THE FINANCIAL CRISIS INQUIRY REPORT
Final Report of the National Commission
on the Causes of the Financial and
Economic Crisis in the United States
OFFICIAL GOVERNMENT EDITION
Here is a story to shoot your blood pressure through the roof:
“While Sgt. James B. Hurley was away at war, he lost a heartbreaking battle at home.
In violation of a law intended to protect active military personnel from creditors, agents of Deutsche Bank foreclosed on his small Michigan house, forcing Sergeant Hurley’s wife, Brandie, and her two young children to move out and find shelter elsewhere.
When the sergeant returned in December 2005, he drove past the densely wooded riverfront property outside Hartford, Mich. The peaceful little home was still there — winter birds still darted over the gazebo he had built near the water’s edge — but it almost certainly would never be his again. Less than two months before his return from the war, the bank’s agents sold the property to a buyer in Chicago for $76,000.”
And it only gets worse from there.
The Sergeant (retired, disabled) has been on a legal odyssey that is in its 7th year. He is battling Deutsche Bank Trust Company and Morgan Stanley subsidiary Saxon Mortgage Services.
Under the Servicemembers Civil Relief Act, Hurley’s lawyers are seeking punitive damages against the two giant banks. The NYT reports the specifics of the Servicemembers Act:
“Under the law, only a judge can authorize a foreclosure on a protected service member’s home, even in states where court orders are not required for civilian foreclosures, and the judge can act only after a hearing where the military homeowner is represented. The law also caps a protected service member’s mortgage rate at 6 percent.”
Big banks routinely violated the act. Wells Fargo and Citigroup were cited, as was JPMorgan Chase (they regularly overcharge servicemen, despite the law).
But as bad as Chase has been, they seem to be trying to make amends. Not so with the weasels who run Deutsche Bank and Saxon in the Hurley case. They seem to be fighting the Hurley’s tooth and nail.
There are many reasons never to bailout banks, but here’s another one: Too many seem to be run by spineless weasels, and they hurting men and women serving in armed armed forces. (Aren’t there any ex service people working at these banks that can get this taken care of promptly?)
Shame on Morgan Stanley, and shame Deutsche Bank.
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Source:
A Reservist in a New War, Against Foreclosure
DIANA B. HENRIQUES
NYT, January 26, 2011
http://www.nytimes.com/2011/01/27/business/27foreclose.html
Yesterday was potentially a very big day in the publishing world with two announcements that could capitalize in the rapid shift toward e-books. As a measure of that shift, USA Today’s list of the top 50 bestselling titles revealed that 46% of those works sold better as ebooks than print copies in the previous week.
The first news was that Amazon’s Kindle launched its new Singles program for long-form writing. It is easy to get over excited about the Singles program but it does create better visibility and cultural authority for a new class of shorter e-books sold at a price lower than the cost of a single magazine issue.
The second news was the New York Times announcing its first e-book to be published in conjunction with a major story in the Times. The e-book is a compilation of Times articles on and around the Wikileaks controversy.
The Times is putting all its firepower behind the ebook. An excerpt appeared online yesterday and will be published in the Times Magazine on Sunday as Keller’s debut in a new role as columnist. The ebook will be published the following day.
This ebook won’t set the world on fire. Keller’s account of his dealings with Julian Assange is more of defense of the paper’s propriety than anything compelling. The best bit of insiderism we get is this scene involving Richard Holbrooke as Keller attends a party in the run-up to release of State Department cables:
A voracious consumer of inside information, Holbrooke had a decent idea of what was coming, and he pulled me away from the crowd to show me the fusillade of cabinet-level e-mail ricocheting through his BlackBerry, thus demonstrating both the frantic anxiety in the administration and, not incidentally, the fact that he was very much in the loop.
The rest of the book, we’re told from the Times’s own press release, is a grab bag of Wikileaks related material, including:
among other items, expanded profiles of Julian Assange, WikiLeaks’s founder, and Bradley Manning, the Army private suspected of being his source, and original essays on what the episode has revealed about American diplomacy and government secrecy. Times correspondents will provide detailed analyses of the documents and the e-book will reprint the full text of all the cables and war logs published on The Times’s Web site, in addition to 27 new cables selected for this volume. The e-book will also incorporate opinion essays by Frank Rich and Maureen Dowd, among others.
