Bad news just gets worse...not only do we have the collapse of the paper credit market.... can you say junk bond scandal of the eighties.. now we have a flashback to bank scandals of the nineties...wait a minute shouldn't the market have regulated itself so this didn't happen, again...once again the myth of self regulation is exposed for the sham it is...global markets are not self regulating never have been that is why Capitalism created the State in its own image.
French bank hit by worst scandal ever
SocGen trader's $7.1B loss dwarfs Barings debacle
PARIS - A junior computer whiz at the French bank Societe Generale has been accused of racking up a $7-billion loss in bad bets on stocks in the biggest trading scandal in banking history.
France's central bank and government scrambled to shore up confidence in the banking system after the 144-year-old SocGen told investors already battered by the credit crisis that it had discovered the "exceptional" fraud late last week.
The trader had circumvented the bank's risk controls through in-depth knowledge of its computer systems, but was caught when he tried to cover up his losses.
The country's central bank chief dubbed the trader "a genius of fraud" while French police announced a criminal probe.
Richard Fuld, the chief of Wall Street firm Lehman Brothers, called the debacle "everyone's worst nightmare" at the meeting of policy and business leaders in Davos.
The losses spiralled to ¤4.9-billion ($7.1-billion) -- nearly its net profit in 2006 -- as the bank tried to close out the rogue trader's stock index futures positions in Monday's sliding market.
2002: Former currency trader John Rusnak accused of hiding US$691 million in losses at Allfirst bank of Baltimore, at the time under parent Allied Irish Bank, pleads guilty to one of the largest bank fraud cases in U.S. history. Rusnak was sentenced in 2003 to 7 1/2 years in prison.
_ 1996: Sumitomo Corp., a 300-year old Japanese metals trader, discovers that its star copper trader, Yasuo Hamanaka, amassed $2.6 billion in losses in unauthorized trades over a decade. The revelation caused copper prices to plummet worldwide. Sumitomo has paid millions of dollars in class action lawsuits and Hamanaka served more than seven years in prison.
_ 1995: Collapse of Britain's Barings Bank after a trader in Singapore, Nick Leeson, lost 860 million pounds (then worth US$1.38 billion) on futures trades. The fraud prompted banks worldwide to tighten internal checks. Leeson spent four years in prison.
_ 1995: Toshihide Iguchi, a New York bond trader for Japan's Daiwa Bank, charged with hiding $1.1 billion in trading losses he accumulated over 12 years. The bank later pleaded guilty to failing to notify U.S. authorities sooner. It was hit with $340 million in fines and ordered to shut its U.S. operations. Iguchi was sentenced to four years in prison and fined.
1994: Joseph Jett, a government bond trader at Wall Street brokerage Kidder Peabody & Co., was fired after the firm accused him of faking $348 million in profits to fatten his bonus. Jett denied wrongdoing and wasn't charged criminally. Last year a federal judge upheld a March 2004 order by the Securities and Exchange Commission saying Jett had booked fake profits of approximately $264 million and had to return $8.2 million of bonuses and pay a $200,000 civil penalty. The scandal contributed to the demise of the venerable Kidder.
_ 1991: Bank of Credit and Commerce International (BCCI), operating in nearly 70 countries, is seized by bank regulators, acting on auditors' reports of huge losses from illegal loans to corporate insiders and from trading transactions. Some 250,000 depositors left without funds. Claims exceeded US$10 billion.
© 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.
Bank of America Settles Suit Over the Collapse of Enron - WSJ.com
By Rick Brooks and Carrick Mollenkamp Staff Reporters of THE WALL STREET JOURNAL
Companies Featured in This Article: Bank of America, Citigroup, J.P. Morgan Chase, Merrill Lynch, Deutsche Bank, Canadian Imperial Bank of Commerce, Toronto-Dominion Bank
Bank of America Corp. became the first bank to settle a class-action lawsuit alleging that some of the top U.S. financial institutions participated in a scheme with Enron Corp. executives to deceive shareholders.The Charlotte, N.C., bank, the third-largest in the U.S. in assets, agreed to pay $69 million to investors who had billions of dollars in losses as a result of Enron's collapse amid scandal in 2001. In making the settlement, Bank of America denied that it "violated any law," adding that it decided to make the payment "solely to eliminate the uncertainties, expense and
Why the Blowup May Get Worse
Not since 1966 -- when the term "credit crunch" was coined after the Fed pushed market interest rates above the legal limits banks and thrifts then could pay on deposits and thus stopped lending in its tracks -- has the nation's mortgage apparatus been so close to breaking down.
The current crisis arguably has the potential for more economic disruption than the celebrated 1998 Long Term Capital Management meltdown. Then, as Northern Trust economist Asha Bangalore points out, the economy cruising along -- in contrast to the past four quarters, which have seen below-potential growth on average.
