March 2009


Faced with a significant amount of negative press surrounding his administration’s seeming inability to select proper gifts for foreign dignitaries, President Obama has issued a mandate to his staff to find the perfect gift to offer HRH Queen Elizabeth II when they meet in London later this month.

The President instructed White House Chief of Staff, Rahm Emanuel, to provide him with a list of “appropriate gifts, of historical meaning” for HRH and her children. In addition, the gifts should hold significant personal value to both the President, and First Lady.

Our sources in the Obama White House were able to obtain a copy of the short list of possible gifts that will be presented to Mr. Obama pending his final decision:

  • A vase containing the ashes of Mrs. O’Leary’s cow.
  • The First Lady’s personal copy of “Diana, Queen of Hearts.”
  • Season tickets to the Cubs.
  • The white flag hoisted by Lord Cornwallis over Yorktown.
  • Boston.

Mrs. Obama will be personally picking the gifts for the Royal children, rumored to include a make over, and an English bulldog puppy named “Camila.”

The British press is reporting that the President’s gift was delivered to The Queen this last Friday by MI5.

The sealed envelope is rumored to contain a copy of President Obama’s Kenyan birth certificate, with the original having been stored in an undisclosed location by HRH.

During the second Presidential debate in October of 2008, candidate Barack Obama was asked to comment on the recent failures in our financial system. Setting what would be one of the prevailing themes of his campaign, and beyond, Mr. Obama made the following statement:

Let’s, first of all, understand that the biggest problem in this whole process was the deregulation of the financial system.

Is deregulation truly the cause for what is going on in our economy today?

If that is the case, then why are the least regulated sectors of the financial market, the least impacted by the credit crisis?

Hedge funds for instance are chugging right along, yes the market has lost significant value, but the mechanics are functioning properly.

It is the most highly-regulated segment of the financial industry, commercial banking, that is reeling under the impact of this economic downturn, with more bank failures in the first three months of 2009 than anytime since the 1980’s.

In The Man Who Sold the World, I discussed how deregulation brought about by the Commodity Futures Modernization Act of 2000 (CFMA) made it easy for AIG’s Financial Products Division to make billions by selling bond insurance packages known as Credit Derivative (or Default) Swaps (CDS), and how the crash of the housing market in America brought AIG to its knees, as bondholders filed claims on their losses.

To many, the story ends right there…greed and deregulation makes for a much simpler explanation (and better headlines) than the intricacies of banking regulations and the market. But while deregulation was certainly the reason why CDS came into being to begin with, and greed ran rampant in Joe Cassano’s AIGFPD, neither greed nor deregulation explains why banks failed to the degree that they did, inciting the filing of the claims that brought AIG down.

That explanation can be found in an accounting standard known as mark-to-market (MTM) accounting, or the US Financial Accounting Standard Board Rule 157 (FAS 157).

The U.S. Financial Accounting Standards Board Rule 157 was set in place in the aftermath of the Enron scandal, as a reaction to that company’s accounting “standards”. In a nutshell, Rule 157 requires all publicly-traded firms to “mark” (price) assets at current market value. In other words, it forces those firms to tell us what their assets would sell for in the current environment.

The aim of MTM is to establish a realistic picture of a publicly-traded company’s current worth.

Sounds great, doesn’t it?

Who wouldn’t want to know what their investments are worth every day?

This accounting practice works great with stocks, as they are traded daily, and in huge quantities. It doesn’t work for mortgage-backed securities, and those are the assets at the center of this financial crisis.

Here’s why.

Driven by government-mandated lower lending standards (a politicized push to sell more houses to lower-income people) many people who couldn’t realistically afford to buy houses, entered into unrealistic mortgage agreements. Adjustable rate, interest-only mortgages and NINJA (No Income, No Job, No Assets) loans became more prevalent as lending institutions, at the bequest (and with the approval) of Fannie Mae and Freddie Mac, sought to comply with the government’s directive to penetrate America’s lower-income consumer market.

As those Adjustable Rate and interest-only mortgages matured, the increased monthly payments became prohibitive to a substantial number of borrowers. Foreclosures began to rise, interest rates climbed, and loans became more difficult to obtain.

As foreclosures climbed, the supply of homes for sale increased, and as is always the case, increased supply meant lower prices. New home sales decreased by more than 25%, and by September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak.

This is where FAS 157 comes into play. It became a standard precisely as the subprime credit market collapsed.

FAS 157 divides assets into three categories, according to ease of evaluation, with home mortgages labeled as a Level 3 asset, or the most difficult level of assets to value. A home’s value is based on many variants, and to seemingly identical homes may evaluate differently, based on everything from location, to features and upgrades.

Indeed, a home’s worth to a buyer is impacted by something as intangible as location; what is a plus for one buyer, could very well be a minus to another.

