Market Talk

Never let it be said that we don’t work our tails off here at Market Talk to get you the news. We have in our hands an advanced, embargoed, exclusive copy of Goldman Sachs chieftain Lloyd Blankfein’s testimony to the Senate Permanent Subcommittee on Investigations, which he will deliver later today.

It took the work of secret couriers, an indigenous Vietnamese agent named Co Bao (“You weren’t expecting a woman, were you?”), one Groucho Marx disguise, and a punk staffer in the Senate who’s shorting the testimony, but here — finally — we got it:

“The issue here is not whether we broke a few rules, or took a few liberties with our in-the-dark counterparties; we did.

“But you can’t hold a whole bank responsible for the behavior of a few sick, perverted individuals. For if you do, then shouldn’t we blame the whole banking system? And if the whole banking system is guilty, then isn’t this an indictment of our financial institutions in general?

“I put it to you, Carl Levin! Isn’t this an indictment of our entire American society? Well, you can do what you want to us, but we’re not going to sit here and listen to you bad-mouth the United States of America! Gentlemen!”

Oh, wait, that’s Eric Stratton’s testimony. I guess we don’t have Lloyd’s after all.

If you want to understand why the current efforts at financial reform fall far, far short of what’s needed, go buy the Journal today and read the lead story on page C1, “Big Banks Move to Mask Risk Levels.”

The financial industry will do absolutely anything, to turn a profit, no matter how risky, how dangerous, how amoral. The culture on Wall Street is so obsessed with profits, and short-term profits to boot, they will never learn a lesson, they will never change a habit if it involves shaving even a basis point off their profit margins. They will use every trick and gimmick at their disposal, well past the spirit and right up to the very letter of the law, and no oversight council or consumer protection agency is going to be able to keep up with them.

Kate Kelly writes in the Journal:

Major banks have masked their risk levels in the past five quarters by temporarily lowering their debt just before reporting it to the public, according to data from the Federal Reserve Bank of New York.

A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters.

In any real sense, this is cheating. They are using accounting and balance sheet tricks to hide their debt levels when they report them, knowing full well that excessive leverage led directly to the financial meltdown of 2008. Somehow, though, through sieve-like accounting rules, this is allowed.

And this is what they’ve been doing after their near-death experience. This is essentially, the same kind of thing Lehman Brothers did, the infamous Repo 105, that precipitated that firm’s demise. To be sure, Lehman took it a step further, parking the assets in off-balance sheet vehicles and pretending their didn’t exist. But the effect is the same: to make highly leveraged companies look less highly leveraged.

This kind of thing illustrates why the Dodd bill’s focus is all wrong: what the nation needs — not the financial industry, but the nation — isn’t an oversight council trying to catch these little devils (to be polite,) what the nation needs are hard and firm rules for the financial industry. And the rules should run past whatever line the bankers want to draw, because it’s obvious they will run right up to, and perhaps even through, whatever line eventually does gets drawn.

On today’s News Hub, we wonder if Wall Street dodged a bullet, and look into that annual springtime ritual, calculating how much money corporate America loses due to hoops-addicted employees watching the NCAA tournament.

Let's see them pearly whites!

Tomorrow we’ll find out for sure what Sen. Chris Dodd has in mind in terms of financial reform, before he retires to his humble cottage on the wild, wind-swept Irish west coast. Early reports this weekend are encouraging, in that the Senate proposal appears to have more teeth than previously assumed.

But given the almost lock-step opposition from the GOP, its survival is still up in the air. And some of those teeth may yet fall out.

From the Journal:

Senate Banking Committee Chairman Christopher Dodd (D., Conn.) is finalizing a bill to rework financial market rules that is expected to be tougher against banks than previously expected, people familiar with the matter said.

The biggest winner in the bill appears to be the Federal Reserve, which would see its powers expand considerably. Large financial companies, particularly big banks, could emerge as the biggest losers. They would face much higher scrutiny from bank supervisors and potentially face sanctions for violating consumer protection rules by an autonomous new division within the Fed.

The Fed kind of wins and loses. It gets the new protection agency, and the authority to monitor any financial institution with assets over $50 billion. But it currently overseas more than 5,000 banks of all sizes. Consumers kind of win and lose, too. The consumer protection agency will be created, but it would be housed within an institution that doesn’t exactly have a sterling record in regards to its regulatory and consumer-protection efforts.

