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“Fear and Loathing” of Wall Street, 2012

by Jeff McCord of The Investor Advocate

“Fear and Loathing” of Wall Street, 2012

To-date, the presidential primaries have studiously avoided reference to the unfolding catastrophe brought to the American public just four years ago by the financial services industry. The political issues contested thus far bring to mind Hunter Thompson’s reporting of the 1972 election campaign:
“This may be the year when we finally come face to face with ourselves; finally just lay back and say it — that we are really just a nation of 220 million used car salesmen with all the money we need to buy guns . . .”
(See: “Fear and Loathing: On the Campaign Trail, 1972,” By Hunter S. Thompson)

Off the campaign trail, however, Stanford University scholar Lindsey Owens writes to tell us:

“Animosity toward banks, financial institutions, and Wall Street has been an important part of the public discourse since the bank bailouts of 2008. Indeed, Americans’ confidence in all three institutions has plummeted accordingly in the years since.

[W] hile changes in the business cycle have an effect on public opinion in this domain, it is the economic contractions that correspond to major scandals in the financial sector that motivate the largest shifts in confidence and provoke the most public outrage.”

Self-Loathing on Wall Street?

Professor Owens’ study of public opinion of Wall Street over the past 30 years suggests that even writer Hunter Thompson’s common man understands the difference between normal changes in the business cycle and financial industry scandals that actually contract real economic activity. Some of the geniuses on Wall Street also get it. In a recent poll by a corporate public relations firm (and long-time defender of financial services companies), a majority of Wall Street marketing executives admitted their industry’s own behavior caused its PR problems. Interestingly, 74 percent said “that increased regulation of the financial services industry will help their firms improve reputations and trust with customers.”

In a similar vein, consider the “cry in the wilderness” of the Goldman Sachs derivatives salesman who publicly resigned via the New York Times over the firm’s routine “ripping off of clients”:

“I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client’s success or progress was not part of the thought process at all. It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as ‘muppets.’ “

Feds Deny Wall Street Execs the Expiation of More Regulation

Sadly, if guilt-riddled Streeters truly want more regulation and reform, this year may mark the rare non-event of Wall Street not getting what it wants from government. Indeed, enactment of the so-called JOBS legislation – a bill with massive bi-partisan Congressional support eagerly signed by the President – may prove the antipathy of what financial marketing executives desire. Here’s what SEC Commissioner Luis Aguilar said in a March 26 statement about the “Jumpstart our Business Start-ups Act”:

“I  share the concerns expressed by many that [the JOBS bill]. . . would be a boon to boiler room operators, Ponzi schemers, bucket shops, and garden variety fraudsters, by enabling them to cast a wider net, and making securities law enforcement much more difficult. Currently, the SEC and other regulators may be put on notice of potential frauds by advertisements and Internet sites promoting “investment opportunities.” H.R. 3606 would put an end to that tool. Moreover, since it is easier to establish a violation of the registration and prospectus requirements of the Securities Act than it is to prove fraud, such scams can often be shut down relatively quickly. H.R. 3606 would make it almost impossible to do so before the damage has been done and the money lost.”

Fear of Wall Street at Regulatory Agencies?

Loathing and self-loathing of Wall Street hasn’t gotten us very far. This is, in part, because of fear of Wall Street – fear that it may not continue to dish out the $14 million plus given to Congressional candidates in the election cylce ending June 30, 2011, and fear that it may take legal action should government bite the hand that feeds it. It is the latter fear that apparently makes regulators timid about implementing even the modest reforms of the Dodd-Frank Act, which requires new rules to reign-in the wild derivatives market, among other changes.

First, a New York Times editorial on March 24 summarized the problem with derivatives:

If there is one lesson from the financial crisis that should be indelible, it is that unregulated derivatives are prone to catastrophic failure. And yet, nearly four years after the crash, and nearly two years since the passage of the Dodd-Frank law, the multitrillion-dollar derivatives market is still dominated by a handful of big banks, and regulation is a slow work in progress. That means Americans, and the economy, remain at risk. . . . Unreformed, [derivatives] will cause havoc again.
Secondly, numerous media explained why neither the Times nor honest Wall Streeters will get the regulation they crave. Underwriters and marketers of derivatives have evidently filed frivolous lawsuits against the feds, making regulatory personnel fearful of writing new rules required by law.

 Here’s how Reuters reported it on March 8:

Some U.S. regulators are “paralyzed” by the threat of lawsuits from Wall Street firms seeking to slow or stop the rollout of rules that would crimp their bottom line . . . Bart Chilton, a commissioner at the Commodity Futures Trading Commissioner, said if regulators live in fear of a lawsuit alleging they failed to consider sufficiently the costs and benefits of a rule, rulemaking slows or halts and opponents have succeeded. Regulators, already months behind in implementing rules from the Dodd-Frank financial reform law passed in 2010, are bracing for additional legal challenges as more regulations are completed.

Turns out, the International Swaps and Derivatives Association, Inc. and the Securities Industry and Financial Markets Association have already filed two lawsuits on behalf of JP Morgan Chase, Goldman Sachs and Morgan Stanley alleging the CFTC did not adequately consider the costs to industry of new regulations on speculative derivatives based upon oil, gas and other commodities. For more, see Bloomberg.

