Friday, September 26, 2008

Cash for Trash (Revised)

President George W. Bush last week laid out a $700 billion Wall Street rescue plan ostensibly aiming at preserving the nation’s overall economy. Dubbed "Cash for Trash,” the plan has sparked a sharp debate. The House Financial Services Committee held a public hearing titled, “The Future of Financial Services: Exploring Solutions for the Market Crisis” on Wednesday, September 24th at Rayburn House Office Building. This was a legislative hearing to examine the Bush Administration’s financial services proposal. Secretary of the Treasury Henry Paulson and Federal Reserve Chairman Ben Bernanke explained the proposal at the hearing.

The hearing started at noon and included two parts. At the beginning, members of the Committee were given an opportunity to note their concerns and to comment on the bailout plan. Most did not endorse the plan: they thought it would be a mistake to rush such a huge expenditure, one that would boost the national debt to over 70% of GDP.

Committee members addressed four major sticking points. First, the lack of communication with the public before the plan came out. Members indicated that the Administration should tell the American people what happened and why the plan is needed. The second concern centered on benefits to the taxpayers, and members suggested that "people must be the first priority - we should protect taxpayers. It is absolutely unfair to use taxpayer funds to fix a hole Wall Street firms dug. Taxpayers should share in the benefits of this plan." Third, some members suggested that “robbing Peter to pay Paul” will not solve the problem. From a long-term development perspective, the country may experience a long and painful recession. Last but not least, members stated that public oversight of the Treasury rescue operation is required, especially in light of the lack of financial asset transparency. Members were concerned that someone may receive a unfair windfall using taxpayers’ money.

In the second part of the hearing, after 2:30pm, Mr. Paulson, and Mr. Bernanke tried to convince Congress that a $700 billion plan is the only way out of the current crisis. Mr. Paulson acknowledged the severity of the problem and stated that he understood the concerns raised, but explained the plan seeks to “avoid a continuing series of financial institution failures and frozen credit markets that threaten American families’ financial well-being, the viability of business both small and large, and the very health of our economy”. He clarified that the $700 billion program was an “asset purchase program” instead of a “government spending program” because these assets would ultimately be resold with proceeds coming back to the government. He also pledged to protect the taxpayer to the maximum possible extent possible and to ensure transparency and oversight while implementing the program. Moreover, he is convinced that, although this approach may look bold and risky, it would be a far less costly approach than other alternatives. Finally, he expressed a desire to have Congress and the Administration work closely together to get through the difficult period. “Many of you also have strong views, and we must have that critical debate, but we must get through this period first,” he said.

The Fed Chairman Mr. Bernanke outlined the threat to the economy from the home mortgage crisis and argued that inaction would produce an even larger catastrophe, hence, the Federal Reserve's strong stand in favor of Treasury’s proposal to buy illiquid assets from financial institutions. He argued that having the government steps in would help restore normalcy to the market. “It’s possible for the government to buy these assets, to raise prices, to benefit the system, to reduce the complexity, to introduce liquidity and transparency into these markets and still acquire assets which are not being overpaid-for in the sense that under more normal market conditions, and if the economy does well, most all of the value can be recouped by the taxpayer.” Mr. Bernanke said in his testimony.

One member noted her worries concerning the adverse impact of the current situation on women and minority owned businesses. Mr. Paulson replied that he got her message but would work through the Treasury plan first.

(Tian Weng, Master of Economics' 09
George Washington University
Washington, DC 20052)

Monday, September 22, 2008


We are stunned to learn that banking and financial market regulators are considering using taxpayer funds to finance the creation of a separate entity to hold "toxic" financial instruments. This is a dangerous suggestion that will not solve the problem. At best, this is akin to moving a fire from, say, your living room to your dining room. At either location, the fire will continue to grow. The proposed separate entity simply provides more oxygen to the fire, wherever it is.

We will be spending all of our reserves:
1. to purchase a set of financial instruments with limited information on what, exactly, we are buying,
2. to purchase a set of financial instruments with limited value,
3. to purchase a set of financial instruments with unlimited risk,
4. to purchase a set of financial instruments with virtually no information on how long we will have to hold them to "turn a profit." (Note that these contracts will never turn a profit. They are not designed to...) and,
5. to do all of this under severe time pressure.

Thus, the plan has the added disadvantage of eventually forcing the US Government to follow Wall Street into bankruptcy. A spectacularly bad deal.

These toxic instruments were created not to stabilize markets, since clearly, they have failed to do so. These newer derivative contracts and products were created to evade regulatory safeguards and to maximize commission revenue. They did so by being opaque and hard, if not impossible, to value. Few serve any truly useful function. We note that, for 100 years, standardized futures contracts and options (derivatives) have been used to stabilize markets. We would not think of buying all outstanding futures contracts traded on the Chicago Board of Trade. Why are we being asked to do so for a private exchange run by a group of firms in New York? This confirms what we wrote on April 3rd: With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic. Using all of the reserves at the Federal Reserve to bail these firms out would be a foolish waste of money.

