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Archive for July 2009

Bernanke in a town-hall meeting, shopping for popularity

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bernankeintownhallmeeting

Last Sunday Ben Bernanke, chairman of the Federal Reserve responded to questions from the public in a town-hall style meeting. For the first time in history an acting Federal Reserve chair stepped into the arena that is usually the prerogative of obligations among elected officials. We truly live in interesting times.

What could have provoked this extraordinary move by the chairman given the daunting unpopularity of cumulative actions taken by the Fed in the last twenty four months? The answer is already given in the question. Ben Bernanke is shopping for popularity in order to better his approval ratings. His term as chairman ends in January 31, 2010, when he is up for reappointment by president Obama.

I can only imagine it must have been scary and embarrassing for the chief to step in front of the very same audience he led down over the course of the last ten years. He certainly did not mean to inflict any harm upon his fellow countrymen, but together with his predecessor Greenspan he helped lay the foundations of a shaky economy based on bubble economics.

Sure he gave birth to many millionaires and even some billionaires, but for most people Greenspan’s and Bernanke’s policies were rather harmful. Certainly one cannot expect any sensational outcome of such meetings with both a preselected audience and preselected questions. Organizers won’t let that happen though the chairman won’t suffer any lasting damages. It would have been nice though to read Bernanke’s mind.

To his defense the chairman admitted that he was disgusted from bailing out giant Wall Street firms like AIG, Bear Stearns or Merrill Lynch and rescuing them from going bankrupt. Though we certainly respect his wish not to reside over a second Great Depression, of course we have to believe him that there were no other options at the time. I might also add we are not yet with absolute certainty out of the woods with regard to another Great one.

Asked about his too-big-to-fail policy he seemed to indicate sympathy for the public’s frustration and promised to make it better in the future. Though his credibility was called into question by reiterating his opposition to an independent outside audit of the Fed. Why no audit if he has nothing to hide? Yes there is the issue of independence of the Fed, but just how much independence was there say in the last ten years?!

The Federal bank closest to Wall Street, and therefore in a special position with regard to the nation’s largest financial institutions, is the Federal Reserve Bank of New York. During the financial crisis Federal Reserve and Treasury Department officials made all major decisions, but the New York Fed executed them.

In the meantime the New York Fed has been criticized as too close to Wall Street. William Poole, a former Fed president, missed a longer-run perspective among the Fed’s staff. They adopted a trader mentality instead and did not pay enough attention to a system skewed towards too much risk taking by numerous bailouts of large Wall Street firms.

The Fed’s board of directors is composed of powerful bankers and corporate titans like Jamie Dimon, the head of JPMorgan Chase, and Jeffrey Immelt, General Electric’s chief. Richard Fuld had to resign after Lehman’s bankruptcy and Stephen Friedman called it quits over a conflict of interest with the other board he served, of investment power house Goldman Sachs. The corporate-federal officials network seems too tight to ever disintegrate.

It is not only the Federal Reserve that has to fear for its independence. The lobbying departments of large financial institutions have expelled their tentacles even into the Financial accounting Standards Board (FASB) of the United States and the International Accounting Standards Board (IASB) of Europe.

According to a recent report by an international team of former regulators and corporate officials, the Financial crisis Advisory Group deplored efforts by politicians to prescribe changes on accounting standards. The integrity of valued assets on the books of financial institutions should not be called into question in an effort to save those institutions from potentially harmful bets gone awry. In April, 2009, FASB already caved in to heavy financial lobbying and paused fair-value accounting rules for illiquid assets.

Beside all the regulatory and statutory powers bestowed on elected or appointed officials their most potent tool still remains the integrity of the person and organization in question. It is by no means sufficient for Fed chair Bernanke to communicate his objection to the bailouts on Wall Street even if it is within such an elaborate setting of a town-hall meeting. There is not enough meet on the bone to undo what has already happened.

A Gallop poll, conducted in mid-July, found that only 30% rated the Fed as doing an excellent/good job. The bank had the lowest score out of nine government agencies and it was down sharply from the 53% who still approved of the Fed’s job in 2003. This time even the CIA and the Internal Revenue Service scored better than the Fed. Bernanke will have to do better. It will most certainly be like walking a tightrope.

