Transactional Transparency: Saying one thing, doing another...

Everyone in the media, financial industry and government is calling for more transparency in financial transactions.

Why then is the Federal Reserve trying so damn hard to hide the truth about what they are doing?

Why are the Fed Governors hopping about, speechifying on various and sundry matters that serve only to roil the market?

Why does the Fed hide the extent of institutional borrowing behind gross numbers and fail to reveal who the recipients of these "loans" are and what collateral they have actually pledged?

Why is the Securities and Exchange Commission failing to regulate hedge funds and ratings agencies; failing to curb rampant speculative short selling and increase the margin ratio to insure that speculators have more "skin" in the game?

Why is the FASB (Financial Accounting Standards Board) promoting new reporting requirements and restructured financial reports which eliminates such concepts as "net income?"

The apparent answer is that many major financial firms are "in trouble" and it is in the best interests of the United States, and by extension the global economy, to avoid investor panic and the demise of "signature name" financial institutions by avoiding naming those that are borrowing from the Fed and allowing the institutions to legally obscure the gory details. By reducing fiscal transparency while failing to implement prudent rules and regulations and then actually enforce them as they are written.

Complicit in defrauding the public?

However, does that not make the Federal Reserve, its member banks and governors complicit in one of the largest frauds in financial history? Along with the accountants and lawyers who certify the results?

Does this also mean that the Fed actually gets a legal pass to screw the citizens of the United States in order to preserve and protect a few large financial institutions?

One need only to look at the results of the Fed's continual lowering of the target Federal Funds rate and its effect on fixed-income citizens who bought into the fiction that a bank is a safe place to keep your money and that it is offering a fair rate of return higher than the debilitating effects of inflation which is steadily eroding purchasing power.

What is the Fed Saying...

Is this what  is actually being institutionalized by the Fed:

The fiction that a depository financial institution (bank) is a safe harbor for your hard-earned life's earnings?

That you need to switch your money from savings to securities to stay ahead of inflation and survive? Whipsawed by brokerages who create nothing but commissions as they charge for buying, holding and selling ever churning securities?

That it is your patriotic duty to "spend, spend and spend some more" to keep the wheels of commerce well-lubricated with a continual flow of consumer money? Even though most consumers already carry a crushing debt burden which makes them extremely susceptible to downturns in the economy and disaster should they encounter health or employment problems?

That the Fed's rules and regulations which are administered by jointly by the other regulators of financial institutions (Comptroller of Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation, National Credit Union Administration, et. al) can be ignored with impunity? And if an institution is caught, allowed to settle with a "record" fine paid into the general Treasury fund, a slap on the wrist, a "go forth and sin no more" proclamation... and, most importantly, no admission of guilt which can be used in civil proceedings? A fine which is miniscule when compared with the ill-gotten gains of the offending institution.

Divided Loyalties...

Of course, one must remember that the Fed is not subject to ordinary rules and regulations. They are not a part of the government and they are not totally private either. They are a quasi-governmental fiction. A seemingly public institution that is owned, in actuality, by their member banks. and chartered by the government to act as the "central banker" for the United States. There is no doubt that their first allegiance is to the banking industry and secondarily to the large financial institutions and brokerages which support banking activities. So why continue the fiction that the Fed is attempting to protect the "little" people?

Does the Fed actually know what it is doing?

While we would all like to think that the Federal Reserve has some amazing power, based on their great insight into financial matters and computerized crystal balls to foretell the future,  the truth is that they know about as much as any other competent industry economist. A lot about the past, but very little of the present and almost nothing of the future.

Considering the number of speeches of the Federal Reserve Governors (plus the number of speeches by the member bank representatives), one might conclude that the Fed actually does have a handle on the situation. Or at least an understanding of what is actually occurring in the financial markets.

