Archive for the ‘Global financial crisis 2.0’ Category


There were many perpetrators involved in the 2007-09 financial crisis and most of them have gotten off scott free. Credit rating firms were a major player that have experienced limited fallout for their role in creating and exacerbating the global financial crisis.

And now it looks like despite a 3-year old Congressional directive for the Federal Securities and Exchange Commission to alter credit rating industry’s business model in which a bond issuer pays for the credit rating, little or nothing will actually be done to change how the industry works. So reports The Wall St. Journal.

This is very unfortunate for a couple of reasons:

  1. An inherent conflict of interest and lack of transparency for investors means that it will be difficult to judge the accuracy of credit ratings on a variety of debt instruments.
  2. The potential for another bubble, which could contribute to another global financial crisis.

The model in which an issuer pays a credit rating agency is inherently flawed because the rating agencies have a financial stake in making their clients happy by assigning the highest rating possible, regardless of the merits of the issue in question. This happened en masse during the housing bubble, when all sorts of questionable mortgage backed securities received top ratings.

Many of those issues later experienced extremely high levels of default, which was a “key cause” of the financial crisis, Congress concluded. Duh.

The SEC conducted a day-long meeting yesterday to get advice from experts about what to do about this problem, but hasn’t said what, if anything, they plan to do with this information. I mean, at this point, what more information do they need?

If they do the right thing, in a few months we’ll see some proposed rules that will change how ratings firms are compensated. If not, nothing will change. Of course, the ratings agencies are firmly in favor of the status quo because it would upset their very profitable apple cart if they had to be paid by investors or supervised more closely.

In the meantime, the U.S. Justice Dept. has somewhat tardily sued S&P — but not Moody’s, the other major ratings agency — for fraud, accusing the company of inflating ratings to gain more business during the real estate bubble. It cites 30 deals in which S&P rated collateralized debt obligations that included bundles of subprime mortgages, most of which fell steeply in value after they were sold to investors.

According to the Wall Street Journal, the Justice Department suit alleges that S&P “knowingly and with the intent to defraud, devised, participated in and executed a scheme to defraud investors.” The Justice Dept.  is seeking $5 billion in what would be the largest fines imposed on any firm for actions during the financial crisis.

S&P has filed to have the case dismissed, saying that the firm is being targeted for failing to foresee the financial crisis and bursting of the housing bubble.

On another front, S&P and Moody’s recently settled civil cases brought by investors. The firms were accused of “negligent misrepresentation” regarding their ratings of several structured investment vehicles.

What does all this mean to you and me? That another one of the major players in the global financial crisis may get off scott free and that a big part of the system that led to the crisis may go on  its merry way, completely unchanged. We can only hope that the SEC may actually do something and that failing that, the Justice Department will get some justice in it’s suit against S&P. Stay tuned…

Washington, DC has long been known for the revolving door that catapults former regulators into high-powered lobbying positions. The Wall Street Journal reported Tuesday that Mary Schapiro, the former chief of the federal Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) was hired as a managing partner by Promontory Financial Group LLC.

Promontory has become known as the “shadow” financial regulator because it’s executive ranks are loaded with former high-level regulators who peddle their insider knowledge and connections to their clients, according to illuminating articles in American Banker and Business Insider. Their knowledge is so deep that they can give clients the inside track on the direction of future regulation and how clients can manage regulatory risk in a more proactive and less reactive fashion.

For firms that can afford their fees, such knowledge is nearly priceless. Financial firms, especially, have been on the hot seat ever since the financial crisis in terms of potential regulation, even though a lot of that heat hasn’t translated into tough regulations and prosecutions.

Promontory’s executive ranks are so loaded with smart, former high ranking government officials that they are actually called on by congressional committees and federal financial agencies to advise on financial and regulatory matters. So what, you say? This happens all the time.

It does, and it doesn’t. Apparently few lobbying firms possess the specialized niche, knowledge, experience and connections that Promontory does. This elevates lobbying and influence-peddling to an unprecedented level. Promontory doesn’t appreciate being referred to as a lobbying firm; it’s CEO told American Banker that the firm endeavors to influence it’s clients to do what the government wants them to do.

It’s amazing how even the smartest, most savvy individuals can convince themselves that what they are doing is right and in the public interest.

My belief is that you can’t have it both ways and that the public interest is in no way, shape or form being served by the proliferation of lobbying firms, especially those that operate at such a high level. Regardless of their motives and intentions, the fact is that wealthy individuals and corporations have the ability to purchase access and influence at an outsize level.

