The Twin Frankensteins: Fannie Mae and Freddie Mac

The current liquidity gridlock and extreme volatility washing across all of our debt and equity markets has caused me to do some reflecting on what I think some of the possible causes may have been. Obviously, mortgage lending took a reckless and unsustainable turn. This is what I believe has been the major catalyst for our current state of affairs. (The second catalyst--and one I will not delve into in this piece--was a combination of the repeal of Glass-Steagall Act in 1999, the bursting of the internet bubble in 2000 and the subsequent squeeze on investment bank profit margins which led to their "all-in" approach to highly leveraged, high fee, structured investment vehicles).

In order to understand how this reckless mortgage lending began, a short history lesson is in order. In a word--regulation. Regulation driven by liberals and progressives, not free-market “deregulators” as the aforementioned would have you believe.

Pushed hard by politicians and community activists, the regulators systematically and deliberately altered financially sound lending practices. The mortgage market was humming along just fine when, in the late 1980s, progressives, in their traditional style of fixing things that aren't necessarily broken, decided that it needed to be “fixed.” Their complaint: some ethnic groups got approved for mortgages at lower rates than others.

The shift began in 1989, when Congress amended the Home Mortgage Disclosure Act to force banks to collect racial data on mortgage applicants. By 1991, critics were using that data to paint lenders as racist by showing that minority applicants were approved at far lower rates. In fact, they found a racial disparity only by ignoring relevant data on applicants’ ability to make mortgage payments - such as their assets and credit history.

But the political pressure was intense - with few in politics or media eager to speak the truth. And then, in 1992, came a study from four researchers at the Boston Fed, which seemed to bear out the critics’ contentions.

That study was, in fact, based on quite flawed data - but the authors’ political, media and academic protectors stifled most serious criticism, smearing the reputation of one whistleblower and allowing the Boston authors to avoid answering serious academic challenges to their work. Other studies with different conclusions were ignored.

The very next year, the Boston Fed announced new requirements for banks - rules that have now turned out to be monumentally catastrophic: Adopt “relaxed lending standards” or risk being labeled as racists, and face serious penalties under the Federal Community Reinvestment Act.

But don't take my word for it. Below is a New York Times article--ironically published 9 years ago to the day--that talks about Fannie Mae relaxing their lending standards in order to allow more minorities to realize the American dream of debt beyond their wildest imaginations.

Here's also an 8.5 minute video spliced together from C-SPAN footage that documents how the democrats protected FNM and FRE from proper oversight.

Fannie Mae Eases Credit To Aid Mortgage Lending

By STEVEN A. HOLMES

Published: September 30, 1999

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.

Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

Fannie Mae officials stress that the new mortgages will be extended to all potential borrowers who can qualify for a mortgage. But they add that the move is intended in part to increase the number of minority and low income home owners who tend to have worse credit ratings than non-Hispanic whites.

Home ownership has, in fact, exploded among minorities during the economic boom of the 1990's. The number of mortgages extended to Hispanic applicants jumped by 87.2 per cent from 1993 to 1998, according to Harvard University's Joint Center for Housing Studies. During that same period the number of African Americans who got mortgages to buy a home increased by 71.9 per cent and the number of Asian Americans by 46.3 per cent.

In contrast, the number of non-Hispanic whites who received loans for homes increased by 31.2 per cent.

Despite these gains, home ownership rates for minorities continue to lag behind non-Hispanic whites, in part because blacks and Hispanics in particular tend to have on average worse credit ratings.

In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups.

The change in policy also comes at the same time that HUD is investigating allegations of racial discrimination in the automated underwriting systems used by Fannie Mae and Freddie Mac to determine the credit-worthiness of credit applicants.

The reason that progressive liberals should never be trusted with anybody's money is that they do not realize the simple fact that money is ethnic, color and race blind. If somebody is a good credit risk, they will be able to secure financing no matter the color of their skin. If by chance a bank really is racist, or there's some wild conspiracy among bankers where they collude to discriminate against qualified borrowers based on the color of their skin, you can bet another bank outside the reach of this cabal of colluding bankers would spring up and do a thriving business with all of these potential borrowers. There's really no need to legislate looser lending standards due to perceived discrimination. I do not expect that that argument will ever hold water in the minds of those who see racism or sexism lurking behind every door, especially when their livelihood and power is predicated on maintaining that illusion; regardless of the cost to society in the aggregate.

UPDATE: here is a report from the Independent Institute that details exactly what was the flawed data in the initial Boston Fed report I mentioned above.

Burning Man 2008

Burning Man: Part IV

Juggernaut: n.

1. Something, such as a belief or institution, that elicits blind and destructive devotion or to which people are ruthlessly sacrificed.
2. An overwhelming, advancing force that crushes or seems to crush everything in its path: “It doesn't assume that people need necessarily remain passive when confronted by what appears to be the juggernaut of history” (Christopher Lehmann-Haupt).

It may sound counter intuitive, but not coming across as redundant after four separate Burning Man experiences is hard to do. There's a certain consistency to the chaos out there on the playa; a familiarity that only reveals itself when you are standing there immersed in it. The last thing most people want to do--me included--whilst standing in the middle of the BM experience is to pause and reflect on the moment in order to create a memory catalog for reference when it comes time to write about it later. Pictures are helpful, but they generally do not provide the proper context in which events unfold. Plus people that take too many pictures miss out on a lot. It is hard to participate (Burning Man is all about participation) with a camera glued to your eyeball, which is why all I have to show for all my picture taking efforts is this pathetic collection of grainy photos from a disposable camera. Personally, I find that kind of charming. For anybody that wants to get into a full on Burning Man pictography, google will provide countless links to professional portfolios.

The "Lido" deck was my favorite place to spend the mornings.
Our camp this year was the best ever. Thanks to all who made it possible!

The playa surface was pretty loose this year. That made biking a bit more difficult.

The Tower of Babel: quite possibly the grandest piece of artwork that has ever been erected on the playa.

The Lido Deck: Cazadores and Coors Light served daily.

Neither was able to knock any sense into the other...

From the inside of the 12 story Tower of Babel.

Back in college we would sometimes get an assignment that required "stream of consciousness" writing. This involved putting the pen to the paper and simply writing whatever came to mind, non-stop, for a specified period of time. It is an exercise I've always enjoyed. Sometimes I'll still do it because I think it helps to quiet the mind and get the ideas flowing. I did a short exercise before starting this post, and one word that really resonated this time around was juggernaut.
Burning Man is a juggernaut, but not so much in the Old Testament style of blind devotion and destrictive sacrafice as defined in the first definition. Rather, it is more like the second definition, the one that defines a juggernaut as an overwhelming, advancing force that crushes or seems to crush everything in its path.

That's Burning Man!