• March 27, 2008: Governor Frederic S. Mishkin, "Comfort Zones, Shmumfort Zones" at the Sandridge Lecture of the Virginia Association of Economists and the H. Parker Willis Lecture of Washington and Lee University, Lexington, Virginia
• March 27, 2008: Governor Randall S. Kroszner, "Protecting Homeowners and Sustaining Homeownership" at the National Association of Hispanic Real Estate Professionals Legislative Conference 2008, Washington, D.C.
• March 14, 2008: Chairman Ben S. Bernanke, "Fostering Sustainable Homeownership" at the National Community Reinvestment Coalition Annual Meeting, Washington, D.C.
• March 11, 2008: Governor Randall S. Kroszner, "The Importance of Fundamentals in Risk Management" at the American Bankers Association Spring Summit Meeting, Washington, D.C
• March 7, 2008: Governor Frederic S. Mishkin, "Exchange Rate Pass-Through and Monetary Policy" at the Norges Bank Conference on Monetary Policy, Oslo, Norway
• March 7, 2008: Vice Chairman Donald L. Kohn, "Implications of Globalization for the Conduct of Monetary Policy" At the International Symposium of the Banque de France, Paris, France
• March 4, 2008: Governor Frederic S. Mishkin, "Outlook and Risks for the U.S. Economy" at the National Association for Business Economics Washington Policy Conference, Washington, D.C.
• March 4, 2008: Chairman Ben S. Bernanke, "Reducing Preventable Mortgage Foreclosures" at the Independent Community Bankers of America Annual Convention, Orlando, Florida
• March 3, 2008: Governor Randall S. Kroszner, "Liquidity-Risk Management in the Business of Banking" at the Institute of International Bankers Annual Washington Conference, Washington, D.C.
• February 29, 2008: Governor Frederic S. Mishkin, "Leveraged Losses: Lessons from the Mortgage Meltdown" at the U.S. Monetary Policy Forum, New York, New York
• February 27, 2008: Governor Frederic S. Mishkin, "The Importance of Economic Education and Financial Literacy" at the Third National Summit on Economic and Financial Literacy, Washington, D.C.
• February 26, 2008: Vice Chairman Donald L. Kohn, "The U.S. Economy and Monetary Policy" at the University of North Carolina at Wilmington, Cameron School of Business' Business Week Program, Wilmington, North Carolina
• February 25, 2008: Governor Frederic S. Mishkin, "Does Stabilizing Inflation Contribute to Stabilizing Economic Activity?" at East Carolina University's Beta Gamma Sigma Distinguished Lecture Series, Greenville, North Carolina
• February 25, 2008: Governor Randall S. Kroszner, "Improving Risk Management in Light of Recent Market Events" at the Global Association of Risk Management Professionals Annual Risk Convention, New York, New York
• February 15, 2008: Governor Frederic S. Mishkin, "The Federal Reserve's Tools for Responding to Financial Disruptions" at the Tuck Global Capital Markets Conference, Tuck School of Business, Dartmouth College, Hanover, New Hampshire
• February 4, 2008: Governor Randall S. Kroszner, "Protecting Homeowners and Sustaining Home Ownership" At the American Securitization Forum 2008 Conference, Las Vegas, Nevada
  Governor Kroszner presented identical remarks at the Women in Housing and Finance Subprime Symposium, Washington, D.C., on February 6, 2008
• January 11, 2008: Governor Frederic S. Mishkin, "Monetary Policy Flexibility, Risk Management, and Financial Disruptions" At the Federal Reserve Bank of New York, New York, New York
• January 10, 2008: Chairman Ben S. Bernanke, "Financial Markets, the Economic Outlook, and Monetary Policy" at the Women in Housing and Finance and Exchequer Club Joint Luncheon, Washington, D.C.
• January 5, 2008: Vice Chairman Donald L. Kohn, "Recent and Prospective Developments in Monetary Policy Transparency and Communications: A Global Perspective" at the National Association for Business Economics Session, Allied Social Science Associations Annual Meeting, New Orleans, Louisiana
• January 4, 2008: Vice Chairman Donald L. Kohn, "Expertise and Macroeconomic Policy, Comments on 'Insiders versus Outsiders in Monetary Policy-Making,' by Timothy Besley, Neil Meads, and Paolo Surico" at the American Economic Association Session, Allied Social Science Associations Annual Meeting, New Orleans, Louisiana

However, the Fed, like other financial institutions does not specifically know what is contained in those toxic securities or the status of the underlying collateral. Likewise, they do not specifically know how to untie the "Gordian Knot" of interlocking dependencies and calls on the collateral should there be a significant number of foreclosures.

Like the rest of the financial community, they must rely mostly on the representations and warranties offered by the executive management of regulated, poorly-regulated and non-regulated financial institutions.

In short, they are making informed guesses about what has happened and what is likely to happen in the future... sort of like gambling with the public's money with no guarantee of a favorable outcome.

But the Fed does have the collective power to move markets and somewhat mitigate the effects of major adverse financial effects.

The Fed plan seems to be a simple one...

