The Market Ticker - Banking System

Solution: ONE DOLLAR OF CAPITAL

nospam@example.com (Karl Denninger) — Fri, 13 Nov 2009 12:27:00 -0500

Our company, J.P. Morgan Chase, employs more than 220,000 people, serves well over 100 million customers, lends hundreds of millions of dollars each day and has operations in nearly 100 countries. And if some unforeseen circumstance should put this firm at risk of collapse, I believe we should be allowed to fail. As Treasury Secretary Timothy Geithner recently put it, "No financial system can operate efficiently if financial institutions and investors assume that government will protect them from the consequences of failure." The term "too big to fail" must be excised from our vocabulary.

But ending the era of "too big to fail" does not mean that we must somehow cap the size of financial-services firms. Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole. Artificially limiting the size of an institution, regardless of the business implications, does not make sense. The goal should be a regulatory system that allows financial institutions to meet the needs of individual and institutional customers while ensuring that even the biggest bank can be allowed to fail in a way that does not put taxpayers or the broader economy at risk.

The solution is very simple, but you will notice that Jamie doesn't bring it up. That's because he finds it unacceptable.

What's that solution?

Prohibit as a matter of Federal Law, and enforce it vigorously under pain of immediately dissolution, THE LENDING OF MONEY UNSECURED THAT EXCEEDS THE FIRM'S CAPITAL.

This is in fact the only way you can both end "too big to fail" and not constrain size or influence.

It is also the definition of sound lending.

It is also how lending was done prior to the banksters corrupting the government and literally usurping the sovereign credit of The United States.

As we have seen clearly over the last several years, financial institutions, including those not considered "too big," can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company's failure to another and to the broader economy.

A requirement that you hold one dollar of actual capital for each dollar of unsecured obligation you have, marked to market nightly, absolutely prevents this risk.

That actual excess capital can be lost but there can be no systemic bleed-through as your capital then backs your bets in each and every instance.

While the strategy of artificial limits may sound simple, it would undermine the goals of economic stability, job creation and consumer service that lawmakers are trying to promote. Let's be clear: Banks should not be big for the sake of being big. Moreover, regardless of a company's size, it must be well managed. As we've seen in many industries, companies that grow for the sake of growth or that expand into areas outside their core business strategy often stumble. On the other hand, companies that build scale for the benefit of their customers and shareholders more often succeed over time.

Then prove it by putting your own capital at risk in each and every unsecured lending transaction. For each loan you write where the collateral is worth less than the outstanding amount of the loan, at any point in time, hold one dollar of your own capital as security against that loan's default and the bleed-through effects on the economy.

And it's not just multinational corporations that rely on such a large scale. J.P. Morgan Chase and others supply capital to states and municipalities as well as to firms of all sizes. Smaller banks play a vital role in our nation's economy, too -- but a fragmented banking system cannot always provide the level of service, breadth of products and speed of execution that clients often need. Capping the size of American banks won't eliminate the needs of big businesses; it will force them to turn to foreign banks that won't face the same restrictions.

Yes, and JP Morgan/Chase will allegedly bribe states and municipalities (aka Jefferson County Alabama) to "obtain" that business and earn a 400% profit beyond the market rate too. Yes, I know, you didn't admit guilt in the "settlement", but you did pay $75 million and forfeit another half-billion+ in termination fees. Is it "usual and customary" for your company to pay nearly three quarters of a billion dollars in forfeits and fines when you did nothing wrong? Our states and municipalities would be far better off without your firm's "services."

Global economic growth requires the services of big financial firms. It also requires that big financial firms be allowed to fail.

ONE DOLLAR OF CAPITAL FOR EACH DOLLAR OF UNSECURED LENDING, MARKED TO MARKET NIGHTLY.

A one-sentence Bill that, were it to become law, would instantly end "too big to fail" and yet let you grow as large as you'd like - provided you are gambling with your own money and not the sovereign credit of The United States.

More Bernanke Follies - Bank Debt Rollover

nospam@example.com (Karl Denninger) — Tue, 10 Nov 2009 14:29:00 -0500

Just when you thought it might be safe to go back in the water with regards to the banking system - and markets:

The flood of expiring debt will hit the US and the UK hard – with $2,000bn of debt coming due by 2012 – and could curb banks’ profits or force them to charge individuals and companies more for their services.

....

Moody’s estimates that a lender wanting to refinance a short-term government-guaranteed bond with 10-year paper could see costs rise nearly 7 percentage points.

The problem is this: The banks, during the "embezzlement years" (that's the housing bubble years of 03-07 and into the crisis up to now) have done the old "borrow short and lend long" game.

But the borrowing was driven down in cost by reducing maturity - in this case, it dropped from about 7 to 4 years over the last half-decade. In the US it was even worse - banks "worked down the curve" to about 3 years as of 2009. The Fed and FDIC made this considerably worse in 2008 with the guarantee programs for short-term debt, which further encouraged financial institutions to shift down the curve.

7 years roughly matches the duration of most people's home ownership experience, and thus is a reasonable "duration match" for similar instruments. Ditto for commercial real estate, which typically is financed on 5 or 10 year terms, interest-only, then is rolled over.

Duration mismatches are a problem, because if interest costs rise while your money is still outstanding you can find yourself in a "negative earnings" situation - that is, it can cost you more to borrow than the rate you lent at!

Banks try to hedge this off with.... you guessed it.... derivatives. Off-exchange derivatives, in many if not most (up to now) cases.

Thus the huge notional outstanding value of interest-rate swaps.

So what happens when the cost of borrowing goes up?

More importantly, what happens if it goes up by as much talked about by Moody's - seven percent?

Well let's see, you borrow at 7% (or is that 10%, since that's the margin, and that old debt was at 3%, right?) but you lent it out for 10 years at 5%.... hmmmm.... what did you say your leverage ratio was again, and how secure is the counterparty on that interest-rate swap you purchased $100 billion worth of swaps from to hedge this risk?

About Those Stress Tests...

nospam@example.com (Karl Denninger) — Fri, 06 Nov 2009 10:17:00 -0500

I said at the time they were nowhere near "stressful" enough in their "more adverse" scenario.

I was right.

Here's the table (thanks to Northwoodspete for pulling and posting it on the forum)

How about a bit of reality?

Real GDP looks to be a fairly decent guess on "more adverse", but the problem is unemployment. The "average" estimate for 2009 was 8.4%, the "more adverse" was 8.9.

But we are now at 10.2, and that's the "headline" number, not including the "disgruntled" or "not in labor force" folks.

The entire premise was that we would turn the corner on or before now, with the usual "lagging indicator" factor on the headline unemployment number.

That hasn't happened, as I reproduce again in this chart:

The turn upward in this chart was a near-exact correlation with the end of the recession in the early part of the decade. Not only are we dramatically worse now, we haven't even begun to turn, and those who have exited the labor force continues to skyrocket.

The key item here is loan losses.

They will not begin to stabilize until year-over-year job loss turns.

The Treasury "stress tests" did not envision this outcome. I said at the time they were nowhere near pessimistic enough and did not demand enough capital be raised (probably because they couldn't.)

But one of the premises of modeling outcomes is that your "worst case" scenario has to be worse than the expected range of outcomes. That clearly has not happened, and leaves open the question of whether the banks that were pronounced "safe" really are.

I'd argue that based on the stress tests and actual economic performance the answer is a resounding NO!

FDIC Bankrupt? Uh Huh Again

nospam@example.com (Karl Denninger) — Mon, 19 Oct 2009 08:35:00 -0400

Gee, who saw this one?

Anyway, the point stands. The FDIC is clearly out of money, and this is nothing more than yet another legalized accounting fraud game, where they'll get "the money" now but allow the banks to "recognize" that "charge" over time.

