Dystopian Paradox

Steve Kroft on 60 Minutes presented an informative program on derivatives tonight. He interviewed Jim Grant, one of the leading experts on credit markets and editor of “Grant’s Interest Rate Observer.” Grant described the behavior of the people at the top of the biggest Wall Street firms as criminal neglect. I think there was more than neglect involved. I think there was criminal intent.

Croft held up a credit default-swap contract document. It was over an inch thick. Scam people with complexity rather than simple non-existent Billie Sol Estes fertilizer tanks.

An attorney that Croft interviewed said that CDSs are called that even though in substance they are insurance. Insurance is regulated. Swaps aren’t. That’s enough of a ruse to warrant a criminal investigation into this horror show.

The attorney did a good job of explaining what a CDS is. First of all, Wall Street is selling derivatives to a bank for example. They have a CDS as a companion product. If the derivative which is based on subprime mortgage goes bad, the CDS pays off.

That all works fine until people can’t pay their mortgages. Joe Sixpack makes $40,000 a year gets an adjustable rate mortgage of $200,000 and makes the payments until the interest rate goes up. Then he defaults. Sixpack’s a bunch of similar subprime mortgages are bundled into a mortgage backed security derivative. That MBS is traunched into say five layers. The bottom layer traunch takes losses on the underlying mortgages first and so sells for a lot less than the top layer traunch. The top layer is the last to take a hit.

Moody’s puts a triple A rating on the top traunch initially. When the subprimes start going bad, Moody’s lowers the rating of even the highest traunch. When that happens, the holder of the top traunch of the MBD who’s used it as collateral gets a call from its lender to put up more and better collateral which the lender had the right to do under the loan agreement.

The holder of the top layer traunch bought a CDS as insurance in case the MBD goes bad. Here’s the problem. The issuers of the CDSs don’t have the funds to pay the holder of the MBS. As mentioned, the CDS is insurance but isn’t called that because insurance is regulated and issuers of insurance products are required to carry sufficient funds to cover losses actuarially determined.

AIG is a big insurance company that got into the unregulated business of issuing CDSs. What you wind up with is H. Paulson the Taxpayerfornicator handing over $85 billion of the taxpayers’ money to bailout AIG. Maybe that’s enough and maybe not. I read something a day or two ago that said that AIG has been through I think about two-thirds of the $85 billion.

Some congressperson should immediately call for Paulson’s resignation. He and others at the top of the Wall Street firms are as culpable as Kenneth Lay and Jeffrey Skilling. For our elected officials to let Paulson and his colleagues off the hook is more criminal than the crimes of Paulson et. al.

Paulson is grandstanding this mess and spending money the taxpayers don’t have to cover his on rearend. Congress must see through this deceit.

The 60 Minutes piece tonight used the term “shadow market” to describe the derivatives market because it is unregulated and doesn’t necessarily show up on financial statements. No one knows what the face value of just CDSs is but a guess is at least $50 trillion. The total notational value of all types of derivatives is over $1 quadrillion.

The Taxpayerfornicator Paulson was CEO of Goldman Sachs when its representative along with those of four other investment banks met with five members of the SEC in April 2004 to discuss exemption of the banks’ brokerage units from an old regulation limiting the debt they could take on. The SEC gave it a go at the short meeting.

That move freed up billions of dollars held as a cushion against losses. The banks used the funds to buy mortgage backed securities, credit derivatives and other esoteric contracts that the Europeans were making big bucks on.

The SEC meeting took 55 minutes. Two years later, the Taxpayerfornicator resigned Goldman Sachs to become treasury secretary. A mere four and a half years after the fateful meeting, the major Wall Street players crumbled. The New York Times ran an in depth article Thursday on event.

Now that the bailout bill is passed, Congress should create an ad hoc committee as soon as it reconvenes to investigate the Wall Street collapse and the competency of the SEC and its members. The committee must be as politically neutral as possible. Paulson’s obvious conflict of interest is more than sufficient for the committee recommend and Congress to demand his resignation.

I posted a comment to a New York Times artcle a few minutes ago that read essentially as follows:

“Congress should adopt the Swedish plan and also place compensation restrictions on executives of institutions benefitted. Paulson should be fired immediately because he reeks of conflict of interest. He resigned as CEO of Goldman Sachs in contemplation of taking the treasury secretary job. Moreover, he spared Goldman Sachs, his alma mater, but not Lehman. The collapsed of Lehman has exacerbated the crisis.

“The congressional finance and banking committees must preclude the influence of special interests and house Republicans, and must not participate in partisan politics in the presidential election or otherwise, in arriving at a plan to present to Congress for vote.

“No plan will be perfect or guarantee success, but I’m proposing a process that has a chance of producing a sensible plan.”

I’m going to email my federal congresspeople with the same message.  They already know how mad taxpayers are at the Paulson proposal and a bailout in general.  My son Chip suggested I come up with a solution rather than just ranting.  The above is the best I can come up with at this time.

BTW, the Swedish plan in the early 90s included the government taking back warrants in the entities that were bailed out.  Net result was that the government and therefore taxpayers lost little and maybe had a zero loss on the deal.

