Wall Street has sold America out!

There is a real good set of reasons why the tea partiers and the Occupy Wall Street groups both think that the Wall Street banks consist largely of immoral criminals. Their behavior has clearly shown that they are. Here is Robert Reich describing the behavior of the banks:

Wall Street’s shenanigans have convinced a large portion of America that the economic game is rigged.

Yet capitalism depends on trust. Without trust, people avoid even sensible economic risks. They also begin trading in gray markets and black markets. They think that if the big guys cheat in big ways, they might as well begin cheating in small ways. And when they think the game is rigged, they’re easy prey for political demagogues with fast tongues and dumb ideas.

Tally up these costs and it’s a whopper.

Wall Street has blanketed America in a miasma of cynicism. Most Americans assume the reason the Street got its taxpayer-funded bailout without strings in the first place was because of its political clout. That must be why the banks didn’t have to renegotiate the mortgages of Americans – many of whom, because of the economic collapse brought on by the Street’s excesses, are still under water. Some are drowning.

That must be why taxpayers didn’t get equity stakes in the banks we bailed out – as Warren Buffet got when he bailed out Goldman Sachs. That means when the banks became profitable gain we didn’t get any of the upside gains; we just padded the Street’s downside risks.

The Street’s political clout must be why most top Wall Street executives who were bailed out by taxpayers still have their jobs, have still avoided prosecution, are still making vast fortunes – while tens of millions of average Americans continue to lose their jobs, their wages, their medical coverage, or their homes.

And why the Dodd-Frank bill was filled with loopholes big enough for Wall Street executives and traders to drive their ferrari’s through.

The cost of such cynicism has leeched deep into America, causing so much suspicion and anger that our politics has become a cauldron of rage. It’s found expression in Tea Partiers and Occupiers, and millions of others who think the people at the top have sold us out.

Wall Street has shown clearly that they cannot be trusted, but when someone tries to enforce regulations on them what do they do? They whine about how misunderstood they are. They are not misunderstood. They are the organized center of financial greed and immorality in the world.

Wall Street Bankers are responsible for the current economic problems because they created and sold “financial weapons of mass destruction.” They bought off the regulators with their K-Street lobbyists, and they have supported the libertarian conservative Republicans who have thwarted and stopped government regulation of bank trading and mergers.

Since the (bank-created) collapse of the Savings and Loan institutions in the 1980's commercial banks have been merging until there are now only about five really massive banks. These banks do not do much business with small businesses because such loans do not provide large profits. They instead compete with the financial trading banks like Goldman Sachs for trading profits, using the savings from commercial customers as the basis for their trades. Why not? It's a lot cheaper than borrowing money in the market, isn't it?

But along the way the banks have forgotten that people have to trust them to do business with them. If we express our lack of trust in the massive banks who don't give a shit what happens to us, then we become their enemy. Their enemies are people that the government they buy (see K-Street Lobbyists) is supposed to suppress. The bankers prefer to wield power rather than work to develop trust.

Bob Reich has the banker's number. The bankers have forgotten that they are not in the power business, they are in the trust business. And a lot of us have been burned and no longer trust them.

Smart bankers will push for stronger and more visible regulation. I doubt that there are very many smart bankers on Wall Street in positions of power within the banking structures.

Another Rogue trader damages his bank.

Swiss Bank UBS has lost an estimated $2 billion because one of their traders in London, Kweku Adoboli, "went rogue." Julia Felsenthal at Slate Magazine explains what a rogue trader is. But first, who is Kweku Adoboli?

Kweku Adoboli is a 31 year-old british trader for the Swiss bank UBS. He was born in Ghana 15 Sept. 1980 and attended Ackworth School, a highly regarded Quaker school located in the village of High Ackworth near Pontefract, West Yorkshire, England. After that he was accepted to the extremely competitive University of Nottingham where he studied computer science and management. He graduated from there in 2003. From his educational history is it clear that Adoboli is a very capable individual.

According to the Wall Street Journal:

Adoboli started at UBS in London as a trainee in March 2006, according to the Telegraph newspaper. On the LinkedIn profile, his title is listed as “Director ETF and Delta1 Trading at UBS Investment Bank.”