That disenfranchises the vast majority of us who can only vote, make a phone call and write a letter in the hope of getting the ear of our elected representatives. It’s not right that the size of your lobbying budget determines what access and influence you have on our elected representatives.

Ultimately, that means that too much of regulation and legislation is in play for those with the resources, while the rest of us look in from the outside. If you’re wondering why not much has changed since the financial crisis in terms of the government reigning in the too big to fail firms that precipitated it, this is one of the reasons.

And it’s a reason why we’re likely to see the same thing — another global financial crisis — happen again…

I’m a bit late to the party on this, but here goes: last week the St. Louis Fed released its U.S. Recession Probabilities chart, which shows the risk of a U.S. recession near zero. I’ve been following the progress of the U.S. economy pretty closely for the past couple years as it has struggled to emerge from the Great Recession and gain a more steady footing, so I’m finding this assessment interesting.

While I believe that the risk of recession is less than it has been in the past few years, I wouldn’t say that it is near zero. Although the recovery does seem to be gaining more traction, that’s happened before. The last couple of Springs, the economy will seem to firm up on a couple of different fronts, whether that’s housing, consumer spending, business investment, industrial production or whatever, only to fallback later in the year because of external or internal issues.

Last year the political uncertainty surrounding the election and the Fiscal Cliff slowed the economy down in the second half, the year before — and the year before that — Europe was the focus of economic fears along with the continuing housing crisis. This year, we’re into Sequestration and the debt ceiling battle is coming up.

Risks from Europe seem to be on the back burner and less fraught than they used to be, but the fact is that nothing fundamental has changed about the European situation except that the European Central Bank is printing a lot of money. Austerity is taking a huge tool, unemployment is sky high and EU leaders are no closer to solving the region’s problems than they were a few years ago.

Anyone of these risks, or a combination of them or other risks that we are unaware of at this time could push the economy into recession. There are a number of positive developments that could continue to keep the economy on a growth track, including the recovering housing market and the brightened employment picture — I’m hopeful because I want a growing economy and it’s benefits just as much as the next person.

Re big picture risk, whether the risks of a recession are low or high, I do believe that we eventually will experience another financial crisis. I actually had an argument on Twitter the other day based on expressing the opinion that another global financial crisis is all but inevitable.

I base that belief on the fact that the fundamental problems in the global economy that lead to the Great Recession haven’t been solved in any meaningful way and that the systems that we have are so complex and interact in so many unforeseen ways that it is a matter of when, not if, another crisis occurs. It could be next month, next year or in five years. I have no idea.

But if you look at economic cycles and the recent history of boom and busts, it is evident that these crises occur periodically and that they are happening more frequently. I would love to be wrong, because the havoc they create causes so much suffering. We’ll just have to wait and see.

Now that the election is over, the ongoing crisis in Europe is back front and center — if it isn’t on your radar, it should be. That’s because all the “solutions” so far have merely kicked the can down the road a bit farther. Meanwhile, as politicians negotiate, meet and talk, actual people are suffering. More.

Nowhere is this more evident than in Greece, which is about to be further brutalized by more austerity as the government just passed another multi-billion austerity package to keep the Euro’s leaders sweet. The bailout funds will keep rolling in, but at a steep price. If nothing else tells the story of the toll austerity is taking, this horrible photo of a riot police officer engulfed in flames should.

Protestors rioted in vain against this latest round of austerity, which looks to be the worst yet. More spending cuts will weaken the already frayed social safety net as tax increases will hit the poorest the hardest and labor reforms will allow further exploitation of workers. All this is happening with a backdrop of Greece entering its sixth year in a row of economic contraction with more than 25 percent of its population out of work.

The leader of the radical left main opposition Syriza party blasted the government for “leading the Greek people to catastrophe and chaos.” The government clung to the fact that these cuts will keep Greece in the Euro, which they believe is better than the alternative. Better for whom? The political and economic elite, no doubt, but not the unemployed, poor and disenfranchised, who make up an increasingly large share of the Greek populace.

I don’t see any good outcome for all of this. All the bailouts are doing is bailing out European banks, who could go under, bringing the entire financial system down with them a la Lehman Brothers. While I certainly don’t relish the idea of another global financial crisis, I really wonder if any kind of meaningful change is possible without one. The grip that the banks have on the political and economic leaders of the West is truly a stranglehold one, and I’m not sure what it would take to break it.

