Will I be hired as the Chairman of the Board for Common Securitization Solution, LLC?

Given that I literally invented the idea of a common securitization platform and know more about how this business should operate than literally anyone else, I wonder if the executive recruitment firm hired by Fannie Mae and Freddie Mac will identify me as one of the candidates for being the Chairman of the Board of the joint venture, the Common Securitization Solution, they are forming?

As reported by National Mortgage News,

The government-sponsored enterprises are making significant progress toward creating a common securitization platform for the issuance of Fannie Mae and Freddie Mac MBS, according to the GSE regulator. 

The Federal Housing Finance Agency said that Fannie and Freddie have leased office space in Bethesda, Md., for the joint securitization venture. And a certificate of formation has been filed with the Delaware secretary of state to create a limited liability company that will be called Common Securitization Solutions LLC. 

In addition, an executive recruitment firm has been retained to identify candidates for the positions of chief executive officer and chairman of the board of managers for CSS, the FHFA said Monday....

Once completed, the common platform will issue Fannie and Freddie MBS and possibly private-label MBS.

Writing book on FDR Framework & current crisis

For the next couple of weeks, I will be finishing writing a book on the FDR Framework and our current financial crisis.  As a result, I will not be blogging, but instead using twitter.  Please follow me on twitter under @tyillc.  Thanks.

Coming this fall will be a series of posts on how Fannie and Freddie building and/or being involved in the day to day operation of the securitization platform has already resulted in and will continue resulting in the US taxpayer being screwed.

London Whale trading scandal legacy is requirement banks disclose their exposure details

The JP Morgan London Whale trading scandal showed how important it is that all market participants, not just management and regulators, have access to each bank's current global exposure details.

For example, when everyone can see a bank's proprietary trades, banks don't make these bets.  JP Morgan demonstrated this fact by closing its position as quickly as possible after the position had been "leaked" to the marketplace.

In his Guardian column, Nils Pratley looks at how the trading scandal demonstrates that JP Morgan is too big to manage and too big for regulators to oversee.  If it is too big to manage or regulate, the logical conclusion is that it should be shrunk.

But how do you effectively shrink JP Morgan or other similar Too Big to Fail bank and exert restraint on it so it doesn't become a problem in the future?

By requiring the bank to provide transparency into its current global asset, liability and off-balance sheet exposure details and letting the market exert discipline.

With transparency, the first thing to go are its proprietary bets, as oppose to the market making positions, as the bank doesn't want the market to trade against its bets.  Hence, we get compliance with the Volcker Rule without 500+ pages of regulations.

With transparency, the second thing to go are the thousands of subsidiaries that exist for regulatory or tax arbitrage.

In short, with transparency, market discipline gives each bank the incentive to reduce its risk profile and organizational complexity as the failure to do so results in a lower stock price and higher cost of funds.

Too big to manage? Too big to regulate? Both criticisms of JP Morgan should ring loud and true for readers of the various regulatory postmortems on the bank's "London Whale" trade. 

From chief executive Jamie Dimon's initial dismissal of the affair as a "tempest in a teapot" to the various botched internal investigations, this was a corporate calamity. 

And the worst part was JP Morgan's high-handed attempt to deceive regulators. The UK's Financial Conduct Authority says it was "deliberately misled" by London-based executives on one occasion. 

Please note that requiring exposure detail transparency would have prevented this entire scandal.

First, the bank wouldn't have made the proprietary bet.

Second, even if it did make the proprietary bet and take on the risk of the market trading against it, management would have been able to get a clear picture as it too could have seen the trades.

Third, there would have been no reason for management to lie to the regulators as the regulators could easily verify, with the assistance of other market participants, what they were being told by the bank.

Total fines of $920m (£574m), to add to the $6bn loss from the trading activities themselves, will destroy any lingering notion that JP Morgan was the smartest manager of risk on Wall Street. 

The FCA's report reveals the bank's almost comical inability to get a handle on its credit derivative exposures even after senior management realised there was a crisis.... 

Incompetence is one thing, of course. Misleading regulators is the serious part of this scandal. 

JP Morgan's behaviour was brazen and extraordinary. In a discussion with the UK regulator in March 2012, JP Morgan staff in London didn't mention that traders on the synthetic credit portfolio – the source of all the problems – had been told to stop trading. 

That was a basic piece of information to reveal. 