Hearing on Speculative Position Limits in Energy Futures Markets, July 29, 2009

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CLU9Sep09WTIcontract-andFFtarget

Donald Casturo, Managing Director, Goldman, Sachs & Co, in his opening testimony during the second day of hearings at the CFTC, blew into a familiar horn with respect to speculative actions in trading energy future contracts. Maybe so because of his position as head of trading and managing the commodity index business at Goldman or maybe it was just something that comes with the job as a trader.

In his defense Casturo referred to convergence at settlement of a future’s contract price with the spot price in a physically deliverable commodity like oil, as vital to well-functioning futures markets.Therefore prices in the future’s market are determined only by supply and demand fundamentals the same way spot prices are.

This makes a lot of sense under normal circumstances but we surely don’t live in normal times. The convergence argument does not take into account that fundamentals are not really that important considering the accommodative stance of the Federal Reserve. Who is going to take the other side when everybody and his cousin are assuming that the Fed will trash the dollar in order to revive an ailing financial industry? By doing so the Fed will increase commodity prices and inflation over the long run. After all that’s what they have done for the last thirty years.

From this it clearly follows that future prices can influence spot prices in such a way detached from market fundamentals. Excessive speculation therefore will drive the spot price in the direction of the shape of the futures curve. To pinpoint such a shift away from fundamentals is of course extremely difficult. Speculators seem to say we are innocent until proven guilty, and see their business in trading energy as legal.

CFTC and others might not be able to refute it but might recognize their illegitimate actions on the basis of common sense. I hope that the CFTC hearings will help them and the public to acknowledge today’s peculiar situation in energy markets and commodity trading in general and act accordingly as outlined in section 4a of the CEA  (Section 4(a) of the Commodity Exchange Act) to protect the public interest.

In order to illustrate this point I charted the monthly price of the front month WTI crude oil futures contract (CLU9) including FOMC decisions on the Fed Funds rate since 2006. The last of a series of restrictive steps was implemented in June 2006, FOMC raised interest rates by 25 basis points to 5.25 percent in that month. After that rates were kept steady at that level for more than a year. Over that time period the price of WTI oil was range bound between $60 and $80.

In September 2007, two months after two Bear Stearns hedge funds had defaulted, FOMC changed course and lowered their target rate by 50 basis points. During September for the first time ever the price of WTI cut through $80 threshold like a knife through butter. Unprecedented cumulative cuts of 125 basis points in January and 95 basis points in March and April the following year saw similar price jumps in WTI crude oil future contracts.

The price of oil kept increasing from about $85 at the end of 2007 to almost $150 in June of 2008 even though the economy was already in a severe recession as determined by NBER since the end of 2007. As one might argue that this was not recognized until many months later, unprecedented actions taken by the Federal Reserve should have proven otherwise. Speculators kept pouring money into commodities and were driving up prices to unsustainable levels.

During the CFTC hearing commissioner Bart Chilton was chastising the industry for their go slow attitude and reiterated CFTC’s commitment to swift action. He was particularly concerned with the London loophole and look-alike contracts traded on London futures markets. In the connection with hedge exemptions traders can buy and sell these OTC contracts on unregulated electronic exchanges with almost no position limits attached to them. These contracts were traded outside of the commissions oversight.

The policy debate according to Chilton is to find the right balance between the amount of commercial hedging and speculation. Within the CFTC he seems to be the driving force behind stronger regulation. In his statement he acknowledged the commission did not perform its due diligence function with as much zeal as it should have last year. No such words coming from chairman Gensler.

In fact there seems to be a rift between Gensler and Chilton on the role speculators played during the commodity bubble of 2008. In last years report CFTC blamed supply and demand fundamentals rather than speculators for the run up in oil prices. Chilton seemed to suggest that this year’s report would deviate from that view, but chairman Gensler merely talked about updating but not necessarily reversing the 2008 findings. CFTC will release the new report next month.

Tyson Slocum is Director of Public Citizen’s Energy Program, an organization that supports the public in helping to ensure households have access to competitive priced energy markets. In doing so they are vitally interested in functioning energy markets and fair prices. Public Citizen is neither funded by the government nor by the corporate sector.

Slocum’s independence represented the true public view on the issue of energy prices, which should be determined only by supply and demand fundamentals. He suggested to the CFTC to implement: 1) aggregate position limits across all energy products and markets for all index traders, swaps dealers and proprietary traders. 2) increased transparency of OTC contracts and clearing them through a CFTC controlled exchange. 3) investigation of potential market integrity concerns.

