Elizabeth Warren: Why Washington Is Not Reforming the Financial System

Elizabeth Warren Discussing the Lack of Bank Reform on the Bill Maher Show.

"The problems could not be more obvious, and quite frankly, the solutions are just about that obvious, but we just can't seem to get the two together...The reason that we are not changing things right now is because the banks have lobbyists in Washington in numbers I have never seen...People who just want to advocate for American families, people who want some changes to level the playing field do not have that kind of lobbying power. And so what we are really watching here is a David and Goliath story."

Five Former US Treasury Secretaries Endorse the 'Volcker Rule'

I do not expect the Volcker Rule to be passed by Congress for the simple reason that the Wall Street banks hate it. They spent hundreds of millions of dollars in lobbying money achieving the overturn of the original Glass-Steagall law.

The Senators who are beholden to the banks will simply not allow this restriction, which 'worked' for almost 70 years as effective regulation.

I have yet to read a coherent reason why the rule should NOT be passed, except that the Banks do not like it. I spent quite a bit of time listening to arguments and reading presentations, and even exchanging emails with a highly respected colleague who was not in favor of it.

Without exception, every argument was specious, misdirected, or founded on spurious assumptions. Most of the alternatives proposed are more complex and require the active vigilance of regulators.

Simple rules are best, and most easily enforced. This is why the banks hate them.

Part of the problem with this rule was the highly awkward method in which the Obama Administration chose to introduce it into the process, with little background and discussion. I would attribute this to the huge split amongst his advisors, with the Summers-Geithner group holding the most influence.

The reform will not be passed, no matter who endorses it. Congress is in the pocket of the Banks. That is the long and short of it, in my opinion.

US Treasury Secretaries of the last 40 years.

John Connally DEAD
George P. Shultz ENDORSES VOLCKER RULE
William E. Simon DEAD
W. Michael Blumenthal ENDORSES VOLCKER RULE
G. William Miller DEAD
Donald Regan DEAD
James Baker
Nicholas F. Brady ENDORSES VOLCKER RULE
Lloyd Bentsen DEAD
Robert Rubin
Lawrence Summers
Paul O'Neill ENDORSES VOLCKER RULE
John W. Snow ENDORSES VOLCKER RULE
Henry Paulson


Reuters
Ex-Treasury secretaries back Volcker rule
by Philip Barbara
Feb 21, 2010 8:49pm EST

WASHINGTON (Reuters) - Five former Treasury secretaries urged Congress on Sunday to bar banks that receive federal support from engaging in speculative activity unrelated to basic bank services.

"The principle can be simply stated," the five said in a letter to The Wall Street Journal. "Banks benefiting from public support by means of access to the Federal Reserve and FDIC insurance should not engage in essentially speculative activity unrelated to essential bank services."

The Treasury secretaries said, however, that hedge funds, private-equity firms and other organizations engaged in speculative trading should be "free to compete and innovate" but should not expect taxpayers to back up their endeavors.

"They should, like other private businesses, ... be free to fail without explicit or implicit taxpayer support," said the former secretaries for both Republican and Democratic presidents.

The appeal comes as Senate lawmakers are pressing ahead with efforts to produce a financial regulatory reform bill that would curb some of the practices that led to the 2008 financial crisis.

Several major financial firms collapsed, were sold or had to be bailed out after a bubble in the housing market popped, causing real estate prices to plummet and leaving markets uncertain about the value of billions of dollars in mortgage-backed securities.

The liquidity crisis that followed threatened the financial system and deepened a U.S. recession that became the worst since the Great Depression.

The regulatory reform proposal endorsed by the five former Treasury secretaries is the so-called Volcker Rule, formulated by former Federal Reserve Chairman Paul Volcker, a top economic adviser to President Barack Obama.

Obama surprised the financial markets in late January when he announced the proposal, which calls for new limits on banks' ability to do proprietary trading, or buying and selling of investments for their own accounts unrelated to customers.

Volcker told the banking committee earlier this month that a failure to adopt trading limits would lead to another economic crisis and warned "I may not live long enough to see the crisis, but my soul is going to come back and haunt you" if proprietary trading is not curbed.

The five former Treasury secretaries -- Michael Blumenthal, Nicholas Brady, Paul O'Neill, George Shultz and John Snow -- said in their letter that banks should not be involved in speculative trading activity and still receive taxpayer backing.

"We fully understand that the restriction of proprietary activity by banks is only one element in comprehensive financial reform," their letter said. "It is, however, a key element in protecting our financial system and will assure that banks will give priority to their essential lending and depository responsibilities."

A Fitting Award for Alan Greenspan

Inhale deeply of the madness and illusions of the financial engineers.

Greenspan was a magnet for the enablers, the spokesman for those primarily responsible for the fraud that led to the series of financial crises. But more Meinhof than Baader, one might say. The monied interests are often not famed economists, having more of a yearning for either raw power or opaque solitude. Their recognition must wait for another day and a different venue.

And as for Bernanke, his time has come, and he may eclipse even Greenspan given a little more tenure at the Fed.

Young Tim is no economist, just a useful pair of hands, the hired help.

For Immediate Release
22 February 2010

Greenspan wins Dynamite Prize in Economics

Alan Greenspan has been judged the economist most responsible for causing the Global Financial Crisis. He and 2nd and 3rd place finishers Milton Friedman and Larry Summers have won the first–and hopefully last—Dynamite Prize in Economics.

In awarding the Prize, Edward Fullbrook, editor of the Real World Economics Review, noted that “They have been judged to be the three economists most responsible for the Global Financial Crisis. More figuratively, they are the three economists most responsible for blowing up the global economy.”

The prize was developed by the Real World Economics Review Blog in response to attempts by economists to evade responsibility for the crisis by calling it an unpredictable, Black Swan event.

In reality, the public perception that economic theories and policies helped cause the crisis is correct.

The prize winners were determined by a poll in which over 7,500 people voted—most of whom were economists themselves from the 11,000 subscribers to the real-world economics review . Each voter could vote for a maximum of three economists. In total 18,531 votes were cast.

Fullbrook cautioned that not all economics and economists were bad. “Only neoclassical economists caused the GFC. There are other approaches to economics that are more realistic—or at least less delusional—but these have been suppressed in universities and excluded from government policy making.”

“Some of these rebels also did what neoclassical economists falsely claimed was impossible: they foresaw the Global Financial Crisis and warned the public of its approach. In their honour, I now call for nominations for the inaugural Revere Award in Economics, named in honour of Paul Revere and his famous ride. It will be awarded to the 3 economists who saw the GFC coming, and whose work is most likely to prevent another GFC in the future.”

Dynamite Prize Citations

Alan Greenspan (5,061 votes): As Chairman of the Federal Reserve System from 1987 to 2006, Alan Greenspan both led the over expansion of money and credit that created the bubble that burst and aggressively promoted the view that financial markets are naturally efficient and in no need of regulation.