And now we find that this is not a short-term issue either:

NEW YORK (CNNMoney.com) -- The government insurance fund designed to protect consumer bank deposits will likely stay in the red through 2012, Federal Deposit Insurance Corp. chief Sheila Bair said Wednesday.

I know I have brought this up repeatedly, but these sorts of losses simply should never happen. In fact, if the law is followed with regards to the FDIC, they can't happen.

What this deficiency shows is that the law has not been followed. It has instead been wantonly and recklessly ignored, as I have repeatedly pointed out:

Well now Doddering Dodd and "I've never been frank" Frank are asking for the impossible:

Today, Senate Banking Committee Chairman Chris Dodd and House Financial Services Committee Chairman Barney Frank asked the heads of U.S. banking regulators to look into whether their companies are carrying home-equity loans at “potentially inflated values,” which “may contribute to resistance on the part of servicers to negotiate the disposition of these liens.”

Most of these loans are in fact worth nothing!

Here's the understatement of the year from the same article:

“It is well understood that the four major banks would likely need an additional capital injection should they be forced to mark the second-lien mortgages on their balance sheets to a realistic value,” Greenwich Financial’s Frey said.

Oh, so you mean our wonderful Congress has in fact encouraged and put into policy and law accounting fraud?

That was easy.

The fact of the matter is that despite Bair continuing to claim "bank deposits are secure" this is an entirely speculative statement and is predicated on the United States being able to continue to borrow money from people who our pigmen and Congress have repeatedly and intentionally ripped off.

The fact of the matter is that almost none of the losses taken by the deposit fund should have occurred, and were the law being followed as written, would not have occurred.

The fact of the matter is that Bair should be under indictment, along with Dugan and the rest of the clown car brigade at OTS and OCC, as all three of these agencies are in fact interlocked by their directorates and all have wantonly and willfully ignored the mandates of the law with regard to not allowing banks and other financial institutions to develop negative equity positions.

The fact of the matter is that our so-called "oversight" instrumentalities, including Congress and Treasury, simply do not give a damn and none of them have lifted a finger to do anything about the wanton and willful disregard for the law. It doesn't help that these laws lack an "or else" that can bring criminal sanction for violations. Gee, was that intentional when these laws were written? Lie to the public about how "safe and sound" one's deposits are, while praying that the ponzi scheme continues to work out ok?

Note that nobody in the mainstream media bothers to bring up "Prompt Corrective Action" and demand from Bair and rest the answer to one simple question: "How does a bank get into a situation where it has a 20, 30, 40, 50% loss on it's asset base when Prompt Corrective Action and Tier Capital requirements are supposed to cause banks to be seized before ANY loss occurs?"

Don't expect the mainstream media to get off their knees any time soon, just as Congress and The Administration have refused to do so.

ALERT: Nelnet Fraud Allegation

nospam@example.com (Karl Denninger) — Sun, 18 Oct 2009 14:56:00 -0400

In a scathing, more-than-100 page sealed complaint, the US and a complainer (Rudy Vigil) allege that some of the nation's largest banks, including JP Morgan/Chase and Citigroup, have defrauded the US Federal Government by running what amounts to the same scam that happened with subprime lending in the student loan arena.

Specifically:

"The alleged False Claims Act violations arise out of Nelnet's false records, statements and certifications of compliance with Higher Education Act ("HEA") statutes, regulations and Department of Education ("DOE'd") policies that (1) forbid the offering of inducements to any individual in order to secure applicants for FFELP loans such as Consolidation, Stafford and PLUS loans and (2) forbid engaging in fraudulent or misleading advertising.

Gee, really?

Where have we seen this before?

Undisclosed "yield spread premium" anyone?

The difference here is that "ysp" was not, at the time, unlawful. However, offering "inducements" (or if you prefer the more common terms, kickbacks or bribes), under the Higher Education Act, is.

Indeed, there is a long list of specifically-prohibited actions, including discrimination against those not on preferred lender lists, illegal inducements including the payment of points, premiums, payments or other inducements. "The rules prohibit inducements to educational institutions, individuals, or other parties. In particular, inducements to colleges and their employees, as well as inducements to students, are prohibited."

Further, the rules go on to disqualify violating lenders from the HEA under conditions where that lender commits a prohibited act, specifically:

DISQUALIFICATION FOR USE OF CERTAIN INCENTIVES. -- The term "eligible lender" does not include any lender that the Secretary determines, after notice and opportunity for a hearing, has after the date of enactment of this paragraph --

offered, directly or indirectly, points, premiums, payments, or other inducements, to any educational institution or individual in order to secure applicants for loans under this part;
conducted unsolicited mailings to students of student loan application forms, except to students who have previously received loans under this part from such lender;
offered, directly or indirectly, loans under this part as an inducement to a prospective borrower to purchase a policy of insurance or other product; or
engaged in fraudulent or misleading advertising.

The truly nasty part of this lawsuit is that it appears that Nelnet was well aware of these practices and in fact had been sued in the past over them. Specifically, the above link has the following paragraphs:

On April 20, 2007, the Nebraska Attorney General announced a settlement with Nelnet Inc., an education lender. Nelnet agreed to pay $1 million to an education fund and to adhere to a code of conduct similar to the one established by the New York Attorney General. It prohibits revenue sharing, opportunity loans, gifts and trips to higher education employees, and paid advisory board service. In some regards it is stronger than the New York Attorney General's code of conduct. For example, Nelnet also agreed to provide borrowers with the better of the direct-to-consumer channel or school channel rates regardless of how the prospective borrower reached Nelnet. Nelnet also supports requiring a minimum of three lenders on preferred lender lists, at least two of which are unaffiliated. In other ways it is weaker. For example, the restriction on paid service on advisory boards is limited to financial aid administrators who are involved with student lending. The prohibition on staffing financial aid offices merely requires proper disclosure and transparency. Nelnet agreed to adopt this code of conduct nationally by August 15, 2007.
On April 25, 2007, the New York Attorney General announced settlements with Bank of America and JP Morgan Chase, where both lenders agreed to adopt the attorney general's code of conduct. Johns Hopkins University announced that it was adopting the Code of Conduct and that it was dropping all preferred lender lists. The University of Texas system had also previously dropped all preferred lender lists.

On July 18, 2007, Nelnet published a summary of findings to date with regard to an ongoing review of its marketing practices, announcing, among other measures, that it was terminating its referral fee relationship with approximately 120 college and university alumni associations.
On July 31, 2007, the New York Attorney General announced an agreement with Nelnet in which Nelnet agreed to contribute $2 million to the national education fund and to adopt the code of conduct. Nelnet also agreed to stop paying alumni associations for loan referrals. This settlement is in addition to the $1 million settlement with the Nebraska Attorney General. However, the New York Times reported on August 1, 2007 that Nebraska Attorney General Jon Bruning has decided to forgive Nelnet's $1 million settlement with Nebraska in light of the $2 million settlement with New York. Higher Ed Watch criticized this lender forgiveness, noting campaign contributions from Nelnet to the Nebraska Attorney General. This may represent a violation of the Nebraska Rules of Professional Conduct. On August 10, 2007, Nebraska Attorney General Jon Bruning announced that Nelnet has agreed to pay the original $1 million settlement after all. The Associated Press reported that the Attorney General approached Nelnet about reinstating the settlement in order to avoid creating the "perception of a conflict of interest".

Reading the entirety of the above link is well worth your time, as is pondering whether there is truly ANY corner of lending in our economy that has not been punctuated with acts that at best violate ethics and at worst violate the law.

More importantly these alleged scams in the education sector have been part and parcel of the reason that college education cost has risen at such an outrageous rate. Absent the "free money" afforded by rip-offs such as are alleged here no university system or college could have possibly maintained an escalation of price at multiples of the increase in wages within our economy.