A different kind of hope for a change

It is entertaining to watch the Obamaniacs soil their capri pants over John McCain's choice of Sarah Palin as his running mate. So far it seems the most dirt they can dig up on her is that her 17 year old daughter is 5 months pregnant and unmarried. For reasons that are unclear to me this seems to be a hypocracy of epic proportions; I guess because Mrs. Palin preaches the insane notion that abstinence is the best form of birth control. Anybody that was once young will recall that teenage rebellion is based on doing exactly what your parents tell you not to.

If she'd only hold still long enough for an abortion, that would surely pacify the left.

Bastard-ette!

Here is a list of 21 famous illegitimate children including poets, actors, authors, popes, and statesmen whose parents were not married. There's actually only 20 listed on the website, but I added one extra at the end.

21 Illegitimate Children

1. Guillaume Apollinaire. Poet.

2. Sarah Bernhardt. Actress.

3. Giovanni Boccaccio. Author.

4. Cesare Borgia. Catholic cardinal.

5. Aleksandr Borodin. Composer.

6. Pope Clement VII. Spiritual head of the Catholic Church.

7. Leonardo da Vinci. Artist.

8. Josephine de Beauharnais. Napoleon's wife.

9. Frederick Douglass. Abolitionist.

10. Alexandre Dumas, fils. Novelist and playwright.

11. Desiderius Erasmus. Scholar and author.

12. Alexander Hamilton. U.S. Secretary of the Treasury.

13. Jenny Lind. Singer.

14. Marilyn Monroe. Actress.

15. Bernardo O'Higgins. Dictator.

16. Francisco Pizarro. Conqueror of Peru.

17. James Smithson. Chemist and inceptor of Smithsonian Institution.

18. August Strindberg. Playwright.

19. Richard Wagner. Composer.

20. William the Conqueror. First Norman ruler.

21. Jrod. Blogger.

For the record, here are the contrasting views on parenthood that we will be able to vote for this November:

Obama…
“If my daughter makes a mistake, I don’t want her punished with a baby.”

Palin…
“As [our daughter] faces the responsibilities of adulthood, she knows she has our unconditional love and support.”

All of this will ultimately be irrelevant since unwed mother will marry unwed father before the baby is born. At that point, they'll have a 50/50 chance of making it work, just like the rest of us married folk.

Andrew Fastow and Milton Friedman would appreciate this

Harvest of cash: Kern County agency buys public water low, sells high

Delta fish suffered a crippling decline while taxpayers paid nearly $100 million to a Kern County water wholesaler for an environmental protection program that was largely ineffective, a Contra Costa Times investigation has found.

In the process, the wholesaler sold water to the state for as much as $200 an acre-foot and last year bought water from the state for as little as $28 an acre-foot.

The Kern County Water Agency was the biggest buyer in a program that delivered discounted Delta water in a way that now appears to have been particularly harmful to the environment. It also was the biggest seller of water to an ill-fated, publicly-financed state program meant to protect the same environment, the investigation found.

The Kern agency collected $96 million in taxpayer money — nearly all of it borrowed on the bond market — for sales to an "environmental water account" that was shelved after seven years at the end of 2007, records show.

While state water officials took steps to ensure they did not directly repurchase the discount water, the exchanges amounted to "classic arbitrage," where investors exploit price differences in financial instruments, said Barry Nelson, a water policy analyst at the Natural Resources Defense Council.

Andrew Fastow would appreciate this because it is a play right out of Enron's own play book.

Milton Friedman would appreciate it because he demonstrated his knowledge of how government spends money when he said this:

There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.

It boggles the mind.

"New " Short Sale Rule

Even if you never pick up the business section of the paper, it has been hard not to notice that the stock market has been particularly volatile lately. Although there are numerous factors involved, most of the volatility has stemmed from the uncertainty surrounding the solvency of our nation's two largest mortgage lenders, Fannie Mae and Freddie Mac, as well as questions surrounding the balance sheets of some of the larger commercial and investment banks with large opaque mortgage portfolios like Wachovia, Washington Mutual, Merrill Lynch and Lehman Brothers.

Just as surely as blood in the water attracts sharks, volatility attracts short sellers. Yesterday the Securities and Exchange Commission announced an emergency order stating that they were going to crack down on naked short selling (i.e. selling shares you have not borrowed, nor have even a reasonable expectation of borrowing) in 19 of some of the most volatile and vulnerable financial stocks. Their plan will go into effect Monday.

Here are the highlights:

No person is permitted to short any of the 19 stocks on the SEC list without first securing one of the following:

1) Have a borrow in hand
2) Have a pre-arranged borrow
3) Have shares in inventory

• There’s culpability at the order entry level, not just the settlement level.
• Pre-borrows will have a fee attached.
• Delivery requirement does not permit any Failure(s) to Deliver (FTD), no penalty for non-compliance is mentioned though.
• Traditionally there has been a 13 day window before a mandatory buy in happens. All trades will have to settle in 3 days.
  
• Exercising a put option that results in a short position is covered by the new rule, auto-exercise of a put option is also covered.
• Assignment of options is not covered
• If you have a pre-borrow (not just a locate) the executing broker can take the short order.
• SEC will exempt market makers, specialists, etc…details not released yet.
• Slated to expire in 10 days but can be extended for 30 days.
• Documentation will be paramount.

It is difficult not to conclude that all of this is SEC political posturing in the face of market turmoil. Naked short selling is already illegal after all, just as it should be. The problem is that there is no enforcement. It seems that a few very heavy fines at the order entry level would go a long way towards stopping the practice since there's no incentive for prime brokers to police beyond their mandate that a short seller must have a "reasonable expectation" of being able to deliver a stock. In fact, there's a disincentive because they collect fees for facilitating a short sale--borrow or not.

The Depository Trust & Clearing Corporation (DTCC), where virtually all stocks go to settle, has in place a system called the continuous net settlement (CNS) system. To oversimplify what it does, each prime broker "nets" out their positions each night which acts to cut down on a lot of back office noise and electronic paper shuffling. If a prime broker acting on behalf of a client fails to deliver a stock because the client did not secure a borrow before selling the stock short, it throws the system out of balance. If this is not rectified over the normal settlement period of 3 days, the stock transaction may be flagged FTD (failure to deliver). After 13 days, the position will theoretically go through a "buy in" where the prime broker goes into the open market and purchases the stock in order to make good on the delivery to the counter party. Since markets are dynamic, the price paid in the open market for the buy in can vary greatly from the reported price on the original transaction, and let's not even consider that the stock you buy in could result in another FTD. To say the least the potential for an ugly and costly situation exists when a FTD is issued. One way to avoid this potentially nasty situation is if all prime brokers on the CNS system collude to not issue FTDs unless under the direst of situations. That is exactly what they do. The whole system is a house of cards supported only by the fact that nobody calls in their chips.

I have to give some credit to the SEC. They're an overworked and under-funded department charged with maintaining the integrity of our markets against the malfeasance of some of the most intelligent, clever and greediest people on the planet.