According to the accounting rule, banks were forced to report losses (albeit on paper only) as the value of their mortgage holdings began to plummet. FAS 157 pushed perfectly healthy commercial banks into virtual bankruptcy, for no good economic reason. I say “perfectly healthy” because most of these banks had no shortage of actual cash when they began to fail. Rather, because of the mark-to-market rule, they were required to take big paper losses on their portfolios of risky mortgages, even though the vast majority of these mortgage-backed securities were still generating healthy interest payments.

The major portion of the mortgages underlying AIG’s credit default swaps, are 20-year and 30-year home loans, so limiting the valuation of these “hold-to-maturity” investments to current value limits the ability to establish their true worth. The majority of these loans – even the subprime ones – are NOT in default, or even behind in their scheduled payments; less than 2% of US households received at least one foreclosure notice in 2008. Most commercial banks have no intention of unloading these mortgages, yet the mark-to-market accounting rule forces a bank to revalue this kind of asset as if it had to get rid of it in 30 days, at whatever price it could get.

Take your house as an example.

Let’s say that you borrowed against your equity to the point where you are now upside down; you owe more to the bank, than what the house is currently worth. You are however, meeting your monthly obligations and have every intention of doing so until you are either able to sell the house (at a profit, or as a loss), or pay your mortgage off.

FAS 157 forces the bank to take a loss on your home, in spite of the fact that there may never be a loss at all.

Forced to mark down their mortgage-backed securities based on FAS 157, and in order to stay within government regulations, including requirements to maintain certain ratios of capital and liquidity to support their loans, banks were forced to line up capital for their balance sheets. Those that were unable to do so were declared insolvent and taken over by the Federal government. Washington Mutual was one such bank; declared insolvent by Federal regulators, it was sold to JP Morgan Chase and Co. for $1.9 billion. WaMu’s assets at the time it was declared insolvent were significant…$307 billion, including $188 billion in deposits.

The fact that no bank was willing to buy WaMu until it failed shows how badly confidence has eroded in a banking system awash with record profits just a few years ago. Faced with deepening losses on mortgages, credit cards and other loans, big and small banks across the country are struggling with what many bank executives say is a crisis far deeper than the savings-and-loan debacle.

The seizure of Washington Mutual is likely to send tremors through the thrift industry. Many of WaMu’s smaller brethren are also struggling with a wave of bad loans and some have already been ordered by regulators to raise capital and stop growing. — WSJ

Banks are not lending because they need to retain capital to stay within liquidity-to-loan-ratio regulations while their assets devalue. Their assets are being artificially devalued by a change in accounting regulations intended to increase transparency in financial reporting.

The treacherous triumvirate of subprime lending, mark-to-market evaluation, and credit derivatives is proving to be the most formidable adversary faced by this nation’s economy in recent history. The case can be made that regulation…the wrong type of regulation is “the biggest problem in this whole process”, contrary to what then candidate, and now President Obama wants us to believe.

None of this excuses consumers from fault…after all, it was consumers who ran up their unsustainable debt, but it does explain how this crisis came about.

I am fairly certain of one thing however: crafting the destructive policies mentioned above was done with the best of intentions in mind.

Good intentions that paved the road to financial Hell.

It appears that Obama’s constant vilification of American industry is beginning to wake the giant.

March 23 (Bloomberg) — The U.S. Senate last month passed a measure limiting “luxury” spending for corporate travel by recipients of federal bailout funds. Two weeks later, about two dozen senators of both parties left town for political meetings on the Florida coast.

Hotel-industry leaders are seizing on those trips as ammunition in a campaign to get lawmakers and the Obama administration to tone down the rhetoric against business travel, which they say is adding to their economic difficulties.

“It’s just the hypocrisy,” said Frank Fahrenkopf, a former chairman of the Republican National Committee who is president of the Washington-based American Gaming Association, one of the groups urging politicians to moderate the criticism. “We’ve got to have Washington stop beating up on us.”

On March 11, hotel executives including Jonathan M. Tisch, chairman of New York-based Loews Corp., which operates a chain of 18 hotels in North America, Bill Marriott, chairman of Bethesda, Maryland-based Marriott International Inc., the biggest U.S. lodging chain, and Jay Rasulo, chairman of Walt Disney Parks and Resorts, a unit of Burbank, California-based Walt Disney Co. that operates its theme parks, met with President Barack Obama and three Democratic senators to express their concern.

Mark my words.

Atlas will shrug.

It was introduced to the House on December 14 of 2000 by a Republican. Cosponsored by three Republicans and one Democrat, it was never debated in the House.

Its companion bill was introduced in Congress the very next day (just hours before Congressional Christmas break) by a Republican. Cosponsored by three Republicans and two Democrats, it was likewise never debated in the Senate.