No regulatory reforms have succeeded in denting that power and it doesn’t look like the West has the political will to break the too big to fail banks and make the changes in the system necessary to restore some balance of power between the haves and the have-nots. No wishful thinking in the form of the granting of the Nobel Peace Prize to the Leaders of the Euro Zone or the G-7 leaders monitoring the crisis will have much of an impact. So, onward we go, with some type of economic crisis or catastrophe all but inevitable.

When the Occupy Wall Street protest started a month or so ago, it was dismissed as a rag-tag group of disgruntled young people, old people and the unemployed. Not surprisingly — from where I sit, at least – it has rapidly gained momentum, spreading around the country and around the world.

So what’s happening, and why? An alternative name the protesters give themselves explains at least some of what’s going on. They call themselves the 99 percent, versus the 1 percent who own and control most of the assets, politics and economics in this country and around the world.

During the past 30 years, the 1 percent have gained in every measurable way — income, assets and political and economic power — at the expense of the 99 percent. Most lower and middle class people have lost real income, political and economic power and their chance to retire comfortably, educate their children and live without fear of an economic catastrophe. For a while, the 1 percent kept the 99 percent from feeling the pain via low interest rates and easy borrowing. That masked the reality that the 99 percent were losing in just about everything.

But no more. Once the housing bubble popped and the global financial crisis appeared, there was no escape from the chilling reality that the 1 percent were on top of the world and the 99 percent were left holding the bag.

That’s the reality that the Occupy Wall Street and it’s affiliated movements spring from. The 99 percent are fed up with being on the short end of the stick. For the old, after a lifetime of working hard and striving to save for retirement, they have faced the reality that no retirement is safe from the ravages of “the market” and that one health crisis could bankrupt themselves and their children due to the shredding and pending destruction of the social safety net.

For the young, they are overloaded with student loans purchased to get an expensive college education that would allegedly position them to get a good job on graduation. Problem is, by the time they graduated, the economy went south and took many decent paying jobs with benefits with it. Now all most of them can get is low paying jobs without benefits so they can choose between paying back their student loans or eating and paying rent.

As for those of us who don’t fall into those two categories, but also fall into the 99 percent, some of us are slightly better off, but many of us aren’t. Too many of the working poor can barely make ends meet or aren’t making them meet at all. Too many who still cling to the middle class are either living paycheck to paycheck or are losing the battle and relying on credit cards — or worse, payday loans — to keep themselves afloat. And don’t forget those who are suffering in the wake of the collapse of the housing market. This includes the millions who are underwater on their homes, those who are being foreclosed against and those who were victims of housing boom fraud.

So it’s about economic injustice and the long simmering anger that many of us feel against the political and economic establishment. That is, those who bailed out the banks at the expense of the rest of us and who continue to shower political, regulatory and economic advantages on the banks, the banking class and the other 1 percent.

It’s about time this rage surfaced and the 99 percent began to hold the 1 percent accountable. It’s long overdue, and I’m hoping something lasting will come from these protests once people are over the romance of protesting. Don’t let the banking class off the hook!

As one of the tweeps who started the Global Financial Crisis 2.0 hashtag (#gfc2) on Twitter, I believe we’re right smack in the middle of a horrific financial crisis that will rival the first one in size and scope. I don’t take pleasure in that forecast for lots of reasons, mainly because of the extended misery that is being inflicted on people across the globe. But the global economy has become such a zombified Frankensteined creature of the financial elite that it’s not serving any useful function except to enrich those who already have a lot at the expense of those who have little.

If you accept that we’re in a financial crisis and that our political and economic leaders have little or no idea about how to cure it except to throw more money at the banks who are causing the crisis yet again, you’ve got to wonder what the end result will be. Like a nightmare that you can’t wake up from, the thoughts are extremely unpleasant, but riveting in some sense.

