Selling billions of dollars worth of insurance on things that turn out to, on occasion, exhibit extraordinary volatility can be a dangerous thing — just ask AIG which was sucked dry by collateral calls from a certain vampire squid when the M2M value of the MBS the company so foolishly insured cratered in 2008 and Goldman came banging on the door for its money. And while the value of the price hedges (i.e. insurance contracts) the US banking sector has sold to the country’s now beleaguered shale drillers may not be large enough to present an imminent systemic risk, as Bloomberg notes, “$26 billion is still $26 billion”: 

For U.S. shale drillers, the crash in oil prices came with a $26 billion safety net. That’s how much they stand to get paid on insurance they bought to protect themselves against a bear market — as long as prices stay low…

 

The fair value of hedges held by 57 U.S. companies in the Bloomberg Intelligence North America Independent Explorers and Producers index rose to $26 billion as of Dec. 31, a fivefold increase from the end of September, according to data compiled by Bloomberg.

 

Though it’s difficult to determine who will ultimately lose money on the trades and how much, a handful of drillers do reveal the names of their counterparties, offering a glimpse of how the risk of falling oil prices moved through the financial system.

 

More than a dozen energy companies say they buy hedges from their lenders, including JPMorgan, Wells Fargo, Citigroup and Bank of America…

 

At the end of 2014, JPMorgan had about $671.5 million worth of derivatives exposure to five energy companies, including Pioneer Natural Resources Co., Concho

 

Resources Inc., PDC Energy Inc. and Antero Resources Corp., according to company records. That’s the amount JPMorgan would have owed if the contracts were settled Dec. 31, not including any offsetting trades the bank made.

 

It’s a similar story for Wells Fargo, which was on the hook for $460.9 million worth of oil and natural gas derivatives for companies including Carrizo Oil & Gas Inc., Pioneer, Antero, Concho and PDC, according to regulatory filings.

Of course, as Bloomberg goes on to point out, these are the same banks which helped to finance the shale bonanza in the first place and as we recently saw with Standard Chartered, collapsing crude prices can spell trouble if you’re in the commodities loans business. 

Those who sold the price hedges now have to make good. At the top of the list are the same Wall Street banks that financed the biggest energy boom in U.S. history, including JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co.

That list is particularly interesting because as the following graphic shows, these banks are the first, second, third, and sixth largest bookrunners for leveraged oil & gas loans over the past three years:

Here’s The Telegraph with more…

A lengthy period of cheap crude is likely to trigger widespread defaults and many oil and gas loans are now changing hands for well below their face value as investors fear they will not get their money back.

 

Banks will offload many of the loans and hedge their losses, and some will have stricter lending standards for high-yield loans than others.

 

Losses will also depend on how long the oil price stays low, so it is unclear precisely how exposed the banks are to the energy industry’s woes…

 

Chirantan Barua, an analyst at Bernstein Research, has estimated that the combined losses of Barclays, RBS, HSBC and Standard Chartered from falling oil prices could amount to $3.4bn.

 

“Someone is feeling the pain,” said Mr Barua. “When you see [this much] high-yield issuance in a sector that has been levering up across the supply chain, any shocks in the underlying business will have risk ripples across the financial system…”

 

According to Dealogic’s data, RBS has arranged $14.3bn of leveraged oil and gas loans in the past four years, making it the biggest UK player in the high-yield space.

 

This compares to $10.5bn for Barclays and $4.7bn for HSBC, but is far less than the biggest Wall Street players. Wells Fargo and JP Morgan have both been bookrunners on almost $100bn since the start of 2011.

…and a bit more color from NY Times:

Two of the banks that may be the hardest hit by lower investment-banking fees are among the biggest. Wells Fargo derived about 15 percent of its investment banking fee revenue last year from the oil and gas industry, while at Citigroup, the business accounted for roughly 12 percent, according to the data provider Dealogic…

 

And Wall Street firms that financed energy deals may now have trouble offloading some of the debt, as they had originally planned.

 

Morgan Stanley, for instance, led a group of banks that made $850 million of loans to Vine Oil and Gas, an affiliate of Blackstone, aprivate equity firm. Morgan Stanley is still trying to sell the debt, according to a person briefed on the transaction.

 

Similarly,Goldman Sachs and UBS led a $220 million loan last year to the private equity firm Apollo Global Management to buy Express Energy Services. Not all the debt has been sold to other investors, according to people briefed on the transaction.

 

A precipitous drop in oil prices can quickly turn loans that once seemed safe and conservatively underwritten into risky assets.

 

The collateral underpinning many energy loans, for example, is oil that was valued at $80 a barrel at the time the loans were made. As oil has dropped well below that price in recent months, the value of the banks’ collateral has sunk.

*  *  *

So it certainly looks like a lot is riding on the degree to which large US banks have been successful at offloading their exposure to the sector (which, thanks to falling crude prices and mounting bankruptcies is likely getting more difficult by the week) and on how well they have been able to hedge the hedges they sold to shale drillers. Any way you slice it, it’s difficult to see how this turns out particularly well, for if Barclays, RBS, HSBC, and Standard Chartered may be facing a combined $3.4 billion in losses and they represent a small portion of the market compared to Wall Street’s largest firms, and if these same US banks are facing $26 billion in exposure on hedges they sold, well, “someone is feeling the pain,” as the Bernstein analyst told The Telegraph. As for the likelihood that most of the risk has been transferred to outside investors or otherwise hedged, we’ll leave you with the following quote from an analyst who spoke to Bloomberg on the matter:

“The banks always tell us that they try to lay off the risk [but] I know from history and practice that it’s great in concept, but it’s hard to do in reality.”

Submitted by David Stockman via Contra Corner blog,

GE’s announcement that its getting out of the finance business should be a reminder of how crony capitalism is corrupting and debilitating the American economy. The ostensible reason the company is unceremoniously dumping its 25-year long build-up of the GE Capital mega-bank is that it doesn’t want to be regulated by Washington as a systematically important financial institution under Dodd-Frank. Oh, and that its core industrial businesses have better prospects.

We will see soon enough about its oilfield equipment and wind turbine business, or indeed all of its capital goods oriented businesses in a radically deflationary world drowning in excess capacity. But at least you can say good riddance to GE Capital because it was based on a phony business model that was actually a menace to free market capitalism. Its deplorable raid on the public purse during the Lehman crisis had already demonstrated that in spades.

Even MarketWatch’s coverage captured a hint of this illicit business model:

GE’s news release announcing its latest and greatest reduction of GE Capital summed up the move beautifully, saying “the business model for large wholesale-funded financial companies has changed, making it increasingly difficult to generate acceptable returns going forward.”

 

“Wholesale-funded” refers to GE Capital’s traditional reliance on the commercial paper market for liquidity. The problem with this short-term funding model for a balance sheet with long-term assets is that during a financial crisis, overnight liquidity tends to dry up as it did for GE late in 2008. When the company had difficulty finding buyers for its paper, the Federal Deposit Insurance Corp. stepped in and through its Temporary Liquidity Guarantee Program (TLGP) was covering $21.8 billion of GE commercial paper. GE Capital registered for up to $126 billion in commercial-paper guarantees under the TLGP.

 

General Electric obviously wishes to avoid ever needing another government bailout…..

Well, its not exactly that “the business model for large wholesale-funded financial companies has changed.”  It was never valid in the first place. Indeed, the fact that GE assembled what was once a $600 billion wholesale funded bank is a testament to the destruction of honest financial markets by the Fed and other central banks.

In fact, GE Capital never had any secret sauce or competitive advantage. At the end of the day, it made its money by investing in long-dated, illiquid financial assets such as real estate, equipment leases, term loans, project finance deals and LBOs, and then funded them with cheaper, shorter term wholesale money. The assets were cold; the funding was hot.

So doing, it picked up billions of nickels in front of the proverbial steamroller—–that is, until the jig was suddenly up in September 2008. What occured next would was the deplorable $60 billion bailout by Washington, but that would never have occurred in an honest free market because the GE Capital house of cards could never have been erected.

The colossal commercial paper funding meltdown experienced by GE Capital in September 2008 would not have happened because an honest market would not have priced its commercial paper so cheaply. That is, its business model, which amounted to yield curve arbitrage, would not have been profitable. As a consequence, even a corporate value destroyer and crony capitalist plunderer like Jeff Immelt would not have been positioned to raid the US treasury in September 2008.

As it is, Immelt was given a thumbs up by the market on Friday for jettisoning GE Capital – even if it was largely for the wrong reason. Namely, that it was accompanied by another gigantic $50 billion share buyback promise – a raid on GE’s balance sheet that makes no sense as the company now plunges into the epochal deflationary era ahead as a “pure play” industrial which will need all the clean balance sheet it can get.

Never mind, through. Immelt did get GE’s stock price back to… .well, to its 1998 level!  That’s 17 years to nowhere, but its better than the alternative.

When the next financial meltdown arrives, GE Capital would have been obliterated. And apparently even Obama’s chief business booster, General Electric’s CEO and Chairman, could see that next time even Washington would be coming not with TLGPs and other dollar-laden acronyms, but with torches and pitchforks.

GE data by YCharts

In the Great Deformation, I singled out Immelt for a special place in the crony capitalist hall of shame. On the occasion of making the world (somewhat) safer by dismantling GE Capital, here is why its good that the latter is gone and that Immelt deserves everlasting ignominy for his rape of the US taxpayers last time around:

From The Great Deformation: 

By that late hour, however, the Fed was not even remotely interested in financial discipline. The Greenspan Put had now been superseded by the even more insidious Bernanke Put. In defiance of every classic canon of sound money, the new Fed chairman had panicked in the face of the first stock market tremors in August 2007 (see chapter 23), and thereafter the S&P 500 had become an active and omnipresent transmission mechanism for the execution of central bank policy.

 

Consequently, after the Lehman event the plummeting stock averages had to be arrested and revived at all hazards. Accordingly, the bailout of AIG was first and foremost an exercise in stabilizing the S&P 500.

 

The cover story, of course, was the threat that a financial contagion would ripple out from the corpus of AIG, bringing disruption and job losses to the real economy. As has been seen, however, there was nothing at all “contagious” about AIG, so Bernanke and Paulson simply peddled flat-out nonsense in order to secure Capitol Hill acquiescence to their dictates and to douse what they derisively called “populist” agitation; that is, the noisy denunciation of the bailouts arising from an intrepid minority of politicians impertinent enough to stand up for the taxpayer.

 

But this hardy band of dissenters—ranging from Congressman Ron Paul to Senator Bernie Sanders—was correct. Everyday Americans would not have lost sleep or their jobs, even if AIG’s upstairs gambling patrons had been allowed to lose their shirts. Still, the bailsters peddled a legend which has persisted; namely, that in September 2008 the nation’s financial payments system was on the cusp of crashing, and that absent the bailouts American companies would have missed payrolls, ATMs would have gone dark, and general financial disintegration would have ensued. But this is a legend. No evidence has ever been presented to prove it because there isn’t any.

Take the case of GE Capital…

On the eve of the crisis about $650 billion, or one-third of prime fund assets, were invested in commercial paper, making these funds the largest single investor class in the $2 trillion commercial paper market. Consequently, when the wave of money moved from prime funds to government- only funds which could not own commercial paper, open market rates on the A2/P2 grade of thirty-day commercial paper spiked sharply. Loan paper that had yielded only 1 percent prior to the spring of 2008 suddenly soared to over 6 percent during the September crisis.

Any garden variety economist might have suggested that commercial paper had been seriously overvalued. The flight from prime funds was living proof that the market had been artificially buoyed by big chunks of demand from what were inherently risk-intolerant prime fund investors. Now, the commercial paper market was in a violent rebalancing mode, causing borrowers to experience the joys of “price discovery” as interest rates sought a higher, market-clearing level.

THE REAL BAILOUT CATALYST: JEFF IMMELT’S THREATENED BONUS

At that particular moment, however, General Electric CEO Jeff Immelt was apparently in no mood for a lesson in price discovery. In fact, he was then learning, along with the rest of Wall Street, an even more painful lesson about the folly of lending long and borrowing short. Notwithstanding that General Electric was one of just a handful of AAA-rated American corporations, it was suddenly discovering that its hugely profitable finance company, General Electric Capital, was actually an unstable house of cards.

GE Capital’s financial alchemy rested on a simple but turbocharged formula straight out of the Wall Street playbook. At the time of the crisis, GE Capital boasted $650 billion of financial investments from customized deals in real estate, equipment leasing, working capital finance, and private equity. While these highly proprietary investments yielded generous rates of return, they were also highly illiquid and prone to blow up at higher than normal loss rates, thus bearing an asset profile that called for generous amounts of equity capital funding. In fact, however, GE Capital’s massive balance sheet was leveraged nearly 10 to 1 and included upward of $100 billion of short-term commercial paper.

Needless to say, this huge load of commercial paper carried midget in- terest rates (4.7 percent), which helped fuel impressive profit spreads on GE’s assets. But this ultra-cheap CP funding also bore short maturities, meaning that GE Capital had to rollover billions of commercial paper debts day in and day out.

When commercial paper rates suddenly spiked during the Lehman crisis, GE was caught with its proverbial pants down. But rather than manning-up for the financial hit that his company deserved, Jeff Immelt jumped on the phone to Treasury Secretary Paulson and yelled “Fire!”

Within days, the sell-off in the commercial paper was stopped cold by Washington’s intervention, sparing GE the inconvenience of having to pay market rates to fund its massive pool of assets. The Republican government essentially nationalized the entire commercial paper market.

Even a cursory look at the data, however, shows that Immelt’s SOS call was a self-serving crock. His preposterous message had been that the commercial paper market was seizing up and that GE was on the edge of collapse—a risible proposition. Nevertheless, that assertion quickly became gospel among panic-stricken officialdom, and from there it rapidly spread to Wall Street and the financial press.

Not surprisingly, even two years later when the dust had settled and facts were readily available to refute this horary untruth, Secretary Paulson insisted upon repeating the GE legend in his memoirs. Describing round the clock staff activities on Wednesday, September 17, he noted that “our most pressing issue” had been to “help the asset-backed commercial paper market before it pulled down companies like GE.”

That was garbled nonsense. GE was not even a significant issuer of “asset-backed commercial paper” (ABCP). Those small amounts it did issue ($5 billion) were non-recourse and self-liquidating, meaning that GE Capital would have already passed ownership of the embedded assets to the ABCP conduit and its investors would have taken a hit, not GE.

By the same token, it was a huge issuer of unsecured commercial paper (100 billion), but even that was not remotely capable of felling the mighty GE. The required rollover funding was less than $5 billion per week, which was petty cash for a $200 billion (sales) global corporation with an AAA credit rating.

Although GE was not heading into a black hole, it was facing the need for a painful bout of liquidity generation which would have required either a fire sale of some of its sticky assets or a highly dilutive issuance of long term equity or debt capital. Both courses were feasible, but each would have resulted in a sharp blow to earnings and top executive bonuses.

Instead of allowing the free market to resolve the matter, however, the taxpayers were thrown into the breach in still another variation of stopping the alleged “run” on Wall Street’s cheap wholesale funding. Again, a necessary and healthy market correction was cancelled while the cronies of capitalism were kept in the clover.

WHY THE ATMS WOULD NOT HAVE GONE DARK: THE SECRET OF “GAIN ON SALE” ACCOUNTING

The commercial paper bailout incited by Jeff Immelt was utterly unnecessary. The facts show that the bailsters conjured up still more economic goblins where none actually existed. What the commercial paper bailout mainly did was prop up the banking industry’s “gain on sale” profit scam.

The single most salient fact about the $2 trillion commercial paper market was that upward of $1 trillion was accounted for by the aforementioned ABCP, or asset-backed commercial paper segment. This was just another form of securitization, and it amounted to the financial equivalent of a twice-baked potato.

In this instance, Wall Street had gone to the banks and credit card companies and purchased massive volumes of “receivables” representing payments owed on millions of auto loans, credit cards, student loans, and other installment credit. These receivables were then dumped into a “conduit,” which was a legal structure that existed only in cyberspace; the underlying payments on loans and credit cards were processed and collected by their bank and finance company originators.

Nevertheless, the conduits were given a top credit rating by S&P and Moody’s because they were over collateralized; that is, they had enough extra assets per dollar of ABCP issued to absorb any likely defaults by the underlying borrowers. Given these AAA ratings, the ABCP conduits were thus enabled to issue billions of commercial paper debt against their “assets,” which were actually, of course, debts of the American consumer.

The crucial point about this $1 trillion ABCP market, however, was that it did not originate new loans; it was merely a mechanism for refinancing debts which already existed. Accordingly, no consumer anywhere in America needed the ABCP market in order to swipe their credit card or get a car loan.

Instead, consumer loans of this type were being advanced, day in and day out, to the public by the likes of JPMorgan, American Express, Bank of America, and hundreds of other banks and finance companies. All of the money passing through cash registers from credit cards and into car purchases from auto loans flowed directly from these banks, not the ABCP market.

While the ABCP conduits accomplished nothing for the consumer, they did permit the banks to enjoy the magic of “gain on sale” accounting. Under the latter dispensation of the accounting profession, banks could immediately book the lifetime profits on these consumer loans the minute they were sold to the securitization conduit, even though such loans were months and even years from maturity.

The profits on a five-year car loan, for example, could be booked practically the day it was made. Likewise, credit card companies essentially had their profits fed intravenously; that is, within virtually the same digital nanosecond that a consumer’s credit card was swiped, there also transpired a nonrecourse sale of this credit card receivable to the conduit. Right then and there, by means of advanced technology and accounting magic, the bank issuer of the credit card was able to book the estimated “gain on sale” directly to its profit column.

So when Bernanke and Paulson regaled Capitol Hill about the “collapse” of the commercial paper market, what they neglected to mention was that the main thing collapsing was these quickie “gain on sale” profits at JP Morgan, Citibank, Capital One, and the rest of the issuers. No credit card authorization was ever denied nor was any car loan application ever rejected because the ABCP market melted down in the fall of 2008.

That the commercial paper market meltdown had never been a threat to the Main Street economy is now crystal clear: the amount of ABCP paper outstanding today is 75 percent smaller than in September 2008, but the banks have had no problem whatsoever funding credit card and other consumer loans on their own balance sheets out of their own deposits and other funding sources. In fact, the banking system is now actually so flush with cash that it is lending $1.7 trillion of excess reserves back to the Fed at the hardly measureable interest rate of 0.25 percent annually.

Another $400 billion layer of the $2 trillion commercial paper market had been issued by industrial companies and was used to meet working capital needs, including payroll. So it did not take the Washington bailsters long to conjure up frightening scenarios about millions of empty pay envelopes at the giant corporations which were heavy commercial paper users.

Had the bright young Treasury staffers racing around behind Hank Paulson’s flaming hair come from the loan department of a Main Street bank rather than the M&A wards of Wall Street, however, they would have known better. At the time of the crisis, there was hardly a single industrial company issuer of commercial paper that did not also have a “standby” bank line behind its program.

Indeed, such back up lines were mandatory features of industrial company commercial paper programs. They were designed to assure investors that if issuers could no longer roll over maturing commercial paper, they would make timely repayment by drawing down their standby lines at their bank.

Moreover, industrial company issuers paid an annual fee of 15 to 20 basis points on these standby credit lines, precisely so that banks would have a contractual obligation to fund if requested. In the event, none of the banks violated their legally enforceable loan contracts to fund these CP standby lines. There was never a chance that corporate payrolls would not be met.

CRONY CAPITALIST SLEAZE: HOW THE NONBANK FINANCE COMPANIES RAIDED THE TREASURY

The final $600 billion segment of the commercial paper market provided funding to the so-called nonbank finance companies, and it is here that crony capitalism reached a zenith of corruption. During the bubble years, three big financially overweight delinquents played in this particular Wall Street sandbox: GE Capital, General Motors Acceptance Corporation (GMAC), and CIT. And all three booked massive accounting profits based on a faulty business model.

When a financial company lends long and illiquid and funds itself with short-term hot money, it needs to regularly charge its income statement with a loss reserve for the inevitable, violent moments of financial crisis when short-term money rates spike or funding dries up completely. At that point, a fire sale of assets at deep losses becomes unavoidable in order to scrounge up cash to redeem their hot-money borrowings as they come due daily.

The big three nonbank finance companies had not provided such rainy day reserves. Consequently, when the commercial paper market seized up, Mr. Market came knocking, intent on rudely clawing back years’ worth of overstated profits. In short order, however, the two largest of these giant finance companies, GE and GMAC, received taxpayer bailouts, proving once again that in the new régime of crony capitalism the kind of muscle which ultimately mattered was political, not financial.

The single most malodorous of the big finance companies was General Motors Acceptance Corporation, which went by the innocent-sounding acronym of GMAC. But it wasn’t innocent in the slightest, perhaps hinted at by the fact that its chairman was one Ezra Merkin, whose major line of business had famously been in the operation of multibillion-dollar feeder funds for Bernie Madoff.

GMAC was not only a huge purveyor of some of the worst slime in the subprime auto loan and home mortgage market, but it was also a giant financial train wreck waiting to happen. Leveraged at more than 10 to 1 and funded with massive amounts of short-term commercial paper, it had no ability to absorb even mild losses in its loan book.

GMAC was in the business of accumulating truly rotten loans. Its operating units appear to have scoured subprime America looking for “twofers.” Thus, the notorious Ditech online mortgage operation put millions of financially strapped households in homes they couldn’t afford. Then it compounded the favor by putting a new car in their garage via a six-year subprime auto loan that was “upside down” (i.e., greater than the value of the car) nearly from day one.

Many of the “twofer” households lured into unsustainable debt by GMAC’s subprime predators defaulted on their auto and mortgage loans when housing prices crashed and the economy buckled. As a consequence, GMAC ended up writing down $25 billion of loans, or more than the cumulative profits it had booked during the previous several years.

By every rule of capitalism, an enterprise as foolish, dangerous, predatory, and insolvent as GMAC should have been completely liquidated by a financial meltdown which was functioning to purge exactly that kind of deformation. Instead, it has remained on federal life support owing to $16 billion in TARP funding and an additional $30 billion in guarantees and subventions from FDIC and the Fed.

