Notes from Underground

This is a composite of chatter and 'gossip' and anecdotes picked up from multiple sources, some that could be considered reasonably informed, formally regarded as hearsay.

Treat it as rumour as none of it can be guaranteed authentic. More of it is coming from Europe than the US. There can be no verification in such opaque conditions without investigative staff and the power of subpoena.

Verify it for yourself; it is not a bad starting point to use as a skeleton upon which to hang events as we go forward. Sometimes you hear enough of the same thing from different sources, things that make sense and ring true, and the dots connected, even if in a rough way.

There was more of a struggle in deciding to allow the speculative portion of this out than you might imagine. The 'history' part seems consistent and valid, but probably a selective caricature. It could all be the overreaction of frightened people who merely do not see the next step yet. But since we started acting on it this week, not in terms of investments, but in bringing capital back to safer harbors, it did not seem right to ignore it.

The whole outlook could change next week, and for the better. Anything is possible, if one does not know what is true and what is not, even if it does not seem probable. And we never trade on rumours, only the charts which tell us things known only to the markets.

It seems as if the government is downplaying the seriousness of the situation a bit while they work to find a way forward. That is natural and expected. What might seem today like a radical solution may be adopted eventually but the people are not ready to hear it yet, and it is not clear that this will be required, so why do it?

No one wants to make the first moves ahead of an unfolding crisis, especially with the Republicans playing hardball politics and the blame game. The pressure is on from the moneyed interests, but there is a growing concern about the public mood.

In the meantime, people's favorite ideas for solutions are getting play because no one can agree on a comprehensive plan. Obama brought in an impressive array of experienced people who know where the levers are. The problem is that they are philosophically at odds with one another, and sometimes poles apart from the president and his inner circle. There are the natural start up problems, but there is a more serious lack of cohesion of vision that is going to be resolved. Obama seems capable of doing this.

There is an air of quiet desperation as the situation grows progressively worse, and there is intense debate on when and how to break it to the public. They are not even sure what exactly to break because the situation is so fluid. No one wishes to be the messenger and possibly be blamed for inciting a loss of confidence.

Wall Street and the banking system has been every bit as irresponsible and out of control as we thought in our worst moments, perhaps more. A group of twenty somethings with little or no adult supervision developed ideas for 'financial products' with the same care and planning that their counterparts perform extreme stunts on Youtube.

They did it because they could. They tested the system for boundaries and didn't find any.

You want leverage? Imagine a 20 billion dollar portfolio of mortgage backed securities with a capital base of $10k, literally 2 million-fold leverage. Imagine the shock of the inventor as he watches as his successors expand similar portfolios up to $900 billion.

After running out of gullible Japanese bankers these young cowboys began trolling for other pools of gullible buyers: hedge funds, pension funds, and University endowments sufficed. They even found some local suckers. Anything to make a sale and keep the money machine turning.

How did we go so far off the tracks?

The guys initially putting these packages together had some sense that they were crazy, that they made no sense, but nobody said stop, and they didn't care. It was a good time to make money and then move along.

Government regulators being paid $100k couldn't tell connected guys making $20 million what to do. They also had their marching orders from above. Don't get in the way of financial progress on Wall Street. The US has to be competitive. The senior managers loved the money flows.

A sea of cubicles were staffed with engineers, chemists, physicists, and mathematicians from the best colleges in the country with no knowledge of the history of financial markets, fat tails, and past human follies. But they knew how to turn the crank on financial engineering.

The average career age in the business is about 7 years. A twenty year veteran is a very old man. The creators of these innovative financial products understood the toxicity at some level. As they retired, however, the next generation of twenty somethings came in and had zero sense of risk. They were simply told which button to push and which lever to pull to make money. Nobody was really driving the bus.

The Street looked from one market to the next to find and angle and make money. Enron was only the tip of the iceberg. And when they found a market that was vulnerable they swarmed on it like a pack of wolves.

The money overwhelmed the system. The money pushed all regulations aside. It bought deregulation, politicians, and anything else necessary to keep the money machine growing. Nobody dared yell stop because so damned much money was being made.

Greenspan became a believer--he lost consciousness of what he was there to do. The reason he turned a blind eye and allowed the damage to accumulate remains unanswered.

So where are we now, and where are we heading?

Our financial system is infected by flesh eating bacteria. Every day looks more dire than the previous day. The solutions being proposed look feeble, and the Fed looks both powerless and confused.

TARP is throwing money down a rathole. That is why there is such a mood of abandon on the Street. They know this is just an exercise.

