Derivatives and banking skullduggery

History ready to repeat?

In October 2009, a Frontline program outlined the rise of derivatives. Titled "The Warning"

it follows the history of Brooksley Born, who was appointed as head of the CFTC (Commodity Futures Trading Commission) in 1993, and the rise of the derivatives market.

Brooksley Born , as head of the CFTC, reported directly to President Clinton. She recognized the danger that the explosive growth in the unregulated derivatives market represented to the financial sector of the US economy. This documentary follows her efforts to get some oversight and regulation into this marketplace, and the ways in which her best efforts were undermined publicly and privately by Clinton's staff.

Alan Greenspan, Larry Summers, Robert Rubin, and Arthur Levitt, members of the President's Working Group, supported the financial lobbyists along with the Republican and Libertarian Ayn Rand "Free Traders" to mount a hysterical response to Brooksley Born's regulatory ideas. Brooksley Born's attention was drawn to this secretive 'dark' market by the exposure of serious fraud by Bankers Trust, when they were sued by Proctor and Gamble.

Born talked regulation. Bankers lobbied Clinton's advisors and Congressmen.

The upshot was a Congressional freeze on the CFTC, preventing Brooksley Born from implementing any changes to the regulatory procedures of the derivatives market.

When the freeze was implemented, Brooksley Born resigned from the CFTC.

Six weeks later, a major hedge fund crashed. Long Term Capital Management (LTCM) melted down in the exact scenario that Brooksley Born had foreseen.

The Congressional prohibition on regulation was only the beginning. During the 8 years of the George W. Bush presidency, this market was completely ignored as it grew from $60,000 billion in 1998, to a monster $595,000 billion by 2007, and caused the crash that brought down the economy.

Let me do that one more time. The derivatives market grew by 148,750% during the George W. Bush Presidency, and nobody noticed. The Wall Street Journal, useless publication that it is, didn't notice. Fox News didn't notice. MSNBC didn't notice. The New York Times didn't notice.

And this situation is still the 800 pound gorilla in the living room that everybody is pretending not to notice. Regulatory efforts are stalled.

Brooksley Born is predicting further upheaval if there is no regulation forthcoming on derivatives. Geithner, Summers, and the other players have reversed their original antipathy, and now suggest they are in favor of regulation. Lip service, perhaps? Because nothing has happened to get the whole system more transparent..

Here's something to think about. The size of the US economy, the Gross Domestic Product for a year, which is the sum of all the goods and services produced, is around $14 trillion. The outstanding derivatives are between $600 trillion and $1,000 trillion. You thought the bailout, at $0.7 trillion was large? Wait for the derivatives to come home to roost!

There are some further interesting items that have not yet been investigated.

It seems that Goldman Sachs and J P Morgan may have used the lack of transparency in the Dark Liquidity market to actually sink their competition, Lehman Brothers and Merrill Lynch, by providing false ratings on the values of their derivatives, and false reports on their corporate health, which caused their liquidity to dry up in the marketplace. http://www.marketrap.com/article/view_article/91172/did-the-markit-group-a-black-box-company-partially-owned-by-goldman-sachs-and-jp-morgan-chase-devastate-markets

There have been warning signs for years that all is not well in the financial sector. In 1970, bankers would never have considered betting against their clients, or pursuing practices that ripped them off. By the 90's, they were fleecing them in complex transactions. When Proctor and Gamble sued Bankers Trust in 1994, the evidence against Bankers Trust included some 3,600 recorded conversations from the trading floor, where traders openly talked about ripping off Proctor and Gamble, amongst other clients, who were all regarded as too dumb to know what was going on. http://www.businessweek.com/1995/42/b34461.htm

This practice seems to be continuing. Goldman Sachs just had an almost perfect quarter. They lost money on only one trading day, despite working a high risk sector in a very volatile marketplace. http://www.zerohedge.com/article/absolute-perfection-goldman-loses-money-just-one-trading-day-q3

Here is an excerpt from one of the comments on that article that talks about derivatives, the problems, and how they work.