Yet there is not a shred of evidence that the Main Street economy has benefited from GMAC’s artificial life extension program. There has never been a shortage of solvent banks, thrifts, and finance companies to serve the auto and housing finance needs of the nation’s diminished pool of creditworthy borrowers. So when the Washington bailsters stopped the commercial paper meltdown on grounds that the likes of GMAC were imperiled, they snatched defeat from the jaws of victory.

Washington’s $30 billion lifeline to AAA-rated General Electric was no less gratuitous. At the time of Immelt’s SOS call to Secretary Paulson a day after the Lehman bankruptcy filing, the stock and bond markets were in a state of turbulence and panic. Even under those dire conditions, however, the world’s capital markets were still valuing GE’s common stock at $200 billion and were trading its $400 billion of term debt at a hundred cents on the dollar. Thus, as measured by the fundamental metric of corporate finance known as “enterprise value” (debt plus equity), the markets were capitalizing General Electric at $600 billion during the very midst of the meltdown.

This puts the lie to an urban legend assiduously promoted by the bailsters at the time and repeated endlessly by their apologists ever since. Their preposterous claim was that the $600 billion globe-spanning behemoth known as General Electric could not find replacement financing for the approximate $25 billion of commercial paper scheduled to mature on a fixed schedule (i.e., it was not subject to call on demand) between September 15 and the final months of 2008. The very idea that GE had been incapable of raising even a billion dollars of funding per business day was ludicrous on its face.

That this proposition was seriously embraced by mainstream opinion is undoubtedly a measure of the panic which had been shamelessly induced by the Washington bailsters. The true facts of the case, of course, were more nearly the opposite. GE Capital could have readily generated sufficient cash to meet its CP redemption obligations by selling only 8 percent of its assets, even at fire-sale discounts of up to 50 percent of book value, if that had been necessary.

In the alternative, the GE parent corporation could have raised new debt and equity capital, again at whatever deep discounts might have been demanded by the distressed markets of the moment. For example, a 4 percent increase in its long-term debt would have raised $15 billion, even if it required a coupon double GE’s average 5 percent rate. And a mere 10 percent increase in its outstanding common shares would have raised $10 billion, even had they been placed at $10 per share or 50 percent below its $20 stock price at the time.

Thus, the mix of potential asset disposals and stock and bond issuance available to GE was nearly infinite. Any combination chosen would have generated sufficient cash to redeem its expiring commercial paper. Indeed, it is blindingly obvious that the taxpayer-supported bailout of General Electric was simply about earnings per share and the threat to executive bonuses that would have resulted from asset sales or stock and bond offerings.

The fact is, these “self-help” methods of raising cash according to free market rules would have also have whacked GE’s earnings by perhaps $2 per share, owing to losses or earnings dilution. Either way, shareholders would have gotten the beating they deserved for having so egregiously overvalued GE’s debt-inflated earnings and for putting such reckless managers in charge of the store.

Instead, GE shareholders were spared any permanent damage. Likewise, GE and GMAC had combined long-term debt outstanding of nearly a half trillion dollars, all of which remained worth a hundred cents on the dollar, thanks to Uncle Sam’s safety nets.

This means that the bond fund managers who were the “enablers” of these unstable finance company debt pyramids got off without a scratch. So the pattern was repeated over and over. The post-Lehman meltdown in the wholesale money markets, including the various types of commercial paper, was of consequence only in the canyons of Wall Street. The thin slab of permanent debt and equity capital that supported these bubble-era pyramids of inflated assets and toxic derivatives was the only real target of Mr. Market’s wrathful attack.

Had this attack been allowed to run its course, hundreds of billions in long-term debt and equity capital that underpinned the Wall Street–based speculation machines would have been wiped out, including huge amounts of stock owned by executives and insiders. Such a result would have been truly constructive from a societal vantage point. It would have implanted an abiding 1930s style generational lesson about the deadly dangers of leveraged speculation.

BERNANKE’S PANICKED DEPRESSION CALL

At the end of the day, the stated purpose of the Wall Street bailouts—to avoid a replay of the 1930s—was drastically misguided. It was based on a phantom threat which arose overwhelmingly from the faulty scholarship of a single official: the former math professor who had come to head the nation’s central bank. The analysis was actually not even his own, but was the borrowed theory of Professor Milton Friedman.

Forty years earlier, Friedman had famously claimed that the Fed’s failure to run its printing presses full tilt during certain periods of 1930–1932 had caused the Great Depression. Bernanke’s sole contribution to this truly wrong-headed proposition was a few essays consisting mainly of dense math equations. They showed the undeniable correlation between the collapse of GDP and the money supply, but proved no causation whatsoever. In fact, as will be shown in chapters 8 and 9, the great contraction of 1929–1933 was rooted in the bubble of debt and financial speculation that built up in the years before October 1929, not from mistakes made by the Fed after the bubble collapsed. In the fall of 2008, the American economy was facing a different boom-and-bust cycle, but its central bank was now led by an academic zealot who had gotten cause and effect upside-down.

The panic that gripped officialdom in September 2008, therefore, did not arise from a clear-eyed assessment of the facts on the ground. Instead, it was heavily colored and charged by Bernanke’s erroneous take on a historical episode that bore almost no relationship to the current reality.

Nevertheless, the bailouts hemorrhaged into a multi trillion dollar assault on the rules of sound money and free market capitalism. Moreover, once the feeding frenzy was catalyzed by these errors of doctrine, it was thereafter fueled by the overwhelming political muscle of the financial institutions which benefited from it.

These developments gave rise to a great irony. Milton Friedman had been the foremost modern apostle of free market capitalism, but now a misguided disciple of his great monetary error had unleashed statist forces which would devour it. Indeed, by the end of 2008 it could no longer be gainsaid. During a few short weeks in September and October, American political democracy had been fatally corrupted by a resounding display of expediency and raw power in Washington. Every rule of free markets was suspended and any regard for the deliberative requirements of democracy was cast to the winds.

Henceforth, the door would be wide open for the entire legion of Washington’s K Street lobbies, reinforced by the campaign libations prodigiously dispensed by their affiliated political action committees (PACs), to relentlessly plunder the public purse. At the same time, the risk of failure had been unambiguously eliminated from the commanding heights of the American economy. Free market capitalism thus shorn of its vital mechanism to purge error and speculation had become dangerously unhinged.

Yet the September 2008 meltdown was a financial cyclone which struck mainly within the vertical canyons of Wall Street, and would have burned out there in short order. This truth exposes the crony capitalist putsch that occurred in Washington during the fall of 2008 and invalidates its self serving narrative that America was faced with a continent-wide flood which would have wracked devastation across the length and breadth of Main Street America.

There was never any evidence for Bernanke’s Great Depression bugaboo, a truth more fully explicated in chapters 28 and 32. So it is also not surprising that bailout apologists cannot explain the origins of the Wall Street meltdown. Indeed, they treat it as sui generis, meaning that the “contagion,” whatever it was, had suddenly arrived as if on a comet from deep space. And after hardly a ten-week visit, as measured by the return of speculators to the beaten-down bank stocks in early 2009, it had adverted once again to interstellar blackness.

It is not surprising, therefore, that the corporals’ guard of Treasury and Federal Reserve officials who carried out this financial coup d’état never once provided any detailed analysis of why this mysterious “contagion” had struck so suddenly; nor did they ever lay out the financial system linkages and pathways by which the contagion was expected to spread; nor did they present any review of the costs, benefits, and alternatives to bailing out the major institutions which were rescued. Hardly a single page of professionally competent analysis and justification for the Wall Street bailouts was presented to the president or any of the leaders of Congress at the time.

Indeed, the Bernanke–Paulson putsch was so imperious and secretive that Sheila Bair, head of the FDIC and the one regulator who thoroughly understood the balance sheet of the American banking system, and also did not buy into knee-jerk fear mongering about “systemic risk,” was simply not consulted, and commanded to fall in line. As Bair recounted the events, “We were rarely consulted . . . without giving me any information they would say, ‘You have to do this or the system will go down.’ If I heard that once, I heard it a thousand times . . . No analysis, no meaningful discussion. It was very frustrating.”

Sheila Bair was the single best informed and most tough-minded and courageous financial official in Washington at the time of the crisis. She had a sophisticated grasp of the manner in which deposit insurance had been abused to fund excessive risk taking in the banking system and a resolute conviction that the capital structure enablers—that is, bank bond and equity holders—needed to absorb losses ahead of the insurance fund and taxpayers.

None of this was remotely understood by Paulson’s cadre of former Goldman associates led by Neel Kashkari. He was a thirty-four-year-old former space telescope engineer who had done two-bit M&A deals in Goldman’s San Francisco office for two years before joining the Treasury Department and being assigned the bailout portfolio.

The fact that the abysmally unqualified Kashkari led the bailout brigade while Bair was systematically excluded from the process speaks volumes as to how completely public policy had fallen into the clutches of Wall Street. Kashkari and his posse had no sense whatsoever about the requisites of sound public finance. So in the fog of Washington’s panic, prevention of private losses quickly and completely supplanted any reasoned consideration of the public good.

If you thought currency-wars were a problem, just wait until crony-wars begin. In a stunning show of disagreement among the omnipotent, The FT reports that a Freedom of Information Act request has confirmed The Bank of England wrote to US authorities seeking clarity about Berkshire’s absence from a provisional list of "systemically import" (Too Big To Fail) financial institutions (SIFIs). The US Treasury declined to comment…

With MetLife suing the US government to try to escape being deemed systemically important by Washington (which means the firm may need to hold more capital to cover unexpected losses and could face a requirement to draw up “living wills” to make them easier to wind down in a crisis), The FT reports on questions over Berkshire Hathaway's status…

British regulators have challenged their US peers over their apparent reluctance to subject Warren Buffett’s Berkshire Hathaway to tougher scrutiny as part of a worldwide push to make the financial system safer.

 

The Bank of England has written to the US Treasury asking why Berkshire’s reinsurance operation — among the world’s most powerful — was left off a provisional list of “too big to fail” institutions drawn up by the Financial Stability Board.

Regulators have already deemed nine primary insurance companies — including AIG of the US, Germany’s Allianz and UK-based Prudential — globally “systemically important”, a designation that could lead to higher capital requirements.

The failure to designate reinsurers has angered insurance companies, which argue reinsurers are more important to the financial system.

 

The Basel-based FSB was expected to make the reinsurance list public last year. But in November, following consultation with national authorities, it postponed the decision “pending further development of the methodology”.

 

In a sign that disagreement between global regulators may be holding up the process, it has emerged that Bank of England officials wrote to US authorities in October seeking clarity about Berkshire’s absence from a provisional list.

 

The Bank confirmed the existence of the letter in response to a request under UK Freedom of Information legislation from the trade publication Risk.net. However, it declined to disclose the letter’s contents.

And here's the punchline…

In the parallel US process, Berkshire crosses thresholds that would allow it to be designated, with more than $50bn in assets and more than $3.5bn of derivatives liabilities.

 

However, the final decision is made by a council of US regulators which has not yet opted to subject Mr Buffett’s company to increased oversight.

So – the bottom line is that you can be a big to fail as you like but if you have the government in your pocket, you are untouchable… and it seems international regulators are none too pleased at this 'one rule for you, another rule for us' plan…

*  *  *

While no comment was received from Warren Buffett, Berkshire Hathaway, The US Treasury, we suspect the following explains why Buffett's business is not being treated as a SIFI…

BOE ASKS US WHY BERKSHIRE ABSENT FROM TOO BIG TO FAIL LIST: FT. Here's why pic.twitter.com/pQS0brillY

— zerohedge (@zerohedge) April 20, 2015

The biggest overnight story was neither out of China, where despite the ridiculous surge in new account openings and margin debt the SHCOMP dipped 08%, or out of Japan, where the Nikkei dropped 2.7%, the biggest drop in months, after the BOJ disappointed some by not monetizing more than 100% of net issuance and keeping QE unchanged, but Europe where for the second day in a row there was a furious selloff of Bunds at the open of trading, which briefly sent the yield on the 10Y to 0.38% (it was 0.6% two weeks ago), in turn sending the EURUSD soaring by almost 200 pips to a two month high of 1.1250, and weighing on US equity futures, before retracing some of the losses.

As we reported earlier, the technicals certainly do not favor Bund flows now, and it is likley that the Bund squeeze is far from over.

Negative news about the Apple watch aka the “tattoo snafu”will likely weigh on the DJIA today, with AAPL stock already down -1% in premarket trading.

A deeper look at the market shows Asian equities falling amid a negative Wall Street close, after the FOMC failed to offer any changes to its policy. Nikkei (-2.7%) led the slump after resuming trade following yesterday’s market closure, with weakness prompted by the BoJ refraining from carrying out further easing. Shanghai Comp (-0.8%) and Hang Seng (-0.9%) also fell with declines led by financials after ICBC (-2.1%) (market cap of USD 310bln) earnings. The ASX 200 (-0.83%) was also weighed on by financials amid worries around higher capital requirements, although support was found at 5,750, which is a triple bottom.

Bunds have continued yesterday’s trend lower sending German 10y yields above 0.3% which traded lower by 268 ticks since yesterday’s open from session lows. Analyst’s state that although the reasoning behind the recent move lower remains unclear, a correction was due with investors too fixated on the prospect of negative yields alongside improving European credit conditions and inflation expectations.

European equities (-0.3%) trade mixed at the height of European earnings season as a slew of positive earnings from major large caps including BASF, Bayer, Shell lift core indices are unable to lift stocks firmly into the green whereby the DAX is the notable underperformer in Europe. However, notable outperformers come in the form of Vallourec (-14.7%) who opened lower by 17% following poor earnings and Nokia (-7.4%) after they reported weak sales from their networking unit which also weighed on Alcatel-Lucent (-6.4%).

The USD-index (-0.5%) has extended its losses following last night’s FOMC meeting despite the Fed failing to rule out a June hike, although analysts discounting the possibility of such a move. The Fed also highlighted that weak US data in Q1 was weighed upon by transitory factors.

Major pairs have been buoyed with EUR/USD higher by almost a point after being bolstered by German Unemployment Change (000’s) (Apr) M/M -8k vs. Exp. -15K and stronger European yields.

Elsewhere, the BoJ refrained from further easing following their rate decision overnight which led to USD/JPY falling below 119.00, while the BoJ’s Semi Annual report showed that the central bank cut their 2015 inflation and GDP forecasts to 0.8% from 1% and cut 2% from 2.1% which caused USD/JPY to give back some all of its losses to sit just below 119.00. Furthermore, the BoJ also pushed back their forecast for inflation to reach their mandated 2% target in H1 2016.

The RBNZ kept rates on hold at 3.50% however, they stated that would be appropriate to lower OCR if demand weakens and if there is lower inflation pressure. The central bank also commented on the strength of NZD and added that it trades at an unjustifiably high level.

Yesterday’s DoE Crude Oil Inventories (Apr 24) W/W 1910K vs. Exp. 3300K as Cushing Crude oil inventories fell for the first time since November has buoyed WTI and Brent crude futures despite both products failing to consolidate the move above USD 59.00 and USD 66.00 respectively. Precious metals are also seen higher with spot gold sitting above USD 1,200 after seeing resistance at the aforementioned level. Overnight iron ore futures fell to 4% at its lows as supply continues to swell, although the metal has pared some of the move.

In Summary: European shares fall with the tech and chemicals sectors underperforming and oil & gas, telco outperforming. Euro-Area consumer prices end four-month streak of declines, German unemployment fell less than expected. The Swiss and Dutch markets are the worst-performing larger bourses, the Swedish the best. The euro is stronger against the dollar. Japanese 10yr bond yields rise; German yields increase. Commodities gain, with natural gas, gold underperforming and nickel outperforming. U.S. Chicago purchasing manager, jobless claims, continuing claims, Bloomberg consumer comfort, ISM Milwaukee, employment cost index, personal income, personal spending due later.

Market Wrap

• S&P 500 futures down 0.3% to 2091.7
• Stoxx 600 down 0.4% to 395.8
• US 10Yr yield up 1bps to 2.05%
• German 10Yr yield up 4bps to 0.33%
• MSCI Asia Pacific down 1.7% to 153.8
• Gold spot little changed at $1204.5/oz
• 6 out of 19 Stoxx 600 sectors rise; telco, autos outperform, basic resources, oil & gas underperform
• Asian stocks fall with the Nikkei outperforming and the ASX underperforming.
• MSCI Asia Pacific down 1.7% to 153.8; Nikkei 225 down 2.7%, Hang Seng down 0.9%, Kospi down 0.7%, Shanghai Composite down 0.8%, ASX down 0.8%, Sensex down 0.6%
• Euro up 0.6% to $1.1195
• Dollar Index down 0.46% to 94.77
• Italian 10Yr yield up 2bps to 1.53%
• Spanish 10Yr yield up 4bps to 1.5%
• French 10Yr yield up 5bps to 0.61%
• S&P GSCI Index up 0.4% to 442.8
• Brent Futures up 0.3% to $66/bbl, WTI Futures up 0.9% to $59.1/bbl
• LME 3m Copper up 0.9% to $6202.5/MT
• LME 3m Nickel up 2.9% to $13805/MT
• Wheat futures up 0.9% to 487.8 USd/bu

Bulletin Headline Summary from RanSquawk and Bloomberg

• Bund sell-off rattles the market with stronger German yields benefitting the EUR.
• The USD-index (-0.5%) has extended its losses following last night’s FOMC meeting despite the Fed failing to rule out June hike but most analysts deem this unlikely
• Looking ahead sees the release of US Initial Jobless Claims, Chicago Purchasing Manager, ISM Milwaukee, EIA NatGas storage change, Fed’s Tarullo and large cap earnings from Exxon, Gilead and Visa

DB’s Jim Reid concludes the overnight summary

It was a bit of a nightmare to be long bonds yesterday as we saw a major sell-off despite a weak US Q1 GDP print and a fairly predictable FOMC statement. It was a good day for us ‘secular stagnationists’ but I’m not sure it would have helped us much in trading the report as bond market positioning seemingly outweighed all else. Having said that Bunds had already sent global yields higher after a slightly stronger German inflation report (+0.3% YoY, +0.2% expected) and a weak auction. A five year Bund auction yesterday only gathered EUR3.649bn in bids which fell short of the EUR4bn sales target. This was the first time a Bund auction had missed its target since 21 Jan and the third bond sale this year that was technically uncovered according to Bloomberg. 10yr Bunds rose +12bps to 0.285%, with the equivalent in France, Spain, Italy, Portugal and the UK up between 12-15bps on the day. The US 10yr actually out-performed, only finishing the day +3.5bps higher. Very few dared to short bunds 10-14 days ago when intra-day they fell below 0.05bp but now there’s a bit of momentum we’re seeing increasing interest in jumping on the bandwagon. Our view on European rates is incredibly confused at the moment as we believe in many different conflicting things. We believe in secular stagnation but think Europe will see a decent cyclical recovery in 2015 and we believe we’re in a giant bond bubble but think we need it to be sustained by central banks to some degree to keep the debt heavy financial system solvent. Overall it probably points to a bias of a mild back-up in yields over the rest of the year but not an excessive one. We still think spreads will tighten though.

Back to the US GDP number, it came in at +0.2% annualised QoQ, well below already low expectations so hats off to the Atlanta Fed GDPNow model we’ve been tracking for a couple of months now. The headline figure actually belied even weaker underlying factors as it was bolstered by inventory accumulation which added +0.7% to output. As DB Chief US Economist Joe LaVorgna wrote, the weak Q1 GDP was to some extent to be expected but the mix does not bode as well for Q2 with the chance that this buildup in inventories is liquidated. Given this Joe thinks that current quarter growth is likely to run at around 2.5% and not the 4% snapback he’d previously anticipated.

Equities and credit markets on both sides of the Atlantic sold off with the Stoxx 600 down -2.2%, the DAX down -3%, iTraxx Main +1.5bps wider and Xover +9bps in Europe. US markets also struggled as the S&P500 closed the day down -0.37%% and CDX IG and HY widened +1bp and +4bps. The USD also suffered as EURUSD rose almost +2%. Commodities enjoyed a stronger day with the CRB Index and Brent up +1.2% and +1.8%, respectively. Oil’s performance was also supported by latest data which showed that inventory gains were less than expected.

Taking a slightly closer look at what was a fairly uneventful Fed statement, Peter Hooper reckons the importance of the April statement was how the Committee saw recent and prospective economic developments. The message was that growth has slowed and the improving trend in the labour market has passed due “in part” to transitory factors. Conditions are still in place to support further improvement in the job market ahead and inflation is also expected to eventually return to desired levels. Reading between the lines Peter thinks the statement is still consistent with a September liftoff as long as economic conditions develop in line with the Committee’s expectations.

Onto more micro matters we’ll quickly roundup yesterday’s earnings. 43 S&P 500 companies reported yesterday and strong EPS beats continues to be the main theme. 31 out of those 43 firms delivered upside surprises (including Time Warner, Mastercard and Hess Corp) to EPS but only 19 of those managed to do the same for sales revenue. The trend remains quite the opposite in Europe where we saw just over half of the companies beat EPS forecasts but just over two-thirds of them beat sales estimates.

Key Asian equity and government bond markets are trading lower overnight. The BoJ has left monetary policy/QQE unchanged as we go to print. Look out for the press conference after we publish. The Nikkei is down -2.6% while the 10yr JGB yield is also up 4bps to 0.329% with the Nikkei weakening -1% since the announcement. The Hang Seng is -1% lower as we type but still on track to close nearly +14% on the month – its biggest monthly gain since May 2009. There seems to also be some profit taking in China with the Shanghai Composite -0.1% lower overnight. The 10yr UST is about 2bps lower at 2.02% as we go to print.

Taking a look at Greece, it looks like EU officials will resume negations today. A reinforced Greek team is set to meet with its international creditors in Brussels today with some new proposals from the Greeks expected to be discussed. The aim is to reach a preliminary deal by 3 May to allow finance ministers to sign off an accord by the next scheduled meeting on 11 May (Bloomberg news).

Looking to the day ahead we have German March retail sales (expected to rise to +0.5% MoM), their unemployment rate (expected steady at 6.4%), French March PPI (expected +0.5%) and consumer spending (expected to fall to -0.5% MoM). We will also get Spanish April CPI (expected to fall to +0.7% MoM) and Q1 GDP (expected to rise to +0.8% QoQ). Continuing what is a busy day for European data we will have the Eurozone March unemployment rate (expected slightly down at 11.2%) and the April CPI estimate (expected to rise to 0% MoM). Finally we will also get Italian April CPI (expected down at +0.5% MoM). In the US we will see the Q1 Employment Cost Index (expected at +0.6%) as well as March personal income (+0.2%), personal spending (+0.5%) and core PCE (expected to rise to +0.2% MoM) as well as the April Milwaukee ISM (expected to fall to 53) and the Chicago Purchasing Manager number (expected to rose to 50).

