The Fed Failed As Regulator - It Was in Good Company

Wall Street veteran Henry Kaufman says in an interview with the Financial Times this week: “Certainly the Federal Reserve should shoulder a substantial part of this responsibility. . . it allowed the expansion of credit in huge magnitudes."

In the Fed's defense, a significant feature of their failure was the chairmanship of Alan Greenspan, who is probably most personally responsible of all the Fed governors for failing to safeguard the US financial system. As the long term chairman he had a significant power and influence over the rest of the board.

Also in the Fed's defense, their failure was no worse than the failure of the SEC and the CFTC, the Bush Administration and the Republican Congress in acting in the public's best interests. However, Chairman Greenspan is a personal standout culprit to anyone who follows the markets closely.

We find it ironic indeed that the plans to 'reform' the markets include giving more power to the Fed, since they are most certainly culpable in the current fiasco, not a public agency, still opaque and unaudited, apparently lacking sufficient checks and balances and public oversight.

Kaufman says Fed failed as regulator
By Aline van Duyn in New York

Published: April 14 2008 03:39 Last updated: April 14 2008 03:39

Henry Kaufman, the distinguished Wall Street economist, has added his voice to the debate about the Federal Reserve’s role in the credit crisis, saying the central bank failed to give enough importance to its role as a regulator.

In a video interview with the Financial Times, Mr Kaufman criticised the Fed’s monetary policy. He said it allowed too much credit expansion over the past 15 years and that this contributed to the market turmoil.

“Certainly the Federal Reserve should shoulder a substantial part of this responsibility. . . it allowed the expansion of credit in huge magnitudes,” Mr Kaufman said.

“Besides its monetary policy approach, [the Fed] really indicated very clearly that it was performing its role as a supervisor . . . in a minute fashion, not in an encompassing fashion. Monetary policy had a high priority, supervision and regulation within the Fed had a smaller priority.”

Mr Kaufman, who is on the board at Lehman Brothers, has long advocated tougher regulation of the biggest financial firms, arguing that they need to be made “too good to fail”, rather than remain “too large to fail”.

The near-collapse of Bear Stearns last month, and the Fed’s intervention which resulted in a purchase of the Wall Street firm by JPMorgan Chase, has triggered a renewed debate about whether banks can regulate themselves, or whether regulators need to impose tougher rules.

The credit crisis, which stems from losses on securities backed by risky mortgages made during the height of the housing bubble, could lead to total losses and writedowns of nearly $1,000bn for banks and investors around the world, according to the International Monetary Fund.

Mr Kaufman said a distinctive feature of the financial crisis was “much greater lapses in official supervision and regulation than in earlier periods”.

He said there should be a new federal regulator appointed who would work with the Federal Reserve but who would have responsibility for “intensively” regulating the 30 or 40 biggest financial firms. Failure to do so could lead to a “crisis that’s bigger than the one which we have today”.

“The supervision of major financial institutions requires deep skills in credit, deep skills in risk analysis techniques and it requires within that organisation, very skilled, trained professional people,” Mr Kaufman said. “That is lacking in the supervisory area in the United States.”

He added that recent proposals from Hank Paulson, secretary of the US Treasury, to overhaul US regulation “lack focus”. “There is going to be some reform of financial supervision and regulation; hopefully it will be along my lines rather than the big compendium of suggestions that came out of the US Treasury”, he said.

Henry Kaufman Video Interview at Financial Times Online

Earnings Lower, Stocks to Follow?

The remedy being prescribed by economic thinkers at the Fed and at the academy is to 'bury the problem in liquidity.' They had better be prepared to pile it high and deep.

In the short term remember this is April stock options expiry week and the Bowery Boys are flush with hot money, so anything can happen.

Goldman Strategists Say U.S. Earnings Are `Awful'
By Alexis Xydias

April 14 (Bloomberg) -- An ``awful'' start to the first- quarter U.S. earnings season is a ``harbinger of things to come'' that will push stocks lower, according to Goldman Sachs Group Inc.

``Early signs are awful,'' a team led by New York-based David Kostin, Goldman's U.S. investment strategist, wrote in a note today. ``We expect generally disappointing results and a swath of lowered profit guidance that will drive the Standard & Poor's 500 Index lower in coming weeks.''

The S&P 500, the benchmark index for American equities, dropped 2.7 percent last week after General Electric Co. said the credit-market crisis caused an unexpected earnings decline, while slowing economic growth and rising energy prices eroded profit at United Parcel Service Inc. and Alcoa Inc. Futures on the S&P 500 lost 0.1 percent at 10:50 a.m. in London.

Analysts surveyed by Bloomberg have cut their projections for first-quarter earnings at S&P 500 companies every week since Jan. 4. They now predict a 12.3 percent drop, compared with an estimate for an increase of 4.7 percent at the start of 2008.

Alcoa marked the start of the earnings reporting season on April 7 when it became the first company in the Dow Jones Industrial Average to post results.

Johnson & Johnson, the world's largest maker of consumer health-care products, is scheduled to report earnings tomorrow, while International Business Machines Corp., the biggest computer-services company, will follow a day later. Merrill Lynch & Co. will report April 17, while Citigroup Inc. will post results April 18.

