luni, 21 iulie 2008

when the invisible hand is showing you the finger...

we all know that Adam Smith theory about the invisible hand. It's that principle according to which market participants trade in the most mutually beneficial manner - without any regulatory intervention needed - so as to maximize self interest while at the same time promoting the interests of the society as a whole. this is one of the most widely used metaphors coined to describe a free market capitalism of the kind that we "should" see in the US.

I have a feeling that the invisible hand has been rather busy lately shaking some very visible and dirty hands and going into that taxpayer's pocket...

firstly the SEC banned naked short selling for a while in order to stop speculators driving further down the market, after Freddie and Fannie started spiraling down. one may see this as a legitimate move from a regulator, in a distressed market, against a legally questionable tactics. but then again why didn't the SEC intervene against this practice when the market was in a better shape? isn't that intervention skewing the market's dynamics by helping create an artificial floor?

now there's more and more talks about the US Government taking an active role in a generalized bail-out of the whole banking system, with an even bolder move such as:

"Some experts say the government needs to set up new agencies to foster a recovery in the housing industry, the financial markets and the economy.

Alan Blinder, a former Fed vice chairman who is now a professor at Princeton University in New Jersey, calls for the return of what he's dubbed ``The Incredible HOLC'' -- the Home Owners Loan Corp. Set up in 1933, the HOLC acquired defaulted residential mortgages from lenders and investors and then refinanced the loans on more favorable terms for the borrowers."

what was that thing about free market self regulation? naah, when push comes to shove, it's still privatize profits & socialize losses...

if I could only believe the good intentions of the politicians to clear the mess and straighten the rules. but what to say when various regulators let loopholes be exploited and even well known figures, from the inner circle, such a Jamie Dimon are pointing at the loaded dice and call the figures a lie.

and please don't tell me that the FED and SEC don't know that this is regulatory forbearance...

or as Nouriel Roubini said in his last post about the coming US banking system bust:

"Most financial institutions are putting increasing numbers of assets in the illiquid buckets of Level 2 and Level 3 assets. While FASB 157 should prevent manipulation of the valuation of such illiquid assets, forbearance by the SEC, the Fed and other regulators allows a massive amount of fudging. An insider told me that in a major financial institution the approach is as follows now: top management decide in advance what the announced writedowns should be and folks dealing with the toxic/illiquid assets come up with totally ad hoc assumptions to make sure that such illiquid assets are valued consistently with the decided-in-advance amount of writedowns and losses. This is not earnings smoothing; this is active manipulation and falsification of financial results aimed at creating even more obfuscation of the true state of financial institutions. This obfuscation is actively abetted by the SEC, the Fed and all other regulators that are now in forbearance crisis management stage where the objective is to avoid at any cost anything that may trigger a financial meltdown. Thus, most of these earnings reports are not worth the paper they are written off.

This earnings manipulation occurs in a variety of ways. First, ad hoc assumptions still used to value and write down level 2 and level 3 assets. Second, banks are leaving aside less reserves for loan losses that are much less than necessary; they do that by using ad hoc assumptions about future losses on mortgages, credit cards, auto loans, student loans, home equity loans and other commercial real estate loans and industrial and commercial loans. Reserves for loan losses have been sharply lagging actual and expected losses, thus padding earnings as decided by the financial institutions' managers. Third, there is disposal of illiquid and toxic assets in ways that misleadingly reduces the amount of actual writedowns. An example is as follows: suppose a bank wants to dump illiquid MBS or leveraged loans that are worth – mark to market – 70 cents on the dollar rather than 100 cents on the dollar. Then, instead of selling these at a price of 70 and showing a 30% writedown these are sold to hedge funds and other investors to a price closer to par – and thus showing in the balance sheet a smaller writedown – by providing a subsidy to the buyer of the security: so a hedge fund will buy such toxic securities at 80 or 90 cents and receive a loan to finance the transaction at an interest well below the borrowing costs for the funds. Thus, writedowns are then shown smaller than the true underlying loss on the asset and the bank finances that fudged transaction with earning less revenues than otherwise on its credit portfolio. This is an accounting scam- bordering on the criminal - that auditors and regulators are abetting on a regular basis."

I don't know about you, but I see an invisible hand waiving with the middle finger way up at the mere thought of "promoting the interest of the society as a whole"...



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