Earnings season continues to roll on with heavy-hitters including Airbus, BNP, RBS and Shell reporting in Europe and Coca-Cola, Exxon, AIG and Visa in the US. A busy day to end another exciting month.

wallstreetexaminer.com / by William Black • June 4, 2015

We have known from the beginning that Lanny Breuer, who the Obama administration chose as its head of the Criminal Division in order to ensure that there would be no prosecutions of the banksters that led, and were enriched by the fraud epidemics that drove the crisis, would be a national embarrassment. Readers may recall that Breuer publicly admitted that what caused him to lose sleep was not the world’s most destructive fraud epidemics that ruined our economy or his grant of effective immunity to the banksters who led and became wealthy through those frauds. He lost sleep solely over his fear that if he held them accountable for the frauds that had bankrupted their corrupt banks those banks might be placed in receivership and honest managers appointed. (Of course, that isn’t how he phrased it, but that is what he was actually saying.)

An additional confirmation of that fact that Breuer was a national embarrassment was just made public in a New York Times article entitled: “U.S. Prosecutors Did Not Question Goldman on Financial Crisis in 2010 Meeting.”

Several people from the general counsel’s office at Goldman attended the March 5, 2010, meeting, including David N. Lawrence, who at the time was global head of the company’s business intelligence group.

Mr. Breuer arranged the meeting to sound out Mr. Lawrence’s views on how best to combat terrorism financing, given his experience in working with Wall Street banks to develop systems to prevent money laundering, the person briefed on the matter said.

This requires some context. Prior to Breuer’s meeting, Goldman had recently been bailed out – and saved many billions of dollars in losses by two acts of governmental intervention at AIG. Goldman, under the leadership of Hank Paulson, had purchased large amounts of toxic mortgage paper (primarily collateralized debt obligations (CDOs) “backed” largely by fraudulently originated loans.

READ MORE

The post Obama’s Fateful Error in Making Bush’s Goldman Sachs/AIG Scandal His Scandal appeared first on Silver For The People.

Earlier today, former AIG head Hank Greenberg’s long-running legal battle of the US government came to a dramatic end when in a 75-page ruling,  U.S. Court of Claims Judge Thomas Wheeler found that Greenberg was indeed correct in claiming the government overstepped its legal boundaries in its “unduly harsh treatment of AIG in comparison to other institutions” which was “misguided and had no legitimate purpose.”

But because “the question is not whether this treatment was inequitable or unfair, but whether the government’s actions created a legal right of recovery for AIG’s shareholders” Wheeler found that Greenberg was not owed any money as AIG would have gone bankrupt without the government’s forced intervention. Greenberg was seeking at least $25 billion in damages for shareholders.

The reason for the case is that years after the initial $85 billion bailout which eventually ballooned to $182 billion, AIG – with the government’s explicit backstop and thus zero credit risk – managed to repay the government bailout funds and the government with a $22.7 billion profit. Greenberg argued that the pre-bailout equity holders deserved a piece of the pie, very much the same way that Fannie and Freddie stakeholders are also arguing they too deserve a piece of the post-government bailout pie.

However, “in the end, the Achilles’ heel of Starr’s case is that, if not for the Government’s intervention, AIG would have filed for bankruptcy. In a bankruptcy proceeding, AIG’s shareholders would most likely have lost 100 percent of their stock value” the judge found, and admitted that the pre-government bailout equity value of financial companies – since all of them were facing bankruptcy without a bailout – was zero.  Whether this opens up the door to a class action lawsuit by all those who were short financials into the bailout and were then squeezed by the Fed’s bailout which the court has found to be an “illegal exaction” remains to be seen.

Here are the key sections from the court ruling:

The weight of the evidence demonstrates that the Government treated AIG much more harshly than other institutions in need of financial assistance. In September 2008, AIG’s international insurance subsidiaries were thriving and profitable, but  its Financial Products Division experienced a severe liquidity shortage due to the collapse of the housing market. Other major institutions, such as Morgan Stanley, Goldman Sachs, and Bank of America, encountered similar liquidity shortages. Thus, while the Government publicly singled out AIG as the poster child for causing the September 2008 economic crisis (Paulson, Tr. 1254-55), the evidence supports a conclusion that AIG actually was less responsible for the crisis than other major institutions.

Well, there was Lehman too, whose stock most certainly went to zero and which never got a government bailout but that was to be expected: after all Goldman needed to eliminate its biggest fixed income competitor at the time, and what better way than to wipe it out completely.

Wheeler continues:

The notorious credit default swap transactions were very low risk in a thriving housing market, but they quickly became very high risk when the bottom fell out of this market. Many entities engaged in these transactions, not just AIG. The Government’s justification for taking control of AIG’s ownership and running its business operations appears to have been entirely misplaced. The Government did not demand shareholder equity, high interest rates, or voting control of any entity except AIG. Indeed, with the exception of AIG, the Government has never demanded equity ownership from a borrower in the 75-year history of Section 13(3) of the Federal Reserve Act. Paulson, Tr. 1235-36; Bernanke, Tr. 1989-90.

In other words, there has never been a Fed-mediated nationalization of a private corporation prior to 2008. Which is accurate. It is also illegal according to the court, a ruling that may have dramatic repercussions for all future government/Fed bailouts of banks that Goldman deems relevant.

Starr alleges in its own right and on behalf of other AIG shareholders that the Government’s actions in acquiring control of AIG constituted a taking without just compensation and an illegal exaction, both in violation of the Fifth Amendment to the U.S. Constitution…. Having considered the entire record, the Court finds in Starr’s favor on the illegal exaction claim.

It is not quite clear why the Fed is equivalent to the Government in this case but we’ll just let that slide.

Here are the details:

With the approval of the Board of Governors, the Federal Reserve Bank of New York had the authority to serve as a lender of last resort under Section 13(3) of the Federal Reserve Act in a time of “unusual and exigent circumstances,” 12 U.S.C. § 343 (2006), and to establish an interest rate “fixed with a view of accommodating commerce and business,” 12 U.S.C. § 357. However, Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower’s equity as consideration for the loan. Although the Bank may exercise “all powers specifically granted by the provisions of this chapter and such incidental powers as shall be necessary to carry on the business of banking within the limitations prescribed by this chapter,” 12 U.S.C. § 341, this language does not authorize the taking of equity.

So if they Fed is not authorized to “take equity”, does that mean that the NY Fed trading desk at Liberty 33 or its backup desk in Chicago, also known as the “Plunge Protection Team” will have to do a firesale of all its stock, E-mini, and ETF holdings obtained as a result of levitating the market ever higher for the past 7 years? Inquiring minds demand to know.

The good news is that while the Fed’s bailout of AIG was illegal, at least it was not unconstitutional, as that particular pathway would have likely led to that Constitutional “Expert”, the president of the US, to get involved and opine on the “fairness” of a Fed bailout now and in the future.

A ruling in Starr’s favor on the illegal exaction claim, finding that the Government’s takeover of AIG was unauthorized, means that Starr’s Fifth Amendment taking claim necessarily must fail. If the Government’s actions were not authorized, there can be no Fifth Amendment taking claim…. Thus, a claim cannot be both an illegal exaction (based upon unauthorized action), and a taking (based upon authorized action).

Furthermore, the Court found that like in the BofA negotations over the Merrill rescue, the government effectively strongarmed AIG management into accepting the terms of the bailout it proposed:

The Government defends on the basis that AIG voluntarily accepted the terms of the proposed rescue, which it says would defeat Starr’s claim regardless of whether the challenged actions were authorized or unauthorized. While it is true that AIG’s Board of Directors voted to accept the Government’s proposed terms on September 16, 2008 to avoid bankruptcy, the board’s decision resulted from a complete mismatch of negotiating leverage in which the Government could and did force AIG to accept whatever punitive terms were proposed. No matter how rationally AIG’s Board addressed its alternatives that night, and notwithstanding that AIG had a team of outstanding professional advisers, the fact remains that AIG was at the Government’s mercy.

This would be especially accurate if an armed drone was flying outside of AIG HQ’s during the “negotiation.”

And yet, despite this clearly favorable to Greenberg ruling, the Court did not award him any damages. Why? For the simple reason that AIG was already effectively broke when the government stepped in, and as such there was be no residual equity value going into Lehman weekend and subsequently.

In the end, the Achilles’ heel of Starr’s case is that, if not for the Government’s intervention, AIG would have filed for bankruptcy. In a bankruptcy proceeding, AIG’s shareholders would most likely have lost 100 percent of their stock value. DX 2615 (chart showing that equity claimants typically have recovered zero in large U.S. bankruptcies). Particularly in the case of a corporate conglomerate largely composed of insurance subsidiaries, the assets of such subsidiaries would have been seized by state or national governmental authorities to preserve value for insurance policyholders. Davis Polk’s lawyer, Mr. Huebner, testified that it would have been a “very hard landing” for AIG, like cascading champagne glasses where secured creditors are at the top with their glasses filled first, then spilling over to the glasses of other creditors, and finally to the glasses of equity shareholders where there would be nothing left. Huebner, Tr. 5926, 5930-31; see also Offit, Tr. 7370 (In a bankruptcy filing, the shareholders are “last in line” and in most cases their interests are “wiped out.”).

 

A popular phrase coined by financial adviser John Studzinski, in counseling AIG’s Board on September 21, 2008 is that “twenty percent of something [is] better than 100 percent of nothing.”

All of this is absolutely correct. It also applies to Goldman, JPM, BofA, Citi, Wells and so on: all of the banks which accepted a government bailout either in equity, loan, discount window access, and so on, primed their stock to the point where the equity was worthless. As such, the entire equity tranches of the US financial system at the moment Lehman failed was worth precisely nothing.  It is also why the Goldman controlled Fed did everything in Hank Paulson’s power to provide the Fed with a blank check to bail out Goldman Sachs the US financial system at any taxpayer means necessary.

Which is precisely what happened, to the tune of trillions and trillions of liquidity injections, government backstops and loans into what was at that moment a financial system which was operating but whose equity was for all intents and purposes utterly worthless.

* * *

Which takes us to the Court’s closing arguments:

the Court finds that the first plaintiff class prevails on liability because of the Government’s illegal exaction, but recovers zero damages.

As the Court noted during closing arguments, a troubling feature of this outcome is that the Government is able to avoid any damages notwithstanding its plain violations of the Federal Reserve Act. Closing Arg., Tr. 69-70. Any time the Government saves a private enterprise from bankruptcy through an emergency loan, as here, it can essentially impose whatever terms it wishes without fear of reprisal. Simply put, the Government often may ignore the conditions and restrictions of Section 13(3) knowing that it will never be ordered to pay damages. 

And there you have it in a nutshell: 103 years after the Aldrich Plan to create a National Reserve Association in which private, commercial banks could create money out of thin air, failed to pass and instead an “impartial” Federal Reserve was created, the US Central Bank is nothing more than what its founder on Jekyll Island first envisioned: a private enterprise above the law, which caters entirely to commercial bank, bails them out, or nationalizes them illegally as it sees fit, and generally does whatever it wishes without any public oversight.

As to the Fed’s take on just how illegal its actions were, or if – gasp – it learned its lesson and will no longer illegally “bail out” this bank or that, here is the answer.

The Federal Reserve strongly believes that its actions in the AIG rescue during the height of the financial crisis in 2008 were legal, proper and effective.  

And judging by the public’s response to the events of 2008, where it is clear that not only the Fed but nobody learned anything, the next bailout of US commercial banks will proceed very much like the previo sone. And the next. And the one after that.

Source: Starr International Company v The United States

• Greek PM sticks to hard line as contagion hits euro zone bonds (Reuters)
• Greek Deadlock Has Leader Hoping for Miracle to Avoid Default (BBG)
• Greek Showdown Puts Merkel’s Teflon Legacy at Risk (BBG)
• Greek standoff saps Europe, dollar swings ahead of Fed (Reuters)
• Allianz Increased Holdings of Greek Debt as Its Largest Investor (BBG)
• French Bonds Infected as Greek Crisis Swells Euro-Region Spreads (BBG)
• Statoil to cut 1,500 more jobs as savings drive intensifies (FT)
• UnitedHealth, Anthem Seek to Buy Smaller Rivals (WSJ)
• Five Million Reasons Why China Could Go to War (BBG)
• Former CIA Chief Says Government Data Breach Could Help China Recruit Spies (WSJ)
• Organic business must be terrible: Goldman Plans to Offer Consumer Loans Online, Adopting Start-Ups’ Tactics (NYT)
• Pope Backs Climate Change Science, Denounces World Leaders (BBG)
• Al Qaeda deputy leader killed in U.S. bombing in Yemen (Reuters)
• The $50 Billion Question: Can Uber Deliver? (WSJ)
• This Former NFL Player’s $8 Billion Mortgage Lender Started With a Google Search (BBG)
• The World Is Facing Its Longest Oil Glut in at Least Three Decades (BBG)
• China says about to finish some land reclamation in South China Sea (Reuters)
• Russian cenbank ready to cut rates if inflation eases – governor (Reuters)
• A New Storm Threatens to Bring Floods Back to Texas (BBG)

Overnight Media Digest

WSJ

* The two biggest U.S. health insurers by revenue, UnitedHealth Group Inc and Anthem Inc, are seeking to buy smaller rivals in a merger scramble aimed at cutting costs as the companies cope with the federal health-care overhaul. (http://on.wsj.com/1ejeSW9)

* Investors are counting on Uber Technologies Inc to upend the delivery business much as it has for taxis, but progress has been slow so far. (http://on.wsj.com/1ejeZAV)

* A computer failure has prevented the U.S. from issuing thousands of temporary and immigrant visas since June 9, leaving agricultural workers stranded in Mexico just as the summer harvest gets under way. (http://on.wsj.com/1ejf47z)

* A federal judge ruled that the U.S. government exceeded its authority in its 2008 rescue of AIG Inc, but the former AIG chief and thousands of shareholders did not win any of the $40 billion in damages they had sought. (http://on.wsj.com/1ejfeff)

* U.S. energy companies are slowing down their natural-gas production growth after years of furious pumping. (http://on.wsj.com/1ejfs6b)

* Goldman Sachs Group Inc, the firm synonymous with Wall Street, is venturing onto Main Street as it plans to attract consumers and small businesses. (http://on.wsj.com/1ejfzi5)

FT

Goldman Sachs has joined a growing number of lenders who have gone online to develop a new line of business providing digital banking services, without the traditional costs involved.

The Scots have called for “serious and substantial” discussions over London handing over more powers to Edinburgh, saying that the current draft legislation under discussion in Westminster is inadequate.

Jaguar Land Rover is using all its off-road capabilities to develop a system of sensors that will give its vehicles the capability to move driverless in adverse weather and environments.

Apple Inc., on a posting on its website, has called out looking for experienced journalists to get on board its new service Apple News, that will deliver personalised content to its readers. Apple News will replace its predecessor Apple’s Newsstand.

NYT

* Gap Inc announced on Monday that it planned to close one-fourth of its stores in North America over the next few years, potentially affecting thousands of jobs, as the brand struggles to turn around a business mired in a long sales slump. (http://nyti.ms/1MH7PRy)

* CVS Health Corp will acquire more than 1,600 pharmacies from Target Corp in 47 states and operate them under its brand name within Target stores. (http://nyti.ms/1MHaRoY)

* Goldman Sachs Group is working on a new business plan to start a consumer lending unit that would offer loans online. While the unit is still in the early planning stages, Goldman has ambitious plans to offer loans of a few thousand dollars to ordinary Americans and compete with Main Street banks and other lenders.(http://nyti.ms/1MHb2R2)

* A group of community and labor organizations is accusing Wal-Mart Stores Inc of inappropriately using the nonprofit Walmart Foundation to help reduce local opposition to its expansion efforts in some urban areas like Washington, Boston, Los Angeles and New York. (http://nyti.ms/1GJ5khx)

Canada

THE GLOBE AND MAIL

** Ontario will bring in regulations to govern police carding in a bid to allay criticisms that the controversial practice violates civil liberties and leads to racial profiling, The Globe and Mail has learned. (http://bit.ly/1Bj2krJ)

** Goldcorp Inc has sold its stake in Tahoe Resources Inc for nearly C$1 billion ($810.24 million) as the gold miner beefs up its balance sheet amid weak bullion prices. (http://bit.ly/1Sk5AaI)

** As Canada’s big banks become increasingly interested in the way consumers make purchases, they are ramping up their attention to a payment product that shows promising growth: prepaid cards. (http://bit.ly/1FZqeVO)

NATIONAL POST

** The Competition Bureau is intensifying its probe into whether the Canadian subsidiary of Apple Inc has employed unfair anti-competitive clauses in contracts with the large and small Canadian wireless carriers that sell iPhone devices in their retail stores across the country. (http://bit.ly/1BfsX0P)

** With the C$3.36 billion ($2.72 billion) purchase of Germany’s Kaufhof chain, Richard Baker, chairman of Hudson’s Bay Co, is banking on the notion that real estate is becoming more important to merchants than ever before in the era of blossoming digital retail. (http://bit.ly/1LcKPwD)

** Bombardier Inc’s CSeries was a “highlight” at the first day of the Paris Air Show, but the company failed to generate any new orders for the aircraft despite confirming that it is exceeding performance targets. While competitors Airbus Group SE and Boeing Co announced about $33 billion of new orders, Bombardier only managed to eke out a couple of small order conversions. (http://bit.ly/1LcL6zI)

China

CHINA SECURITIES JOURNAL

- China’s summer crops are expected to have a good harvest, and might hit a record high, said Han Changfu, China’s agriculture minister.

SHANGHAI SECURITIES NEWS

- Provincial governments have approved 766.7 billion yuan ($123.5 billion) in public private partnership (PPP) projects in the last month, according to calculations by Shanghai Securities News. The 321 demonstration projects are primarily in the areas of transport, energy, urban construction, environmental protection, agriculture and water treatment.

CHINA DAILY

- It is time for Chinese nuclear power equipment makers to explore overseas markets, and demonstrations of domestic equipment is needed to boost exports, Premier Li Keqiang said at a visit to China Nuclear Power Engineering Co Ltd in Beijing on Monday.

Britain

The Times

Greece is heading for a “state of emergency” and exit from the euro after negotiations to prevent the country defaulting on international debts broke down amid acrimony last night, said Günther Oettinger, Germany’s commissioner. (http://thetim.es/1GoHN3U)

Thomas Cook Group Plc, the UK-based travel company, has launched a joint venture with Chinese company Fosun International Ltd to take its package holidays to China. (http://thetim.es/1FjmrRM)

The Guardian

Leisure industry entrepreneur Luke Johnson is investing 1.5 million stg ($2.34 million) in Eclectic Bar Group Plc and has taken over as executive chairman of the struggling chain aimed at wealthier students. The deal, which needs approval by shareholders next month, will give him an 18.5 percent stake.(http://bit.ly/1LbEAZW)

U.S. gun maker Colt Group SA has filed for bankruptcy protection, the company announced on Sunday. The company is hoping for an accelerated sale of its operations in the United States and Canada.(http://bit.ly/1dGWwND)

The Telegraph

Aviva Plc, the insurance group, is closing its offices in Salisbury, Stretford and Salford and slimming down at other sites as it attempts to cut 225 million stg ($350.71 million) from its yearly costs following the merger with Friends Life. (http://bit.ly/1C9yVLF)

Aberdeen Asset Management Plc has agreed to raise 100 million stg ($155.87 million)by issuing preference shares to Japan’s Mitsubishi UFJ Trust and Banking Corporation. (http://bit.ly/1LcKKpv)

Sky News

The chairmen of Barclays Plc and Prudential are to take the helm at lobbying group TheCityUK, as the financial services sector braces for a referendum on the UK’s European Union membership, according to Sky News. (http://bit.ly/1IG7pdr)

The Jamaican government has contacted HSBC Holdings to pitch the island-state as a potential destination, as the lender decides whether to move its head office away from the United Kingdom, according to Sky News. (http://bit.ly/1GoKvXb)

The Independent

Nationwide Building Society’s banking customers took to Twitter on Monday morning to report that their current accounts have “vanished” and they had been unable to log on to online banking. Problems seem to have been caused after a planned upgrade on Sunday. (http://ind.pn/1cXkvri)

Thousands of working-class people are being denied jobs at top firms, as they effectively need to pass a “poshness test” to join elite employers, according to the official body set up by the government to promote social mobility. (http://ind.pn/1TncL3a)

• Greek central bank issues ‘Grexit’ warning if aid talks fail (Reuters)
• Kerry says ‘patience wearing thin’ on Syria’s Assad (Reuters)
• Juncker accuses Athens of misleading Greek people (FT)
• Al Qaeda kills two Saudis accused of spying for America (Reuters)
• Hedge-Fund Bet Hits Pensions (WSJ)
• ‘Flash Crash’ Trader Navinder Sarao Worked With Fund Network Now Under Investigation (WSJ)
• ‘Me? Rich?’ U.S. presidential hopefuls play middle-class card (Reuters)
• You’ve Been Warned: Central Bankers Turning Less Market-Friendly (BBG)
• Hillary Clinton to Propose Tax Credit for Businesses to Train Apprentices (WSJ)
• Botox Owner Allergan to Buy Maker of Double-Chin Treatment (WSJ)
• A year after the crash, oil markets risk more trouble ahead (Reuters)
• Swiss Prosecutor Examines Bank Transactions in FIFA Probe (BBG)
• Former AIG Chief Greenberg to Appeal Damages Ruling in Bailout Case (WSJ)
• The China Bubble Is Going to Burst (BBG)
• Canadian rocker Neil Young strikes sour note on Donald Trump’s use of song (Reuters)
• How FitBit Can Avoid Becoming Another BlackBerry After Its IPO (BBG)
• Wal-Mart Has $76 Billion in Overseas Tax Havens, Report Says (BBG)

Overnight Media Digest

WSJ

* Starbucks Corp is closing its La Boulange pastry shops and will focus on expanding the brand in house. (http://on.wsj.com/1HRMuFP)

* Former American International Group Chief Executive Maurice “Hank” Greenberg said he would appeal a decision not to award shareholders any of the $40 billion in damages they were seeking in the government bailout case. (http://on.wsj.com/1HRLEJh)

* U.S. companies from Ford Motor Co to supermarket chain Kroger Co have boosted their pension plans’ bets on hedge funds, a shift that left many of them on the short end of a stock-market rally. (http://on.wsj.com/1HRLUrL)

* Amazon Inc is developing a mobile application that would pay individuals to drop off packages in an effort to cut down on rising shipping costs. (http://on.wsj.com/1HRMlCd)

* Video-streaming service Hulu is working harder to please television giants, and in the process luring some content producers from Netflix Inc. (http://on.wsj.com/1HRMTYS)

FT

Former AIG chief Hank Greenberg’s victory against the U.S. government on the terms of the AIG bailout during the financial crisis may give a new lease of life to the shareholders of Fannie Mae and Freddie Mac. Activist investor Bill Ackman among others have sued the U.S. government over the way it treated mortgage companies.

