Great Leap Forward

More News From the Financial Front: We’re Not Out of the Woods Yet

Here’s a quick round-up of recent financial news. You cannot make this stuff up.

1. Yes, Crime Still Pays.

What happens if you help Mexican drug lords launder $7 Billion of drug profits through US bank branches, and you finance purchases for international terrorists committed to attacks on America, and you have processed $60 Trillion (Yes, with a “T”) of questionable activity in 17,000 suspicious accounts?

Well, obviously you do not go to prison, much less face the electric chair. Indeed, if you are at a big bank, US State and Federal authorities decide you should not even be indicted with criminal charges. Why? Because that might shake confidence in your bank. You see, no bank has ever survived criminal charges against top management.

And so we read that HSBC, perhaps the biggest money-laundering racketeer in world history (and I say perhaps only because there are another half dozen banks big enough to rival HSBC and thus potential candidates for first prize in the money-laundering business), won’t be prosecuted.

Instead, in yet another vigorous rump-kissing by President Obama’s Justice Department, HSBC will just pay a settlement. The Justice Department’s Lanny Breuer trumpeted the $2 billion settlement he worked out with the fraudsters, bringing the running total that he’s got from global money-launderers to $4 billion. Folks, these are Trillion Dollar Plus banks. A trillion is a thousand billion. The Chicago mob would have considered this a real steal—buy the cops a couple of donuts and you are free to launder.

Think about that: flagrantly fund terrorists and launder drug money, and the consequence is a slap on the wrist.

Why? Well, let us presume that Attorney General Holder as well as Breuer are not running cover. Indeed, according to a NYTimes article, the Justice Department had wanted the bank to plead guilty to violations of the Federal Bank Secrecy Act (a lesser crime); however, they were waived off such “harsh” punishment by the Treasury Department, the Fed, and the Office of the Comptroller of the Currency who cautioned that this might hurt the bank’s reputation. See .

After all, in banking reputation is everything! We wouldn’t want to tarnish a known money-launderer and terrorist funder. That might put a crimp in their business model. Senator Tom Coburn remarked, the OCC is “a lap dog, not a watchdog.” Sort of like Timothy Geithner, who said that while he headed the Federal Reserve of NY he was not a regulator. This reminds me of the Saving and Loan fiasco, when the chief regulator of the thrifts told his staff they ought to act like “cheerleaders” for the industry. When our regulators become cheerleaders for bank fraud, we’re in big trouble.

As I said, you can’t make this stuff up. Are we out of the woods? No. Banks are not only too big to fail. They are too guilty to prosecute.

And what lesson would a criminal enterprise masquerading as a bank learn from this whole exercise?

Crime pays.

2. A Veritable Litany of other Settlements and Lawsuits against Banksters.

*Some estimate that lawsuits and claims filed against $1 trillion of toxic MBSs issued by banks could ultimately result in $300 Billion or more of bank losses.

*Fannie and Freddie initiated a lawsuit for $200 Billion against 17 banks.

*JPMorgan and Credit Suisse settled for $417 Million with the SEC.

*Bank of America was forced to repurchase $2.5 Billion of fraudulent MBSs from Fannie and Freddie; and it had to pay $1.6 Billion to an insurer for misrepresentation of the quality of securities.

*BoA might have to settle another $1 Billion with the Justice department for toxic Countrywide mortgages.

*BoA already paid $8.5 Billion to various investors including PIMCO and the NYFed for toxic securities.

*BoA still faces $22 Billion of repurchase demands by investors who believe quality of securities was misrepresented.

*NY Attorney General Schneiderman is after Credit Suisse for $11.2 Billion worth of fraud and sales of toxic securities.

*JPMorgan faces $5 Billion in repurchase demand for toxic securities it issued.

Does anyone see a pattern here?

3. Banks and Government Sponsored Enterprises Still Have Toxic Balance Sheets

In addition to all the lawsuits, demands for put-backs, and settlements, banks still hold a lot of garbage. And that is in spite of three rounds of Quantitative Easing, through which the Fed has taken much of the toxic waste onto its own balance sheet.