The Intercontinental Exchange (ICE) according to Slocum operates OTC and Exempt Commercial markets (ECM), both are not effectively regulated by CFTC, yet their overall market penetration has exploded in the last couple of years. ICE’s electronic exchange volume increased 567% from 2004 to 2008 (from 35 million contracts to 237 million) and the company’s OTC platform has seen volume grow 700%, from 31 million contracts in 2004 to 247 million in 2008.

Major investment firms like Goldman Sachs, JP Morgan Chase/Bear Stearns, Morgan Stanley, Citigroup and Bank of America/Merrill Lynch invest in commodity index funds by buying huge amounts of energy and other commodities future contracts in OTC markets. The same firms hedge their exposure to these markets in offsetting portfolios of future contracts on regulated exchanges. These hedges are very often exempt from position limits. Since many firms operate index funds and at the same time function as swap dealers they manage to evade CFTC regulation not once but twice through OTC markets and hedge exemptions.

GS operates the long only GSCI index fund, with 65% of its 24 commodities being in the energy space and only 25% in agricultural commodities. The CME has a 20000 contracts hedge exemption on the GSCI index fund. When GS radically changed the weighting of the index in the summer of 2006, selling about $6 billion worth of gasoline futures contracts, future prices fell by nearly 10 percent.

To gain inside into physical movements of energy products large energy traders like Goldman Sachs are acquiring energy infrastructure assets like pipelines and storing facilities or in some cases even outright oil and gas fields. Highbridge Capital Management, a hedge fund controlled by JP Morgan Chase, bought a stake in oil and natural gas trader Louis Dreyfus Group. As of November 2008  Morgan Stanley paid $452 million to lease storage facilities for 2009. In January 2009, investment banks like Morgan Stanley and Citigroup stored about 80 million barrels of oil in takers at sea. According to a Wall Street Journal report financial speculators were snapping up leasing rights in Cushing, the most important delivery point of physical crude in North America.

In August 2006, Goldman Sachs, AIG and Carlyle/Riverstone took over pipeline operator Kinder Morgan for $22 billion, thereby controlling 43,000 miles of crude oil, refined products and natural gas pipelines, in addition to 150 storage terminals. In 2005, Goldman Sachs and private equity firm Kelso & Co. bought a 112,000 barrels/day oil refinery in Kansas operated by CVR Energy. In May 2004, Goldman spent $413 million to acquire royalty rights to more than 1,600 natural gas wells in Pennsylvania, West Virginia, Texas, Oklahoma and offshore Louisiana from Dominion Resources.

Goldman Sachs owns a six percent stake in the 375-mile Iroquois natural gas pipeline, which runs from Northern New York through Connecticut to Long Island. In December 2005, Goldman and Carlyle/Riverstone together invested $500 million in Cobalt International Energy, an oil exploration firm.

During yesterday’s hearings senator Sanders characterized the situation in the financial industry as heads, bankers win; tails, everyone else loses. Looking at the vast increase in scope of energy specs, their many loopholes in electronic exchanges where thousands of contracts are evading CFTC regulation with the speed of light, or the explosion of hedge exemptions to those very same traders that are fleeing into the dark pools of OTC markets, makes me think he is on to something.

The goal has to be to avoid extreme volatility in energy and other commodity prices for the sake of the common good. To achieve this we must implement Tyson Slocum’s suggestions and constitute strict aggregate position limits, close all possible loopholes and absolutely assure market integrity. In the nearby future big investment firms like GS and Morgan Stanley have to make a decision, whether they want to continue their lucrative trading venues or switch to the physical part of the commodity business. Either commercial or non-commercial, we should not allow this huge firms to be both at the same time.

Hearing on Speculative Position Limits in Energy Futures Markets, July 28, 2009

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CushingWTIspotprce1985-09

British Petroleum reported second quarter results with earnings off 53 percent compared to the same period last year. The company still earned $4.39 billion compared to $9.3 billion a year ago, but during the quarter the price of oil had averaged $59.13 a barrel compared to a stunning $121.18 in the second quarter of 2008.

Several industry insiders and analysts have stated time and again that based on fundamentals of supply and demand the price of oil should not exceed $60 per barrel and yet in the last 12 months we have seen prices spike to $150, to fall back to about $30 and to rise again to about $70 in the first half of 2009. Even the staunchest free market defendants will have a hard time to explain these prices swings.