The timing of the e-book seems a bit off which illustrates one of the key issues that will crop up quickly with e-book publishing. It is hard to know, when chasing a story, how long it will remain urgent or, even, relevant. Wikileaks offers a good example of how this works. The New Yorker’s profile of Julian Assange was probably read more widely long after its publication.
The same could happen with the Times’s e-book. If Wikileaks scores again with its Bank of America trove later this year, the e-book will be relevant and salable again.
The New York Times’s publishing plan somewhat trumps Amazon’s announcement of its Kindle Singles program. But that’s alright. Everyone’s working from the same script here.
Kindle Singles are works that are too long to fit into a magazine but not long enough to present a reasonable value as a precious little tome. The real goal is to create a new genre at e-friendly price point of 99 cents to a few dollars.
The idea isn’t new or revolutionary. Short books have popped up from time to time as novelties and succeeded now and again. What is new about Kindle Singles is the way that it circumvents publishers. Amazon has gone to writers and asked them for these orphaned works or asked them to write such works to promote the idea.
For authors making 70% of the a dollar or two, the proposition begins to make sense if they can sell a few thousand copies of their work. With the narrowing of magazine writing opportunities, this should be a boon to authors.
The only problem is the missing ingredient: publicity. As anyone who has tried to publish digitally or physically will tell you, the biggest challenge is not writing the book but finding an audience. Authors will go to great lengths to get someone to notice, mention and recommend their work.
Indeed, the most valuable currency in the writing game is name recognition and a loyal following. That’s what David Sedaris and Malcolm Gladwell and Michael Lewis all have. Many equally well-known figures don’t. Take Steve Martin, a movie star and a talented writer. His novels are not guaranteed bestsellers. Other celebrities suffer too when they try to publish.
Amazon knows this. They have cleverly partnered with TED and Pro Publica to create these works. TED has three titles in the launch and Pro Publica has one 13,000 word report on the 2008 Mumbai attacks. Like the Times, it seems as if Pro Publica is warily testing the waters here with a low-risk project.
TED will take half of the author’s 70% as compensation. Pro Publica will probably pocket all of it since their staff is getting paid.
This is very important because Amazon is offering well-known media outlets–those with the audience and name-recognition so essential to successful publishing–a higher margin outlet for their work. TED plans to publish monthly and one hopes that Pro Publica will be releasing longer versions of more current stories in the future.
For both media companies, the Kindle Singles present another revenue channel. Amazon’s ubiquity make this almost seamless. With Apple charging the same 30% distribution fee on the apps, there’s not much incentive for the TED or Pro Publica to go elsewhere. Of course, the start-up costs and promotion that come with Amazon are attractive too.
If the Singles program gets traction, it will be another blow to the publishing companies who have long sourced their best works from magazines and newspapers with loyal readers. Social currency is evanescent. A hot story will generate demand for more information much sooner than most book publishers can bring books to market.
That won’t be the case with Kindle Singles. Publishing through Kindle will allow the media outlet a chance to benefit from the success of writers they helped establish without depriving the writer of royalties.
Current ebook royalties are 25% of the publisher’s net receipts. That means the author would get 70 cents from a $3.99 ebook. Under the Singles model, the author will get twice that if he or she splits the royalty with TED or The New York Times.
Everybody wins in this new model except the book publishers who are cut out of the game. All that the author gives up is a physical book. Even there, the new model offers some wiggle room. It makes more sense–and generates more dollars–to publish a series of 20,000 word pieces in this manner. That would leave book publishers the opportunity to buy the rights to sell hard-copy versions of 80,000+ compilations.
Admittedly, that’s not a very glamorous position for publishers to be left in.