As such merely accusing the banks of such conduct is insufficient. We the parents must also rise and demand that the outrageously opportunistic parasitic games played by colleges and universities end immediately, and withdraw our consent to the exploitation of our children at the hands of these latter-day robber barons.

If our young adults wish to be exploited in such a fashion that is their right and privilege as adults, but it is my considered opinion after examining a litany of such abuses for more than a decade, all of which have gone unchecked and all of which have occurred with the full knowledge and consent of the colleges and universities in the United States, that I will not subscribe to nor assist in any such scam when it comes to my daughter.

I therefore call for a general boycott by all parents in the completion, filing, or provision of ANY family financial information, including but not limited to the FAFSA. Specifically, the following is an outright scam and fraud upon our young adults:

Under Federal law your family is primarily responsible - to the extent they are able - for paying for your college expenses. To determine how much your family can afford to pay towards your college expenses, we must collect your financial information and if you are a dependent student, we must also collect your parents' financial information.

This statement, by the way, is a lie.

Federal law does not change legal realities as ensconced in The Constitution of The United States, as The Constitution is the supreme law of the land. At the age of 18 you are a legal adult, entitled to all of the rights and privileges thereupon (excepting the consumption of alcohol.) You may tell your parents to piss off and never speak to them again. Your parents do not have a right, at 18, to control your coming and going, they cannot control where you live, who you sleep with or what you eat or drink. Your right to travel, live as you wish, and determine the path of your own life is unrestricted irrespective of your parents' wishes, as a matter of The Constitution.

This does not (and should not) prevent your parents from contributing, on their own volition, to a young adult's education but it most certainly must prohibit the rubric of mandatory "contributions" to someone who is, under The Constitution, Federal and State law, a legal adult with all rights, duties and privileges that attach.

There is in fact no federal law that states that a parent is required to pay for their child's college education. What the law actually states is that The Government will not provide you with free money unless your parents "contribute" to the extent that their formulas say they can. That's a very different thing indeed, but the government, like your college, is not above lying to you as a student - or the parent of one. The parents of a student are in fact under no legal obligation to provide any information requested. Of course the government isn't obligated to provide you with "free money" (really, money they stole from a taxpayer at gunpoint) either!

If you're a student, do you want to attend a school that lies to you before you even get there?

If you're a parent, do you want to "contribute" to a school that lies to you (and your son or daughter) before they even set foot on the campus?

It is time to break the backs of these lenders and universities that have declared financial war on this nation, including a long-standing pattern of conduct of violating the law with impunity, all of which has caused the spiraling of college costs to a degree that is absolutely unsupportable by any means other than raw theft from the public.

If you EVER want to see college educations return to an affordable status then you must support and enforce within your own household a total and complete boycott on this rank attempt by the financial industry to extend to you, as an adult, a demand for payment at any rate a college so chooses for "educational expenses" for another legal adult (even though they may be your progeny.)

College education used to be something that could be paid for through working while attending school along with scholarship monies for those who showed promise in their educational future.

Today, college educations are virtually dependent upon transfer payments and tens or even hundreds of thousands of dollars in debt taken on by families and students, induced and coerced by both schools and lenders who do not even comply with the law in an astounding number of cases, and whom have together lobbied for Federal Laws that are blatantly unconstitutional attachments of financial obligation for those who are, under the law, legal adults.

This is Constitutionally indefensible and amounts to nothing other than preying upon our youth through the use of them as "levers" to both induce them to take on unconscionable debt and, when possible, abuse their parents - all for the benefit of the banksters who, this lawsuit alleges, don't even comply with the thin protections that Federal Law is supposed to provide!

Reform Of OTC Derivatives

nospam@example.com (Karl Denninger) — Wed, 07 Oct 2009 08:19:00 -0400

The Parade Of Mendacity continues in The Capitol today, with a committee hearing on the reform of the OTC Derivatives market.

The witness list reads as a who's who of the den of wolves, of course. We have the obligatory commercial interests who use derivatives (Cargill and John Deere) along with SIFMA via Morgan Stanley, the Managed Funds Association, the insurance companies (Prudential) and the mandatory academics.

Many of the witnesses make the obvious point that derivatives are useful to hedge off risks of various types, some of which are "custom" in their implications - that is, there is no currently-corresponding exchange-traded instrument that duplicates what they are trying to accomplish. In this they are correct.

But two pieces of testimony are deeply troubling; those of James Hill and Dave Hall of SIFMA and Chatham Financial, respectively.

James asserts as his opening volley:

We believe that a guiding principle for congressional action should be not to impose new regulations that will limit the availability or usefulness of derivatives or increase their cost unless there is a compelling reason to do so.

In other words, James asserts that there should be no regulation that provides for actual safety improvements to the system, because such improvements will of course increase their cost.

He goes on to say:

It was the lack of meaningful regulation of AIG’s derivatives affiliate that allowed poor business practices to lead to a situation in which the federal government had to invest tens of billions of dollars in that enterprise in order to avert what could possibly have been a systemically significant business failure. The Act would address this regulatory shortcoming by creating a legislative and regulatory framework that ensures such a lapse should not occur again.

That's a nice sentiment, but it does not take Mr. Hill long to gut his own prescription. See, AIG's problems revolved around a simple reality: It was operating while insolvent, and allowed to become not only insolvent but ridiculously insolvent, to the point that it literally threatened to be unable to cover ANY of its outstanding derivative positions.

SIFMA's position becomes clear almost immediately thereafter:

For example, the Act would authorize regulators to impose margin requirements on swaps in which one of the counterparties is an end user. It is difficult to understand why counterparty credit exposure created through a swap transaction should be required to be collateralized when lending arrangements between the parties can be made on an unsecured basis. The Act would direct regulators to allow parties to post non-cash collateral, but even that carries a cost, including reducing the end user’s borrowing capacity and potentially causing an end user to violate negative pledge covenants.

There's the problem with the banking system right there - in your face! We had multiple failures last year because banks lent money unsecured beyond their excess capital; when that money was not paid back by the supposedly-credit worthy customers in a sufficient number the bank failed, forcing the intervention of the Federal Government.

Worse, we have hard proof that this conduct is still going on in the form of nearly 100 bank failures thus far in the crisis. In virtually every case it is discovered that these banks are not just insolvent, they are ridiculously beyond insolvent, having burned through their so-called 6% Tier One regulatory capital three, four, five or even six or seven times over before being "caught" and closed.

These deficiencies did not happen overnight. Indeed this sort of insolvency takes weeks, months or years to develop, during which there has been willful blindness both in Washington DC and the several States to the pending implosion of these firms. In many states, such as Virginia, Michigan, Maryland, Nevada, North Carolina, Indiana, Missouri this is defined as an offense, and some states define it as a criminal felony for which one can be imprisoned for a term of years. All of the above named states define such an offense as one that subjects all officers, directors, and branch managers to personal liability for loss of such deposits, and demands personal knowledge of the books of account of such institutions by all these individuals. While some states apply this only to "state banks", others are far more broad, applying these strictures simply to "banks", strongly implying that these standards apply to any firm that operates a bank in their state by virtue of corporate charter (as a foreign corporation or not!)

Now SIFMA has the gumption to come to The House of Representatives and put forth the position that institutions are "free" to do this sort of thing, exposing themselves to insolvency via lending, they should be able to expose themselves to even greater insolvency via derivatives contracts, and that no margin supervision should be required as a matter of law in order to prevent insolvency from occurring.

This is tantamount to asking for official federal sanction to commit a felonious act under the laws of several states.

Another provision concerns dealer segregation of funds or other property posted as margin. We believe it is important for end users to have that option in connection with over-the-counter swaps, but both the decision to require margin and the details of how it is handled should be left to negotiation between the dealer and the end user in the ordinary course of their lending and risk management processes.