Milton Friedman (3,349 votes): Friedman propagated the delusion, through his misunderstanding of the scientific method, that an economy can be accurately modeled using counterfactual propositions about its nature. This, together with his simplistic model of money, encouraged the development of fantasy-based theories of economics and finance that facilitated the Global Financial Collapse.

Larry Summers (3,023 votes): As US Secretary of the Treasury (formerly an economist at Harvard and the World Bank), Summers worked successfully for the repeal of the Glass-Steagall Act, which since the Great Crash of 1929 had kept deposit banking separate from casino banking. He also helped Greenspan and Wall Street torpedo efforts to regulate derivatives.

In total 18,531 votes were cast. The vote totals for the other finalists were:

Fischer Black and Myron Scholes 2,016
Eugene Fama 1,668
Paul Samuelson 1,291
Robert Lucas 912
Richard Portes 433
Edward Prescott and Finn E. Kydland 403
Assar Lindbeck 375

The poll was conducted by PollDaddy. Cookies were used to prevent repeat voting.

Note: By way of disclosure, I voted for Fama, Greenspan, and Summers. - Jesse

Modern Economic Myths and The Failure of Financial Engineering

"The whole history of civilization is strewn with creeds and institutions which were invaluable at first, and deadly afterwards." Walter Bagehot

The housing bubble did nothing for real median incomes in the US but it did wonders for the insiders in the financial sector.

This is why the average Joes in the States went into debt to continue to maintain their consumption.

Until this situation is addressed, there will be no sustained economic recovery in the US. The US Census Bureau only goes to 2007, but it is highly likely that the median income has taken another serious downturn in the latest financial crisis.

Very little has been done by the Obama administration to address this problem.



Trickle down or supply side economics does well for the upper percentiles of income but does much less for the median wage.



Why care? For several reasons.

First, the median wage is the bulwark of general consumption and savings, and the prosperity of a nation. It must match the character of the social fabric, or place a severe strain on the contract between classes and peoples. A nation cannot survive both slave and free without necessarily resorting to repression.

Second, in any relatively free society, the reversion to the mean in the distribution wealth and justice is never pleasant, and often bloody and indiscriminate.

There are several economic myths, popularized over the last thirty years, that are falling hard in the recent series of financial crises: the efficient market hypothesis, the inherent benefits of globalization from the natural equilibrium of national competitive advantages, and the infallibility of unfettered greed as a ideal method of managing and organizing human social behaviour and maximizing national production.

One has to wonder what would have happened if some more coherent, approachable science, had put forward a system of management that relied upon the nearly perfect rationality and unnatural goodness of men as a critical assumption in order to work? They would have been laughed out of the academy. Yes, there is a certain power to befuddle and intimidate common sense through the use of professionally specific jargon, supported by pseudo-scientific equations.

Why doesn't 'greed is good' work? Because rather than work harder, a certain portion of the population, not necessarily the most productive and intelligent, will immediately seek rents and extraordinary income obtained by unnatural advantages, by gaming the system, by cheating and coercion, by the subversion of the rule of law, which saps the vitality of the greater portion of the population which does in fact work harder, until they can no longer sustain themselves. And then the lawless few seek to expand their reign of greed, and colonies and empires are born.

What will take the place of these modern economic myths? Time will tell, and it will vary from nation to nation. But the winds of change are rising, and may soon be blowing a hurricane.

Gold and Silver Weekly Charts - Explosive Silver Situation Intensifies

Gold Weekly

Gold held against two determined bear raid this past week, centered around 'announcements.' The first was the re-announcement of the IMF gold sale, and next was the largely symbolic gesture by the Fed in raising the Discount Rate to 75 basis points, without touching the target rate. That announcement was made AFTER the bell, rather than before as is more usual. There was noticeable front running of the miners before each announcement.

There is likely to be another bear raid, since this coming week is metals options expiration, and there is a cluster of contracts around 1100. There is also something brewing under the surface which is creating tension on the tape, with a violent back and forth motion in the spot price of gold. We can only speculate for now, but choose to wait and see what is revealed.

The most interesting speculation is that metals bears target is not gold, but rather silver.

Silver Weekly

Silver is in a potential inverse H&S formation that targets $30 per ounce. There are two or three big bullion banks that are massively short silver, that cannot possibly cover their short positions without significant pain, including a risk of default if a higher price fuels demand and breaks the confidence of the paper market.

If this is true, it is a big problem for the US government, because unlike gold, the central banks have no ready store of silver to sell into the markets, having exhausted their strategic stores some years ago.

If silver explodes because of a paper default, gold will follow. The central banks view that as a very risky development since several of the banks are already breaking ranks with the ECB, BofE, and the Fed over this issue of the de facto dollar reserve currency regime.

We do not anticipate a resolution of this quickly. DO NOT try and trade this for the short term. The 'beta' of the silver market could be terrific. The forces aligned around this market are determined and not easily moved. The small specs can get crushed if the titans start shoving.

These sorts of big changes tend to drag out over long periods of time. But we are aware of the situation. The breakout is at 19.50 and the pattern is negated with a drop below 12.

Look for more old arguments of the metals to resurfaces, and nonsensical arguments to be put forward by those banks and funds talking their books through contacts in the media and analyst community.

I cannot stress enough that if there is an all out stock market crash and liquidation both gold and silver will get deeply sold off, with everything which is what happens in a general liquidation of assets. Then we would begin to look for opportunities to buy in as the dust settles.

Miners 'Gold Bugs Index' Weekly

If silver breaks the paper shorts, the miners will break out, targeting 600 on this index. The silver plays would be remarkable.

What could trigger this? We suspect it would have to be a strong indication from the nations of the developing world for a bi-metallic content in the proposed SDR replacement for the dollar reserve currency.

Since central banks currently do not hold any significant silver bullion positions, the resulting buying panic could rival that of the 'Hunt corner' in the silver market. Therefore we would expect a maximum effort to control it ahead of time. A default on paper positions is certainly within the realm of probability.



Keep an Eye on the Long End of the US Bond Curve

This has been a long trend change as can easily be seen from this chart. The trend is bottoming and may be starting a reversal. Again, these things tend to play out over long periods of time. Don't expect to start day trading this next week.



Disclosure: I added initial positions in the gold and silver miners last week. I expect to add to them if the markets confirm. I have been hedging them against a 'market crash' in US equities such as the panic selloff in late 2008 which took us into the market lows.

"How Could I Be So Selfish and So Foolish"

Were Lloyd and Jamie and the pigmen of Wall Street and Washington taking notes during Tiger Woods' apology?

Doubtful.

No one is perfect, of course. Everyone makes mistakes, everyone sins. We are all weak, and insufficient in ourselves. And yet we attempt great things, in fear and trembling. The spirit endures and abides.

But there are moments in history that are epidemic with excess, a pathological pursuit of lust, greed, and deceit with a nihilistic determination that is more like a fashion of the age than an aberration. Chic to be above conventional morality and the law, lacking all proportion. Accepted, and even admired.