While the S&P credit downgrade of Japan shouldn’t be much of a surprise, it does highlight what many countries in the developed world face, too much debt and not enough growth. Japan’s new S&P rating is one notch below Fitch and Moody’s and is now in line with China and Taiwan. Japanese 5 yr CDS is rising 5 bps to 84, just a few bps from the highest since July ’10. S&P said “the downgrade reflects our appraisal that Japan’s gov’t debt ratios, already among the highest for rated sovereigns, will continue to rise further than we envisaged before the global economic recession hit the country.” Yields are moving higher also in Europe and the US. German 10 yr bund yield is at the highest since Feb ’10 and the US 30 yr yield is at the highest since Apr ’10 (also after CBO $1.5T budget deficit est yesterday and pushback against FOMC dovishness). US 5 yr CDS is up to 51 bps, the highest since Feb ’10.
Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He is a white-collar criminologist who has spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
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By William K. Black
When Reputation becomes Ineffective or even Perverse
Control fraud also makes reputation perverse. Theoclassical economists predict that reputation trumps everything, even auditors’ conflicts of interest. This prediction has repeatedly been falsified by reality. The asserted reputational trump ignores crippling errors. Several theoclassical assumptions about reputation and fraud are implicit and interrelated. Implicit assumptions pose the greatest risk of error because the people making the assumption never had to defend the unstated assumptions. Reputation and fraud turn out to have an important, and complex, relationship. One cannot understand reputation without understanding fraud techniques. Common theoclassical assumptions, most of them implicit, about fraud and reputation include:
White-collar criminologists have found that each of these assumptions is unreliable. Economists rarely study fraud or read the criminology literature, yet they often have powerful ideological “priors” about fraud. Easterbrook & Fischel (1991), the deans of applying law and economics to the study of corporate law, exemplify each of these characteristics. They assert that “a rule against fraud is not an essential or … an important ingredient of securities markets.” That assertion is remarkable for its certainty, lack of exceptions, and certitude. It would be wonderful if the assertion were true. Fraud, one of history’s great scourges, would (like polio) be eradicated. Financial markets would be efficient. Bubbles would be much rarer and far less severe. Unfortunately, the assertion is also unsupported and unsupportable. Fischel was an expert for three notorious control frauds during the S&L debacle, where he employed the theories he and Easterbrook would soon write about in their 1991 treatise containing their remarkable assertion.
Individuals, entities, society, and market participants are all far more complex than theoclassical economists assume. It is normal that the same person is perceived differently by every person with a perception, and those differences can be polar. “Fraud” is one of the most variegated of activities. One common characteristic, however, is that fraudsters do not rely on fooling everyone. Many successful frauds, such as the Nigerian “419 frauds”, are obvious to nearly everyone, but “nearly” universal detection of the 419 frauds is not sufficient to prevent them from being profitable. Fraud detection is rarely universal because people vary in their susceptibility and because detection by one person typically fails to spread to most people.
When most people, including economists, think of “fraud” they generalize from what they know from personal life. Nigerian 419 scams, most things advertised on cable television after 10:00 p.m., and con jobs shown on television dramas are what the general public thinks of when they consider “fraud.” The nature of these frauds typically leads the victim to discover (albeit too late) that he has been defrauded. Victims of 419 frauds send “fees” or make “deposits” and do not get the $40 million in funds that the late oil minister allegedly stole from the Nigerian government. The “debt counseling” service charges its victims fees, falsely claims that one need no longer pay one’s creditors and leaves its victims even more insolvent.
These frauds, if they succeed, almost certainly will be discovered by the victim. (There are important exceptions – many fraudsters prey on victims suffering from the earlier stages of Alzheimer’s, those who are functionally illiterate in English, or are incapable of understanding financial matters. Fraudsters profit from their selective reputation with their peers as criminals by selling their mailing lists of vulnerable victims to other fraudsters.) The fraudsters who run the 419 and debt counseling scams know that most of their victims will become aware that they were defrauded. The fraudsters also know that they can continue to defraud others even though the victims learn that they were defrauded and even if the government closes their business. Entry is exceptionally easy for each of these common frauds. If the government shuts down a debt counseling scam it can create a new name and be in operation again within a week. If the fraudulent CEO were banned from the industry he would recruit someone to serve as his “straw” and be back in operation within a week.
Victims of some common, unsophisticated frauds typically do not discover that they have been defrauded. The classic example is the scam drug that promises to enlarge the penis. The victim buys the drug. He is desperate for the drug to work. It is easy for the victim to believe that the drug is working. The alternative is to feel inadequate, hopeless, and made a fool of by a con. This fraud illustrates a key point; an “unsophisticated” fraud can be highly successful because it rests on an insightful understanding of human nature and vulnerabilities.