The SEC did well when they eliminated the plus tick rule. Now it is imperative that they extend these naked short rules to the market as a whole and then actually enforce them. The electronic paper trail is not difficult to follow, and if the chances of getting caught go from close to zero (as they are now) to close to 100%, you'll see the practice stop virtually overnight. Nothing hurts a trader more than getting kicked right square in the pocket book.

Short sellers provide a vital service to financial markets. They are often the first to point out that the "emperor has no clothes" and they provide another source of liquidity when markets get overheated. But the artificial conditions created when one engages in naked short selling needs to be stopped.

I wonder why he came here?

Of all the nations on earth, upon escape from being tortured in an Iranian prison for 9 years, Mr. Batebi chose to come to the United States of America.


From The Economist print edition

An Iranian student protester, sentenced to death for appearing on our cover, has escaped to America

NINE years ago, Ahmad Batebi appeared on the cover of The Economist. He was a 21-year-old student, one of thousands who protested against Iran’s government that summer. He was photographed holding aloft a T-shirt bespattered with the blood of a fellow protester. Soon afterwards, he was arrested and shown our issue of July 17th 1999. “With this”, he was told, “you have signed your death warrant.”

During his interrogation he was blindfolded and beaten with cables until he passed out. His captors rubbed salt into his wounds to wake him up, so they could torture him more. They held his head in a drain full of sewage until he inhaled it. He recalls yearning for a swift death to end the pain. He was played recordings of what he was told was his mother being tortured. His captors wanted him to betray his fellow students, to implicate them in various crimes and to say on television that the blood on that T-shirt was only red paint. He says he refused.

He was sentenced to death for “creating street unrest”. But after a global outcry, the sentence was commuted to 15 years in jail. He speculates that his high profile made it hard to kill him without attracting negative publicity. For two years, he was kept in solitary confinement, in a cell that was little more than a toilet hole with a wooden board on top. He was tortured constantly. Only when he was allowed to mingle with other prisoners again did he begin to overcome his despair.

He suffered a partial stroke that left the right side of his body without feeling. He needed medical attention. The regime did not want to be blamed for him dying behind bars, he says, so he was allowed out for treatment. Three months ago, on the day of the Persian new year, he escaped into Iraq. On June 24th he arrived in America.

He spoke to The Economist on July 7th. Looking at the picture that sparked his ordeal, he says that another man in his place might be angry, but he is not. Mr Batebi is a photographer himself. He says he understands what journalism involves. Had we not published the picture, he says, another paper might have. Looking at the same picture, his lawyer, interpreter and friend Lily Mazahery says she is close to tears: in it, the young Mr Batebi’s pale arms are as yet unscarred by torture.

The protests Mr Batebi took part in nine years ago frightened Iran’s rulers. The students were angry about censorship, the persecution of intellectuals and the thugs who beat up any student overheard disparaging the regime. Mr Batebi thinks Iran could well turn solidly democratic some day. In neighbouring states, religious extremism is popular. In Iran, he says, the government is religiously extreme, but the people are not.

He is cagey about how exactly he escaped. But he says he used a cellphone camera to record virtually every step of his journey, and will soon go public with the pictures and his commentary. Meanwhile, he seems to be enjoying America. He praises the way “people have the opportunity to become who they want to be”. Shortly after he arrived, he posted a picture of himself in front of the Capitol on his Farsi-language blog, with the caption: “Your hands will never touch me again.”

“People have the opportunity to become who they want to be.” It's what the American Dream all comes down to. Sometimes it takes an outsider to comment on the obvious, something so obvious it is taken for granted by most of us.

“The obscure

we see eventually.

The completely obvious.

it seems

takes longer”.

– Edward R. Murrow

Racism in Brazil

When I think of Brazil, the first three things that come to mind are passionate, scantily-clad, soccer fans, that Chiquita banana lady, and of course Charo. As far as I'm concerned that's clever brand management on Brazil's part, because upon further reflection the next three things that come to mind are institutionalized corruption, favelas and that depressing movie City of God. So on balance, Brazil appears to be just another BRIC nation taking the good with the bad while trying to navigate their way to a successful future.

But maybe all is not what meets the eye:

Brazilian Secret 93 Million Don't Want to Talk About Is Racism

Brazilians pride themselves on their multicultural society, home to the largest black population outside of Africa. Their food, music and dance -- their feijoada, the national dish of black beans stewed with pork and beef, and their rhythmic samba and bossa nova -- are a mishmash, the legacy of more than 200 indigenous peoples, Portuguese colonists and about 4.5 million Africans who were brought to the country during more than 350 years of slavery. Interracial marriages are common.

So pervasive is the perception that Brazil is a paragon of racial harmony and equality that it makes the discussion of discrimination all but impossible, says Carlos Santana, a Workers' Party legislator who represents Rio de Janeiro and heads the National Congress's Parliamentary Group to Promote Racial Equality.

``In Brazil, we can talk about anything but race,'' Santana says. ``The myth of racial democracy created a taboo.''

Some people outside of government use harsher terms.

``We have the strongest apartheid ever because people deny racism exists,'' says Humberto Adami, head of the nonprofit Institute for Racial and Environmental Laws in Rio de Janeiro. ``It's very hard to combat what is taken as nonexistent.''

Statistics paint a picture of a nation tainted by the legacy of unequal opportunities. One hundred twenty years after becoming the last country in the Americas to abolish slavery, Brazil remains divided by color. People of African descent are ``a large, impoverished and discriminated-against population,'' the Brazilian embassy in Washington said in a press release posted on its Web site in April.

Blacks -- defined by the government and nongovernmental organizations as people who describe themselves as either ``preta'' (black) or mixed-race ``parda'' (brown) -- make up almost half of the population. Of the nation's more than 187 million people, 92.7 million are black and 93.1 million are white; Asians, Indians and those who haven't declared a race make up the rest. On average, they earn little more than half as much as whites, 578.2 reais ($361) a month compared with 1,087.1 reais, according to a report based on 2006 data by IPEA Institute for Applied Economic Research, a government group in Brasilia.

(snip) The whole article is worth a read.

So often here in the United States we're told by the social justice crowd that our nation remains mired in an antebellum mindset, but I do not believe that to be true for a second. While racism surely exists in the hearts of a percentage of Americans--Americans of all colors by the way--as a nation we're light years ahead of places like Brazil where the legacy of slavery and current race relations have simply been ignored. If the social justice crowd acknowledged that they'd be out of a job; for their livelihood depends on the perpetuation of the myth. Second of all, it would seem that they should be in a lather over this. They usually get worked up over far less. Maybe they're not because Lula De Silva is a leftist himself, though admittedly he seems to be doing a better job at governing than most of his peers.

Upon further reflection, this is the Brazil of my mind's eye: Brigitte Bardot in the Girl From Ipanema

The carpenter and his tools

It's a poor carpenter who blames his tools for a shoddy job.