Investment banks’ Delta One operations trade securities that attempt to track an asset closely. Our Journal colleague Paul Sonne reported Adoboli has worked since 2006 in the European equities division of UBS, focusing on exchange-trading funds, or baskets of securities that aim to track a specific stock index or commodities.

The Slate Article describes how traders are supposed to deal with risk.

Every trader is allowed to take on a certain amount of risk, and if he wants to exceed that value he must get the permission of his supervisors. ("Risk" refers not to the amount of money invested but rather the amount one might expect to lose on a particular gamble given the best available estimate of the odds.) Traders are said to have gone rogue when they've either made investments that are too risky, or invested much more money than they're supposed to.

What did Adoboli do that went so wrong? It looks like he made some losing trades, then attempted to take riskier trades or larger trades that would cover his losses if he succeeded, but they also failed. Somehow UBS risk management system failed to identify the risks and their size, either because Adoboli concealed them or because the risk management system was inadequate. Here's more from Slate.

A starting employee at a bank like UBS might be allowed to take on risk measuring in the thousands, not millions, of dollars. As a trader gains experience—and demonstrates an ability to make a profit—his authorized risk would increase; a very senior person at a bank might even be permitted a billion dollars' worth of exposure. Nobody has reported just how much Adoboli had been trusted with, but the Wall Street Journal did report that he worked for an equities desk called Delta One that conducted relatively safe trades. Charges against Adoboli allege that he falsified accounting records going back to October 2008. That suggests he was hiding unauthorized losing investments for a long time, as opposed to making one gigantic, really bad bet.

It has been reported that UBS' internal controls did not recognize that Adoboli was conducting unauthorized trades. He handed himself into UBS and told them what he had done, and only then did they realize that UBS had lost approximately $2 billion on his trades.

Two earlier rogue traders were Nick Leeson and Jérôme Kerviel. These were traders who were conducting large numbers of trades, made losing trades and learned how to conceal those losing trades from their supervisors while they took increasing risks attempting to achieve an overall winning situation. Nick Leeson's trades bankrupted and destroyed the Barings Bank. Jérôme Kerviel was similar to Adoboli in that Kerveil was a junior trader in the Delta One financial products department of the French bank, Société Générale. Kerviel lost approximately €4.9 billion for the bank through his trading actions.

Kerviel has always claimed that his supervisors were aware of his trades and that he simply became the fall guy when the trades failed. Did the risk management systems really fail in all three of these cases? How much did managers really know about the trades before they were exposed?

The massive power of these big banks to damage the lives and livelihoods of billions of people has be been clear since they initiated the Great Depression, and again has been exposed by their disastrous actions which caused the mortgage fraud that led to the financial collapse of Wall Street in 2008. The unrestrained management of these massive institutions cannot be trusted. This is the message that the Wall Street protesters are highlighting this weekend.

This story begins with one more banking "rogue trader", but it highlights the real problem of rogue financial institutions themselves.

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Addendum 9/20/11 @ 1:43 AM CDT
Here is One view on why Bank Reform has not stopped rogue traders.

Morality is for the little people - ask the MBA

This is an excellent video on the utter hypocrisy being practiced by the wealthy. Avoiding strategic default on mortgages is not really about the morality of paying your bills. It's about the need for the wealthy to be sure the streams of income they depend on to maintain their dominant social position are maintained.

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Mortgage Bankers Association Strategic Default
www.thedailyshow.com
Daily Show Full Episodes Political Humor Rally to Restore Sanity

Think these are any of the same guys who are hiring crooks to fabricate documents that support the bank's efforts to foreclose on property they can't prove they own. Once the documents are fabricated then the companies are declaring to the Courts that the documents really were filed legally, but they weren't.

Any Questions?

The SEC vs Goldman Sachs: an instructive court case

The SEC lawsuit against Goldman Sachs is not all that complicated. The SEC is alleging that G/S worked with an investor, John Paulson, to design Collateral Debt Obligations (CDO's) that were designed to fail. Paulson then bought derivitaves on those CDOs that paid large sums if the CDOs failed. Goldman Sachs then went out and sold investors the CDOs telling them that the CDOs were solid, safe investments. The allegation made by the SEC is that Goldman Sachs committed fraud by failing to inform the investors that the individual who was betting the CDO's would fail had also selected many of the mortgages that were included in the CDO.