Accounting control frauds closely approximate the perfect crime. To be a nearly perfect crime a control fraud must reduce the risks of regulatory and prosecutorial sanctions. They are normally not identified as frauds. Even when they are identified as frauds they are normally not sanctioned. Instead of destroying the CEO’s reputation, accounting control fraud normally creates the CEO’s undeserved reputation as a “genius.” This is a subject deserving of extended treatment in future columns, so I will only summarize the key points here in the context of mortgage lending.
Control frauds exploit “agency” problems in order to turn reputation perverse. The Big Four audit firms do have a substantial financial interest in their reputations. The Big Four audit firms are able to charge far more for their audits than can second tier firms. Unfortunately, the more valuable the audit firm’s reputation the more value the audit partner can extract by “selling” that reputation by blessing an accounting control fraud’s financial statements. White-collar criminologists have found that the theoclassical assumptions about top tier audit firms are false.
This has always been one of my favorite Bimmers of the modern era — its a big car, but feels nimble. Comes with a 6 speed stick mated to a big V8, a real back seat, and a powerful torque-happy, engine.
They seemed to really clean up the lines of the 6 series:
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It appears we got hit with another 10-12 inches of snow overnight. Schools are cancelled, and my trains are not running into the city yet.
I need to go blow the snow off the driveway, then figure out what I am gong to do today. I was hoping to read the FCIC report, but it does not look like I will get to the store today.
And speaking of Snow Jobs, the dissenters in the FCIC continue their embarrassing foolishness.
The NYT devotes two paragraphs to Peter Wallison — they mention he was “chief lawyer for the Treasury Department and then the White House during the Reagan administration” and that he is “now at the conservative American Enterprise Institute.”
But nowhere do they mention that he was co-director of the AEI’s Financial Deregulation Project. This is a serious omission by a major publication.
The New York Times should be much better than this . . .
States and cities are in dire financial trouble. So how did they get to this point? WSJ’s David Wessel says thanks to a spend-now-ask-questions-later approach, they only have themselves to blame.
1/26/2011 6:07:01 PM
Invictus reporting for duty.
In view of the release of the FCIC report, specifically the reported implication that Ben Bernanke shares the blame (which he no doubt does), it brought to mind the small step I took to try to stop the madness in 2005:
On August 9, 2005, Al Hubbard, Director of the National Economic Council, and Ben Bernanke, Chairman of the Council of Economic Advisors, held a press briefing. Very shortly after reading the transcript, I sent the following letter to Dr. Bernanke (and yes, quaint though it may seem, I really did write to Bernanke. Just call me a starry-eyed dreamer.):
On August 9, you participated in a press briefing during which you fielded questions about your meeting with the president.
Among the questions you were asked was this one:
Did the housing bubble come up at your meeting? And how concerned are you about it?
Your answer, in part, follows [emphasis mine]:
We talked some about housing. There’s a lot of good news on housing. The rate of home ownership is at a record level, affordability still pretty good.
I have reproduced below two charts created by brokerage firm Merrill Lynch using data compiled from the National Association of Realtors.
The charts speak for themselves: First-time buyer affordability has collapsed to a 16-year low, and overall homeowner affordability has plunged to a 14-year low.
So my question is simply this: Given the hard data, on what basis did you make the claim that housing affordability is “still pretty good”?
Thank you.
Sadly, but not unexpectedly, I never did receive a reply.
Becky Quick is Rockin’. Is There a Muni Selling Climax?
January 26, 2011
David R. Kotok
www.cumber.com
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Becky Quick is rockin’. These days, early morning ablutions are interrupted whenever CNBC’s Worldwide Exchange and Squawk Box are doing interviews on the Muniland turmoil. Becky, kudos, you are on it! Nicole, you rocked, too.
In our previous missive “Muni Madness and CNBC Squawk Box” (January 21, 2011) we cited the interview with Thomas Doe. During that segment, Becky noted how the AAA state GO scale had traded through a 5% yield. Let us probe this number since it is one of the indicators that there is a selling climax in Muniland. That’s right: a selling climax in municipal bonds.