While the oil industry is still coping well with the current situation others are more unfortunate. In a recent CFTC testimony Ben Hirst on behalf of the Air Transport Association of America outlined that airlines consumed 5 percent fewer fuel in 2008 yet their fuel costs went up by $16 billion. According to Hirst who is also senior vice president of Delta Airlines fuel expenses consumed 40 percent of Delta’s total revenue in 2008, forcing the company to lay off about 10000 employees. A price swing of $1 had an annual impact of $100 million to Delta’s bottom line.

This reminiscent of beg-thy-neighbor policy where some are profiting handsomely at the expense of others has now become the subject of a series of hearings by the Commodity Futures Trading Commission (CFTC). The hearings are scheduled to be held between 9:00 a.m. EDT and 1:00 p.m. EDT on Tuesday, July 28, Wednesday, July 29, and Wednesday, August 5, 2009. In the spirit of transparency all hearings will be live webcast and testimony and statements as well as supplementary material will be available till August 12, 2009.

The subject of the hearings concerns the recent price volatility in energy futures trading and their impact on the spot price for this diverse class of commodities. Chairman of the CFTC Gary Gensler laid out the primary objective to gather information from a wide-range of industry participants and academics in several points. The most important are 1) how to apply aggregate position limits consistently across all markets and participants and 2) how to deal with exemptions from position limits by bona fide hedgers and others.

As chair Gensler pointed out in his statement 37 exemptions were granted to NYMEX spot month speculative position limits for crude oil as of July 21, 2009. The average size was 5.639 contracts, almost 2 times the size of the 3000 contracts set as position limit. A survey conducted by the CFTC from July 1, 2008 to June 30, 2009, found that in the nearby NYMEX futures contract for WTI crude oil 2 traders exceeded 10% or more of open interest in all futures and options combined. The largest trader’s position held 14% of OI total. In the first deferred month 5 traders exceeded 10% of OI with a maximum of 18% OI, and in the second deferred month 6 traders held more than 10% with a maximum of 19% OI. This of course does not include bilateral swap trades because CFTC does not have regulatory oversight within the dark pool of OTC markets.

For senator Bernard Sanders Rome is burning, using his words to characterize the current situation in the energy markets. As the first one to testify in this most recent hearing he demanded that the CFTC takes urgent action and puts an end to heads, bankers win; tails, everyone else loses.

Last year Sanders introduced S.1225, the Energy Markets Manipulation Prevention Act, to address rampant speculation. Last July the House of Representatives overwhelmingly passed similar legislation by a strong bipartisan vote, yet S.1225 did not become law. Congressman Bart Stupak also introduced legislation included in the American Clean Energy and Security Act (ACESA), which recently passed the U.S. House of Representatives and is now pending in the Senate.

In his testimony Stupak emphasized the influence index investors have on price developments. From January 2008 till the end of June 2008 index investors were responsible for $55 billion of hot money inflows driving the price of oil from $99 to $140 per barrel. A massive financial crisis caused investors to withdraw $73 billion over the next six months, and the price collapsed to about $30 per barrel. Since the end of 2008 index investors have again increased their holdings of future positions by 30 percent to the equivalent of more than 600 million barrels of crude oil.

During his testimony he also addressed the issue of non-commercial traders, namely those banks, hedge funds and large institutional investors who qualify as speculative traders and yet are able to operate under almost unlimited conditions. As of June 30, 2008, at the height of the commodities bubble, non-commercial traders held about 60 percent of the open interest in natural gas markets, and 75 percent of the West Texas Intermediate crude oil market. At the same time commercial traders, who actually take delivery of physical oil because they need it to operate their businesses, held only about one third of the long positions in OTC markets.

LongpositionsinOTCmarkets

The CFTC is an independent agency of the United States government and operates under the regulatory powers of the Commodity Exchange Act (CEA) enacted June 15, 1936. In 1974, congress amended the Act in an attempt to provide more comprehensive regulatory oversight for the trading of future contracts, and created the Commodity Futures Trading Commission. Since then the commission has fine tuned its regulatory framework but many including Sanders and Stupak urge CFTC to take more decisive steps towards regulation of future markets.