One of the so-called model banks is on a don't ask/don't tell policy; the Fed simply cannot handle another mega-catastrophe while they wrestle with the fully-insolvent among the top five. (Note: think derivatives). The word on the Street is to keep everything bad off the radar to buy time.

There are rumours swirling that there will be a bank holiday in the UK, and they will be particularly hard pressed because of the high percentage of their GDP that financial services represent. The pound is heading to parity with the dollar. The good news is that it will probably not be as bad as Iceland.

The problem with Germany, and by inference continental Europe, is that their regulators refuse to acknowledge their errors and deal with the problems. They are the polar opposite of the Fed which acts first and plans later. The problem is that the Germans cannot seem to get beyond the planning stage because they cannot believe that their regulations and safeguards failed so badly. It has shaken their confidence. Additionally, the failed German bond auction was deemed catastrophic in its implications and has them fearful of policy error.

There is no way out of this mess without serious pain. Despite a deflationary bias today, most insiders see inflation and spiking interest rates as the risk going forward, probably early 2010 or sooner depending on how fast things start moving.

Are We Ready to Try Market Capitalism?

'When I use a word,' Humpty Dumpty said, in rather a scornful tone, `it means just what I choose it to mean -- neither more nor less.'

`The question is,' said Alice, `whether you can make words mean so many different things.'

`The question is,' said Humpty Dumpty, `to be master -- that's all.'

The refrain from Wall Street these days is "I worked hard for that bonus."

Lots of people work hard. Most of the people we know, probably many of the readers of this blog, could give lessons in working hard to these Wall Street whizkids.

A waiter or waitress works hard, very hard. But they don't get huge tips when they dump hot soup in the customer's lap.

You don't get paid for how hard you work, you get paid for how much value you add for your customers and your shareholders. If you work on commission and bonus your pay is intended to vary with performance, not by how much you can grab off the table before the police arrive.

The pay structure on Wall Street looks less like a profit based enterprise and more like organized crime.

What starts as a valuable component, a method of efficiently allocating capital for a small fee, becomes an oversized drain on the process it is intended to serve.

There is nothing wrong with capitalism and competitive markets and a healthy meritocracy. It is probably the most efficient and effective means of creating wealth and managing businesses.

We should try that system now that the cult of pay for privilege, interconnected frauds, rule by empty suits, and crony capitalism has failed.

Economic Times
For CEOs, thirst for bonuses may be in their DNA31 Jan 2009, 1151 hrs IST

NEW YORK: Why do CEOs need extravagant perks even when they are firing staff and pleading for taxpayer bailouts? It may just be in their makeup, experts say.

It takes arrogance and narcissism to become leader of a Fortune 500 company. Those same traits, however, have become their undoing during the deepest recession in decades. (If their narcissism is particularly acute they might become a Senator instead - Jesse)

U.S. President Barack Obama has noticed, telling reporters on Thursday he was outraged by a New York State report that $18.4 billion in Wall Street bonuses were paid in 2008 as taxpayers rescued the crumbling financial system.

"That is the height of irresponsibility. It is shameful," Obama said. (And as recent denizen of Congress he has a refined palate for shameful irresponsibility, which has been the primary product from Washington DC in recent years. - Jesse)

New York State Attorney General Andrew Cuomo, who is investigating Wall Street bonuses, welcomed Obama's comments.

"While Wall Street melted down, top executives believed that, unlike the rest of the country, they still deserved huge bonuses," Cuomo said. (And Congress took increasing pay raises, and a private pension system, and superior healthcare, while the median wage stagnated and the middle class dwindled - Jesse)

For Bob Monks, a former executive who has written nine books on corporate governance, the reason is that the rich and powerful simply love their toys.

"It's a boy thing. Sort of, 'Mine's bigger than yours.' It's really childish," said Monks, a shareholder rights activist and the subject of a book called "A Traitor to His Class." (It is not childish, for that is a slander on children. It is pathological. It is an addiction, a compulsion, a sickness that transcends the occasional petulance of childhood - Jesse)
Monks related a story about flying on someone's corporate jet. The host was devastated when, upon landing, he saw that while he planned for a limo to be waiting at the airport another captain of industry had a helicopter take him to town.

"I thought my guy was going to die. ... It's entirely about people's self-image." (It is about a sense of personal worthlessness. Some people have a huge hole in the center of their being, and and a compulsion to fill it up with things and people, to try to make themselves feel whole, but it can never satisfies, and they are ravening - Jesse)
Longtime advocates of shareholder rights were handed a gift in November when Detroit auto executives flew to Washington on corporate jets to ask for billions of dollars in taxpayer money, sparking a public outrage.