The following month, on a conference call, London executives said there had been no material changes to the portfolio since the March meeting. In fact, the portfolio was expected to lose a significant amount of money that very day, pushing losses for the year beyond $1bn, as London management had been told by their traders prior to the call with the regulator. 

Thus the FCA's damning assessment that it had been deliberately misled.

We need a fair system for restructuring debt

Since the beginning of the financial crisis, your humble blogger has predicted that the global economy will not recover until creditors recognize their losses on the debt in the financial system that will never be repaid.

Embedded in this prediction is the notion that a fair system can be developed for rapidly restructuring this debt.

The closest we have come to a fair system for rapidly restructuring debt is Iceland.

Iceland adopted the Swedish Model for handling a bank solvency led financial crisis and required its banks to recognize upfront the losses on the excess debt.

Specifically, the banks had to write down the value of their loans to a level where the borrower could afford the repayment.  Affordability was based on standards like limiting debt payments to 35% of gross income.

However, there were limits placed on this write down.

Specifically, if an independent third party would pay more for the asset collateralizing the loan than the supportable loan amount, the banks only had to write down the loans to this level.  This meant the write down was limited so that it would not create any equity for the borrower.

On the surface, this system for restructuring appears fair.

The creditor takes responsibility for the portion of the loan that exceeds the borrower's capacity to repay.  This is as it should be as the creditor is suppose to evaluate the borrower's repayment capacity and not extend debt in excess of this level.

The borrower takes responsibility for paying what they can afford.  They cannot simply walk away from the debt.

Please note that this system for restructuring debt could be applied to sovereigns as well as to individuals and companies.

In an interesting column, Joseph Stiglitz argues that a fair system for restructuring sovereign debt is needed.

In debt crises, blame tends to fall on the debtors. They borrowed too much. 

But the creditors are equally to blame – they lent too much and imprudently. 

Indeed, lenders are supposed to be experts on risk management and assessment, and in that sense, the onus should be on them. 

The risk of default or debt restructuring induces creditors to be more careful in their lending decisions.

As JP Morgan pays over $1 billion in fines today, it is worth noting bad behavior occurs across banking industry

As JP Morgan pays over $1 billion in fines today (including for lying about London credit default swap trade and for lying about credit card add-on products it charged for but didn't provide), it is worth noting that the fines are a cost of doing business and that this type of behavior cuts across the entire banking sector.

Regular readers know that the only way to change bank behavior for the better is to require transparency.  Specifically, transparency under which the banks disclose the current global asset, liability and off-balance sheet exposure details.

Why transparency?

Because sunlight is the best disinfectant.  With exposure detail transparency, sunlight is shown on the banks and all of their activities.

Gone are the days of misleading or politically bullying their regulators as market participants can use this data to independently assess what banks are doing.  Based on this independent assessment, market participants can exert market discipline on the banks; something that has been absent for the last 40 years.

Zoe Williams nicely summarizes the bad behavior of the banking sector and why transparency is needed in her Guardian column.

Putting aside the people who just can't bear for this to be true, it is plain to everyone that the main high street banks are morally bankrupt. If only we could have bailed them out morally instead of financially – I feel sure our moral deficit would have been easier to pay down. 

Two scandals hit Barclays this week within 24 hours of each other – in one it is contesting a £50m fine for reckless Qatari fundraising that it hadn't told its shareholders about. In the other, it may have to repay £100m for mistakes (in its favour) made in personal loans. 

This doesn't tell us much we didn't already know. 

We knew from Liborand the mis-selling of personal protection insurance that cheating people has become peer-normalised among the main banks, and we know this has been going on since at least 2005. 

There has been a moral deficit since then, and the crash didn't make a dent in it. 

We also know, from those epic fines issued by the Financial Services Authority (now the FCA) over Libor, that much of the punishment is as good as meaningless. Money was just taken from one bank and distributed among the others. This only works if just one of them is crooked. When they all are, it's just a kitty....

We spend so much time talking about this titanic clash between the free market and the social state – yet ignore the fact that most of our major "markets" no longer operate as such. 

This is an oligarchy whose only governing authority is the administrator of wrist-slaps, and whose principles begin and end with the preservation of its jointly and severally managed profit. 

Which is to say that they're not competing against each other; they collaborate brilliantly – which would be sweet to watch were it not for the fact that they are working together the better to screw us. 

When you criticise a bank, you are often accused of the crime of "minding profit". I don't mind profit. But the system as it stands has come untethered from all the principles by which profit justifies itself. 

