Draining the Swamp: The Fed's Tri Party Repo Machine

A triparty repo transaction is a transaction among three parties: a cash lender acting on behalf of all holders of dollars (the Fed), a borrower that will provide collateral (dodgy debt holder in shaky financial condition), and a clearing bank, most likely a primary dealer like J.P. Morgan, which is only too happy to collect its fees as an agent of the Fed.

The triparty clearing bank provides custody (agency) accounts for parties to the repo deal and collateral management services. These services include ensuring that pledged collateral meets the cash lenders’ requirements, pricing collateral, ensuring collateral sufficiency, and moving cash and collateral between the parties’ accounts. What if any liabilities the clearing bank such as J.P.Morgan might obtain for the mispricing of risk remain undisclosed, but are probably negligible at worst.

This is the method of obtaining toxic assets from the books of non-primary dealers, and providing stability and liquidity from the aggregate value of all dollar holders to cover the misdeeds of diverse financial institutions and other favored parties.

In other words, the Fed is draining the financial debt swamp and toxic waste dumps into your basement, if you hold Federal Reserve Notes. Your IRA's, your 401k's, your savings, as long as you hold Federal Reserve Notes, which are claims on their balance sheet loosely backed by the Treasury. When the Fed's balance sheet contained nothing but Treasuries and explicity backed agencies that relationship was firmer. Now, we are into the realm of make believe and Timmy's credibility.

The Fed pledges Morgan assure them that there will be no radioactive material in the sludge pond headed your way, and levels of carcinogenic and toxic contamination will be within levels that they believe are adequate based on the non-binding estimates.

In practice the Fed has a defaults account on its book for the shortfalls from fat valuations due to the toxic debt it has already assumed on your behalf.

The source and composition of the sludge will remain a secret among the bankers, without oversight. This seems like taxation without representation, at least for holders of dollars that are US citizens, since the Fed is engaging in the expenditure of public money without hearings, votes, public oversight, or controls. The Fed seeks to become a financial Star Chamber, dispensing 'justice' as it pleases.

WSJ
Tri-Party Repo Could See 1st Round Of Reforms By Year-End
By Deborah Lynn Blumberg
NOVEMBER 30, 2009, 5:20 P.M. ET.

NEW YORK (Dow Jones)--Progress is being made in reaching agreement on a first round of reforms for the crucial tri-party repo market and details could be revealed as early as the end of this year, according to people familiar with ongoing discussions.

The reforms, which focus on margin requirements and intraday credit, are a first step in making security repurchase transactions more secure and preventing this $4.3 trillion over-the-counter market, where firms raise cash against collateral, from becoming a source of instability for the broader financial system.

They also come at a time when the repo market will be in the spotlight as the Fed plans for the day when it will start to pull the massive amounts of cash it has extended to markets from the system. The Fed is planning to use reverse repo operations--selling dealers securities such as Treasurys for cash with the agreement to buy them back later at a higher price--as one tool to achieve that goal.

The drive to reform the repo market--whose smooth functioning is key to the health of the financial system--has recently gained traction, in part due to the expiry of the Fed's primary dealer credit facility in February 2010. The facility serves as the current borrowing backstop for the big banks that deal directly with the central bank. Without it, the banks will have to rely more on repo for funding, which adds to the need to strengthen its functioning.

According to one person involved with the talks, the New York Fed-sponsored Tri-Party Repurchase Agreement Infrastucture Task Force could issue a progress report on repo reform discussions and seek feedback from the broader market as early as December.

The New York Fed was unavailable for comment.

The reforms will focus on the tri-party repo market, which makes up the biggest chunk of the repo market. In this market, a clearing bank stands between the borrower and the lender, holding collateral and facilitating the trades. The two dominant clearing banks in the U.S. are J.P. Morgan Chase & Co. (JPM) and the Bank of New York (BK).

In a first step, reform will focus on steps that market participants can address without outside input: standardizing margin requirements and tackling the issue of the intraday extension of credit in the market. Longer-term reforms to reduce systemic risk in tri-party repo are still being debated.

Standardized, or minimum margin requirements, would add security for the two clearing banks. Higher margins could be required for certain types of securities, such as commercial paper, or high-yield debt, or for riskier banks.

Intraday credit has also been a top concern. Currently, for operational efficiency, the two clearing banks extend intraday credit on term repos, or repos longer than overnight, meaning they return cash to the lender and securities to the borrower each day even though the contract continues to run. That leaves the clearing bank on the line should either counterparty falter.