In the past 24-hours, I’ve seen several articles posted on Twitter that capture a view of what might happen if or when this crisis gets completely out of control. Here they are, plus a few comments:

  1. Nouriel Roubini channels Karl Marx: In a video interview with the Wall Street Journal, Roubini agrees with Marx’s conclusion that capitalism is ultimately self-destructive. The video 22 minutes long and well worth watching, but if you’d rather read an analysis, here’s one. Roubini dismisses the conclusion that we are at the point where capitalism will actually self-destruct; I’m not so sure. He does say that an economic depression is a possibility due to zombie housing, zombie banks and zombie governments.
  2. Buy gold, hide $$$ under your mattress: A really scary potential scenario of what could happen if the global economy completely unravels by David Freedom of  The Victory Report sees money market funds collapsing, rampant inflation and high unemployment as well as a lot of social unrest. As ugly as this is, I don’t think it’s a scenario that’s out of the question. In some ways, it’s the logical outcome of years of inequality and fiscal/economic mismanagement.
It’s entirely possible that the political and economic powers-that-be will keep this global economic charade going for a few more years or even longer. It’s not a good idea to underestimate the enormous stake that the financial and political elite have in maintaining the status quo; they will do anything and everything to maintain it. So we may sit in an economic recession/depression for a while until the whole beast collapses under it’s own weight. Either way, the next couple of years aren’t likely to be much fun for anyone but those who already are in power.

As the global economy inches closer to Global Financial Crisis 2.0 or GFC2, the Leadership of the Group of 20 Nations is attempting to head it off at the pass by assembling a Frankenstein coalition of nations willing to underwrite a huge new bailout of ailing banks. Although estimates vary as to the total amount that might be needed, figures from $2.5 to $6.7 trillion dollars have been floated (hat tip to @paulstpancras):

These forecasts — excepting the Times article — are all old: the NPR article is a month old and the other two are from the Spring. So, conceivably, the total could be higher today. And, considering how the leadership of the world usually waffles over exactly how to handle these situations until a bad situation gets worse, the total price tag will continue to increase while some kind of solution is found.
I don’t know about you but I can’t even wrap my head around these numbers. As if the first round of bailouts during the first global financial crisis wasn’t bad enough — these numbers are higher, and even more offensive. Really, we know better. But so little has been done to change the regulatory, economic, political and financial environment that this outcome is virtually inevitable.
Worst yet, another bailout won’t change anything. Well, it might change something: banks and the financial elite who run them will be further emboldened by the wholesale enabling of the politicians and taken even more risks with someone else’s money. And the people who are already struggling to make ends meet will find themselves facing benefit cuts, higher unemployment in recession-oriented economies. That’s because politicians will justify even more austerity in the name of deficit reduction following this next round of bailouts.
But even if the G-20 can conjure up this mind-blogging sum, it still might not be enough. That’s because the system is so volatile, so full of risk, that something unexpected could come out of left field and bust the system wide open before this new bailout is put together.
Obviously, the banks are the biggest risk out there right now. Markets are pricing bank stocks in an eerily similar fashion to pre-bailout 2008; 186 US financial institutions are trading at 60 percent of book value, including Bank of America, Citigroup and Morgan Stanley, according to Bloomberg.
Then, the problem was toxic mortgage assets. Now, the problem is toxic sovereign debt AND an overhang of toxic mortgage debt. Not only have banks not cleared all the bad mortgages from the housing boom, but they are being sued right, left and center over bad securitization and underwriting practices from that era. Not surprising.
Credit rating agencies are one wildcard; we’ve seen the turmoil that one rating agency downgrade of the US can foster. In this unstable economic environment, an ill-timed sovereign debt downgrade could start a cascade of bank downgrades or write-downs, sending the global economy into a Lehman Brothers style crisis.
Actually, the rumors surrounding French Bank Societe Generale are already raising fears that a French sovereign debt downgrade would negatively impact the bank’s capital, according to the New York Times. Conversely, a bailout of this or any other French bank would also potentially imperil the country’s AAA credit rating.
And if France losses it’s top-notch credit rating, say goodbye to the AAA credit rating of the European Central Bank (ECB), one of the main entities behind the attempt to save the Euro.
And what about the banks here in the USA? Rumors have been swirling for weeks that Bank of America is in a perilous financial situation, and may need some kind of bailout. BOA or any other large bank failure could start a destabilizing chain reaction impacting other banks and freezing up the bank system internationally.
And that’s not even including the whole issue of credit default swaps, a type of insurance that banks and companies can take out to hedge against default. No one even knows the CDS exposure on sovereign debt or what might happen if a big sovereign, such as Italy or Spain, needed a massive bailout or a systemically important bank did.
Ugh. I’m getting a headache. The longer the situation goes on, the more potential there is for destabilizing events that could blow up the entire system. Sounds like the choices are:
  1. A horrifically expensive bailout that will kick the can down the road a few more years
  2. A financial crisis that will cripple the global economy and all but destroy the TBTF banks
  3. The unknown
None of these alternatives is particularly appetizing. But I’m betting it won’t be too long before one of them is a reality.

