Felix Salmon


Felix Salmon
Oct 18, 2010 05:49 UTC

How JP Morgan lent its clients’ money to the doomed Sigma SIV, losing them millions — NYT

Joe Miller’s private security guards detain a reporter — ADN

Somebody find me a dish with chicken gizzards, sichuan peppercorns, fish sauce, scallions, and lime — MR

A Xerox Alto sells for $30,100 on eBay — eBay

Cuomo cruising to victory in NY by simply not being Paladino. Rick Lazio wondering why that didn’t work for him — NYT

17 years later a Japanese homeowner sells condo for a third of what he paid for it — TBI

The Swedish professor, the laptop thief, and the memory stick — The Local

Stieg Larsson spent a year with Eritrean People’s Liberation Front, teaching female guerrillas about grenade launchers — Tribune

Benoit Mandelbrot, Mathematician, Dies at 85 — NYT

One company the soaring gold price doesn’t seem to have helped: Cash4Gold — Fortune

Beard Awards Will Not Distinguish Between Online and Print Journalism — NYT


@ 5:52 above should be “And lost their clients millions.”

On the same thread as banks lending their client’s money, however, I would like to add that BP Pension North America has asserted that Northern Trust in their capacity as investment manager lent the shares that the pension fund was long to short sellers. They then used the cash collateral from the shares lent to purchase shares from those same short sellers.

Plaintiff objected to “NTI’s …lending the NTGI Trust’s securities to some of the same borrowers from whom NTI purchased securities for the Collateral Funds…”

http://www.insurereinsure.com/files/uplo ad/73764-BP1.pdf paragraph 32

Posted by bidrec | Report as abusive

The historical echoes of the mortgage bond scandal

Felix Salmon
Oct 17, 2010 02:37 UTC

What did Wall Street used to be like, before the Securities Act of 1933? Michael Perino’s new book on Ferdiand Pecora, which I reviewed here, reminds us. For instance, there was National City Bank’s Peru deal.

National City’s South American experts had reported that the government’s finances were “positively distressing”, with the treasury “flat on its back and gasping for breath” and the president surrounded by “rascals”. Yet, inevitably, National City decided to underwrite a series of bonds from Peru. Nowhere in the prospectus was there any indication of National City’s view on the country; meanwhile, National City’s ads stated that “when you buy a bond recommended by The National City Company, you may be sure that all the essential facts which justify the Company’s own confidence in that investment are readily available to you”.

Perino continues:

National City kept right on offering Peruvian bonds in 1927 and 1928, even though one of its own South American experts continued to conclude that he had “no great faith in any material betterment of Peru’s economic condition in the near future”. The political situation, he wrote, was “equally uncertain,” with “revolution” a distinct possibility. Would the public have purchased these bonds, Pecora asked, if that information had been included in the prospectus? “I doubt if they would,” Baker replied.

Pecora did something similar with a bond offering for the Brazilian state of Minas Gerais. National City used much of the proceeds to pay off a loan due to itself, without telling telling investors that it was using their money to exit the very credit they were buying into. And that’s not all:

How Minas Gerais would use the proceeds of the bond offering was not the only misrepresentation in the prospectus. Pecora put George Train, the man who originally urged National City to underwrite these bonds, on the stand. Train, it seemed, was willing to play fast and loose with other crucial facts in order to get the deal done. In 1927, analyzing Minas Gerais’s history of bond offerings in Europe, Train was amazed at the shoddy way the government had handled its obligations. The “laxness of the State authorities,” he wrote in an internal company memorandum, “borders on the fantastic”. His review of Minas Gerais’s history “showws the complete ignorance, carelessness and negligence of the former State officials in respect to external long-term borrowing.” It would, he wrote, “be hard to find anywhere a sadder confession of inefficiency and ineptitude than that displayed by various State officials.” Despite those conclusions, Train wrote in the prospectuses for the bond offerings, “Prudent and careful management of the State’s finances has been characteristic of successive administrations in Minas Gerais.”