To protect the public and the markets, these newer derivative contracts should be extinguished. To put the fire out, put the fire out. Again, they serve no purpose but to generate revenue for brokerage firms and investment banks. Even in that, over the long term, they failed. The best way to extinguish these instruments is to create a database showing the transaction chain (seller, buyer, intermediary) for each and every financial derivative contract, something the State of NY is moving to do with credit default swaps. We note that this is the role of an exchange. The transaction database should includes information on prices and commissions paid. Instruments should be reviewed one-by-one by a panel of objective experts to determine economic value and utility. Legal contracts supporting those without either should be vacated immediately by the SEC, operating with the consent of the US Congress. Note that we are not opposed to the creation of an entity holding assets backed by real property or loans.

Finally, there should be a 14 day "cooling off" period before anything is done. If this means forcing banks to lend (short term) to corporations, so be it. This is cheaper (and better) than the alternative, spending $700 billion at once.

We are deeply concerned.

Thursday, September 18, 2008

Christopher Cox

Christopher Cox is still, without a doubt, the best financial regulator appointed thus far by the Bush Administration. We base this on performance. Mr. Cox knew the situation. He came in at a time of unprecedented corporate and market institution fraud and malfeasance. Things got worse, of course, but it was bad when he walked in the door. As soon as he took over, he increased staff and started investigating Wall Street broker/dealers, something many did not believe he would do, given his close ties to the Street. His Office of Interactive Disclosure is a masterpiece, and shows he understands the role technology will play in preventing future crises. The Office created an online tool that enables investors to easily and instantly compare what 500 of the largest American companies are paying their top executives, an Internet Web page that enables investors to more easily read, analyze, and compare the information provided by mutual funds related to fund cost, risk, and past performance, Financial Explorer, an open source tool to help investors quickly and easily analyze the financial results of public companies, and a web tool that permits investors to obtain information directly from company disclosure documents about their business interests in countries the U.S. Secretary of State has designated 'State Sponsors of Terrorism (later taken down because of objections from business lobbyists).

The problem is not at the SEC, as we noted on 5/5/2006.

Wednesday, September 17, 2008

Money market fund breaks a buck

Forget everything else you have heard about the financial crisis. Focus on this. According to USA Today,

"The share price of the Reserve Primary fund, a money market mutual fund, has fallen below the sacred $1 mark, thanks to the Lehman Bros. meltdown.

Money market funds have been the fund industry's haven for more than three decades, and investors often view them the same way they do bank checking accounts. The funds' safety record has attracted more than $3.5 trillion in assets.

Until now, no money fund open to the general public has ever allowed its share price to dip below a dollar — "breaking the buck," as it's called. (A small institutional money fund, Community Bankers Money fund, broke the buck in 1994.)

Money market funds have long feared that if they broke the buck, thereby shrinking investors' principal, people would shift their money into bank money market accounts or ultrasafe Treasury securities. The question now is whether other money funds will follow the Reserve fund in dipping below $1."

Let me answer that for you: yes. What do we suggest? Two things:

One - Treasury Direct. Now.
And two - Pray. Hard.

Monday, September 15, 2008

10th Annual Endowment and Foundation Forum

The 10th Annual Endowment & Foundation Forum will cover the issues that are most relevant to endowments and charitable foundations today and will provide participants with opportunities to network with investors and fund managers in a relaxed setting.

Topics Covered Will Include:
• Trends in Asset Allocation for Endowments and Foundations
• Portfolio Construction and Implementation, Developments and Advances
• Challenges facing Endowments and Foundations, past, present and future
• Socially Responsible Investing
• Incorporating Alternatives and Emerging Asset Classes into a Smaller Plan
• Manager Selection

Sponsorship and Exhibiting Opportunities are Available!
Please contact or call 212-532-9898, ext. 275.

Register by visiting us online here! Registrations for representatives of endowments and foundations are complimentary.

Monday, September 8, 2008

Fannie and Freddie

Of course, the US Treasury forced Freddie and Fannie into "Conservatorship."

According to FHFA Director James B. Lockhart and the Treasury, "Conservatorship is a statutory process designed to stabilize a troubled institution with the objective of returning the entities to normal business operations. FHFA will act as the conservator to operate (Fannie and Freddie) until they are stabilized.

There are several key components of this conservatorship:

First, Monday morning the businesses will open as normal, only with stronger backing for the holders of MBS, senior debt and subordinated debt.

Second, the Enterprises will be allowed to grow their guarantee MBS books without limits and continue to purchase replacement securities for their portfolios, about $20 billion per month without capital constraints.