Tiger himself is what they call 'small potatoes,' the personal foibles of a star athlete. What is more significant is the festival of fraud going on in the financial world, centered around Chicago and New York.

Tiger's words could be the new American Anthem for a generation of reckless, selfish, and self-destructive behaviour by those most blessed by its freedom, offered the greatest opportunities and privileges, sometimes undeserved, and most often paid for by the sacrifice of others.

Most of them still have no regrets, except of course for the fear of discovery. They will have to somehow grow a conscience for that. Or face the withdrawal of support by their sponsors. In the case of Tiger it was Nike. In the case of the Banks it is the US government. And in the case of the US government it is a gullible and complacent public.

"Many of you in this room know me. Many of you have cheered for me, have worked with me, always supported me. Now, every one of you has good reason to be critical of me. I want to say to each on of you simply and directly I am deeply sorry for my irresponsible and selfish behaviour I engaged in. I know people want to find out how i could be so selfish and foolish.

I knew my actions were wrong but I convinced myself that the normal rules didn't apply. I never thought about who I was hurting. Instead, I only thought about myself...

I felt that I had worked hard my entire life and deserved to enjoy all the temptations around me. I felt that I was entitled.

Parents used to point to me as a role model for their kids. I owe all those families a special apology. I want to say to them that I am truly sorry.

I recognize I have brought this on myself and I know, above all, I am the one who needs to change.

I was wrong. I was foolish. I don't get to play by different rules."

Managing Perceptions: Fed Raises Discount Rate After the Close

"The last duty of a central banker is to tell the public the truth." Alan Blinder, former Vice Chairman of the Federal Reserve

In a largely symbolic move, the Fed raised the Discount Rate after the bell by 25 basis points to .75%.

As you know, the Discount Rate is the interest rate that the Fed charges banks who borrow from them short term on an emergency basis.

This is the shaping of perception by the Fed. It does not raise rates for the consumer or businesses, and does not affect the rates and guarantees in the many Fed and Treasury programs which are still supporting the commercial banks.

One has to wonder why the Fed chose to jawbone at this time. Is this a move to help them with next week's $100+ Billion Treasury auction? We are discounting rumours that the nose counts among the Primary Dealers showed the risk of another 'failed' auction was rising.

Or was this mainly to provide another opportunity for the bullion banks to take the prices down ahead of their option expiration next week? Plan B stands for Bernays.

"We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake. Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The US Fed was very active in getting the gold price down. So was the U.K." Eddie George, Bank of England Governor to Nicholas J. Morrell

Its all about managing perception.

When the Fed starts backing off on quantitative easing, we will know that things are truly changing. Bernanke is all too aware of the Fed's policy error in 1931 of raises rates prematurely, which caused the second leg down to the trough of the Depression in 1933. So let the Fed wave their hands all they want, but watch the Adjusted Monetary Base. In other words, its not what they say, but rather what they do.

One wonders if Obama is also aware of Hoover's policy error in trying to balance the budget as the nation slid into the most serious part of the Great Depression. He is certainly no FDR, and the nation is unlikely to be on the road to recovery during his hapless Administration. Will he, like Greenspan, later confess that he erred for a theory, a mistaken belief? A small comfort for those they have ruined.

Man wird nie betrogen, man betrügt sich selbst.
[We are never deceived; we but deceive ourselves.]
Johann Wolfgang von Goethe

WSJ
Fed Raises Discount Rate Quarter Percentage Point
By LUCA DI LEO And JON HILSENRATH

WASHINGTON— The U.S. Federal Reserve Thursday raised the rate it charges banks for emergency loans by a quarter percentage point, but emphasized that the step didn't represent a broader tightening of credit.

In a widely expected move, the U.S. central bank said the increase in the discount rate to 75 basis points from half a point was part of its step away from its emergency-lending efforts. The increase will be effective from Friday.

"Like the closure of a number of extraordinary credit programs earlier this month, these changes are intended as a further normalization of the Federal Reserve's lending facilities," the Fed said in a statement...

SP and Nasdaq 100 Futures

Here is where the equity markets stand.

Remember that tomorrow is options expiry for February.

As an aside, the bear raid on gold that occurred in conjunction with a non-announcement from the IMF about their previously announced gold sale did not stick, with prices snapping back today to the paint at which the raid hit, first the miners, and then the metals, largely in the thin after hours trade.

Next week is an option expiry in the metals futures markets, and the US is planning on auctioning an enormous amount of Treasuries, so we would not be complacement at this point.

Still, it was gratifying to see that Dennis Gartman bought back the gold position he sold before the rally. He sold at the bottom, let's see if he can do better and not jinx us for a short term top.

Risk? What Risk? We Don't See No Stinkin' Risk..

"It is the absolute right of the state to supervise the formation of public opinion." Paul Joseph Goebbels

As measured by the VIX, the volatility index, the perception of risk in US markets has declined significantly in the last twelve months from over 50 to current readings around 20.



As a response to this changed perception, mutual funds are once again fully invested, with levels of cash reserves at record lows. In other words, the 'other people's money' crowd are all in.



There is an interesting distribution top forming in the US equity markets. This rally has been driven by liquidity delivered from the Fed and the Treasury primarily to the Wall Street banks, who are deriving an extraordinary amount of their income from trading for their own books, at least based on published results.

Much of the rally in US stocks has occurred on thin volumes and in the overnight trading sessions. Definitely not a vote of confidence, and a sign of potential price manipulation in fact.

Is this a 'set up' to separate the public from even more of their own money, using their own money? Perhaps.

The government is frantic to restore confidence in the US markets, and the toxic asset rich banks are more than capable of using that sincere interest to unload their mispriced paper on the greater fools again.

The perception of risk is a powerful tool in shaping the response of markets, and as an instrument of foreign and domestic government policy actions. It is nothing new, as indicated by the quote from Joseph Goebbels, but it is rising to new levels of sophistication and acceptance in nations with at least a nominal commitment to freedom of choice and transparency of governance.

"There is a social theory called reflexivity which refers to the circular relationship between cause and effect. A reflexive relationship is bidirectional where both the cause and the effect affect one another in a situation that renders both functions causes and effects.

The principle of reflexivity was first introduced by the sociologist William Thomas as the Thomas theorem, but more importantly it was later popularized and applied to the financial markets by George Soros. Soros restated the social theory of reflexivity eloquently and simply, as follows:

markets influence events they anticipate – George Soros

This theorem has become a basic tenant of modern central banking. The idea is that manipulation of the psychology of market participants affects the markets themselves. Therefore, if you artificially suppress the price of gold, you reduce inflationary expectations and reduce inflation itself…so the theory goes."

Why Do the World's Central Banks Manipulate the Price of Gold?

For now we must watch the key levels of resistance around 1115 in the SP. A trading range is most probable but there is a potential distribution top forming with a down side objective around 870 on the SP 500.