I’m quoting Perino at length, here, because I’m getting a lot of pushback from various commenters to my assertion that pretty much every major investment bank in the world withheld material nonpublic information when they failed to pass on to investors the results of the due diligence tests that Clayton did on mortgage loan pools.

Kid Dynamite says that we’re not talking about material nonpublic information here. But of course we are: it’s information, it’s nonpublic, and it’s certainly material, since it resulted in the investment banks negotiating down the price of the loan pool in question.

The Securities Act came into law largely in reaction to exactly the kind of behavior that Pecora uncovered with the Peru and Minas Gerais bonds. The banks knew bad stuff about the bonds they were selling, but they didn’t pass on that information to investors. And so the Securities Act was written to put an end to such shenanigans.

The Clayton reports were much more than mere opinion, like the ratings agencies pretend to be. (And in any case, credit ratings are public information.) Clayton did detailed empirical research on the loan pools, and when the banks didn’t like what they saw, they used that information to their own advantage — by asking for a discount on the loans from the originator.

The whole point of the Securities Act was to ensure that information like that was passed on to investors. That’s why bond prospectuses are so long: they include every conceivable piece of information, and every conceivable risk factor, that might possibly be relevant to the price of the bond.

Yet the MBS prospectuses for the loan pools that Clayton examined didn’t include the fact that Clayton had done due diligence on them, didn’t say what Clayton’s results were, and certainly didn’t disclose that those results had allowed the underwriter to buy the loans from the originator at a discount.

If Ferdinand Pecora were alive today, he would recognize all this behavior — and be shaking his head at the way in which banks simply ignored the spirit of the laws which FDR put into place in the wake of the Pecora Commission.

Did the banks behavior violate the letter of the law? I think there’s a good case that they did; they certainly broke the law as it exists today. But let’s find out! Come on, prosecutors — file some suits, here, and see what happens. This crisis has yet to reach the stage at which people start going to jail. And we need to pass through that stage before it’s all over. So let’s get to it.


The banking bailout was a blunder. The taxpayer gave banks billions of dollars yet they did little to stave off foreclosures. In the mean while they grab properties and sit on the cash they received from the treasury and the Fed. If they are threatened by insolvency again their influence in the Senate will be used to obtain more bailouts and lax regulation.

This fact alone really chaps my ass when I hear pundits claim the that those who lost their homes to foreclosure were somehow financially reckless. More people lost their homes to foreclosure after the financial industry was bailed out. Besides, how is losing one’s job to an economic downturn “financially reckless” on the part of the mortgagee?

Chase, Citibank, BOA, etc… are holdings of the private banks the form the Federal Reserve Board. The Treasury has been staffed by successive presidents with former employees of Wall Street, namely Goldman Sachs. The U.S. banking industry clearly is an Oligarchy which is strangling the economies ability to manufacture anything but paper profits. We have all seen how fast they can erode.

Two decades ago Britain made it illegal for corporations and organizations to contribute financially to any politician’s election fund. Only voters can contribute with strict limits and caps. How is it that the British people can get their government to respond to the will of the people and we cannot?

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The Daily Caller vs the banks

Felix Salmon
Oct 15, 2010 23:50 UTC

Joseph Tauke has a monster 5,600-word excoriation of the mortgage industry. It’s a great read, and it includes a lot of information you probably won’t know unless you’re a regular reader of Naked Capitalism and 4closureFraud. But the most important thing about the story is nowhere to be found in the story itself; rather, it’s the fact that it was published by the Daily Caller, Tucker Carlson’s right-wing website.

The Tea Party wing of the Republican party has never been a big fan of Wall Street, of course. But at the same time, it has also tended to oppose any Democratic attempts to bring Wall Street into line. And it hasn’t made bank-bashing a central part of its platform at all. (TARP-bashing, yes. But TARP was a government program.)

