Rolfe Winkler

Paulson says Russia urged China to dump Fannie/Freddie holdings (McKee/Nicholson, Bloomberg)

Avatar breaks $2 billion worldwide box office mark (Box Office Mojo) Very impressive of course, though on an inflation-adjusted basis, Avatar ranks just 25th all time. Nothing will ever beat Gone with the Wind.

Volcker Op-Ed: How to reform the financial system (NYT) Unfortunately not a lot of additional detail over his proposed reform plan. But for those not already familiar with it, this does offer a helpful articulation of Volcker’s reform philosophy. Yves is happy Volcker has entered the fray, but believes he needs to go beyond his current thinking.

Frank says banks “recognize reality” by throwing support behind wind-down fund (Howell, Reuters) Am I alone in my fear that a wind-down fund will make matters worse? The idea that new “resolution authority” must be accompanied by a pool of funds to bail out systemic failures compounds moral hazard greatly. Even assuming that banks will be charged high enough insurance premiums to give the fund sufficient financial heft — how well has that worked with the Deposit Insurance Fund? — the very existence of this fund will provide an implicit guarantee to the creditors of the firms’ backed by it. The DIF already creates major moral hazard by removing all depositor incentives to worry about the health of their banks. Now an even larger slice of creditors would be insulated from risk.

PDF — TARP inspector general says program will cost less than expected, warns that little has changed (SIGTARP) In his latest quarterly report, Neil Barofsky acknowledges that TARP won’t cost as much as once expected. But he also warns that “even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car.” Section 3 of the report emphasizes that present government policy risks re-flating the housing bubble.

PDF – Treasury releases first quarterly PPIP report (Treasury) A breakdown of the the legacy securities program, which combined public and private capital in order to support the price of toxic assets. The use of non-recourse government leverage, plus Treasury’s equity investment, shifted principal risk on these assets to the public’s balance sheet. It took a while to get off the ground, and the program isn’t very large — less than $25 billion of investments. So far the funds are breaking even.

Justice, medieval style (Leeson, Boston.com) Interesting article, though the author offers little evidence to support his claim that trials by “ordeal” worked. (e.g. judging innocence/guilt based on whether the accused sank/floated when tied up and thrown in water.) ht reader Paul M.

New amateur video of Challenger disaster (LiveLeak)

Your brain on football (Time) Is brain trauma the rule more than the exception?

Awesome impressions (Funny Ordie) Comedian does DeNiro, Ahnold, Stallone and Morgan Freeman

Actor Rip Torn arrested drunk, armed in bank (Michaud, Reuters)

Volcker criticizes bankers (Dealbook) “Wake up gentlemen.” Indeed.

Geithner extends TARP to next October (Treasury) He buries the lead near the bottom of his letter. It had been scheduled to expire in December. Nothing so permanent as a temporary government program….

50% bonus tax would hit 20,000 London bankers (Aldrick/Armitstead, Telegraph) What’s to stop banks from boosting salaries in response? This is a backwards way to shrink the banking sector. Recapping balance sheets (i.e. bankruptcy) is the way to go.

Greek finance minister says no risk of default (Lacqua/Petrakis, Bloomberg) Reminds me of last year when every troubled bank reassured us that liquidity and capital were solid. When they have to make that comment publicly, you know the run is already on.

MUST READ—Greek debt could be timebomb for euro (Reuter, Spiegel)

Gerry Corrigan’s case for large integrated financials (Johnson, Baseline Scenario) Corrigan is one of the more responsible folks in the banking sector, yet he’s repeating the same old tripe that we “need” large banks.

Fed keeps testing the exit (NY Fed) It’s third tri-party reverse repo test in the last week. This, again, is one of the mechanisms that the Fed says it will deploy to pull liquidity out of the system, when and if it decides to.

Hillary ex-pollster Mark Penn got $6m of stimulus funds (Bolton, The Hill)

Drug dealer takes a snowday (imgur) Clever…

Tiger, lion, bear form unusual friendship (Telegraph) see below…

Paul Volcker wants to kill money market funds. He says that investors don’t understand them and that the funds could crash the financial system. He’s right.