Both Lehman and AIG's failures were systemically significant as a direct consequence of the failure to demand margin segregation.

Lehman is particularly troubling. As I have previously documented there were tens of billions of dollars in NY Fed money that Lehman had outstanding at the time of its bankruptcy filing. What appears to have transpired, however, is that The NY Fed was repaid in apparent violation of bankruptcy preference laws after the petition was filed, even though such actions are per-se improper once an insolvency is declared by the firm (indeed, any payment made that appears to be in "preference" looking back prior to the filing for a reasonable time, usually 90 days, can be reversed in bankruptcy.)

The larger issue is simply this: SIFMA is arguing that collateral posted with a bank or other financial institution to secure a current liability under a derivative contract should be available to the institution for general corporate purposes. This runs contrary to every principle of fiduciary responsibility, agency status for a broker/dealer and common sense.

Indeed, these funds are not, under any circumstances, the broker/dealer's to use. They are posted as security for performance, just as is an earnest money deposit on a home purchase or margin posted for a short stock position. These funds are collected for the express purpose of securing performance, nothing more or less, and they need to be held and kept separate under formal escrow protection.

The legislation under consideration does not go far enough to guarantee this protection for customers. Under no circumstances should the assets of a customer that are posted for margin purposes be able to be co-mingled with the general operating funds of the corporation holding them, nor should they be subject to seizure and conflation with the firm's assets in the event of insolvency. The money or other collateral in these instances is posted for the specific purpose of securing performance; nothing more or less, and does not belong to the institution holding these funds!

SIFMA's objection is both self-serving and outrageous. By permitting the corporate use of these funds not only are the banks able to "double dip", that is, earn interest lending out money that is not theirs, effecting theft (even if temporary) by conversion, they also expose customers to the risk of loss in the event of a firm's insolvency - a risk that is not disclosed clearly and conspicuously to them when they enter into these derivatives contracts. Indeed with that disclosure it is likely that no customer in his or her right mind would agree to such a contract, as the very time when a loss occasioned by this would be realized would be when that firm would be making maximal use of its hedging activity via these derivatives.

I will note for the record that other institutions have been caught using customer segregated funds generally for their own corporate purposes in recent years, and subjected to fines for doing so. This is insufficient; such a violation should be punishable by criminal sanction as well as revocation of a firm's operating charter, as this is nothing more or less than theft by conversion.

Dave Hall echoes the sort of ridiculous statement of SIFMA with regards to margin:

Margin – Any requirement for business end users to cash collateralize hedging transactions would create an extraordinary and unnecessary drain on working capital.

Huh? The exposure on a short transaction that has gone "against" the customer is real! The requirement to post margin comes out of the fact that performance, assuming the position remains where it is or continues to move adversely, will require the payment of those funds. Posting of margin may "drain working capital" but so does performance! What will be next? Repudiation of swaps that go the wrong way for the customer?

Mr. Hall goes on to say:

To illustrate this point, a bank may choose to make a loan without collateral if the business is creditworthy, therefore it is reasonable that a derivative should be allowed to be offered to a business end user without margin if the business end user is creditworthy.

And again I note that we have nearly 100 proved cases thus far in the form of bank seizures where so-called "credit-worthy" customers in fact were not and the refusal of those institutions to maintain the sound banking practice of never lending unsecured beyond the bank's own collateral has resulted in insolvency from three to nine times over (vis-a-vis the Tier 1 Regulatory Capital) prior to seizure.

In short OTC derivatives, over the previous ten years, have become a mechanism for avoidance of sound financial regulations and gross abuse of regulatory arbitrage. These abuses have led to billions of dollars of losses in the case of Lehman and taxpayer expense of over $100 billion dollars that was passed through AIG to counterparties that, on their face, had a claim to exactly nothing following AIG's recognition of inability to pay as agreed.

These failures were not accidents, they were systemic and intentional abuses that, under the laws of several states, should have been charged and prosecuted as felonies. That there is no corresponding federal law prohibiting a financial institution from accepting funds and/or operating while it is in a negative equity position and criminalizing this conduct - that is, operating while insolvent - is an outrage.

SIFMA and The Chatham Financial Corporation wish to not only continue this charade but, it appears, to be given formal permission from The Federal Government to expand it.

Their requests not only must be denied but Congress must also write into law criminal penalties mirroring that of states such as Nevada, which formally define the operation of a "bank" (but extending it to all financial institutions) while insolvent as a felonious act, exposing all officers and directors not only to prison time but also to personal liability for all losses suffered by customers and counterparties as a consequence thereof.

Sound Banking: A Capitalist Imperative

nospam@example.com (Karl Denninger) — Mon, 05 Oct 2009 12:56:00 -0400

It is time to "clear the decks" and talk about exactly what a sound banking system is - and is not.

It is time to identify that which is an exercise in capitalism, and that which is an exercise in fraud.

It is time to strip back the mask of the so-called "moneychangers" and lay bare for all to see exactly what has been going on for the last two decades, and more importantly, to identify whether or not there is a kernel of respectability contained therein.

And finally, it is time to dispense with many of the calls from all corners for "hard money" and the demise of fractional lending as nothing more than an interesting philosophical exercise masquerading as an intentional (or horribly-misguided) misdirection.

Let's first define a few terms; these should be familiar:

Principal: The amount of money you borrow for a given term of time.
Interest: The amount of money you pay, usually expressed as a percentage, to cover three risks and costs - the risk you will not be able to pay the principal, the risk of currency devaluation and the demanded profit on the loan by the lender.
Collateral: The item or items you post with the lender to secure your indebtedness. While "collateral" in the broadest sense includes anything that could be seized after a judgment should you fail to pay (including your labor at subsequent points in time), for the purpose of this discussion we will limit the term "collateral" only to that specific physical, tangible property you post to secure a specific loan, explicitly excluding anything of a speculative nature (such as your ability to earn money in the future.)
Monetary Base: The monetary base of all credit-based monetary systems is the sum total of all unencumbered assets against which one is both able and willing to borrow. (No, it is not "M1", "M'" or any such nonsense.) If you run into a so-called "Economist" who claims to have letters after his name yet makes the argument that "base money" (or any such thing) is the monetary base in a debt-based system find out where he got those letters from and petition them to revoke his degree; he fails at the fundamental skill of logic and deduction, yet it is a near-certainty that he carries proof that his claimed position is wrong in his wallet (a credit card, which spends identically to the dead president it resides next to.)

Ok, having settled on definitions, we will now turn to the fundamental reality of fractional reserve banking. Many people claim that banks "create money" or "print money." This is not true; a bank recycles money, that is, it increases the velocity of a given amount of money in circulation, but an ordinary bank (not a Central Bank) never creates new money.

We'll start with our hypothetical bank that has no assets and no deposits, and a 10% fractional reserve requirement. Joe walks in and deposits $10,000 and leaves. The bank now has $10,000 in assets (cash) and $10,000 in liabilities (a book entry that says it owes Joe that $10,000 on his demand.)

Jane now walks in and wants to borrow money to buy a car. She borrows $9,000 from the bank and posts as security the title for the car she purchased. The bank now has exchanged $9,000 of the cash asset that it had for a piece of paper (the title to a car and a promissory note.) Let's, for the sake of argument, agree that Jane paid half cash for the car and that it is worth far more than the $9,000 she borrowed (this becomes important in a minute.)

Now the car dealer comes in and deposits the $9,000 that Jane spent. The books look like this:

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$9,000	($9,000)	Car Dealer (Chk Acct)

This is where the complaint that the bank is "printing money" comes from; notice that there was only $10,000 in the beginning, but there is now suddenly $19,000 worth of both assets and liabilities.

The "purists" will argue that both the car dealer and Joe can't come in and demand their money - its not there (only $10,000 is, not $19,000.)

