How the GAME is played.

[tw]

God Awful Market Economics.

In so many previous posts in Current Events and as summarized in a post in Politics entitled Why is it OK to bailout Citi, but not auto companies? are so many examples from a closed loop system we know as the stockmarket meltdown. In all those examples and summaries, many may still not have a sound byte grasp. This is maybe the best I can do.

Imagine your home; a real asset. Now we create financial contracts so that you could buy that home (mortgage) and protect your ownership (insurance). Once these contracts were not assets. Contracts were valued because they were connected to a real asset - your house.

Another asset is a company. We own that company by purchasing stocks. Like the house, those stocks represent something tangible - the company.

A farmer has crops. He surrenders part of a profit margin to protect his cash flow - a derivative called crop futures. Again, a financial contract connected to something real and to provide the farmer with financial security. He surrenders part of a future asset to protect his cash flow – to stay solvent.

Deregulation made it possible to rename that mortgage, insurance, and futures as assets. So we renamed contracts as equities. We pretend new financial contracts are tied to tangible values equivalet to as houses, companies, and crops. Then we created new layers of contracts based on a fictitious real asset - what were once only called contracts.

Had regulation been properly applied (which is what Basel 2 tried to do and was not implemented in America), then many of these fictitious assets would have required financial institutions to also hold real assets - ie cash. Instead, George Jr's administration even let investment banks to increase their debt to equity ratios from 12 to 30. Basically, the investment banks were nothing more than hedge funds. As if we learned nothing from the meltdown of Long Term Capital Management (LTCM).

Since all those financial contracts were now considered assets like homes, companies, and crops, then those debt obligations now increased America’s net worth. Assets were invented. Enron accounting made it possible to claim debts as assets. Even debts were now added to homes, companies, and crops as additional wealth.

And if that were not bad, Enron accounting now permitted bad debts to be removed from the balance sheets by creating new companies. Companies that were nothing more than shelters of debts were then listed on the home company's balance sheets as another asset. Just another way of claiming debt as an asset.

In short, we created wealth using fiction and then rewarded those who were creating these myths. Wall Street executives now 'deserved' $tens of millions in bonuses. After all, look at all the wealth that was created!

Damning is so little useful facts from those here who work in the finance industry. They cannot really comment. They don't really have a grasp of what they have helped create. After all, they are really nothing more than salesman. Yes, these Enron accounting schemes were created by salesmen. Salesmen who had no idea of risks and had insufficient knowledge to measure that risk. So they developed computerized risk models that 'proved' stablity. After all, it runs on a computer. It must be true. Salesmen are excellent at inventing things - reality be damned.

AIG had maybe $1trillion in newly invented debt obligations with almost no cash. No wonder AIG has now eaten through $140billion of government money and will still need more. An example of why in the next paragraph.

The homeowner defaults on his mortgage. For every $1 in that default, suddenly tens or maybe hundreds of dollars of debt obligations (contracts) that were once called assets are now worthless. Suddenly $100 of assets just disappear from the company spread sheets. When the $1 mortgage failed, then $100 of contracts suddenly have no value. Or insurance on those contracts (once called assets) suddenly changed from a small income source to a massive debt obligation. Welcome to the house of cards made possible by deregulation.

The stock market is desperately looking for the real value of America. Appreciate the market's problem. Which asset is really a fictitious credit obligation? Which loan was backed by collateral that was really nothing more than a contract? Nobody knows. Especially since 2000, we have been inventing assets using the new Enron accounting scheme. How do you value any company when there is no way to evaluate the risks? Suddenly things once listed as small income earners are now a massive debt obligations - because some homeowner in Iowa could not pay a mortgage so many months ago.

How many $trillion of contracts must be completely re-evaluated to determine their actual value? One Collateralized Debt Obligation (CDO) was typically defined by maybe a 200 or 400 page document. Nobody could actually know what that CDO value was. No problem. Salesmen selling to salesmen created a Ponzi scheme as long as the underlying asset - the house, company, or crop - remained solvent.