May 21 (Bloomberg) -- Moody's Investors Service said it's conducting ``a thorough review'' after the Financial Times reported that a computer error was responsible for Aaa ratings being assigned to complex debt securities that slumped in value.

In an up market the glitch is called a "feature." In a down market the glitch is called a "bug."

Banks obtained the highest grades in 2006 and 2007 for constant proportion debt obligations, funds sold in Europe that used borrowed money to speculate on an improvement in credit quality. The subprime crisis caused banks including UBS AG and ABN Amro Holding NV to unwind their CPDOs, triggering losses of as much as 90 percent for investors.

Some senior staff at Moody's were aware in early 2007 that CPDOs rated Aaa the previous year should have been ranked as many as four levels lower, the FT reported today, citing internal Moody'sdocuments. The firm adjusted some assumptions to avoid having to assign lower grades, the paper said.

Senior staff was aware of the problem, but when the moneytrain is rollin' few are brave enough to point out that the wheels look loose and might be in danger of falling off.

`If it is true, does that mean other products haven't been rated correctly?'' said Puneet Sharma, Barclays Capital's head of investment-grade credit strategy in London. ``Will they be downgraded? It could lead to turmoil.''

Rest easy Puneet, surely this is an isolated incident.

Moody's and Standard & Poor's stripped CPDOs of their Aaa grades this year as rising defaults in the U.S. housing market increased the cost of credit-default swaps referenced by the funds by as much as 670 percent in the past year.

Guess there's no penalty for piling on at this point.

``The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised about European CPDOs,'' New York-based Moody's said in an e-mailed statement. ``We are therefore conducting a thorough review of this matter.''

I love it when hookers talk about integrity, especially when they still have lastnight's mascara and lipstick smeared all over their face.

Moody's has ``adjusted its analytical models on the infrequent occasions that errors have been detected,'' the statement said. ``It would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors.''

Computer glitches aside, it never ceases to amaze me how these supposedly brilliant builders of analytical models account for the possibility of a black swan event occurring by just tossing out the possibility. And since Wall St. is ruthlessly efficient when it comes to sucking up all the best talent that money can buy, it occurs to me that the programmers working for ratings agencies are not necessarily the best and brightest.

Where the rubber meets the pavement

Ever since environmentalism became a shibboleth of the left, and therefore the Democrats, I have wondered how they would react when the time came to reconcile their actions with their purported beliefs. It appears I will not have to wonder much beyond the DNC in Denver this summer:

Caterers find eco-standards tough to chew

Fried shrimp on a bed of jasmine rice and a side of mango salad, all served on a styrofoam plate. Bottled water to wash it all down.

These trendy catering treats are unlikely to appear on the menu at parties sponsored by the Denver 2008 Host Committee during the Democratic National Convention this summer.

Fried foods are forbidden at the committee's 22 or so events, as is liquid served in individual plastic containers. Plates must be reusable, like china, recyclable or compostable. The food should be local, organic or both.

How are we ever going to make the shift from fossil fuel to vegetable oil power if fried food is forbidden? That's a serious question I keep meaning to ask somebody with a "powered by vegetable oil" sticker proudly displayed on their bumper.

And caterers must provide foods in "at least three of the following five colors: red, green, yellow, blue/purple, and white," garnishes not included, according to a Request for Proposals, or RFP, distributed last week.

...All the pretty colors of the rainbow.
Reading this far I was reminded of the first Burning Man theme camp planning meeting I attended a few years ago. We had settled on a genie-type theme and purchased a used golf cart we intended to turn into an art car. One of my camp mates proposed turning the golf cart into an elaborate motorized genie bottle and she had done some nice sketches to show us what she had in mind. We all agreed that it looked great, then somebody asked her for a list of materials and a rough outline of the building plan so we could get started. Her confusion over the question turned to slight irritation when she realized that not only did she not have any specs, we weren't going to do it all for her. The vision quickly turned to dust.
I imagine the person who was tasked with creating the DNC catering RFP is similar to my idealistic camp mate that year.

The shrimp-and-mango ensemble? All it's got is white, brown and orange, so it may not have the nutritional balance that generally comes from a multihued menu.

"Blue could be a challenge," joked Ed Janos, owner of Cook's Fresh Market in Denver. "All I can think of are blueberries."

Ed nails it. Blueberries being the only exception that immediately springs to mind, every first year culinary student knows that putting blue on a plate is a cardinal sin.

Caterers praise the committee and the city for their green ambitions, but some say they're baffled by parts of the RFP.

"I think it's a great idea for our community and our environment. The question is, how practical is it?" asks Nick Agro, the owner of Whirled Peas Catering in Commerce City. "We all want to source locally, but we're in Colorado. The growing season is short. It's dry here. And I question the feasibility of that."

Agro's biggest worry is price. Using organic and local products hikes the costs.

"There is going to be sticker shock when those bids start coming in," he says. "I'll cook anything, but I've had clients who have approached me about all-organic menus, and then they see the organic stuff pretty much doubles your price."

Mr. Agro,

Please resist the urge to use words like "practical" and "feasibility", for they have no meaning in the eco-lexicon. Just make it happen, and if you're not prepared to put the good of our planet above your personal profits, we will find somebody that does.

Signed, DNC

P.S. we've noted your propensity to question authority, and we're not happy, but we'll address your insouciance after the convention.

The document, which applies only to the host committee's parties, came after months of work that involved discussions with caterers and event planners along the Front Range, says Parry Burnap, Denver's "greening" director.

Months of work filled by many, many hours spent in committee and sub-committee meetings to come up with the RFP. There's nothing bureaucracy loves more than more bureaucracy.

Thousands of other parties hosted by corporations, lobbying groups, individuals, nonprofits and more will happen in Denver during the convention, Burnap says. None of them is subject to the committee's green agenda.

The committee's effort to host eco-friendly events, she says, hinges on its determination not just to put on a smart convention but to transform Denver into a top-shelf green city.

What's a law without a gaping loophole afterall? I hope somebody keeps score of all the non-conforming parties that take place and who hosted them.

"We are hoping that everything we are doing for greening (the convention) has some legacy value," she says.

The RFP, for example, will likely live on after the convention in a brochure the city will distribute widely to help guide local businesses interested in improving their green practices.

It will have legacy value alright. My guess is that the DNC will host a small handful of perfectly "eco-friendly" parties and showcase them as the rule rather than the exception.

Burnap says taking the organic and local route may be more costly, but the committee thinks caterers will find ways to comply and still make a profit.

"It takes some creativity because some of these things are more expensive," she says. "But we're at the front end of a market shift."