Coty Inc is emerging as the frontrunner to acquire some of the cosmetics, haircare and fragrance brands from Procter & Gamble worth $12 billion, people familiar with the matter said.

Nestle’s chief executive for African equatorial region, in an interview to the Financial Times said the company is cutting 15 percent of its African workforce, spread across 21 countries in the continent, as it overestimated the demand and growth of its middle class.

European carmakers like BMW and Audi, who have been depending on China – the world’s largest car market – for their growth, have warned that returns from the Asian country have been declining in light of a slowing economy, limits on car ownership in metro cities and competition from homegrown car brands.

NYT

* Starr International, the firm through which Maurice Greenberg continues to hold a stake in the American International Group, said on Tuesday that despite persuading a judge that the government overstepped its bounds in its 2008 bailout of AIG, it planned to appeal his decision not to award any monetary damages. (http://nyti.ms/1BhSeYm)

* U.S. chip makers say that without the Trans-Pacific Trade Partnership, they will be squeezed out of the growing Asian market for computer chips by competitors in countries like China. (http://nyti.ms/1BhR7I2)

* Greece’s prime minister, Alexis Tsipras, on Tuesday blasted his country’s creditors for austerity measures that he said were humiliating and strangling his people as pressure mounted on Athens to present reforms in exchange for bailout funding. (http://nyti.ms/1BhQaQf)

* As the Federal Reserve edges toward rate increases, some longtime money managers worry about investors who have entered new markets since the financial crisis, and have never experienced the kind of volatility that disrupts trading even during periods of normal activity. (http://nyti.ms/1BhQs9K)

* The U.S. Food and Drug Administration says two generic versions of Concerta, an extended-release form of Ritalin for ADHD, don’t measure up to the brand drug. But both are still on the market. (http://nyti.ms/1BhRMtc)

China

CHINA SECURITIES JOURNAL

- The number of new investors in the
Shanghai and Shenzhen stock markets hit 1,413,500 last week, data from
the China Securities Depository and Clearing Corp Ltd showed.

-
China Everbright Bank Co Ltd said it would cooperate with Xiaomi on its
payment application, Everbright Cloud Payment Platform, in a bid to
expand its mobile business.

SHANGHAI SECURITIES NEWS

-
Authorities plan to use China’s north-west Xinjiang region as a testing
ground for the country’s energy reforms and intend to issue policies in
line with this, the newspaper reported, citing unnamed sources.

CHINA DAILY

-
China will export six to eight domestically produced third-generation
nuclear reactors by 2020, a senior official at China National Nuclear
Corp said.

- Beijing has drafted its first regional action plan
to control and combat air pollution in the area, a senior official from
the municipal environmental authority said.

Britain

The Times

Majestic Wine’s new chief executive has cancelled plans to expand to 330 stores and has started trials of single-bottle sales in an attempt to attract customers put off by the present minimum six-bottle order. (http://thetim.es/1GXBlEz)

A new regulatory investigation by Ofcom into Royal Mail was announced just a week after the government successfully offloaded 750 million pounds ($1.17 billion) worth of shares in the letters and parcels delivery company. (http://thetim.es/1GXB3NP)

The Guardian

An independent currency designed to boost Bristol’s economy by keeping cash in the area is celebrating a major success after renewables provider Good Energy Group agreed that its customers could pay their bills using the local money. (http://bit.ly/1G1y9lr)

The British Broadcasting Corp announced that television and radio presenter Chris Evans had signed a three-year deal to host Top Gear, ending weeks of speculation over who would front the popular motoring show in the wake of Jeremy Clarkson’s dismissal. (http://bit.ly/1J3h1C4)

The Telegraph

The Bank of England is under increasing pressure to publish its research into the impact of the UK leaving the European Union, with George Osborne and influential MP Andrew Tyrie urging action. (http://bit.ly/1SlixAU)

Britain’s so-called “bad bank” Northern Rock and Bradford and Bingley is looking to spin off its mortgage servicing arm, according to Richard Banks, the chief executive of UK Asset Resolution (UKAR), in a move that could create an unexpected long-term legacy of the financial crisis. (http://bit.ly/1R6x8xS)

Sky News

British Prime Minister David Cameron will shortly appoint a new line-up of business people to advise him as he seeks to address industry’s concerns about the implications of a possible British exit from the European Union. (http://bit.ly/1BgjwOH)

European Union leaders have failed to agree on measures to share the burden of an influx of thousands of migrants crossing the Mediterranean to seek refuge in Europe. Ministers met in Luxembourg to discuss how to distribute 40,000 new refugees who have arrived in Italy and Greece. (http://bit.ly/1N0vrS1)

The Independent

Alexis Tsipras, the Greek prime minister, has railed against attempts to humiliate his government by international creditors such as the EU and the International Monetary Fund, claiming the IMF has ‘criminal responsibility’ for the deadlock. (http://ind.pn/1dIrTYq)

Economic expectations tumbled but rate hike expectations surged… labor market hopes rose but economic growth is expected to weaken… so buy stocks you retard! Artist's impression of the last 2 days in The Eccles Building…

And furthemore… *YELLEN SAYS FED STRONGLY BELIEVES 2008 AIG ACTIONS WERE LEGAL

The result of all this confusion… A 3rd Hindenburg Omen in the last 5 days…

Futures show the full day's vol…

Futures eneded up dumped back perfectly to VWAP…

Cash Indices on the day

Since Friday, Trannies remain ugly…

While stocks are back in the green from Friday, VIX remains higher

And Credit remains thoroughly unimpressed…

Bonds bought with both hands and feet…

The Dollar was monkey-hammered…

Gold and Silver stacked… (and crude and copper playing catch up)

*  *  *

Post FOMC performances…

Stocks…

Bonds…

Commodities…

Charts: Bloomberg

Bonus Chart: Still Confused after today's FOMC?

Someone found THE perfect gift for FOMC days. Especially when Yellen speaks -> http://t.co/h8YoYWyMoO $SPY $TLT pic.twitter.com/VeaTxqDqM6

— StockTwits (@StockTwits) June 17, 2015

Submitted by Louis-Vincent Gave via InvestorInsights.com,

The Fed's QE policies of recent years have, for all intents and purposes told the world that “the dollar is our currency and your problem.”

And, in recent years, the dollar has been a genuine problem for a number of emerging countries. Indeed, if nothing else, the Lehman Brothers bust revealed the extent to which almost all of the trade (and project financing, and private bank lending, etc…) between emerging markets still takes place in dollars. This means that emerging market nations must either first earn dollars, or find someone to lend dollars to them, before expanding their trade and capital spending. It also means that, if US banks are mismanaged, emerging markets tend to fall apart as companies there can no longer obtain financing for trade, investment projects, etc…

This was the main lesson that most emerging market policymakers learnt in 2008. Until then, having 100% of one's trade denominated in dollars did not seem awkward. But once the Lehman bust showed to the world that American bankers were no smarter than anyone else's and worse, that American regulators were also no better than any other countries’, then financing every trade and every investment in dollars rapidly shifted from being the “easy thing to do” to a “problem that needed to be addressed”. All of a sudden, it became obvious that depending on the dollar made no sense if the US banking system was badly managed and badly regulated. The scales fell from the eyes of the emerging markets' policymakers. And chief amongst the countries looking to make a shift was China which, by 2008, had become the number one, or at worst number two trading partner for almost any emerging market, importing commodities from Latin America, Africa, the Middle-East, Russia or South East Asia and exporting manufactured goods everywhere around the world.

With Lehman and AIG hitting the skids, trade finance just dried up and China’s exports fell -25% YoY:

Now the fact that the US, or Europe, would import less as they entered into a recession was understandable enough. But really what stung most was that China’s emerging market trading partners also cancelled orders and, as a result, some 25mn migrant workers lost their jobs almost overnight.

Following this traumatic event, and the change in the perception of US stability, China went around the world and invited the likes of Brazil, Indonesia, South Africa, Turkey and Korea to shift some of their China trade away from the dollar and into renminbi. China started doing this in 2011 and, as we see it, the renminbi’s attempt to become a trading currency is potentially one of the most important financial developments. Yet no-one seems to care.

For the likes of Brazil, Turkey or South Africa to start trading in renminbi means that these countries' central banks will need to keep some of their reserves in renminbi. Which, in turn, means that China needs to offer assets for these central banks to buy. This simple reality has pushed China to create the offshore renminbi bond market in Hong Kong, the “dim-sum” bond market. China’s invitation to other countries to start trading more in renminbi also explains why, over the past two years, the PBoC has gone around the world and signed swap agreements with the central banks of Brazil, Korea, Turkey, Australia, Argentina and countless others. In essence, China has told her emerging market trading partners: “Let’s move our trade to renminbi and if you don’t have any, you can come borrow some on my HK dim sum bond market, or alternatively, we will just lend some to you directly through our central bank.”

Given the increasing risk that a US with a structurally improving trade balance (thanks to falling energy imports) will send ever fewer dollars abroad, China’s attempt to mitigate its dependency on the dollar could not be better timed. Of course, these efforts can only bear fruit if both the renminbi bond market and the renminbi exchange rate prove to be stable — in essence, if the renminbi is seen as offering a reasonable alternative to the dollar; if the renminbi manages to transform itself into the deutschemark of emerging markets.

Which brings us to the global bond market meltdown that followed the Fed’s announcement of a possible tapering of US treasury purchases — the Spring 2013 ‘taper tantrum’. Following Ben Bernanke’s May 2013 declarations, emerging and OECD government bond markets sold off aggressively to the point where, in the second quarter of 2013, renminbi bonds were the only bonds globally to offer investors positive returns! Like the hounds in Silver Blaze, the renminbi bond market has been the dog that did not bark; and just as Sherlock Holmes was quick to deduce an important message from the dogs’ silence, perhaps we should listen to the sound of the renminbi bond markets stability?

Indeed, in the face of weak Asian currencies, underwhelming Chinese economic data and disappointing global industrial and consumption numbers during 2013 (weak US ISM, weak EU retail sales, etc.) most would likely have expected Chinese bonds, or the renminbi, to fare poorly. Yet, renminbi bonds have been the new shelter-in-the-storm; a reality which draws two possible explanations:

1. The offshore renminbi bond market, and the Chinese exchange rate, represent small, easily manipulated markets. And Beijing is manipulating them to suck in even more foreign capital into an economy that is increasingly spinning its wheels. Beijing will soon enough lose control and this will all end in tears (from our meetings, this would seem to be the consensus view — the pessimism on China is so deep that, if there was an Olympic medal for pessimism, most investors wouldn't even fancy China's chances).  
2. The offshore renminbi bond market, and exchange rate, represent small, easily manipulated markets. And Beijing is manipulating the markets in a clear bid to transform the renminbi into a trading currency.

We tend to favor the latter explanation, probably because, for China, successfully transforming the renminbi into a trading currency is more than just evolving towards settling its own imports in its own currency (as advantageous as that may be). Internationalizing the currency may well be the key to China’s future economic growth. Indeed, when thinking about China’s economic development, most of us intuitively think of all the “Made in China” goods stocking up the aisles of Walmart or Carrefour. And it is undeniably true that China’s prosperity has relied heavily on the export of cheap consumer goods to rich countries. China’s modern economy has mostly been export-led. This is unlikely to change overnight, even if ‘net trade’ has historically not been such a large contributor to GDP growth. Instead, exports have been central to China’s development model as the country’s insertion into the global supply chain has forced constant productivity gains. This cycle of improvement has been driven by technology and management know-how transfers, along with rapid shifts in the labor force. Thus, it is hard to imagine a strongly growing future for China without growing exports.

Which brings us to China’s current quandary: basically, over the past 30 years, China got rich by selling cotton underwear and plastic-soled shoes to the world. This is why most people carry an image of China as a phalanx of sweatshops, churning out T-shirts and toys for American and European shoppers. However, this image is now as outdated as skinny jeans. Instead, most of the growth in Chinese exports comes from industrial goods — and the customers are increasingly firms in developing countries building local infrastructure. China clearly no longer wants to pursue the high volume, highly polluting, low margin businesses which enabled it to rise from dire poverty. Instead, China (or at the very least, the Chinese Ministry of Commerce) now envisions its future as one of selling earth-moving equipment to Indonesia, telecom switches to India, cars to the Middle East, oil rigs to Russia and auto machinery to Eastern Europe or Latin America. The problem, of course, is that once one starts to compete with the likes of Caterpillar, Siemens, or Komatsu, having low prices may not be enough. Instead, offering attractive financing terms may be the deal clincher.

Submitted by Daniel Drew via Dark-Bid.com,

As Zero Hedge previously noted, liquidity is there when you don't need it, and it promptly disappears once it is in demand. Consider it "cocktease capitalism." If liquidity lasts longer than 4 hours, call the CFTC because you may be experiencing a spoof. Right now, the ultimate spoof is setting up as the credit default swap market collapses, and a global bond market margin call is just around the corner.

The most serious risk at the moment is the lack of bond market liquidity. This problem was created by the Federal Reserve. By flooding the market with liquidity, the Federal Reserve paradoxically destroyed the liquidity it sought to create. Initially, the Federal Reserve's actions helped stem the panic selling when it stepped in as the buyer of last resort. However, the Fed is quickly becoming the buyer of first resort. The CME even has a Central Bank Incentive Program to encourage foreign central banks to buy S&P 500 futures. It's not a stretch of the imagination to presume the Federal Reserve is buying S&P 500 futures alongside the foreign banks.

As the Fed's balance sheet expanded ever larger, they transformed from being a mere market participant to becoming the market itself. The Federal Reserve, along with the rest of the world's central banks, are essentially engaging in a multi-year effort to corner the global bond market. As we have seen in every case, no one has ever successfully cornered a market indefinitely. From the Hunt Brothers in the 1980 silver market to the Saudi royal family in the modern fractured oil market to the Duke brothers in the frozen concentrated orange juice market, it simply has not worked. Running a monopoly is an uphill battle that eventually results in a spectacular blowup. Why would the central banks be any different?

As Zero Hedge pointed out recently, the run on the central banks has already begun. For the first time ever, QE failed. The first casualty was the Riksbank in Sweden.

The Swedes have shown there is a limit on how low interest rates can go. The limit may be different for every country, but it does exist. Investors will eventually revolt against the post-crash Bizarro bond markets that dot the global landscape.

The same problem that brought Long-Term Capital Management to its knees is what will bring down the central bankers: liquidity. They seem to have forgotten that without liquidity, there are no markets. You can't be the only player in the game. It is often said that cash is king, but what that really means is liquidity is king. In the capital markets, investors will pay a premium for liquidity. Right now, liquidity trumps credit ratings in the bond market. As liquidity thins out dramatically, that premium is becoming smaller and smaller. One day, every central bank will have their Riksbank moment when, despite their best efforts, it all blows up.

In one of the largest ironies in regulatory history, the crackdown on the CDS market may ultimately exacerbate the inevitable bond market crash. A credit default swap allows someone to speculate on or hedge against the risk of a credit default. The outrage behind credit default swaps was not actually about the swaps themselves; it was about the leverage. AIG was just in over its head. Leverage is power, and like an amateur gun enthusiast, AIG couldn't handle the recoil on the trillion dollar caliber CDS market. However, used properly, credit default swaps can function effectively – particularly when the underlying markets have been squeezed dry of every last drop of liquidity by the bond market monopolists at the Fed. If the bonds themselves freeze up, perhaps the CDS market will continue trading.

This kind of derivative-driven salvation was one of the defining legacies of the stock market crash of 1987. When the market was at its lows and the stock exchanges considered closing, Karsten "Cash" Mahlmann, Chairman of the Chicago Board of Trade, decided to continue trading the Major Market Index (MMI) futures contract when virtually all other trading was at a standstill. A large rally in the MMI futures eventually led to a rally in the Dow Jones, proving once again that the futures market is the tail that wags the dog. In a moment of crisis, Wall Street took a back seat to Chicago.

All of this points to the power of the derivative to bolster confidence during a crash. As we have seen, the derivative market is many times larger than the actual underlying securities they represent. This is due to the nearly infinite amount of side bets that can be created. Even a casual investor can see this aspect in the proliferation of ETFs. However, the CDS market has been in a state of deleveraging and decline since the 2008 crash as a result of risk mitigation and new regulations.

Initially, this was a positive development, but now, the CDS market is slowly disappearing altogether. Last year, Deutsche Bank dropped out of the "single name" CDS market, which means less liquidity for anyone who has a legitimate need to hedge risk in particular entities. Without "single name" credit default swaps, hedgers and speculators alike are left with imprecise index swaps, such as the 10-year Markit CDX North America Investment Grade Index Series 9, the contract that cost JPMorgan $5.8 billion in 2012.

The central bankers are already anticipating the collapse of quantitative easing. They meet in Basel every other month at the Bank for International Settlements. A year ago, they met to attend a workshop called "Re-thinking the lender of last resort." One of the papers discussed was written by Perry Mehrling. It is called "Why central banking should be re-imagined." Mehrling said,

A market-based credit system requires market pricing of capital assets as a prerequisite for market funding. The assets are collateral for the funding, and if the market does not believe the asset prices then it's going to be pretty hard to get the funding, and if the private sector won't fund private holding of the Fed's asset positions then exit is de facto impossible.

When the bond market collapses, no one will be able to sell. And if they can't hedge, their hands are tied.

Submitted by Nomi Prins via TomDispatch.com,

Money, they say, makes the world go round. So how’s $10 billion for you? That’s a top-end estimate for the record-breaking spending in this 1% presidential election campaign season. But is “season” even the right word, now that such campaigns are essentially four-year events that seem always to be underway? In a political world stuffed with money, it’s little wonder that the campaign season floats on a sea of donations. In the case of Jeb Bush, he and his advisers have so far had a laser-focus on the electorate they felt mattered most: big donors. They held off the announcement of his candidacy until last week (though he clearly long knew he was running) so that they could blast out of the gates, dollars-wise, leaving the competition in their financial dust, before the exceedingly modest limits to non-super PAC campaign fundraising kicked in.

 

And give Jeb credit — or rather consider him a credit to his father (the 41st president) and his brother (the 43rd), who had Iraq eternally on their minds. It wasn’t just that Jeb flubbed the Iraq Question when a reporter asked him recently (yes, he would do it all over again; no, he wouldn’t… well, hmmm…), but that Iraq is deeply embedded in the minds of his campaign team, too. His advisers dubbed the pre-announcement campaign they were going to launch to pull in the dollars a “shock-and-awe” operation in the spirit of the invasion of Iraq. Now, having sent in the ground troops, they clearly consider themselves at war. As the New York Times reported recently, the group's top strategist told donors that his super PAC "hopes to 'weaponize' its fund-raising total for the first six months of the year."

 

The money being talked about: $80-$100 million raised in the first quarter of 2015 and $500 million by June. If reached, these figures would indeed represent shock-and-awe fundraising in the Republican presidential race. As of now, there’s no way of knowing whether they’re fantasy figures or not, but here's a clue to Jeb’s money-raising powers: according to the Washington Post, his advisers have been asking donors not to give more than a million dollars now; they are, that is, trying to cap donations for the moment. (As the Post's Chris Cillizza wrote,“The move reflects concerns among Bush advisers that accepting massive sums from a handful of uber-rich supporters could fuel a perception that the former governor is in their debt.”) And having spent just about every pre-announcement day for months doing fundraisers and scouring the country for money, while preserving the fiction that he might not be interested in the presidency, Jeb, according to the New York Times, bragged to a group of donors that “he believed his political action committee had raised more money in 100 days than any other modern Republican political operation.”

 

Let’s not forget, of course, that we’re not talking about anyone; we're talking about a Bush. We’re talking about the possibility of becoming number three (or rather Bush 45) in the Oval Office. We’re talking about what is, by now, a fabled money-shaking, money-making, money-raising machine of a family. We’re talking dynasty and when it comes to money and the Bushes (as with money and that other potential dynasty of our moment), no one knows more on the subject than Nomi Prins, former Wall Street exec and author of All the Presidents' Bankers: The Hidden Alliances That Drive American Power. In her now ongoing TomDispatch series on the political dynasties of our moment, fundraising, and the Big Banks, think of her latest post as an essential backgrounder on the election you have less and less to do with, in which Wall Street, the Koch brothers, Sheldon Adelson, and the rest of the crew do most of the essential voting with their wallets.

All In 
The Bush Family Goes for Number Three (With the Help of Its Bankers) 
By Nomi Prins

[This piece has been adapted and updated by Nomi Prins from her book All the Presidents' Bankers: The Hidden Alliances That Drive American Power, recently out in paperback (Nation Books).] 

It’s happening. As expected, dynastic politics is prevailing in campaign 2016. After a tease about as long as Hillary’s, Jeb Bush (aka Jeb!) officially announced his presidential bid last week. Ultimately, the two of them will fight it out for the White House, while the nation’s wealthiest influencers will back their ludicrously expensive gambit.

And here’s a hint: don’t bet on Jeb not to make it through the Republican gauntlet of 12 candidates (so far). After all, the really big money’s behind him. Last December, even though out of public office since 2007, he had captured the support of 73% of the Wall Street Journal’s “richest CEOs.” Though some have as yet sidestepped declarations of fealty, count on one thing: the big guns will fall into line. They know that, given his family connections, Jeb is their best path to the White House and they’re not going to blow that by propping up some Republican lightweight whose father and brother weren’t president, not when Hillary, with all her connections and dynastic power, will be the opponent. That said, in the Bush-Clinton battle to come, no matter who wins, the bankers and billionaires will emerge victorious.