Here is a very readable explanation from Business Week.

The SEC chose this case because it is comparatively stark. In early 2007, at the request of Paulson & Co., the hedge fund run by billionaire John Paulson, Goldman structured a deal called Abacus 2007-AC1, designed to let Paulson wager that the subprime-mortgage industry would collapse. Goldman lined up two counterparties for a fee of $15 million: ACA, a bond-insurance company, lost about $950 million (with the banks backstopping it), and a German bank called IKB lost $150 million. Goldman's offense, according to the SEC, was telling IKB that the portfolio of mortgage bonds used for the deal was "selected by ACA," when in fact Paulson was deeply involved in the process, cherry-picking the worst bonds it could find. Goldman didn't tell IKB who was on the other side of the trade, or the extent to which Paulson influenced selections. As a result, the SEC claims, Goldman's statement to IKB was false, misleading, and fraudulent.

The issue in the case hides the complexity. Paulson and Co is not being charged by the SEC. Nor is the investor, IKB. Business Week goes on, however, to describe everyone involved as being a great deal less than angels. And what about the rating agencies which gave the CDO's very good ratings?

The Abacus case is of course far more complex and nuanced than the SEC complaint lets on. This is a cast of characters without a single hero. Not even the supposed victims are sympathetic. IKB sold commercial-paper IOUs to investors in mid-2007 that were worthless by year's end. Its former CEO, Stefan Ortseifen, went on trial last month in Germany for allegedly lying about IKB's financial condition before its near-collapse.

The credit-rating merchants, whose incompetence cannot be overstated, make their usual cameo, as well. And while Paulson didn't get sued, because the SEC said he made no misrepresentations, he did make $1 billion on the deal. Having his name associated with this alleged fleecing carries its own unknowable reputational risk.

The other major player in this case is the SEC. The SEC has also been reported to have known of the ponzi scheme by the Texan, Allen Stanford, since at least 1997 but failed to act because it was a large, messy and complex case and their statistics would look better if they took on many smaller, simpler cases.

The final villain in this case has to be the Bush Administration and Congress, both of whom strongly believed the conservative myth that regulation of financial firms should not be done because it would hurt business.

This case seems quite clear. Goldman Sachs told those who they sold the CDOs to that one of the investors (ACA) had selected the mortgages included in the CDO but failed to inform anyone that John Paulson, who was betting the investments would fail, was instrumental in getting many of the mortgages in the CDO included. Did Goldman Sachs know the CDO's were likely to fail? That's the allegation. They were selling bad product to investors and misrepresenting it. The market was totally unregulated, so there was no transparency in the transaction. The brokers and Paulson (who was betting the mortgages would fail and made billions when they did) were fully aware that the product Goldman Sachs was selling was a bad investment.

For anyone puzzled why the intentionally unregulated US and World economies came so close to collapsing into Great Depression II in the fall of 2008, this case is a microcosm of the reasons.

Good anti-Wall Street Bank ad.

Go to Open left (or click on the title above) to see the discussion behind this ad.



From OpenLeft.

What's wrong with "Value at Risk" as a risk measure?

A big part of the current financial crisis is a failure of Risk Management. How could professional bankers fail at risk management? That's been the essence of successful banking since the earliest history of banking!

If you have been trained in modern finance theory, then you know that financial experts use some highly sophisticated mathematical techniques to measure risk. Banks have traditionally been institutions in which expert risk managers look at investments, measure the possible return, then evaluate how much risk there is that the return will not cover the cost of the investment and provide a profit.

Financial Quants have been leading the charge in measuring risk since some academics developed the theory of Value at Risk since the early 1990's. Joe Nacera at the New York Times has an excellent article on what the weaknesses of Value at Risk are and how the various Wall Street banks, regulatory agencies, and investors have misused Value at Risk and how that has contributed to the current Wall Street crisis.

Hilzoy discusses Value at Risk and links to additional criticisms of the concept by some bloggers.

The WaMu story; how the Wall Street banks screwed up

Wamu's story is rather extreme, but unfortunately, not very extreme. The Executives of WaMu simply took the Wall Street philosophy to its logical conclusion.

