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)

SP 500 WEEKLY Chart - Bear Market Update April 12

The intra-week volatility is significant, and snapback short covering rallies are normal, and not the exception in this market.

Despite the Fed's almost unprecedented interventions, at least since the 1930's, the market trend is still lower. Look at the daily charts linked on the side of this blog to keep an eye on those chart formations.

Be careful with your leverage, and in particular the use of options, especially April stock index and 'popular plays.' With these continuing low volumes heavy trades to one side invite a violent hit from the well-heeled trading desks.

Watch for cross market correlations and inversions and use these as hedges if you wish to be an aggressive trader. This requires significant capital to maintain adequately.

Cash is a position. Contra-dollar 'cash' positions paying decent yields have been some of our most rewarding plays. There are forex ETF's in addition to actual foreign government bonds and high dividend stocks. Forex trading is triple black diamond, for experienced traders only, with the odds heavily against even a talented amateur.

Sometimes NOT trading is a very powerful tool as you wait for the odds to improve in your favor, or your gains to run higher over time in a position. We have positions contra-dollar we've not touched since early 2006.

Hyperinflationary Depression in the US 2010 - John William, Shadow Government Statistics

We don't necessarily agree with John Williams' analysis here. But its not sufficient to merely disagree. One has to listen to the argument, the key points and mechanisms, and then show WHY they might be invalid and where they might be less probable than something else.

John may be right. We have an enormous respect for him. His site is worth looking at, and his arguments are worth a listen. But we think he makes the error of assuming that the trends will be as they are today, and one can just extend them into the future, without limit, and not account for 'step changes' and likely exogenous events. This is an all too common error with model based predictors.

As a thumbnail sketch of our disagreement, we think that deflation and hyperinflation can only occur deterministically with reference to an external standard. With the lapse of the gold standard, there is none. Therefore its more likely to be the end result of policy decision(s).

Before the US lapses into a hyperinflationary depression the G8 will have an enormous incentive to essentially bail the US out by inflating their own currencies in sympathy and allowing the US to essentially and selectively default on its sovereign debt, in order to save the world financial system. In many ways Bear Stearns is a microcosm of the United States Treasury.

Doing nothing increases the probability that there will be a war, a significant world war, which will tend to wipe the slate clean, at least for the victor (if there is one) in terms of debt obligations. Not only is the US too big to fail, its too big a warpower for anyone to be easily able to collect what's owed to them.

That's what we think, but all things being equal, John does have his points in order, and his hypothesis is probable, more so than deflation, which is also a possibility. Volcker said deflation has an extraordinarily slim chance of occurring in the US. We tend to view it as an overt policy decision. Net debtors do not willingly choose deflation; they are compelled to it by some external force or constraint.

The best argument for the deflation alternative is that our monetary system is dependent on bank loans for the expansion of debt, and debt is money. However, we think the Fed is going to give us a lesson in monetizing debt, and there is plenty of it to go around. Common sense is a fine tool, but more detailed knowledge and rigorous thinking is essential.

John Williams is interviewed by Jim Puplava - MP3 Audio download: A Hyperinflationary Depression in the US 2010

Shadow Government Statistics Homepage

An Accounting View of the Financial Credit Crisis

Here's a joke to cheer up GE shareholders on this difficult morning.
(Hat tip to Sean, the Irish gnome in Zurich)

There are two sides to a bank's balance sheet - the left side and the right side.

The problem is that, on the left side, there is nothing right,
and on the right side, there is nothing left!

And some weekend reading for Jeff Immelt.

As a reminder, US financial companies start reporting their quarterly results next week.

PigMan of the Week Award

Thanks go to Lloyd Blankfein of Goldman Sachs for giving the markets some weasel-worded false encouragement Thursday morning that the credit crisis is "almost over." It helped to trigger a sucker's rally.

And "if we are in a recession, its a mild one." We'll put that one down in the books. In fact, we wish someone would take a look at your trading book.

Lloyd, who received about $70 million of compensation last year by some estimates, also said that shareholder votes on executive pay would "constrain the board and hurt the investment bank's ability to attract the best employees."

Lloyd, you get the "PigMan of the Week Award."

Reuters
Goldman CEO says "say on pay" a bad idea
Thursday April 10, 2:24 pm ET
By Joseph A. Giannone

NEW YORK (Reuters) - Goldman Sachs Group Inc (NYSE:GS - News) Chief Executive Lloyd Blankfein, who received about $70 million of compensation last year by some counts, said on Thursday that shareholder votes on executive pay would constrain the board and hurt the investment bank's ability to attract the best employees.