Defenders of the Fed rightly point out that much of the waste it bought (perhaps all of it—we are not actually sure what the Fed bought) is insured by the GSEs. What that means is that if the mortgages go bad, Uncle Sam is on the hook. So whether the toxic assets are held by banks or by the Fed doesn’t much matter—Uncle Sam will make the banks or the Fed whole. True enough. Economically it doesn’t matter much. I’m not so sure about the politics.

The GSEs are going to face one heck of a tongue lashing in Congress. The FHA is already in the news. It guarantees $1.1 Trillion of mortgages, many of which will go bad. Its fund is now valued at a negative $13.5 Billion, which reflects an estimate of the value of future insurance premiums it will receive as income less expected losses. It will ask Uncle Sam to cover the loss. I’d hate to go to Congress with hat-in-hand to explain why Uncle Sam should cover losses created by Banksters who made fraudulent loans. Banksters who might not be on the hook because they sold the waste to the Fed. You see, the GSEs need Uncle Sam’s bail-out so that they can bail-out the Fed.

I expect that just won’t sound right to Congress.

The GSEs are under pressure to unload mortgages. They were supposed to insure them, not buy the damned things. Oh, and QE3? The Fed is buying up MBSs. GSEs are selling them off. The Fed’s purchases happen to match the GSE sales. What a surprising coincidence! What is effectively a branch of government (GSEs) is selling toxic waste to another branch of government (the Fed). The justification used by the Fed is that if those toxic securities went into the markets, they could be sold only by depressing prices of securities.

And that would be bad for mortgage rates. You see, we need to keep the MBS market pumping out more securitized mortgages in order to try to prop up the sagging real estate market (which is still down 29% since the peak). This is the convoluted thinking we’ve got in Washington.

You want to really help real estate markets? Stop the foreclosures and give real debt relief. We need a national plan to write down all mortgages and to provide good terms on refinancing to all underwater homeowners.

For some reason, home equity loans have virtually disappeared from view. Yet they’re still on the books of banks. The Fed ain’t buying them, and they ain’t insured. Note that if the mortgage is bad, these are worthless since they stand in line after the claim on mortgages. They should be carried on bank books as unsecured credit that is highly discounted. The underwater portion of mortgages is also unsecured credit—by definition, if the mortgage is underwater the value of the house cannot cover the underwater portion. Add those two things together and banks have about $1 Trillion of unsecured and highly problematic assets still on their books.

If we add together that $1 trillion of unsecured credit, plus the Trillion dollars (more or less) of student loans, plus the Trillion dollars (more or less) of credit card debt and all the other consumer debt, what we find is that it totals up to an amount equal to the bubble-era peak before the crisis.

There’s been no material de-leveraging of the household sector. And for every debtor that cannot make the payments, there is a creditor that is not being paid. The banks are still waist deep in the toxic soup.

How can they pretend to be solvent? Extend and Pretend: our national regulators and supervisors do not force them to mark down asset values to realistic market values. Note that some have argued that the drop-off of foreclosure rates indicates things are improving in the housing sector. Not at all. Banks have a strong incentive to pretend that the mortgages are good—facilitated by rules that allow them to count loans as still OK if the borrower can occasionally make a payment.

And even once the mortgage goes into default, the servicers have strong incentives to continue to service the loans up to the point that their claim on the homes is equal to market value (leaving no residual value to pay investors in the toxic MBSs).

During the speculative euphoria in the mid 2000s, we quipped that assets were “marked to myth”—traders just made up prices for the trash. We’re still living in a mythical world of high finance. It will crash again.




11 Responses to “More News From the Financial Front: We’re Not Out of the Woods Yet”

EugenRDecember 12th, 2012 at 6:25 pm

We know the whole financial system is based on faith in the value of Money. Yet we also know what a tremendous lie it is. 90% of the Money is created and allocated by the commercial banks. What if someone will start to ask questions?

jerryDecember 12th, 2012 at 8:23 pm

How is that the Fed could buy MBS from a GSE or anyone other than a bank? They buy them with reserves, so are people maybe selling this trash to the banks first and then the banks sell it to the Fed? GSE's don't have accounts at the Fed do they?