As you read these excerpts from the New York Times, notice the motivation of chief executive Kerry K. Killinger. Then notice how he influenced the entire bank by choosing and financially motivating the supervisors who worked for him.

On a financial landscape littered with wreckage, WaMu, a Seattle-based bank that opened branches at a clip worthy of a fast-food chain, stands out as a singularly brazen case of lax lending. By the first half of this year, the value of its bad loans had reached $11.5 billion, nearly tripling from $4.2 billion a year earlier. [Snip]

According to these accounts, pressure to keep lending emanated from the top, where executives profited from the swift expansion — not least, Kerry K. Killinger, who was WaMu’s chief executive from 1990 until he was forced out in September.

Between 2001 and 2007, Mr. Killinger received compensation of $88 million, according to the Corporate Library, a research firm. He declined to respond to a list of questions, and his spokesman said he was unavailable for an interview.

During Mr. Killinger’s tenure, WaMu pressed sales agents to pump out loans while disregarding borrowers’ incomes and assets, according to former employees. The bank set up what insiders described as a system of dubious legality that enabled real estate agents to collect fees of more than $10,000 for bringing in borrowers, sometimes making the agents more beholden to WaMu than they were to their clients.

WaMu gave mortgage brokers handsome commissions for selling the riskiest loans, which carried higher fees, bolstering profits and ultimately the compensation of the bank’s executives. WaMu pressured appraisers to provide inflated property values that made loans appear less risky, enabling Wall Street to bundle them more easily for sale to investors.

“It was the Wild West,” said Steven M. Knobel, a founder of an appraisal company, Mitchell, Maxwell & Jackson, that did business with WaMu until 2007. “If you were alive, they would give you a loan. Actually, I think if you were dead, they would still give you a loan.” [Snip]

“I never had a clue about the amount of off-the-cliff activity that was going on at Washington Mutual, and I was in constant contact with the company,” said Vincent Au, president of Avalon Partners, an investment firm. “There were people at WaMu that orchestrated nothing more than a sham or charade. These people broke every fundamental rule of running a company.” [Snip]

“It was a disgrace,” said Dana Zweibel, a former financial representative at a WaMu branch in Tampa, Fla. “We were giving loans to people that never should have had loans.”

If Ms. Zweibel doubted whether customers could pay, supervisors directed her to keep selling, she said.

“We were told from up above that that’s not our concern,” she said. “Our concern is just to write the loan.”

The ultimate supervisor at WaMu was Mr. Killinger, who joined the company in 1983 and became chief executive in 1990. He inherited a bank that was founded in 1889 and had survived the Depression and the savings and loan scandal of the 1980s.

An investment analyst by training, he was attuned to Wall Street’s hunger for growth. Between late 1996 and early 2002, he transformed WaMu into the nation’s sixth-largest bank through a series of acquisitions.

A crucial deal came in 1999, with the purchase of Long Beach Financial, a California lender specializing in subprime mortgages, loans extended to borrowers with troubled credit.

WaMu underscored its eagerness to lend with an advertising campaign introduced during the 2003 Academy Awards: “The Power of Yes.” No mere advertising pitch, this was also the mantra inside the bank, underwriters said.

“WaMu came out with that slogan, and that was what we had to live by,” Ms. Zaback said. “We joked about it a lot.” A file would get marked problematic and then somehow get approved. “We’d say: ‘O.K.! The power of yes.’ ” [Snip]

Branches were pushed to increase lending. “It was just disgusting,” said Ms. Zweibel, the Tampa representative. “They wanted you to spend time, while you’re running teller transactions and opening checking accounts, selling people loans.”

Employees in Tampa who fell short were ordered to drive to a WaMu office in Sarasota, an hour away. There, they sat in a phone bank with 20 other people, calling customers to push home equity loans.

“The regional manager would be over your shoulder, listening to every word,” Ms. Zweibel recalled. “They treated us like we were in a sweatshop.”

On the other end of the country, at WaMu’s San Diego processing office, Ms. Zaback’s job was to take loan applications from branches in Southern California and make sure they passed muster. Most of the loans she said she handled merely required borrowers to provide an address and Social Security number, and to state their income and assets.