So-called "say on pay" initiatives, which allow shareholders to provide a nonbinding approval or rejection of a board's proposed pay package for senior executives, have become a hot topic among shareholder groups, pensions and other large investors focused on corporate governance issues.

In a spirited annual meeting held in a downtown Manhattan, a number of Goldman shareholders urged the board and investors to adopt an advisory vote as a tool to keep a lid on excessive pay. Advocates also argued the proposal would give shareholders a greater voice on an important matter, without binding directors.

Blankfein, in an extended response, expressed his concern that "say on pay" would limit directors in exercising their judgment.

Say on pay would "create a feedback loop. It would create a cloud, a constraint, a limitation on decisions that have been at the heart of what a board has done," Blankfein said.

The board, he said, needs to have the flexibility to weigh compensation packages and the market environment. He also expressed concern that decisions by board member could be judged by uninformed investors.

"Our compensation has been very well-correlated to performance," he said.

Goldman's shareholders apparently agreed, as the say on pay proposal was rejected, receiving approval by 43 percent of shares voted and 30 percent of shares outstanding.

Some speakers argued Goldman's compensation was enormously high. According to the proxy statement, Goldman's top five senior executives received roughly $250 million last year in salary, cash bonuses, stock awards and other compensation, excluding stock options.

For context, that haul was greater than JPMorgan Chase & Co's initial fire-sale takeover bid of $236 million for Bear Stearns Cos Inc.

"Nothing Fundamentally Broken on Wall Street" - Bernanke

If this is ANYTHING like the assurance that Benny gave us last year about the minimal impact of the subprime mortgage situation we'd have to conclude that the markets are probably screwed up beyond all recognition, and that a major Depression lasting twelve years and a day is on our doorstep.

THE FED
Nothing fundamentally broken on Wall Street: Bernanke
By Greg Robb, MarketWatch
Last update: 1:58 p.m. EDT April 10, 2008

WASHINGTON (MarketWatch) -- There is nothing fundamentally broken on Wall Street that a little regulation and incentives for participants to be slightly more honest couldn't fix, said Federal Reserve Chairman Ben Bernanke said Thursday. (You could have said the same thing about Ma Barker and her boys - Jesse)

Bernanke's comments put him at odds with former Fed chairman Paul Volker, who said in a speech earlier this week that the financial turmoil that began last summer showed that the "new Wall Street" hadn't passed the market test. (Our money is on Volcker. Ben is Bush-Paulson's schmendrick. Volcker is always and everywhere a no BS econo-asskicker. - Jesse)

At issue is the move by Wall Street over the past twenty years to an "originate to distribute" business model, where commercial and investment banks create new complex forms of securities and sell them to investors looking for high yield. This replaced the old "originate and hold" model. (Bring back Glass-Steagall. Bring it back today. - Jesse)

In a speech to the World Affairs Council in Richmond, Bernanke said that it is clear the originate-to distribute model "broke down at a number of key points." (No shit, Shalom. - Jesse)

But he quickly added that "these problems notwithstanding, the originate-to-distribute model has proved effective in the past and with adequate repairs could be so again in the future." (Our unquestioned nominee for Meshugener of the Year - Jesse)

This model "seems likely to remain an important component of our system of credit provision," he said. (The Wall Street three card monty system feeding bad debt to the world. These guys are like herpes. - Jesse)

The Bush administration and the Fed have poured billions of dollars into financial markets since August seeking to restore the flow of credit to consumers. (Its all about confidence, children. You can't buy back a good reputation - Jesse)

The Fed is concerned that a lack of credit is creating a vicious downward growth spiral. (That's what happens when a Ponzi scheme collapses, propeller head - Jesse)

"Healthy, well-functioning financial markets are essential to sustainable growth," Bernanke said.(Hence our almost-certain-to-be-severe recession - Jesse)

The turmoil has led some to raise fundamental questions about Wall Street. (Would y'all like that Necktie party with or without tar and feathers on a rail? - Jesse)

In a speech in New York on Tuesday, Volker said that in his view, simply stated, the bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the marketplace."

But Bernanke argued against any need for radical reform. (What would it take to require some serious reform? The dollar worth .20 euros and the Dow Industrial at parity with gold? - Jesse)

He trumpeted a recent road-map released by the President's Working Group on Financial Markets, chaired by Treasury Secretary Hank Paulson and which includes the heads of the Securities and Exchange Commission and the Commodity Futures Trading Commission.

The PWG plan called for several steps to strengthen federal oversight of the mortgage and credit markets and a complete overhaul of the market for mortgage derivatives. (Their track record has been so outstanding, right Elliot? - Jesse)

The plan also said that credit-rating agencies must differentiate between ratings for derivatives and corporate bonds. (Grading on a curve? Let them eat CAPM model and only exchange traded products to be held by government regulated entities like banks - Jesse)

In addition, international financial market reform will be spearheaded by the Financial Stability Forum, set to release their recommendations this weekend.