First a quick digression. When we see selling climaxes in stocks, they can be easily identified. Leading up to a climax, stocks fall and the price decline accelerates. Then it reaches a panic, and one can track it by the price changes on a minute-by-minute basis. The bottom is usually formed when the last emotional seller capitulates to fear, panics, and then dumps at the market. We saw this in March 2009. We saw it on “Black Monday” in 1987. We saw it when the NASDAQ crashed in 2001. Astute observers saw it at the onset of the Iraq war in 2003, although it was only visible in the European markets and in the futures prices of US stocks. When the war started in 2003, the Dow fell by about 600 points as measured by the London futures market. Within hours, the US had achieved air superiority, and the market fall reversed. American forces dominated Iraqi air space by the time the US market opened at 9:30 AM New York time. Therefore, if you look at the trading in the US, you will not see evidence of a selling climax. If you look at the trading in London in the futures market the same day, you will observe a 600-point Dow fall and intraday reversal. That was a selling climax in stocks.
Back to Muniland.
Climaxes in bonds are not as easy to see. Muni bonds trade in a dealer market. Moreover, dealers have limited capital to support inventories in this post-crisis period. Therefore, Munis are very volatile.
In a dealer market the inventory can be marked up or down without any trading. The manager of this inventory in each firm determines the price he wants to use to buy or sell and can change it at any time. Therefore, when there is selling pressure the dealers just mark down their bids. Alternatively, they refuse to bid by saying “pass.” The reverse is true when prices are rising sharply.
So, media hype by Whitney and others triggers inventory marking up –or down. Forced selling from mutual funds exacerbates the volatility. Pricing references then seem to make no sense.
When Becky Quick reported that the AAA state GO scale was above 5%, she demonstrated an indicator of a climax in Muniland. This composite is of the highest-grade states. No California or Illinois here. AAA is Utah, Virginia, Delaware, Maryland, North Carolina, and others. Think about it: AAA states, tax-free trading above 5% when the US taxable treasury is closer to 4%. That only happens in a tax-free Muni selling climax when a mutual manager MUST raise cash to pay redemptions by selling his most liquid bond.
Another indicator of a selling climax is in comparative spreads. Take two bonds that are nearly identical as to issuer, structure, and security of the pledge that makes them creditworthy. If you see anomalous pricing behavior, you are witnessing signs of a climax. In the list below, we compare a tax-free Muni vs. taxable BABs. The only real difference between the bonds in each pairing is the federal income tax code. We know the tax rate is 35%. Unlike Meredith’s generalizations and assertions, we offer the actual description of the bond that we hold and the CUSIP number so each reader can check our facts. These are live prices from last week. The pricing is the yield to worst (maturity). Remember, the tax arbitrage is supposed to be 35%.
NJ State Turnpike – A3/A+/A, BABs 7.4% 1/1/40 – 646139W35 – pricing @ 6.55%, tax-free 5.0% 1/1/36 – 646139X59 – pricing @ 5.55%. Tax arbitrage was only 18%. At full 35% tax arbitrage, the Muni would price to yield 4.25%. That is a sign of a selling climax in the Muni.
North Texas Municipal Water District – Aa2/AAA, BABs 6.01% 9/1/40 – 662903MH3 – pricing @ 6.20%, tax-free 5.0% 9/1/38 – 662903JH7 – pricing @ 5.41%. Tax arbitrage was 15%. At full tax arbitrage, the Muni would yield 4.03%. Climax indicator?
MD Washington Suburban Sanitation District – Aaa/AAA/AAA, BABs 5.0% 6/1/28 – 940157RG7 – pricing @ 5.85%, tax-free 4.0% 6/1/28 – 940157SC5 – pricing @ 4.76%. Tax arbitrage was 22%. At full tax arbitrage, the Muni would yield 3.8%. Climax?
The tax arbitrage test in Muniland is at an extreme. At a 35% federal rate, the entire curve of Muni yields from 3 months to 30 years is higher than treasuries. In fact, this is true when tested at the 25% tax rate. Such a comparison is extraordinary and rare. Climax?