It does bear watching, closely, keeping in mind that this is an option expiration week, and the traders expect the market to misrepresent its price discovery, as the result of conscious manipulation.

SP Futures and Options Expiration

It's that time of month again, when the option players are gamed by the broker dealers and the hedge funds.

Volumes are light, and the market is range bound.

It needs to break out decisively from the area of resistance, otherwise the formation of a distribution top starts to look compelling.

Why the 'Trickle Down' Approach Is Not Working in the US

The approach taken by the last two administrations to the financial crisis has been to pack liquidity into the big Wall Street banks, certainly not the regional and local banks, without serious reform.

The notion is that by 'saving the banks' they will be able to support the real economy with loans to spur economic activity. It is the same mindset that provides for huge tax cuts to the top end of the income chain, the very group that benefited from the latest bubble. Its a variant of the 'trickle down' theory popularized by the Republicans under Reagan.

The banks prefer to take the Fed and Treasury money and guarantees at near zero percent cost, and loan it back to the public (after all it is their money) in revolving credit (credit cards) at 18%. It's a sweet setup, provided by the Fed and the Congress. Long term loans and leases? Why bother.

If they want risk, they shove the speculative markets around and make side bets on the failure of companies and now, even nations. Failures, we should add, that are intimately tied into various frauds marketed by the banks themselves.

This is the fatal policy error at the heart of the failure of the Obama Administration and the Fed to intervene effectively in the collapse caused by the Fed's heavy handed manipulation over the past fifteen years.

In fact, one could easily make the case that their intervention does much more harm than good, placing additional debt burdens that are strangling the productive economy, serving only to support and perpetuate a distorted and outsized financial sector concentrated in a few elite corporations that are heavy contributors to the Washington politicians of both parties.

It's trickling down all right. But not in the form of productive allocation of capital.

Soros More Than Doubled His Gold Position in 4Q '09

Regulatory filings disclose that Soros more than doubled the gold position in his Soros Fund Management LLC at the end of 2009. There is a lag in official reporting in regulatory filings, so he *could* have sold his entire position before he called gold 'a bubble' at Davos last month.

Then again, he might not have. In which case what would that make him?

We will have to wait for the next round of filings to see.

Certainly not a man of serious intent, regardless of his positions, since he is buying the Gold ETF rather than something more --- substantial.

How are the mighty fallen.

And speaking of the fallen, Dennis Gartman advised that he was selling out his gold position last week, near the lows for the correction around $1060, at least so far, and just in time to miss a rather sharp rally to the upside of $1100. Of course, no one is always right; we all make bad calls. But then again, not everyone goes on financial television and makes a prat of themselves by talking trash about those who have been mostly right about a market while he has been so often wrong.

"When your heart is covered with the snows of pessimism and the ice of cynicism, then, and then only, are you grown old. And then, indeed as the ballad says, you just fade away.” Douglas MacArthur

A fade indeed.

Bloomberg
Soros More Than Doubles Gold ETF Holding in Fourth Quarter
By Katherine Burton

Feb. 17 (Bloomberg) -- Billionaire George Soros’s Soros Fund Management LLC more than doubled its holding in the SPDR Gold Trust exchange-traded fund in the fourth quarter, according to a regulatory filing.

The $25 billion New York-based firm added shares valued at $421 million in the SPDR Gold Trust, the biggest ETF backed by the metal, according to yesterday’s filing with the U.S. Securities and Exchange Commission. Its holding in the fund was worth about $663 million as of Dec. 31.

The filings are done quarterly with a 45 day lag, so Soros could have sold some or all of the position since then. Soros, while speaking last month at the World Economic Forum in Davos, called gold the “ultimate asset bubble” and said the price could tumble, according to a report in the Daily Telegraph...

Eleven Principles of Financial Reform

Personally I doubt that the US is capable of self-reform at this time.

The corruption of the socio-political system runs deep, and is embedded in a reflexive set of slogans that substitute for practical thought and effective policy formation.  People become parrots for their favorite corporate media to which they become emotionally addicted, because otherwise reality is too painful and complex to face.  And so they become willfully blind and cut off from productive, and even civil discourse, standing at the bottom of deep wells of subjectivity.

The major media in the States are owned by a few corporations. The Congress listens to its large contributors and ignores the public except at election time, when it inundates them with expensive media campaigns, political spin, false promises, and propaganda. And then it is back to business as usual.

"When plunder becomes a way of life for a group of men in a society, over the course of time they create for themselves a legal system that authorizes it and a moral code that glorifies it." Frederic Bastiat

What will it take? It took the Japanese about twenty years of economic privation to finally get rid of the LDP political party that had ruled the country since the Second World War. It may take ten years of stagflation and economic hardship for the American people to wake up and put an end to the crony capitalism that has captured its two party political system. A good start would be to continue to defeat incumbents from both parties, and to start electing viable third party candidates.

But that demands a more thoughtful venue than is currently the norm. It really does seem that bad to a relatively objective observer.

Vox
Eleven Lessons From Iceland
Thorvaldur Gylfason
13 February 2010

...What can be done to reduce the likelihood of a repeat performance – in Iceland and elsewhere? Here are eleven main lessons from the Iceland story, lessons that are likely to be relevant in other, less extreme cases as well.

Lesson 1. We need effective legal protection against predatory lending just as we have long had laws against quack doctors. The problem is asymmetric information. Doctors and bankers typically know more about complicated medical procedures and complex financial instruments than their patients and clients. The asymmetry creates a need for legal protection through judicious licensing and other means against financial (as well as medical) malpractice to protect the weak against the strong.

Lesson 2. We should not allow rating agencies to be paid by the banks they have been set up to assess. The present arrangement creates an obvious and fundamental conflict of interest and needs to be revised. Likewise, banks should not be allowed to hire employees of regulatory agencies, thereby signalling that by looking the other way, remaining regulators may also expect to receive lucrative job offers from banks. (I would add a prohibition of movement between regulators and the banks without a significant hiatus of at least four years. - Jesse)

Lesson 3. We need more effective regulation of banks and other financial institutions; presently, this is work in progress in Europe and the US (Volcker 2010). (Too slow, too driven by the banks themselves in the US - Jesse)

Lesson 4. We need to read the warning signals. We need to know how to count the cranes to appreciate the danger of a construction and real estate bubble (Aliber’s rule). We need to make sure that we do not allow gross foreign reserves held by the central bank to fall below the short-term foreign liabilities of the banking system (the Giudotti-Greenspan rule). We need to be on guard against the scourge of persistent overvaluation sustained by capital inflows because, sooner or later, an overvalued currency will fall. Also, income distribution matters. A rapid increase in inequality – as in Iceland 1993-2007 and in the US in the 1920s as well as more recently – should alert financial regulators to danger ahead. (The problem was not seeing the developing problems and bubbles in the US. The problem was that the regulators were compromised, the politicians were bought, the economists and media were craven, and most of the stewards of the public trust were willing to turn a blind eye - Jesse)

Lesson 5. We should not allow commercial banks to outgrow the government and central bank’s ability to stand behind them as lender – or borrower – of last resort.