One of two things will happen. The caterers will sacrifice a large percentage of their profit margin and "make it happen" for the "greater good" or they will cheat and charge organic prices for non-organic products. Most people are not able to tell when a filet mignon has been replaced with an "eye of round" which is a much cheaper cut of meat, for example. Who will be able to tell if the avocados used in the guacamole are organic or not? Catering is hard work fraught with unforeseen hassles and much pressure in order to put out a quality product that the clients are unlikely to even fully appreciate. I would be shocked if any caterer that was not independently wealthy would sacrifice any part of their already slim profit margin. Cheating would be far easier, especially when the theme is all a pose in the first place.

Joanne Katz, owner of Three Tomatoes Catering in Denver, cheers the committee's environmental aspirations and is eager to get involved with the convention, but she wonders if some of the choices the committee is making are really green.

Compostable products, such as forks and knives made from corn starch, are often imported from Asia, delivered to the U.S. in fuel-consuming ships. But some U.S. products are made from recyclable pressed paper. Which decision is more environmentally sound?

"Customers are beginning to demand these things, and we don't have all of the information," she says. "And we are doing the best we can, one project at a time."

Ms. Katz,

Your wondering is troubling. We will deal with you after the convention, too.

Signed, DNC

Burnap acknowledged that figuring out what is most green can be difficult.

"Maybe in 20 years, there will be better analysis for us to make better choices," she says. "One we are talking about now is, is it better to compost or to recycle? If you are using a cup for a beverage, is it better to be (plastic) and back in the materials stream, or compostable, biodegradable waste and go into the waste stream or compost? There are no definitive answers."

Composting for the convention hasn't been entirely figured out yet, she says.

What a wonderful nation we live in; where the greatest problem of the moment seems to be whether it is better to compost or to recycle? I wonder what a typhoon survivor in Burma, or an earthquake survivor in China, or a Darfur refugee, or, or, or--thinks is the biggest problem of the day?

The committee is working with other groups to develop a carbon-footprint "calculator" that will measure the environmental impact of each event and suggest an "offset" — a fee — that will go toward a fund helping to match carbon losses with carbon gains.

"That's a fun one," Burnap says. "If these event planners will calculate and offset, it will start to get the money flowing into the Colorado Carbon Fund, a fund that will reinvest in renewable energy here in Colorado."

Whoooopppieeeee! Boy I know nothing gets my motor revved quite like carbon-footprint calculations. Next up, a self-administered root canal sans novicane!

I hope they don't plan on encouraging people to walk around Denver during the convention, since it has been proven in the U.K. that walking kills the planet.

The only advice I can give to the caterers of Denver is to get all of your money up front, in cash.

The two faces of Citigroup

Banks, like all businesses outside of the non-profit realm, are in the business of making money. The difference between banks and most other businesses is that banks do not create anything tangible. Of course they make tangible products possible by providing financing for companies that do actually create things, but the value in a bank resides in the intellectual capital of its workforce.
Any industry that promotes the promise of a big payday tends to attract the most clever among us, and there is no shortage of clever people on Wall Street. It is safe to say that if it is possible to squeeze a dollar out of a rock, lever it to return $100 and charge 20% for the service, Wall Street has come up with 25 ways to do it.
Auction rate securities (ARS) are one of the many inventions of Wall Street. Pitched to municipalities, port authorities, school districts and other entities that don't always grasp the full meaning of caveat emptor, they were assumed to be as "safe as cash" while providing a little extra yield. Like many things that work great until they don't, it turns out ARS aren't exactly as safe as cash.

Citigroup Leads Wall Street Drive to Hurt Taxpayers

May 9 (Bloomberg) -- Taxpayers from Massachusetts to California are paying Wall Street banks to end derivative contracts gone bad as they exit the collapsing auction-rate bond market, with penalties in some cases topping $10 million and compounding the pain of rising borrowing costs.

Sacramento County, California, paid Morgan Stanley $5 million to cancel an interest-rate swap agreement when it refinanced $79.5 million in auction-rate securities last month. The fee added to the cost of the bonds after the rate on the securities more than doubled to 9.8 percent in March as dealers stopped supporting the market.

As you may have heard, there's a home price melt down going on out there. Sacramento County is one of the hardest hit areas in the nation. This is good news for those who have been patiently saving towards a down payment on a starter home. It is not so good news for a county government with a declining tax base. Can Sacramento County really afford an extra $5million just to cancel a deal gone bad?

States, cities, hospitals and colleges face penalties exceeding $10 million to terminate swaps that failed to protect them against higher rates, according to interviews with borrowers and advisers. That's on top of the $1 billion in fees they're paying to dealers to help sell bonds that would replace auction-rate securities they sold, based on industry averages.

Citigroup, based in New York, was the top underwriter of auction-rate securities in the municipal market, arranging $55 billion in sales between 2000 and the end of last year, according to data compiled by Thomson Reuters. Zurich-based UBS AG, which said on May 6 it will close or sell its municipal bond department, underwrote $42 billion, followed by Morgan Stanley of New York at $22 billion and 19 others.

The banks are earning fees on both sides of the trade and us taxpayers are footing the bill. That's a nice hedge if you're the bank.

All this is just a drop in the bucket though:

Citigroup Plans to Shed About $400 Billion of Assets

May 9 (Bloomberg) -- Citigroup Inc. Chief Executive Officer Vikram Pandit plans to get rid of about $400 billion of assets over the next three years as he starts to whittle away at the company built by Sanford``Sandy'' Weill.

When he's done, Citigroup may cease to be the biggest U.S. bank, a title the firm has held for a decade. ``There will be more'' divestitures, Pandit told shareholders at a meeting today at the bank's New York headquarters.

The company, which lost $5.1 billion in the first quarter, has booked more than $40 billion of credit losses and writedowns since the subprime mortgage market collapsed last year. The shares dropped in New York trading today, as analysts said they were unimpressed by Pandit's proposals for returning to profitability.

What is it that causes some of the most clever people in the world to rack up such huge losses?
Besides being the most lucid resident of Berkeley, Michael Lewis, author of the famous Wall St. book Liar's Poker, remains one of my favorite columnists. He has this to say:

To both their investors and their bosses, Wall Street firms have become shockingly opaque. But the problem isn't new. It dates back at least to the early 1980s when one firm, Salomon Brothers, suddenly began to make more money than all the other firms combined. (Go look at the numbers: They're incredible.)

The profits came from financial innovation -- mainly in mortgage securities and interest-rate arbitrage. But its CEO, John Gutfreund, had only a vague idea what the bright young things dreaming up clever new securities were doing. Some of it was very smart, some of it was not so smart, but all of it was beyond his capacity to understand.

Ever since then, when extremely smart people have found extremely complicated ways to make huge sums of money, the typical Wall Street boss has seldom bothered to fully understand the matter, to challenge and question and argue.

New New Thing

This isn't because Wall Street CEOs are lazy, or stupid. It's because they are trapped. The Wall Street CEO can't interfere with the new new thing on Wall Street because the new new thing is the profit center, and the people who create it are mobile.

Anything he does to slow them down increases the risk that his most lucrative employees will quit and join another big firm, or start their own hedge fund. He isn't a boss in the conventional sense. He's a hostage of his cleverest employees.