It was immediately incorporated by reference into an omnibus budget bill that was passed by a vote count of 290 to 60 in the House. The Senate version passed by “Unanimous Consent.”

It was signed into law by President William Jefferson Clinton on December 21st, 2000, and it provided Joseph Cassano with the opportunity to make more money that he could have ever imagined.

“It” was the Commodity Futures Modernization Act of 2000, the law that deregulated credit default swaps (CDS), making it possible for Cassano, head of AIG’s London-based Financial Products Division (pictured peering from the door of his $11 million home in London) to sell those swaps at an incredible rate, and at great profit to himself and to those around him.

Cassano’s AIGFPD is the acknowledged epicenter of the AIG meltdown which threatens to derail the financial stability of the world.

What is a credit default swap?

It is a contract or insurance policy between a seller (a bank) and a buyer (bondholder). The CDS maintains that the seller agrees to pay the buyer in the event of a bond default or bankruptcy. A CDS is essentially bond insurance.

The idea was presented to Cassano ten years ago, soon after his selection as head of AIGFPD, by derivative specialists from J.P. Morgan: AIG should try writing insurance policies on packaged debts known as collateralized debt obligations (CDO), pooled loans sliced into tranches and sold to investors based on their credit worthiness.

Basically, the proposal meant that the London-based unit was agreeing to provide insurance to financial institutions holding CDO’s and other debts in case they defaulted…much like homeowners are required to purchase mortgage insurance to protect lenders in the eventuality that the borrower cannot pay back the loan.

Because the underlying debt securities were highly rated, AIG Financial Products was more than happy to book income in exchange for providing short-term (according to AIG, four or five years at the longest) insurance policies, Joe Cassano and his colleagues never dreamed that they would actually have to pay any claims. Since AIG was a highly-rated company, it did not have to put up any collateral on the insurance it wrote, making the sale of CDS even more profitable.

These credit default swaps turned AIG’s 377 man office into a veritable cash register…Joe Cassano had discovered a money tree.

Revenues rose from $737 million in 1999, to $3.26 billion in 2005; AIGFPD provided 17.5% of AIG’s operating income for 2005. Along with operating income, personal earnings rose dramatically; Joe Cassano, and the employees of AIGFPD were paid in excess of $3.56 billion in the last seven years, which means that on the average, each person in the unit made more than $1 million per year.

Joe Cassano himself earned $280 million in cash during that period of time– more than AIG chief executives — and for every dollar his financial products unit made, 30 cents came back to Cassano and other top execs.

Meanwhile, back in the United States, things were turning sour on the post 9-11 economic boom. Speculative home buying, spurred by interest rates that hovered around 1%, began to bottom out. In addition, a major push by the Democratic majority in Congress to make buying a home a reality to lower-income families, had Fannie Mae and Freddie Mac lowering down-payment requirements and relaxing lending standards, which added to the already alarming build up of bad mortgage debt. When these new homeowners found themselves incapable of dealing with the increases in their mortgage payments as their interest-only and Adjustable Rate Mortgages, matured, they were forced to walk away from their homes.

The real estate market plummeted. Following close behind it, and possibly as a reaction to the real possibility of Barack Obama (who campaigned on doubling the capital gains tax upon being elected) winning the election, the stock market followed. And AIG’s Financial Products Division suddenly found itself in a position they never expected to be in…they had claims to pay, a lot of claims to pay.

At this point in time, AIG’s Financial Product’s portfolio of credit default swaps stood at $500 billion, and it was generating $250 million a year in income on insurance premiums. AIGFPD was not an insurance company, it was set up as a bank, never required to report to state insurance regulators, and as the worth of the securities they insured declined, they had to put up collateral to their trading partners. Collateral they did not posses.

Any obligations that Cassano’s AIGFPD could not meet had to be paid by its corporate parent, and AIG, the 18th largest public company in the world (according to Forbes Global 2000 list of 2008) was brought to its knees.

Joseph Cassano was fired by AIG in February of 2008 after his unit posted an $11 billion loss, but was allowed to keep $34 million in bonuses, and was kept on as a consultant on a salary of $1 million per month. Since his firing, AIG has posted additional losses of nearly $89 billion, for total posted losses to date of nearly $100 billion. The US government has pumped $173 billion into AIG in an effort to stave off a global financial failure of indescribable proportions.

Unread legislation, slammed through without debate in a show of bipartisan recklessness, signed into law by a lame-duck President in the waning days of his tenure. Thoughtless, politically-driven financial decisions designed to garner votes. Promises of higher corporate taxation from a Socialist Presidential candidate drunk on the wine of populism and hubris. All these factors contributed to this crisis, and led to the loss of untold billions. And Joseph Cassano figured out a way to make all of that pay off in spectacular fashion.

