 am, by cmartenson
Some pretty big news came out on Thursday (9/24/09) regarding a seemingly obscure program to end what were called "currency infusions."
In fact, these are "currency swaps," and you might want to pay attention to them, because of their high degree of correlation with the rise and fall of the dollar. Currency swaps also offer the perfect vehicle for central banks to engage in currency intervention and manipulation, especially if one of the parties (*cough*US*cough) has a massive trade imbalance and lacks sufficient FOREX reserves to use in daily market intervention activities.
Here's the news:
World central banks trimming U.S. dollar infusions
WASHINGTON (Reuters) - Major world central banks announced on Thursday that they planned to scale back massive injections of U.S. dollars into their banking systems as financial markets stabilize after a devastating crisis.
The U.S. Federal Reserve said it would begin to scale back short-term cash auctions in early 2010, while the European Central Bank, the Swiss National Bank, and the Bank of England announced they would curtail steps taken to ensure dollar liquidity.
This isn't part of the exit strategy per se," said Chris Rupkey, an economist for Bank of Tokyo/Mitsubishi UFJ in New York. "It just recognizes that banks have less need for liquidity."
What are currency swaps? Erik deCarbonnel provides this description:
How currency swaps work
The easiest way to understand currency swaps is to think of them as two separate zero-interest loans. For example, let’s say the fed and the ECB arrange a 80 billion euros ($107 billion) swap. The ECB then lends the 80 billion euros to the US, and the US loans $107 billion dollars to the ECB. Later, at an agreed date, the currency swap is reversed: the ECB returns the $107 billion dollars to the fed, and the fed pays back 80 billion euros.
How central banks use currency swaps
Central banks use the foreign currency from swap agreements to prop up their domestic currency by:
A) Providing the foreign currency to domestic financial institutions. (If those institutions were forced to go to the exchange markets for funding, it would drive down the value of the domestic currency.)
B) Using the foreign currency to directly intervene in exchange markets.
Why currency swaps are so popular
Currency swaps allow central banks to borrow foreign currencies without revealing that their country's banking system or currency is in trouble. In other words, since both central banks involved in a currency swap borrow foreign currencies at the same time, it is difficult to tell which central bank needed them the most. It is this lack of transparency which makes currency swaps so attractive to central banks.
In late 2008, the Federal Reserve entered a massive currency swap arrangement with a variety of central banks all over the globe. Here's how the Fed describes that program:
Currency Swaps At the same time it introduced the TAF, the Federal Reserve announced it would extend currency swap lines with the European Central Bank and the Swiss National Bank. The swap lines provide these central banks with dollars, which they can use to supply liquidity to credit markets in their jurisdictions that are based on dollars. In September 2008, the currency swap lines with the ECB and SNB were increased, and new swap lines with other central banks were authorized, including the Bank of Japan, the Bank of England, and the Bank of Canada.
And here's the reason that we might care to track such programs carefully. Note the strong correlation between the currency swap program and the USD index:
Here we might note that the startling run of dollar strength that caught so many investors off guard (but not Goldman Sachs or JP Morgan, it should be noted) began just in front the steep, half-trillion US dollar currency swap operation that began in earnest in fall of 2008.
Note also that the double top in the USD and its subsequent slide all line up nicely with the swaps additions and withdrawals. Correlation is not causation, but this is a pretty cozy relationship, and it possibly explains one of the more unusual periods of dollar strengthening in recent history.
Speaking of cozy relationships, the one between the NY Federal Reserve and big Wall Street institutions stands out, as do the outsized trading returns that quite conveniently repaired more than a few large firms during this same period of time.
I would humbly submit that Goldman Sachs 97% trading win ratio for 2Q09 is perfectly acceptable evidence that the playing field is not level and that, at the very least, we can agree that the appearance of insider trading exists.
Even now Goldman is "struggling" with the PR nightmare of how to explain an "embarrassment" of riches:
For Goldman Sachs CEO Lloyd Blankfein, an embarrassment of riches has turned into embarrassing riches.
Goldman's bonus pool is expected to swell to an estimated $16 billion after what's expected to be another stellar quarter, and Blankfein is struggling to figure out how to pay his employees in a way that keeps them happy while avoiding another round of populist and political outrage like the bank experienced over the summer.