Buyers and sellers are only equal parties working towards mutually beneficial deals when both have all the relevant information. 

Generally we have no information and discover what the banks are up to roughly six years later, if at all....

[RBS] has all the garden variety failures that affect me personally as a customer – you can check them on a scorecard produced by Move Your Money – as well as occupying the hot epicentre of an FT diagram which details the causes of the 2008 financial crash. 

That was a complicated disaster, caused by bad lending, bad investments, risky funding structures, low capital, and mergers and acquisitions. RBS alone had a finger in every pie chart (it is actually a Venn diagram). 

So this institution is at the very heart of an event that has caused misery for millions of people, not to mention lobotomised our political culture...

Why we are not in recovery mode or having seen the end of QE

Deutsche Bank's Jim Reid, global head of fundamental credit strategy, explained why the global economy is not in recovery mode and why we have not seen the end of QE:  too much debt that will never be repaid still in the financial system.

“Nominal GDP growth is important because of the level of debt we still have in the system,” he told an audience on asset owners and their advisors. 

“At an aggregate level, we’re still on a huge pile of debt: if there’s little growth, there’s little chance of eroding that debt. And that makes us vulnerable to market shocks.”...

Please re-read Mr. Reid's observation that effectively we have not reduced the excess debt in the financial system since the financial crisis began.

This lack of debt reduction reflects the policy choices made and still being implemented to deal with a bank solvency led financial crisis.

Specifically the choice to adopt the Japanese Model and protect bank book capital levels and banker bonuses at all costs.

Just like Japan, the EU, UK and US has made little to no progress in restructuring the excess debt in their financial systems.  The burden of the excess debt has instead been placed on the real economy where it diverts capital needed for growth and reinvestment to debt service.

The result of adopting the Japanese Model has been the same economic malaise that has plagued Japan for the last 2+ decades.

Part of the situation has been caused by monetary policy interventions being directed at the wrong end of the market, Reid continued. 

Quantitative easing (QE) has resulted in an inflation in asset prices, but the money isn’t trickling down into the public’s pockets, making those wealthier people with assets better off, and the poorest people worse off, Reid said. 

This led to an effective propping up of the inefficient resources in our economies, instead of a radical redesign, he said. 

The financial system doesn't need a radical redesign.  It just needs to be used the way it was designed in the 1930s.

Specifically, policymakers need to adopt the Swedish Model which a modern banking system was designed to support and have the banks recognize upfront the losses on the excess debt.

This ends the excess debt burden on the real economy and allows capital to flow to where it is needed for growth, reinvestment and support of the social programs.  The Swedish Model also ends the need for all sorts of monetary policies like QE and ZIRP.

Banks are able to support the Swedish Model because of the combination of deposit guarantees and access to central bank funding.  With deposit guarantees, taxpayers are effectively the banks silent equity partners when the banks have low or negative book capital levels.

One partial consequence of QE and the greater access to refinancing methods is a decade of record-low default rates, making credit an attractive asset class for investors seeking greater returns in a low-yielding environment. 

Under normal circumstances, withdrawal of QE should lead to default rates increasing, as money is removed from the refinancing pool. 

But Reid argued central banks and governments won’t be able to accept a rising default rate as they want to keep markets calm. This will force central banks to put yet more unconventional monetary policies back on the table. 

Even worse, this will in turn hamper GDP growth by allowing bad companies to continue running, blocking more efficient, better performing new companies from breaking through. 

“The authorities are trapped,” he said. “I predict this low default rate environment will stay that way for a couple of years. But this isn’t a free market, it’s not capitalism. 

“A normal default cycle is good: if companies go bust it cleanses the system and allows entrepreneurial spirit to come through. I expect that default rates will be kept artificially low to keep the markets calm… it will get to the point where it chokes off economic activity.”

Please note, just like Japan, there is no endpoint for QE and a return to a "normal" capitalistic financial market where default rates are allowed to fluctuate freely.

Roger Lowenstein: Obama should name banker, not economist, to Fed

In a Bloomberg column that sent fear through macro economists everywhere, Roger Lowenstein laid out the case for why Obama should appoint someone other than a macro economist as the next chairman of the Fed.

Mr. Lowenstein looked at the task at hand and identified what he felt were the credentials the next Fed chairman should have.

Rather remarkably, your humble blogger possesses these credentials.

Mr. Lowenstein left out the two most important credentials for the next Fed chairman.

First, did they predict the financial crisis.  This is important because it strongly suggests that they had an insight into why the crisis occurred.