TARP was a bipartisan deal to save the banks, and its outcome is now regarded as desperately unfair: the rich bankers are now back to making multi-million-dollar bonuses, even as most of the country continues to suffer from a weak economy and high unemployment.

So if the Daily Caller’s story is any indication, there might just be a consensus in Congress to gang up on the banks and dole out a bit of punishment for their fraudulent behavior with respect to respectable homeowners.

The big question mark with regard to foreclosure fraud has always been the willingness, rather than the ability, of authorities to prosecute the banks involved. If the political winds change so that regulators have every incentive to sue, you can be sure that they will do so. Given that any indication of friendliness towards banks constitutes political suicide right now, I’d guess that the banks’ litigation risk is higher than it has ever been.

Which is maybe why JP Morgan Chase set aside $1.3 billion in additional litigation reserves last quarter. At this rate, they might well need all of that — and more.


Hi there. I’m Joe Tauke, so I would probably be the best person to answer your question. The Comptroller of the Currency only lists what banks will owe if the derivatives are activated, which is 233 trillion dollars. Those derivatives will be activated. All that’s left is the court system’s willingness to activate them, because courts, up until this point, have been acting quite stupidly, and I intend to highlight this in my next piece, which will examine why judges have been saying quite extraordinary things like, “Well they owe someone, don’t they?” to proceed with foreclosure cases that would force homeowners to pay not “someone,” but a particular bank, in order to keep their homes.

The derivatives will be activated. I just want to tell you why. Courts won’t keep acting this way forever, and when they stop, that will make the derivatives very, very important.

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Why financial stocks haven’t fallen much

Felix Salmon
Oct 15, 2010 22:58 UTC

Bank stocks didn’t do so well this week, what with foreclosuregate coming to a boil. But they didn’t do all that badly, either, as a group: the XLF financial sector ETF ended the week down a pretty modest 2.45% from where it started.

You might remember the XLF fund from a famous column by Evan Newmark two years ago, a few weeks after Lehman Brothers declared bankruptcy and the global financial system threatened to implode into a mess of nationalization and mass insolvency:

Bear Stearns, gone. Lehman Brothers, gone. Merrill Lynch, gone. Washington Mutual, gone. Wachovia, gone. Fannie and Freddie, basically gone. AIG, almost gone.

Absolute carnage. The fastest restructuring of a banking system in economic history.

Will the U.S. financial-services industry survive? Plenty of folks think not. But if you believe yes, now is the time to buy financial stocks.

Which is why I have been buying the XLF, the financial sector exchange-traded fund…

The optimist will tell you that we have a crisis of confidence. That with the Treasury’s bailout program in place, bad assets will be speedily removed from balance sheets and credit will again flow. Throw in a Federal Reserve interest-rate cut and soon banks profits will follow.

Frankly, I don’t know who is right today. But I have a five- to 10-year time horizon, so I don’t have to know that.

All I have to do is believe that the US financial-services industry will survive…

For the XLF a break down of more than 20% from Friday’s close, would put it at less than $15.

This would probably indicate the total collapse of the U.S. financial system. And I just don’t buy that. I am buying the XLF instead.

In many ways, the column was prescient. The US financial system did survive. Treasury’s bailout program, along with Fed rate cuts, did indeed break the back of the financial crisis, and large bank profits have followed as a result.

Yet XLF has been trading between $13 and $15 since May — a level which, according to Newmark, “would probably indicate the total collapse of the U.S. financial system”. And looked at over the past three years, it’s pretty clear what happened to the XLF: it fell off a cliff and then recovered to settle happily at a new, low level. Here’s the chart; the vertical line marks the date that Newmark’s column appeared.


I think that this helps to provide, at least in part, an answer to Ezra’s question about why the markets don’t seem to care about the foreclosure crisis: they’ve known about it all along. (For instance, see this story from Reuters’s Patrick Rucker, dated July 27 2007.)