One possible solution is to bring the U.S. term repo market more in line with overseas markets, by not allowing term repos using less liquid securities, such as corporate debt, to unwind every day. Other transactions, such as those using the more liquid Treasury securities, would still unwind every day.

The need for repo reforms has been apparent to policymakers for years, but was paid greater heed after severe disruptions in the market during the recent financial crisis.

Borrowers, lenders, clearers, industry groups and the Fed came together in September to form the repo task force and have been meeting every few weeks since then. Members have been working on crafting an initial set of reforms that would help to protect the tri-party repo market from future financial market disruptions.

The Dangerous US Financial Sector Is Still Smoldering and May Reignite

Timmy and the Merry Pranksters at the Treasury and the Fed are throwing taxpayer money at the financial sector with the same prudence with which Angelo Mozilo used sunblock.

Smothered by paper, the fire in the financials is still smoldering, and could reignite with the breezes of further credit contractions in commercial real estate, mortgage foreclosures, and frothy debt in the developing world.

When the US financial system tumbles there should be little doubt where Ben, Tim, Larry, and their Boss failed the American taxpayer and all holders of US debt.

The ratings fraud and accounting deception will continue until confidence is restored.


Barron's
More Nasty Bank Surprises
By JIM MCTAGUE
November 28, 2009

THERE'S GROWING EVIDENCE THAT THE CASE FOR buying financial stocks is larded with "bulloney." Recent indications are that bank regulators from the Treasury to the Federal Reserve to the Federal Deposit Insurance Corporation and on to the state level remain in the dark about the quality of bank-loan portfolios -- especially at small to midsize institutions. An estimated 21 publicly traded banks that have received TARP injections are on the ropes, according to published reports. The number likely will grow, leading to some nasty surprises for investors.

Because of the political antipathy toward Wall Street, the consensus is that any Congressional financial regulatory reform bill will be punitive in the extreme and consequently inhibit the growth and profitability of the sector for years to come. This hardly is a buy signal.

The latest and perhaps most startling evidence of endemic regulatory weakness is the failure this month of two banks and the bankruptcy of CIT, all recipients of TARP funds from Treasury after they were deemed earlier in the year by "expert" regulators to be safe and sound. CIT received $2.3 billion in taxpayers-financed TARP funds; UCBH Holdings, parent of San Francisco's United Commerce Bank, received $299 million; and Pacific Coast National Bank, a San Clemente, Calif., lender, received $4.1 million. All were publicly traded.

The aforementioned 21 wobbly publicly traded companies that have received TARP money had zero or negative net income. They've suspended dividend payments to the Treasury. Regulators vetted all of these institutions, using the "CAMELS" rating system. CAMELS stands for "Capital, Asset quality, Management, Earnings, Liquidity, and Sensitivity (which measures interest-rate risk, exchange-rate risk, and other market risk). Each bank's CAMELS score is secret. Banks with the lowest scores were excluded from TARP. Those with the highest scores were fast-tracked. Banks with average CAMELS scores received the most extensive vetting. They were recommended by their primary regulators for review by a panel of experts from the FDIC, the Fed and the Office of the Comptroller of the Currency. The panel then forwarded the case file on to the Treasury.

Some of the TARP awards seem outlandish. Linus Wilson, an assistant professor of finance at the University of Louisiana, points out that CIT Group's preferred stock was yielding an astronomical 20% before it received a TARP investment intended for healthy banks. The regulators demanded dividends on the TARP money of just 5%. Wilson says that regulators should have been able to determine in five minutes that this return was far too low to compensate taxpayers for the risk.

No surprise then that regulators recently determined that $5.1 billion in TARP funds are not in healthy banks but rather in banks that have failed or, may soon fail.

As for legislation, be assured it will toughen oversight, increase capital requirements and enhance consumer protection. Profits will shrink. The universe of financial institutions will contract. Here's hoping that you are better than regulators at picking winners from losers.

The 38 Year Cycle in US Monetary History

I am not a big believer in comprehensive cycle theory. The weakness of cycles is the same as all systems that seek to impose an external order on natural events and occurrences: one can always find something to fit in a less than rigorously defined methodology. This applies from biblical prophecy codes based on the placement of words and letters, to cycle and wave theories with a wide range of alternatives.