Second, do they have a plan for ending the financial crisis and restoring the economy and financial markets to normal functioning based on this insight.

I have written extensively on this blog about how I would end our bank solvency led financial crisis.  Virtually every aspect of my plan can be implemented by the Fed chairman.

As the head of bank regulation, the chairman has the power to bring transparency to the banking system and require banks to disclose their current global asset, liability and off-balance sheet exposure details.

As the head of monetary policy, the chairman has the ability to raise short-term interest rates above 2% and eliminate the economic headwinds caused by ultra-low rate monetary policy.

Mr. Lowenstein observed:

But the next chairman will have to decide when to trim the Fed’s portfolio, swollen with its extraordinary program of bond purchases. And it will have to raise short-term interest rates, which are currently near zero. It may be sooner, it may be later -- the moment will come. 

Money cannot be free forever. 

To make this decision, the Fed should be led by a fresh pair of eyes -- one not compromised by its current policies....

And what will these fresh pair of eyes see?

ultra-low interest rates are punishing savers and discouraging thrift, not a healthy condition. 

Investors are responding to razor-thin yields by “looking for yield” in suspect places. (Rwanda offered $400 million of debt this year, and the issue was wildly oversubscribed.) 

As we’ll recall from the mortgage crisis, chasing yield can lead to big trouble....

If ultra-low interest rates worked as a monetary policy for ending a bank solvency led financial crisis, then Japan's crisis should have been over years ago.  Instead, Japan has had ultra-low interest rates for 2+ decades.

In addition, there was no reason to believe ultra-low interest rates would work as Walter Bagehot, the founder of modern central banks, set the minimum interest rate at 2%.  He observed that there are changes in economic behavior that occur below 2%.

History suggests that moving away from zero rates will be unpopular and difficult -- especially for a Fed on cozy terms with the White House....

Actually, moving away from zero rates would be incredibly popular with individuals who save and invest.

Moving away from zero rates would be unpopular with the banks.

For those of us who are concerned with fixing the financial system and restarting the economy, winning popularity contests is not a consideration.

If the next chairman isn’t a Washington hand, who should it be? 

It is too soon after 2008 to tap an executive from Wall Street, which bundled the toxic mortgages at the heart of the crisis. That rules out William Dudley, president of the New York Fed and a former Goldman Sachs Group Inc. economist. 

There is no head-hunting recipe for a Fed chairman, but knowing a little institutional background helps....

I got this credential covered.

In recent times, the Fed has been dominated by policy makers. Bernanke was an academic and then a government official (Yellen has a similar background, though she also ran the San Francisco Fed). Greenspan was a consultant and adviser to President Gerald Ford. Geithner was a Treasury official before taking over the New York Fed. 

But Paul Volcker, the most independent Fed chairman in history, was a banker -- president of the New York Fed and an economist at Chase Manhattan Bank when Chase was a lender to corporations....

I got the banking credential covered.

Rather than look for a consultant, an academic or a regulator, Obama should nominate a chairman with an institutional grasp of the banking system.

I have the required institutional grasp of the banking system.

Regular readers have read literally hundreds of posts that I have written on how a modern banking system is designed and how it can be used to end our financial crisis.

Is Barclays raising capital simply to absorb existing losses on its balance sheet?

In its independent analysis of Barclays, PIRC, a UK institutional investor consultancy firm, raises the question of is the bank raising capital simply to cover losses that already exist on its balance sheet.

Regular readers know that this question would be easy to answer if banks like Barclays were required to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants could independently assess the exposure details and determine if and where any losses might be.

Barclays AGM in April 2013 was against a backdrop of the company denying the PIRC analysis that it needed more capital due to overvalued assets, whilst at the same time seeking a general authority to issue new shares. 

The rights issue announced in July 2013 as a result is contrary to that denial and there will not be an EGM to give accountability for the rights issue and its reasons. 

Furthermore, inspection of the rights issue announcement reveals that the story in it does not quite stack up. Barclays is saying that its £5.8bn equity capital raising, is to reduce “leverage” (gearing). 

That might be the case in its IFRS accounts where it is not booking the £4.1bn losses that the PRA has identified and is the substantial reason for the rights issue. However, when adjusted for the loss, the proper accounts would show that the bulk of the equity capital raising is to deal with the overvalued assets. 

Therefore the substantial reason for the rights issue is not to reduce gearing it is funding the loss that the PRA has identified that Barclays is not putting through its IFRS books. The explanations not matching is inherently a problem with running two sets of books. 

