CSI: US Senate – Autopsy on the Wrong Body

NOTE: This blog post preceded S&P's April 18, 2011 'negative' outlook on the U.S. economy in which they warned of a loss of AAA rating but, as this post reveals, failed to have the independence to tell investors the true risks facing the illusion of investment grade.


Let me begin by saying that Senators Carl Levin and Tom Coburn had a thankless job. Together with their staff, they were asked to investigate the Wall Street and Financial Crisis of 2008 and following. To their credit, they did an amazing job of wading through documents and testimony and came up with copious evidence of theft, fraud, greed, and most of the customary Deadly Sins. And, if I had CEOs lying under oath in front of me, I would probably have to appeal to my higher angels not to want to submit a one page report – in lieu of the 639 pages – with a simple conclusion…

“They lied, we paid, our economy is toast. But, the real perpetrator is running amok and ready to strike again.”

Instead, in the hundreds of pages, they detail the breakdown of a system that was engineered to serve the interests of the likes of Goldman Sachs at the expense of the people but they conveniently ignored the real beneficiaries. Before I get to that, however, I thought it might be nice to comment on their ‘recommendations’ which, in the main, are agreeable. So, at the end of this post, I’ve copied their recommendations and added my commentary on what I see.

However, given that some of you might not get to the end, let me observe that the committee focused on the a) WRONG BODY; and, b) WRONG PERPETRATOR. And, no, I’m not going to rehash my now vindicated assessment from 2006 that this was never a ‘housing’ or ‘real estate’ crisis but rather a profligate consumer credit orgy that led to a persistent vegetative state of brain damage. Regrettably, that would sound like an, “I told you so.” No, rather we need to understand that the BODY that needed the autopsy was the Congress and its use of tax and monetary policy to incentivized mindless behavior. And the PERPETRATOR was and remains the Reserve Corporation and its progeny – the unholy alliance of life insurers and Fed banks – who led the monetary coup d'état in 1913 and who continue to staff both sides of the feeding trough.

Congress’ tax and monetary policy has been used to dictate unconsidered social policy for a long time. It is no surprise that it was in 1913, the same year that the Federal Reserve was established by, and for, fixed income investors in the life insurance industry, that the U.S. ratified the Sixteenth Amendment allowing Congress to levy income tax. By collecting income tax and apportioning it “without regard to any census or enumeration,” Congress solidified its capacity to use income tax (and deductions thereto) as a primary means of influencing public behavior. By allowing interest to be deducted from income tax in the same year the Fed was established, Congress introduced a statutory bribe to the American people to co-opt them into the belief that duration matched investments would be good for them and that the best way to insure systemic adoption would be to link mortgages, life insurance premiums, and federal bonds in actuarial, perpetual wedded bliss.

Oh, and anecdotally, is it any wonder that the fixed income terminal horizon of the past century – the much venerated 30-year duration (life insurance, bonds, and pensions) – matches the productive life expectancy of an adult male in 1913?

Linking home ownership – backed by the creation of the Federal Housing Administration in 1934 – to the hegemonic monetary returns for life insurers at the creation of the Federal Reserve; and by combining mortgage and life insurance as necessary public financial utilities, the Congress incented (and the public acquiesced to) the mindless embrace of debt-based citizenship. Our collective indebtedness on a personal and national level is NOT a surprise – it exists by statute. Wall Street is not the problem, it’s merely the utility used by the perpetrators. If Levin and Coburn really did their job, they’d realize that it is the tax and monetary policy of 1913 that created the Crisis and NONE OF THEIR RECOMMENDATIONS change that one bit.

As long as we have “fixed income” requirements in banking, insurance, and other regulated finance (including pensions) where independent rating of risk (including the ability to call U.S. Treasuries the junk that they truly are), we will have done NOTHING to treat the present contagion or spare us from future shocks. As long as we have a debt-based monetary system architected by and for life insurers and reserve bank members which continues to enslave every productive citizen to transfer wealth to the incumbent coup leaders (for the moment, Goldman Sachs), we will have done NOTHING to build a stable future.