There's an aphorism that states, "you can't cheat an honest man." It means that in order for a scheme to work, the one being solicited for the deal needs to feel like they're getting something for nothing. In the case of ARS, the purchasers thought they were getting a debt instrument as safe as cash but with a higher yield. Just as many of the most clever among us end up on Wall St, many of the not-so-clever among us end up in government, especially local government.

The late, great Milton Friedman had this to say:

There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.

So there you have it. Clever people fleecing not-so-clever people spending money that doesn't belong to them. I have a feeling that the other industry that attracts clever people in search of riches, the law industry, will make out OK in all this too.

And some believe we should have higher taxes...

Level 3 Asset Watch

DJ Merrill Level 3 Assets $82.4B At 1Q End, 8% Of Total Assets
Tuesday, May 06, 2008 4:37:57 AM (GMT-07:00)

Merrill Lynch & Co. (MER) said Tuesday that its Level 3 assets at the end of the first quarter increased nearly 70%, to $82.4 billion, from $48.6 billion at the end of the fourth quarter.
The Wall Street firm said the Level 3 assets, which include assets measured at fair value on a recurring and non-recurring basis, increased because of the recording of trading assets, for which the exposure was previously recognized as derivative liabilities at the end of the fourth quarter.
The company said it also transfered $5.6 billion of European commercial real estate mortgage loans into level 3 that had previously been classified in Level 2.
"During the first quarter of 2008, there was a decrease in the liquidity for these products, resulting in the increased use of unobservable inputs to derive their fair value," Merrill said.
In its quarterly report filed with the Securities and Exchange Commission, Merrill said Level 3 assets as a percentage of total assets amounted to 8% at the end of the first quarter, compared with 5% at the end of the fourth quarter.

In an earlier post I talked about level 3 assets as the bucket that banks dump the stinkiest of their dirty laundry into. Management literally guesses what the asset is worth and assigns it that value. Here's an interesting screenshot that captures the current top 18 companies sorted by their level 3 assets:




Merrill is number 3 at the moment. Citigroup and Goldman Sachs own the number 1 and 2 spots respectively. The question that continues to nag me is if by definition level 3 assets are assigned a best guess value in the first place, how can we take seriously what a company says they have in their level 3 bucket? Where's the tipping point?

If it were not for financial institution convertible security secondary offerings floated to shore up their sick balance sheets, investment bankers would have little to no business to speak of so far this year. That would make their balance sheets look even worse.

I see more writedowns to come.

Global Warming Mulligan #1

In this crazy, mixed up, topsy-turvy world--where anything can cause everything, or even nothing at all--it makes perfect sense that a cooling trend can be interpreted as further evidence that man is causing global warming.

Ocean Cooling to Briefly Halt Global Warming, Researchers Say

April 30 (Bloomberg) -- Parts of North America and Europe may cool naturally over the next decade, as shifting ocean currents temporarily blunt the global-warming effect caused by mankind, Germany's Leibniz Institute of Marine Sciences said.

Average temperatures in areas such as California and France may drop over the next 10 years, influenced by colder flows in the North Atlantic, said a report today by the institution based in Kiel, Germany. Temperatures worldwide may stabilize in the period. `

`Those natural climate variations could be stronger than the global-warming trend over the next 10-year period,'' Wood said in an interview. ``Without knowing that, you might erroneously think there's no global warming going on.''

Germany's universities have been going downhill since they quit charging tuition; arguably longer. I assume that the Leibniz Institute of Marine Sciences is staffed by many graduates of German universities. But honestly, is "don't believe your lyin' eyes" the best they can offer the world?

``Natural variations over the next 10 years might be heading in the cold direction,'' Wood said. ``If you run the model long enough, eventually global warming will win.''

Yes, Dr. Wood, and if you ran your model even longer, I bet global cooling would win. Variations in global temperature is the nature of, er, global temperature variation afterall. By the way, what does global warming win?

Here's my favorite part:

``We thought a lot about the way to present this because we don't want it to be turned around in the wrong way,'' Keenlyside said. ``I hope it doesn't become a message of Exxon Mobil and other skeptics.''

Cause, like, only shills for BIG OIL don't believe in global warming.




This is a picture of Palm Jumeirah, which is a man-made luxury island just off the coast of Dubai. It has more than doubled the waterfront area of Dubai and created luxury homes for thousands of people. I was reading an industry report today from a well-known investment bank and it stated that there is estimated to be $1.5 trillion invested in Dubai and the greater surrounding area over the next 5 years. Dubai, is at sea-level. I wonder how serious those who are going to invest $1.5 trillion at sea-level consider the imminent threat of rising tides due to anthropogenic global warming?

I hope Al Gore is translating "An Inconvenient Truth" into Arabic. Who else can save them from themselves?

Now taking nominations for the Worst Magazine Cover of the year

I humbly submit the following:


I saw this magazine cover sitting on the coffee table at a friend's house two days ago and I had to look twice to believe what I was seeing. After digesting my double-take i concluded my eyes had not deceived me; for there it was for all the world to see: Time Magazine equates the importance of "The War on Global Warming" with the Battle for Iwo Jima. I'll give Time an "A" for shock value alright, but if their intention was to shock folks like me into thumbing through the issue--let alone purchase it--well let's just say they failed miserably.

Dennis Prager sums up my thoughts on the matter rather succinctly, so I'll just add, "yeah, what he said."

The Time cover is cheap heroism. It is a liberal attempt to depict as equally heroic those who fight carbon emissions and those who fought Japanese fascists and Nazis.

Second, for much of the left, the cover reflects the primacy of environmental concerns over moral concerns. For example, the left seemed never to care about the millions of Africans who continued to die from malaria largely because of the environmentalists' worldwide ban on the use of DDT as pesticide. The same holds true for another leftwing environmentalist fantasy. Changing corn into biofuels is causing a surge in food prices throughout the world. The European Union continues this policy despite warnings even from some environmentalists that food shortages, starvation and food riots are imminent. But human suffering is not as significant as environmental degradation.

Third, the left is far more internationalist -- global, if you will -- in its orientation than national. As the Time article states, "Going green: What could be redder, whiter and bluer than that?" Whereas, for most Americans patriotism remains red, white and blue, for much of the left it is green.

Fourth, the further left you go, the more inclined you are to hysteria. From the threat of DDT to the threat of heterosexual AIDS in America to that mass killer secondhand smoke, the left believes and spreads threats that, unlike the threat of Islamic terror, really are "scare tactics."

I'm sure there are plenty of people out there who see nothing wrong with Time's cover this week--even going so far as to celebrate it as speaking "truth to power" or something--and will take the opportunity to dismiss any objection as typical right-wing hysteria. Too bad they'll also not realize that the men on the cover and their brothers-in-arms fought for their right to hold and express their mis-guided feelings and opinions.