The Times notes the bill includes provisions for regulating derivatives, and adds in some window dressing in the form of a few shareholder-friendly proposals, like a non-binding “say on pay” vote and the ability to nominate directors through proxy ballots.

The Volcker Rule doesn’t seem like it’s going to make it, but regulators will have some say over what kinds of activities regulated banks can engage in, if they threaten the bank or the economy.

There’s a long road to go here, and the details need to be hammered out. But we are getting relatively hopeful signs this weekend. It’s something.

Repo 105? Yeah, let's do 105. And 106, and 107, and 108, and 109...

So I had some things I wanted to write about, Jon Kyl’s pathetic bashing of the unemployed, the parallels between Greece and the states of the United States, the continued foot-dragging on financial reform, but this Lehman report thing, well it’s jumped to the top of the charts — with a bullet. There are so many things to talk about with this report it’s hard to know where to start.

Let’s start with the five W’s:

A scathing report by a U.S. bankruptcy-court examiner investigating the collapse of Lehman Brothers Holdings Inc. blames senior executives and auditor Ernst & Young for serious lapses that led to the largest bankruptcy in U.S. history and the worst financial crisis since the Great Depression.

Accounting fraud? Off-balance-sheet debt? Lies? Deceict? Auditor negligence? What are we talking about here, Lehman Brothers or Enron? Congress should repeal Sarbanes-Oxley and start over, because this report makes it fully, painfully obvious that we learned absolutely nothing from Enron’s collapse (we did get a hit Broadway show out of it, though, so it’s not a total loss.) We allowed the same exact kinds of fraud that eventually sank Enron to remain on the scene, and get picked up by other players eager for a quick buck, despite the much despised Sarbox rules.

Al Capone kept cleaner books than these guys. And ask yourself this: do you really think Lehman Brothers and Enron were the only two companies that did this stuff? Who’s being naive now, Kay? The report also makes clear, because clearly it wasn’t clear to some interested parties, that the accounting rules need to be part and parcel, and a big part and parcel, of any and all financial reform.

This report is a daisy cutter through all the self-serving defenses for saving the banks, and more than one reputation is likely to be ruined by it. The financial meltdown wasn’t some hundred-year storm, and it wasn’t a crisis of confidence, and it wasn’t an attack of short sellers. It was a willful, conscious, mad dash for money, come hell or high water. Both eventually showed up.

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Satyajit Das, author of “Traders, Guns & Money, in a long-but-worth-your-time guest post at naked capitalism, lays out the depressing, albeit likely, route that derivatives regulation is likely to take (which at one point I recall was estimated to be a $62 trillion market. Not sure where it is now, or, given Das’ post, how anybody could even know.) He explains in detail the extreme granular complexity of the market, which itself is a formidable obstacle to regulation.

Keep in mind here, the banking lobby is a very well-oiled machine, and will throw whatever needs to be thrown in the path of any new rules that might crimp profits. Given everything that has happened, it’s beyond me that strong regulation of the derivatives market would not be a cornerstone of any reform plan that comes out of Congress, but this isn’t the sharpest Congress we’ve ever had.

From Das:

Debate over regulation of financial services has taken on a frenzied tone. Regulators and think tanks are producing voluminous, overlapping and (sometimes) contradictory proposals. Regulatory agencies are jockeying for position, sometimes forming unlikely coalitions to preserve or expand territory. In the U.S. Congress, multiple bills and several committees are jostling to make sense and harmonise complex and irreconcilable draft legislation. Activity and achievement are confused.

Banks and their lobbyists do not believe that there is a case for regulation. In William Davenant’s words: “Had laws not been, we never had been blam’d; For not to know we sinn’d is innocence.”Banks argue that the complex nature of derivative trading dictates that self-regulation is the only feasible approach. If that fails, then banks seek to minimise scrutiny of major issues, such as the size of the market, speculative activity, pricing issues, complexity and mis-selling of derivatives to unsuitable clients. They argue that existing regulations already adequately cover some issues. Proposed regulations will be masterfully narrowed to minimise impediments to profitable activities.