However, I also believe in what call 'generational memory.'  People as a group often forget the lessons of the past, and human nature being what it is, events based on bad judgement and reckless behaviour seem to recur at regular intervals.  Or as J.K.Galbraith observed, there are essentially no new financial frauds, just new variations on the established themes.

If there was any 'tell' for the current crisis, it was the general overturning of the safeguards for the financial system that had been put in place in the aftermath of the financial panic of 1929 and the Great Depression that followed, culminating in the eventual overturn of Glass-Steagall and the ascendancy of extreme leverage using exotic, unregulated instruments.

This is why we call this a generational change. This is no slump, and not even a common recession. And it is far from over.

We are experiencing some major changes that are easily lost when one only looks at the day to day moves, listens to the description of events on the mainstream media, and of course, have a lack of memory, a knowledge of history, of things that have happened to their grandfathers and great grandfathers. The arrogant ignorance of so many still in place is a sure sign of greater chastisement to come, until the lessons of history are learned again, and the system is brought back into a sustainable balance.

2009

The story is still being written, and history will have its say over time. But it will likely include the reckless expansion of credit by the Greenspan Fed, the lapses in financial regulation, the overturn of Glass-Steagall, and the financial scandals including LTCM, Enron, Worldcom, culminating in the failure of the US banking system which began in 2007 including the de facto nationalization of the banks.

The loss of confidence in the informal Bretton Woods II arrangement with the dollar as the world's reserve currence with the rise of alternatives, precipitated by the unprecedented expansion of the monetary base by the Bernanke Fed including the monetization of private debts, will be the hallmark of the crisis from a monetary perspective.

1971

Nixon Closes the Gold Window on Bretton Woods

"The Nixon Shock was a series of economic measures taken by U.S. President Richard Nixon in 1971 including unilaterally canceling the direct convertibility of the United States dollar to gold that essentially ended the existing Bretton Woods system of international financial exchange.

By the early 1970s, as the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. was running a balance of payments deficit and a trade deficit, the first in the 20th century. The year 1970 was the crucial turning point, which, because of foreign arbitrage of the U.S. dollar, caused governmental gold coverage of the paper dollar to decline 33 percentage points, from 55% to 22%. That, in the view of Neoclassical Economists and the Austrian School, represented the point where holders of the U.S. dollar lost faith in the U.S. government’s ability to cut
its budget and trade deficits.

In 1971, the U.S. government again printed more dollars (a 10% increase) and then sent them overseas, to pay for the nation's military spending particularly in Vietnam and private investments. In May 1971, inflation-wary West Germany was the first member country to leave the Bretton Woods system — unwilling to deflate the deutsche mark to prop up the dollar.

Because of the excess printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America’s “promise to pay” - that is, the redemption of their dollars for gold. On 5 August 1971, Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against foreign speculators.

To stabilize the economy and combat runaway inflation, on August 15, 1971, President Nixon imposed a 90-day wage and price freeze, a 10 per cent import surcharge, and, most importantly, “closed the gold window”, ending convertibility between US dollars and gold. The President and fifteen advisors made that decision without consulting the members of the international monetary system, thus the
international community informally named it the Nixon shock.

Given the importance of the announcement — and its impact upon foreign currencies — presidential advisors recalled that they spent more time deciding when to publicly announce the controversial plan, than they spent creating the plan. He was advised that the practical decision was to make an announcement before the stock markets opened on Monday (and just when Asian markets also were opening trading for the day). On August 15, 1971, that speech and the price-control plans proved very popular and raised the public's spirit. The President was credited with finally rescuing the American public from price-gougers, and from a foreign-caused exchange crisis." Wikipedia

1933 - 1934

Suspension of the Gold Standard and Dollar Devaluation

"In early 1933, in order to fight severe deflation Congress and President Roosevelt implemented a series of Acts of Congress and Executive Orders which suspended the gold standard except for foreign exchange, revoked gold as universal legal tender for debts, and banned private ownership of significant amounts of gold coin. These acts included Executive Order 6073, the Emergency Banking Act, Executive Order 6102, Executive Order 6111, the Agricultural Adjustment Act, 1933 Banking Act, House Joint Resolution 192, and later the Gold Reserve Act. This set up the devaluation of the dollar. In early 1934 F.D.R. increased the price of gold by 69%($20.67 to $35/oz). This represented a 41% devaluation of the US dollar." Dollar Devaluation in 1934, I. M. Vronsky

1895

Gold Panic: U.S. Gold Supply Running Dry

"The early 1890s were not kind to America's gold reserves...Coupled with declining revenues triggered by various protective tariffs, the reserves plummeted, taking a severe toll on the economy. In 1893, the falling gold supply helped spark a debilitating financial crisis known as the Panic of 1893...By February 8, 1895, the gold supplies had thinned out to a paltry $41 million.