Bernanke stressed that the financial crisis was not over. But he said it was not too early to draw some conclusions about the turmoil on public policy.

"We do not have the luxury of waiting for markets to stabilize before we think about the future," Bernanke said. (And we're not sure we have the luxury of waiting for you to quit being a spineless putz - Jesse)

He dismissed suggestions that markets should be left to sort the crisis out without government interference.

Bernanke, a student of the Great Depression, said that, although there are similarities between the current credit crunch and the 1930s, the U.S. "will not experience" anything like the Depression, which lasted for 12 years. (We are so fucked - Jesse)

Greg Robb is a senior reporter for MarketWatch in Washington.

SP 500 Bear Market Update - Daily Charts - April 10

In this comparison of the SP 500 declines in the bear markets of 2000-3
and 2007-9 we perform a more precise time comparison.

In each chart the end point is exactly 183 days from the top.

US Losses Likely to Top $1 Trillion - IMF and Soros

Worst from credit crisis yet to come; losses likely to top US$ 1 trillion
10 Apr, 2008, 1020 hrs
The Economic Times

SHANGHAI: The credit crisis is far from over, billionaire financier George Soros warned Thursday, urging regulators to move faster to contain damage from the collapse of the housing finance markets.

``I think the situation is more serious than the authorities admit or recognize,'' Soros told journalists in a conference call. Measures taken so far to slash interest rates and stimulate the economy were ``necessary but not sufficient,'' he said.

``Because of that, I think the situation is going to get worse before it gets better.'' Soros is promoting a new book, ``The New Paradigm for Financial Markets: The Credit Crisis and What It Means.'' He has urged regulators to move more aggressively to improve market oversight to curb risks from excessive reliance on debt for financial speculation.

He said he agreed with the International Monetary Fund's estimate of more than US$1 trillion (euro640 billion) in losses linked to the collapse of mortgage-backed securities. Losses disclosed by financial institutions so far are related only to the decline in value of those financial instruments, Soros said.

``They do not reflect in any way a possible decline in the value of the loans held by the banks,'' he said. ``We have not yet seen the full effect of the possible recession.''


Soros pointed to the potential for massive losses from complex investments linked to the U.S. subprime mortgage market, such as credit default swaps, or CDS, which allow investors to put bets on the likelihood that companies will default on bond payments.

He described as a ``Sword of Damocles'' the US$45 trillion (euro29 trillion) worth of credit swaps. ``That's more than five times the entire government bond market of the United States. It's almost equal to the entire household wealth of the United States,'' Soros said. ``This US$45 trillion market is totally unregulated,'' he said.

What's In Ben's Wallet: Roll the Printing Presses and The Fed Panics

Not to worry about the Fed's Balance Sheet as reported in The Dollar Is Being Devalued. As suspected, the Treasury and Fed have plans to print plenty of money in case the bankers feel the need, as outlined in the WSJ story below.

Will there be austerity plans on Wall Street? Besides the inevitable layoffs-- the Street always eats its young. Thinner bonuses? Get real. More banks cutting the dividend? F-- the shareholders, but don't touch the options. Johnnie Walker Black instead of Johnnie Walker Blue for après-fraud? Oh all right. K instead of coke? Damn. Cabs instead of limos? Ouch. Scandals instead of Scores? Oh the humanity!

Sacrifices must be made, and all you rubes must do your part. Perhaps CNBC can host a telethon: PigAid.

Not to put too fine a point on this, but since about ninety-nine out of a hundred readers will not understand the implications of "the Plan," let's just say that IF the Fed and Treasury actually go through with this as described, depending on how its structured our fiat currency has just kicked it up a notch and the money machine is switched to "on." And for what? Bonuses for the uber rich?

No, afraid not. There's a more likely possibility. Its worse, MUCH worse than they are letting on. The US financial system is teetering on the edge of a nasty fall, and the Fed and Treasury are in a panic. They are concerned as the word of how bad this is reaches the global public awareness, and not for stocks per se. The stock market is an important player, but the Bond and the Dollar are the franchise.)


Fed Weighs Its Options In Easing the Crunch
By GREG IP
April 9, 2008; Page A3

WASHINGTON -- The Federal Reserve is considering contingency plans for expanding its lending power in the event its recent steps to unfreeze credit markets fail.

Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed; issuing debt under the Fed's name rather than the Treasury's; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.

• The Issue: The Fed has sold or committed a lot of its Treasury portfolio to support markets. Some worry it will soon run out of room to do more.
• The News: The Fed is considering several contingency plans for getting more lending capacity so that won't happen.
• The Bottom Line: The Fed has lots of firepower left before it has to turn to these contingencies.