The issue of political blood and family lines in Washington is not new. There have been four instances in our history in which presidents have been bonded by blood. Our second president John Adams and eighth president John Quincy Adams were father and son. Our ninth president William Henry Harrison and our 23rd president Benjamin Harrison were grandfather and grandson. Theodore and Franklin Delano Roosevelt were cousins. And then, of course, there were our 41st and 43rd presidents, George H.W. and George W.

If Jeb becomes the 45th president, it will be the first time that three administrations share the same blood and “dynastic” will have a new meaning in America.

The Bush Legacy

The Bush political-financial legacy began when President Ronald Reagan chose Jeb’s father, George H.W., as his vice president. Reagan was also the first president to choose a Wall Street CEO, Donald Regan, as Treasury secretary. Then-CEO of Merrill Lynch, he happened to be a Bush family friend. And talk about family tradition: once upon a time (in 1900, to be exact), Jeb’s great-grandfather, George Herbert Walker, founded G.W. Walker & Company. It was eventually acquired by — you guessed it! — Merrill Lynch, which was consumed by Bank of America at the height of the 2008 financial crisis.

That merger was pressed by, among others, George W. Bush’s Treasury Secretary (and former Goldman Sachs chairman and CEO), Hank Paulson. It helped John Thain, Paulson’s former number two at Goldman Sachs, who was by then Merrill Lynch’s CEO, out of a tight spot. Now chairman and CEO of CIT Group, Thain is also a prominent member of the Republican Party who sponsored high-ticket fundraisers for John McCain during his 2008 campaign. Expect him to be there for Jeb. Paulson endorsed Jeb for president on April 15th. That’s how these loops go.

As vice president, George H.W. co-ran a task force with Donald Regan dedicated to breaking down the constraints of the 1933 Glass-Steagall Act, so that Wall Street banks could become ever bigger and more complex. Once president, Bush promoted deregulation, while reconfirming Alan Greenspan, who did the same, as the chairman of the Federal Reserve. In 1999, after President Bill Clinton (Hillary!) finished the job that Bush had started by overseeing the repeal of Glass-Steagall, banks began merging like mad and engaging in increasingly risky and opaque practices that led to the financial crisis that came to a head in George W.’s presidency.  In other words, it’s a small world at the top.

The meaning of all this: no other GOP candidate has Jeb's kind of legacy political-financial power. Period. To grasp the interconnections between the Bush family and Wall Street that will put heft and piles of money behind his candidacy, however, it’s necessary to step back in time and see just how his family helped lead us to this moment of his.

Bush Wins

By the time George H.W. Bush became president on January 20, 1989, the economy was limping. Federal debt stood at $2.8 trillion. The savings and loan crisis had escalated. Still, his deregulatory financial policies remained in sync with those of the period’s most powerful bankers, notably Citicorp chairman John Reed, Chase (now JPMorgan Chase) Chairman Willard Butcher, JPMorgan chief Dennis Weatherstone, and Bank of America Chairman Tom Clausen.

With the economic odds stacked against him, Bush also remained surrounded by his most loyal, business-friendly companions in Washington, who either had tight relationships with Wall Street or came directly from there. In a preordained arrangement with President Reagan, Bush retained Nicholas Brady, the former chairman of the board of the blue-blood Wall Street investment bank Dillon, Read & Co., as Treasury secretary.

Their ties, first established on a tennis court, extended to Wall Street and back again. In 1977, after Bush had left the directorship of the CIA, Brady even offered him a position at Dillon, Read & Co. Though he didn’t accept, Bush later enlisted Brady to run his 1980 presidential campaign and suggested him as interim senator for New Jersey in 1982. The press dubbed Brady Bush’s “official confidant.”

The new president appointed another of his right-hand men, Richard Breeden (who had drafted a “Blueprint for Reform” of the banking industry as directed by a task force co-headed by Bush), as his assistant for issues analysis and later as head of the Securities and Exchange Commission (SEC). Then, on February 6, 1989, Bush unveiled his plan to rescue the ailing savings and loan (S&L) banks. Initial bailout estimates for 223 firms were put at $40 billion. It only took the Bush administration two weeks to raise that figure to $157 billion. On the offensive, Brady stressed that this proposal wasn’t a bailout. Instead, it represented “the fulfillment of the Federal Government’s commitment to depositors.”

A few months later, under Alan Greenspan’s Fed, JPMorgan Securities, the investment banking subsidiary of JPMorgan Chase, became the first bank subsidiary since the Great Depression to lead a corporate bond underwriting. Over the next decade, commercial banks would issue billions of dollars of corporate debt on behalf of energy and public utility companies as a result of Greenspan’s decision to open that door and Bush’s deregulatory stance in general. A chunk of it would implode in fraud and default after Bush’s son became president in 2001.

The S&L Blowout

The deregulation of the S&L industry between 1980 and 1982 had enabled those smaller banks, or thrifts — focused on taking deposits and providing mortgages — to compete with commercial banks for depositors and to invest that money (and money borrowed against it) in more speculative real estate ventures and junk bond securities. When those bets soured, the industry tanked. Between 1986 and 1989, 296 thrifts failed. An additional 747 would shut down between 1989 and 1995.

Among those, Silverado Banking went bankrupt in December 1988, costing taxpayers $1.3 billion. Neil Bush, George H.W.’s son, was on the board of directors at the time. He was accused of giving himself a loan from Silverado, but denied all wrongdoing.

George H.W.'s second son, Jeb Bush, had already been dragged through the headlines in late 1988 for his real estate relationship with Miguel Recarey Jr., a Cuban-American mogul who had been indicted on one charge of fraud and was suspected of racking up to $100 million worth of Medicare-related fraud charges.

Meanwhile, the president was crafting his bailout plan to stop the S&L bloodletting. On August 9, 1989, he signed the Financial Institution Reform, Recovery, and Enforcement Act, which proved a backdoor boon for the big commercial banks. Having helped stuff the S&Ls with toxic real estate products, they could now profit by selling the bonds that were constructed as part of the bailout plan, while the government subsidized the entire project. Within six years, the Resolution Trust Corporation and the Federal Savings and Loan Insurance Corporation had sold $519 billion worth of assets for 1,043 thrifts that had gone belly up. Key Wall Street banks were involved in distributing those assets and so made money on financial destruction once again. Washington left the public on the hook for $124 billion in losses.

The Bush administration and the Fed’s response to the S&L crisis (as well as to a concurrent third-world debt crisis) was to subsidize the banking system with federal and multinational money. In this way, a policy of privatizing bank profits and socializing their losses and risks became embedded in the American political system.

The New Banking Game in Town: “Modernization”

The S&L trouble sparked a broader credit crisis and recession. Congress was, by then, debating the “modernization” of the financial services industry, which in practice meant breaking down remaining barriers within institutions that had separated deposits and loans from securities creation and trading activities. This also meant allowing commercial banks to expand into nontraditional banking activities, including insurance provision and fund management.

The Bush administration aided the bankers by advocating the repeal of key elements of the Glass-Steagall Act. Related bills to dismantle that Depression-era act won the support of the House and Senate banking committees in the fall of 1991, though they were defeated in the House in a full vote.  Still, the writing was on the wall. What a Republican president had started, a Democratic one would soon complete.

In the meantime, the Bush administration was covering all the bases when it came to the repeal of Glass-Steagall, which would be the nail in the coffin of decades of banking constraint. As commercial bankers pushed to enter non-banking businesses, Richard Breeden, Bush’s SEC chairman, began championing the other side of the Glass-Steagall divide — fighting, that is, for the rights of investment banks to own commercial banks. And little wonder, since such a deregulation of the financial system meant a potential expansion of Breeden’s power: the SEC would be tasked with monitoring the growing number of businesses that banks could enter.

Meanwhile, Wendy Gramm, head of the Commodity Futures Trading Commission (CFTC), promoted another goal the bankers wanted: unconstrained derivatives trading. Gramm had first been appointed chair of the CFTC in 1988 by Reagan (who called her his “favorite economist”) and was then reappointed by Bush. She was determined to push for unregulated commodity futures and swaps — in part in response to lobbying from a Texas-based energy trading company, Enron, whose name would grow far more familiar to Americans in the years to come. While awaiting legislative approval, bankers started sending their trading exemption requests to Gramm and she began granting them.

9/11 Overshadows Enron

In early 2001, in the fading light of the rosy Clinton economy and an election result validated by the Supreme Court, the second President Bush entered the White House. A combination of Glass-Steagall repeal and the deregulation of the energy and telecom sectors under Clinton catalyzed a slew of mergers that consolidated companies and power in those industries upon fabricated books. The true state of the economy, however, remained well hidden, even as it teetered on a flimsy base of fraud, inflated stocks, and bank-created debt. In those years, the corporate and banking world still appeared glorious amid so many mergers. But the bankers’ efforts to support those transactions would soon give way to a spate of corporate bankruptcies.

It was the Texas-based energy-turned-trading company Enron that would emerge as the poster child for financial fraud in the early 2000s. It had used the unregulated derivatives markets and colluded with bankers to create a slew of colorfully named offshore entities through which the company piled up debt, shirked taxes, and hid losses. The true status of Enron’s fictitious books and those of other corporate fraudsters nonetheless remained unexamined in part because another crisis garnered all the attention. The 9/11 attacks at the World Trade Center, blocks away from where many of Enron’s trading partners were headquartered (including Goldman Sachs, where I was working that day), provided the banking industry with a reprieve from probes. The president instead called on bankers to uphold national stability in the face of terrorism.

On September 16, 2001, George W. famously merged financial and foreign policy. “The markets open tomorrow,” he said. “People go back to work and we’ll show the world.” To assist the bankers in this mission, Bush-appointed SEC chairman Harvey Pitt waived certain regulations, allowing corporate executives to prop up their share prices as part of a plan to demonstrate national strength by elevating market levels.

That worked — for about a minute. On October 16, 2001, Enron posted a $681 million third-quarter loss and announced a $1.2 billion hit to shareholders' equity. The reason: an imploding pyramid of fraudulent transactions crafted with banks like Merrill Lynch. The bankers were now potentially on the hook for billions of dollars, thanks to Enron, a client that had been bulked up through the years with bipartisan support.

Amid this financial turmoil, Bush was focused on retaliation for 9/11. On January 10, 2002, he signed a $317.2 billion defense bill. In his State of the Union address, he spoke of an “Axis of Evil,” of fighting both the terrorists and a strengthening recession, but not of Enron or the dangers of Wall Street chicanery.

In 2001 and again in 2002, however, corporate bankruptcies would hit new records, with fraud playing a central role in most of them. Telecom giant WorldCom, for instance, was found to have embellished $11 billion worth of earnings. It would soon supplant Enron as America’s biggest fraud of the moment.

Bush Takes Action

On July 9th, George W. finally unveiled a plan to “curb” corporate crime in a speech given in the heart of New York’s financial district. Taking the barest of swipes at his Wall Street friends, he urged bankers to provide honest information to investors. The signals were now clear: bankers had nothing to fear from their commander in chief. That Merrill Lynch, for example, was embroiled in the Enron scandal was something the president would ignore — hardly a surprise, since the company’s alliances with the Bush family stretched back decades.

Three weeks later, he would sign the Sarbanes-Oxley Act, purportedly ensuring that CEOs and CFOs would confirm that the information in their SEC filings had been presented truthfully. It would prove a toothless and useless deterrent to fraud.

And then the president acted: on March 19, 2003, he launched the invasion of Iraq with a shock-and-awe shower of cruise missiles into the Iraqi night sky. Two days later, by a vote of 215 to 212, the House approved his $2.2 trillion budget, including $726 billion in tax cuts. Shortly thereafter — a signal to the banking industry if there ever was one — he appointed former Goldman Sachs Chairman Stephen Friedman director of the National Economic Council, the same role another Goldman Sachs alumnus, former co-Chairman Robert Rubin, had played for Bill Clinton.

By the end of 2003, grateful bankers were already amassing funds for Bush’s 2004 reelection campaign. A bevy of Wall Street Republicans, including Goldman Sachs Chairman and CEO Henry Paulson, Bear Stearns CEO James Cayne, and Goldman Sachs executive George Herbert Walker IV (the president’s second cousin), became Bush “Pioneers” by raising at least $100,000 each.

The top seven financial firms officially raised nearly three million dollars for George W.’s campaign. Merrill Lynch emerged as his second biggest corporate contributor (after Morgan Stanley), providing more than $586,254. The firm’s enthusiasm wasn’t surprising. Donald Regan had been its chairman and the Bush-founded investment bank G.H. Walker and Company, which employed members of the family over the decades, had been absorbed into Merrill in 1978. Merrill Lynch CEO Earnest “Stanley” O’Neal received the distinguished label of “Ranger” for raising more than $200,000 for Bush’s reelection campaign. It was a sign of the times that O’Neal and Cayne hosted Bush’s first New York City reelection fundraiser in July 2003.

Government by Goldman Sachs for Goldman Sachs

The bankers helped tip the scales in Bush’s favor. On November 3, 2004, he won his second term in a tight election. By now, bankers from Goldman Sachs had saturated Washington. New Jersey Democrat Jon Corzine, a former Goldman Sachs chairman and CEO, was on the Senate Banking Committee. Joshua Bolten, a former executive director at the Goldman Sachs office in London, was director of the Office of Management and Budget. Stephen Friedman, former Goldman Sachs chairman, was one of George W.’s chief economic advisers as the director of the National Economic Council. (He would later become chairman of the New York Federal Reserve Board, only to resign in May 2009 amid conflict of interest charges concerning the pile of Goldman Sachs shares he held while using his post to aid the company during the financial crisis.)

Meanwhile, from 2002 to 2007, under George W.’s watch, the biggest U.S. banks would fashion nearly 80% of the approximately $14 trillion worth of global mortgage-backed securities (MBS), asset-backed securities, collateralized debt obligations, and other kinds of packaged assets created in those years. And subprime loan packages would soon become the fastest-growing segment of the MBS market. In other words, the financial products exhibiting the most growth would be the ones containing the most risk.

George W. would also pick Ben Bernanke to replace Alan Greenspan as chairman of the Federal Reserve. Bernanke made it immediately clear where his loyalties lay, stating, “My first priority will be to maintain continuity with the policies and policy strategies during the Greenspan years.”

In 2006, two years after persuading the SEC to adopt rules that enabled many of the “assets” being created to be undercapitalized and underscrutinized, the president selected former Goldman Sachs CEO Henry Paulson to be his third Treasury secretary. Joshua Bolten, who had by then had become White House Chief of Staff, arranged the pivotal White House meeting between the two men that sealed the deal. As Bush wrote in his memoir, Decision Points, “Hank was slow to warm to the idea of joining my cabinet. Josh eventually persuaded Hank to visit with me in the White House. Hank radiated energy and confidence. Hank understood the globalization of finance, and his name commanded respect at home and abroad.”

Under Bush, Paulson, and Bernanke, the banking sector would buckle and take the global economy down with it.

Goldman Trumps AIG

Insurance goliath AIG stood at the epicenter of an increasingly interconnected financial world deluged with junky subprime assets wrapped up with derivatives. When rating agencies Fitch, S&P, and Moody’s downgraded the company’s credit worthiness on September 15, 2008, they catalyzed $85 billion worth of margin calls. If AIG couldn’t find that money, Paulson warned the president, the firm would not only fail, but “bring down major financial institutions and international investors with it.” According to Bush’s memoir , Paulson convinced him. “There was only one way to keep the firm alive,” he wrote. “The federal government would have to step in.”

The main American recipients of AIG’s bailout would, in fact, be legacy Bush-allied firms: Goldman Sachs ($12.9 billion), Merrill Lynch ($6.8 billion), Bank of America ($5.2 billion), and Citigroup ($2.3 billion). Lehman crashed, but Merrill Lynch and AIG were saved. The bankers with the strongest alliances to the Bush family (and the White House in general) needed AIG to survive. And it did. But the bloodletting wasn’t over.

On September 18, 2008, George W. would tell Paulson, “Let’s figure out the right thing to do and do it.” He would later write, “I had made up my mind: the U.S. government was going all in.” And he meant it.  During his last months in office, the Big Six banks (and marginally other institutions) would thus be subsidized by an “all-in” program designed by Bernanke, Paulson, and Geithner — and later endorsed by President Barack Obama.

The bankers’ unruliness had, however, already crippled the real economy. Over the next few months, Bank of America, Citigroup, and AIG all needed more assistance. And in that year, the Dow Jones Industrial Average would lose nearly half its value. At the height of the bailout period, $19.3 trillion in subsidies were made available to keep (mostly) American bankers going, as well as government-sponsored enterprises like Fannie Mae and Freddie Mac.

As George W. headed back to Texas, the economy and markets went into free fall.

The Money Behind Jeb

Jump seven years ahead and, with the next Bush on the rise and the money once again flowing in, it’s still the age of bankers. Jeb already has three mega super PACs — Millennials for Jeb, Right to Rise, and Vamos for Jeb 2016 — under his belt. His Right to Rise Policy Solutions group, which, as a 501(c)(4) nonprofit, is not even required to disclose the names of its donors, no less the size of their contributions, is lifting his contribution tally even higher. None of these groups have to adhere to contribution limits and the elite donors who contribute to them often prove highly influential. After all, that’s where the money really is. In the 2012 presidential election, the top 100 individual contributors to super PACs and their spouses represented just 1% of all donors, but gave a staggering 67% of the money.

Of those, Republican billionaire Sheldon Adelson and his wife, Miriam, donated $92.8 million to conservative groups, largely through “outside donor groups” like super PACs that have no contribution limits. Texas billionaire banker mogul Harold Simmons and his wife, Annette, gave $26.9 million, and Texas billionaire homebuilder Robert Perry coughed up $23.95 million. Nebraska billionaire (and founder of the global discount brokerage TD Ameritrade) John Joe Ricketts dished out $13.05 million. Despite some early posturing around other candidates with fewer legacy ties, these heavy hitters could all end up behind Bush 45. Dynasties, after all, establish the sort of connections that lie in wait for the next moment of opportune mobilization.

“All in for Jeb” is the mantra on Jeb’s official website and in a sense “all in,” especially when it comes to national bankers, has been something of a mantra for the Bush family for decades. With a nod to his two-term record as Florida governor, Jeb put it this way: “We will take command of our future once again in this country. I know we can fix this. Because I've done it.”

Based on Bush family history, by “we” he effectively meant the family’s billionaire and millionaire donors and its cavalcade of friendly bankers. Topping that list, though as yet undeclared — give him a minute — sits Adelson, who is personally and ideologically close to George W. In April, the former president was paid a Clintonian speaking fee of $250,00 for a keynote talk before the Republican Jewish Coalition meeting at Adelson’s Las Vegas resort. While Adelson has expressed concerns about Jeb’s lack of hawkishness on Israel when compared to his brother, that in the end is unlikely to prove an impediment. Jeb is making sure of that.  He recently told a gathering of wealthy New York donors that, when it came to Israel, his top adviser is his brother. (“If you want to know who I listen to for advice, it’s him.”)

Let’s be clear.  The Bush family is all in on Jeb and its traditional banking allies are not likely to be far behind.  There is tradition, there are ties, there is a dynasty to protect.  They are not planning to lose this election or leave the family with a mere two presidents to its name.

The Wall Street crowd began rallying behind Jeb well before his candidacy was official.  Private equity titan Henry Kravis hosted a 25-guest $100,000-per-head gathering at his Park Avenue abode in February, one of six events with the same entry fee. In March, Jeb had his first Goldman Sachs $5,000-per-person event at the Ritz Carlton in New York City, organized by Dina Powell, Goldman Sachs Foundation head and George W. Bush appointee for assistant secretary of state.  A more exclusive $50,000 per head event was organized by Goldman Sachs exec, Jim Donovan, a key fundraiser and adviser for Mitt Romney who is now doing the same for Jeb.

And then there’s the list of moneyed financiers with fat wallets still to get behind Jeb. New York hedge fund billionaire Paul Singer, who donated more than any other conservative in the 2014 election, has yet to swoop in.  Given the alignment of his foreign financial policy views and the Bush family’s, however, it’s just a matter of time.

With the latest total super PAC figures still to be disclosed, we do know that Jeb’s Right to Rise super PAC claims to have raised $17 million from the tri-state (New York, New Jersey, and Connecticut) area alone so far. Its head, Mike Murphy, referred to its donors in a call last week as “killers” he was about to “set loose.” He intimated that the July disclosures would give opponents “heart attacks.” Those are fighting words.

Sure, all dynasties end, but don’t count on the Bush-Banker alliance going belly up any time soon. Things happen in this country when mountains of money begin to pile up. This time around, the Bush patriarchy will call in every chip. And know this: Wall Street will be going “all in” for this election, too. Jeb(!) and Hillary(!) will likely split that difference in the primaries, then duke it out in 2016. Along the way, every pretense of mixing it up with the little people will be matched by a million-dollar check to a super PAC. The cash thrown about in this election will be epic. It’s not the fate of two parties but of two dynasties that’s at stake.

Greetings from Jackson Hole, where I am attending the 7th Annual Rocky Mountain Economic Summit.  Below is my latest research note from KBRA. Have received a number of interesting reactions from in and outside the Kremlin walls.  You can read the comment with footnotes on www.kbra.com.  

Best,

Chris

Dodd-Frank and the AIG Litigation: Implications for Investors

Kroll Bond Rating Agency

July 7, 2015

Summary

Kroll Bond Rating
Agency (KBRA) believes that the recent court decisions regarding the bailout of
American International Group (NYSE:AIG) hold significant implications for
investors. Read together with the 2010 Dodd-Frank Wall Street Reform and
Consumer Protection Act, the Court’s decision greatly narrows the discretion of
the Fed in making emergency loans to troubled financial institutions. More, the
AIG decision illustrates how excessive debt and related financial crises serve
to erode the rights of investors by undermining prudential limits and the rule
of law.