Lesson 6. Central banks should not accept rapid credit growth subject to keeping inflation low – as did the Federal Reserve under Alan Greenspan and the Central Bank of Iceland. They must take a range of actions to restrain other manifestations of latent inflation, especially asset bubbles and large deficits in the current account of the balance of payments. Put differently, they must distinguish between “good” (well-based, sustainable) growth and “bad” (asset-bubble-plus-debt-financed) growth. (An honest measure of inflation might go a long way to reforming this. The current CPI measure in the US is a limp measure as compared to the CPI of even twenty years ago - Jesse)

Lesson 7. Commercial banks should not be authorised to operate branches abroad rather than subsidiaries if this entails the exposure of domestic deposit insurance schemes to foreign obligations. This is what happened in Iceland. Without warning, Iceland’s taxpayers suddenly found themselves held responsible for the moneys kept in the IceSave accounts of Landsbanki by 400,000 British and Dutch depositors. Had these accounts been hosted by subsidiaries of Landsbanki rather than by branches, they would have been covered by local deposit insurance in Britain and the Netherlands.

Lesson 8. We need strong firewalls separating politics from banking because politics and banking are not a good mix. The experience of Iceland’s dysfunctional state banks before the privatisation bears witness. This is why their belated privatisation was necessary. Corrupt privatisation does not condemn privatisation, it condemns corruption.

Lesson 9. When things go wrong, there is a need to hold those responsible accountable by law, or at least try to uncover the truth and thus foster reconciliation and rebuild trust. There is a case for viewing finance the same way as civil aviation: there needs to be a credible mechanism in place to secure full disclosure after every crash. If history is not correctly recorded without prevarication, it is likely to repeat itself. (Good luck with this one. All those in power reach immediately for the cover up and a dilution of guilt to 'everyone' so as to hold no one accountable - Jesse)

Lesson 10. When banks collapse and assets are wiped out, the government has a responsibility to protect jobs and incomes, sometimes by a massive monetary or fiscal stimulus. This may require policymakers to think outside the box and put conventional ideas about monetary restraint and fiscal prudence temporarily on ice. A financial crisis typically wipes out only a small fraction of national wealth. Physical capital (typically three or four times GDP) and human capital (typically five or six times physical capital) dwarf financial capital (typically less than GDP). So, the financial capital wiped out in a crisis typically constitutes only one fifteenth or one twenty-fifth of total national wealth, or less. The economic system can withstand the removal of the top layer unless the financial ruin seriously weakens the fundamentals. (I would provide guarantees from the bottom up, rather than financial backstopping from the top down. Keep the depositors whole within limits, and let the banks and their owners take the maximum pain. - Jesse)

Lesson 11. Let us not throw out the baby with the bathwater. Since the collapse of communism, a mixed market economy has been the only game in town. To many, the current financial crisis has dealt a severe blow to the prestige of free markets and liberalism, with banks – and even General Motors – having to be propped up temporarily by governments, even nationalised. Even so, it remains true that banking and politics are not a good mix. But private banks clearly need proper regulation because of their ability to inflict severe damage on innocent bystanders. (The blow is not to free markets and liberalism, but to the efficient market theory, supply side economics, neo-liberalism and neo-conservatism, and of course the magic of deregulation and privatization as inherently good, as a substitute for the proper role of government. - Jesse)

Bomb Explodes At J. P. Morgan Offices in Athens

A bomb was detonated outside the JP Morgan offices in Athens, Greece. No one is reported injured at this time. A warning was called in prior to the explosion allowing police to cordon the area.

This is somewhat remniscent of the bombing of the J.P. Morgan headquarters on Wall Street in 1920, presumably by anarchists. The marks and pitted holes on the JPM building remained to the modern day. I saw them myself some years ago.

The Wall Street bombing occurred at 12:01 p.m. on September 16, 1920, in the Financial District of New York City. The blast killed 38 and seriously injured 400.

The investigation had quickly stalled when none of the victims turned out to be the driver of the wagon. Though the horse was newly shod, investigators could not locate the stable responsible for the work. When the blacksmith was located in October, he could offer the police little information.

The Bureau of Investigation and local police investigated the case for over three years without success. Occasional arrests garnered headlines but each time false hopes evaporated within days. Most of the investigative effort focused on the same network of Galleanist anarchists law enforcement tied to the 1919 bombings and to Sacco and Vanzetti. In the Harding administration, new attention was paid to the Soviets as possible masterminds of the Wall Street bombing and then to the renascent Communist Party USA.

In 1944, the Federal Bureau of Investigation, successor to the BOI, performed a final investigation and concluded by saying its agents had explored the involvement of many radical groups, "such as the Union of Russian Workers, the I.W.W., Communist, etc....and from the result of the investigations to date it would appear that none of the aforementioned organizations had any hand in the matter and that the explosion was the work of either Italian anarchists or Italian terrorists." Wikipedia

The actual perpetrators of the 1920 bombing were never discovered. There was no warning and the bomb was detonated at the height of business hours.

It is good that no one was hurt in this recent bombing. Violence is never the answer. Never.

"An eye for an eye makes the whole world blind." Mohandas K. Ghandi

Reuters
Bomb goes off at JP Morgan offices in Athens
By Renee Maltezou
16 Feb 2010 18:17:54 GMT

ATHENS, Feb 16 (Reuters) - A bomb exploded outside the JP Morgan offices in Athens on Tuesday, causing minor damage to the building, police said.

There were no immediate reports of injuries.

"It was a time-bomb at JP Morgan's offices in central Athens," a police official said. "The explosion damaged the outside door and smashed some windows."

The official said police cordoned off the area after a local newspaper had received a warning call.

Simon Johnson: Goldman Faces Special Audit and Possible Ban in Europe

"The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government - a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF's staff could speak freely about the U.S., it would tell us what it tells all countries in this situation; recovery will fail unless we break the financial oligarchy that is blocking essential reform." ~ The Atlantic Monthly, May 2009, by Simon Johnson

Regular readers will be aware of our thesis that the American Wall Street banks have become dominated by a culture of compulsive sociopaths who are incapable of reforming or restraining their greed. Like all addicts, they push the envelope looking for a new high, emboldened by each successful scam, the weakness of regulators, and the craven support of politicians, going further and further until at long last they go one step too far, with spectacularly destructive results.

Goldman Sachs may have reached that point. And as also suggested here, the rebuke may be coming from European and Asian nations who become weary of the extra-legal antics of the rogue American banks.

In the interests of harmony, the Europeans may once again bow to US pressure and continue to permit the Money Center privateers to roam through the interational financial system wreaking havoc, as they have been doing through the domestic US economy. It will be too bad if they do.