Oh yeah, HAPPY EARTH DAY, whatever that means.

The Cost of Healthcare

One thing that I've never been able to understand with regards to our nation's perpetual health care debate is why anybody thinks that insurance is the best way to pay for health care in the first place. If one looks at the insurance industry model in general, the whole system is geared toward pricing the probability of one-off events occurring among a certain portion of those who are insured. For example, automobile insurance exists to protect against theft and accidents; home insurance to protect against catastrophic loss from fire and natural disasters; and life insurance to protect one's family against the untimely death of the breadwinner. Insurance companies can stay in business because the risk of all policy holders making a claim at the same time is unlikely, and most policies never pay out anything substantial if they pay anything at all.

Now consider health care. The probability that somebody with a health care policy is going to make a claim, actually several claims over the life of the policy, is all but assured. What would happen to the price of auto insurance if every time you got a tune up for your car, or filled the tank with gas, you then submitted a claim? Where would home insurance premiums be if it was standard practice to ask for reimbursement after having your house painted or the hot water heater fixed? Would it be within the realm of possibilities that insurance companies would try any number of tricks to make the process of filing a claim more cumbersome so as to cut down on the number of claims they were bound to honor?

The way the system is now, going in for a health check up or a minor procedure and submitting the bill to your insurance company for payment is akin to submitting an automobile tune up receipt or a general home maintenance receipt to your insurance company. A health check up, car tune up and the upkeep of one's home are all similar inasmuch as they can be categorized as general maintenance. Items that fall under general maintenance should not be subjected to the insurance reimbursement maze. As Dr. Kellerman puts it in an opinion article in today's WSJ:

The health insurance model is closest to the parasitic relationship imposed by the Mafia and the like. Insurance companies provide nothing other than an ambiguous, shifty notion of "protection." But even the Mafia doesn't stick its nose into the process; once the monthly skim is set, Don Whoever stays out of the picture, but for occasional "cost of doing business" increases. When insurance companies insinuate themselves into the system, their first step is figuring out how to increase the skim by harming the people they are allegedly protecting through reduced service.

Insurance companies act as middlemen, and middlemen add layers to the cost of business, not take them away.

Insurance is all about betting against negative consequences and the insurance business model is unique in that profits depend upon goods and services not being provided. Using actuarial tables, insurers place their bets. Sometimes even the canniest MIT grads can't help: Property and casualty insurers have collapsed in the wake of natural disasters.

Health insurers have taken steps to avoid that level of surprise: Once they affix themselves to the host – in this case dual hosts, both doctor and patient – they systematically suck the lifeblood out of the supply chain with obstructive strategies. For that reason, the consequences of any insurance-based health-care model, be it privately run, or a government entitlement, are painfully easy to predict. There will be progressively draconian rationing using denial of authorization and steadily rising co-payments on the patient end; massive paperwork and other bureaucratic hurdles, and steadily diminishing fee-recovery on the doctor end.

Anybody that's ever been to an auto body shop knows that a 2-tier system of billing exists. Tell them you are going to submit the bill to insurance for payment and you will get a much different estimate than if you reveal you'll be paying out of pocket. The same 2-tier system exists in our current health care system:

Some of us are old enough to remember visiting the doctor and paying him/her directly by check or cash. You had a pretty good idea going in what the service was going to cost. And because the doctor had to look you in the eye – and didn't need to share a rising chunk of his profits with an insurer – the cost was likely to be reasonable. The same went for hospitals: no $20 aspirins due to insurance-company delay tactics and other shenanigans. Few physicians became millionaires, but they lived comfortably, took responsibility for their own business model, and enjoyed their work more.

Several years ago, I suffered a sports injury that necessitated an MRI. The "fee" for a 20-minute procedure was over $3,000. My insurance company refused to pay, so I informed the radiologist that I'd be footing the bill myself. Immediately, the "fee" was cut by two thirds. And the doctor was tickled to get it.

Like so many things in life, personal responsibility needs to be introduced into the health care equation. Being forced to pay for one's own health maintenance should in theory promote a more healthy lifestyle. Young, healthy individuals need little more than catastrophic health insurance to protect against the big unforseen bumps in life. As one gets older, perhaps the level of coverage could go up on a sliding scale. In any case, whatever system of payment for health services is eventually instituted needs to be market-based and portable so it is not dependent on a particular job or social circumstance. Once the tremendous amount of inertia caused by the millions of minute claims processed each day by insurance companies is reduced, maybe then they can focus on the efficiency of the system; or get out of the business altogether.

Quantifying a WAG

Today several investment banks announced their share of Level 3 assets. In case you are wondering what level 3 assets are--and level 1 and 2 assets for that matter--the Wall St. Journal has this definition:

Level 1 is assets that have observable market prices. Think a stock traded on the NYSE.

Level 2 assets don’t have an observable price, but they have inputs that are based on them. Think an interest-rate swap where its components are observable data points like the price of a 10-year Treasury bond.

Level 3 is for assets where one or more of those inputs don’t have observable prices. This is the bucket that has been described as a guesstimate, because it is reliant on management estimates. As things stand now, companies who haven’t early adopted FAS 157 don’t give this more detailed breakdown to investors. So, one result of FAS 157 is more information.

Warren Buffet famously said that he never invests in things that he does not understand. I wonder how many investment banks truly understand what they have filed under Level 3 assets? (Bloomberg article)

Goldman's share of Level 3 assets surged 39 percent to $96.4 billion at the end of February from $69.2 billion in November, according to a filing with the U.S. Securities and Exchange Commission today. The ratio of Level 3 to total assets rose to 8.1 percent from 6.2 percent.

While many subprime-related stakes that lost almost 100 percent of their value since July were categorized in Level 3, other holdings such as private-equity stakes, real estate and rarely traded corporate debt are also included because market prices for them aren't available. More assets have become difficult to value in the last three months as investors shunned a wider array of credit, reducing trading.

Goldman Sachs has $96.4 billion of Level 3 exposure that is valued on what amounts to a wild ass guess (WAG). The obvious question is how can the figure $96.4bil be taken seriously if it is, by definition, a WAG?

Goldman Chief Financial Officer David Viniar said last month the Level 3-to-assets ratio had risen to about 8 percent mostly because some assets classified as Level 2, including commercial real estate loans, dropped to Level 3. The biggest increase in the hard-to-value category was a 59 percent jump in derivative contracts, according to today's filing. Mortgage and other asset-backed loans and securities increased 56 percent in the quarter.

Mr. Viniar does not seem too concerned that assets that were formerly able to be valued (Level 2) are dropping into the Level 3 bucket. This is the same Mr. Viniar that last August was shocked when their volatility models did not anticipate the severity of the sub-prime melt-down.

“We are seeing things that were 25-standard deviation events, several days in a row,” he said then.