The U.S. bankruptcy has little to do with mortgages. They were merely a symptom in the massive immunosuppressant-induced lethargy observed in the deceased prior to expiration. No, this virus was introduced by Presbyterians (in their corrupt invention of life insurance), was mutated by the likes of Metropolitan Life, Aetna and others (despite the valiant, albeit futile vaccination injected by the Clayton Act of 1914), and became contagious through the combined vectors of tax deductions, pensions, and life insurance. Our reincarnation – should it appear – will only be possible when we realize that 639 pages of evidence on the wrong body will neither solve the crime nor prevent the serial felon from striking again.


From the Senate Report
Recommendations on High Risk Lending

1. Ensure “Qualified Mortgages” Are Low Risk. Federal regulators should use their regulatory authority to ensure that all mortgages deemed to be “qualified residential mortgages” have a low risk of delinquency or default.

2. Require Meaningful Risk Retention. Federal regulators should issue a strong risk retention requirement under Section 941 by requiring the retention of not less than a
5% credit risk in each, or a representative sample of, an asset backed securitization’s tranches, and by barring a hedging offset for a reasonable but limited period of time.

3. Safeguard Against High Risk Products. Federal banking regulators should safeguard taxpayer dollars by requiring banks with high risk structured finance products, including complex products with little or no reliable performance data, to meet conservative loss reserve, liquidity, and capital requirements.

4. Require Greater Reserves for Negative Amortization Loans. Federal banking regulators should use their regulatory authority to require banks issuing negatively amortizing loans that allow borrowers to defer payments of interest and principal, to maintain more conservative loss, liquidity, and capital reserves.

5. Safeguard Bank Investment Portfolios. Federal banking regulators should use the
Section 620 banking activities study to identify high risk structured finance products and impose a reasonable limit on the amount of such high risk products that can be included in a bank’s investment portfolio.

InvertedAlchemy: The real problem here is the separation of Origination and Retention. When incentives are in place to induce the public to indebt, the ‘bank’ to loan, and the ‘fixed income market’ (as evidenced in statutory investment policies for ‘stable investment products’) to compulsively purchase bundled instruments, the demand for inventory of financial products to satiate the asset allocations mandated under statutory and pension policy will always favor origination at all cost. As a result, until we limit the appetite for ‘fixed income’ we will, unfortunately, persist in careless origination. The worse the U.S. dollar and economy get, the more illusory inventory will be required so we’re going to get worse – not better. Note that Goldman Sachs has upped its municipal exposures well out-pacing market wisdom not because these represent good investments but rather, because statutory rating bumps are valued when risk isn’t correctly measured.


Recommendations on Regulatory Failures

1. Complete OTS Dismantling. The Office of the Comptroller of the Currency (OCC) should complete the dismantling of the Office of Thrift Supervision (OTS), despite attempts by some OTS officials to preserve the agency’s identity and influence within the OCC.

2. Strengthen Enforcement. Federal banking regulators should conduct a review of their major financial institutions to identify those with ongoing, serious deficiencies, and review their enforcement approach to those institutions to eliminate any policy of deference to bank management, inflated CAMELS ratings, or use of short term profits to excuse high risk activities.

3. Strengthen CAMELS Ratings. Federal banking regulators should undertake a comprehensive review of the CAMELS ratings system to produce ratings that signal whether an institution is expected operate in a safe and sound manner over a specified period of time, asset quality ratings that reflect embedded risks rather than short term profits, management ratings that reflect any ongoing failure to correct identified deficiencies, and composite ratings that discourage systemic risks.

4. Evaluate Impacts of High Risk Lending. The Financial Stability Oversight Council should undertake a study to identify high risk lending practices at financial institutions, and evaluate the nature and significance of the impacts that these practices may have on U.S. financial systems as a whole.