Merrill and Citigroup will reveal at least $15 billion more of subprime mortgage writedowns this week, the Sunday Times of London reported yesterday, citing analysts it didn't identify...

To contact the reporter on this story: Alexis Xydias in London at axydias@bloomberg.net.

Wachovia Posts Loss, Plans $7 Billion Capital Raising
By David Mildenberg

April 14 (Bloomberg) -- Wachovia Corp., the fourth-largest U.S. bank, reported an unexpected loss because of subprime- infected mortgage holdings, cut its dividend and said it will raise about $7 billion in a share sale to replenish capital.

The first-quarter loss of $393 million, or 20 cents a share, compared with earnings of $2.3 billion, or $1.20, a year earlier, the Charlotte, North Carolina-based company said in a statement today. Analysts had been estimating Wachovia would earn about 40 cents a share, according to a survey by Bloomberg. Wachovia fell 8.4 percent to $25.66 in German trading.

Chief Executive Officer Kennedy Thompson said he was ``deeply disappointed'' after Wachovia posted its first quarterly loss since 2001 and reduced the dividend to preserve $2 billion of funds. The company's market value has dropped 50 percent since its ill-timed $24.6 billion takeover of Golden West Financial Corp. in 2006 at the peak of the housing market.

``The most painful decision was to reduce the dividend because it adversely affects our shareholders,'' Thompson said in the statement. ``But we believe the long-term benefit to shareholder value outweighs the disadvantage of the dividend reduction as we fortify our balance sheet against continued instability in the housing and capital markets.''

Wachovia also said today it will cut 500 investment banking jobs, without providing specifics. The planned capital raising, comprising common stock and convertible preferred shares, has attracted strong interest from investors and will ``enhance our ongoing financial flexibility,'' Thompson said. The bank listed a Tier 1 capital ratio of 7.5 percent.

Fed Says the Credit Crisis Is Not Over

From The Times
April 14, 2008

US Federal Reserve says that credit crisis is not over yet
Suzy Jagger in Washington

The credit crisis engulfing the banking system on both sides of the Atlantic has further to run, said the vice-chairman of the US Federal Reserve. As the US Treasury Secretary and central bankers gave warning that proposed financial reforms would not prevent a repeat of the biggest shock to the world economy since the Great Depression, Donald Kohn, of the Fed, said of the present trouble: “It is not over yet.”

His gloomy forecast about the duration of the credit crisis, delivered at the annual spring meeting in Washington of the Group of Seven leading economies, came after the International Monetary Fund had estimated that the market turmoil would trigger losses of almost $1 trillion (£507 billion) among banks, hedge funds and pension groups since last summer. Mr Kohn said: “The market is still adjusting. The turmoil has not settled down yet. It is still a very fragile situation.”

Finance ministers from the United States, Britain, Canada, Japan, France, Germany and Italy endorsed a set of wide-ranging financial reforms to address the credit crisis, but they also said that none of the measures would prevent a similar crisis in the future.

Among the ideas being considered are changes to the way that banks reward staff with huge annual bonuses. Officials are concerned that bonuses encourage risk taking and have proposed an alternative remuneration system that would pay out over a longer time period. Henry Paulson, the US Treasury Secretary, said: “No silver bullet exists to prevent the excesses of the past from re-occurring. It took time to build up recent excesses and it will take time to work through the consequences. We must expect more bumps in the road: 2008 will be a more difficult year.”

Mr Kohn said: “All we can do is to try to make the system more resilient. To make the effects more muted, absorbed by liquidity. Enhanced information and transparency will be greater and will, hopefully, make markets and economies more resilient.”

Mr Kohn was speaking as part of the executive team running the Financial Stability Forum, whose recommendations have been endorsed by the G7 group of nations in a bid to strengthen regulation. The G7 wants to force banks to adopt new crisis prevention measures, such as eventually raising the amount of capital that they hold on their books to act as a cash cushion during difficult market conditions. (The banks do everything they can to circumvent this, as in SIVs in response to the Basel II requirements. So what will change? This is a bandaid on an infected wound. - Jesse)

They have also issued more immediate demands for financial institutions to quickly declare their losses from the crisis. They want to make banks increase the level of transparency to shareholders and regulators about the strength of assets on their balance sheets and to urge regulatory bodies to co-operate better and to share information. They also threatened to introduce legislation that would compel credit rating agencies to admit to conflicts of interest when they rate securities. (Oooooh. Everything they do is a conflicted under the current system. - Jesse)

The G7 finance ministers and bankers agreed to implement reforms within a 100-day timetable, which would make banks set out “fully and promptly” losses and exposures to illiquid mortgage-backed securities blamed for the seizure of credit markets.

However, the policymakers were also keen to say that it was unrealistic to expect regulators to devise an early warning system that would identify the start of a financial crisis or a banking institution that was in difficulties. (Bring back Glass-Steagall. Firewall the guaranteed banking system from reckless speculation and conflicts of interest - Jesse)

Timothy Geithner, of the Federal Reserve Bank of New York, said: “If we could figure out a way to have on our desks a screen with the capacity to predict financial crises it would be terrific, but it is very hard to do. What we can do is make the system more resilient.”