What’s happened over the past week or so is that the mortgage shoe has finally dropped, as it inevitably was going to do sooner or later. But since the markets were already pricing in that shoe-drop, they haven’t needed to overreact this week. They didn’t know when all this was going to happen, but they were relatively well prepared for this: it’s a slow trainwreck, not a sudden crisis. And the still-depressed level of financial stocks is testament to how none of this comes as much of a surprise.


The most important factor is that we know Obama will bail them out no matter what. After all they’re not called TBTF for nothing.After the U.S. Congress votes for legislation to save the banks, and all the newly-elected “Tea Party” congressmen and congresswomen? They’ll vote for it too, after they are sufficiently scared by a major stock market crash a la the first vote on TARP in the House of Representatives.

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Regulators have known about the mortgage bond scandal for three years

Felix Salmon
Oct 15, 2010 20:49 UTC

Clayton isn’t the only company doing due diligence on mortgages: another company doing the same thing is Allonhill. Whose CEO, Sue Allon, has a blog post up today explaining that there’s nothing to get excited about here:

In the run-up to the crisis, there was no rule that issuers had to perform due diligence at all. They obtained diligence for their own purposes, and when they did, no rule dictated that the results be disclosed to rating agencies and investors.

Allon goes on to say that “nobody – not investors, nor the SEC nor the rating agencies” was demanding that the due diligence reports be made public.

But this doesn’t make sense to me: why wouldn’t investors want to see the reports, if they knew they were being conducted?

And then there’s this:

The fact remains that investors still don’t have access to due diligence reports.

Still? How is that even possible? Isn’t the whole point of Section 15E(s)(4)(A) of the Exchange Act — introduced recently as part of Dodd-Frank — to force underwriters to give investors access to due diligence reports?

And as for the SEC not caring about this, I’d point you to to a letter that Clayton sent to the Financial Crisis Inquiry Commission. The idea was to distance itself from its former employees’ testimony, but check out this admission, towards the end:

Clayton began to review prospectuses in the summer and fall of 2007 in response to specific questions from regulators about whether Clayton’s due diligence results were set forth in MBS prospectuses.

Clearly, regulators have known about this issue for three years now; they’ve certainly known about it for long enough to insert Section 15E(s)(4)(A) of the Exchange Act into the Dodd-Frank bill.

So while Allon is right that there might not have been a specific rule requiring disclosure of the diligence results, there were still general rules requiring that underwriters disclose all relevant information when they sold mortgage bonds — or any other kind of security — to investors. That’s where the huge potential liability lies.

Update: Patrick Rucker of Reuters was all over this back in July 2007:

Investment banks that bundle and sell home mortgages often commissioned reports showing growing risks in subprime loans to less creditworthy borrowers but did not pass much of the information to credit rating agencies or investors, Wall Street sources said…

“If all the information about these investments was properly disclosed, our client would have made different decisions…and, specifically, not bought these investments,” said Dale Ledbetter, a Florida attorney suing Credit Suisse.


mattski, first of all this was demand driven by the buyside. Secondly, of all the players involved the buyside are the ones who have a clear cut fiduciary responsibility to due proper due diligence not the sellside. They are the ones who get paid to do exactly that.

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How much money is flowing to mortgage bonds?

Felix Salmon
Oct 15, 2010 16:05 UTC

If bankers are good at anything, surely it’s counting money. If there’s a cashflow, anywhere, bankers will surely be able to quantify it and report it. Or, not:

Mortgage-bond buyers are losing faith in the accuracy of remittance reports, and some say the apprehension could soon factor into their investment strategies.

Remittance reports, distributed monthly by securitization trustees, are supposed to provide routine snapshots of the cashflow-collection and distribution activities of servicers. However, investors say there has been a rash of recent instances in which the reported data differed considerably from what actually happened.

Loan servicers, it seems, are so spectacularly incompetent that they can’t even report to bondholders how much money they’re being paid. Especially when a loan has been modified, the servicers don’t seem to be able to report the new cashflows accurately.