More recently, it became known that former Merrill Lynch CEO John Thain spent $1.2 million remodeling his office last year, including $1,405 for a trash can. Merrill Lynch is owned by Bank of America, which consumed $45 billion of taxpayer money through bailouts.

Then on Tuesday, Citigroup canceled plans to buy a $50 million executive jet after a White House rebuke.

"People don't become head of Merrill Lynch without having a certain sense of self-importance. Once they arrive at that position, they have all kinds of toadies tell them what geniuses they are, then of course they begin to feel their lifelong feelings of self-importance have been confirmed," said Charles Goodstein, a psychoanalyst and professor at New York University School of Medicine.

Defenders of executive perks say generous compensation is needed to retain talent. (Generous, not extravagant. There is a direct proportion between the emptiness of the suit and the extravagance of the trappings. There are only a few Steve Jobs; most of the others are verbally adept, highly cunning, political animals. For the most part it is the myth of the "Great Man." A surprisingly large number of them are frauds. The problem is the system does not manage them, eliminate them. It pays for the office, not for the performance. - Jesse)
Sometimes it's jets but can also include home security systems, country club memberships, sports tickets and financial advice. The value of these benefits is considered income, so CEOs also sometimes get another perk: company help in paying their taxes. (Set the tax rates so bloody high that they might consider competing on something more useful, like the performance of their companies - Jesse)
"I was CEO of a bank once and it's not rocket science. You need the same skill set as somebody running a hardware store in a medium-sized town," Monks said. (For many corporate managers the most difficult of the job is protecting the business from overpaid corporate goons with nothing better to do than to subvert the good of the business to their own personal ends in some of the most imaginative ways possible. And in high tech startups, the most intractable problem is trying to keep the VCs from destroying the company with their clumsy attempts at stealing the business. - Jesse)

Steve Thel, a former lawyer with the Securities and Exchange Commission and now a professor at Fordham Law School, blames compliant board members who often come from the same privileged world and can get paid hundreds of thousands of dollars for attending a few meetings each year. (The Boards are bastions of the fraternity of empty suits and the brotherhood of professional courtesy -Jesse)

"It's endemic to the system. The last administration didn't think there was any structural flaw. Now across the political spectrum people feel that Wall Street executive compensation is out of control," Thel said. (The former president is the epitome of a thin veneer of privileged arrogance covering a deep well of incompetence. - Jesse)
He predicted Congress would pass legislation granting minority shareholders more say on pay and possibly introduce higher taxes on some parts of executive compensation.

"A year ago it was absolutely unthinkable that this would be heard in Congress," Thel said.

Three Banks Closed on Friday, One With No Willing Acquirer

Utah's MagnetBank closed without an acquirer

MarketWatch
FDIC shuts down three banks in one day amid ongoing credit crisis
By John Letzing

Federal regulators closed three banks in a single day Friday, as the ongoing credit crisis showed no signs of abating.

Utah's MagnetBank became the fourth bank failure of the year, and the Federal Deposit Insurance Corp. was forced to directly refund depositors after being unable to find another institution willing to take over its operations.

That marked the first time the FDIC has been unable to find an acquirer for a failed bank in nearly five years, according to FDIC spokesman David Barr. "This bank did not have an attractive franchise value, and not many retail deposits or core deposits," Barr said. The FDIC had conducted an extensive marketing process for the bank's assets, he said.

Salt Lake City-based MagnetBank had total assets of $292.9 million as of Dec. 2, and $282.8 million in total deposits. "It is estimated that the bank did not have any uninsured funds," the FDIC said in a statement.

The FDIC later said it has also closed Maryland-based Suburban Federal Savings Bank, and Florida's Ocala National Bank.

Suburban Federal had total assets of roughly $360 million as of Sep. 30, and total deposits of $302 million, the FDIC said in a statement. Tappahannock, Va.-based Bank of Essex agreed to assume all of the failed bank's deposits, the FDIC said.

Ocala National had $223.5 million in total assets as of Dec. 31, and $205.2 million in total deposits, the FDIC said. Winter Haven, Fla.-based CenterState Bank has agreed to assume all of the failed bank's deposits.

The closures mark the fourth, fifth and sixth bank failures of 2009, bringing the total to 31 since the start of the credit crisis.