(What we need to do is make the system accountable, credible, and honest. Bring back Glass-Steagall and close the loopholes as we saw with the S&L's. The banks spent hundreds of millions of dollars lobbying to repeal it. Firewall the banking system while they try to reform the speculative arenas. Let them steal from each other and not dip into the public's pockets. - Jesse)

The Financial Stability Forum Meets the Bowery Boys

Financial Stability Forum Report to the G7 April 7/08 (PDF)

"...the balance sheets of financial institutions are burdened by assets that have suffered major declines in value and vanishing market liquidity. Participants are reluctant to transact in these instruments, adding to increased financial and macroeconomic uncertainty.

To re-establish confidence in the soundness of markets and financial institutions, national authorities have taken exceptional steps with a view to facilitating adjustment and dampening the impact on the real economy. These have included monetary and fiscal stimulus, central bank liquidity operations, policies to promote asset market liquidity and actions to resolve problems at specific institutions. Financial institutions have taken steps to rebuild capital and liquidity cushions.

Despite these measures, the financial system remains under stress. While national authorities may continue to consider short-term policy responses should conditions warrant it, to restore confidence in the soundness of markets and institutions, it is essential that we take steps now to enhance the resilience of the global system.

To this end, the FSF proposes concrete actions in the following five areas:

• Strengthened prudential oversight of capital, liquidity and risk management.
• Enhancing transparency and valuation.
• Changes in the role and uses of credit ratings.
• Strengthening the authorities’ responsiveness to risks.
• Robust arrangements for dealing with stress in the financial system."


FINANCIAL STABILITY FORUM

Executive Summary

Strengthened prudential oversight of capital, liquidity and risk management

Capital requirements:

Specific proposals will be issued in 2008 to:
• Raise Basel II capital requirements for certain complex structured credit products;
• Introduce additional capital charges for default and event risk in the trading books of banks and securities firms;
• Strengthen the capital treatment of liquidity facilities to off-balance sheet conduits.

Changes will be implemented over time to avoid exacerbating short-term stress.
(Special challenge: banks have been using SIVs extensively to blow off the Basel II requirements as they had been. What good will raising them do? - Jesse)

Liquidity:

Supervisory guidance will be issued by July 2008 for the supervision and management of liquidity risks.
(Yeah it can wait. Its only the heart of the crisis. - Jesse)

Oversight of risk management:

Guidance for supervisory reviews under Basel II will be developed that will:
• Strengthen oversight of banks’ identification and management of firm-wide risks;
• Strengthen oversight of banks’ stress testing practices for risk management and capital planning purposes;
• Require banks to soundly manage and report off-balance sheet exposures;

Supervisors will use Basel II to ensure banks’ risk management, capital buffers and estimates of potential credit losses are appropriately forward looking.
(Here's a teaspoon and a feather-duster, go clean that Augean Stable. - Jesse)

Over-the-counter derivatives:

Authorities will encourage market participants to act promptly to ensure that the settlement, legal and operational infrastructure for over-the-counter derivatives is sound.
This sounds like sending a copy of MISS MANNERS to Al Capone. -Jesse)

Enhancing transparency and valuation

Robust risk disclosures:
• The FSF strongly encourages financial institutions to make robust risk disclosures using the leading disclosure practices summarised in Recommendation III.1 of this report, at the time of their mid-year 2008 reports.
• Further guidance to strengthen disclosure requirements under Pillar 3 of Basel II will be issued by 2009.
(Sixtieth Rule of Ferengi Acquisition: Keep Your Lies Consistent. - Jesse)

Standards for off-balance sheet vehicles and valuations:
Standard setters will take urgent action to:
• Improve and converge financial reporting standards for off-balance sheet vehicles;
• Develop guidance on valuations when markets are no longer active, establishing an expert advisory panel in 2008.

Transparency in structured products:

Market participants and securities regulators will expand the information provided about securitised products and their underlying assets.
(The core of the problem is that the risk management models these jokers have been using have some whoppers of assumptions in them, and are essentially grounded in foo-foo dust. But let's do more of it and it will get better. - Jesse)

Changes in the role and uses of credit ratings

Credit rating agencies should:
• Implement the revised IOSCO Code of Conduct Fundamentals for Credit Rating Agencies to manage conflicts of interest in rating structured products and improve the quality of the rating process;
• Differentiate ratings on structured credit products from those on bonds and expand the information they provide.

Regulators will review the roles given to ratings in regulations and prudential frameworks.


Strengthening the authorities’ responsiveness to risks

• A college of supervisors will be put in place by end-2008 for each of the largest global financial institutions.
(College! Cool! We'll be Animal House. Ben can be Dean Wurmer. Aw, everyone wants to be Bluto. The Board wants to dance wif yo dates. Road Trip!! - Jesse)

Robust arrangements for dealing with stress in the financial system
• Central banks will enhance their operational frameworks and authorities will strengthen their cooperation for dealing with stress.
(Group yoga sessions? - Jesse)