Discussion

The 2010 Dodd-Frank
Act limits the Fed’s emergency lending to programs or facilities with
broad-based eligibility and requires the approval of the U.S. Treasury
Secretary before making such loans. The law also requires the Fed to wind down
its emergency facilities in a “timely and orderly fashion” and
prohibits the U.S. central bank from lending to insolvent institutions. The
proposal defines an insolvent borrower as “any person or entity that is in
bankruptcy, resolution under Title II of the Dodd-Frank Act, or any other
Federal or State insolvency proceeding.”

Prior to the July
2010 passage of the Dodd-Frank Act, the Fed was authorized under Section 13(3)
of the Federal Reserve Act (FRA) to lend to “any individual, partnership,
or corporation” provided certain conditions were met, including the
presence of “unusual and exigent” circumstances and the approval of
at least five members of the Board of Governors. In 2014, the Federal Reserve
Board adopted changes to Regulation A that maintain those standards and others,
while placing additional limits on the Fed’s emergency lending authority as
required by Dodd-Frank. Below we discuss how the changes made to the FRA and
recent litigation impact how and when emergency loans can be extended by the U.S.
central bank.

The
AIG Litigation

Starr International
Company, Inc. (Starr), a company controlled by insurance executive Hank
Greenberg, commenced a lawsuit against the United States on November 21, 2011.
The suit challenged the government’s financial rescue and takeover of AIG in
September of 2008. Before the takeover, Starr was one of the largest
shareholders of AIG. Starr alleged in its own right and on behalf of other AIG
shareholders that the government’s actions in acquiring control of AIG in 2008
constituted a taking without just compensation and an illegal exaction, both in
violation of the Fifth Amendment to the U.S. Constitution.

In a recent decision, the U.S. Court
for Federal Claims ruled in favor of Starr and the other plaintiffs, confirming
that the Treasury and Federal Reserve Board acted illegally in the rescue of
AIG. The Court, however, awarded no damages. Of significance to investors,
Judge Thomas C. Wheeler found that the Fed and Treasury (and their legal
advisors) conspired to deprive investors of their rights. Treasury and the Fed,
incredibly, then tried to argue in court that investors had somehow waived
their legal privileges. The Court stated in its findings of fact:

“The record supports a conclusion that
FRBNY, Treasury, and their outside counsel from Davis Polk & Wardwell
carefully orchestrated the AIG takeover so that shareholders would be excluded
from the process. These entities avoided at all cost the opportunity for any
shareholder vote. Having intentionally kept the shareholders in the dark as
much as possible, it rings hollow for Defendant to contend that the
shareholders waived the right to sue by failing to object.”

The significance of
the Court’s decision to investors in terms of the handling of future crises is
manifold.  Now that the U.S. government
and the Fed’s Board of Governors have been rebuked by the judicial branch for
the rescue of AIG, it appears unlikely that either the Fed or Treasury could
orchestrate similar actions in the future. Even the most duplicitous of legal
counsel tend to pay close attention to the utterances of federal judges when it
comes to willful violations of law. Yet the fact remains that in rescuing AIG,
our appointed officials chose to ignore the law (as well as the Fed’s long
established rules on collateral) in the name of saving the world from
catastrophe, real or imagined.

One could argue
that the rescue of AIG really was about saving a number of large, politically
powerful banks from financial loss, just as the alleged rescue for Greece has
really been about bailing out EU banks and the politicians who stand behind
them. But the fact of the AIG rescue and how different classes of investors
were treated raises questions for the future. More important is the fact that
exigent circumstances compelled U.S. officials to finance the AIG rescue using
the balance sheet of the central bank. A federal court held that they did this
without the authorization of Congress raises fundamental questions of public
governance.

In the 1930s, the
restructuring of troubled banks and companies were handled by specially
empowered fiscal agencies like the
Reconstruction Finance Corporation (RFC) and the Federal Deposit Insurance
Corporation (FDIC). In contrast, the financial rescues of AIG and Citigroup (NYSE:C) were financed in
haste and relied upon the balance sheet of the central bank as the financing
mechanism. These bailouts by the Fed and Treasury evaded legal and
Constitutional limits on government agencies incurring liabilities in the name
of the public.

During the period
following the 2008 market collapse, numerous U.S. banks were propped up using
Fed discount window loans and even the deliberate placement of cash deposits by
the U.S. Treasury, the latter being one of the least recognized methods of
bailing out troubled banks. The Fed made the loans to AIG against dubious
collateral, namely the equity of the insolvent insurer. These assets would
likely not qualify as “good collateral” under the Federal Reserve Act, much
less Walter Bagehot’s famous rule. As Professor J. Bradford DeLong notes, the properly-formulated Bagehot Rule is that in a
financial crisis, the lender-of-last-resort:

1. Lends freely,
2. At a penalty rate,
3. On collateral that
   is good in normal times, and
4. Institutions that
   are still underwater get “resolved” immediately and completely. 

In terms of public governance, the recent court ruling made clear that the
appointed officials of the Fed and Treasury made decisions in lending to AIG
that Congress did not authorize and thus interfered in the American political
process.

Walker Todd, who
served as legal counsel at the Fed of New York and collateral officer at the
Reserve Bank’s discount window, provides an assessment of the Court of Claims
decision in the AIG case:

“[A]t least
the judge called out a lot of actors (one dare not say malefactors) in this
drama, with particular attention to the lack of authority for the Fed to do
what was done. And someone should have said the words ‘Reconstruction Finance
Corporation’ in the judge’s presence to address situations where (a)
policymakers are desperate to do a financial rescue but (b) the Fed has no
authority and should not be lending into those situations anyway. Rule no. 1:
The Fed is not the RFC. RFC matters are fiscal
policy matters, not monetary policy. Monetary policy is the Fed’s business, not
fiscal policy. Treasury/White House and Congress are the entities supposed to
be accountable for fiscal policy. In any case, this opinion is a clear illustration
that keeping Section 13(3) [of the Federal Reserve Act (FRA)] on the books is
an open invitation to mischief going forward. Section 13(3) should be
repealed.”

With the passage of
the 2010 Dodd-Frank law, the ability of regulators to fashion such rescues has
been greatly constrained, although as Todd notes there remains a mechanism for
the Fed to make loans in “unusual and exigent circumstances” under Section 13(3) of the FRA. That said, KBRA
believes that the combined effect of Dodd-Frank and the Court’s decision in the
AIG case will lead to a narrowing of alternatives for the managers of troubled
financial institutions. 

Resolutions
Post-Dodd Frank

In days gone by,
the Fed and FDIC had discretion to make loans to troubled financial companies
as a means of buying time in order to sell these institutions. In 1982, for
example, former Federal Reserve Chairman Paul Volcker tried to convince
then-FDIC Chairman William Isaac to bail out Penn Square Bank.  Isaac famously responded that he would agree
if the Fed bore half of the cost, but the Fed under Chairman Volcker balked.[1] 

A decade later in
January 1991, the FDIC extended loans to Bank of New England (BNE) to
facilitate the formation of bridge banks which were sold six months later. The
resolution of the three BNE subsidiary banks is notable because the FDIC,
considering the region’s financial conditions, decided to protect all
depositors (except those affiliated with BNE Corp.), including those whose
total deposits exceeded the $100,000 insurance limit. Of the approximately
$19.1 billion on deposit in the three BNE subsidiary banks, more than $2
billion were in accounts larger than $100,000. Then-FDIC Chairman L. William Seidman
stated, “It was clear to us that to protect the stability of the system, we
should protect all depositors.”[2]

Now, however, these
lending powers have been significantly qualified. While the FDIC retains its
discretion in paying out bank depositors consistent with achieving a least cost
resolution, neither the Fed nor the FDIC would be able to extend open bank
assistance as was done in the past. This means, in our view, that in the event
that a financial institution becomes unstable, the situation is far more likely
to end up in either a traditional bankruptcy or FDIC receivership under the
Dodd-Frank Act. 

KBRA sees several
possible avenues for the resolution of a troubled financial institution. In the
event that the operating units of the troubled entity are book solvent, a
financial institution can in theory file for a voluntary restructuring under
Chapter 11 of the U.S. bankruptcy code – but market factors and investor
concerns would probably lead to a liquidity crisis that would make that choice
impractical. From the perspective of creditors, a voluntary bankruptcy
reorganization is preferable since the management keeps control over the assets
of the institution and has an opportunity to reorganize short of a liquidation.

A more likely
scenario, KBRA believes, is that the troubled financial institutions would
likely be subject to a receivership under the FDIC as provided under
Dodd-Frank. In this scenario, the FDIC would have complete control over the restructuring
process and could replace management, separate the assets and liabilities from
the troubled institution, and would be empowered to pursue claims against third
parties who contributed to the failure. By now, all market participants should
understand that any financial institution that is large enough to be considered
“systemically significant” should be subject to an FDIC receivership to
forestall the problems made obvious in the cases of Lehman Brothers, Bear
Stearns, and AIG. 

The Court’s
decision with respect to damages sought by Starr et al was the correct
conclusion, KBRA notes, because AIG was insolvent and thus the shareholders had
no basis for a claim. The AIG rescue and the Court of Claims ruling, however,
illustrates why the government cannot lawfully just take an equitably insolvent
entity’s stock without providing due process to investors. “The government
needs to appoint an equity receiver such as the FDIC to first assure there is
nothing left for shareholders before ignoring them,” notes attorney Fred
Feldkamp.

The Treasury
continues to claim that its actions and those of the Fed with respect to AIG
were both lawful and justified, but the AIG case seems to confirm that ad hoc
financial rescues of failing financial institutions are contrary to current law
and public policy. But so long as regulators and central bankers are given
discretion with respect to using the public credit to satisfy private investor
claims, it will be impossible to say that “too big to fail” is truly
eliminated. What does seem clear, however, is that the options available to
public officials for exercising discretion have become greatly limited in the
wake of the Dodd-Frank law and the Court’s finding with respect to the AIG
rescue. 

Conclusion

In the case of AIG
and other financial rescues following the 2008 financial crisis, U.S. officials
arguably went beyond their legal authority, this under the rubric of saving the
world, and ignored the rights of investors in the process. Events of default
such as the restructuring of General
Motors (NYSE:GM) and Chrysler
Corporation also saw investor rights ignored or actively attacked by
officials of the U.S. Treasury.[3]
The fact of financial distress and market constraint gave regulators and their
political sponsors free license to ignore the contractual rights of investors
in favor of some ill-defined public policy objective.

It
can be argued that the rescue of AIG delivered enormous benefits to markets and
investors, preventing the failure of yet another large financial firm in that
terrible year of 2008. But KBRA notes that public governance and the rule of
law are important attributes of a sovereign rating. The refusal of regulators
to address the risky behavior that led to the AIG failure and the subsequent ad
hoc rescue should not serve as a source of comfort to investors. Quite the
contrary, KBRA believes that the rescue of AIG and other institutions
illustrate the need to call for greater focus on how investors are treated in
insolvency situations.

-30- 

Yesterday, Nomura’s Richard Koo presented one of the better assessments of the situation in Greece, when he said that the “IMF is slowly beginning to understand the Greek economy“, which explains its strategic U-turn, one which now demands far greater debt cuts than what Europe, and Germany in particular, is willing to concede.

Koo further notes that “the reason is that Greece’s GDP has plunged because fiscal consolidation was carried out during a balance sheet recession, resulting in a destructive deflationary spiral that has devastated the lives of ordinary Greeks. While the nation may appear to be making progress when we view the data as a percentage of GDP, the raw data show an economy in collapse. This difference in perspectives widened the gap separating European creditors who thought everything is going well, and the Greek public who has been suffering serious declines in their standard of living. And this rift in perceptions was perhaps nowhere as evident as in the results of the national referendum on 5 July.”

The observation of the Greek economic devastation is absolutely accurate, and is no surprise to our readers: it has been our base case that not only Greece, but the rest of Europe’s peripheral countries would suffer an ongoing deterioration in living standards due to lack of an external rebalancing (thanks to the common currency) leaving internal devaluation (plunging wages, deflation, economic devastation) as the possibility to remain competitive in the Euro Area; however where our opinion differs from that of Koo is the “motives” behind the creditors’ unwillingness to honestly interpret the situation on the ground in Greece.

Yes, it is true that it is the same creditors who were the next beneficiaries of some 90% of incremental debt-funded proceeds entering Greece (only 11% of the €220+ billion in Greek bailouts ever reached the general population), and as a result they may have had the impression that ordinary Greeks are also enjoying the spoils of their bailout.

They were not, as the events of July 5 showed.

But while the former Fed economist will surely attribute this “oversight” to mere carelessness or at best, stupidity, even if an entire nation of 11 million people is suffering more than ever in history as a result of what is, at best, a failed experiment, there may be a more ulterior truth to events in Greece in the past 5 years especially considering Germany’s stern insistence on not writing off Greek debts despite what is now an accepted fact that without a major debt haircut Greece simply is unviable.

Meet Bernard Connolly.

Barnard is a British economist whose rise to prominence started when he worked for many years at the European Commission in Brussels, where he was head of the unit responsible for the European Monetary System and monetary policies. In other words, if any one was familiar with what the ascent of the Euro would lead to, it would be him.

We say “eventual” because he was terminated by the Commission in 1995. The catalyst may well have been his book “The Rotten Heart of Europe: The Dirty War for Europe’s Money, a negative treatment of the European Exchange Rate Mechanism” which Eurocrats did not take too very lightly.

However, Bernard is more notable not his books, or his employment in Brussels, but where he went next and what he did there.

After ending his relationship with Europe, Bernaned worked at Banque AIG, the Paris-based financial arm of the infamous AIG whose collapse together with that of Lehman, was the primary catalyst for the great financial crisis. Bernard however was not in the front office and did not trade CDS, but was the global strategist. Here is euro skepticism flourished and culminated in a report on May 30, 2008, months before the GSEs and Lehman failed, and AIG was bailed out.

The report was titled “Europe – Drive or Driven“, and it should have been a must read for all Greek (and Europeans) some 7 years ago as it not only lays out precisely why Greece is now on the verge of not only sovereign capitulation but total collapse, but presents what may be the true motives behind Europe’s perpetual crisis and why it almost appears as if the core European countries demand that the sick men of Europe, because Greece is just the first of many, remain and keep Europe in a state of perpetual turmoil.

And since this report is as relevant now as it was 7 years ago, we lay out some of its key highlights again.

From May 30, 2008

The Global Economic Crisis and the EMU Crisis

• The global crisis is the result of intertemporal misallocation (Greenspan; EMU).
• In effect, there has been a global Ponzi game.
• In Europe, this was intensified by the myth that “current accounts don’t matter in a monetary union”: EMU is the biggest credit bubble of them all.
• The treaty says that government should have the same credit status as private sector borrowers.
• Monetary union means greater economic instability.
• These two factors should mean a worsened credit standing in EMU, yet government bond spreads actually diminished in EMU and ratings agencies actually upgraded governments

When the bubble bursts…

• A collapsing credit bubble in the world means collapsing domestic demand in deficit countries (e.g. US, Britain, Balkans, Baltics – and several euro-area countries)
• In the US, and to some extent Britain, domestic demand is being supported by rate cuts and, in the US, by a fiscal stimulus
• In the affected euro-area countries, it isn’t
• In the absence of support for domestic demand, affected countries will be forced into an improvement in net exports via improved competitiveness
• In the US and Britain, this is happening through currency depreciation; in the euro area it isn’t.

[ZH: it is now, but for Greece it is far too late, plus any incremental “support” merely makes the European debt bubble even greater as we have shown recently]

And the implied real exchange rate movements are enormous…

• Obstfeld and Rogoff saw a need for perhaps a 65% real effective exchange rate move for the US if current account adjustment were sudden (e.g., after a housing collapse).
• The effect is linear in the size of the current account deficit relative to the size of the traded goods sector, so for the four
  large euro-area deficit countries we get the required real exchange rate movements as:
  • Greece: 94%
  • Spain: 55%
  • Portugal 36%
  • Italy: 9%
  • France 15%

…meaning huge required inflation differentials between blocs within the euro area

• If the ECB tries to avoid depression in the deficit bloc (i.e., keeps its inflation rate at, say, 3%) and the deficit countries as a bloc (equivalent to about 2/3 of euro-area GDP) have to improve competitiveness by, say, 30%, over a five-year period, then that would involve euro depreciation of 50% and (with1/3 passthrough into German Bloc CPI) a rise of 17% (almost 3½% a year) German Bloc price level, taking German Bloc inflation to around 6½% for five years.

The ECB did not. Instead it chose the following, which is also why youth unemployment in the periphery is about 50%:

• If instead the ECB tried to keep euro-area inflation at 2% (and no change in the euro), all the competitiveness change would have to come from Latin Bloc deflation; that would almost certainly involve a horrible depression, financial chaos, widespread default, social distress and possibly political instability.
• But this would mean substantial euro-area deflation, too, so hitting the euro-area target must involve substantial euro depreciation and a substantial increase in German Bloc inflation.
• These are all first-round calculations – they do not take account of wage-price spirals in the German Bloc as economies overheat.

And this is where it all comes home for Greece:

Things are even worse for individual countries

• If the ECB decides to avoid depression, deflation and default in the weakest country (Greece), the required depreciation of the euro would be enormous and German Bloc inflation would be well into double digits for several years.
• If weak countries have, individually, little political influence, it will be hard for them to get the ECB to bail them out via low interest rates and a weak euro.
• But if there is no ECB bailout, vulnerable economies face catastrophe.

That’s not only how it all played out, but it has also led – as we have seen – to Greece which clearly had “little political influence” to lose it all, and is now on the verge of abdicating its sovereignty to an oligarchy of unelected political bureaucrats and German industrial interests (remember: German exports account for 40% of GDP and a weak EUR is far, far more valuable than a strong DEM).

In further retrospect, the above assessment and the current events also explain Wolfgang Schauble’s cryptic statement to Welt am Sontag in this 2011 interview:

Schauble: “We decided to arrive at a political union via an economic and currency union. We had the hope – and we still have it today – that the Euro will gradually bring about political union. But we’re not there yet, and that’s one of the reasons why the markets are distrustful.

 

Welt am Sontag: “So will the markets now force us into a political union?”

 

Schauble: “Most member states are not yet fully prepared to accept the necessary constraints on national sovereignty. But trust me the problem can be solved.”

And, thanks to Greece, we are about to see precisely how.

So is there an other way out? The answer is yes – and it is precisely the basis for Varoufakis huge “game theory” gamble over the past 6 months, a gamble which was all about “who has more leverage” as we explained in January. However, thanks to the arrival of QE just in time, it allowed the ECB to set and control market prices (markets which no longer had to discount adverse outcomes and merely frontrun a central bank) of equities and bonds, in the process crushing all Greek leverage.

• Current account deficits can be closed without a corresponding reduction in the trade deficit if current transfers are big enough.
• The treaty prohibits a takeover of a country’s public debt, but does not prohibit additional transfers to support private spending.
• The ECB is in effect already helping some banking systems by accepting increasingly risky collateral (but note that this may be helping German, Dutch/Belgian banks as well as, say, Spanish banks – note public disagreement between Mersch and Weber).
• But the numbers involved in a complete fiscal bailout would be staggering: eliminating current-account deficits within the euro area by fiscal bailouts would require the surplus countries (the German Bloc) to make payments equivalent to 16% of their total government revenues (7% of their GDP).

Yes, Varoufakis was right, and will be right in the end: the cost of a Grexit would have been too great in the future. However he did not anticipate that Europe has a just as powerful counterweapon: locking up Greek deposits indefinitely right now.

Greece folded.

Which brings us to the final question: What Europe Wants?

Here is Connolly’s answer:

To use global issues as excuses to extend its power:

• environmental issues: increase control over member countries; advance idea of global governance
• terrorism: use excuse for greater control over police and judicial issues; increase extent of surveillance
• global financial crisis: kill two birds (free market; Anglo-Saxon economies) with one stone (Europe-wide regulator; attempts at global financial governance)
• EMU: create a crisis to force introduction of “European economic government”

And there it is: in four simple bullet points laid out in a 7 year old presentation, a prediction which is about to be proven right. Because once Greece folds, next will be Italy, Spain, Portugal, and so on, until the European Economic Government, also known as the “European Empire”, controlled by a handful of “northern” European players and the bankers financially backing them, shifts from mere vision to reality.

* * *

Full presentation below

h/t @TrueSinews

Submitted by David Stockman via Contra Corner blog,

Let’s see. Google’s record market cap gain on Friday was actually a squeaker. At $66.9 billion it easily passed in one day the entire $50 billion market cap of Caterpillar’s global heavy machinery and engine franchise built up over a century. But only by a hair did it best Cisco’s $66.0 billion gain on April 17, 2000.

But perish the thought that Friday’s fireworks had any resemblance to the shooting star act of Cisco and hundreds of other tech high-flyers 15 years ago or the epic bloodbath that commenced shortly thereafter.

Then again, something was going on with the GOOG beyond the fundamentals. Notwithstanding that Google is one of the most fantastic value creating enterprises on the planet, there was nothing in Friday’s earnings report for Q2 that warranted a 16% re-rating of its market cap.

Indeed, the $345 million or 9.6% gain in net income from the prior quarter was not much of a talisman. Fully 75% of the gain was accounted for by a lower tax rate (from 22.1% to 20.7%) and a cutback of what had been ballooning G&A expenses (from 8.8% of sales to 8.2%). Aside from these benefits at the margins of what is a $70 billion sales machine, net income grew at an unremarkable 2.9% over prior quarter and 7.4% over prior year.

Yet Friday’s re-rating was considerable on a valuation basis. GOOG is entering corporate middle age as it presses upon the law of large numbers, and even with the Q2 uplift its financials clearly show its age. During the three and one-half years since CY 2011, Google’s growth rate for both sales and net income has slowed to 15% per annum.

Consequently, it is hard to see why its LTM net income of $15.1 billion was re-rated from 26X to 31X in less than two hours’ trading. That’s especially the case because 90% of GOOG’s revenues are from advertising, and even the digital ad portion of that space is slowing and getting saturated by GOOG’s preponderant market share.

To wit, the global market for digital advertising outside of China (which lies unavailable behind red-coded firewalls) is projected at $140 billion for 2015. This means that GOOG’s projected digital ad sales of $65 billion this year will compute to a 46% worldwide market share.

Moreover, digital ads already account for 35% of the total worldwide ex-China advertising spend. So the easy digital share gains have been had and no one—–not even the madcap money printers running the central banks—-has eliminated either the business cycle or the cyclicality of ad spending.