This is in no way an excuse for the Greek government. But what Simon Johnson is saying in this essay below is that Goldman is not only not blameless, but is enabling, complicit and perhaps even presenting the opportunity for market manipulation and fraud to other parties. Typically they like to 'package' these scams and take them from one customer to another, so that greed meets need, as a corrupting influence. It is no different than a bank engaging in money laundering in support of the criminal activity of another organization.

Is he right? Will the EU begin to act to curtail the transgressions of multinational banks based in the US? I think he may very well be. It is one thing to take on pension funds and speculators, and to run raids on companies. It is another thing to start taking on countries, and especially those not so alone and weak as Iceland.

And even more than that. If it ever comes to the light of day, the complicity of a few central banks and governments in the actions of one or two of the money center banks in manipulating several global commodity and asset markets may ignite a firestorm of a political scandal of epic proportions.

At the very least, it remains a practical imperative that the banks be restrained, the financial system reformed, and the economy brought back into balance, before there can be any sustainable recovery and stability.

And it is now apparent that Obama and the US Congress, for whatever reasons, are incapable of doing this. And yet, hope remains.

"It is said an Eastern monarch once charged his wise men to invent him a sentence to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: And this, too, shall pass away. How much it expresses. How chastening in the hour of pride. How consoling in the depths of affliction." Abraham Lincoln

Baseline Scenario
Goldman Goes Rogue - Special European Audit to Follow
By Simon Johnson

"...We now learn – from Der Spiegel last week and today’s NYT – that Goldman Sachs has not only helped or encouraged some European governments to hide a large part of their debts, but it also endeavored to do so for Greece as recently as last November. These actions are fundamentally destabilizing to the global financial system, as they undermine: the eurozone area; all attempts to bring greater transparency to government accounting; and the most basic principles that underlie well-functioning markets. When the data are all lies, the outcomes are all bad – see the subprime mortgage crisis for further detail.

A single rogue trader can bring down a bank – remember the case of Barings. But a single rogue bank can bring down the world’s financial system.

Goldman will dismiss this as “business as usual” and, to be sure, a few phone calls around Washington will help ensure that Goldman’s primary supervisor – now the Fed – looks the other way.

But the affair is now out of Ben Bernanke’s hands, and quite far from people who are easily swayed by the White House. It goes immediately to the European Commission, which has jurisdiction over eurozone budget issues. Faced with enormous pressure from those eurozone countries now on the hook for saving Greece, the Commission will surely launch a special audit of Goldman and all its European clients...

...Goldman will probably be blacklisted from working with eurozone governments for the foreseeable future; as was the case with Salomon Brothers 20 years ago, Goldman may be on its way to be banned from some government securities markets altogether. If it is to be allowed back into this arena, it will have to address the inherent conflicts of interest between advising a government on how to put (deceptive levels of) lipstick on a pig and cajoling investors into buying livestock at inflated prices.

And the US government, at the highest levels, has to ask a fundamental question: For how long does it wish to be intimately associated with Goldman Sachs and this kind of destabilizing action? What is the priority here - a sustainable recovery and a viable financial system, or one particular set of investment bankers?

To preserve Goldman, on incredibly generous terms, in the name of saving the financial system was and is hard to defend – but that is where we are. To allow the current government-backed (massive) Goldman to behave recklessly and with complete disregard to the basic tenets of international financial stability is utterly indefensible. (There is a case to be made that the money center banks, in particular Goldman and JPM, are sometimes acting as instruments of US foreign policy - Jesse)

The credibility of the Federal Reserve, already at an all-time low, has just suffered another crippling blow; the ECB is also now in the line of fire. Goldman Sachs has a lot to answer for."

Read the entire essay from Simon Johnson here

US GDP - Estimated Percentage by State

A regional view is probably more meaningful, but this is some useful information.

The Approaching US Dollar Reserve Currency Crisis

"US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941."

No matter how they wrap it, spin it, try to hide it, we have seen an epic expansion in the US monetary base not seen since 1932.

This monetary expansion has not yet reached into the broader money supply figures because it is not reaching the public, despite the chant from the "Yes We Can" Kid. Bernanke has most of that liquidity bottled up in a few big banks collecting an easy riskless spread, with some of it chasing beta in the speculative markets.

Ben can talk a tough game, and jawbone rates with his plans to someday return to normalcy. But at the end of the day, the US is playing out a well worn script that is highly predictable.

There are three choices the Sith Lords at the Fed and their western central bank apprentices have at this point: inflation, inflation, and inflation.

The only question is how and when it will become obvious even to the most stubborn believers in the Dollar Über Alles. Ben will seek to control it, to unleash it from its cage very slowly, spread the pain to the US trading partners overseas.

The US dollar reserve currency status is faltering, but not yet under a serious assault. The monied elite will try to eliminate any serious competition, such as the euro or precious metals, by any and all means possible.

Greece is roughly 2.6% of the Eurozone GDP. California is 13% of the US.

How long they can continue this is anyone's guess. These things tend to play out slowly, over years. I do not expect the US dollar to fail precipitously in the manner of the Zimbabwe dollar or with Weimar Reichsmark, but rather to be devalued in a step-staggered manner, over time, until it stabilizes and the debts are liquidated.

When the US starts closing the greater portion of its 700+ overseas military bases, we will know that it has become serious about financial reform and balancing its books. Until then, all is posturing, self-interest, demagoguery, and deception.

Financial Times
A Greek crisis is coming to America
By Niall Ferguson
February 11 2010 02:00

It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate...

Yet the idiosyncrasies of the eurozone should not distract us from the general nature of the fiscal crisis that is now afflicting most western economies. Call it the fractal geometry of debt: the problem is essentially the same from Iceland to Ireland to Britain to the US. It just comes in widely differing sizes.

What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not "save" us half so much as monetary policy - zero interest rates plus quantitative easing - did. First, the impact of government spending (the hallowed "multiplier") has been much less than the proponents of stimulus hoped. Second, there is a good deal of "leakage" from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect

For the world's biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the "safe haven" of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.

Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase "safe haven". US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.

Even according to the White House's new budget projections, the gross federal debt in public hands will exceed 100 per cent of GDP in just two years' time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That's right, never.

The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). Then came Ireland, Spain and Greece (9 per cent). And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF.

Explosions of public debt hurt economies in the following way, as numerous empirical studies have shown. By raising fears of default and/or currency depreciation ahead of actual inflation, they push up real interest rates. Higher real rates, in turn, act as drag on growth, especially when the private sector is also heavily indebted - as is the case in most western economies, not least the US.

Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities.

But now the Fed is phasing out such purchases and is expected to wind up quantitative easing. Meanwhile, the Chinese have sharply reduced their purchases of Treasuries from around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an estimated 5 per cent last year. Small wonder Morgan Stanley assumes that 10-year yields will rise from around 3.5 per cent to 5.5 per cent this year. On a gross federal debt fast approaching $1,500bn, that implies up to $300bn of extra interest payments - and you get up there pretty quickly with the average maturity of the debt now below 50 months.