She ran applications through WaMu’s computer system for approval. If she needed more information, she had to consult with a loan officer — which she described as an unpleasant experience. “They would be furious,” Ms. Zaback said. “They would put it on you, that they weren’t going to get paid if you stood in the way.” [Snip]

The sheer workload at WaMu ensured that loan reviews were limited. Ms. Zaback’s office had 108 people, and several hundred new files a day. She was required to process at least 10 files daily.

“I’d typically spend a maximum of 35 minutes per file,” she said. “It was just disheartening. Just spit it out and get it done. That’s what they wanted us to do. Garbage in, and garbage out.”

WaMu’s boiler room culture flourished in Southern California, where housing prices rose so rapidly during the bubble that creative financing was needed to attract buyers.

To that end, WaMu embraced so-called option ARMs, adjustable rate mortgages that enticed borrowers with a selection of low initial rates and allowed them to decide how much to pay each month. But people who opted for minimum payments were underpaying the interest due and adding to their principal, eventually causing loan payments to balloon.

Customers were often left with the impression that low payments would continue long term, according to former WaMu sales agents.

For WaMu, variable-rate loans — option ARMs, in particular — were especially attractive because they carried higher fees than other loans, and allowed WaMu to book profits on interest payments that borrowers deferred. Because WaMu was selling many of its loans to investors, it did not worry about defaults: by the time loans went bad, they were often in other hands.

WaMu’s adjustable-rate mortgages expanded from about one-fourth of new home loans in 2003 to 70 percent by 2006. In 2005 and 2006 — when WaMu pushed option ARMs most aggressively — Mr. Killinger received pay of $19 million and $24 million respectively.

WaMu’s retail mortgage office in Downey, Calif., specialized in selling option ARMs to Latino customers who spoke little English and depended on advice from real estate brokers, according to a former sales agent who requested anonymity because he was still in the mortgage business.

According to that agent, WaMu turned real estate agents into a pipeline for loan applications by enabling them to collect “referral fees” for clients who became WaMu borrowers.

Buyers were typically oblivious to agents’ fees, the agent said, and agents rarely explained the loan terms.

“Their Realtor was their trusted friend,” the agent said. “The Realtors would sell them on a minimum payment, and that was an outright lie.”

According to the agent, the strategy was the brainchild of Thomas Ramirez, who oversaw a sales team of about 20 agents at the Downey branch during the first half of this decade, and now works for Wells Fargo.

Mr. Ramirez confirmed that he and his team enabled real estate agents to collect commissions, but he maintained that the fees were fully disclosed. [Snip]

By 2005, the word was out that WaMu would accept applications with a mere statement of the borrower’s income and assets — often with no documentation required — so long as credit scores were adequate, according to Ms. Zaback and other underwriters.

“We had a flier that said, ‘A thin file is a good file,’ ” recalled Michele Culbertson, a wholesale sales agent with WaMu.

Martine Lado, an agent in the Irvine, Calif., office, said she coached brokers to leave parts of applications blank to avoid prompting verification if the borrower’s job or income was sketchy. [Snip]

By the time shareholders joined WaMu for its annual meeting in Seattle last April, WaMu had posted a first-quarter loss of $1.14 billion and increased its loan loss reserve to $3.5 billion. Its stock had lost more than half its value in the previous two months. Anger was in the air.

Some shareholders were irate that Mr. Killinger and other executives were excluding mortgage losses from the computation of their bonuses. Others were enraged that WaMu turned down an $8-a-share takeover bid from JPMorgan.

“Calm down and have a little faith,” Mr. Killinger told the crowd. “We will get through this.” [Snip]

In September, Mr. Killinger was forced to retire. Later that month, with WaMu buckling under roughly $180 billion in mortgage-related loans, regulators seized the bank and sold it to JPMorgan for $1.9 billion, a fraction of the $40 billion valuation the stock market gave WaMu at its peak.

Billions that investors had plowed into WaMu were wiped out, as were prospects for many of the bank’s 50,000 employees. But Mr. Killinger still had his millions, rankling laid-off workers and shareholders alike.

“Kerry has made over $100 million over his tenure based on the aggressiveness that sunk the company,” said Mr. Au, the money manager. “How does he justify taking that money?”