There will be a familiar threat. Lack of international agreement and regulatory uniformity makes compliance impractical. Banks and derivative activity will relocate with losses of jobs and taxes to the host country. Familiar arguments will be heard regarding the loss of competitive advantage, diminished financial innovation, slower capital formation and higher cost of capital. Each is a well-known step in the familiar “regulatory tango”.The complexity of the issues means that ultimately no laws may be truly effective. As one famous law maker, Adlai Stevenson, observed “Laws are never as effective as habits.”Groucho Marx observed that “[government] is the art of looking for trouble, finding it, misdiagnosing it and then misapplying the wrong remedies.” Legislators and regulators are likely to discover the truth of that proposition in their attempts to regulate the derivative market.

Wall Street may be great at many things, like making money (however they manage to make it,) but they stink at one thing: regulating themselves. Amid all the things that need to be fixed about the financial industry that we’ve focused on this week, we’ve neglected to mention the issue of self-regulation.

Our colleague Kristen McNamara filed this snippet earlier this afternoon that corrects that oversight:

Congressional efforts to reform the financial regulatory system haven’t adequately addressed the failures of self-regulatory organizations charged with protecting investors and maintaining financial market integrity, the Project On Government Oversight, a nonprofit government watchdog, wrote in a letter to Congressional leaders.

The group urged Congress to take a closer look at the Financial Industry Regulatory Authority, which oversees the securities industry

The watchdog says Finra failed to prevent scandals, including the fraud committed by Bernard Madoff and Allen Stanford, due to its close relationship with the securities industry. Congress should consider curtailing the power of SROs in favor of independent regulation, the group wrote.

I’ve long considered the whole earnings vs. Street expectations thing to be one big rigged game. When writing about earnings, I try as much as possible to avoid even talking about “Street expectations,” preferring instead the more reliable comparison to the previous year’s corresponding quarter. This is the best comparison of a company’s sales and earnings; sequential comparisons are helpful but, given the seasonality with some companies, can be misleading (think about a retailer’s fourth quarter compared to their first.)

I long ago developed a mistrust of “Street expectations.” For one thing, those “expectations” are largely based on “guidance” supplied by the companies themselves. Not hard to see the ripe opportunity for gaming there. For another, it was always curious how some companies always beat expectations — GE is absolutely notorious for it — and I’ve always suspected that it was pretty easy for the accountants to come up with a number that somehow “topped” what the Street was looking for. A tax loss here, a carry-forward there, mark this one to make believe, it’s not that hard when you think about it. There are probably hundreds of ways to do it.

Now, though, we have some measure of proof that companies are “managing” earnings per share in order to beat expectations. From the Journal:

A new study provides further evidence suggesting many companies tweak quarterly earnings to meet investor expectations, and the companies that adjust most often are more likely to restate earnings or be charged with accounting violations.

The study, which examined nearly half a million earnings reports over a 27-year period, reached its conclusion by going beyond the standard per-share earnings results that are reported in pennies and analyzing the numbers down to the 10th of a cent.

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Today’s Upshot column takes a look at dividends; scoffed at during the go-go days, an attractive haven during turbulent times. And while corporate profits are returning, and more companies are starting to increase dividends, the numbers don’t quite match the profit growth.

February is a big month for dividends; companies have closed the books on the old year, shareholders meetings are coming up. So we may see a trend emerge this month. But it hasn’t quite happened yet.

From the Journal (yes, it’s behind the pay-wall; subscription required):

Nothing spells success to a corporation like rising cash balances. And nothing signals a company’s good fortune quite like a juicy dividend increase.

That’s why the early look on dividends this year is so disconcerting. Corporate profits are rebounding and more companies reporting they are feeling better about their finances. But a smaller number are being more generous toward their shareholders.

Of course, you know, this means war!

President Obama, in full populist rhetoric, tsk-tsked the bankers today, and swore to make them pay for their “obscene” bonuses  — literally, by proposing his bonus tax, or whatever fancy name he’s given it. (For the record, they’re calling it a “financial crisis responsibility fee.” Sounds like they’re charging a fee for being responsible, no? Is that ironic or what?) He said he’s committed to getting back “every single dime” the American people are owed.

Don’t get me wrong,  I have no sympathy for the banking industry, which deserves its fair share of the blame for the financial meltdown. But the president’s little assault today is just a blatant attempt to draw some popular support, or at least deflect popular anger.

To be sure, in some ways, the banks brought this on themselves. As my colleague Madeleine Lim commented during today’s Tomorrow’s News Today (coming later this afternoon,) among all the various parties that bear some responsibility for the housing crash and credit crisis, the banks remain the most tin-eared.

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