It seems like it'd be fairly easy for some guy at hedge fund XYZ to sell his crap MBS to a Citibank or Goldman Sachs in anticipation of the Fed then buying it from the bank? Is this even possible from an operational perspective or am I way off my rocker?

kevin_globalDecember 12th, 2012 at 11:29 pm

Don't give electric chair to Banksters. It will be an easy death. I recommend that Banskters should be sent to Guantanamo bay and applied with enhanced interrogation techniques. It will be fun.

L. Randall Wray L. Randall WrayDecember 13th, 2012 at 2:15 am

Obviously it makes no difference if the Fed buys directly from GSE, or if GSE sells to bank that sells on to the Fed. The point is that the amount spent by the Fed matches (almost dollar for dollar) the amount sold by the GSEs. That is what QE3 is all about–taking off the market all the MBSs sold by GSEs.

L. Randall Wray L. Randall WrayDecember 13th, 2012 at 2:18 am

Obviously that is what we’ve done to other terrorists, so management of a bank that funds terrorists (and launders drug money) ought to be treated the same way.

benleetDecember 13th, 2012 at 9:29 pm

The Fed's QE3 will buy $40 billion per month, $480 billion per year, of MBS from the banks and from GSEs (Fannie Mae, Freddie Mac, FHA). How much in $ are the bad mortgages the banks will not write off? How much of this stuff is waiting to be purchased by the QE3 Fed? Is "Mark-to-Market" still suspended? Are the banks actually bankrupt? — I wrote this before I read the entire article. I just looked up Flow of Funds table D.3, "Credit Market Debt Outstanding by Sector", showing since 2008 Q4, total financial sector debt (at its peak) down 19% ($3.3 trillion,from $17.1 trillion to $13.8 trillion), total household mortgage debt down 9.6% ($1 trillion), total fed. government debt up 77% (almost $5 trillion). Am I missing something — do the Fed purchases enter into the equation in more trillions?

benleetDecember 13th, 2012 at 11:56 pm

Neil Barofsky has a similar article at Naked Capitalism:
" . . .the largest banks have demonstrated an unbridled zeal for pushing the boundaries of the law as part of their relentless pursuit of profits. DOJ’s actions with regards to HSBC are beyond unfair: They are downright terrifying for weakening the general deterrence for megabanks, both foreign and domestic, which could rationally interpret yesterday’s actions as a license to steal."


And Daniel Alpert wrote an analysis in March 2012 about the re-leveraging of consumer debt, saying,
"The crash in the housing market has left us with $873 billion in Home Equity Line of Credit balances (at Q4 2011) owed by consumers, most of which is no longer collateralized by home value. While borrowers may be making payments (many at vastly reduced rates of interest giver the floating rate nature of those loans), I would put forward the argument that as a practical matter unsecured consumer debt in the U.S. is actually well over $3 trillion.

L. Randall Wray L. Randall WrayDecember 14th, 2012 at 1:04 pm

Thanks to the link to Barofsky. And, yes, Dan has been on the forefront of this and I had talked to him about this before I wrote my piece. Sorry I missed that particular piece as I would have loved to cite it!

Joseph GlynnDecember 19th, 2012 at 4:09 pm

Great article and I enjoyed Frank's Guardian link above.
Here in Ireland the commercial banks wrecked a strong economy where, for the first time in 700 years, most people enjoyed a good standard of living. Bankers have likewise destroyed the solidarity which underpinned the European Union. Privately owned banks, guided only by the profit motive, have outgrown national and international regulatory capabilities.
It is time for global action, if we wish to avoid global anarchy. Abraham Lincolns monetary policy is surely the best guide for the fundamental reform….I found it in Michael Rowbotham's brilliant book The Grip of Death….its in the Congressional Papers but I have yet to see it online.

jerryDecember 21st, 2012 at 3:15 pm

So what's to say that every hedge fund in the world with crappy MBS has not just sold them all to the banks for good prices, who have then turned around and dumped it off at the Fed through QE?

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