This was a disaster caused by Killinger's greed, his excessive pay and his prospective bonuses. But on a more global scale, it was also caused by bankers hiring people who are motivated by money instead of the satisfaction of growing a long term effective business. The clearest example of that in this story is the role of the advertising slogan "The power of Yes." Policy was set to match the advertising slogan rather than to build a bank for the long term, and the proof of its effectiveness was the short-term growth of revenue (which was "jacked up" by dubious accounting.) Since Killinger had been an analyst himself, it's where that attitude came from - Wall Street. All that counts for the company is the bottom line, and financial reporting is done quarterly and annually, while stock market price is considered daily and even hourly.

Killinger had no interest in anything about WaMu except his salary and his excessive bonuses, and Wall Street's short-term obsession with quarterly performance fed right into that. True, the bonus system itself was clearly poorly structured, but remember that it was structured for Killinger by the Board of Directors who Killinger himself had appointed.

To achieve those bonuses, Killinger made sure that apparently high profit but dubious loans were pumped out at high rates of speed (1)by pressuring employees to do whatever it took to sell the loans and (2) by kickbacks to mortgage brokers who initiated the loans and faked the paperwork to make sure they could be sold to investors, then (3) by running loan approval sweatshops in which it was never permissible to say No because saying No meant the supervisors bonus was reduced. In every case the supervisors were motivated by high bonuses dependent on achieving short term goals by any means possible and by ignoring long term consequences.

As an exercise for the reader, consider how and why Wall Street itself, run by bankers motivated by money (instead of building businesses) and obsessed with the latest quarterly reports, has collapsed. Remember that Wall Street itself is now on life support being funded by none other than Henry Paulson, currently Secretary of Treasury and previously Chairman of Goldman Sachs Wall Street Bank. And Paulson himself is using taxpayer money to bail out his precious banks. The Wall Street attitudes that destroyed WaMu dominate Wall Street and have had much the same effect there as on WaMu.

What's the chance that Switzerland will soon go bankrupt?

We've already seen Iceland go bankrupt as a result of the failure of its major bank, Kaupthing. The two Swiss banks, UBS and Credit Suisse, are a larger part of the Swiss economy than Kaupthing was of the Iceland economy, and both Swiss banks are teetering on the brink. Here is Portfolio.com's Felix Salmon:

UBS has a $2 trillion balance sheet; Credit Suisse has another trillion on top of that. Call it $3 trillion between the two of them, which is about ten times Switzerland's GDP of $300 billion or so. Now that's what I call too big to save. Oh, and did I mention? At the end of 2007, Credit Suisse was levered by more than 40 times; UBS was levered by more than 64 times. A 16% fall in UBS's assets would wipe out not only all of its equity but 100% of Swiss GDP on top.

John Quiggen at Crooked Timber also points to the risk presented by Citi Group.

The failure of Citigroup, which looks increasingly likely to happen in the near future, would mark the end of the beginning of the financial crisis. Until now, the prevailing view has been that the crisis and recession will pass in a year or so, after which things will go back, more or less, to the way they were, with a few less financial institutions, and a bit more regulation. A Citigroup failure would put paid to that idea.

Citi is not only too big to fail, it’s too big to rescue with any of the half-measures that have been tried so far. Only outright nationalization is feasible, and that will probably require joint action by a number of governments; Citigroup’s global operations are too big for the US to handle alone. After that, the kinds of tinkering discussed at the G20 last week will be irrelevant. It’s now unsurprising to read (on CNBC!) predictions that all US financial institutions will be nationalized within a year. That’s probably an overstatement: as long as the economy doesn’t really crash, there are plenty of small banks and credit unions that will survive, but few of the big names will be among them.

So Credit Suisse, UBS and Citi are all being looked at as the next Lehman Brothers, which Treasury Secretary Henry Paulson made the massive error of allowing to go bankrupt without considering the consequences for the overall economy. Lehman Brothers put the banking industry on notice that any one of them could be the next to go and there was no certainty that the government would bail them out. Now we look at Citi which is so large that no single government can bail it out, and the two Swiss banks which dwarf the Swiss economy even without the rather amazing levels of leverage they have.

This of course it just banking institutions. But consider the way the banks reacted to Paulson allowing Lehman Brothers to fail. Now Paulson and the American Congress are delaying any action at all to bail out General Motors. What happens to the rest of the economy if GM goes under? I frankly don't think they understand that they brought a lot of their crisis on to themselves, but they are highly overpaid executives. Such people to not learn because they already know it all and their paychecks prove it.