It really is up to the Fed to prove that they did not tip off a few favored struggling big banks (which magically repaired their balance sheets with magnificent winning trading-desk results over this time frame), than it is up to anybody else to prove that they did.
After all, in a supposedly free market economy, it is critical that the appearance, if not the fact, of an even-playing field be maintained.
This next story, which I carefully saved because I thought it provided critically important insights into the cozy relationship between Wall Street and the Federal Reserve, makes it pretty obvious that the free flow of information between the two is not a matter of speculation, but is a matter of normal daily operations:
At N.Y. Fed, Blending In Is Part of the Job
NEW YORK -- The low-slung cubicles wrap around the ninth floor of a building three blocks from Wall Street, each manned by a young staffer staring at flashing numbers on a flat-screen computer monitor and working the phones to gather the latest chatter from financial markets around the world.
It could be any investment bank or hedge fund. Instead, it is the markets group of the Federal Reserve Bank of New York, which has been on the front lines of the government's response to the financial crisis. Federal Reserve and Treasury Department officials make the major decisions, but the New York Fed executes them.
The information gathered there provides crucial insights into the financial world for top policymakers. But the bank is so close to Wall Street -- physically, culturally and intellectually -- that some economic experts worry that the New York Fed puts the interests of the financial industry ahead of those of ordinary Americans.
"The New York Fed sticks out as being not just very, very close to Wall Street, but to the most powerful people on Wall Street," said Simon Johnson, an economist at MIT. "I worry that they pay too much deference to the expertise and presumed wisdom of a sector that screwed up massively."
Even some former insiders at the Fed say the bank does not pay enough attention to the fundamental flaws in the country's financial system or to the risks associated with bailing out financial firms -- for instance, the chance that banks will be encouraged to take more unwise gambles. These experts worry that the New York Fed has adopted the mindset of a trading floor: well attuned to ripples in financial markets but not to long-term trends and dangers.
Last month, for instance, Wall Street bond traders wanted the central bank to ramp up its purchase of Treasury bonds, which would help the traders by driving up prices. But Fed officials in Washington and around the country concluded that such a move would be counterproductive in the longer run, in contrast to some New York Fed staffers, whose views more closely mirrored those on Wall Street.
New York Fed employees "play a very valuable role, day in, day out, with detailed contacts with the big financial firms," said William Poole, a former president of the Federal Reserve Bank of St. Louis who is now at the Cato Institute. "What I think is missing is a longer-run perspective. They tend to be sort of short-term in their outlook, which is true of a lot of the financial firms. Traders have a horizon of a few hours or a few weeks, at most."
Conclusion
The announcement of the unwinding of the dollar swaps seems largely to be a matter of announcing something that is already mostly over. More than 90% of the program has already been unwound, and there is only roughly $50 billion left to go.
Noting the tight correlation between the dollar index and the dollar swaps, anybody with insider information to these programs would have been ideally situated to thoroughly clean out the other market traders, who were in the dark as to the timing and magnitude of the program. It could merely be coincidence that the very same Wall Street firms with daily contact with the NY Fed staff secured outsized gains during this period of time, but it is hard to trust that this was mere coincidence, given all that we've recently learned about Wall Street's inability to control its greed.
Let me not just pick on Wall Street. Steven Friedman, the NY Federal Reserve board head in 2008, somehow could not stop himself from buying shares in Goldman Sachs, even as he was overseeing their dramatic rescue. He resigned over the scandal, but good luck locating much analysis or discussion of this amazing turn of events outside of the blogs.
Because a level playing field is vital to our market structure, it would be an enormous relief to both audit the Fed and secure testimony under oath about whether or not certain large Wall Street banks received information that allowed them to game the trading system in unfair ways.
This is not a small matter. One of the consistent reasons given for why foreigners favor our capital markets with their money is because they are large, liquid, and trusted.
As it turns out, there's no real competitive advantage or barriers to entry in capital markets. There's nothing to prevent any other capital center from taking over New York's functions. There are clever people willing to work hard for paper wealth all over the world, every bit as eager and clever as those in the US.
A vital pillar remaining at the forefront of this particular industry rests on trust. And sometimes trust requires a little transparency, especially if appearances have been compromised.
If the Fed and Wall Street have nothing to hide, then they should welcome an audit and investigation with open arms.
Otherwise, investors all across the globe may come to the unfortunate conclusion that the playing field is tilted.
jg – September 25, 2009