For any additional regulation to be successful it will be necessary to close loopholes many energy traders are using today to circumvent existing regulation. Most importantly 1) swap exemptions included in the CEA, 2) Foreign Board of Trade no Action letters, and 3) general swap loopholes which allow swap dealers to circumvent position limits. Hopefully the hearings will help to deal with these very issues, since they are crucial to any successful attempt to reign in rampant specs in energy markets.

The Intercontinental Exchange (ICE) is under the supervision of authorities in the UK although it is based in Atlanta, U.S.A. ICE is the largest internet market place to trade futures and OTC energy and commodity contracts in the world and as such detrimental to price developments in energy markets. The exchange cooperates with the CFTC though a no-action letter prevents the commission to impose tough regulation on foreign markets. This loophole has to be closed.

Similar to ICE the Dubai Mercantile Exchange (DME) is a fully electronic exchange with its contracts listed on CME Globex and primarily offers energy futures contracts. The DME is regulated by the Dubai Financial Services Authority and can serve as another loophole for trigger happy energy traders. In August 2008 the CME has acquired a 32.5% stake in the DME from NYMEX. In addition about 20% belong to Goldman Sachs, Morgan Stanley, Shell and JP Morgan.

In 1991, CFTC authorized the first bona fide hedging exemption to a swap dealer, since then 15 different investment banks have taken advantage of this exemption. Since 2006, NYMEX has granted 117 hedging exemptions for West Texas Intermediate crude contracts, many of which are for swap dealers without physical hedging positions. These exemptions have to end and swap dealers need to come under the umbrella of conventional regulation by the CFTC.

Craig Donohue, Chief Executive Officer of CME, admitted that future exchanges took disciplinary actions in 1,334 cases, levying fines and restitutions of $10.3 million, suspending traders for a total of 3,414 days and barring 22 traders from trading at the exchange for at least a year in some cases. According to his testimony he is ready to adopt a hard limit regime to regulate energy future contracts that will include all-months combined limits and tailored hedge exemptions for swap dealers and index funds.

But that’s about as far as Donohue goes. During his testimony he defied any involvement of speculation in the recent volatility in energy prices. As much as he condoned this unfortunate development supply and demand remained as the sole culprit. To support his thesis he cited research that used quantitative evaluations rather than qualitative ones from his opponents. In January this year a GAO report did not grant conclusive evidence to some of those qualitative studies which designate speculators as being responsible for the price swings in energy markets. A Wall Street Journal survey of 53 economists agreed and found that market fundamentals were driving prices of food and energy.

Donohue confronted the issue of causation by citing evidence that net long exposure of futures-equivalent swap positions declined by 11% in the first half of 2009, refuting the fact that speculators were behind the run up in energy prices during this time period. This somehow neglects the issue of absolute positions in a sense that even less of something can still be a lot, and I do not think it can be used as an effective argument against a casual relationship between speculators and excessive price movements in energy futures and spot prices.

According to Donohue an exchange and not the CFTC is best suited to police activities in its markets. This is very reminiscent of what Siebel Harris, then vice-president of Chicago Board of Trade, said to senator Capper in a 1936 hearing about the establishment of the CFTC. Capper responded: “I take it that your position all hangs on this point, that you want the board of trade to make all the rules and regulations governing the grain trade rather than an impartial agency of the Government that will function in the interest of all parties interested?”

The most compelling argument of those who support speculation has historically been to provide liquidity to the market and in doing so helping to find the real price for the underlying commodity. For them the logic followed the more speculation in the markets the better for transparency and price discovery. Granted the mediators in this process were the regulators but markets worked best with the least amount of regulation possible.

Senator Saunders begged to differ and saw Rome burning with respect to modern day players in the field of energy speculation. He therefore suggested three swift and unmitigated actions. 1) Immediately classify all bank holding companies and hedge funds engaged in energy futures trading as noncommercial participants and impose strict positions limits on them. 2) Eliminate the conflicts of interest between Wall street’s trading desks and their internal research departments. 3) Revoke all staff no-action letters for foreign boards of trade that have established trading terminals in the United States.

Were CFTC to follow these three simple rules excessive volatility in energy prices would almost certainly be a relict of the past. The question is not will it be effective but rather will regulators have what it takes to pierce the zone of influence of powerful financial institutions. Since the necessity to act is so urgent, by no means is it trivial anymore to be complacent and ignore the call for action, there is a good chance we might get tougher regulation this time, even though traders will explore all possible venues to avoid it.

Is CRE the next accident to happen?