This is false: The bank holds a piece of paper worth at least $9,000 and can sell it immediately into the market if necessary. As such it CAN pay both the car dealer and Joe should they both demand their money by disposing of the asset it holds in lieu of the other $9,000 - Jane's loan.

This also looks ok from an accounting perspective - both sides of the ledger balance. Let's keep going.

Steve now comes into the bank and opens a credit card account with a $8,100 credit line. He immediately blows the entire line on an exotic cruise vacation. The cruise line deposits the funds. This is what we've got now (note that the $8,100 he borrowed was 90% of the deposit from the car dealer; I have grouped the transactions to make it simpler to follow.)

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$900	($9,000)	Car Dealer (Chk Acct)
Credit Card (Steve)	$8,100

Cash (Cruise Line)	$8,100	($8,100)	Cruise Line (Chk Acct)

Now we have a problem. See, the "Credit Card" loan that Steve took out is unsecured. That is, it is nothing more than a raw promise to pay in the future, backed by nothing other than Steve's word, and what's worse, Steve immediately consumed the entire $8,100 - it's gone.

So now if the cruise line, car dealer and Joe all come into the bank and demand their money the bank has a very high probability of not being able to pay. It may be able to sell Steve's paper (the card account) for $8,100, but that line, being unsecured, is likely going to be subject to some sort of haircut in the market - maybe a big one. The particular "haircut" is entirely dependent on the exact state of the economy at any given point in time, along with Steve's personal financial situation.

The important point is that the asset that the bank holds from Steve is nothing more than a signature and promise.

This is unacceptable and in fact is the cause of every economic Depression featuring a deflationary credit collapse over time, as defaults begat more defaults and those defaults, uncovered with capital, cascade through the system instead of being isolated to the failed institution. All of them. 1873, 1929 and the present mess were all caused by systemic and pernicious violation of the most fundamental rule of sound banking: One must never lend out more unsecured than one has in excess capital.

So how could the bank have avoided this? Simple. Let's say that the bank had taken in capital in the form of stock issued to the public; it thus might have a balance sheet that looks like this:

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Paid In Capital	$10,000	($10,000)	Shareholder Equity

Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$900	($9,000)	Car Dealer (Chk Acct)
Credit Card (Steve)	$8,100

Cash (Cruise Line)	$8,100	($8,100)	Cruise Line (Chk Acct)

Now everything is fine. Why? Because the shareholder equity can get whacked as required. Let's assume Steve defaults; we now have:

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Paid In Capital	$10,000	($1,900)	Shareholder Equity

Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$900	($9,000)	Car Dealer (Chk Acct)
Credit Card (Steve)	$8,100	($8,100)	Defaulted (Steve)

Cash (Cruise Line)	$8,100	($8,100)	Cruise Line (Chk Acct)

Assets and Liabilites	$37,100	($37,100)

Notice that the books balance, but the loss was taken out of the shareholder's hide.

"Paid in Capital" is one of several types of "excess capital" that a bank can hold. A bank could also issue bonds and it can retain earnings; all three are actual hard cash.

Therefore, the fundamental rule is this:

No bank may be permitted, under any circumstances, to have outstanding more in unsecured lending than it has in actual excess capital.

So long as this rule is adhered to there is never a risk of depositor loss and "deposit insurance" such as the FDIC is irrelevant. Indeed, the FDIC should exist only to cover the malfeasance of government officials who have failed in their essential task - that is, guaranteeing that the banks under its supervision never exceed their excess capital in unsecured lending.

The counter-argument - that one cannot quantify asset prices accurately and thus incursion of this rule will occur "accidentally" - is often raised. This is a chimera - the standard is that it may never happen, and it is the responsibility of bank management to decide how close they want to fly to the Sun! That is, the more leverage they take on, the lower the down payments they permit for their asset-based lending and the closer they run in today's market prices for the assets they hold to their excess capital the greater the risk that an economic dislocation of some sort will render them instantly insolvent and closed, wiping out the entirety of their unsecured bond and stockholders.

In point of fact any bank which has outstanding more in unsecured lending than it has in excess capital is at that moment insolvent, in that it has no security against the amount outstanding in loans that exceed excess capital.

Note that this has exactly nothing to do with whether you are on a Gold Standard nor does it have anything to do with fractional reserve lending. In fact the Depressions of both 1873 and the 1929/1930s occurred while on "hard money". A gold standard (or any other "hard" currency) will do nothing to stop this, because the problem has never been the fiat nature of currency - it is the fact that credit is being extended without collateral beyond the actual cash reserves of the institution in question.

Now here's the nasty: It is illegal in many states for a bank to accept a deposit while in this condition. As just one of many examples (Nevada):

1. It is unlawful for a president, director, manager, cashier or other officer or employee of any bank to permit the bank to remain open for business, or to assent to the reception of deposits or the creation of debts by the banking institution, after he has knowledge of the fact that it is insolvent or in failing circumstances. An officer, director, manager or agent of a bank shall examine the affairs of the bank and shall know its condition. Upon the failure of any such person to discharge his duty of examination, he must be held, for the purpose of this title, to have had knowledge of the insolvency of the bank, or that it was in failing circumstances, and shall be deemed to have assented to the receipt of deposits while the bank was insolvent or in failing circumstances. A person who violates the provisions of this subsection is individually responsible for deposits so received, and all such debts so contracted, but any director who has paid more than his share of such liabilities has a remedy at law against other persons who have not paid their full share of such liabilities for contribution.

....

3. A person who violates the provisions of this section, or who is an accessory to, or permits or connives at, the receiving or accepting of any such deposits, or the giving of such preferences, is guilty of a category D felony and shall be punished as provided in NRS 193.130.

Each and every bank officer and manager is not only civilly liable for any loss suffered (e.g. balances beyond insured limits) but is also CRIMINALLY liable for the acceptance of deposits while the bank they work for is factually insolvent in many of these states, including Nevada.

If The Federal Government will not close these institutions and will not act in this fashion then we must insist that the STATES do so in accordance with their legal code.

These laws exist for a simple reason: When you walk into a bank and deposit money you have a contractual understanding that it will be returned to you either immediately on demand or in a relatively short period of time (effectively on demand.) This is even true for so-called "time deposits"; you will forfeit some amount of interest (sometimes all of it!) but if you cash a CD early they are still required to hand over your money.

If the bank does not have it nor can they raise it immediately as a consequence of lending out money unsecured in amounts that exceed their excess capital then they have committed the common-law crime of fraud; they have induced you to lend them money with a promise to repay that they know is entirely speculative in terms of their capacity to perform. Unless that is disclosed to you before you tender your funds to them they have committed fraud by concealing the speculative nature of their ability to return your funds on demand. It is that simple and a number of states recognize this as a formal section of their legal code.

IF THE FEDERAL GOVERNMENT WILL NOT DO ITS JOB THEN IT IS TIME FOR WE THE PEOPLE TO DEMAND THAT THE STATE GOVERNMENTS DO SO FOR THEM!

Lionized? You're Kidding, Right?

nospam@example.com (Karl Denninger) — Thu, 01 Oct 2009 08:10:01 -0400

Look at how Bloomberg is treating BAC's resignation:

Oct. 1 (Bloomberg) -- Kenneth D. Lewis bet Bank of America Corp.’s future on America at a time when America went bust.

Lewis, 62, said yesterday he will resign as chief executive officer at the end of the year, leaving his successor to capitalize on, or salvage, the acquisitions that led to his downfall. The bank didn’t name a replacement.

Yeah, such a bet. "We'll play 'give me bailout or the puppy dies!'" games along with Bernanke, raiding not one but two companies (don't forget Countrywide!), was a huge part of people getting tossed out of their homes on their ear, was a major funding and "partner" with ACORN (just-recently "suspended") and more.

