April, 2010 archive

David Weidner at MarketWatch predicts that forcing banks to spin off the units that market derivatives would

strike a blow to heart of the industry that would, more than any regulation, change the way the industry does business.

They go on to say, in the same story (emphasis added),

Derivatives — contracts based on underlying securities such as commodities, mortgages, stocks and bonds — represent an estimated $500 trillion market used across Wall Street to hedge, insure and bet on the future prices of those underlying assets. It represented $20 billion in revenue last year to Wall Street.

Actually, they didn’t insure anything. We have seen how that worked. As soon as the real estate and related credit markets fell, they became (remember this phrase?) “toxic assets,” toxic because they were worthless.

What the heck kind of insurance is that? (Oh, I forgot, it’s like WellPoint heath insurance–great as long as you don’t get sick.)

MarketWatch concludes

The unintended consequences of such a move could be devastating to banks such as Bank of America Corp., Citigroup Inc., and J.P. Morgan Chase & Co. On
the other hand, the move would definitely bring much needed credit evaluation since banks would no longer be able to take insurance on their risk.

“Devastating,” I reckon, because they would have to stop the three-card monte and pay attention to fiduciary responsibility and sound business practices–things they may have forgotten how to do.

That should be an intended consequence.

Simon Johnson on Goldman’s creating bad investments so others could turn around and bet against them while Goldman collects fees from both sides. Remember, these guys are making money from primarily from fees and sales, not from growth in the value of investment.

They have no incentive to care about value when fees and sales pay for their mansions in Greenwich (emphasis added):

The SEC lawsuit and associated discussion make clear three points:

First, Goldman Sachs had great difficulties managing its operational and reputational risks during the boom. In testimony before the Senate Banking Committee in February, Gerald Corrigan, former head of the New York Federal Reserve Bank and a longtime Goldman Sachs executive, argued that the firm’s risk- management systems are world class. That may be the case, but “world class” looks much less than perfect when Goldman Sachs treats so many of its customers in the fashion described in the SEC’s suit.

This reinforces the widely held — and correct — notion that our largest banks have become too big and too complex to manage properly.

Second, whether the SEC prevails in court, to mainstream opinion the case confirms — in excruciating detail — what Sen. Ted Kaufman, D-Del., has been arguing for a considerable time: There is fraud at the heart of Wall Street.

Third, the great myth of finance has been exploded. In its heyday, leading policy makers such as former Treasury Secretary Robert Rubin, another one-time Goldman Sachs banker, were proud to preside over ever-more unregulated financial markets. In the aftermath of the Goldman Sachs case, and much else since September 2008, even Rubin now is at pains to claim — implausibly — that he has always favored regulating derivatives. The question now isn’t whether to regulate, but rather how to make regulation much more effective.

Meanwhile, Paul Krugman looks at the ratings agencies. Guess what? They also make their money from fees:

The Senate subcommittee has focused its investigations on the two biggest credit rating agencies, Moody’s and Standard & Poor’s; what it has found confirms our worst suspicions. In one e-mail message, an S.& P. employee explains that a meeting is necessary to “discuss adjusting criteria” for assessing housing-backed securities “because of the ongoing threat of losing deals.” Another message complains of having to use resources “to massage the sub-prime and alt-A numbers to preserve market share.” Clearly, the rating agencies skewed their assessments to please their clients.

These skewed assessments, in turn, helped the financial system take on far more risk than it could safely handle. Paul McCulley of Pimco, the bond investor (who coined the term “shadow banks” for the unregulated institutions at the heart of the crisis), recently described it this way: “explosive growth of shadow banking was about the invisible hand having a party, a non-regulated drinking party, with rating agencies handing out fake IDs.”