Stated differently, GOOG is hurtling fast toward single-digit growth land.  It has not invented a new product that’s on a 100X or 1000X market penetration ramp. Instead, its captured an impressive share of the old-line advertising spend that amounts to $190 billion in the US and $500 billion worldwide ex-China, and which will head south as it always does during the very next recession.

Its probably even worse. GOOG’s estimated 2015 advertising revenues of $65 billion compares to about $44 billion in 2012 before the tech sector was ignited by a tsunami of VC funding and soaring pre-IPO valuations. So some considerable portion of that $21 billion revenue gain may well represent burn-rate money from start-up customers that most definitely will not be around after the next day of reckoning in Silicon Valley.

Never mind. When all else fails, there is nothing like a spree of PE multiple re-ratings to keep the Wall Street party going a few additional months.

But don’t call them re-ratings. After all, this time is different because nothing which happened during the last two Wall Street crashes is remotely relevant to today’s awesome outlook. For example, here’s a real yucker from Morgan Stanley’s ultra-bullish chief US equity strategist, Adam Parker. Unlike during the last tech-wreck, he avers, we are dealing with real companies with substantial sales and earnings, not dotcom eyeball candy:

Today’s tech companies bear little resemblance to the makeshift operations that quickly burned through cash more than a decade ago, says Adam Parker, Morgan Stanley & Co.’s Chief US Equity Strategist. In 1999, fewer than half of tech companies were profitable. With some notable exceptions, around 90% of tech firms now have positive operating margins.

Undoubtedly, Mr. Parker was still guzzling beer in his dorm room during the last tech crash, but that doesn’t excuse his abysmal ignorance of the historical facts. In the Great Deformation I tracked the fate of the dozen big cap tech companies before and after the dotcom crash. These included Cisco, Dell, Intel, Microsoft, Lucent Technologies, Juniper Networks, Hewlett-Packard, Nortel, WorldCom and Global Crossing—–with General Electric and AIG thrown in for spice.

Needless to say, these weren’t “makeshift operations”. Among them they had posted in excess of $300 billion in sales and $50 billion in net income at the turn of the century.

But here’s what happened. During the time between Greenspan’s infamous “irrational exuberance” speech in December 1996 and the March 2000 dotcom peak, the aggregate market cap of these dozen high flyers soared from $600 billion to $3.8 trillion. Notwithstanding respectable rates of sales and earnings growth, operating performance of these big cap tech giants did not remotely justify a 6X gain in market cap during this 39 month period.

For once Greenspan had been right. It was irrational exuberance on steroids——a proposition validated in spades by subsequent events. To wit, during the next 18 months a stunning $2.7 trillion of this market cap vanished and never returned. In fact, by 2012 four of these companies had disappeared and the market cap of those which remained was just $850 billion or 22% of the peak level.

But here’s the stunner. The market value gain of this dozen highflyers between Greenspan’s irrational exuberance mutterings and the end of 2012 amounted to the grand sum of 2.5% per annum.

So beware of the re-rating game. It works in both directions, and violently so when it goes into reverse. And in any event, young Mr. Parker should flunk freshman economics for missing the $3 trillion elephant in the room. Makeshift operations, indeed.

Nor did history put a crimp in the re-ratings game this time around. On Friday, Wall Street sounded just like February 2000:

And at least five brokerages — J.P. Morgan, Bernstein Research, Nomura Research, Jefferies and Evercore — think Google’s stock will can and will go still higher. After Google reported a sharp rise in earnings and sales that trumped Wall Street’s expectations, they all raised their 12-month targets on the company’s stock Friday morning to $800. At that price, Google’s market cap would catapult above the half-trillion-dollar mark to $547 billion, making Google only the second company, along with Apple AAPL, +0.86% to be valued above the half-trillion-dollar threshold. Apple is currently trading at a $740 billion valuation.

Indeed, the Cisco story alone is dispositive. At the time of its $66 billion one-day surge, Cisco was posting about $15 billion of net sales and $2.5 billion of net income. Not at all makeshift.

CSCO Market Cap data by YCharts

Needless to say, that didn’t stop its $555 billion peak market cap from being ionized during the tech wreck. By October 2002, $475 billion or 85% of that total had disappeared, and 15 years later Cisco’s market cap is still only 25% of its once and glorious top.

Yet this is not because CSCO slide down the tubes as an operating company in the interim. In fact, its current $49 billion of LTM sales are triple its year 2000 level and net income of $9 billion is nearly 4X higher than it was then.

In short, even as Cisco did become “all things digital” and a dominant behemoth in its server, router and internet equipment space, it got “re-rated” downward with a vengeance as it became clear that it was not Jack’s financial beanstalk after all. That is, its results kept on growing, but just not to the sky.

CSCO Net Income (TTM) data by YCharts

In the Cisco case, the downward rerating after the dotcom crash was considerable, to say the least. At the time of the April 2000 crash it was trading a 220X LTM reported earnings. That compares to 13X today.

And that gets to the real truth about the Wall Street bubblies which were flowing last Friday. Morgan Stanley’s chief equity strategist, like the rest of the sell-side stock peddlers, has it exactly upside down; and the proof of the pudding in this instance lies is in Morgan Stanley’s own “New Tech” index of 16 high flyers of the present era.

This charmed circle includes Google, Amazon, Baidu, Facebook, Saleforce.com, Netflix, Pandora, Tesla, LinkedIn, ServiceNow, Splunk, Workday, Ylep, Priceline, QLIK Technologies and Yandex. Taken altogether, their market cap clocked in at $1.3 trillion on Friday. That compares to just $21 billion of LTM net income for the entire index combined.

The talking heads, of course, would urge not to be troubled. After all, what’s a 61X trailing PE among today’s leading tech growth companies?

As it happens, quite a bit. When you take GOOG’s middle-aged profits machine out of the mix, you get something altogether more frisky. Namely, a collective market cap of $840 billion for the other 15 names in the Morgan Stanley index and LTM net income of exactly $6.0 billion.

As we said at the top—-let’s see. That’s a PE multiple of 140X. That’s February 2000 all over again.

Take cover. The Wall Street bubblies are back!

Why haven’t the panic of the recent decline followed by the government induced rally spilt over into other markets?  While there was obvious concern that answer is simple enough… The Shanghai Stock Exchange Composite index rose 150% for the 12 months through June 12th. The rally, however, wasn’t based on any material upswing in economic fundamentals. Instead, over much of this period, the economy slowed with both exports and domestic demand weakening as did corporate profits. Capital outflows increased and even with high trade surpluses, the balance of payments turned negative for two quarters. Importantly, the authorities continued to guide public expectations towards lower medium-term growth as they had done over the past two years.

 But after a very lackluster performance at best for the preceding four and half years, sometime at the start of 2H14, market sentiments changed. It is likely that talks of market liberalization, including an opening of the capital account, and in particular the authorities’ presumed intention to “rebalance” the economy’s portfolio from the excessive and worrisome dependence on bank credit to more equity and bond financing is likely to have been the catalyst.  

Starting last November, the PBOC also began cutting lending rates and bank reserve requirements. While the easing was intended to support growth and liquidity, which had dried up because of increased capital outflows, market participants took this as corroboration of the government’s intended “support” for equity market expansion.  

Talks of A-share’s inclusion in the MSCI index that could potentially bring in significant foreign inflows added to the froth and the rally accelerated. China’s onshore stock market has historically been thin on institutional participation with previous rallies largely driven by retail investors. Between 80% to 90% of the China’s market is dominated by retail investors, many of which subscribe to domestic investor newsletters that have been bullish on China’s push towards new tech IPOs. The all led to speculative excess in the ChiNext and Shenzhen exchanges primarily. Hundreds of new brokerage accounts were opened and amateur investors bought on margin. An estimated 4,000 new hedge funds were opened in China in one month, and China had over 200 companies list their shares for the first time, the most of any other country. Studies have shown that most of China’s day traders are working class investors that do not have a college education. They tend to treat stock investing like a day at the horse track.

This time it wasn’t different. For instance, during the past twelve months, the number of individual investor accounts rose from 93 million to 115 million in the Shanghai stock exchange, and rose from 113 million to 142 million in the Shenzhen stock exchange. 

Initially this correction was driven by high valuations, accelerated pace of IPOs, market fears that the monetary easing would slow down, and a tightening of rules on margin financing. Subsequently, the correction intensified as policy measures were seen as inadequate or ill-targeted. 

However this latest correction is not remarkable in the history of China’s stock market. There have been at least two previous cycles since 2000 where the price volatility has been much larger. The previous stock market volatility during 2006-08 was much more dramatic (up 450% between June 2005 and October 2007, and down 70% between October 2007 and October 2008). The impact on the real economy in these cycles was limited, including through wealth effects and contagion to other financial assets.

The development of new market instruments (futures & options), in particular the extensive use of margin financing, hints at potentially more extensive wealth destruction among household and corporate retail investors. For example, margin financing provided by brokerage firms rose from 0.4 trillion yuan in June 2014 to 2.3 trillion yuan at the recent peak level on June 18th (coming back down to about 1.4 trillion yuan by July 9). Compared to previous episodes of stock market correction, this time round there is greater concern over the potential spillover to the real economy, especially as the economy doesn’t have the buffer from strong export growth. China’s export growth has fallen to 0.6%oya during the first five months of this year, after continuously slowing in the past five years from the heady days of high double-digit growth before 2008. In the absence of the buffer from export growth, the burden of keeping up the pace of activity and income has fallen squarely on domestic drivers that could be adversely affected.

The government’s attempt to stem the free fall has involved a number of intrusive interventions in market operations .

• June 27th 2015: Interest rate and RRR cut (China Financials: Reinforcing the Policy Put vs Deleveraging) 

• June 29th 2015: pathways for national pension funds to invest in the equities market; 

• July 1st 2015: a) reduce transaction costs; b) CSRC abolished mandatory requirement on margin calls and liquidation for margin loans; c) broaden financing channels for brokers (China Securities: Policy makers roll out further “market-saving” measures) 

• July 4th 2015: a) 21 brokers pledged to buy blue chips stocks; b) suspending 28 IPOs; (China Securities: A pledge to “national service”)

 • July 5th 2015: PBOC to provide liquidity support to CSFC to stabilize the market (More measures to support the A-share market: PBOC to provide liquidity support to CSFC) 

These interventions, along with the voluntary suspension of trading by 43% of the listed companies, do not help promote the orderly development of the equity and corporate bond markets. While these measures are likely to be short-lived and one expects them to be removed once the market stabilizes, the interventions could discourage foreign institutional participation. While the government has recently changed investment norms to encourage local pension and other long-term funds to invest in the stock market, an orderly growth of the equity market typically also requires foreign institutional participation to add depth and maturity as evidenced in other emerging market economies. In the absence of the equity market providing a reliable source of funding, the burden of financing China’s growth would again fall back on bank credit. The experience could also make the authorities more cautious in liberalizing the corporate bond market and outward capital account transactions.

The mainland Chinese stock market only recently opened to investors this year. A handful of qualified institutional investors have had access to that market for less than two years. It’s never been opened to the world.

The market is still immature and although the Chinese have an interventionist mind set, over here we have hardly set the greatest example..we stopped the shorting of stocks during the financial crisis; we bailed out AIG and engaged in massive quantitative easing which at best has altered the price discovery process and put the stock market at major risk on the longer term and although on the face of it they are doing similar actions there are stories of people being arrested or disappearing for minor infractions, brokerage houses that can do nothing but recommend buys….this is not the type of thing to encourage institutional investment. The whole idea of socialism with Chinese characteristics, which is the government mantra, is paradoxical. Chinese communism in charge of a very capitalistic economy has always been a bit mysterious, and something that those from capitalist countries have been puzzled by.

At first glance, it might appear strange to argue that even after a roughly $3.5 trillion loss of market capitalization, the wealth effect on consumption will be limited, but this is likely to be the case While retail participation had increased substantially in the rally, this had not translated into a consumption boom. In fact, retail sales growth slowed when the stock market was rallying. While increases in wealth may not have been immediately translated into higher consumption, the slide could sour consumer sentiment. Moreover, there could be threshold effects if the stock prices continue to downward trend.

The effect on commodity markets, cart or horse?

Much of the global commodity markets have for sometime now been weighed down by the slowdown in China’s growth. With commodities being  used as collateral for borrowing, it is worth noting that the The risk comes when prices fall by a large magnitude within a short time, driving down the value of the collateral.

WTI & Copper charts

With Hong Kong and Singapore’s ratio of bank credit to GDP close to multi-year highs, the risk is that a worsening of credit quality could further tighten credit conditions and dampen domestic demand. In the coming weeks While the Chinese stock market appears to have calmed down, this may not be the true reflection of market sentiments. 

People have been drawing similarities between US 1929-1935 and the Japanese lost decades, but there are  two things tip a country from recession into depression: too much debt, and the way dealing with that debt pushes down prices (i.e. deflation). In 1929 the US messed up by failing to counteract falling prices by freeing up money—in fact, it catastrophically raised interest rates in the immediate wake of the 1929 crash.

When deflation sets in, falling prices cause the relative cost of debt to rise. That sinks debtors in even deeper, and makes would-be borrowers unwilling to take out loans to build their businesses. As people desperately sell off assets to pay back what they owe, they drive prices down even further—exactly what happened in the Great Depression. Unemployment surged to a quarter. More than 5,000 banks failed, taking with them untold sums of household wealth. It wasn’t until 1939 that the US truly emerged from the Great Depression.Although Bureaucrats and bankers believed that with enough time and loose money, they could grow out from under the debt burden.

Japanese growth forecasts have been,shall we say…..poor…..

But Japan had too much debt for that approach to work. Loose money only went to keep broke companies alive—a phenomenon called “zombies”—instead of funding productive investment that might spur the economy. 

The lesson Japan failed to master is that too much debt makes it near-impossible to grow—and that the only way to get rid of that burden is therefore to recognize losses.

Whereas in the Great Depression, lots of companies and banks went bust, in 1990s Japan, hardly any did. America’s bankruptcy epidemic destroyed huge sums of wealth and, as a result, damaged the economy. But it also cleared away debt problems, preparing the country to borrow, invest, and grow again. While the Great Depression lasted just shy of a decade, Japan’s debt woes haunt it to this day, more than 25 years after its stock crash. Much of it’s simply shifted onto the Japanese government’s balance sheet. 

The threat of deflation still looms….

The growth-obsessed Chinese government is clearly going to do everything to prevent a Great Depression—which, at least in the short term, is good news for the global economy.

What’s worrisome, though, is the longer term. Along with the recent stock market bailout effort, aggressive credit loosening, revived infrastructure stimulus, and a steadfast refusal to let companies fail signals that the Chinese government is planning to grow out from under its $30-trillion debt burden. That suggests that China’s leaders are already busy repeating Japan’s mistakes.

Bloomberg Commodity Index weekly chart

Back in 2007/2008, China’s A-shares were trading at 50 times forward earnings and fell 70% from the high and on these current levels the average forward P/E ratios stand at 48.46….the commodity markets are on multi year lows, Let this be a warning……

In regards to more detailed options and futures advice volatility analysis etc ,please contact Darren Krett through www.maunaki.com or dkrett@maunaki.com 

“Futures and options trading involves substantial risk and is not for everyone. Such investments may not be appropriate for the recipient. The valuation of futures and options may fluctuate, and, as a result, clients may lose more than their original investment. Nothing contained in this message may be construed as an express or an implied promise, guarantee or implication by, of, or from Mauna Kea Investments LLC. that you will profit or that losses can or will be limited in any manner whatsoever. Past performance is not necessarily indicative of future results. Although care has been taken to assure the accuracy, completeness and reliability of the information contained herein, Mauna Kea Investments LLC makes no warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, reliability or usefulness of any information, product, service or process disclosed.”

After a lukewarm start by the Chinese “market”, which had dropped for the past 6 out of 7 days despite ever escalating measures by Beijing to manipulate stocks higher, finally the Shanghai Composite reacted favorably to Chinese micromanagement of stock prices and closed 3.7% higher as Chinese regulators stepped up their latest measures by adjusting rules on short-selling in order to reduce trading frequency and price volatility, resulting in several large brokerages suspending short sell operations. At this pace only buy orders will soon be legal which just may send the farce of what was once a “market” limit up.

Elsewhere in Asia, equities traded mixed following a lackluster Wall Street close amid further declines in commodity prices, after Brent crude dropped below $50/bbl for the first time since January, only to rebound in overnight trade. ASX 200 (+0.3%) traded in the green with gains in financials offsetting losses seen in commodity names. Elsewhere, the Nikkei 225 closed lower by 0.1% while JGBs rose following the latest 10-yr auction which drew highest b/c since Jan with 10-yr yields at a 9-week low.

Speaking of “buy only” trading, Greece may want to consider that soon because on the second day after reopening its market for trading, Greek banks traded limit down for the second day in a row. End result: banks such as Piraeus is now down over 50% in two days.

This is Piraeus Bank -51% in two days… We need a name for this chart. pic.twitter.com/x05r9omPEN

— Jonathan Ferro (@FerroTV) August 4, 2015

The reason: the same one we explained in “Greek Banks Just Became A “Strong Sell” At Any Price” – a recapitalization and an equity wipe out are now virtually assured, In fact, judging by the amount of jawboning against it, as seen by these headlines that hit the BBG tape moments ago…

• GREEK BANKS SAID TO SEE DEPOSIT INFLOWS SINCE JULY 20 REOPEN
• GREEK BANKS’ STRESS TEST TO BE COMPLETED BY END-OCT: OFFICIAL
• GREEK DEPOSITORS WILL NOT BE BAILED-IN: CENTRAL BANK OFFICIAL

… a bail in of depositors is also practically assured. Only this time anyone who puts their money in the bank really has nobody but themselves to blame.

Elsewhere, the energy sector continues to underperform despite the complex seeing a mild turnaround with Brent and VVTI Sep’15 futures both in the green, with the former retaking $50.00 handle. The European morning has seen Brent Crude pare some of its recent losses to rise above $50 heading into the NYMEX pit open, with WTI following suit and also residing in firm positive territory on the session . The metals complex have also seen a modest bout of strength during European hours, with gold trading higher by around $5.00 at USD 1090, while platinum and palladium are both off their multi year lows, with platinum earlier reaching its lowest level since 2009 and Palladium reaching its lowest level since 2012.

Brent oil, which has slumped more than 20 percent over the last month, was up almost 1 percent. Copper seen as a bellwether of global growth, nudged off a six-year low. 

The dollar also helped relieve the pressure, with it pegged back by another bout of weak U.S. data on Monday. Raw material reliant Canadian and Australian dollars both got lifts, alongside Russia’s rouble and other emerging FX.

The Aussie dollar was by far the biggest mover. It rose 1.25 percent to an almost two-week high of $0.7375 after a major change in tone from its central bank that suggested it was now more satisfied with the currency level. “You have had a key shift from the RBA that they don’t need to intervene as strongly, so that has triggered a considerable Aussie bounce,” said John Hardy, head of FX strategy at Saxo Bank.

“And the (U.S.) dollar view is just flat and we are just waiting for payrolls on Friday. We have had a relatively hawkish set-up from Yellen and co (that interest rates may go up next month) but the rates market just doesn’t believe it.”

European Equities reside in mixed territory (Euro Stoxx: -0.3%) heading into the North American crossover, with financials the worst performing sector after Credit Agricole (-9.5%) reported earnings pre-market and announced that they are delaying structural reforms.

Bunds reside in positive territory albeit off their best levels, gaining amid the weakness in equities, while the German curve has flattened in line with the post FOMC trend, following the trend set in USTs. While also of note, the ECB announced further QE details yesterday, which showed extending maturities in German debt. Bunds also took out yesterday’s highs to reach their highest level since May 29th before paring some of these gains amid profit taking with macro news flow fairly light, while the UK 30Y also reached 2.5%, its highest level since April before the weak UK Auction (b/c 1.37, Prey. 1.54, tail 0.4bps, Prey. 0.2bps) saw a weakness in UK fixed income products.

In FX, AUD was the notable outperformer after the RBA dropped comments that a further fall in AUD is ‘likely and necessary’, with the central bank leaving rates unchanged, while Australian retail sales (0.7% vs. Exp. 0.4%) and trade balance data both beat expectations. Meanwhile the USD (USD-Index: -0.1%) remains relatively flat today amid a tight range in major pairs.

The notable tier one data from the European morning saw UK Construction PMI (57.1 vs. Exp. 58.5) print its lowest figure since May, but fail to have a sustained affect in GBP. Also of note, the Greek finance and economy ministers are set to meet the Quadriga (Troika + ESM) regarding bank recapitalisation and privatisation.

Looking ahead, today’s highlights include US ISM New York, factory orders and IBD/TIPP economic optimism, Canadian Manufacturing PMI and New Zealand unemployment.

In Summary: European shares decline, though pare the worst of earlier declines as U.S. equity index futures also slip. Asian shares gain. Oil rises for first day in 4. Gold, silver rise with metals, food commodities, cotton, while platinum, palladium fall. Italian, Spanish stocks among largest underperformers in Europe. Yields on eurozone 10-yr notes fall; dollar also declines. U.S. ISM New York, factory orders, IBD/TIPP economic optimism,  due later.