Bank of America is one of the "bad guys" in transaction re-ordering too:

A few weeks ago, Bank of America hit the Chicago marketing man with a $35 overdraft fee when he had more than $130 in his account. The bank was apparently “holding” his money for charges that hadn’t cleared — only they appear to have been holding three times more than he actually spent. Then, if that wasn’t enough, they “reordered” his subsequent purchases in a way that tripled his overdraft charges. Within a couple days, he had racked up $140 in fees.

Let's not even talk about "authorization holds" - that's yet another sneaky trick (this is where a gas station will place a hold for $50 on your account when you swipe your card; if you buy $20 in gas, the other $30 can remain "held" for as much as five days!) Or shall we talk about ATMs and online balance systems showing uncleared funds as part of your "balance", thereby encouraging you to overdraw your account - and allowing it at an ATM without a warning that it will incur an overdraft fee too!

Now to be fair Bank of America says they're changing some of these policies with implementation dates out into the middle of next year.

But to also be fair I must point out that until there was a threat of legislation banks refused to stop this blatant robbery - tactics that hit consumers at the lowest end of the economic strata the hardest.

Was Ken Lewis forced out? Nobody's admitting it if so, which brings up another question - why not?

The better question from my perspective is why any of us in America tolerate this garbage. There are alternatives, and when it comes to blatantly unfair practices boycotts, moving business to credit unions and bringing pressure on your state attorneys general to file criminal complaints and suits for blatantly unfair practices are three of those alternatives that in my opinion every American should be considering.

Finally, as I have written about dozens of times, we are starting to see more notice in the mainstream press on the hiding of losses on bank balance sheets:

Georgian’s clean-up will be unusually costly. The book value of Georgian’s assets was $2 billion as of July 24, about the same as the bank’s deposit liabilities, according to a Federal Deposit Insurance Corp. press release. The FDIC estimates the collapse will cost its insurance fund $892 million, or 45 percent of the bank’s assets. That percentage was almost double the average for this year’s 95 U.S. bank failures, and it was the highest among the 10 largest ones.

Right. Colonial anyone? But look at what Jonathan says:

The cost of Georgian’s failure confirms that the bank’s asset values were too optimistic.

OPTIMISTIC?

"Estimating" the value of a bucket of "assets" at nearly double what their realistic market value happens to be is "optimistic"? I can see being off by 5% or maybe 10% as "optimistic", but nearly half is a matter of "optimism"?

I can think of a handful of other adjectives that better describe this situation, which we have seen repeated over and over during this fiasco. How about "Scam"? "Ripoff"? "Charade"? "Myth"?

Or perhaps we should use the word that would be used were I try to pull something like this in essentially any other line of work (and which, by the way, was used repeatedly when this sort of "optimistic" valuations were exposed after the .COM blowup):

FELONY

That's right folks.

One can argue that people are being "optimistic" in a vacuum with single instances, but when you keep seeing bank failure after bank failure - nearly 100 of them now - where balance sheets are universally overvaluing claimed "assets" .vs. their disposition value at some point you have to call this what it is: a pattern of intentional conduct designed to deceive regulators and the public as to the condition of these institutions.

And that folks, is not a mistake.

It is, in my opinion, a criminal offense, and one that every member of the board of these banks, along with their auditors, should be answering for.

We are far beyond where we should have been demanding full forensic audits of every bank in the nation to determine the extent to which "loss hiding" through "optimistic" valuations have infested those institutions we call "too big to fail", along with the community and mid-sized banks.

Why?

Because it is a criminal offense to intentionally overstate asset valuations in a publicly-traded company, and especially post-SARBOX, doing so is a not just a civil matter of screwing shareholders for which one can be sued, it is a crime (18 USC Sec 1519, up to 20 years in prison.)

While not all of these firms have been public companies, a good number of them were and are.

How blatant and outrageous does the "optimism" need to be before criminal indictments are handed up in these cases?

We can pass all the laws we want but if they remain unenforced then their value in protecting the public and deterring the blatant looting that has gone on over the last decade is in fact zero.

STOP THE LOOTING AND START PROSECUTING

And Here It Comes! (Bank Malfeasance)

nospam@example.com (Karl Denninger) — Wed, 30 Sep 2009 09:13:53 -0400

It was just a matter of time....

A global regulator would ensure that U.S. banks aren’t subject to tighter regulations than the rest of the world, Mack said. A push for regulation during the financial crisis has weakened as the administration of President Barack Obama pursues other tasks, he said.

Got it?

The way this game works is that you find a significantly-large nation that is willing to allow all sort of accounting games and extreme leverage (cough-Germany-cough!) and then you whine and bitch because you can't get the same rules over here.

Heh, it worked for Paulson, right? Remember that investment banks were limited to 14:1 leverage - until 2004 when Paulson went to the SEC and got them to lift the cap.

What was Lehman and Bear's leverage when they blew up?

Oh, and what is the actual leverage at Deutche Bank? Does anyone know? What are they holding on their balance sheet (and off), and does anyone know what their actual risk on those alleged "assets" are?

Nope.

The ECB-space banks are in many ways worse than ours in terms of disclosure.

But what Mack wants, having been bailed out after running his organization at an untenable level of risk and leverage, is to be able to take on even more leverage and risk!

This sort of perversion must be stopped; if Mack doesn't like reasonable leverage limits (like 12:1, with no off-balance sheet exposures and everything marked to the market) then he should move to Germany.

I'll buy him a one-way first-class ticket - provided he renounces his US Citizenship and agrees to a permanent bar on ever entering this nation again on the jetway.

Wall Street's Fraud

nospam@example.com (Karl Denninger) — Tue, 29 Sep 2009 08:15:00 -0400

Janet Tavakoli has launched another salvo related to the massive Fraud Street machine:

Wall Street gave mortgage lenders large credit lines (similar to credit card debt) and packaged the loans into private-label residential mortgage backed securities (RMBS). Most of the RMBS was rated “AAA,” since subordinated investors absorbed the risk of a pre-agreed amount of loan losses. But many RMBSs were backed by portfolios comprising risky fraud-riddled loans. Most of the “AAA” investment was imperiled, and subordinated “investment grade” components were worthless. Wall Street disguised these toxic “investments” with new value-destroying securitizations and derivatives.¹

As I have repeatedly pointed out it is not possible for the value in a transaction to ever be higher than at the point of origination of a loan. It is mathematically impossible for it to be otherwise as the cash flow from the debtors is a fixed quantity; you can divide it up and siphon part of it off, but you can't manufacture that which does not exist. Any claim that you can do so is fraud on its face.

Meanwhile, collapsing mortgage lenders paid high dividends to shareholders (old investors) and interest on credit lines to Wall Street (old investors) with money raised from new investors in doomed securities. New money allowed Wall Street to temporarily hide losses and pay enormous bonuses. This is a classic Ponzi scheme.

Securities laws chiefly apply to financiers (the underwriters and traders) that create, sell, and trade securities. Underwriters are responsible for appropriate due diligence, an investigation into the risks.² If you know or should know that investments are overrated and overpriced when they are sold, those facts must be specifically disclosed. If you fail to disclose material information, expect to be investigated for fraud. If you have a mortgage subsidiary, expect it to be investigated, too.

One question: When?

An IMF official asserted: “You can’t prove fraud” and insisted it was in the interest of risk managers not to let their institutions collapse. (He was unable to attend my exposition based on Chs. 5-12 of Dear Mr. Buffett). This IMF officer isn’t just soft on crime; he’s in denial. Failure to recognize fraud led to statements like the one that opened Chapter 2 of the IMF’s April 2006 Global Financial Stability Report:

Actually, proving fraud is simple: All you need to do is prove that a financial institution marketed securities from some batch of debt that had as its total claimed return a number greater than the original deals that went into the package.