Risk models designed to measure risk were developed by your peers in school who were the lesser intelligent students – but were so popular. Who do not even know how their own risk measurement tools work. How does he really evaluate risk on a contract of 200+ pages? When the only real asset is buried in layer upon layer of contracts. When even the mortgage backed security contained only NINJA (No Income No Job Apparent) loans. And when the equity trader never bothered to notice those mortgages were ARMs.

These salesman are excellent at promoting themselves as smart. As proof, they put forth that 200 page CDO to demonstrate that only they understand finance. Nonsense. They have no clue what was in the CDO. They only know what laws cannot be violated without SEC prosecution. Just another reason why financial firms and their stock brokers must be highly regulated. They will only be as honest as the law requires them to be.

For every $1 in a mortgage or a commodity tied into a futures contract, how many layers of invented assets exist in what would otherwise be called a contract? Appreciate the scale of Enron style accounting that now must be paid for by mortgaging America to foreigners.

BTW, what foreigner will loan us the money considering how widespread this finance industry scheme has been. When risks are high, expect to pay that foreigner heavily to borrow some dollars. Our Treasury alone needs to borrow $7trillion from a world worth maybe $70trillion. Those interest payments for the next 30 years will be steep. Then the American standard of living will correct accordingly. This is how great empires fall quickly.

[Undertoad]

(which is what Basel 2 tried to do and was not implemented in America)

Basel 2 was adopted in America in November 2007. source source

[xoxoxoBruce]

First source

November 1, 2007 OCC Approves Basel II Capital Rule

Second source

November 13, 2007
Banks subject to the final rule on a mandatory basis, the core banks, have up to six months to adopt an implementation plan. Of course, banks may always submit their plans earlier, and I understand that a number of core banks are working toward that goal. This deadline for submission of plans by core banks is intended to prevent delays in starting implementation efforts. However, the final rule provides flexibility and gives banks adopting Basel II ample time to fully meet the qualification requirements once they have adopted an implementation plan. Specifically, a bank's plan may include developmental goals for full implementation for up to thirty-six months from the effective date of the final rule.

Sounds to me like when they were forced to meet the Basel II requirements, it exposed the crap the banks had been pulling and the shit hit the fan when they couldn't comply.

Would have been better to implement it in 2004, when it was first proposed.

[tw]

Originally Posted by Undertoad

Basel 2 was adopted in America in November 2007.

Too late. The current meltdown started in mid 2007 and slowly picked up momentum. Basel 2 only one year ago was too late to cause finance industry to remeasure and adjust equity. There are $trillion of contracts. Banks suddenly adjusted their liquidity profile to meet all those obligations? Obviously not. Basel 2 was not implemented except in a press release.

With that Nov 2007 announcement, banks had to implement a complex and detailed plan. Then followed by four quarters of trying to implement that plan. That plan was to be submitted by May 2008 and fully implemented by May 2009. The tumbling financial industry was already obvious in June 2008. IOW Basel 2 still was not implemented. Only planning for Basel 2 existed - too little too late.

Basel 2 was only implemented in a government announcement meaning that UT is wrong.

... specifically plans for those banks not subject to the advanced approaches of Basel II.

Government then exempted many banks from Basel 2 on a theory that these banks were using more sophisticated risk management programs and had more complex risk structures. Therefore these banks did not need to meet Basel 2. What do we know? Those with most complex structures were at greatest risk. Those with large capital reserves - who best met Basel 2 - were at least risk.

UT tells us they had already implemented Basel 2. Hardly. They were not even planning to implement Basel 2 when this economic meltdown started gaining momentum. Basel 2 was only implemented officially. In reality - too little and too late. Posted was reality. American banks did not meet Basel 2.

[Undertoad]

They could have and I believe some did, but it didn't help the European banks involved. This article explains it better than almost anything else I've seen. The critical bit:

AIG appeared to offer banks a way to get around the Basel rules, via unregulated insurance contracts, known as credit default swaps.

Here's how it worked: Say you're a major European bank... You have a surplus of deposits, because in Europe people actually still bother to save money. You're looking for something to maximize the spread between what you must pay for deposits and what you're able to earn lending. You want it to be safe and reliable, but also pay the highest possible annual interest. You know you could buy a portfolio of high-yielding subprime mortgages. But doing so will limit the amount of leverage you can employ, which will limit returns.