But at the same time, the ripple effects of any of the Detroit big three going into bankruptcy will be massive, even though the details are totally unpredictable.

In the meantime, Paulson and the Bush administration are doing absolutely nothing as everything collapses around their ears. sort of, you know, like the unaware and unlearning Detroit big three executives, aren't they? Probably not a Democrat in the bunch in Detroit, and the Republican Bush administration is so conservative that they probably still believe that the free market will magically save everyone in the last reel of the movie.

I've been saying for a while now that we see no change from the downward trajectory of the economy, and we don't know where the bottom is. That's still true - in Spades.

Major US banks announce more large losses

There's an old saying in business that the job of the accountants is to wait until the battle is over and then go out and bayonet the wounded. Well, today the New York Times reports some more bayoneting going on with Citigroup, Merrill Lynch and J.P. Morgan banks. There is some strong doubt, however, that the battle is over.

A year into the tight credit market, and the losses keep coming.

Citigroup said Friday morning that it lost $2.5 billion, or 54 cents a share, in the second quarter.

The loss was largely caused by $7.2 billion of write-downs of Citigroup’s investments in mortgages and other loans and by a weakness in the consumer market, which cost Citigroup $4.4 billion in credit losses and $2.5 billion to increase reserves.

But the chief executive, Vikram Pandit, positioned the $2.5 billion loss as progress. Last quarter, the financial conglomerate lost $5.1 billion. [Snip]

Citigroup is a barometer of the pain felt in all parts of the financial industry, and the company’s results show the downturn spreading from the credit markets to the real economy. Consumers — stung by high oil and food prices — are falling behind on their mortgages, auto loans and credit cards. Increasingly, that pain is being felt beyond the United States.

The bank has recorded more than $56 billion in credit losses and write-downs in the last four quarters. Citigroup lost more than $17 billion in that time. And its share price has fallen nearly 70 percent since the credit market began to tighten. [Snip]

Citigroup’s revenue was $18.7 billion, down 29 percent, mostly because of its write-downs. In addition to mortgage bond deteriorating, Citigroup was hurt by a drop in the credit quality of companies that reinsure its bonds.

Operating expenses were up 9 percent at $15.9 billion, in part because of charges taken while the bank lays off thousands. So far this year, the bank has reduced its work force by 11,000.

Citigroup’s credit card income fell around the world, with North America the hardest hit but growing problems evident elsewhere. Troubled spots included Brazil, India and Mexico where there was a rise in past-due payments and credit costs.

Citigroup continued to be stung by lower securitization revenues, as the pipeline for repackaging loans into bonds remained frozen.

Bank executives said a recovery would take two to three years. [Snip]

On Thursday, Merrill Lynch announced a loss of $4.8 billion, surprising even the most pessimistic analysts. The loss was largely caused by another $9.7 billion in write-downs in mortgage investments. Merrill was forced to raise capital by selling assets like its 20 percent stake in Bloomberg, the financial data service mostly owned by Mayor Michael R. Bloomberg of New York.

Also on Thursday, JPMorgan Chase said its quarterly income fell 53 percent from the second quarter last year.

While the reports of lower revenue and losses are from past operations, the highlighted fact that "Consumers are falling behind on their mortgages, auto loans and credit cards" indicates that the battle is far from over.

Here's the reason why the Bear stearns crisis occurred

Let's look at Bear Stearns to see why it failed. Then we need to see why the federal government is bailing the bankers out even though by law, they're not supposed to.

Bear Stearns is a bank. Banks borrow money and then lend it out, making their profit by paying lower interest rates on the borrowed money than they charge on the loans they make.

The borrowed money is of two kinds. Retail banks take deposits from savers. Those are the savings accounts we know that the government insured for up to $100,000. Financial banks, like Bear Stearns, get loans from investors. But as far as the bank is concerned in both cases they are borrowing money to lend.

The difference between what the bank pays for borrowed money is rarely more than one or two percent. The bank only has to keep enough money on hand to cover repayments to the depositors/lenders who supplied the funds in the first place. This is the reserve requirement. The greater the reserves the bank keeps, the less likely that bad loans will prevent it from repaying depositors/lenders who provided the money in the first place. Currently the Federal Reserve requires commercial banks to keep a 10% reserve behind all loans made for working capital and transactions loans for which there is no security other than the borrower's signature.