This requires nothing more than a calculator. The claimed returns are known from the marketing and the coupon on each asset that went into the package is also known. 2 + 2 still equals 4 and if the institution claimed to have "manufactured" wealth it committed fraud.

Likewise, the risk-adjusted return of each loan in the package is known (interest .vs. growth at the time of origination.) If, at the time of origination, the risk-adjusted return of the "securities" was greater or equal (remember, nobody works for free!) than the components, once again, fraud was committed.

Yes, there were thousands (or tens of thousands) of loans in a package. So what? We have a thing called a "computer" nowdays that makes summing and dividing large quantities of numbers a trivial, sub-second enterprise.

To demonstrate that fraud was the essence of these securities we need only show that a financial institution represented that it had invented perpetual motion in the financial sense. As that is mathematically impossible any such claim is ipso facto fraudulent.

Troubled financial entities should be put into receivership and restructured. Old shareholders will be wiped out. Debt-holders will take a haircut (discount) along with a debt for new equity swap to recapitalize the entity. But the job won’t be complete until we separate high risk activities from traditional banking in a return to a Glass-Steagall like structure with regulators that indict fraudsters, snuff out systemic fraud, and allow honest bankers to prosper.

The laws already exist; it is illegal to promote perpetual-motion machines and take money from people for their promised delivery, irrespective of where and how you claim to have "invented them", because such a machine, whether in the form of a physical engine or a financial product, cannot possibly exist.

Janet does a great job in this piece of exposing the web of interconnections between parties, including the fact that Tim Geithner headed the NY Fed when the "big burst" of this fraudulent activity took place and that as the NY Fed's head at the time he was directly and personally responsible for the willful regulatory blindness to what was an obvious and "in your face" scam.

As Janet says, we have the tools to take care of these problems - we simply need to will to use them.

FDIC Bankrupt? Uh huh.

nospam@example.com (Karl Denninger) — Mon, 28 Sep 2009 15:51:00 -0400

From CNBC's "Breaking News" banner:

FDIC to Ask Banks to Pre-Pay Premiums to Inject Cash Into Deposit Insurance Fund (story developing)

"Ask"?

Somehow I suspect it will be something like this:

(Gee, I need to graft Geithner's head on that one..... along with Bair!)

Anyway, the point stands. The FDIC is clearly out of money, and this is nothing more than yet another legalized accounting fraud game, where they'll get "the money" now but allow the banks to "recognize" that "charge" over time.

Gee, what happens if the bank doesn't have any money somewhere between now and then and fails?

Oh we won't bother with that, right? Remember, there will be no more failures - and just like in Oz, if you say it enough times it might even become true!

Mark To Myth Losers: Americans

nospam@example.com (Karl Denninger) — Mon, 28 Sep 2009 08:29:00 -0400

I have often written about the fraud in marking so-called "assets" to mythical values. But nowhere does the damage of this practice hit more home than it does in places like this:

Vacant homes can become havens for drug sales and other crimes. Health and sanitation is another issue when homeless people move in to properties where utilities have been disconnected. And as the weather cools, there is yet another worry -- fires started by intruders trying to keep warm in vacant homes.

"They want to find a place to get out of the cold," Rigler says at another home near 300 East and 800 South. Several windows and even two doors have needed boarding up in recent months to keep out those doggedly determined to take up residence.

Those homes are the "visible side" of accounting fraud.

This is not limited to Utah. In Oakland CA:

"Just about every foreclosed property on my beat has some kind of problem," said Derek Smitheram, a police officer in East Oakland, which he said has thousands of vacant homes.

Again, the issue here is that these properties are being intentionally kept back from the market due to valuation.

Or in Miami....

But the real estate agent now brings a pistol when he visits the foreclosures he is trying to sell for banks, in case he runs into squatters in the long-vacant homes.

The problem in all three places, and thousands of towns across the country, is the same: Banks have every incentive to drag their feet in both recognizing that loans are delinquent and thus to prosecute foreclosure in the first place, but also, once that has occurred, they have every incentive to hold properties off the market - the so-called "shadow inventory" - to avoid recognizing losses that have already occurred.

Dr. Housing Bubble puts a bit decent amount of focus on this, drilling down into one particular MSA and finding 465 homes in the MLS. Of those, about 160 are either short sales or foreclosures.

But there are 1639 homes that are in pre-foreclosure, bank-owned or defaulted. Take the public listings out and you have 1,477 homes thare are "missing in action" yet in fact are not owned by a stable, paying owner.

OTS, on May 22nd, acknowledged these practices and yet is doing nothing about it:

The review disclosed several practices that may not be in accordance with supervisory guidance and generally accepted accounting principles (GAAP).

Translation: Under GAAP these practices are accounting fraud.

Institutions charge-off losses only at foreclosure or when deemed uncollectible. A sound practice is to establish charge-off policies in accordance with the Uniform Retail Credit Classification and Account Management Policy (CEO Memo #128, July 27, 2000). Institutions should assess the current value of the collateral and selling costs when a loan is no more than 180 days past due. Any loan balance in excess of that assessment should be classified Loss.

Translation: Banks and Thrifts are holding loans at values that do not reflect the value of the collateral or likelihood of collection. That is, they're lying.

Institutions stated that modifications to interest rates that reflect current market rates are not troubled debt restructurings (TDRs), even when these rates are concessions granted to borrowers. However, if the borrower cannot obtain a loan at a similar rate and with similar terms with another lender, the modification is likely a TDR. Institutions should properly identify TDRs in accordance with GAAP and properly account for the TDRs. A loan modification is a TDR when a creditor grants a borrower a concession it would not otherwise consider because of economic or legal reasons pertaining to the borrower’s financial difficulties.

All loans under "HAMP" (the government modification program) are TDRs. No borrower, absent distress of some sort, would get a similar extension of term or modification. Again, another lie.

Institutions place loans on nonaccrual status when “deemed uncollectible” and do not reverse accrued but uncollected interest through current earnings. An institution’s nonaccrual policy should require that a loan be placed on nonaccrual status in a timely manner, generally when 90-days delinquent, and accrued but uncollected interest should be reversed through current earnings when it is probable that the interest will not be collected in cash from the borrower.

This is the "OptionARM" mess that I started writing the Ticker over in early 2007. Banks are not reversing their so-called "earnings" taken from accrued negative amortization. This amounted to tens if not hundreds of billions of dollars during the bubble years, yet these so-called "earnings" were FICTIONAL.

Institutions refresh or increase interest reserves on construction loans and continue to accrue interest income even when the borrower cannot make out of pocket payments and the construction project shows signs of trouble. Interest income accrual from interest reserves on construction loans should only continue when it is probable that interest will be received in cash from the borrower and collection of principal is also probable.

If you're wondering how Colonial Bank managed to book a sixty percent loss on its construction book when BB&T came in and took it over, this is how it happened. Banks are holding construction loans at or near "par", that is full value, even when there is basically no chance that these loans will ever perform and the interest and principal will never be paid.

The bottom line here folks is as I have been hollering about for over two years: Banks and other institutions are carrying paper at FAR beyond its reasonable fair-market value - or that which it will EVER realize under any reasonable set of assumptions going forward.

Bluntly, we have institutionalized accounting fraud and the so-called "regulators" that are supposed to put a stop to and even prosecute these acts are willfully and intentionally ignoring them. The cities and towns across America are the big losers where these practices cause blight through intentional neglect while these "banks" claim to be in far better financial condition than is in fact the case.

In addition, this willful disregard for the truth means that these bankrupt institutions remain in the system as "zombies", unable to perform their critical role in credit intermediation.

Virtually everyone, including our regulators, has recognized the infirmity of these practices and written about it - newspapers, bloggers like myself, and even the OTS.