Not that this is a bad time to reduce investors’ faith in the transparency and reliability of mortgage-backed securities, or anything.


“This is why the RMBS market needs to imitate the CMBS market, and have special servicers for properties in distress”

One of the things that surprised me most about the US subprime market back in 2007 was learning that special servicers weren’t commonly used. In the UK, it was standard practice at all but a handful of sponsors.

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Mortgage datapoints of the day

Felix Salmon
Oct 15, 2010 14:21 UTC

Just how bad is the mortgage mess right now?

Mike Konczal finds an Andy Kroll piece from January which shows just how unregulated mortgage servicing has been: the OCC, for instance, has never taken action against mortgage servicers. And it’s far from clear that it’s inclined to now:

The OCC, which regulates the nation’s largest banks, has initiated “examinations” of foreclosure and loss-mitigation procedures at big banks, “to be conducted over the next several weeks to confirm compliance and that banks have remedied any identified issues,” an OCC spokesman said.

The point here is that the decision to go after banks and loan servicers is ultimately a political one, and there doesn’t seem to be a huge amount of appetite in Washington to have another huge fight with the banks, so soon after the last one. The OCC could, at any minute, get very tough on the servicers. But will it? That’s very uncertain.

Meanwhile, the incredibly low rate of existing home sales looks like it’s going to plunge still further:

New buyers have stepped back from the market for distressed property, which now accounts for more than 30% of new transactions, according to RealtyTrac. New owners are worried they don’t have a legal right to their homes. Title insurers are worried about their exposure to faulty documents and unwilling to stand behind new purchases. Since title insurance is required for most mortgages, the market is essentially at a standstill.

In other words, the housing market, which was broken before, is even more broken now.

What’s this all going to cost? Nelson Schwartz is throwing around numbers less than $10 billion, which is decidedly manageable, but that’s just the cost to banks, and crucially it assumes that the problem is merely one of paperwork. Hire a few new people, be a bit more diligent, and things will be able to sort themselves out.

If you start looking at the mortgage market, the potential cost gets much, much higher:

An alarming report on Bank of America, compiled by Branch Hill Capital, a San Francisco hedge fund, circulated widely on Wall Street on Thursday. Branch Hill suggested that the bank, the nation’s largest, could be facing more than $70 billion in losses from mortgage securities that it may have to repurchase from Fannie Mae and Freddie Mac, as well as private investors.

“We think this is a very important issue, and the liability will be substantial,” said Manal Mehta, a partner at Branch Hill. “There has been pervasive bad behavior throughout the system.”

The problem is hardly confined to Bank of America, of course. All investment banks did this, which means they all have enormous potential liabilities.

And then the costs to the broader housing market are higher still. The longer that market fails to properly clear, and the longer that the overhang of unsold houses continues to grow, the less it makes sense to talk about what any given house is “worth” — and the more it makes sense for homeowners to default on their mortgages. They’re very unlikely to get thrown out of their homes for at least a year and possibly much longer, and there’s a pretty good chance, if they’re underwater, that at the end of this mess they’ll be able to negotiate some kind of principal reduction.

So what are the mortgage originators and investors doing about this huge problem? It looks as though they’re sticking their heads in the sand:

The Executive Director of the American Securitization Forum, Tom Deutsch, released the following statement regarding misinformation circulating within the financial markets that transfers of residential mortgage loans to securitization trusts were not valid.

“In the last few days, concerns have been raised as to whether the standard industry methods of transferring ownership of residential mortgage loans to securitization trusts are sufficient and appropriate. These concerns are without merit and our membership is confident that these methods of transfer are sound and based on a well-established body of law governing a multi-trillion dollar secondary mortgage market.”

Apparently the Forum is going to release a white paper “over the course of the next two weeks” designed to put our minds to rest. Needless to say, it won’t. Even if the narrow question of the transfer of ownership to the securitization trust is cleared up, there are still numerous enormous concerns surrounding mortgage bonds, including whether the banks misled investors, whether investors might be able to force the banks to buy the bonds back, and whether the bonds themselves are going to plunge in value as house prices fall, defaults rise, and the ability to foreclose on notes in default slowly evaporates.