UK banks received favorable accounting treatment from regulators

PIRC, a UK institutional investor consultancy firm, looked into how UK banks were required to report their financial statements since the beginning of the financial crisis.

What PIRC found is the regulators effectively broke the spirit if not the letter of the law by letting banks report financial statements that made the banks appear healthier than they were.

This is yet another example of why banks must be required to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  This disclosure minimizes the potential for banks to overstate their health as the statement can be independently verified by market participants.

Amidst the fallout of the banking crisis, where all of the failed banks appeared healthy by their accounts, is the question of quite why did the Financial Reporting Council quietly dissolve the legal entity the Accounting Standards Board (“ASB”), shortly afterwards, and subsume the functions within itself? 

PIRC has discovered tucked away at the back of the ASB’s yawningly long Statement of Principles, from 1999 (a very good year for very bad ideas) the very clear admission that the ASB had a systemic disregard for the law, because it thought it knew better. Or, quoting from the document, the ASB preferred to focus on “what is deemed to be right”. 

Given that “what is deemed to be right” included abolishing general provisions for bad debts, meaning that risky lending was overvalued in the balance sheet and underpriced for the risk, what was “deemed to be right” was in fact nothing less than reckless and wrong and illegal. 

The law that was being disregarded was the very simple rule that accounts must show whether any company is solvent or not. The full statement is below: 

“However, the development of the Statement has not been constrained by legal requirements because the Board believes that accounting practice evolves best if regard is had in documents such as the Statement of Principles to what is deemed to be right rather than what is required by law.”

Hard evidence that bankers frame the discussion of the financial crisis and financial reform

Mike Berry at Cardiff University provides hard evidence that the mainstream media effectively allowed the bankers to frame the discussion of the financial crisis.

Being able to frame the discussion of the financial crisis was critically important as it allowed the bankers to effectively block the discussion of solutions that would have been unfavorable to them.

For example, the bankers blocked discussion of both the Swedish Model and transparency.

Under the Swedish Model, the banks would have been required to recognize upfront their losses on the excess debt in the financial system.  Doing so would have protected the real economy from the burden and distortions caused by the excess debt and the policies to protect bank book capital levels and banker bonuses.

The Swedish Model was almost never discussed (it was and still is by your humble blogger).

Instead, the focus was on the need to adopt the Japanese Model and protect bank book capital levels and banker bonuses at all cost because without doing this banks couldn't lend more to support economic growth.

Of course, the argument for adopting the Japanese Model wasn't true.  Banks are designed to continue to support the real economy even when they have low or negative book capital levels.

Why can banks do this?  Because of the combination of deposit guarantees and access to central bank funding.  With deposit guarantees, taxpayers effectively become the banks' silent equity partners when they have low or negative book capital levels.

Bankers kept transparency out of the discussion (despite opaque, toxic subprime RMBS deals being at the heart of the crisis) because they make their money from the use of opacity.  When investors and regulators cannot properly assess the risk of the banks or the financial products the bankers produce, bankers profit off of the underpricing of risk.

However, if you want to take risk out of the financial system, you have to bring valuation transparency to all the opaque corners of the financial system.

To date, any conversation about bringing transparency has focused on price transparency.  However, price transparency is meaningless without the ability to independently assess the risk of and value using valuation transparency.  Without valuation transparency, there is no point of comparison to make buy, hold or sell decisions based on price.

Instead, market participants are simply gambling on the content of black boxes and brown paper bags.

Mr. Berry and his colleagues did a content analysis on the BBC coverage of the financial crisis.  What they found was:

The robustness of these findings is reinforced in research on how the BBC’s Today programme reported the banking crisis in 2008. 

The table below shows the sources featured during the intense six weeks of coverage following the collapse of Lehman Brothers.

Today programme banking crisis interviewees 15/9/2008 to 20/10/2008.

The range of debate was even narrower if we examine who the programme featured as interviewees in the two week period around the UK bank bailouts. This can be seen in the next table.

Today programme banking crisis interviewees 6/10/2008 to 20/10/2008.

Here opinion was almost completely dominated by stockbrokers, investment bankers, hedge fund managers and other City voices. Civil society voices or commentators who questioned the benefits of having such a large finance sector were almost completely absent from coverage. 

The fact that the City financiers who had caused the crisis were given almost monopoly status to frame debate again demonstrates the prominence of pro-business perspectives.