Other than managing the perceptions of the media and the investment community, almost all of the Fed's actions to date seem to be for the purpose of:

• allowing the major depository institutions to avoid the "insolvency" designation by shoring up their legally-mandated core capital reserves;
• allowing  the major financial institutions to bolster "investor confidence" by postponing the need to create such large loan loss reserves that everyone notices that the institution has zero shareholder equity and has a computational negative net worth;
• neutralizing the "mark-to-market" requirement for toxic securities by allowing those securities to serve as collateral for loans;
• buying time for the foreclosures and other adverse events to work their way through the system thus preparing for the next growth phase;
• allowing the major financial institutions to continue to do business as usual by providing additional working capital for new loans;
• avoiding the failure of major financial firms by arranging for takeovers by more liquid firms to prevent a cascading failure of the firm's customers --which could snowball into the widespread mutual destruction of investor confidence and the necessity of the United States government guaranteeing everyone's investment;
• but most of all, not providing an open and transparent balance sheet that would allow the investing public to peek behind the curtains.

The unstated goals of not angering the present Administration, interfering in the current election cycle, and insuring that Fed governors will have a cushy and profitable retirement should not be overlooked. 

Where is the money going...

No matter what you call the Federal Reserve program; the Discount Window, TAF (Term Auction Facility), TSLF (Term Securities Lending Facility), the fact remains is that the Federal Reserve is loaning  BILLIONS of freshly printed dollars to financial institutions and accepting questionable "paper" as collateral. Most of the money is being used to buy the time necessary  to work beyond the current difficulties. Exacerbated, no doubt by people who want instant gratification and quarter-by-quarter improvements.

A reward for greed and fraud...

Unfortunately, on a macro scale, people who knowingly engaged in institutional fraud, aided and abetted by their lawyers, accountants, consultants are likely to escape without criminal or civil penalty -- and keep those outrageously large bonuses which we often based on cooked books.

On a micro scale, we see homeowners and speculators who have committed state and federal crime in connection with their loans being given a pass and a bailout as the price for keeping the financial industry's balls in the air.  Or should I say, "out of a sling?"

What should happen...

In my not so humble opinion, I believe that the present Administration, in cooperation with the regulatory agencies and Congress should formalize the Federal Reserve's fictional loans. The should create another quasi-governmental organization to serve as the repository for all suspect loans.

All of the loan processing, payments as well as foreclosures, would be centralized and would be handled on an individual basis. Instead of the mishmash of  "voluntary efforts by the financial industry," uniform processing regulations would apply.

All monies would be pooled and distributed on a pro-rata basis to those who had first call on the underlying collateral. For those who engaged in leveraged investment activities, they could recover any leftover funds (doubtful) or be rewarded by an embossed, engraved and suitably inscribed certificate of loss -- along with a cover letter expressing the mutual regrets of the financial industry and the personal regrets of the CEO of the institution which sold the toxic paper. 

This quasi-governmental corporation could also sell "stay out of jail" certificates to executives who received major bonuses based on nothing more than being a part of management who systematically defrauded the investing public. The cost of these "indulgences," if you will, would be exactly 98% of the actual bonus amounts awarded.

Next, we could deport all of the executives who used offshore entities in the Cayman Islands and elsewhere to hide their manipulated monies to their new home located next to the post office box which serves as their current (or former) company's official offshore address.

Politics?

While political and economic conditions would not allow for many of my suggested ("wished for") remedies, I would appreciate it if the Administration took official notice that the shell game is continuing and that if they do not take the following eight actions, it is likely to, once again, spin out of control.

1. Regulate the hedge funds, offshore capital funds doing business in the United States, and the ratings agencies.
2. Increase the regulatory scrutiny of firms formed, headed or operated by executives and key personnel of organizations which lost significant investor or depositor funds or were complicit, but unindicted, in wrongdoing. The national mortgage registry should be extended to executives and other who may exert operational control over a mortgage-related business.
3. Sanction  the accounting and legal firms associated with wrongdoing or massive investor losses by preventing them from rendering audit or operational opinions to firms engaging in the same general business. This would be a precursor to the loss of the entire practice or the surrender of a professional license by individuals.
4. Restore "simple" accounting rules which provide for financial transactional transparency.
5. Treat derivatives like pyramid schemes and restrict the number of abstraction layers to three or less.
6. Restore the "uptick" rule against short selling or prohibit it altogether during periods of financial unrest. We have seen numerous firms buy "put" options then massively sell short as to drive the prices downward. Making additional fortunes when the sheeple abandon their investments -- based on bad publicity and falling stock prices.
7. De-politicize the Administration's regulators and fire and/or prosecute those who have been complicit in fraud, waste and the mismanagement of an Agency.  Reinforce the Inspector General's office to avoid the conflict of interest in having the Administration investigate their own appointees. One need only look at what happened in the prosecution of former HUD Secretary Henry Cisneros (who went on to serve on the Board of Countrywide Financial) or National Security Advisor Samuel Berger who stole classified documents to get the point. 
8. Implement a plan to "sop up" all of the excess capital which has been pumped into our economy lest we become prey, once again, to easy money and increased inflation which robs everyone of their purchasing power.