So rather than rule out having any high-yielding securities in your portfolio, you simply call up the friendly AIG broker you met at a conference in London last year.

"What would it cost me to insure this subprime security?" you inquire. The broker, who is selling a five-year policy (but who will be paid a bonus annually), says, "Not too much." After all, the historical loss rates on American mortgages is close to zilch.

Using incredibly sophisticated computer models, he agrees to guarantee the subprime security you're buying against default for five years for say, 2% of face value.

Although AIG's credit default swaps were really insurance contracts, they weren't regulated. That meant AIG didn't have to put up any capital as collateral on its swaps, as long as it maintained a triple-A credit rating. There was no real capital cost to selling these swaps; there was no limit. And thanks to what's called "mark-to-market" accounting, AIG could book the profit from a five-year credit default swap as soon as the contract was sold, based on the expected default rate.

Whatever the computer said AIG was likely to make on the deal, the accountants would write down as actual profit. The broker who sold the swap would be paid a bonus at the end of the first year – long before the actual profit on the contract was made.

With this structure in place, the European bank was able to assure its regulators it was holding only triple-A credits, instead of a bunch of subprime "toxic waste." The bank could leverage itself to the full extent allowable under Basel II. AIG could book hundreds of millions in "profit" each year, without having to pony up billions in collateral.

It was a fraud. AIG never any capital to back up the insurance it sold. And the profits it booked never materialized. The default rate on mortgage securities underwritten in 2005, 2006, and 2007 turned out to be multiples higher than expected. And they continue to increase. In some cases, the securities the banks claimed were triple A have ended up being worth less than $0.15 on the dollar.

Even so, it all worked for years. Banks leveraged deposits to the hilt. Wall Street packaged and sold dumb mortgages as securities. And AIG sold credit default swaps without bothering to collateralize the risk. An enormous amount of capital was created out of thin air and tossed into global real estate markets.

On September 15, all of the major credit-rating agencies downgraded AIG – the world's largest insurance company. At issue were the soaring losses in its credit default swaps. The first big writeoff came in the fourth quarter of 2007, when AIG reported an $11 billion charge. It was able to raise capital once, to repair the damage. But the losses kept growing. The moment the downgrade came, AIG was forced to come up with tens of billions of additional collateral, immediately. This was on top of the billions it owed to its trading partners. It didn't have the money. The world's largest insurance company was bankrupt.

The dominoes fell over immediately. Lehman Brothers failed on the same day. Merrill was sold to Bank of America. The Fed stepped in and agreed to lend AIG $85 billion to facilitate an orderly sell off of its assets in exchange for essentially all the company's equity.

Most people never understood how AIG was the linchpin to the entire system. And there's one more secret yet to come out...

AIG's largest trading partner wasn't a nameless European bank. It was Goldman Sachs.

[tw]

Still little understood. How much of this is directly traceable to Hank Greenberg, the ousted AIG CEO? Surprisingly, so little criticism is directed his way.

[Undertoad]

Somebody should be charged. Somebody should be doing a perp walk right about now. It's the only thing these execs universally understand.

[tw]

First post in this thread defines what was considered routine and legal on Wall Street. How finance companies 'invented' money. Yesterday, the government filed charges against Goldman Sachs, one of the more transparent investment banks, for outright fraud. To understand it, grasp that first post.

Goldman threw together mortgages that were doomed to fail. Did so at the request of a largest customer who was betting on a complete meltdown of the American mortgage industry. No such financial instrument existed. So Goldman created it. Then, as the underwriter, represented and sold it to others as a perfectly safe investment. Did exactly what is normal behavior on Wall Street. (See many previous cautions to those who pay for expensive stock brokers to invest for them.)

Goldman so knew this mortgage backed security would fail as to take out insurance from AIG. AIG wrote the insurance policy so that it would not be insurance. Would not be subject to oversight or scrutiny. And so more parties doing what was necessary to protect the fraud - what was now openly encouraged after 2000.