Fear and Loathing of Wall Street: Private Investors Pick-up Slack

Fortunately, as timid federal regulators move at a snail’s pace, private investors led by pension funds are actually taking action against the underwriters of spurious derivative products, misrepresented sub-prime mortgage backed securities products and other hooligans along with their professional enablers.

Interestingly, although the number of resolved securities class action lawsuits alleging fraud and other wrongdoing (typically led by institutional investors) declined overall in 2011 to 65 from 86 in 2010, settlements by underwriter defendants in such lawsuits matched an all-time high of 26 percent of the total (of all securities class action settlements) reached in 2010. And, $1.36 billion was recovered for investors through all securities class action settlements approved by federal courts in 2011.

Last year’s largest legal victory for shareholders was the $208.5 million won from the officers, directors, the underwriter and auditor of Washington Mutual bank, the first and largest bank to fail in the then unfolding sub-prime mortgage and derivative catastrophe.
Read more here.

SEC Two Months Late in Fulfilling Dodd-Frank Obligation

Unfortunately, the Supreme Court decisions eliminating private accountability for those who knowingly enable securities fraud (Central Bank and Stoneridge) and immunizing from liability in America foreign based fraudsters who prey upon US investors (Morrison) continue to limit the ability of private actions to enforce securities laws and protect the public.

And, speaking of Morrison and foot dragging on implementing the lawful reforms of the Dodd-Frank Act, as of March 19, the SEC was two months late in issuing a report to Congress on whether or not the anti-US investor Morrison decision should be overturned.

Apparently, federal regulators cannot fully decide just whose side they are on: the American people they are empowered to protect or the financial services firms they are empowered to regulate?
Fear and loathing of Wall Street may be universal sentiments among the public, thoughtful financial executives and the federal government during this election year.

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State pension funds, funding, and options

Felix Salmon writes on the question of appropriate pension plans for state systems (emphasis on teacher retirement systems) in Reuters…however, the comment section offers a superb range of thoughts by non-experts on the matter of state pensions as well.

1. Is a 7-8% return reasonable to expect (smoothed over time) in the future?
2. If a different system is used from here on out? what are appropriate transitions?…Felix compares to 401k plans as being totally inadequate but there are other proposals.
3. What about the question of buyouts?
4. Interestingly several of the commenters were using the MA teachers retirement system as an example, which makes it useful for the AB post here.
5. What are the incentives inherent in the current system? (ie. most value is actually ‘accrued’ in the last five (?10) years of acummulated contribution for a pensioner? Not unlike any plan based on yearly contributions over decades.
6. The meme of baby boomers/versus younger contributors was brought forward but without numbers…this also could be subsumed under #2 and #3.
7. What is ‘underfunding’ in this context?

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A Look at the Evidence: Predatory Lending, Borrowing, and Jack Cashill

The opening chapter of Jack Cashill’s Popes and Bankers relates his version of the tale of Melonie Griffith-Evans, a woman who in 2004 borrowed her way to losing her house.  Ms. Griffith-Evans accepted loans in order to buy a house priced at $470,000 that resulted in her having to pay “roughly $3,500 a month.”  Of course, she ends up not being able to pay those loans, and—since ex post is ex ante—the result must be All Her Fault.  Mr. Cashill allows as to how a “traditionalist” might “if feeling churlish, talk of  Griffith-Evans as a ‘predatory borrower.’ ”

Working solely from the information as provided by Mr. Cashill, let us test the validity of his hypothesis, assuming the “traditionalist” were sane.

Taking Mr. Cashill at his word on that “roughly $3,500 a month” and assuming that the ancillary loan is described correctly, Ms. Griffith-Evans would have to have taken out the following loans to buy the house for $470,000:

  1. A $  94,000 (20% of the price of the house, an amount Ms. Griffith-Evans did not have in savings) loan.  This loan—which I’m guessing was for 30 years was offered at the rate of 12.5%.  (Mr. Cashill stipulates this.) Presumably, it was not secured by the property itself.
    1. This would produce a payment due of approximately $1,000 per month.
  2. A $376,000 (80% of the price of the house) 30-year fixed-rate mortgage, securitized by the property, at 7.00%
    1. This is the only way to total $3,500 per month if we assume Ms. Griffith-Evans borrowed the entire 20%, which seems to be Mr. Cashill’s contention.  Otherwise, she only borrowed around $57,000 and made a down payment of around $35,000—certainly not the actions of a “predatory borrower.”

All of this excludes the closing costs or title searches or inspections or any of the other minutiae that is required before such loans are approved. But the process is transparent in Mr. Cashill’s tale, so we should assume that is the way he wants it to be.

Strangely, the details Mr. Cashill offers do not jibe with that. He claims that Ms. Griffith-Evans “took out a fairly standard 8.5% loan on 80% of the purchase price.” And—in a case of poor writing that betraying poor thought—he collaterally notes that the $3,500 payment due was “increasing as the loan was adjusted.”  This would lead to an initial combined payment of approximately $3,900 a month—more than 10% higher than “about $3,500,” though still significantly below the rental costs of “about $5,000 to $6,000 per month” for apartments that, per Mr. Cashill, “suited her fancy.”