With the U.S. Treasury teetering on the brink of bankruptcy, Cleveland intervened, and using a syndicate led by J.P. Morgan as an intermediary and U.S. bonds as bait, attempted to buy back gold from foreign investors. Cleveland sold roughly sixty-two million dollars worth of bonds, valued at 3.75 percent, to Morgan's syndicate. Morgan and company in turn shopped the issues to foreign parties for a handsome profit. Although clearly borne of desperation, the deal nonetheless provided some badly needed relief: it briefly spelled the gold crunch and saved the Treasury from disaster. " This Day in History

1857

The Panic of 1857

"The Panic of 1857 abruptly ended the boom times that followed the Mexican War. The immediate event that touched off the panic was the failure of the New York branch of the Ohio Life Insurance and Trust Co., a major financial force that collapsed following massive embezzlement. Hard on the heels of this event arrived other setbacks that shook the public's confidence...

Widespread railroad failures occurred, an indication of how badly over-built the American system had become. Land speculation programs collapsed with the railroads, ruining thousands of investors.

Confidence was further shaken in September when 30,000 pounds of gold were lost at sea in a shipment from the San Francisco Mint to eastern banks. More than 400 lives were lost as well as a loss of public confidence in the government's ability to back its paper currency with specie.

In October, a bank holiday was declared in New England and New York in a vain effort to avert runs on those institutions. Eventually the panic and depression spread to Europe, South America and the Far East. No recovery was evident in the United States for a year and a half and the full impact did not dissipate until the Civil War."

1819

The Panic of 1819

"The causes of the Panic of 1819 were the first to largely originate within the U.S. economy. The resulting crisis caused widespread foreclosures, bank failures, unemployment, and a slump in agriculture and manufacturing. It marked the end of the economic expansion that had followed the War of 1812. However, things would change for the US economy after the Second Bank of the United States was founded in 1816, in response to the spread of bank notes across United States from private banks, due to inflation brought on by the debt following the war.

In the event, President Monroe, interpreting the economic crisis in the narrow monetary terms then current, limited governmental action to economizing and ensuring fiscal stability. He acquiesced in suspension of specie (gold) payments to bank depositors, setting a precedent for the Panics of 1837 and 1857."

Mark Pittman, Investigative Journalist

Bloomberg
Mark Pittman, Reporter Who Foresaw Subprime Crisis, Dies at 52
By Bob Ivry

Nov. 28 (Bloomberg) -- Mark Pittman, the award-winning investigative reporter whose fight to open the Federal Reserve to more scrutiny led Bloomberg News to sue the central bank and win, died Nov. 25 in Yonkers, New York. He was 52.

Pittman suffered from heart-related illnesses. The precise cause of his death wasn’t known, said his friend William Karesh, vice president of the Global Health Program at the Bronx, New York-based Wildlife Conservation Society.

A former police-beat reporter who joined Bloomberg News in 1997, Pittman wrote stories in 2007 predicting the collapse of the banking system. That year, he won the Gerald Loeb Award from the UCLA Anderson School of Management, the highest accolade in financial journalism, for “Wall Street’s Faustian Bargain,” a series of articles on the breakdown of the U.S. mortgage industry.

“He was one of the great financial journalists of our time,” said Joseph Stiglitz, a professor at Columbia University in New York and the winner of the 2001 Nobel Prize for economics. “His death is shocking.”

Pittman’s fight to make the Fed more accountable resulted in an Aug. 24 victory in Manhattan Federal Court affirming the public’s right to know about the central bank’s more than $2 trillion in loans to financial firms. He drew the attention of filmmakers Andrew and Leslie Cockburn, who gave him a prominent role in their documentary about subprime mortgages, “American Casino,” which was shown at New York City’s Tribeca Film Festival in May.

‘One Reporter’

“Who sues the Fed? One reporter on the planet,” said Emma Moody, a Wall Street Journal editor who worked with Pittman at Bloomberg. “The more complex the issue, the more he wanted to dig into it. Years ago, he forced us to learn what a credit- default swap was. He dragged us kicking and screaming.”