InvertedAlchemy: CAMELS doesn’t work. The notion that we somehow play in a world where we can ‘call our own fouls’ doesn’t work in lacrosse and it doesn’t work in an economy. I completely agree with the OTS recommendation but I would encourage the OCC to actually amplify its own enforcement to take a more central role than it has in the past.

Recommendations on Inflated Credit Ratings

1. Rank Credit Rating Agencies by Accuracy. The SEC should use its regulatory authority to rank the Nationally Recognized Statistical Rating Organizations in terms of performance, in particular the accuracy of their ratings.

2. Help Investors Hold CRAs Accountable. The SEC should use its regulatory authority to facilitate the ability of investors to hold credit rating agencies accountable in civil lawsuits for inflated credit ratings, when a credit rating agency knowingly or recklessly fails to conduct a reasonable investigation of the rated security.

3. Strengthen CRA Operations. The SEC should use its inspection, examination, and regulatory authority to ensure credit rating agencies institute internal controls, credit rating methodologies, and employee conflict of interest safeguards that advance rating accuracy.

4. Ensure CRAs Recognize Risk. The SEC should use its inspection, examination, and regulatory authority to ensure credit rating agencies assign higher risk to financial instruments whose performance cannot be reliably predicted due to their novelty or complexity, or that rely on assets from parties with a record for issuing poor quality assets.

5. Strengthen Disclosure. The SEC should exercise its authority under the new Section
78o-7(s) of Title 15 to ensure that the credit rating agencies complete the required new ratings forms by the end of the year and that the new forms provide comprehensible, consistent, and useful ratings information to investors, including by testing the proposed forms with actual investors.

6. Reduce Ratings Reliance. Federal regulators should reduce the federal government’s reliance on privately issued credit ratings.

InvertedAlchemy: The Rating Agency industry is a Sherman Act violation and should not be exempt from racketeering and related civil and criminal penalties. The monopolistic nature of the industry is problem number 1. The compensation structure for incentivizing rated customer rather than public investor interest is problem number 2. These problems will be unaddressed until Rating Agency executives are jailed for their complicity in the theft of assets from municipal, academic and other pensions across the country. The Attorneys General from the 50 states should lead where no federal regulator will have the courage to go. Indictments, lawsuits, and recoveries are the only path to reform and waiting for the SEC to get there is a fantasy.

Recommendations on Investment Bank Abuses

1. Review Structured Finance Transactions. Federal regulators should review the RMBS, CDO, CDS, and ABX activities described in this Report to identify any violations of law and to examine ways to strengthen existing regulatory prohibitions against abusive practices involving structured finance products.

2. Narrow Proprietary Trading Exceptions. To ensure a meaningful ban on proprietary trading under Section 619, any exceptions to that ban, such as for marketmaking or risk-mitigating hedging activities, should be strictly limited in the implementing regulations to activities that serve clients or reduce risk.

3. Design Strong Conflict of Interest Prohibitions. Regulators implementing the conflict of interest prohibitions in Sections 619 and 621 should consider the types of conflicts of interest in the Goldman Sachs case study, as identified in Chapter VI(C)(6) of this Report.

4. Study Bank Use of Structured Finance. Regulators conducting the banking activities study under Section 620 should consider the role of federally insured banks in designing, marketing, and investing in structured finance products with risks that cannot be reliably measured and naked credit default swaps or synthetic financial instruments.

InvertedAlchemy: I would love to agree with this recommendation but for my knowledge of both regulators and policy makers and their collective illiteracy surrounding financial products, their use and abuse. The report is correct as far as it goes but Congress needs some serious IQ enhancement so that it can adequately understand what it thinks it’s regulating. And the Tea Party is NOT helping this at the moment. By appealing to sound-bites, they are diluting their message of accountability and making it come out sounding like pandering.