As long as the borrowers pay the bank its loans, borrowing money to lend at a higher interest rate is a money machine. What's the flaw? Well, loaning money to borrowers always runs the risk that the borrowers won't pay it back. Then the bank loses not only the interest they were expecting, but also some or all of the money they loaned out. Remember, this money was from depositors or lenders, who are also in danger of losing the money they deposited with or loaned to the bank.

Here is where the government steps in. If the bank can't repay its depositors, the government guaranteed repayment of up to $100,000. That makes lending to a commercial bank (depositing money savings accounts) a lot less risky than lending to a financial bank. (A side effect is that such deposits, being loans to the bank that have no risk, pay a low interest rate.) But the government is not in the business of handing bankers money to lend at a profit and then covering the bank's losses when it makes bad loans. So they demand that the bank have "reserves" - money kept on hand and not loaned out that will be the bank's first source of funds to cover bad loans. A 10% loans means that the bank borrows $100, but can only lend out $90. The bank loses the interest on the $10 kept in reserve, but those funds permit it to repay depositors/Lenders when they demand their money back. It is when those depositors/lenders demand their money back and the bank cannot provide it that a "Run on the Bank" occurs.

But reserve requirements only apply to banks that expect the government to repay its depositors if it can't. Bear Stearns was not a retail bank and had no insurance from the government. By giving up the insurance, Bear Stearns was given the privilege of not keeping reserves and not being subject to bank inspections. It was assumed that the lenders who provided the funds would be sufficiently knowledgeable and informed so that they could measure the risk Bear Stearns was bearing on its loans. For every dollar of capital the company had, it loaned out $32 which amounts to about a 3% reserve. They could make a lot more money than a regulated bank that had to keep a 10% reserve and was prohibited from making the most risky (and most profitable) loans. There was no expectation that the government would step in and save the bank when it underwent a Run.

Only - Bear Stearns was so large, and so deeply embedded in the entire financial system, that it was decided if they went under they could take a number of their lenders with them. The entire financial system was at risk when Bear Stearns failed. So the Federal Reserve provided guarantees of a lot of taxpayer money to Bear Stearns' lenders and then sold it off to J. P. Morgan.

So now the financial banks are on notice that they, too, are protected by government guarantees. Only they don't have to avoid the risky loans and the low capital ratios that made Bear Stearns so vulnerable.

That set the financial bankers up to be able to make the riskiest and most profitable loans, knowing that if the loans go bad the government will bail them out, and if the loans don't go bad, they get the profits.

Even the financial bankers are now saying that some regulation and reporting requirements need to be imposed on the riskiest high-flying financial banks.

Oh, and what caused the credit crisis? These high-flying financial banks were supposedly very knowledgeable about the risks they were taking when they loaned money. Residential mortgages were supposed to be the safest of loans with a very low rate of default. So they were bundled together in great securities with thousands of individual mortgages. The rating agency looked at them, assumed that the good mortgages would cover the risky sub-prime mortgages, and sold the whole package as very safe AAA securities.

When it was learned that the number of bad loans were much higher than previously known, suddenly the lenders providing funds to Bear Stearns and other did not know if they could get back money they loaned those banks. So they quit loaning to anyone depending on such massive mortgage-backed securities. And that turned out to be almost everyone.

Worse, when the mortgage-backed securities were first created and sold, the original documentation did not go with the security. Just a computerized summary of each mortgage. The cost of finding that original paper documentation and having someone review it was impossible to imagine. So no one knows just how risky any mortgage-backed security is.

Since Bear Stearns had only about $3 reserve behind every $100 of loans they had made, no one who loaned money to them had any reason to believe they would get their money back. So all lending to Bear Stearns stopped and all lenders with loans already made wanted their money back - all at once. That $3 reserve was smoke in a high wind.

Bear Stearns was bankrupt and the offer of $2 a share was a gift to the stockholders. There was nothing of any value to back even that $2 per share price. That's what a run does to a bank. But it was too big to fail, so the government had to provide taxpayer money to bail out the bankers who made the bad loans.