Mutual fund redemption rates are a key indicator of Muniland selling climaxes. Ned Davis Research’s excellent databases help us. Redemption rates of 2% mark previous climaxes. In this selling rout, we have exceeded that level. Net outflows from Muni funds are at a record. $4 billion last week is an all-time high. Other measures of the decline in Muni prices during the last three months also set new records for the history books. These are all signs of a climax.
Who is selling and who is buying? This, too, helps define a climax. The statement is usually characterized as assets moving from weak (unsophisticated and unskilled) to strong hands. Again, we thank Ned Davis. Households and mutual funds each hold about a trillion in Munis. They have been the sellers. Banks and Insurance companies have been the buyers. So have we and our clients.
Lastly, we must note that a climax and the subsequent turn are usually marked by a firming of market prices in the midst of bad news. Wall Streeters call it “climbing a wall of worry.” We think the climax extreme day may have been the freefall pricing of last Wednesday. Two days later, the media hyped this cockamamie political scheme to amend the federal bankruptcy law so sovereign states can avoid payment. Oh, what wonders spring from the fevered brows of our politicians! Is this the ultimate stupidity in a proposal? Ugh!
Markets have actually rallied in the face of the news. They realized that such a law would raise the entire cost of financing for every state and every local government. Since the announcement we have seen governor after governor say, do not do it. Congressional representatives are speaking out against it, too. Thank you Eric Cantor. The Illinois State Treasurer opposed it. Thank you Carl Quintanilla and Becky Quick for the Squawk Box interview with Dan Rutherford. And S&P state rating specialist Robin Prunty clarified the states’ condition in detail. And thanks to Worldwide Exchange’s Nicole Lapin for bringing Delaware Governor Jack Markell on for a full hour. Readers may find those interviews helpful. Search under the names on CNBC.com.
And, last but not least, thank you Meredith Whitney. You made a good call on banks. That is to your credit. Then you segued into economics and forecast a 13% unemployment rate. We haven’t seen that yet. Maybe CNBC can find that tape and replay it. And now you forecast “50 to 100 large defaults,” measured in the 100s of billions. Nope. We doubt we will see that either.
In our view, the media hype has presented the Muni buyer with one of the classic selling climaxes in Muniland, and they do not happen often. Investors can panic, sit tight, or buy. We have been buyers.
Finally, we get lots of email. Many smaller investors ask what to do when they don’t have enough money to engage professional research and get help to determine which bond to buy. This is a very fair question.
Answer: go with what you know and understand. Look around at your town and county and school board. Choose a name that you can identify easily and where you can understand the municipal business model. The NJ Turnpike is a key example. It simply has a government monopoly position on a toll road that goes from New York to Wilmington Delaware. Try and drive it without using the Turnpike. Those tolls secure the bondholders. FHA- and VA-backed mortgages support the North Dakota Housing Authority. Water revenues pay off the bonds of the Cleveland water utility, and on and on and on. There are 90,000 idiosyncratic, publicly available, tax-free municipal bond issues. The facts are transparent for anyone willing to do the work to find them out.
Meredith and others have given the tax-free bond buyer one of the great entry points in modern times. It doesn’t get much better. All the signs and indicators are aligned. That is what a selling climax is all about. In stocks it was in March, 2009. In Munis we think it is January, 2011.
BUT if you think the world is coming to an end, if you think that all these bonds will default, if you believe the media hype, then don’t buy them. Put your money in the bank and earn a lousy fraction of one percent in taxable interest. Stock the cave with canned food and bottled water and ammunition.
Good luck.
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David R. Kotok, Chairman and Chief Investment Officer
"Markets can remain irrational longer than you can remain solvent." —John Maynard Keynes
After 3 quarters in a row that averaged just 1.2%, Q4 GDP grew 2.8%, a touch below expectations of 3.0% BUT Nominal GDP grew well below forecasts. Because the price deflator was up just .4% vs the estimate of 1.9%, Nominal GDP was up 3.2% vs the estimate of 4.9%. Personal Consumption rose 2.0% vs the forecast of 2.4%. Fixed Investment rose 3.3% helped by a 5.2% increase in equipment and software spending and residential construction rose by 10.9%. Trade was a slight drag on GDP growth and government spending was as well led by a 12.5% decline on national...
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