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Commercial real estate is shaping up to become another causality of the financial crisis and CRE mortgage delinquencies and loan defaults are now starting to pile up on the balance sheets of US financial institutions. That is of course on top of losses from residential real estate, consumer credit and the securitization markets that sort of connect all the sore spots on Wall Street.

$817 billion of total CRE-loans are still outstanding in June, 2009, and about 29 billion have run into trouble. In the month of June loan delinquencies soared by $10 billion heating up the debate about future CRE losses by financial institutions.

But that’s not all. About $105 billion worth of troubled loans have been worked out. A majority of those loans experienced an averaged loss of almost 64 percent. Delinquency rates on CRE are up to 4.5 percent in the second quarter from 3.6 percent in the first quarter, 2009.

Similar to residential real estate CRE property prices have also collapsed. Moodys/REAL Commercial Property Price Index (CPPI) has not bottomed as of April 2009:

CREallPropertynationalindex

In CRE much like with residential real estate many loans have been securitized and actual losses to financial institutions and investors will therefore depend largely on two conditions. First, the total amount of loan defaults will be substantial given the collapse in prices. Second, FASB statements 166 and 167 will determine how big the losses are or if they can be deferred onto some future time horizon.

FASB statements 166 and 167 refer to securitized loans in special purpose entities, and require banks to consolidate insufficiently capitalized SPEs onto their balance sheets. Although this should foster more disclosure for investors its impaired with whims of possible rule-bending.

FASB determination to implement these rules is another uncertainty factor. In April, 2009 FASB halted fair value accounting to stop the hemorrhaging of impaired financial assets. Statements 166 and 167 are supposed to take effect in the first fiscal quarter beginning after November 15, 2009.

Some are already preparing for the worst. Bank of America now expects to bring about $150 billion back onto its balance sheet under the new FASB rules. This 150 billion off-balance-sheet assets comprise of $12 billion home equity conduits, $85 billion card securitizations, and other variable interest entities make up the remaining $53 billion. Maybe BofA is just lucky.

Neil Diamond at The Greek Theatre in Los Angeles in 1972

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About 2 years later president Nixon resigned over the Watergate scandal. Ford while in office pardoned Nixon and inflation and economic depression plagued the nation. In 1977 Jimmy Carter moved into the White House. The 39th president of the United Sates was uncharacteristically farsighted and introduced a national energy policy asking his countrymen to conserve. They did not like it and along came Ronald Reagan. Together with Margaret Thatcher he helped orchestrate men’s biggest heist – a corporate takeover of democratic societies. Sure we got 1989, the internet, a digital revolution but we also got Friends, Spice Girls and worst of all we got soft.

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“He sounds just like Eric Burdon playing Elmer Gantry, the melodrama is irresistible, and the only thing he could do to top this would be to collaborate with James Michener and Frank Capra on a Cinerama rock opera about the second coming of Thomas Jefferson as a wandering Jesus Freak minstrel who sews this wicked land up at the seams and brings the children home and their parents into the street to dance. Starring none other.”                   The Rolling Stone

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26. July 2009 at 11:03 am

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Wall Street – Washington Connection, Part II

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The Troubled Asset Relief Program (TARP) was enacted by Congress and signed into law by the president of the U.S. in October 2008. The Obama administration had asked the American people to commit a staggering $700 billion of taxpayer money to bailout Wall Street.

In order to insure appropriate oversight the president appointed and the senate confirmed a Special Inspector General (SIG) shortly after the establishment of the TARP. Neil Barofsky, head of SIGTARP, endowed with special powers is not required to report and to be supervised by the secretary of the Treasury. Moreover only the president can remove the SIG, which would be somewhat embarrassing since he appointed him in the first place.

The Inspector General’s special rights make sure that he remains independent in his oversight from the secretary of the Treasury, who is ultimately responsible for the TARP. It was therefore surprising to learn that the Treasury department refused to provide Barofsky with documents about a financial institution receiving tens of billions in bailout dollars. Barofsky received support from lawmakers on that issue who are sympathetic to SIGTARP’s work and also complained about the lack of transparency in major recipients of TARP funds.

In its most recent audit SIG surveyed 360 banks participating in the TARP and found that they misused the funds. 110 banks had invested some of the funds, 52 banks had used the money to repay existing debt and 15 used it to buy other banks. About 83percent used at least some funds to support new lending.