Third, as the conservator, FHFA will assume the power of the Board and management.

Fourth, the present CEOs will be leaving, but we have asked them to stay on to help with the transition.

Fifth, I am announcing today I have selected Herb Allison to be the new CEO of Fannie Mae and David Moffett the CEO of Freddie Mac. Herb has been the Vice Chairman of Merrill Lynch and for the last eight years chairman of TIAA-CREF. David was the Vice Chairman and CFO of US Bancorp. I appreciate the willingness of these two men to take on these tough jobs during these challenging times. Their compensation will be significantly lower than the outgoing CEOs. They will be joined by equally strong non-executive chairmen.

Sixth, at this time any other management action will be very limited. In fact, the new CEOs have agreed with me that it is very important to work with the current management teams and employees to encourage them to stay and to continue to make important improvements to the Enterprises.

Seventh, in order to conserve over $2 billion in capital every year, the common stock and preferred stock dividends will be eliminated, but the common and all preferred stocks will continue to remain outstanding. Subordinated debt interest and principal payments will continue to be made.

Eighth, all political activities -- including all lobbying -- will be halted immediately. We will review the charitable activities.

Lastly and very importantly, there will be the financing and investing relationship with the U.S. Treasury, which Secretary Paulson will be discussing. We believe that these facilities will provide the critically needed support to Freddie Mac and Fannie Mae and importantly the liquidity of the mortgage market."

Freddie and Fannie common stock is, basically, worthless. If you own the stock, I would hold onto it, but recognize that it is now a long term investment. A VERY long term investment.

On June 15, 2000, I testified before the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises (GSE’s) of the US Congress. I suggested that the GSE’s (Fannie Mae and Freddie Mac) be subject to a through “Social Audit.” A Social Audit is an examination of the performance of an enterprise relative to certain social objectives. It also includes a review of ethical practices at the firm.

Had they been subject to this audit, certain flaws in their operation, including certain ethical shortcomings, would have been revealed earlier, in a better market in which to make corrections.

At best, conservatorship is a half measure, designed to, as noted above, stabilize the patient. It is life support, nothing more.

The patient is still, however, in the ER.

Thursday, September 4, 2008

Chief of Adams National Resigns Bank Faces Rising Real Estate Losses

According to Washington Post,

"The chief executive of District-based Adams National Bank (Woman owned) resigned on the eve of a meeting scheduled for today with federal banking regulators to review the company's financial condition. Jeanne Delaney Hubbard also stepped down as chairwoman and chief executive of the bank's parent company, Abigail Adams National Bancorp.

Adams National faces mounting losses on real estate loans and this summer disclosed that it had been classified as "troubled" by its regulator, the Office of the Comptroller of the Currency, subjecting the bank to greater scrutiny. Last week, the Abigail Adams board voted to suspend quarterly dividend payments to shareholders."

Wednesday, September 3, 2008

SEC Charges Two Wall Street Brokers in $1 Billion Subprime-Related Auction Rate Securities Fraud

According to the SEC:

"Washington, D.C., Sept. 3, 2008 — The Securities and Exchange Commission today charged two Wall Street brokers with defrauding their customers when making more than $1 billion in unauthorized purchases of subprime-related auction rate securities. The SEC's Division of Enforcement in 2007 formed a subprime working group, which is aggressively investigating possible fraud, market manipulation, and breaches of fiduciary duty that may have contributed to the recent turmoil in the credit markets.

The SEC's complaint, filed in federal court in Manhattan, alleges that Tzolov and Butler, while employed at Credit Suisse Securities (USA) LLC in New York, deceived foreign corporate customers in short-term cash management accounts by sending or directing their sales assistants to send e-mail confirmations in which the terms 'St. Loan' or 'Education' were added to the names of non-student loan securities purchased for the customers. Tzolov and Butler also routinely deleted references to 'CDO' or 'Mortgage' from the names of the securities in these e-mails. As a result, the complaint alleges that customers were stuck holding more than $800 million in illiquid securities after auctions for auction rate securities began to fail in August 2007. Those holdings have since significantly declined in value."

SEC Charges Former CEO of Kellogg, Brown & Root, Inc. with Foreign Bribery

According to the SEC:

"Washington, D.C., Sept. 3, 2008 — The Securities and Exchange Commission today charged former Kellogg, Brown & Root, Inc. (KBR) executive Albert Jackson Stanley with violating the anti-bribery provisions of the Foreign Corrupt Practices Act (FCPA) and related provisions of the federal securities laws. The Commission alleges that over a 10-year period, Stanley and others participated in a scheme to bribe Nigerian government officials in order to obtain construction contracts worth more than $6 billion. The contracts were awarded to a four-company joint venture of which The M.W. Kellogg Company, and later KBR, was a member."