The game continues...

To provide a simple illustration of how the game is continuing, I will introduce you to the latest financial organization, somewhat cutely-named to form a recognizable acronym  resembling the quasi-governmental agencies (Ginnie Mae, Fannie Mae, Freddie Mac):

Private National Mortgage Acceptance Co. LLC or as it will be popularly known "Penny Mac." ("PNMAC")

• The new organization will be headed by Stanford Kurland,  who, depending on the story, either resigned or was forced out as the President of Countrywide Financial.
• The company will be partially funded by BlackRock, Inc. one of the largest public asset managers and the hedge fund Highfields Capital Management.
• The new company is seeking to raise $2 BILLION dollars to purchase delinquent residential mortgages at deep discounts -- thus insuring a substantial profit when the economy recovers.

A quick look at the major players indicates that the new firm taps into a wealth of expertise from both Countrywide Financial and its one-time sister firm, IndyMac. 

Considering the IT (Information Technology) requirements listed on PNMACs  website, one could believe that this company could be well-positioned to quickly become a major player in the mortgage workout sector as well as potentially trumping other servicing firms in becoming one of the Government's preferred contractors should the Government decide to "federalize" delinquent loans.

It potentially could roll its own Mortgage Backed Securities (MBS) to sell into the marketplace to internally sustain its own growth. And provide another multi-million dollar payday for its investors and executives if and when a portion of the organization is sold off to the public.

For Stan Kurland, unlike his Countrywide replacement David Sambol who is reportedly being paid $28 million in cash and stock  to move to the Bank of America and operate Countrywide, this is an opportunity to make his mark as a top banana in the mortgage marketspace.

The new organization, headquartered in Calabasas, should not be confused with the National Mortgage Acceptance Corporation ("NMAC") whose principal business is issuing bonds principally secured by, or with interests in, "Mortgage Collateral." Mortgage Collateral may include mortgage loans and deed of trust loans secured by real estate and certificates evidencing interests in pools of such mortgage and/or deed of trust loans, which certificates may be issued or guaranteed by the Government National Mortgage Association (Ginnie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal National Mortgage Association (Fannie Mae), and/or private issuers.

Full Circle?

Lest we not forget, Merrill Lynch owns approximately 50% of BlackRock and was responsible for the subprime activities of First Franklin (purchased for 1.3 BILLION) and the now-bankrupt Ownit Mortgage Solutions (20% purchased for $100 MILLION). The very same Merrill Lynch that can now borrow additional money from the Fed, using mortgage backed securities (possibly acquired by PNMAC) as collateral, to feed additional monies into BlackRock or even for investing directly in PNMAC.

In the final analysis...

How bad could the mortgage business really be if hedge funds are lining up to purchase all manner of distressed mortgages,  mortgage-backed securities and distressed property pools? Either they have some estimate of the real risk involved or they are planning to spin them off as additional securities to continue the shell game.

One more time...

I though this might be a nice time to repeat my little ditty which originally appeared in my blog entry, The Ways of Wall Street: Circles within Circles."

"Instead of my usual "What can YOU do?" section, I thought I would take this opportunity to entertain you with my little song...  to the tune of  Windmills of My Mind (Theme Song of  The Thomas Crown Affair -  Original Music by Alan Bergman and Michel Jean Legrand)

Circles within circles, wheels within wheels

It all keeps on spinning, with ever increasing deals

Until the model is broken and it reaches some undetermined end

When all the investors are broke and the game begins again."

Reference Links:

Speeches by Federal Reserve Officials|The Fed

PennyMac website

The Ways of Wall Street: Circles within Circles|OneCitizenSpeaking