SIG goes on to encourage the Treasury to require regular, more detailed information about the use of TARP money by participating banks. This would help to achieve the goal of transparency and satisfy the taxpayer. Treasury responded by saying it is impossible to track the money because it’s fungible, much like water running through fingers: "…paying an expense from one source frees up cash to be used for other purposes”.

Barofsky did not buy it and argued Treasury was ignoring the common sense view. His latest audit found that banks could give at least a general indication of how they were using the money. It is not feasible why financial institutions using billions of dollars of taxpayer money to fund their operations are not required by the Treasury to maintain at least a documentation of the original disbursement of these funds. Treasury even admits that most banks don’t manage their TARP money separately from other funds.

A paper trail would help to hold banks accountable but the Treasury seems to think that it is best not to interfere with the financial industry’s business at all in order to achieve results. Why government officials would think that, is not clear under circumstances that rendered proponents of financial deregulation to be dead wrong. This epochal mistake grudgingly coerced taxpayers to fund bailouts in the form of TARP in the first place.

Back in March a Government Accountability Office (GAO) review found that regulators blatantly failed to do their job by ignoring the risks that had piled up in the financial industry. According to GAO, regulators like the Federal Reserve and the SEC relied too much on promises given to them by Wall Street’s representatives. They assumed according to SEC chairwoman Schapiro the industry would not take foolish risks and jeopardize their business model. Given the current dispute is it possible that we are going to make the same mistake again?

Treasury has only one problem with their laissez-faire approach, it is not showing results. Even after injecting massive amounts of liquidity lending to businesses and consumers has not resumed to pre-crisis levels. Some see this as a necessary adjustment, but others are calling for more forceful actions from the government.

Under pressure to revive lending the U.S. Treasury began to demand monthly reports on lending activities from banks participating in TARP. It took them until January to implement most basic reporting, when this should have been mandated immediately with the commencement of the funds. I strongly feel this shortcoming is indicative of a culture that has pervaded Washington to dismiss common sense when it comes to Wall Street. The perpetual lobbying of Wall Street’s executives in Washington is certainly not helpful in this regard (see WW Part I).

Results from Treasury’s latest monthly bank lending survey showed that total outstanding consumer loans, including first lien mortgages, home equity lines of credit, credit card loans, and other consumer loans, were flat in May, 2009. Commercial and Industrial loans (C&I) were also flat with demand well below normal. Commercial real estate loans (CRE) even fell with demand again lower than normal in May, 2009. Small business lending showed some growth but outstanding loan balance grew only by a meager one percent.

These results were based only on data from the top 21 recipients of TARP funds. SIGTARP’s audit on the other hand was based on results from 360 participating institutions. There is really no feasible reason why oversight should be limited to 21 when according to the Treasury 651 banks have received government funds so far.

The argument that banks don’t have enough capital to lend does not ring through. The Capital Assistance Program (CAP) was designed to make sure that financial institutions are sound and have sufficient capital to support businesses and consumers. The results of a financial stress test on banks published in May, 2009, speak for themselves and even sparked a stock market rally on Wall Street that nobody thought would be possible just a couple of months ago. Treasury secretary Geithner also confirmed that the vast majority of U.S. banks have more capital than needed.

Yet the evidence is indisputable. Lending to consumers and business while not at a halt remains strongly subdued and remarkably insufficient to support potential economic growth. Every day that passes makes it harder for the Obama administration to explain to the public why consumers and small businesses are being asked to be frugal and patient all the while Wall Street is celebrating. The mice are not dancing because the cat has left the house, they are celebrating because all cats have been stymied once and for all to never hurt them again ever. The public wants to know when Washington will stop working for Wall Street and start to work for the people again.

Treasurylendingloanoriginations TARP loan originations from BofA, C, JPM, and WF

TreasuryMay09growthinloanoriginations growth of TARP loan originations in 21 largest recipients

fredgraphCIloansweeklyJuly09 C&I loans weekly reporting by large commercial banks

Wall Street – Washington Connection, Part I

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DimonandBlankfeininWashington

When we think about the financial crisis on Wall Street and in the economy we try to figure out why it happened, who was responsible and how can we prevent it from happening again in the future. Today we still have a lot more questions than we have answers, but the sun is beginning to shine, and one issue is starting to emerge which probably for years and years has been tucked away from the public’s view.