When asked last September if he felt responsible for the AIG crisis, Joe Cassano smiled and said “I left there six months ago.”

Oh no, not me
I never lost control
You’re face to face
With The Man Who Sold The World

Alan Dershowitz shares a rather odd spotlight with Rupert Murdoch today.

In The Jerusalem Post, American Constitutional expert Dershowitz blogs about the recent call by “a group of 16 self-described experts on ‘international justice and reconciliation of conflict'”, among them Bishop Desmond Tutu, for the establishment of “a United Nations Commissions” to conduct an “independent and impartial investigation” of possible Israeli war crimes stemming from its handling of the Gaza conflict.

Bishop Tutu has gone as far as to call the Israeli self-defense actions “unchristian”, indicating that whatever else His Excellency may claim expertise on, religion doesn’t appear to be included among them.

Dershowitz comments on Hamas and the suggestion by that group of sixteen “experts” (excerpted):

There is of course no need to conduct any investigation into whether Hamas has committed war crimes: they readily admit – indeed they boast – that they are trying to kill as many Jewish Israeli citizens as their anti-personnel rockets are capable of killing. They also acknowledge, as a Hamas legislator did on television, that they use women and children as “human shields.”

Only a group as skewed against Israel as this one is would regard the UN as capable of conducting an “independent and impartial investigation” of anything involving Israel.

A UN investigation of Israel – in the face of that body’s absolute refusal to investigate Russia, China, Zimbabwe, Iran and so many other countries that routinely violate human rights in an egregious manner – would constitute a major victory for Hamas’s strategy. It would send a powerful message to all terrorist groups that provoking democracies into responding to attacks on its civilians will result in United Nations condemnation.

Ruport Murdoch strikes a similar position on the Israeli/Hamas conflict in the Opinion section of the publication, within a transcript of his speech to the American Jewish Committee on receiving its National Human Relations Award.

For months now, Hamas has been raining down rockets on Israeli civilians. Like all terrorist attacks, the aim is to spread fear within free societies, and to paralyze its leaders. This Israel cannot afford. I do not need to tell anyone in this room that no sovereign nation can sit by while its civilian population is attacked.

Hamas knows this better than we do. And Hamas understands something else as well: In the 21st century, when democratic states respond to terrorist attacks, they face two terrible handicaps.

THE FIRST HANDICAP is military. It’s true that Israel’s conventional superiority means it could flatten Gaza if it wanted. But the Israel Defense Forces – unlike Hamas – are accountable to a democratically chosen government.

THE SECOND HANDICAP for Israel is the global media war. For Hamas, the images of Palestinian suffering – of people losing their homes, of parents mourning their dead children, of tanks rolling through the streets – create sympathy for its cause.

But I am curious: Why do we never hear calls for Hamas leaders to be charged with war crimes?

Why, for example, do we hear no calls for human rights investigations into Hamas gunmen using Palestinian children as human shields? Why so few stories on the reports of Hamas assassins going to hospitals to hunt down their fellow Palestinians? And where are the international human rights groups demanding that Hamas stop blurring the most fundamental line in warfare: the distinction between civilian and combatant?

Bishop Tutu and the cause of justice would be better served by demanding that Hamas be investigated for war crimes against both the Israeli and Palestinian peoples.

Now THAT would be the Christian thing to do.

The media coverage of the AIG $165 million bonus, and the “outrage” exhibited by the Obama administration and Congressional Democrats helped keep an interesting item from receiving much attention yesterday:

WASHINGTON – The Federal Reserve Wednesday escalated its massive campaign to stabilize the economy, saying it would flood the financial system with an additional $1.2 trillion.

One-point-two trillion dollars…to put it into perspective, that’s roughly $165 billion times 7,300.

And this is not the first time that the Fed has engaged in this sort of thing…

Nov. 10 (Bloomberg) — The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.

Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn’t require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.

So, between the two trillion in November, and yesterday’s trillion point two, eighteen thousand times the $165 million of the taxpayer’s money that Obama and the Democrats want us to focus our attention on, has been given to someone (or someones) without Congressional approval, or any kind of oversight…and the Fed will not disclose the name of the recipients, or what they put up in collateral for these “loans”.

There’s just so much irony in this story, that comments are unnecessary:

FOX News

Three global warming researchers stranded in the North Pole by cold weather were holding out hope Wednesday as a fourth plane set off in an attempt deliver them supplies.

The flight took off during a break in bad weather after “brutal” conditions halted three previous attempts to reach the British explorers who said they were nearly out of food, the Agence France-Presse reported.

“We’re hungry, the cold is relentless, our sleeping bags are full of ice,” expedition leader Pen Hadow said in e-mailed statement. “Waiting is almost the worst part of an expedition as we’re in the lap of the weather gods.”

…and those weather gods apparently have a sense of humor.

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