The Obama administration's new budget blithely assumes real GDP growth of 3.6 per cent over the next five years, with inflation averaging 1.4 per cent. But with rising real rates, growth might well be lower. Under those circumstances, interest payments could soar as a share of federal revenue - from a tenth to a fifth to a quarter.

Last week Moody's Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers' killer question (posed before he returned to government): "How long can the world's biggest borrower remain the world's biggest power?"

On reflection, it is appropriate that the fiscal crisis of the west has begun in Greece, the birthplace of western civilization. Soon it will cross the channel to Britain. But the key question is when that crisis will reach the last bastion of western power, on the other side of the Atlantic.

Primary Dealer Banks Want Their Treasury Sales Franchise Protected

Direct bidding means bypassing the 'percentage' that the dealer banks take. The banks hate it. It not only dents their vigorish, but it makes it more competitive in pricing the auction, which cuts into profits as well.

Today's Ten Year Auction was a bit weak, with Direct Bidders down as a percentage.

I have heard that more firms that are not PIMCO class in size are seeking to become Direct Bidders because of the price gaming that is going on with the Primary Dealer Banks serving as intermediaries.

By way of information, 'indirect bidders' are often considered a proxy for foreign purchasers from the official sector.

The Treasury auctioned $25 billion 10-year notes on 10 February 2010.

The high yield was 3.692%, which was 3+ basis points lower than the 1pm "When Issued" yield.

The bid to cover ratio, a measure of auction demand, was 2.67 bids submitted for every one accepted by the Treasury. This compared to a 3.0 BTC in the last 10yr auction

Dealers took 53.3% vs. 53.2% last time

Direct Bidders took 12.9% of the issuance. Previously 17.2%

Indirect Bidders were awarded 51.2% of the auction, vs 52.9% last time.

For some interesting background reading on some relatively recent changes in the bidding process and the definition of indirect bidding made by Treasury, read Smoke, mirrors and Treasury sales by Izabella Kaminska.

ForexPros
Angry US bankers seek curbs on direct bidders
By Emily Flitter
2010-02-09 17:18:22 GMT

NEW YORK, Feb 9 (Reuters) - Two minutes after the U.S. Treasury Department closed a multi-billion dollar debt auction last month, one banker was angrily punching in numbers of a hotline he'd found on the Treasury's Web site.

Primary dealers, including his bank, had just been blindsided by a large order from a group of so-called direct bidding firms whose presence is growing.

Financial firms acting as direct bidders are sapping profits for the big banks that have long seen themselves as the main intermediaries in the sale of government debt.

Primary dealers say direct bidders need tighter control given risks they could make auctions more volatile and expensive for the U.S. government at a time when it is borrowing record amounts to fund its programs.

The U.S. Treasury, however, says it supports broader access to auctions on grounds it raises competition and cuts costs.

The banker, who did not want to be named for this story, said he called Treasury to find out more about the firms in this group: He wanted to know how many had bid that day and what the standards were for allowing them to participate.

Primary dealers say a large direct bid in an auction makes it harder for them to properly price their own bids for Treasuries ahead of time. If primary dealers guess direct bidders will turn out in force for an auction, they could choose to pull back from a portion of their bids. They say Treasury auctions could begin to show less stable results. This would likely raise borrowing costs for the U.S. government.

"Because of the direct bid, determining the accurate price in the auction becomes more problematic. If it becomes more problematic fewer people will be willing to put capital at risk for size in the auctions," said Ian Lyngen, senior government bond strategist at CRT Capital Group in Stamford Connecticut.

Some primary dealers are asking the Treasury for limits on the percentage of direct bids that can be placed in a given auction. This, they say, would cut down on the level of uncertainty that has taken hold ahead of auctions recently.

WHY SO ANGRY?

On the day the angry banker made his phone call, direct bidders took down more than 17 percent of a $21 billion auction of 10-year notes, a far higher portion than normal. Direct bidders took 8.9 percent of the December 10-year note auction, and in November their bids made up 4.5 percent of the total. Similarly, January's three-year note auction saw direct bidders take 23 percent, while they accounted for only 2.9 percent of the December three-year auction.

"More and more buy-side accounts are so starved for yield that they're trying to go around the dealers," said Chris Whalen, co-founder of Institutional Risk Analytics. "Why should PIMCO go through a primary dealer?"

But despite the constant communication between these big banks and the government, they can't hope for much change.

"We support broad access to the auction process and we think that this is a good thing from the standpoint that it breeds competition and helps us achieve our goal of financing the government at the lowest cost over time," said Matthew Rutherford, the deputy assistant Treasury secretary for federal finance, speaking to reporters at last week's quarterly refunding announcement.

The direct bidder issue is one on which the primary dealers have little leverage in persuading Treasury. Despite the record size of recent Treasury issuance, investors are still snapping up U.S. government debt, creating healthy demand that has led to smoothly executed auctions.

This means the Treasury Department has little incentive to do more than listen to primary dealers' complaints about direct bidders.

"I think they like having a larger number of people with access to their auctions," said Rick Klingman, managing director of Treasury trading at BNP Paribas in New York. He explained that in the event of a disaster such as the 9/11 attacks, which knocked out New York firms' systems, a broader network of direct bidders could step in and make sure an auction went smoothly.

There are few details on the makeup of the group of direct bidders available to the public. Treasury does not disclose the number of firms authorized to participate as direct bidders, and there's little information available to indicate the potential size of firms that have direct bidding terminals.

Primary dealers aren't afraid to speculate on who the mystery bidders might be. Some posit they are smaller securities firms that are preparing to apply to become primary dealers, while others say those firms aren't well-capitalized enough to make much of a dent in a single auction.

Current List of Primary Dealers with the New York Fed

BNP Paribas Securities Corp.
Banc of America Securities LLC
Barclays Capital Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Credit Suisse Securities (USA) LLC
Daiwa Securities America Inc.
Deutsche Bank Securities Inc.
Goldman, Sachs & Co.
HSBC Securities (USA) Inc.
Jefferies & Company, Inc.
J. P. Morgan Securities Inc.
Mizuho Securities USA Inc.
Morgan Stanley & Co. Incorporated
Nomura Securities International, Inc.
RBC Capital Markets Corporation
RBS Securities Inc.
UBS Securities LLC.

NAV of Certain Precious Metal Funds and ETFs

Rorschach's Journal: Last Night, a Comedian Died in New York...

This was no accident, no act of God. No unforeseen mishap, no simple miscalculation.

Somebody pushed AIG out a window, to collect the insurance. Then they saw the opportunity to extort billions from the Congress and a Presidency in transition by bringing the financial system to the point of collapse. And they took it. And somebody knows who and how they did it.

Somebody knows.

NY Times
Goldman Helped Push A.I.G. to Precipice
By GRETCHEN MORGENSON and LOUISE STORY
February 6, 2010

...Well before the federal government bailed out A.I.G. in September 2008, Goldman’s demands for billions of dollars from the insurer helped put it in a precarious financial position by bleeding much-needed cash. That ultimately provoked the government to step in.