Market Wrap

• S&P 500 futures down 0.1% to 2089
• Stoxx 600 down 0.2% to 398.5
• US 10Yr yield up 1bps to 2.16%
• German 10Yr yield down 2bps to 0.61%
• MSCI Asia Pacific up 0.3% to 141.5
• Gold spot up 0.4% to $1091.1/oz
• Eurostoxx 50 -0.2%, FTSE 100 +0.3%, CAC 40 -0.2%, DAX +0%, IBEX -0.4%, FTSEMIB -0.8%, SMI +0.1%
• Asian stocks rise with the Shenzhen Composite outperforming and the Sensex 30 underperforming; MSCI Asia Pacific up 0.3% to 141.5
• Nikkei 225 down 0.1%, Hang Seng down 0%, Kospi up 1%, Shanghai Composite up 3.7%, ASX up 0.3%, Sensex down 0.4%
• Apollo Buys Spain’s Lico Leasing From Fortress: El Confidencial
• Euro up 0.18% to $1.097
• Dollar Index down 0.14% to 97.36
• Italian 10Yr yield down 4bps to 1.74%
• Spanish 10Yr yield down 4bps to 1.91%
• French 10Yr yield down 3bps to 0.91%
• S&P GSCI Index up 1% to 372.3
• Brent Futures up 1.4% to $50.2/bbl, WTI Futures up 1.5% to $45.9/bbl
• LME 3m Copper up 0.3% to $5236/MT
• LME 3m Nickel up 1.3% to $10885/MT
• Wheat futures up 1.1% to 504.5 USd/bu

Bulletin Headline Summary from Bloomberg and RanSquawk

• Treasuries drift lower as commodities recover from yesterday’s rout; markets wait for ADP tomorrow, nonfarm payrolls Friday for  clues on Fed’s next move; data calendar light, with Factory Orders at 10am.
• European Equities reside in mixed territory heading into the North American crossover, with financials the worst performing sector, weighed on by Greek banks and Credit Agricole, who reported earnings pre-market
• AUD is the notable outperformer after the RBA dropped comments that a further fall in AUD is ‘likely and necessary’, with the central bank leaving rates unchanged
• Oil and industrial metals led a rebound in commodities, boosting Russia’s ruble as emerging-market currencies  rallied and supporting shares of raw-material producers
• Stocks in Athens fell almost 5%, extending biggest slump since at least 1987 as the nation seeks a return to  normal after a five-week shutdown of its exchange; Piraeus Bank SA slumping 30%, while National Bank of Greece SA tumbled 29%
• Daniel Yu, best known for betting against companies via his short-selling firm Gotham City Research LLC, says he’s waiting in the wings for Greece to leave the euro – so he can start buying
• Puerto Rico’s debt crisis escalated as it suspended deposits into a fund that pays its general-obligation bonds and one of its agencies defaulted for the first time, jeopardizing the cash-strapped government’s ability to raise money
• Indian central bank Governor Raghuram Rajan kept interest rates unchanged, rebuffing pressure from the  Finance Ministry to reduce borrowing costs that are among the highest in Asia
• Aetna Inc. raised its full-year earnings forecast after reporting profit that topped analysts’ estimates as it added more members in government insurance programs
• Sovereign 10Y bond yields mixed. Asian stocks mixed, European stocks, U.S. equity-index futures fall. Crude oil, copper and gold rise

US Event Calendar

• 9:45am: ISM New York, July (prior 63.1)
• 10:00am: Factory Orders, June, est. 1.8% (prior -1%); Factory Orders Ex Trans, June (prior 0.1%)

DB’s Jim Reid completes the overnight event recap

Commodities continue to be the main game in town at the moment with the highlight being Brent (-5.15%) hitting 6 month lows yesterday at $49.52/bbl. This helped send 10 year Treasuries to two-month lows at 2.149% (-3.2bps) while Fed Funds contracts fell for a second consecutive session with the Dec15 (-0.5bps), Dec16 (-2.5bps) and Dec17 (-4.0bps) contracts down to 0.300%, 0.960% and 1.555% respectively. Despite some resilience, US equity markets succumbed to the sell-off in energy stocks with the S&P 500 eventually finishing -0.28% with the energy component tumbling 2% as some of the larger cap names including Chevron (-3.25%) and Exxon Mobil (-1.45%) led the move lower.

China’s soft PMI numbers from the weekend and yesterday, as well as the latest ISM numbers out of the US didn’t help but it was supply noise out of Iran where the bulk of the blame was centered. Iran’s Oil Minister, speaking on Sunday, said that production out of the country can increase by as much as 500k barrels a day within a week after sanctions end and by 1m barrels a day within a month following that. The Minister added that he expects sanctions against the country to be lifted by late November.

Talking of Iran, I was reading over the weekend that the country has been enduring a ‘heat dome’ with a heat index of 72C (162F) which measures heat and humidity and is kinda the opposite of the wind chill factor reading (ie how warm/cold it actually feels). Such a number is extraordinary and reflects a heatwave in the region. I’ve cooked pizzas at lower temperatures than this!! I showed this article to my wife who at the moment is struggling when it gets above 18 degrees and she nearly had a funny turn just reading it.

Once again it wasn’t just Oil markets where we saw weakness yesterday with most of the commodity complex enduring another tough session. In the metals space Gold (-0.82%), Silver (-1.79%) and Platinum (-2.22%) tumbled while Aluminum (-0.37%) and Copper (-0.19%) followed suit. Commodity sensitive currencies also felt some of the pain yesterday too with the Aussie Dollar (-0.30%), Russian Ruble (-2.84%), Norwegian Krone (-0.90%) and Canadian Dollar (-0.52%) some of the notable movers.

Staying on credit, DB’s Oleg Melentyev touched upon the latest moves in US credit markets on the back of the recent fall in oil in a note at the back end of last week. Oleg noted that last week we saw US HY energy spreads touch their peak levels from mid-December of last year (860bps) and that that weakness has now extended to metals where spreads are now at their widest level since the 2011-2012 peaks. Interestingly, Oleg notes that cross-asset volatility has experienced its biggest drop since October in recent weeks despite the weakness in commodities. The fall has come since the resolution in Greece in mid-July and right around the time of the commodity-driven widening in HY resulting in the regression-estimated HY spread being materially inside of its actual values (50-75bps depending on the time horizon) for the first time since December 2014. Oleg notes that, absent any meaningful bouts in volatility higher in the coming days and weeks, this should help encourage a rebound in US credit. However this hasn’t yet convinced Oleg that it’s a good enough reason to tighten spread target levels. In particular he notes of material headwinds from commodities, EM, rising credit risks and deteriorating issuer fundamentals which muddles the picture leaving him predisposed to keep existing longer term spread targets in place.

Looking at how markets in Asia are trading this morning, it’s been another choppy session in China but bourses are in positive territory as we hit the midday break with the Shanghai Comp (+1.34%), Shezhen (+1.76%) and CSI 300 (+1.16%) all up, supported in part by news on Reuters that the Shanghai and Shezhen bourses are cracking down on short-selling. The new rules are restricting the ability for day-traders to short-sell, forcing investors now into a T+1 settlement and so mitigating intraday volatility. Elsewhere this morning the Kospi (+0.50%) and ASX (+0.32%) are also up, however it’s a weaker start for the Nikkei (-0.20%) and Hang Seng (-0.13%). It’s been a much quieter session for commodities meanwhile. Brent (+0.34%) and WTI (+0.71%) have recovered slightly while Gold (-0.19%) is modestly lower. Asia and Australia credit markets are +2bps and +1bp respectively. The RBA have left rates unchanged as we go to print.

Back to yesterday, data in the US, which along with the moves in Oil, helped support the move lower in yields. Despite no change in the final July manufacturing PMI reading of 53.8, the ISM manufacturing reading for the same month attracted some disappointment with the print falling 0.8pts to 52.7 (vs. 53.5 expected) with employment, export orders and order backlogs components all falling. The ISM prices paid print was also disappointing, falling 5.5pts to 44.0 (vs. 49 expected). Construction spending data for June was the other notable disappointment yesterday, with just a +0.1% mom rise during the month versus expectations of +0.6%, the smallest monthly increase since January although we did see a reasonable upward revision to the May print (+1.8% from +0.8% previously). Elsewhere the June personal spending print of +0.2% mom was as expected while the personal income reading print came in a touch ahead of consensus (+0.4% mom vs. +0.3% expected). In terms of the PCE readings the deflator was as expected at +0.2% mom for June, although the annualized rate ticked up a notch to +0.3% yoy (from 0.2%). The core was also as expected for the month at +0.1% mom, keeping the annualized rate unchanged at +1.3% yoy. Finally July vehicle sales rose to a slightly firmer than expected 17.46m saar pace (vs. 17.20m expected), up a touch from June.

It was a quieter session on the earnings front yesterday with just a post-market beat from AIG the notable report yesterday. At the latest count of 370 S&P 500 companies having now reported, both earnings and sales beats are unchanged versus yesterday’s tally at 74% and 50% respectively. Over in Europe meanwhile, the trend has also remained unchanged at 63% and 65% respectively.

Elsewhere in the US yesterday we also saw the latest Fed Senior Loan Officer Opinion Survey on Bank Lending which showed that on the whole banks reported little change in their standards on commercial and industrial and commercial real estate loans, while on the household side the survey suggested that banks have reported a slight easing of lending standards for a number of residential mortgage loans over the past three months.

Moving on, Puerto Rico attracted its fair share of attention yesterday after halting payments into a fund used to cover its general obligation debt and as a result defaulting on a $58m bond payment. The default looks likely to be the trigger to start a restructuring of Puerto Rico’s roughly $72bn debt load with the WSJ noting that a group of policy makers are working on a restructuring plan and are due to present their findings at the of the month.

In the European session yesterday there was much focus on the reopening of the Greek stock market after a five-week closure. The ASE closed the session down 16.23% having initially plunged as much as 25% with banks (-26%) unsurprisingly leading the move lower. Elsewhere it was actually a fairly constructive day for European markets, offsetting a weak start on the back of the China data to close in positive territory with earnings reports from Heineken, Commerzbank and TomTom in particular helping sentiment. The Stoxx 600 (+0.77%), DAX (+1.19%) and CAC (+0.75%) all enjoyed their fifth consecutive daily gain. A 0.2pt upward revision to the final Euro area manufacturing PMI print to 52.4 in July only helped support a better tone in the European session yesterday. Regionally Germany (+0.3pts to 51.8) and Italy (+1.2pts to 55.3) were both revised up, with France unchanged at 49.6 and Spain (-0.9pts to 53.6) falling. In the UK the print was revised up 0.5pts and above expectations to 51.9. It was a much more mixed session in the European sovereign bond market. 10y Bunds eventually closed 1.6bps lower in yield at 0.627% as the US session kicked in while Gilts closed 1.5bps lower. The periphery was generally a basis point wider. Elsewhere the Euro closed down 0.3% versus the Dollar, not helped by the news that S&P has revised the outlook on the European Union to Negative from Stable (at AA+) on the expectation that the EU will provide first-loss guarantee support for financing connected to the Juncker Plan as well as the repeated use of its balance sheet to provide higher-risk financing to EU member states.

Taking a look at today’s calendar now, data-wise June factory orders is the highlight in the US while the ISM New York and IBD/TIPP economic optimism survey are also due. Earnings season continues meanwhile with Walt Disney and CVS Health Corp two of the notable reporters.

“It’s all noise,” squeaks Laszlo Birinyi, deflecting concerns about revenues, earnings, Europe, China, commodities, and rates as he unleashes his latest extrapolation. “If we continue to grow at 11 bps per day, the S&P will be at 3,200 within 2 years,” adding “you can dismiss 40% of the S&P”, supposedly the 40% that is not going up, he warbles as he hopes his ruler – which missed its 2013 projection by 1100 points or 40% – is is more accurate at forecasting this time.

Good luck with the ruler this time Laszlo.

This would represent a 24x multiple on Goldman Sachs’ already exuberant $134 estimate for 2017 earnings, which in turn assumes oil soars back to $100 or higher, and S&P earnings grow by almost 20% over the next two years. Dare we suggest that in order for the S&P to reach 3,200 within 2 years, the dollar will have to collapse in a Venezuela-esque hyperinflation. By then, the real question will be not if 3,200 but whether 32,000 or 320,000…

Finally, his 2013 “forecast” aside, here is what he said would happen entering the biggest economic and market collapse in US history:

LASZLO BIRINYI, PRESIDENT, BIRINYI ASSOCIATESA

 

Wall Street veteran who landed his first job at a financial services firm, Auerbach, Pollack & Richardson, in 1972, Birinyi has seen many market crises. The current one doesn’t faze him much: “Based on historical data, I articulated a principle some years ago that has been very profitable for me,” he says. According to Birinyi’s “Cyrano principle,” “if the concerns of the market are as obvious as the nose on your face, the market and monetary policymakers will have an amazing ability to adapt and adjust.” He believes the Fed will do what it takes to calm the credit crisis.

 

Birinyi thinks the bull market that started in 2002 is still very much intact. He expects the current economic expansion to continue, with 5% corporate earnings growth helping to propel the Dow to 15,000 by the end of 2008. The signs of a market top, which include speculative fervor and rising stock valuations, “really aren’t present,” he adds. At 15 to 18 times estimated earnings—the exact number depends on how you measure earnings—stock market values are neither cheap nor expensive. If the market were a traffic light, Birinyi says, it would be flashing a yellow signal now.

 

Birinyi sees “pockets of value.” With risk aversion rising, he thinks investors will pay more for such predictable growth stocks as Google (GOOG) and Deere (DE). He expects commodity prices to keep rising “as the emerging markets continue to emerge.” He also favors buying stocks which were “excessively punished” in the recent subprime-related meltdown. They include retailers Tiffany (TIF), Nordstrom (JWN), J. Crew (JCG), and financial giant American International Group (AIG).

Source: Bloomberg, December 2007

Whether you love him or hate him, tonight marks Jon Stewart’s final taping of The Daily Show as he steps down as host – a position he’s held for 16 years. During that time, the show has won 20 Emmy Awards, two Peabody Awards, and Stewart even managed to win a Grammy for himself in 2005 for the recording of his audiobook, America, A Citizen’s Guide to Democracy Inaction.

Despite the fact Stewart has always claimed The Daily Show is just a fake news show, the influence he’s had on politics and the media cannot be denied. 

In October of 2004, Stewart appeared on CNN’s Crossfire where he heavily criticized the state of journalism and called the show’s hosts, Tucker Carlson and Paul Begala, “partisan hacks.” Stewart commented that the show failed to educate and inform its viewers by not taking politics seriously, stating that calling Crossfire a debate show is like “saying pro wrestling is a show about athletic competition.” In January of 2005, CNN announced the cancelation of Crossfire with CNN’s then-incoming president, Jonathan Klein stating, “I think he [Stewart] made a good point about the noise level of these types of shows, which does nothing to illuminate the issues of the day.”

Stewart also announced a fake crowdfunding campaign to buy CNN back in July of 2014 after Rupert Murdoch offered $80 billion to buy its parent company, Time Warner. Stewart claimed that for a donation of $5 million, CNN would air a “24-hour, two-week hunt for your lost car keys.” 

In March of 2009, The Daily Show lambasted CNBC for its shoddy reporting of the financial crisis of 2008. Stewart claimed the network dodged its journalistic duty by merely accepting information from corporations without bothering to investigate further into matters at hand. On March 12, Jim Cramer appeared on The Daily Show where Stewart told him, “I understand you want to make finance entertaining, but it’s not a fucking game. And when I watch that, I get, I can’t tell you how angry that makes me. Because what it says to me is: you all know. You all know what’s going on. You know, you can draw a straight line from those shenanigans to the stuff that was being pulled at Bear, and AIG, and all this derivative market stuff that is this weird Wall Street side bet.” That episode of The Daily Show garnered 2.3 million total viewers, and the next day The Daily Show website saw its highest day of traffic year-to-date.

Stewart has also been an advocate for veterans and 9/11 first responders. He’s credited with breaking a Senate deadlock over a bill that would offer healthcare for 9/11 first responders, which passed three days after he featured a group of responders on the show. He also criticized a White House proposal to remove veterans with private insurance plans from the Department of Veterans Affairs rolls. The White House dropped the plan the next day.

South African comedian, Trevor Noah, who has been a regular contributor to The Daily Show since December of 2014, will replace Stewart. He will begin his hosting duties on September 28. On Wednesday it was announced that Stewart’s Daily Show set will be put on display at the Newseum in Washington, D.C. 

[original]

EquityNet | The Leading Equity Crowdfunding Platform

For all the talk of how the financial world nearly ended in the aftermath of first the Lehman bankruptcy, then the money market freeze, and culminating with the AIG bailout, and how bubble after Fed bubble has made the entire financial system as brittle as the weakest counterparty in the collateral chain of some $100 trillion in shadow liabilities, the truth is that despite all the “macroprudential” planning and preparations, all the world’s credit, housing, stock, and illiquidity bubbles may be nothing when compared to the oldest “glitch” in the book: a simple cascading error which ends up taking down the entire system.

Like what happened in the great quant blow up August 2007.

For those who may not recall the specific details of how the “quant crash” nearly wiped out all algo and quant trading hedge funds and strats in a matter of hours if not minutes, leading to tens of billions in capital losses, here is a reminder, and a warning that the official goalseeked crisis narrative “after” the fact is merely there to hide the embarrassment of just how close to total collapse the global financial system is at any given moment.

The following is a true story (courtesy of b3ta) from the archives, going all the way back to 2007:

I.T. is a minefield for expensive mistakes

There’s so many different ways to screw up. The best you can hope for in a support role is to be invisible. If anyone notices your support team at all, you can rest assured it’s because someone has made a mistake. I’ve worked for three major investment banks, but at the first place I witnessed one of the most impressive mistakes I’m ever likely to see in my career. I was part of the sales and trading production support team, but thankfully it wasn’t me who made this grave error of judgement…

(I’ll delve into obnoxious levels of detail here to add color and context if you’re interested. If not, just skip to the next chunk, you impatient git)

This bank had pioneered a process called straight-through processing (STP) which removes the normal manual processes of placement, checking, settling and clearing of trades. Trades done in the global marketplace typically have a 5-day clearing period to allow for all the paperwork and book-keeping to be done. This elaborate system allowed same-day settlement, something never previously possible. The bank had achieved this over a period of six years by developing a computer system with a degree of complexity that rivalled SkyNet. By 2006 it also probably had enough processing power to become self-aware, and the storage requirements were absolutely colossal. It consisted of hundreds of bleeding edge compute-farm blade servers, several £multi-million top-end database servers and the project had over 300 staff just to keep it running. To put that into perspective, the storage for this one system (one of about 500 major trading systems at the bank) represented over 80% of the total storage used within the company. The equivalent of 100 DVD’s worth of raw data entered the databases each day as it handled over a million inter-bank trades, each ranging in value from a few hundred thousand dollars to multi-billion dollar equity deals. This thing was BIG.

You’d think such a critically important and expensive system would run on the finest, fault-tolerant hardware and software. Unfortunately, it had grown somewhat organically over the years, with bits being added here, there and everywhere. There were parts of this system that no-one understood any more, as the original, lazy developers had moved company, emigrated or *died* without documenting their work. I doubt they ever predicted the monster it would eventually become.

A colleague of mine one day decided to perform a change during the day without authorisation, which was foolish, but not uncommon. It was a trivial change to add yet more storage and he’d done it many times before so he was confident about it. The guy was only trying to be helpful to the besieged developers, who were constantly under pressure to keep the wretched thing moving as it got more bloated each day, like an electronic ‘Mr Creosote’.

As my friend applied his change that morning, he triggered a bug in a notoriously crap script responsible for bringing new data disks online. The script had been coded in-house as this saved the bank about £300 per year on licensing fees for the official ‘storage agents’ provided by the vendor. Money that, in hindsight, would perhaps have been better spent instead of pocketed. The homebrew code took one look at the new configuration and immediately spazzed out. This monged scrap of pisspoor geek-scribble had decided the best course of action was to bring down the production end of the system and bring online the disaster recovery (DR) end, which is normal behaviour when it detects a catastrophic ‘failure’. It’s designed to bring up the working side of the setup as quickly as possible. Sadly, what with this system being fully-replicated at both sites (to [cough] ensure seamless recovery), the exact same bug was almost instantly triggered on the DR end, so in under a minute, the hateful script had taken offline the entire system in much the same manner as chucking a spanner into a running engine might stop a car. The databases, as always, were flushing their precious data onto many different disks as this happened, so massive, irreversible data corruption occurred. That was it, the biggest computer system in the bank, maybe even the world, was down.

And it wasn’t coming back up again quickly.

(OK, detail over. Calm down)

At the time this failure occurred there was more than $12 TRILLION of trades at various stages of the settlement process in the system. This represented around 20% of ALL trades on the global stock market, as other banks had started to plug into this behemoth and use its capabilities themselves. If those trades were not settled within the agreed timeframe, the bank would be liable for penalties on each and every one, the resulting fines would eclipse the market capital of the company, and so it would go out of business. Just like that.

My team dropped everything it was doing and spent 4 solid, brutal hours recovering each component of the system in a desperate effort to coax the stubborn silicon back online. After a short time, the head of the European Central Bank (ECB) was on a crisis call with our company CEO, demanding status updates as to why so many trades were failing that day. Allegedly (as we were later told), the volume of financial goodies contained within this beast was so great that failure to clear the trades would have had a significant negative effect on the value of the Euro currency. This one fuckup almost started a global economic crisis on a scale similar to the recent (and ongoing) sub-prime credit crash. With two hours to spare before the ECB would be forced to go public by adjusting the Euro exchange rate to compensate, the system was up and running, but barely. We each manned a critical sub-component and diverted all resources into the clearing engines. The developers set the system to prioritise trades on value. Everything else on those servers was switched off to ensure every available CPU cycle and disk operation could be utilised. It saturated those machines with processing while we watched in silence, unable to influence the outcome at all.

Incredibly, the largest proportion of the high-value transactions had cleared by the close of business deadline, and disaster was averted by the most “wafer-thin” margin. Despite this, the outstanding lower-value trades still cost the bank more than $100m in fines. Amazingly, to this day only a handful of people actually understand the true source of those penalties on the end-of-year shareholder report. Reputation is king in the world of banking and all concerned –including me– were instructed quite explicitly to keep schtum. Naturally, I *can’t* identify the bank in question, but if you’re still curious, gaz me and I’ll point you in the right direction…

Epilogue… The bank stumped up for proper scripts pretty quickly but the poor sap who started this ball of shit rolling was fired in a pompous ceremony of blame the next day, which was rather unfair as it was dodgy coding which had really caused the problem. The company rationale was that every blaze needs a spark to start it, and he was going to be the one they would scapegoat. That was one of the major reasons I chose to leave the company (but not before giving the global head of technology a dressing down at our Christmas party… that’s another QOTW altogether). Even today my errant mate is one of the only people who properly understands most of that preposterous computer system, so he had his job back within six months — but at a higher rate than before

Conclusion: most banks are insane and they never do anything to fix problems until *after* it costs them uber-money. Did I hear you mention length? 100 million dollar bills in fines laid end-to-end is about 9,500 miles long according to Google calculator.

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And here is Zero Hedge’s conclusion: the next time you think all those paper reps and warranties to claims on billions if not trillions of assets, are safe and sound in some massively redundant hard disk array, think again.