Tuesday, July 28, 2009

Regulation or Safety?

Huffington Post
- Ryam Grim: Goldman Sachs: Gambling With Your Money?

- Matthew Goldstein: Goldman’s real estate gambit

- JPMorgan Chase CEO warns against too many regulators

ABC News
- First Madoff Interview: Can't Believe I Got Away with It


There is consensus that the financial meltdown was caused by unbridled greed and ruthless profiteering by those in the financial industry at the expense of taxpayers. Everyone agrees that new regulatory oversight of the financial system is paramount to prevent the future repeating perhaps even a worse uncontrollable disaster. There is amble evidence that those in power, financially and politically, were reluctant to limit the irresponsible actions of their friends and colleagues. The new financial regulatory system must employ all the checks and balances need to prevent a similar crash. We may not be so lucky the next time.

When it comes to safety, NASA employs multiple redundancy, cross-over checks, and balanced key indicators as telltales of potential problems. The same must be true of any new financial regulations because it is not just supervising the financial system's adherence to the law, but in fact, it is the final safety system to safeguard the livelihoods of the world's billions of people. There is nothing that is more important. When it comes to safety, let's not save and scrape by in the name of efficiency (as Jamie Dimon suggested). Let's make sure the fail-safe is beyond Six Sigma.

Otherwise, the next Madoff, the next WorldCom, the next Enron, the next AIG, will surely find a way around whatever new regulations are put in place in the name of efficiency, and take the world for a ride to the crash that will end all crashes.


Huffington Post - Ryam Grim: Goldman Sachs: Gambling With Your Money?

Goldman Sachs is using its new taxpayer-subsidized status to bring increased risk to the financial system, a group of House members charged Monday. They want to know why the Federal Reserve is allowing it.

The group on Monday sent a letter to the Fed asking for an explanation of why Goldman Sachs is being allowed to speculate wildly even while officially redesignating itself a bank holding company, which theoretically means stricter regulation. The bank designation gives Goldman access to dirt-cheap Federal Reserve loans.

Goldman initially applied for the new designation last fall, so that it could access bailout funds (since paid back). Because bank holding companies, unlike investment banks, have access to a host of valuable taxpayer subsidies, they are required to reduce the risk associated with their investment activity. But Goldman then applied to the Federal Reserve for an exemption to the rules, saying that it takes time to alter a business model. The exemption was granted in February -- and Goldman went on to take even greater risks. Its Value-at-Risk model, a widely used measure of the risk of loss, recently showed potential trading losses at $245 million a day; in May 2008, it was $184 million a day.

The bets paid off in the most recent quarter as the market rose and Goldman posted stellar earnings. Morgan Stanley, meanwhile, was similarly given an exemption by the Fed but did what it said it would do and reduced its risk. The company lost money, largely as a result of that decision.

The likely result: Other players on Wall Street will follow Goldman back toward the cliff they dangled over just months ago. In announcing its lousy earnings, Morgan Stanley assured that it will increase the risk it takes in the future. Citigroup is racing to increase its exposure, too, handing another billion dollars worth of chips to its riskiest traders, bringing its hedge fund operations to close to $2 billion. On the brink of collapse, it had scaled such investing down to around $800 million.

Lucas van Praag, a Goldman spokesman, declined to respond directly to the charges in the letter, but said that the firm is working to reduce its exposure.

"We're very cognizant of risks inherent in risk taking. We have one of the highest capitalizations of any bank," said van Praag. He said that the Value-at-Risk numbers, while the only publicly released measure of risk, are only one metric and that internal measures show the bank has reduced its exposure over the past year.

He also took a dig at other Wall Street players who have avoided using mark-to-market accounting in an effort to fluff their balance sheets. Earlier this spring, banks lobbied Congress and the Financial Accounting Standards Board to soften mark-to-market rules. The new rule allowed banks to inflate their balance sheets by claiming that an asset was worth more than it could fetch on the market because the market was frozen. Goldman Sach, said van Praag, doesn't use that slight of hand, so its balance sheet is an honest reflection of its exposure.

"We have dramatically reduced our leverage and as a mark-to-market firm--we aggressively mark our assets to market--our leverage ratio is a true reflection of risk," said van Praag.