Mr. Cashill is determined to argue that the loan Ms. Griffith-Evans took out was not “predatory,” but was an 8.5% mortgage rate “fairly standard” in 2004?



It doesn’t seem to be. Even the highest rate for conventional mortgages in 2004—6.29%—is  more than 220 basis points (2.20%) below the rate of Ms. Griffith-Evans’s loan, and that is excluding whether her rate was itself adjustable.  (It is unclear from Mr. Cashill’s account whether the 8.50% mortgage, the 12.5% additional loan, or both were adjustable.)  Or, to put it simply, the lender was charging Ms. Griffith-Evans more than a 35% premium for her loan.  Quite a premium to accept if one wants to be a “predatory borrower,”

One might fairly wonder why she was not offered a loan for the entire amount at a fixed rate that would produce a loan payment due of about $3,500 a month, eliminate the risk to the second, unsecured lender, and leave the primary mortgage lender with a less encumbered “owner.” (That rate would be 8.10% for a $3,500 per month payment, or—given Mr. Cashill’s figures—a loan of 9.30% for the entire amount.) Certainly, if the primary lender honestly believed the property was worth $470,000, they would have been willing to offer a loan for such an amount, with the attendant Mortgage Insurance.

Mr. Cashill wonders about none of those actors, either, however. Tis Ms. Griffith-Evans who is wholly at fault, from the Very Christian perspective presented.  Somehow, it was venal of her to elect to pay $3,500 a month for a house for her family, instead of half again more for an apartment.

I raise the possibility that the primary lender didn’t believe the house was worth $470,000—or even anything beyond $375,000—solely because the evidence runs that way.  There is first the fact that the lender was not willing to loan Ms. Griffith-Evans the entire amount—or even within 20% of  it—against the value of the property. (We can safely conclude this because the alternative is to believe that she, given the choice between paying 8.5% and paying 12.5%, honestly preferred the latter.)  The second piece of evidence comes from Mr. Cashill, who declares that the lender was “embarrassed” into allowing Ms. Griffith-Evans and her children to stay in the house—“presumably free of charge” (quite the presumption, that)—“while she tried to find a buyer.”  (Those of us who do not understand this behavior from a “predatory borrower” probably don’t understand Christianity either.)

Do I need to note that she failed to find a buyer? And that the lender clearly didn’t have one either, for—as Mr. Cashill continues—“When she failed to find one, the lender gave her still more time to find an apartment.”  The benevolence of lenders is legendary, to be certain, but this one is clearly destined for sainthood.

The world in which I live—clearly one with a different color sun than that of Mr. Cashill in this chapter—is one in which businesses make decisions based on revenue and cash flows.  So when the seller of the house accepted Ms. Griffith-Evans’s original bid, even with its dodgy financing, during the peak of the housing market, we must presume that they did so because they expected to receive more net money, easier, from that sale than from any other bid.  And we must presume the lender was fully aware of what they were doing—and charged usurious interest rates (compared to the market) accordingly.

So we have a situation in which, ex ante, all parties got the best deal they could, given the information they had.  Ms. Griffith-Evans paid around $1,000 a month less than she would have paid in rent, even  before any tax benefits.  The seller received a price to which they agreed, and which they represented as fair market at the time—with a lawyer doing a title search, a home inspector, and a home appraiser all corroborating that the property and the structure were as represented, and that the price was reasonably on the market (even if it wasn’t, or soon thereafter was not), all of whom were paid for their expertise and conclusion.  The lender received a significantly higher interest rate than they would have from another buyer, which presumably compensated them for their additional risk—and they had the property in reserve.

In the world in which the sun is yellow and Ms. Griffith-Evans is a single mother—not General Zod—economic agreements were reached consensually among the parties and of whom except Ms. Griffith-Evans were compensated professionals. Strangely, in the “traditionalist” world of Mr. Cashill, the one person in the entire series of transactions who is most likely to have been deprived of information is the one who should be described as “predatory.”

After a start like this, I can’t wait to read the rest of the book.

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QOTD: There are Shareholders and then there are Share Holders

The Epicurean Dealmaker notes that the stock market “game” is irrevocably rigged against the individual investor, and the best thing anyone can do is realise that is so:

I believe [Leo E. Strine Jr, vice chancellor of the Delaware Court of Chancery]’s analysis should conclusively disabuse participants in the current debate over financial regulatory reform of two related notions….The second is the canard that all public shareholders are alike, and they all share the same interests and motivations.

Realizing that the second of these is false, and that Fidelity Investments and SAC Capital do not have the same investment timeframe and objectives as Aunt Millie or even the Ohio Teachers Pension Fund, would have a highly salutary effect on the beliefs and behavior of truly long-term shareholders.

If nothing else, getting Aunt Millie to realize she is the only one in the shark tank without a safety cage should do her a world of good. [emphasis mine]

Read the whole thing, as well as Mr. Strine’s piece in the NYT’s DealBook that inspired it, for a glimpse of the soft, white underbelly of corporate governance and management.

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