The root of the problem is that money market funds are sold as “cash equivalents,” when really they’re anything but.

Investors allocating a percentage of their assets to “cash” are typically looking for a “riskless” place to park money. They want their principal protected, but they would  also like a few extra points of interest thank you very much. Free checks ? Even better.

Money market funds can offer all of the above, so naturally investors gravitate to them.

What they don’t realize is that their principal is at risk. The $1 net asset value that money funds market is just an accounting gimmick, a milder version of the same gimmick banks use to avoid writing down bad loans.

Because money market funds hold their assets to maturity, they’re allowed to use so-called “amortized cost” accounting instead of mark-to-market. If the value of securities in the portfolio rises or falls, investors don’t see that because it isn’t reflected in the fund’s share price. So they sleep soundly thinking their principal is perfectly protected.

To be fair, their principal is pretty safe. Most money market funds invest only in high quality ultra-short term paper. If the NAV did reflect the fluctuating value of holdings, it would still be very stable, probably never moving more than a penny or two.

And that’s what Volcker wants to do. He wants to force money funds to abandon accounting gimmickry that essentially permits them to market short-term fixed income funds as a “cash equivalents.”

Last fall, when an investment in Lehman Brothers paper forced the Reserve Primary Fund to break the buck, the veil was suddenly lifted and cash was pulled from money funds everywhere. Agile investors knew the money wasn’t perfectly safe, so they pulled out – redeeming at the promised $1 per share – leaving all the losses to be absorbed by slower shareholders.

That’s how that $785 million investment in Lehman paper turned into a systemic rout that threatened to drain a $3.5 trillion pool of capital from the market over a period of days. To stop the run, Treasury Secretary Hank Paulson offered a blanket guarantee for all money market fund assets, a guarantee that was extended earlier this year.

Volcker doesn’t want investors blindsided again. He wants money funds to stop marketing unbreakable $1 NAVs.

Money fund managers are fighting back because they know this would kill their business. If they can’t market $1 NAVs, their place in the asset allocation pie would be the “fixed income” slice not the “cash equivalent” slice. Investors would dump the funds in favor of bank accounts and CDs.

This would put significant pressure on the banking system. With hundreds of billions of deposits suddenly flowing in, banks would have to raise a lot of capital to protect their balance sheets.

If money funds want to keep operating like banks, fine. But in that case they should raise capital and subject themselves to bank regulation. Money funds aren’t keen on this idea either, it presents a number of problems that would also kill their business.

Perhaps it should be killed. It’s built on the fiction that investors can make riskless profits investing in short-term paper.

But when fiction meets reality, people panic. The only way to avoid that is to tell investors the truth. For money market funds, that means advertising them as what they are – fixed-income funds, not cash equivalents.

The BBC reports on the latest subprime writedown at a major bank. The conventional wisdom is that most of the subprime related credit losses that have to be taken already have been. Going forward, a larger problem for bank net income will likely be increasing provisions for loan losses, as opposed to straight writedowns on holdings gone South. Here’s a list of writedowns to date for major banks worldwide:

MAIN CREDIT LOSSES SO FAR

• Citigroup: $40.7bn
• UBS: $38bn
• Merrill Lynch: $31.7bn
• HSBC: $15.6bn
• Bank of America: $14.9bn
• Morgan Stanley $12.6bn
• Royal Bank of Scotland: $12bn
• JP Morgan Chase: $9.7bn
• Washington Mutual: $8.3bn
• Deutsche Bank: $7.5bn
• Wachovia: $7.3bn
• Credit Agricole: $6.6bn
• Credit Suisse: $6.3bn
• Mizuho Financial $5.5bn
• Bear Stearns: $3.2bn
• Barclays: $3.2bn

Source: Bloomberg and company reports

The main impact of credit losses is that they reduce bank lending. A handy way to think about it, is that banks typically lend out $10 for every $1 in capital on the books. So credit losses of this magnitude can be incredibly DEflationary.

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