Nevertheless, as Wall Street follows Goldman, overall systemic risk is ramped up. Meanwhile, Congress is debating whether to give the Fed authority to regulate systemic risk throughout the economy. The congressional letter puts the Fed on the spot, demanding that it explain why it's allowing Goldman to use taxpayer dollars to increase systemic risk.

"The only difference between Goldman Sachs today and Goldman Sachs last year is that today, the company is officially gambling with government money. This is the very definition of 'heads we win, tails the taxpayers lose,'" reads the letter.

Reuters - Matthew Goldstein: Goldman’s real estate gambit

Is history repeating itself at Goldman Sachs?

In late 2006, Goldman shrewdly began backing away from the residential mortgage market. With little fanfare, the firm began aggressively hedging its exposure to home loans, in particular mortgages to borrowers with shaky credit histories.

This savvy and somewhat stealthy strategy enabled Goldman to pawn off lots of its soon-to-be toxic mortgages and mortgage-backed securities on other institutions — forcing those foolhardy speculators to pay the price when the subprime market blew up.

And much to everyone else’s chagrin, Goldman even made money off the housing meltdown when some of its hedges — specifically a bet that a subprime mortgage index would plunge — paid off handsomely.

It appears Goldman is following a similar script with U.S. commercial real estate, the next big asset class that many believe is on the verge of disaster.

Goldman recently reported owning $6.4 billion in commercial mortgage loans. It also is holding some $1.6 billion in commercial mortgage-backed securities, or CMBS. That’s a big retreat from where it was just two years ago.

And in a sure sign that Goldman expects a good number of commercial real estate borrowers to default, the firm says it marked down the overall value of its commercial mortgages portfolio by nearly 50 percent.

By contrast, regional banks, many of which have disproportionately high exposures to commercial real estate, are being far less aggressive than Goldman in marking down their respective portfolios.

But Goldman, with a $950 billion balance sheet, can afford to take the lead in marking down loans and indirectly putting pressure on other lenders to follow suit, because its overall exposure to commercial mortgages is relatively light.

Goldman used to have a rather large footprint in the commercial real estate market, with some $16.27 billion in loans and $2.75 billion in CMBS on its books in late 2007. That year, Goldman ranked seventh in bundling commercial mortgages into securities, churning out $15.1 billion in so-called CMBS, according to Thomson Reuters.

By the end of 2008, Goldman managed to whittle its total commercial mortgage portfolio down to a less imposing $10.9 billion.

Goldman says in a regulatory filing that it was able to rid itself of a good deal of its “long positions” in commercial mortgages and CMBS through “dispositions,” or sales of mortgages to other institutions and investors.

No doubt, Goldman also bundled some of it commercial mortgages into the nine CMBS deals it brought to market in 2007.

To be sure, Goldman has taken more hits on commercial mortgages than it did with residential real estate. The firm has taken at least $3.5 billion in write-downs. But Goldman has been able to easily absorb those losses by posting strong trading gains in bonds, stocks and commodities.

And there’s the possibility that Goldman’s strategy for hedging its remaining exposure to commercial real estate could pay dividends if the market collapses. Just as it did with residential real estate, Goldman says in regulatory filings that it relies on “cash instruments as well as derivatives” to reduce some of the firm’s commercial mortgage exposure.

It should come as no surprise that Goldman won’t talk about its hedging strategy. So there’s no way to determine whether Goldman traders are betting that an index that serves as a derivative trade on the CMBS market will plunge, just as the one that tracked the subprime-backed securities market did.

So far, the main Markit indexes for tracking the performance of the highest-rated CMBS are off just 10 to 13 points from their respective par values. By comparison, the most widely followed Markit index for tracking the performance of subprime-backed debt dropped by more than 80 points at its nadir.

Right now, the odds of subprime-like collapse in CMBS valuations appear long and that’s not good news for anyone selling the index short. But further declines would appear likely given the deep haircut Goldman has taken on its own portfolio of commercial mortgages.

No matter what, it would appear Goldman is in a better position than most banks to weather a further slide in the commercial mortgage market. It could even benefit if the market improves and Goldman gets to write up the value of some of the mortgages it’s marked down.

And, if lightning strikes twice, Goldman might even profit while others feel only pain.