With taxpayer assistance to A.I.G. currently totaling $180 billion, regulatory and Congressional scrutiny of Goldman’s role in the insurer’s downfall is increasing. The Securities and Exchange Commission is examining the payment demands that a number of firms — most prominently Goldman — made during 2007 and 2008 as the mortgage market imploded.

The S.E.C. wants to know whether any of the demands improperly distressed the mortgage market, according to people briefed on the matter who requested anonymity because the inquiry was intended to be confidential.

In just the year before the A.I.G. bailout, Goldman collected more than $7 billion from A.I.G. And Goldman received billions more after the rescue. Though other banks also benefited, Goldman received more taxpayer money, $12.9 billion, than any other firm.

In addition, according to two people with knowledge of the positions, a portion of the $11 billion in taxpayer money that went to Société Générale, a French bank that traded with A.I.G., was subsequently transferred to Goldman under a deal the two banks had struck.

Goldman stood to gain from the housing market’s implosion because in late 2006, the firm had begun to make huge trades that would pay off if the mortgage market soured. The further mortgage securities’ prices fell, the greater were Goldman’s profits...

In its dispute with A.I.G., Goldman invariably argued that the securities in dispute were worth less than A.I.G. estimated — and in many cases, less than the prices at which other dealers valued the securities.

The pricing dispute, and Goldman’s bets that the housing market would decline, has left some questioning whether Goldman had other reasons for lowballing the value of the securities that A.I.G. had insured, said Bill Brown, a law professor at Duke University who is a former employee of both Goldman and A.I.G.

The dispute between the two companies, he said, “was the tip of the iceberg of this whole crisis.”

“It’s not just who was right and who was wrong,” Mr. Brown said. “I also want to know their motivations. There could have been an incentive for Goldman to say, ‘A.I.G., you owe me more money.’ ”

Goldman is proud of its reputation for aggressively protecting itself and its shareholders from losses as it did in the dispute with A.I.G.

In March 2009, David A. Viniar, Goldman’s chief financial officer, discussed his firm’s dispute with A.I.G. in a conference call with reporters. “We believed that the value of these positions was lower than they believed,” he said.

Asked by a reporter whether his bank’s persistent payment demands had contributed to A.I.G.’s woes, Mr. Viniar said that Goldman had done nothing wrong and that the firm was merely seeking to enforce its insurance policy with A.I.G. “I don’t think there is any guilt whatsoever,” he concluded.

Lucas van Praag, a Goldman spokesman, reiterated that position. “We requested the collateral we were entitled to under the terms of our agreements,” he said in a written statement, “and the idea that A.I.G. collapsed because of our marks is ridiculous.”

Still, documents show there were unusual aspects to the deals with Goldman. The bank resisted, for example, letting third parties value the securities as its contracts with A.I.G. required. And Goldman based some payment demands on lower-rated bonds that A.I.G.’s insurance did not even cover.

A November 2008 analysis by BlackRock, a leading asset management firm, noted that Goldman’s valuations of the securities that A.I.G. insured were “consistently lower than third-party prices.”

To be sure, many now agree that A.I.G. was reckless during the mortgage mania. The firm, once the world’s largest insurer, had written far more insurance than it could have possibly paid if a national mortgage debacle occurred — as, in fact, it did.

Perhaps the most intriguing aspect of the relationship between Goldman and A.I.G. was that without the insurer to provide credit insurance, the investment bank could not have generated some of its enormous profits betting against the mortgage market. And when that market went south, A.I.G. became its biggest casualty — and Goldman became one of the biggest beneficiaries.

Longstanding Ties

For decades, A.I.G. and Goldman had a deep and mutually beneficial relationship, and at one point in the 1990s, they even considered merging. At around the same time, in 1998, A.I.G. entered a lucrative new business: insuring the least risky portions of corporate loans or other assets that were bundled into securities.

...Mr. Egol structured a group of deals — known as Abacus — so that Goldman could benefit from a housing collapse. Many of them were actually packages of A.I.G. insurance written against mortgage bonds, indicating that Mr. Egol and Goldman believed that A.I.G. would have to make large payments if the housing market ran aground. About $5.5 billion of Mr. Egol’s deals still sat on A.I.G.’s books when the insurer was bailed out.

“Al probably did not know it, but he was working with the bears of Goldman,” a former Goldman salesman, who requested anonymity so he would not jeopardize his business relationships, said of Mr. Frost. “He was signing A.I.G. up to insure trades made by people with really very negative views” of the housing market.

Mr. Sundaram’s trades represented another large part of Goldman’s business with A.I.G. According to five former Goldman employees, Mr. Sundaram used financing from other banks like Société Générale and Calyon to purchase less risky mortgage securities from competitors like Merrill Lynch and then insure the assets with A.I.G. — helping fatten the mortgage pipeline that would prove so harmful to Wall Street, investors and taxpayers. In October 2008, just after A.I.G. collapsed, Goldman made Mr. Sundaram a partner.

Through Société Générale, Goldman was also able to buy more insurance on mortgage securities from A.I.G., according to a former A.I.G. executive with direct knowledge of the deals. A spokesman for Société Générale declined to comment.

It is unclear how much Goldman bought through the French bank, but A.I.G. documents show that Goldman was involved in pricing half of Société Générale’s $18.6 billion in trades with A.I.G. and that the insurer’s executives believed that Goldman pressed Société Générale to also demand payments.

Goldman’s Tough Terms

In addition to insuring Mr. Sundaram’s and Mr. Egol’s trades with A.I.G., Goldman also negotiated aggressively with A.I.G. — often requiring the insurer to make payments when the value of mortgage bonds fell by just 4 percent. Most other banks dealing with A.I.G. did not receive payments until losses exceeded 8 percent, the insurer’s records show.

Several former Goldman partners said it was not surprising that Goldman sought such tough terms, given the firm’s longstanding focus on risk management.

By July 2007, when Goldman demanded its first payment from A.I.G. — $1.8 billion — the investment bank had already taken trading positions that would pay out if the mortgage market weakened, according to seven former Goldman employees.

Still, Goldman’s initial call surprised A.I.G. officials, according to three A.I.G. employees with direct knowledge of the situation. The insurer put up $450 million on Aug. 10, 2007, to appease Goldman, but A.I.G. remained resistant in the following months and, according to internal messages, was convinced that Goldman was also pushing other trading partners to ask A.I.G. for payments.

On Nov. 1, 2007, for example, an e-mail message from Mr. Cassano, the head of A.I.G. Financial Products, to Elias Habayeb, an A.I.G. accounting executive, said that a payment demand from Société Générale had been “spurred by GS calling them.”

Mr. Habayeb, who testified before Congress last month that the payment demands were a major contributor to A.I.G.’s downfall, declined to be interviewed and referred questions to A.I.G. The insurer also declined to comment for this article. Mr. van Praag, the Goldman spokesman, said Goldman did not push other firms to demand payments from AIG....

Read the entire story here.