My biggest problem with derivatives in general is that once you move beyond the realm of equity index options and futures, they seem to become easily decoupled from the underlying asset from which they are supposed to derive their worth. Many derivative markets, until recently, were several times more liquid than the market for the underlying asset, which is why a derivative was created in the first place. The problem then becomes once the music stops, the person left without a chair is stuck holding a bag that is impossible to value accurately. Once that person tries to value his "bag" it forces everybody else to do the same. And so the downward spiral of valuation begins; unless you can stuff it in the Level 3 sack. Eventually though, the can that keeps getting kicked down the road is going to get kicked back. I won't be surprised if it's loaded with gun powder and the fuse is lit.

To be sure, Goldman Sachs is not the only investment bank with this problem, just the biggest.

Morgan Stanley's Level 3 assets rose 6.1 percent to $78.2 billion last quarter, the firm said today in an SEC filing. Lehman, which also filed a report with the agency today, said its Level 3 holdings rose 1.3 percent to $42.5 billion. All three firms are based in New York. The harder-to-value securities made up 7.2 percent of Morgan Stanley's total assets at the end of February, up from 7 percent three months earlier. Lehman's ratio declined to 5.4 percent from 6.1 percent as total assets grew faster.Lehman CFO Erin Callan said last month the ratio would be around 5 percent.

Before we congratulate Lehman Brothers for a job well done, recall that they just raised $3bil a couple weeks ago to shore up their liquidity issues.

``The uncertainty of Level 3 asset valuation is already priced in the stocks of brokerage firms,'' said Steve Roukis, managing director at Matrix Asset Advisors Inc. which oversees $1.8 billion of assets in New York. ``We expect more writedowns in coming quarters, but they're not going to be huge numbers like the past quarters.''

I wish I was as optimistic as Mr. Rourkis, who believes that assets valued by WAGs are already priced into the market. However, I do not see this liquidity problem ending any time soon, which may be a contrary indicator...or not.

John Meriwether's 9...8...7...lives

Fool me once, shame on you.

Fool me twice, shame on me:

John Meriwether's Bond Fund Loses 24% on Credit-Market Plunge
2008-03-19 13:42 (New York)


By Katherine Burton and Saijel Kishan
March 19 (Bloomberg) -- JWM Partners LLC, the investment
firm run by ex-Long-Term Capital Management LP chief John
Meriwether, lost 24 percent in its $1 billion fixed-income hedge
fund this year through March 14, according to two people with
knowledge of the matter.

Meriwether's Relative Value Opportunity fund was hurt as
bond managers such as Peloton Partners LLP and Carlyle Capital
Corp. were forced to sell securities to meet margin calls, said
the investors, who asked not to be identified because JWM
doesn't publicly disclose returns. The Greenwich, Connecticut-
based firm, which is selling holdings to reduce borrowings and
lower risk, didn't have any loans called, they said.

``There's been a lot of forced de-leveraging,'' said
Benjamin Sarly, head of marketing at Sanno Point Capital
Management in New York, a relative-value credit fund.
Meriwether declined to comment.

JWM Partners opened a year after Russia's 1998 default
resulted in almost $4 billion of losses for Greenwich,
Connecticut-based Long-Term Capital. The Federal Reserve
orchestrated a bailout by its 14 lenders.

Relative-value funds try to profit from price changes
between related bonds. They rarely make outright bets that a
specific bond will rise or fall. Investors in these funds expect
to make about 1 percent a month.

The Pope of Hope

Barack Obama's meteoric rise to stardom is an interesting phenomena. It is not often that a politician can capture the imagination of so many people across such a broad spectrum. For this to happen, the ground must be fertile, and fertile it is. After 8 years of Bush, and before that, 8 years of Clinton, and before that, 4 years of Bush, I suspect that there is a large portion of the population suffering from both Bush and Clinton fatigue. People are hungry for a new message, even if that message is no deeper than "hope for the future." Handsome in an exotic way, articulate almost to a fault, full of youth and vigor, Obama provides the perfect vessel into which people can project their vision of the future.

Kathleen Parker writing in the Washington Post elaborates:

So what is the source of this infatuation with Obama? How to explain the hysteria? The religious fervor? The devotion? The weeping and fainting and utter euphoria surrounding a candidate who had the audacity to run for leader of the free world on a platform of mere hope?

If anthropologists made predictions the way meteorologists do, they might have anticipated Obama's astronomical rise to supernova status in 2008 of the Common Era. Consider the cultural coordinates, and Obama's intersection with history becomes almost inevitable.

To play weatherman for a moment, he is a perfect storm of the culture of narcissism, the cult of celebrity, and a secular society in which fathers (both the holy and the secular) have been increasingly marginalized from the lives of a generation of young Americans.

All of these trends have been gaining momentum the past few decades. Social critic Christopher Lasch named the culture of narcissism a generation ago and cited addiction to celebrity as one of the disease's symptoms -- all tied to the decline of the family.

That culture has merely become more exaggerated as spiritual alienation and fatherlessness have collided with technology (YouTube, Facebook, MySpace, etc.) that enables the self-absorption of the narcissistic personality.

I agree that the cult of celebrity and the marginalization of fathers as role models are symptoms of the larger problem that is narcissism. It is not surprising that narcissism is so prevalent in our society. One should outgrow their narcissistic tendencies at some point during adolescence. Sadly, and to the detriment of society, this is not happening. Personal responsibility and accountability are the greatest antidotes to narcissism; and these two traits are anathema to government's reason for existence as they greatly diminish the need for what government offers. If one has a nation of citizens who are responsible and accountable, there is no need for government to act as a nanny. It is one thing to treat children like children, it is another thing to treat adults like children. Treating adults like children arrests one's development, and though there are numerous side effects to this, the most dangerous is narcissism. Perhaps this is why Senator Obama has such wide appeal among our nation's youth, and those who's personal growth was arrested during their adolescent years. I am not saying that every person that likes Obama is a childish narcissist, but what he offers seems to hold more sway with those possessing a narcissistic bias than those who do not.

Then there's this:

But underpinning that popularity is something that transcends mere policy or politics. It is hunger, and that hunger is clearly spiritual. Human beings seem to have a yearning for the transcendent -- hence thousands of years of religion -- but we have lately shied away from traditional approaches and old gods.

Thus, in post-Judeo-Christian America, the sports club is the new church. Global warming is the new religion. Vegetarianism is the new sacrament. Hooking up, the new prayer. Talk therapy, the new witnessing. Tattooing and piercing, the new sacred symbols and rituals.

Obama as an empty vessel offers his supporters anything they choose to fill him with. He reminds me of a big stick of fluffy cotton candy. Looks great, tastes good, but ultimately un-fulfilling; and if you eat too much, you'll wake up with a belly ache.

I am of the opinion that many of those who are currently swooning under the spell of the Pope of Hope will wake up with a belly ache soon enough.

When a Man stops believing in God he doesn't then believe in nothing, he believes anything.--G. K. Chesterton