Obama: Spinning Wall Street Reform ...
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Financial Reform: What the New York Times did not say ...

Once again, the New York times has angered me by not telling the complete story and ostensibly spinning the story to support their left-leaning political agenda which routinely excoriates big business in favor of a faux-consumerism that does not really exist.

The story according to the New York Times …

“Rating Agency Data Aided Wall Street in Deals”

“One of the mysteries of the financial crisis is how mortgage investments that turned out to be so bad earned credit ratings that made them look so good.”

“One answer is that Wall Street was given access to the formulas behind those magic ratings — and hired away some of the very people who had devised them.”

“In essence, banks started with the answers and worked backward, reverse-engineering top-flight ratings for investments that were, in some cases, riskier than ratings suggested, according to former agency employees.”

The major credit rating agencies, Moody’s, Standard & Poor’s and Fitch, drew renewed criticism on Friday on Capitol Hill for failing to warn of the dangers posed by complex investments like the one that has drawn Goldman Sachs into a legal whirlwind.

“The rating agencies made public computer models that were used to devise ratings to make the process less secretive. That way, banks and others issuing bonds — companies and states, for instance — wouldn’t be surprised by a weak rating that could make it harder to sell the bonds or that would require them to offer a higher interest rate.”

“But by routinely sharing their models, the agencies in effect gave bankers the tools to tinker with their complicated mortgage deals until the models produced the desired ratings.”

There were other ways that the models used to rate mortgage investments like the controversial Goldman deal, Abacus 2007-AC1, were flawed. Like many in the financial community, the agencies had assumed that home prices were unlikely to decline. They also assumed that complex investments linked to home loans drawn from around the nation were diversified, and thus safer.

Both of those assumptions were wrong, and investors the world over lost many billions of dollars. In that Abacus investment, for instance, 84 percent of the underlying bonds were downgraded within six months.”

“But for Goldman and other banks, a road map to the right ratings wasn’t enough. Analysts from the agencies were hired to help construct the deals.”

The real story that you need to know …

1. The proximate cause of the mortgage meltdown that triggered the current financial catastrophe was governmental interference.

The Federal Reserve – although not a government agency, the Federal Reserve maintained artificially low interest rates to recapitalize financial institutions who lost big in the crash of the dot com bust. The global pool of capital could no longer earn an acceptable rate of return by buying safe government securities, so they turned to the mortgage markets – the next safest investment at that time.

The Congress – through lobbyist-sponsored legislation, the government removed many of the older depression-era safeguards that protected our financial systems. Gone was the separation between banks and brokerages which gave rise to financial behemoths with their built in conflicts of interests and competing internal goals. Gone was the ability of the states to regulate against toxic derivatives using the states “gaming” and bucket-shop laws.

The Administration – Both parties were taking significant amounts of money from both the trial lawyers and Wall Street wizards. Both parties were pandering to the minorities by promoting the “American Dream” of home ownership. Both parties were openly supportive of Administrative agencies severely penalizing financial insitutions if they did not make loans in disadvantaged areas – even if those loans demanded a relaxation of underwriting standards.

The democrats – I am specifically pointing the finger at democrats for using the GSEs (Government Sponsored Entities) like Fannie Mae and Freddie Mac as instruments of social change, their personal piggybank and a place to park politicians and friends in high-paying positions. As the executives of Fannie Mae and Freddie Mac were cooking their books to earn large executive bonuses and please Wall Street, Barney Frank, Maxine Waters and others were openly defending these corrupt institutions as being safe, sound and well-managed. Something that was far from the truth.

The bottom line being that the government either demanded, authorized, encouraged or allowed reduced underwriting standards which led to unsound banking practices which saw hairdressers pyramiding homes as speculative investments and other egregious acts. That is, in addition to, the relaxed atmosphere of the Administration’s regulatory agencies who were seemingly in bed with the very firms they regulated. Lax oversight was rampant and most bureaucrats did not understand or even care about the systemic influence on the economy. They were happy to keep their jobs and promote the interests of their respective agencies.

2.  The data used to feed the Wall Street ratings models was extremely flawed.

The failure of historic data – Models are built on assumptions and use historic data as a comparison to current situations. In this particular case, the older data on mortgage delinquencies was based on older, more sound banking rules. The older data did not reflect newer financial constructs such as the Home Equity Line of Credit which, in essence, is a subordinate lien secured by your home. The older data did not reflect the ease at which troubled homeowners could refinance their troublesome mortgages in a rising and speculative marketplace.