Yet nothing has been done - not by The Fed, not by Congress, not by OTS and not by the FBI, even though accounting fraud is in fact a felony.

The law is not supposed to apply only to the "little people", but it is in fact the "little people" who have to suffer through the crack houses, squatters living in homes with no running water and the public health problems this creates and the damage to neighborhood values caused by boarded up and broken-into homes that are being intentionally withheld from the market as a tactic to prolong and enable financial institutions to remain operating with their executives siphoning off salary and even bonuses while they are, under GAAP, bankrupt.

Stop the looting and start prosecuting!

One TINY Piece Of Bezzle Dies

nospam@example.com (Karl Denninger) — Wed, 23 Sep 2009 08:02:00 -0400

I guess the threats from Congress got a small response:

Sept. 22 (Bloomberg) -- Bank of America Corp. and JPMorgan Chase & Co., the two biggest U.S. banks by deposits, are cutting overdraft fees amid criticism from lawmakers over the way the lenders charge customers.

The two banks, which currently enroll all checking accounts in overdraft protection, will allow consumers to opt out of the service, eliminating the potential for paying overdraft fees.

The actual changes are:

You can opt out of all overdraft charges (your checks will bounce, as will debit attempts.)
The maximum number of overdraft charges will be reduced to three from six at JPM, and to 4 from 10 at BAC. Per day (!)
JP Morgan also says it will stop re-ordering transactions to force the largest number of possible overdrafts. BAC apparently made no comment on this (gee, I wonder why?)

BAC's changes will phase in between October and the second quarter of 2010, while JP Morgan will implement theirs in the first quarter of next year.

Is this enough?

No.

Here's what The Fed (and if they won't, Congress) should mandate for all banking institutions:

Overdraft protection is a loan. (A thing is not what you call it, it is what it is.) Therefore, the interest rate and fee charged should be treated as a loan and all such provisions that apply to loans must apply (Truth-In-Lending disclosures on interest rates, state usury laws, etc.)
This "protection" on accounts must be opt in, not "opt out."
The customer should be able to specify whether he or she wants it to apply only to written checks (whether electronically presented or otherwise) or to debit card transactions, or to both.
All transactions must be processed as they come in, without exception. The practice of re-ordering transactions in a fashion that intentionally causes the maximum number of overdraft fees must be barred as a matter of law.

THAT would be a reasonable policy, and is what we should demand.

CORRUPTION: Reverse-Insurance?! (FDIC)

nospam@example.com (Karl Denninger) — Tue, 22 Sep 2009 11:06:00 -0400

Let me pose a question to you.

Let's say you own a $200,000 house free and clear.

Let's further say that you would like fire insurance. Just in case you are a klutz in the kitchen, for example.

So you sit down and write yourself a fire insurance policy. You promise to pay yourself $200,000 to rebuild your house if it burns to the ground.

You then put your "insurance policy" in the safe and pat yourself on the back - you're insured!

Now, you want to re-do your kitchen and add a pool, so you go to the bank to get a mortgage to finance those improvements.

The mortgage company would accept your self-written policy as proof of insurance, right?

Oh wait - they'd call that fraud?

Well gee, what's this then?

Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors. That would enable the fund, which is rapidly running out of money because of a wave of bank failures, to continue to rescue the sickest banks.

The plan, strongly supported by bankers and their lobbyists, would be a major reversal of fortune.

Of course it would. Writing insurance on yourself is a highly-lucrative business, especially when you can charge interest to the supposed insurer who you are supporting!

Insurance is supposed to work the other way around - you are supposed to pay into a pool to cover the risk of loss that some people in the pool might suffer.

Who would have thought that a government agency would actually contemplate paying the insured party for the coverage on their own risk?

In a world where we had a rule of law this would be identified instantly as what it is: rank, outrageous fraud.

But we don't live in such a world.

In the world we live so-called "government officials" of the FDIC feel free to engage in such sham transactions, smug in the knowledge that The American Sheeple, along with their handmaidens in Congress, can be counted on to allow a blatantly-fraudulent exercise such as this to be consummated - where the banks that are beneficiaries of FDIC insurance (and whom have also issued literally billions of dollars in covered bonds on an issuance-insurance program that has no legal basis in the foundational principle of the FDIC in the first place) not only do not have to pay for the insurance coverage they enjoy, but actually get paid to have it instead.

I couldn't make stories like this up if I tried.

CORRUPTION: Is The Lid About To Come Off?

nospam@example.com (Karl Denninger) — Mon, 21 Sep 2009 10:56:00 -0400

One has to wonder after this surfaced....

WASHINGTON — For months, Bank of America has been trying to keep secret its legal conversations at the end of last year about its coming merger with Merrill Lynch. So far, it has succeeded, mainly by arguing that those conversations should remain confidential because they are protected by attorney-client privilege.

But now, the bank is facing questions from a House panel, the Committee on Oversight and Government Reform, whose chairman, Representative Edolphus Towns, has told the bank that it cannot use attorney-client privilege when dealing with Congress.

This is interesting for a number of reasons, chief among them is that there are multiple competing interests at issue here, to wit:

The Fed. The FOMC (Bernanke .et.al.) have been implicated in having twisted arms (or worse) during the merger discussions. There was a lot of "I can't recalls" during sworn testimony in Congress.
Geithner. He ran the NY Fed; what was he aware of and what, if any, role did he play? Was his appointment in some way connected to all the BS and games? I have to wonder whether Geithner's appointment was an attempt to shield him from testimony related to all the bailouts and handouts, along with The NY Fed's knowledge of (and perhaps obfuscation or worse) "problems" and "forced resolutions" during this mess. Let's be frank: Do you really believe that Geithner, out of 330 million people in this nation and with his history of tax cheating, was the most-qualified person in the US to head both Treasury and The Internal Revenue Service, or do you believe that he was appointed to the position so that he would have a shield to hide behind in deflecting investigative questions about exactly what happened and who knew what along with when they knew it?
Ken Lewis. He is under attack from all sides, with a lawsuit over the SEC/BAC merger having been dealt a "no dice" answer in court by Judge Rakoff, the NY AG's office on the civil side generally and late last week it was disclosed that the FBI may be looking into criminal issues.
The BAC board. What did they know before they voted for approval, and what did they disclose (or hide)?
Paulson. His immunity as a government official only extends to acts that are within his lawful authority as a Treasury Secretary. If he overstepped that boundary there is potential civil and criminal liability for him in this mess as well.

Lewis looks like the perfect pressure point, since there is a potential issue of both civil and criminal liability here. "The big bad Fed made me do it", or at least as good "Paulson threatened to shoot me" (metaphorically or otherwise) could easily wind up being the play of the day.

The question of course is what Lewis and these other actors actually have. A conversation in which no notes or tapes were kept is one thing; if there is actual written documentation (even if in email) that's an entirely different matter.

The bank, for its part, has decided to engage the lobbyists, who are raising the argument that a bill passed by The House but never signed into law should control. That this sort of nonsense receives anything other than a loud guffaw in response should tell you everything you need to know.

Nobody bothers to try to hide something that won't at least prove embarrassing to one's reputation - or worse, disclose some sort of conduct for which one might be culpable either civilly or criminally.

It is long past the time when we the people should accept this sort of hiding of the facts. If government or quasi-government (e.g. NY Fed) actors overstepped their legal authorities they must be held to account.

If what amounts to a $20 billion bribe was given by Treasury, funded by the taxpayer, to "coerce" BAC into taking over Merrill, that needs to be brought into the open and, if that wasn't done in accordance with all laws and regulations, everyone involved needs to be held to account.

If private parties broke the law they must be held to account.

And if losses are still being hidden (I'm quite sure they are!) the truth must be forced into the open, irrespective of whether the government or private parties want this to happen or not!

STOP THE LOOTING AND START PROSECUTING.