"Various articles have mentioned that there is likely $600-$1,000 trillion (yup, a quadrillion!?) of derivatives out there, all of it unregulated and virtually undocumented. It boggles my mind that I could sit down with one of my neighbors and basically write a derivatives contract on a napkin that if one of our other neighbor's houses burns down, then the person that wrote the contract with me would have to pay me say $200,000. If 9 other people wanted to bet that it wouldn't burn down, I could write derivatives to collect $2 million if it burned down. I don't even have to have the money to pay my side of the contract if the house doesn't burn down. It doesn't matter a bit if I have no interest in my neighbor's house or am not a party to their insurance policy."

Read the whole article and the comments. Then ask yourself, why isn't more of this being investigated?

Maybe the answer is that the revelations of a real investigation would create global economic panic, destroying the dollar as the global reserve currency, sinking the US economy?

If you have a better answer, leave a comment.

Want to buy a house?

Housing market and rising foreclosure rates

Get ready to catch the wave, and buy a house!

The Mortgage Bankers Association have released their weekly report.

To help you understand the Association, and to see a good summary of the report, have a look at this page first:

http://www.mortgagenewsdaily.com/11042009_11_4_mba_applications.asp

Now on with the story, and your great opportunity.

http://www.mbaa.org/NewsandMedia/PressCenter/70938.htm

"The seasonally adjusted Purchase Index is at its lowest level since December 2000. The unadjusted Purchase Index decreased 13.7 percent compared with the previous week and was 21.6 percent lower than the same week one year ago."

This means that mortgage applications to buy a house are at their lowest level since December 2000, the end of the dot com bomb. There are lots of refinancing applications, but financing by home buyers is abysmal.

This sets the stage for a perfect storm. Since early 2009, the banks have been avoiding foreclosing on their customers who are severely delinquent. The banks figured if they don't foreclose, they don't have to write those loans to market. The banks have been doing this in the vain hope that real estate prices would bottom out and prices would start to recover, or the Government would bail out the huge losses they are still incurring.

But these new figures show a continuing huge and growing weakness in the property sales market. There is currently over 11 months of housing inventory, enough property to supply the needs of all the buyers who want to buy houses for the next 11 months. If the banks foreclose on more mortgages, then the inventory would push towards the 30 month mark, and property auctions would drop the price of a house to 50% of its current depressed level. But nobody is buying!

Take a house California, that rose to $520,000 at the height of the property boom, whose owners continuously refinanced as interest rates fell. There is now a mortgage for about $460,000 on this hypothetical house. But the house is now worth $205,000, and the mortgage is going unpaid. Meanwhile, the bank continues to report the mortgage as current, adding the income to it's profit, along with the late fee charges, which makes the loan look like an asset, rather than a disaster waiting to happen.

This house is going to drop to $140,000 in the coming wash-out, and the bank will record a $320,000 loss on the property, which does not include the price of remarketing the property, or the further write-down they will take on past unpaid mortgage payments and late fees.

This creates an interesting dilemma for those people who are still paying the mortgage on a very inflated property value. It may be a good strategy to simply walk away fromtheir old house, and buy a new one. If they have steady employment, they will be able to get a mortgage, and paying 14% interest on a $140,000 loan is a lot cheaper than 6% on a $460,000 loan, and the real benefit is that they will only have to pay off a $140,000 capital value to completely own the property. Every dollar they pay off saves them that 14% interest rate, which makes it really worthwhile to pay off the house faster.

I think we have just about hit the tipping point at which the banks are going to have to declare their insolvency, and take their medicine. The property crash may be severely aggravated by people walking away from inflated mortgages, because there are going to be so many people with horrible credit scores, the whole credit score issue will be meaningless in assessing loan risk. Mortgages will be given on the basis of people having the income to support them, at low property values which protect the financial institutions for the future.

Every cloud has a silver lining. If you are thinking of buying a house, prices may be ready to plummet again, creating a wonderful opportunity to buy either a new residence or a rental property.

Get ready to ride this wave of opportunity. The wave will break in the next few months, and the time to buy is when property prices actually start to recover. In the meanwhile, find yourself a banker and explain your strategy. You can't surf the waves without the right equipment and people.