Market Talk

The market got a fresh jolt this afternoon, when it was reported that the NY Fed is one of the entities suing Bank of America over mortgage secutiries in an attempt to get BofA to buy back soured mortgages. The inclusion of the names seemed to really grab people’s attention; after all, the story had been reported this morning in the Journal, but sans names was buried in the public consciousness under China’s surprise rate hike and high-profile earnings.

So, why is the Fed forcing an issue like this? Whether BofA should be forced to absorb those loans isn’t the issue I’m getting at. This move runs counter to everything the Fed’s done to prop up the banks since the crisis started. It just seems, well, odd.

The consortium includes the NY Fed, BlackRock and Pimco, according to Bloomberg. Those are big, big names. Those are names that carry a lot of water in the markets. The NY Fed, a branch of the Federal Reserve, is ostensibly an independent entity, but obviously is rather closely aligned with the government. Pimco and BlackRock are obviously independent entities, but collect fees for advising the government in various capacities. I’m not suggesting this is some government-sponsored action. I’m not sure if there even is a point there. But it sure is interesting.But the Fed’s involvement seems very odd to me. We’re talking about the central bank here.

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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.

How long should we wait?

Former Dallas Fed President Bob McTeer posted a short blog post yesterday saying people shouldn’t rush to judgment on the AIG bailout and how the NY Fed caved in to demands from AIG creditors. The growing consensus is that the NY Fed should’ve negotiated a haircut on money owed to AIG counterparties instead of paying 100% on the dollar. But McTeer says more time is needed to properly analyze the situation.

Apparently, 14 months isn’t enough time.

McTeer argues the point of bailing out systemically important institutions is to limit collateral damage. “If that is the rationale of the assistance, it would seem inconsistent to intervene and then inflict the damage on counterparties that the intervention was intended to prevent,” he says.

That’s fine. He then he goes on to say that extraordinary events of the financial crisis seemed to occur at once in September 2008.

“Monday morning quarterbacking over a year after shouldn’t assume that what has become clearer in the past year was clear then,” he says.

That’s where we take issue with the learned gentleman.

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