James Mark Pittman was born Oct. 25, 1957, in Kansas City, Kansas, where he played linebacker on the high school football team. He took engineering classes at the University of Kansas in Lawrence before graduating with a degree in journalism in 1981. He was married soon after and had a daughter, Maggie, in 1983. The marriage ended in divorce.

Pittman’s first reporting job, covering the police department for the Coffeyville Journal in southern Kansas, paid so little he took a part-time job as a ranch hand across the Oklahoma border in Lenapah, according to an interview he gave to Ryan Chittum for the Columbia Journalism Review’s The Audit, a watchdog for the business press.

‘Huge Personality’

“What a funny guy -- huge personality,” Chittum said in an e-mail message. “Mark was my favorite reporter working. In a time when too much journalism is timid or co-opted, Mark personified the whole ‘afflict the comfortable’ tenet of the business. Mark’s passing is a huge loss for journalism at a time when we can least afford it.”

Pittman spent a year in Rochester, New York, with the Democrat & Chronicle newspaper and 12 years at the Times Herald- Record in Middletown, New York, where he met his second wife, Laura Fahrenthold-Pittman in 1995.

“All I know is we fell in love the moment we met,” Fahrenthold-Pittman said in an interview Friday. “We moved in together a week later. He was as serious about his family life as he was about work. Mark did nothing in a small way.”

Pittman joined Bloomberg News in 1997. In 2007, he was writing about the securitization of home loans when subprime borrowers, who have bad or limited credit histories, began missing payments on their mortgages at a faster pace.

S&P, Moody’s

His June 29, 2007, article, headlined “S&P, Moody’s Hide Rising Risk on $200 Billion of Mortgage Bonds,” was excoriated at the time by Portfolio.com for “trying to play ‘gotcha’ with the ratings agencies.”

“And that really isn’t helpful,” said the unsigned posting.

Pittman’s story proved prescient. So did his reports on U.S. banks exporting toxic mortgages overseas, on Treasury Secretary Henry M. Paulson’s role in creating those troubled assets while he was chief executive officer of Goldman Sachs Group Inc. and on the U.S. bailout of American International Group Inc.

“He’s been on this crisis since before the crisis,” said Gretchen Morgenson, the Pulitzer Prize-winning financial columnist for the New York Times. “He was the best at burrowing into the most complex securities Wall Street could come up with and explaining the implications of them to readers of all levels of sophistication. His investigative work during the crisis set the standard for other reporters everywhere. He was a giant.”

‘Fearless, Trusted’

In the “Faustian Bargain” series, Pittman explained how 5 percent of U.S. mortgage borrowers missing monthly payments could lead to a freeze in lending throughout the world.

“Mark Pittman proved to be the most fearless, most trusted reporter on the most important beat during the 12 years he wrote about credit markets, corporate finance and the Federal Reserve at Bloomberg News,” said Bloomberg Editor-in-Chief Matthew Winkler. “His colleagues will miss his laughter and generous sense of mission. Bloomberg readers were rewarded by his many achievements culminating with a federal court ruling validating his search for records of taxpayer-financed policies withheld from the public and the Gerald Loeb Award.”

Public policy would be more effective if reporters, lawmakers and citizens understood how the financial system worked and why the crisis happened, Pittman said in the Feb. 27, 2009, interview with Chittum.

“Hopefully, we will be able to inform the people enough to know how badly we’re getting screwed,” he said with a laugh. “We need to know how to prevent it from happening again, and we need to know who did it.”

Booming Laugh, Bourbon

Standing 6 feet 4 inches (1.93 meters) with a booming laugh, a loud telephone voice and a taste for bourbon, Pittman made lifelong friends on Wall Street, in Congress, in journalism circles and in the artistic community after he and his wife opened an art gallery in Yonkers in 2005.

“I always learned something new when I spoke with Mark,” said Representative Scott Garrett, a New Jersey Republican on the House Financial Services Committee. “He was dogged in pursuit of the truth. This is a great loss for journalism and for those who relied on Mark for his insight.”

In “American Casino,” the title of which comes from an expression Pittman uses in the documentary, the filmmakers profile subprime borrowers who are losing their homes, mortgage brokers who made loans they knew their customers could never repay and bankers and ratings analysts whose companies profited from the housing boom...