The failure of economists – Many economists did not see the impending bubble forming nor were able to adequately assess its impact on the broader economy. Former Federal Reserve Chairman Alan Greenspan, arguably one of the smartest financial wonks in the world, confessed that he had not seen the true picture until it was too late. And the chief economic shill for the National Association of Realtors was openly touting real estate investment while the bubble was bursting. Like they say: “on one hand, we know a lot about the statistics; but on the other hand, we know little about their real impact on the broader economy.”

The failure of the FICO scoring system – there is no doubt in my mind that one of the key components of the financial models was compromised during the time period in question. The FICO score is accepted by most financial people as a predictive indicator of potential default on financial obligations. Unfortunately, the system overwhelmed the FICO system and rendered this most important tool almost irrelevant. Consider a troubled homeowner, barely able to pay his bills, overburdened with credit card debt and about to miss his first mortgage payment. Through the magic of a rising real estate market, this poor soul is able to re-finance his mortgage burden, pay off his credit card debt and possibly take back cash to spend on fixing up the house (adding to its value) or use the money on vacations. Consider his FICO score after the transactions:  A notation of a satisfactorily paid off mortgage (plus points), no substantial credit card debt (plus points) and no derogatory information which would indicate that the consumer was a major credit risk in dire straits and ready to default. When this consumer’s loan is now included in a mortgage-backed security, it is a ticking time bomb waiting to explode. Now replicate this scenario a hundred thousand or more times over and you begin to see the problem.

3. The Wall Street financial wizards concocted a hedge based on a form of insurance that never was actuarially sound.

It was a very, very bad idea to use a company’s strong balance sheet to underwrite a form of  “insurance” which allowed investors to purchase protection against defaults in securitized pools. Using statistical models, mostly based on flawed historical mortgage default rates, a company promised to pay a counterparty for the declining value of a mortgage pool in return of a small “insurance like” premium. Figuring that they could hardly lose money in a rising real estate market, these firms wrote many more contracts that they could fulfill if the market turned sour. From the issuing company’s perspective, it looked like a free flow of profits. From the Wall Street Wizard’s perspective, it looked like these contracts could be used to hedge toxic assets against default and thus persuade the ratings agencies to provide a triple-A investment-grade rating on toxic crap. And from the investor’s perspective, one could use these contracts to bet on assets that, unlike real insurance, you didn’t even own. And because these companies did not use actuarially sound methods to build adequate reserves, we were presented with an AIG – which required a government bailout to prevent other financial firms from crashing and burning.

4. The professionals allowed the system to be compromised for personal gain …

The accounting professionals –created accounting standards which enabled financial institutions to hide their growing risk from the regulatory agencies, the public and their counterparties in “off balance sheet” accounts known as special purpose vehicles. Where changes in a billion dollar portfolio of assets were done by only recording profits and losses on the assets – and never showing the assets themselves on the parent firm’s balance sheet where they would have served as a red flag for all to see.

The legal professionals – all of these complex machinations carried lawyer’s letters stating that they were legal, proper and in compliance with all of the existing local, state and federal laws, rules, regulations, interpretations and guidelines. With a caveat that one could either go by the strict word of the law or take a much looser interpretation.

Bottom line …

Regulatory reform by dishonest brokers such as the Obama Administration and Congress, acting to promote a political agenda and satisfy their special interests, are once again subverting the financial system.

They are using the faux-opposition of the financial industry to disguise the fact that the legislation’s “resolution authority” provides for government control and bailouts in perpetuity.

They are excusing the failure of the Administration’s regulatory agencies to oversee the financial sector and punish wrongdoing – by creating an even more complex bureacracy that will be more inept than the regulators currently in place.

They are whitewashing this entire sordid chapter in financial history in favor of receiving ever greater campaign funding in the upcoming 2010-2012 election cycle.

And the legislation does not even strongly regulate the derivatives which were the vehicles that almost crashed the American economy.

And we can only urge our representatives to vote NO on Obama’s corrupt financial regulatory reform initiatives. That is, until the government can prove that the regulatory agencies and regulations they have in place are working in the public’s interest – and not as a subsidiary of the firms they purport to regulate.


-- steve

Reference Links:

Rating Agencies Shared Data, and Wall St. Seized on It - NYTimes.com

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