Reuters: JPMorgan Chase CEO warns against too many regulators

Too many regulators will only increase costs and reduce credit opportunities for consumers, JPMorgan Chase & Co Chief Executive Jamie Dimon warned in a column he wrote in Saturday's Wall Street Journal.

While praising President Barack Obama's efforts to reform the U.S. financial system, Dimon said the emphasis should be on strengthening existing regulators over creating new ones.

"Any regulatory overhaul should ensure that governmental oversight of the financial system is efficient," wrote Dimon, who is widely regarded as the top banker to have been least tarnished by the financial crisis. "We should avoid the temptation to have multiple regulators just for the sake of having them.

"Three or four different regulators all looking at (and fighting over) the same issue is not a wise use of taxpayer money," he said. "Companies can't operate that way. Neither should the government."

Obama last week unveiled a sweeping package of reforms to rewrite the rules for banks and capital markets in response to a severe financial crisis that has dragged down economies worldwide for more than a year.

Dimon said he supports the creation of a single bank regulator, a move he said was long overdue.

Another major Obama goal is to do more to protect consumers by transferring consumer protection dealing with mortgages, credit cards, payday loans and other financial products out of 10 agencies and into a new agency.

Dimon agreed with the need to boost consumer protection but warned regulators must be careful.

"Before creating an entirely new federal bureaucracy, policy makers should first examine ways to strengthen and refocus the authority of existing regulators," he wrote. "Creating duplicative and overlapping functions could increase costs and reduce credit opportunities for the consumers we are trying to protect."

A key catalyst for the financial crisis has been the enormous amount of debt shouldered by Americans during a real estate bubble fueled by subprime mortgages that many borrowers could not afford or understand.

As defaults and foreclosures rose last year, exotic financial instruments backed by shaky mortgages broke down and the capital markets froze for a time amid uncertainty about the condition of banks' balance sheets.

The combined effects helped drag the United States into recession.

Dimon said financial institutions need to clean up their act and earn back the public's trust.

"Company leadership must foster a culture within their institutions that focuses on integrity, strong execution, quality products, long-term value creation and doing the right thing," he wrote.

"Golden parachutes, special contracts, and unreasonable perks must disappear."

ABC News - First Madoff Interview: Can't Believe I Got Away with It

"There were several times that I met with the SEC and thought 'they got me,'" Madoff told Joseph Cotchett, a San Francisco lawyer threatening to sue his wife, sons and brother on behalf of a group of victims.

Cotchett said he and his partner, Nancy Fineman, met with Madoff for four and a half hours Tuesday afternoon at the federal prison in Butner, NC, where Madoff is serving his 150-year sentence.

"He looked pretty good and seems to be working out," said Cotchett. "He looked a lot better than he has in some months since I've seen photographs of him."

Click here to go behind the scenes of Brian Ross' investigation into Bernie and Ruth Madoff.

Cotchett said Madoff was "very articulate, very direct" and did not appear to hold back anything. "He talked about how he pulled it off, how many years he got away with it," the lawyer said.

"I was surprised at how candid he was," Cotchett told ABCNews.com after the session, the first time Madoff has talked with outside lawyers. Madoff refused to cooperate with the FBI after his initial, largely untruthful confession last December.

Click here for complete Blotter coverage of Madoff and his Ponzi scheme.

Cotchett said Madoff "did not dodge" any of the questions he asked and that Madoff's lawyer did not object to any of the questions.

"He obviously wanted to speak with us because in his opinion, certain members of his family knew nothing about it, had no involvement of it," said Cotchett who was able to arrange the unusual session after threatening to sue Madoff's wife Ruth.

"He cares about Ruth," said Cotchett, "but he doesn't give a ---- about his two sons, Mark and Andrew." The sons have not spoken with their father or mother since Madoff's arrest on December 11. They say there were unaware of the fraud scheme until he confessed to them as his money was running out and it appeared the crime would be exposed.

Cotchett said he did not yet know if he would name Ruth or the sons in the lawsuit, but that he was almost certain to name Madoff's brother, Peter, who served as the firm's chief compliance officer.

Peter Madoff has declined to comment but others with knowledge of the case say he maintains he did not know of the scam until two days before his brother's arrest.

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