This crisis is pulling the blanket of secrecy from a bunch of Wall Street bankers smooching and spooning undercover with Washington’s big guys for the last several decades. Of course we would expect them to be somewhat embarrassed about busting their secret arrangements, maybe even flee the scene to break up their unholy unity for good. Much to our surprise none of this is actually happening.

Mr. Dimon, chairman and head of JPMorgan Chase, has sought to ratchet up his business of influencing Washington in late 2007, when the financial crisis hit and the democrats together with the Obama administration were beginning to settle in. Jamie Dimon together with Goldman’s Loyed Blankfein are among a rare breed of executives who have not jeopardized their companies by taking unwise decisions. Both CEOs in the meantime have returned all funds received from Treasury’s capital assistance programs (CAP).

These days JPMorgan’s chairman comes to town about twice a month and not twice a year as he used to. He met with Treasury secretary Geithner, White House economic advisor Lawrence Summers, and several lawmakers in recent months and gets a list from his staff to call a half-dozen public officials each week. He has made it a regular thing to nurse his precious Washington relations to make sure he is not kept out of the loop.

When JPMorgan wanted to return its TARP funds his influential connections helped him to ease the terms for banks allowing them to repay the money. In the end Washington caved in to Dimon’s complaints about limitations for hiring skilled foreigners and on executive pay. He also helped thwart attempts to lower the principal on mortgage payments which would have benefited homeowners.

Another contentious issue is Mr. Dimon’s objection to regulate the market for credit derivatives by keeping part of it independent from regulated clearing operations. Fees from underwriting over-the-counter credit derivatives are a major source of income for JPMorgan Chase.

Mr. Dimon’s connections to Washington date back to his day at Citigroup when he offered Mr. Rahm Emanuel, then senior advisor to president Bill Clinton, a job at the firm. Today Mr. Emanuel serves in the Obama administration as White House Chief of Staff. William Daley, former commerce secretary and influential Chicago lobbyist, is also currently on JPMorgan’s payroll. Mr. Dimon mindfully replaced some of his staff with wired democrats to better serve his Washington agenda. 

Most surprising is his connection to Treasury secretary Geithner. Mr. Dimon holds a seat on the board of the New York Federal Reserve. Mr. Geithner served as president of the NY Fed till he joined the Obama administration in January of this year. How can a CEO of a public company sit on the board of a federal regulator? That’s like John Gotti being a member of the U.S. Department of Justice.

For the first time this Monday JPMorgan Chase held a meeting of the firm’s board in the nation’s capital. Messrs. Geithner and Emanuel were both invited, but only the chief of staff first agreed to later withdraw not to appear too cozy with Wall Street bankers. This invitation is nonetheless testament to the arrogance of invincibility that has shrouded executives of our most powerful corporations.

In Washington nothing gets done without support from Wall Street and Wall Street knows it. Wallshington is more important and influential than the oil industry, the industrial complex or even the powerful military. This has never been so true like it is today with a handful of firms left unfettered from the crisis and government’s control. Their power is more concentrated in the hands of a few and therefore even more difficult to control.

Executives on Wall Street get whatever they wish from every administration or congress there is. This too big to fail monster is sucking the lifeblood of morality, decency and sustainability out of a societal fabric that once was the envy of the rest of the world.

In the latest report for the period ending July 17, 2009, the Treasury department listed employed funds under the Troubled Asset Relieve Program (TARP). The financial industry received $204.2 billion, $70.2 billion have been returned, leaving the industry with a total of $134 billion outstanding. In the automotive industry $77.8 billion from 79.9 are still owed to the taxpayer. Automotive suppliers received a more humble $3.5 billion. Targeted investments in Citygroup and Bank of America totaled $40 billion and asset guarantee programs for Citigroup another $5 billion. The Troubled Asset Loan facility (TALF) committed $20 billion. Rescuing troubled insurer AIG required another $69.8 billion.

To this day the financial and the automotive industry owe the taxpayer $350 billion, yet government has devoted only $18.7 billion in home affordable modification programs to avoid foreclosures. While taxpayers were required to fund the bailout of Wall Street with 350 billion dollars the financial industry is reluctant to modify loans and scores of families are still forced out of their homes.

This current administration with the most eloquent president since years will have a hard time to sell this to the general public. Wall Street firms reverting to old habits by once again doling out mega bonuses to their club members will not make it any easer.