When the credit rating agency (CRA) Standard & Poor’s downgraded U.S. sovereign debt on Friday night, it was the financial equivalent of shock and awe. News sites, news shows and Twitter were abuzz with the news. Though the timing of the news was a surprise, coming as it did shortly after the debt ceiling deal, the downgrade of U.S. debt was almost inevitable and one that the credit ratings agencies themselves helped create.

Rather than being the main contributing event to the downgrade, the debt ceiling debacle, which certainly showcased the ineptitude of Congress and the sad state of fiscal affairs in Washington, DC, was just the icing on the cake following a decade of catastrophic financial mismanagement. From what used to be a budget surplus, the US has run up unprecedented budged deficits fueled by tax cuts for the rich and powerful, two wars that show no signs of ending and a wholesale bailout of the very financial institutions that took a leading role in the financial crisis in the first place.

The credit bubble of the early and mid-2000s has been well documented. Fed by a loose money policy from the Federal Reserve and aided and abetted by lenders, mortgage brokers, appraisers, securities firms and credit ratings agencies, the US blew up a gigantic housing and credit bubble. Securities firms packaged mortgages and sold them to investors around the globe, who snapped them up because of their high credit ratings and relatively generous yields. Unfortunately, many of those securities were build around sub-prime mortgages.

In retrospect, we’ve learned that the subprime mortgage market was rife with fraud from beginning to end. Not only were many buyers fraudulently induced to buy homes that they could have never afforded, many criminals also obtained mortgages under false pretenses. Some mortgage brokers and loan officers pushed through mortgages that they knew would never be repaid. Securities firms had a voracious appetite for these mortgages, which they securitized to investors seeking higher yields. Many residential mortgage backed securities were packaged into collateralized debt obligations.

That’s where the credit rating agencies come in. The job of credit rating agencies is to assign a rating that reflects how likely a certain bond issue and bond issuer is to default. The highest rated bonds, AAA, are deemed the safest.

The compensation structure surrounding credit ratings is an inherently flawed one, as the very securities firms that seek the credit rating pay for that rating. Securities firms could, and did, play the credit rating firms off each other in an effort to get the best ratings for their prime and sub-prime mortgage securities.

And that wasn’t the only flaw in the system. In many cases, the credit rating firms didn’t independently verify the information provided to them about the mortgages packaged into securities. In retrospect, it became evident that their models were seriously flawed as far many more mortgages that were ever anticipated went into default.

When the system blew up, beginning in 2007 and into 2008, it seemed like the only path towards rescuing the global economy was a massive bailout of financial institutions. It was that, or see the whole system come down in flames.

Trillions of dollars were poured into that rescue efforts by the U.S. and other Western governments. While this massive transfer of funds from the people and their governments to the banks did succeed in rescuing the banks and the financial system itself, it was a hollow victory. Like an addict in search of a fix, once the global financial elite realized that the system was, indeed, too big to fail, they had no reason not to continue to take massive risks with other people’s money.

While the system was “saved” in a sense, it still isn’t whole. Imperiled by huge sovereign debts created by bank bailouts, Europe is struggling with a crisis that may very well spell the end of the Euro Zone. In the U.S., the budget deficit is swollen by bank bailouts and tax cuts.

This current sovereign debt crisis has the potential to further savage bank balance sheets, as downgraded debt is eventually written down to market value. Some analysts believe that what’s going on in Europe is that continent’s Lehman moment, the tipping point in a crisis that could again spread across the globe, creating Global Financial Crisis 2.0 (#gfc2). Sped by credit rating downgrades, the global financial system is once again heading towards economic armegeddon.

Which brings us back to the credit rating agencies. There’s no doubt that they were instrumental in creating the first global financial crisis which as led, inevitably, to the second one. As they downgrade sovereign debt across the globe, it’s important to realize that these downgrades are a self-fulfilling prophecy in several senses.

First of all, by their involvement in the first financial crisis, they set the stage for the bailouts that are now crippling sovereign governments. Secondly, through downgrades, they are worsening an already bad situation. Downgrades tend to be a vicious cycle which lead to further downgrades. Thirdly, by threatening downgrades unless countries adopt austerity, they are helping kill any hope of economic recovery, which makes more downgrades likely.