After the big pow wow in Washington today, Republican Senator Richard Shelby from Alabama who’s on the banking committee and strong critic of Paulson’s plan, announced that he didn’t believe that they had an agreement on the plan. He waived five pages of letters from what he said were from leading economists at Harvard, Yale, MIT and the U of Chicago that said they viewed Paulson’s plan as bad and would create more problems than it would solve.

As to tomorrow night’s debate, indications from MaCain’s campaign a couple hours ago were that he would show up. 

My kids are now witnessing the drama and fear my generation experienced in 1962 and 1963 with the Cuban missile crisis and JFK’s assassination followed by Jack Ruby killing Oswald. Wish they weren’t.

The New York Times reported that all the players in Washington are near an agreement on the terms of the $700 billion bailout.

Taxpayers will really being taking a hit if the fed is going to buy bad assets based on what those assets are suppose to pay the holder at maturity. That bails out Wall Street, at least to this point, totally at the taxpayers’ risk.

While the $700 million bailout debate in Washington goes on, the debate tomorrow evening may not. Obama held a press conference yesterday in Florida after a rally, in which he said that a president has to deal with more than one issue at a time and so he wants the Friday debate to happen. You can watch the whole press conference on YouTube.

Meanwhile, Congress yesterday overwhelmingly passed a $25 billion bailout of the automakers. This move was politcaly motivated because it directly affects jobs in swing states. This move would have been earth shaking news a year ago. Today it’s second page news.

In 1980, the CATO Institute called the Chrysler bailout a move toward feudalism. The Paulson plan as he proposed it is a giant step in turning the US of A into a feudalistic state. I’ll discuss the process in a subsequent post.

The Financial Times carried an article today by George Soros addressing Paulson’s proposed bailout. The Hungarian born Soros was co-founder of the Quantum Fund along with Jim Rogers in 1970.

Soros said that Paulson’s plan is ill-conceived. Paulson is asking Congress to write a blank check.

His plan also would preclude court and administrative review of the treasury secretary, which Soros called “. . . the ultimate fulfillment of the Bush Administration’s dream of a unitary executive.”

Soros agreed with Obama’s four conditions to the bailout: take care of the taxpayers; bipartisan oversight; help homeowners as well as the mortgage holders; limit on compensation to private individuals who benefit from the taxpayers’ money.

Congress turned the foreign policy keys to Bush himself when it voted to invade Iraq. Now he wants the keys to the treasury. My son Chip told me about the Soros article today and noted that it was like when the good guys in Star Wars voluntarily turned all power over to Darth Vader’s boss. In real life, it’s like Hitler taking power as Chancellor in 1933 and dissolving the Reichstag.

Bush has done a pretty good job of burning down Iraq. Yesterday, Warren Buffett likened the financial crisis to Pearl Harbor. Difference is, we attacked ourselves this time and Bush the Feckless is out to burn his own damn country down.

Coincidentally, I received a non-fiction how-to book in the mail today totally unrelated to the financial meltdown. However, it relates a strategy to accomplish a particular task. Right up front, it quoted from Albert Einstein as follows:

“Problems cannot be solved at the same level of awareness that created them.”

As that concept applies to present circumstances, we don’t need Paulson involved at all in the bailout. He was CEO of Goldman Sachs two years ago. He helped create the problem. Soros in today’s FT article notes that Paulson’s actions last week brought on the crisis when he allowed Lehman Brothers to fail. Soros also gives Paulson bad marks on the way he handled the AIG and Fannie and Freddie bailouts.

We need someone with the intellect and character of Leon Jaworski, the special prosecutor in the Nixon impeachment proceedings, to head up an investigation into this whole mess and hold accountable those complicit both in the private and public sectors. There is too much cross pollination between the Bush administration and Wall Street to trust any of those people in solving the problem or in an investigation. (Note: News today is that the FBI is investigating all the bailees except for Goldman Sachs and Merrill Lynch).

In the meantime, the Paulson plan as modified by Barack’s conditions, plus firing Paulson, will hopefully bridge the US of A into a level of confidence in our financial system sufficient for our economy to go about its business.

Bush is coming on TV tonight most likely to try and cram the Bailout down our throats.  I sent an email to Senator Kay Bailey Hutchinson of Texas (R) a few minutes ago.  I urge you to email your federal congress people immediately to let them know your views.

My email read as follows:

Dear Senator Hutchinson:

Please vote against Paulson’s plan unless:

Taxpayers get paid back with interest before any bank profits.

Reduce executive compensation

Bipartisan oversight of funding the Bailout.

Paulson was CEO of Goldman Sachs immediately before he became SOT.  He has a direct conflict of interest with what he is proposing.  Congress must force him to resign if he doesn’t do so volutarily. 

Why isn’t the FBI investigating Goldman Sachs and Merrill Lynch?

Please vote for your constiuents. Not Wall Street and not the Bush administration.

Ridge Dickey

The FBI is investigating Fannie Mae, Freddie Mack, Lehman and AIG. Why not Goldman Sachs and Merrill Lynch?

Paulson has a direct conflict of interest as Treasure Secretary. Paulson was CEO at Goldman Sachs when he came on as SOT two years ago.