No moves are imminent because the Fed still has plenty of balance sheet room for additional lending now. The internal discussions are part of a continuing effort at the Fed, similar to what is under way at foreign central banks, to determine its options if the credit crunch becomes even more severe. Fed officials believe the availability of such options largely eliminates the risk of exhausting its stockpile of Treasury bonds and thus losing its ability to backstop the financial system, as some on Wall Street fear.

British and Swiss central banks also are contemplating contingency plans. For now, the European Central Bank is reluctant to consider options that require substantial modifications of its standard tools. (The ECB should thank God for the German memory of Weimar - Jesse)

The Fed, like any central bank, could print unlimited amounts of money, but that would push short-term interest rates lower than it believes would be wise. The contingency planning seeks ways to relieve strains in credit markets and restore liquidity without pushing down rates. (more like break the bill and strain the acceptability of US debt to all but captive subordinate financial entities like US taxpayers [and client states like the Saudis and Japan] - Jesse)

The Fed is reluctant to heed calls from some Wall Street participants and foreign officials for the Fed to directly purchase mortgage-backed securities to help a market that still is not functioning normally. (reluctant but could be persuaded, no? Those strumpets. LOL - Jesse)

Before the credit crunch began in August, the Fed had $790 billion in Treasury securities on its balance sheet, about 87% of its total assets. Since then, it has sold or lent about $300 billion. In their place, the Fed has made loans to banks and securities firms to assist them in financing holdings of mortgage-backed and other securities. Some on Wall Street say the potential for further declines in Fed treasury holdings could leave it out of ammunition.

The Fed holds assets to manage the nation's money supply and influence the federal-funds rate, which banks charge each other on overnight loans. When the Fed buys Treasuries or makes loans directly to banks, it supplies financial institutions with cash; in effect, it prints money. The cash ends up as currency in circulation or in banks' reserve accounts at the Fed.

Since reserves earn no interest, banks lend cash that exceeds their required minimum. That puts downward pressure on the federal funds rate, currently targeted by the Fed at 2.25%. The Fed could purchase securities and make loans almost without limit, expanding its balance sheet. That would cause excess reserves to skyrocket and the federal funds rate to fall to zero. The Fed would contemplate such "quantitative easing" only in dire circumstances. The Bank of Japan took this step this decade after years of economic stagnation.

Weighing the Possibilities

So the Fed is seeking ways to expand its balance sheet without causing the federal funds rate to drop. The likeliest option, one the Fed and Treasury have discussed, is for the Treasury to issue more debt than it needs to fund government operations. The extra cash would be left on deposit at the Fed, where it would be separate from bank reserves on deposit and thus would have no impact on interest rates. The Fed would use the cash to purchase an offsetting amount of Treasuries in the open market; for legal reasons, it generally cannot buy them directly from Treasury. (that's a bookkeeping nicety at best. The Fed is trying to get a little bit pregnant, to keep it from showing. - Jesse)

Treasury's principal constraint is the statutory limit debt. Treasury debt was $453 billion below the limit Monday. In the past, Congress always has responded to administration requests to raise the limit, sometimes only after political theatrics. (they also have another constraint, the value of the US dollar in world trade - Jesse)

Fed officials also are investigating the feasibility of the Fed issuing its own debt and using the proceeds to purchase other assets or make loans. It has never done so; the legality is unclear. Some foreign central banks, such as the Bank of Japan, do so.

Another possibility is seeking congressional approval to pay interest on banks' reserves immediately instead of waiting until a 2006 law permits that in 2011. If the Fed paid, say, 2% interest on reserves, banks would have no incentive to lend out excess reserves once the federal funds rate fell to that level. (as opposed to raising the minimum reserve requirements and tightening the rules on sweeps? - Jesse)

Congress put off the effective date because paying interest on reserves reduces the Fed profits that are turned over to the Treasury each year, widening the budget deficit. Although preliminary explorations suggest Congress would be open to accelerating the date, the Fed is leery of depending on action by Congress.

The Fed is inclined to use any additional maneuvering room to lend through its existing and recently expanded avenues. Officials are reluctant to buy mortgage-backed securities directly. They worry that such purchases would hurt the market for MBS that the Fed is not permitted to buy: those backed by jumbo and subprime and alt-A mortgages, which are under the greatest strain.

Moreover, the Fed is not operationally equipped to hold MBS and would probably have to outsource their management. Such holdings wouldn't help avert foreclosures much, since the Fed would have little control over the mortgages that comprise MBS.

Write to Greg Ip at greg.ip@wsj.com1