And what happens if and when the homeowners who have already been foreclosed upon start filing class action suits against various parts of the financial-services industry, saying that the banks had no right to do that? If the verdicts of kangaroo courts start being overturned, things could start getting really messy.

What’s desperately needed here — and what isn’t going to happen — is someone to come in and take ownership of the whole mess, and cobble together a roadmap for getting out of it. But that would take more political will than seems to exist in the White House. So this is going to drag on, painfully, state by state, quite possibly for years. And while it’s doing so, the chances of any kind of robust economic recovery — at least outside the world of high-priced legal firms — seem slim indeed.


Potential Liabilities with the big banks and Force Placed Insurance is an understatement….talk about a scandal…

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Felix Salmon
Oct 15, 2010 06:48 UTC

John Cassidy on the blogonomics of Gawker — TNY

Microfinance institutions are now kidnapping minor children?! — India Microfinance

Justice, as expected, is appealing the DADT ruling — Reuters

Signature debit refuses to die

Felix Salmon
Oct 15, 2010 05:31 UTC

I took the subway downtown from work today, since it was raining rather heavily, and saw an ad for something called Chase Commuter Cash. The idea is that you enroll your Chase debit card in the scheme, use that debit card to pay for your Metrocards and then get $10 back from the bank for every $150 you spend.

Now Metrocard vending machines are, by their nature, a huge security hole when it comes to credit cards. They’re completely anonymous, you don’t need to sign anything, you don’t need to show ID: all you need to do is swipe and maybe punch in your Zip code. Which isn’t much of a security check:

When paying by credit card it may ask you for a zip code. I just use the New York Zip code 10007. It has always worked for me so far.

As such, you’d think that Chase would be urging all its customers to use the much more secure PIN code when they pay with debit cards. But you’d think wrong. In order to get the cash back from Chase, only ” transactions made without using your PIN” qualify.

The reason, of course, is that Chase gets higher interchange fees if you press the “credit” button on the machine and don’t put in your PIN, even though you’re using a debit card. Why are the interchange fees higher for credit than for debit? To make up for all the extra fraud, of course. But clearly Chase doesn’t seem to be worried about that.

All of this is prima facie evidence, of course, that the interchange fees for signature debit are far too high. But it’s also a way of getting the public into the habit of hitting the “credit” button whenever they use their debit card — something which will ultimately only serve to increase the amount of fraud in the system.

Signature debit is an abomination which ought never to have existed in the first place and which really ought to be abolished rather than encouraged by the very banks who will ultimately suffer ever-greater losses as a result of its use. But the banks, desperate for fee income, are ignoring the obvious fact that what they’re doing simply is not sustainable.

I’m reminded of airlines’ bag-check fees:

Here’s an indisputable truth: The more baggage fees that the big airlines pile on their customers, the faster their overall revenue is collapsing. In fact, the only carriers that escaped a double-digit revenue decline in the second quarter were the two that still allow all passengers to check at least one bag for free…

“Baggage fees are the kind of shortsighted things that are killing us,” the top U.S. executive of a European airline told me recently. “The accountants we have are great at tracking the ‘ancillary’ revenue we generate whenever we invent something like a baggage charge. But they have absolutely no way to match that against our potential overall revenue exposure if travelers book away from us. And no one holds them accountable for their one-way accounting. It’s a scandal.”

For “baggage fees” read “signature debit” and I suspect that we’re seeing exactly the same thing with the commercial banks. No good can come of this, over the medium term. Which only goes to prove that bankers are no better at building long-term value than they ever were.


While signature fraud might occur more frequently than PIN fraud it is harder to prove PIN fraud than signature. A person can clearly prove they did not sign for something via a receipt than they can show it wasn’t them who entered a PIN without a visual comformation (i.e. a security camera).

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