If Paulson doesn’t have the decency to resign as SOT voluntarily, Congress must demand his resignation.

More Bush administration shenanigans.

Notational value appears to be a made-up number by those people who create derivatives. It bears no relation to fair market value, that is, what a willing buyer will pay for and a willing seller will sell for when neither is under no duress to complete the transaction.

There are over $1 quadrillion ($1000 trillion) notional value of over the counter derivatives sitting on computers worldwide. One type of OTC derivative is a collateralized debt obligation (CDO). While CDOs may be collateralized, the fail market value of the collateral may be much less than notational value.

A Merrill Lynch transaction at the end of July illustrates the shenanigans which is the OTC derivative and what should be fraudulent accounting practices. ML sold $30.6 billion notational value CDOs to an affiliate for $6.7 billion. As of June 30, ML carried the CDOs at $11.1 Billion, so there was a prior $19.7 billion writedown. The sale would thus produce an additional $4.4 billion loss.

Merrill Lynch financed 75 percent of the $6.7 billion sale and took back a non-recourse loan of a little over $5 billion secured only by the CDOs and got cash of $1.7. So it got $1.7 billion for the $30.6 billion notational value. The writedown on the books was to 22 percent of the 30.6 billion. However, ML only got $1.7 billion for sure so the true writedown is to 5.5 percent of the notational value.

I found the above information at www.elitetrader.com when I googled “notational value.” To get an idea of what we may be dealing with, look at the name of a CDO. Collaterized debt obligation. Collateraized by what? And whose obligation is it that is collaterized? Is there some entity out there that has the legal obligation to pay 100 percent of the notational value of a CDO? Or are these liabilities non-recourse. If so, then we have a giant $1.1 quadrillion Ponzi scheme.

Keep in mind that ML at one time was carrying these CDOs at $30.6 billion. There was more than just a liquidity problem with ML. There was a financial statement problem. And there is still a balance sheet problem because ML has some amount of liability exposure directly related to these alleged assets.

Even if there has been no formal regulation of derivatives, that does not mean that there aren’t plenty of people who may be guilty of criminal fraud. We’ve had the fox watching the henhouse at least since June of 2006 when Bush nominee Henry Paulson was confirmed as Treasury Secretary. Paulson was CEO of Goldman Sachs when he took on the job as SOT.

Obama said today or yesterday that he wants to retain Paulson as Treasury Secretary because he knows what’s going on. The question is, did he know what was going on two years ago?

Newt Gingrich unequivocally stated today in an NPR interview that Paulson was wrong on this $700 bailout of Wall Street. When asked if he felt betrayed by the Bush adminstration, Gingrich said no but that the administration was wrong in calling for it.

If the ML scenario above is representative of the relationship between notational and fair market value of all derivatives, then an implosion is inevitable. This monopoly money is being carried on books all across the planet. If there were a $700 trillion writedown, who takes the hit? Has there been as much notational liability created as notational asset value?

Dennis Kucinich introduced articles of impeachment against GW Bush in June of this year alleging that he created a massive propaganda campaign to sell the nation the Iraq war. Bush should be removed as president before his term is up because of his complete and total incompetence. This guy has been at the helm for almost eight years and has participated (by gross negligence) in taking apart this country’s financial system.

The Iraq war has played a part in the disintegration of the financial system. But to be so stupid as to allow a Ponzi scheme to develop in the name of free enterprise is unbelievable. And all the men and women in the military who have lost their lives or health because of the stupidity of one human being. And all the poor citizens of Iraq who have lost their lives or families and country because of the stupidity of one human being.

McCain is absolutely not the man for the job as president. He wants to continue the Iraq war until we win. The Iraq war is a Ponzi scheme of the Billie Sol Estes variety. BSE got loans on West Texas fertilizer tanks that did not exist. We are continuing to pursue the Iraq war on empty underlying assumptions. One of those assumptions is that if we don’t win the war, we will be fighting terrorists here in the USA. We might be doing that whether or not we continue the war. Another assumption is that we must have Mideast oil to continue our way of life and that the Iraq war is necessary to assure the continued flow of that oil to us. There is no guarantee that our way of life can continue no matter how much oil we import because our financial situation is so desperate.

Obama is right about keeping Paulson on as SOT. It’s wise to keep your enemy close so you know what he or she is doing.

Below is Henry Paulson’s statement published today that explains at least part of the problem and action the Treasury and the fed will be taking. Please note that the Paulson’s describes the steps that fed will be taking as tactical. There is no hint of a strategy to deal with the root cause of the meltdown.

September 19, 2008
hp-1149

Statement by Secretary Henry M. Paulson, Jr. on Comprehensive Approach to Market Developments

Washington, DC– Last night, Federal Reserve Chairman Ben Bernanke, SEC Chairman Chris Cox and I had a lengthy and productive working session with Congressional leaders. We began a substantive discussion on the need for a comprehensive approach to relieving the stresses on our financial institutions and markets.

We have acted on a case-by-case basis in recent weeks, addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner. And this morning we’ve taken a number of powerful tactical steps . . . more