Goldman's reply? Customers that were duped should have known Goldman was fraudulently selling an intentionally manipulated security. They should have known better. And since information was withheld, rating agencies also could not see through the scam (and may not have wanted to since profits - not ratings - was also the new philosophy).

Now, Goldman was one of the more honest banks. Goldman was only doing what was acceptable business especially after SEC chairman Harvey Pitts refused to let Congress even increase his budget. This was only a $15 million deal. Government charges are really not about that deal. The government is saying to every American that these scams from the investment banks are routine. Fraud - especially in the past decade - was the new business model. Enron accounting is alive and well. We know know that non-existant government regulation in the 2000s is why Lehman Bros was doing the exact same thing. Moving bad debts into other companies. Then claiming those companies on the books as assets. Typical example of what Wall Street does especially in the past ten years. What is now considered acceptable business practice by brokers and investment bankers.

Many new service commentators have been editorializing (and accurately so) that these routine business dealings are major reasons why so many Americans are unemployed, why ARMs were so routinely promoted, why a housing bubble was openly encouraged, why financial spread sheets could not report the impending financial disaster. And why so many extremist politicians will attack Obama rather than address an across the board major regulation of the entire finance industry.

Top of the list. All those securities and derivatives must be traded only on open markets where transparency would have made those scams obvious and where punishment includes banning the bank (or investment house) from any trading.

They literally underwrote a financial instrument that all but had to fail. Even bought insurance so that they could reap profits from the failure. They literally and intentionally lied about that security to their own customers because a business school philosophy says the only purpose of a business is profit. Especially since 2000, this has been business as usual.

Purpose of every finance company: to provide superior financial services. Contrary to the philosophy in most every major American financial institution. They are only doing what it taught in business schools. Take profits by any means no matter who might be hurt. As long as the government does not prosecute, then it is good.

The Senior Vice President of Merrill Lynch warned of the impending disaster years previously. So O'Neal had him fired. Honestly might hurt profits. He was thinking in terms of 'customer service' rather than the business school philosophy of 'profits no matter what'. AIG executives ignored those warnings take any deal no matter how risky it might be. Wrote contracts that were thousands of pages long so that it would not be subject to government oversight.

And so we begin the next major endeavor - the regulation of the financial industry so that all such deals can only occur in transparent markets. Wacko Democrats and Republicans will go to war. Then the party whips will line everyone up according to party politics. America's interests - especially transparency everywhere in Wall Street - would not make Obama fail. The wacko agenda is to protect people who most paid to own them. That means we will again see more of "We want Obama to fail" which means we want finance companies to continue to destroy America.

Washington is finally addressing issues made so obvious by LTCM, Enron accounting, GM money games, and ... who is your banker and stock broker really working for? Goldman Sachs is one of the more honest investment bankers. Even in GS, this fraud has long been normal business.

Why were investment banks even exempt for Basel II banking standards? Purpose of Wall Street is not profits and bonuses. Wackos will now start a campaign to keep finance business out of transparent markets – because that fraud is what made K Street and other corruptions so profitable. And because they want Obama to fail.

At this point, everything in that first post should be understood by everyone. It’s a major reason why (ie according to Singapore’s President) we almost lost the entire economy.

[Trilby]

Originally Posted by Undertoad

Somebody should be charged. Somebody should be doing a perp walk right about now. It's the only thing these execs universally understand.

*thunderous applause*

what's wrong with the guillotine? It worked for the French.

[tw]

Originally Posted by Brianna

what's wrong with the guillotine? It worked for the French.

They beheaded too many people who make the cakes. The people then starved.

[Trilby]

Originally Posted by tw

They beheaded too many people who make the cakes. The people then starved.

ah, so that's why French women are so thin!

[xoxoxoBruce]

I think the lack of deodorant makes it hard to sneak up on a decent meal.

[lumberjim]

Originally Posted by tw

Still little understood. How much of this is directly traceable to Hank Greenberg, the ousted AIG CEO? Surprisingly, so little criticism is directed his way.

I'm gonna take a shot in the dark and say ... uhmm....... 85%???

assuming that guy qualifies as 'Top Management' that is....

[classicman]

hahahahaha