Moreover, mortgage borrowers perversely benefited from the LTCM fiasco. Not only did the Greenspan Fed lower rates, sparking a huge bond rally, but, also, the government-sponsored enterprises Fannie Mae (FNM) and Freddie Mac (FRE) went on virtual buying sprees. As a result, the biggest part of the credit market -- mortgages -- remained flush. Now, Fannie is looking to expand its portfolio beyond the $727 billion limit imposed on it after its accounting and governance scandals -- a move viewed skeptically by the White House but supported by some congressional Democrats.
Indeed, the full impact of the mortgage crisis still lies ahead. From the beginning of 2007 through mid 2008, interest rates on over $1 trillion of adjustable-rate mortgages are slated to be reset, many from low "teaser" rates.
THE SUBPRIME MESS ALSO RECALLS another crisis -- the virtual collapse of the commercial-paper market in the wake of the Penn Central bankruptcy of 1970. Back then, the paper market consisted of relatively simple short-term corporate IOUs. Now, so-called asset-backed commercial paper is backed by all manner of things, from credit cards and auto loans to collateralized debt obligations, and comprises over half the CP outstanding. Moreover, notes MacroMavens' Stephanie Pomboy, money-market funds own 27% of CP outstanding.
While the Fed managed to soothe the financial markets' nerves by week's end, the potential for future upheavals remains. As a result, the futures market is looking for the central bank to ride to the rescue with rate cuts. Fed-funds contracts are fully discounting a quarter-point cut, to 5%, at the Sept. 18 Federal Open Market Committee meeting, and a further reduction to 4¾% in December.
As the chart here shows, financial crises have tended to coincide with peaks in the fed-funds rate and subsequent Fed easing. The subsequent rate relief would be hailed by the markets as the start of a new bull run.
There is a new wrinkle -- the precarious state of the dollar. No longer is the greenback viewed as a safe haven in the world, contends Barclay Capital's currency team.
Indeed, as MacroMavens' Pomboy has posited, a Fed rate cut that sends the dollar tumbling could have a perverse effect. The influx of foreign capital has kept U.S. interest rates low and provided a flood of credit for everything from leveraged buyouts to, of course, subprime mortgages. If there's an exodus of foreign capital fleeing a declining dollar, credit could tighten even as the Fed eases. Be careful of what you wish for.
High-yield debt - Wikipedia, the free encyclopedia
The original speculative grade bonds were bonds that once had been investment grade at time of issue, but where the credit rating of the issuer had slipped and the possibility of default increased significantly. These bonds are called "Fallen Angels".
The investment banker, Michael Milken, realised that fallen angels had regularly been valued less than what they were worth. His time with speculative grade bonds started with his investment in these. Only later did he and other investment bankers at Drexel Burnham Lambert, followed by those of competing firms, begin organising the issue of bonds that were speculative grade from the start. Speculative grade bonds thus became ubiquitous in the 1980s as a financing mechanism in mergers and acquisitions. In a leveraged buyout (LBO) an acquirer would issue speculative grade bonds to help pay for an acquisition and then use the target's cash flow to help pay the debt over time.
In 2005, over 80% of the principal amount of high yield debt issued by U.S. companies went toward corporate purposes rather than acquisitions or buyouts.
High-yield bonds can also be repackaged into collateralized debt obligations (CDO), thereby raising the credit rating of the senior tranches above the rating of the original debt. The senior tranches of high-yield CDOs can thus meet the minimum credit rating requirements of pension funds and other institutional investors despite the significant risk in the original high-yield debt.
Hedge funds have gotten rich from credit derivatives. Will they blow up?
|From:||"Kevin McKern" |
|Received:||10/19/2006 11:45 AM|
|Subject:||Will they blow up?|
Balancing the Books
A Legacy Worth Disinheriting: The Federal Reserve remains spooked by the specter of the Great Depression
Edited by Jay Palmer
A History of the Federal Reserve Volume 1: 1913-1951
By Allan H. Meltzer
University of Chicago Press; 800pp; $75
Reviewed by Randall W. Forsyth
Central bankers, like generals, often are accused of fighting the last war. The Federal Reserve remains haunted by its most humiliating defeat -- an utter failure not only to prevent the Great Depression, but its ineptitude in countering the most severe downward spiral in American economic history. That failure arguably has a profound impact on Fed policy to this day.
Serious students of monetary policy will be familiar with the broad outline of what's told in Allan H. Meltzer's monumental "A History of the Federal Reserve: Volume 1: 1913-1951." The Great Depression is the most crucial period covered in the book, which encompasses the span from the Fed's founding to the Treasury Accord of 1951, when it gained its independence as a modern central bank.
Unlike others who lay the blame for the Depression on a single cause -- the stock-market Crash of '29, the Smoot-Hawley tariff, the collapse of the international gold standard or the Fed's permitting a one-third contraction in the money supply -- Meltzer reasonably attributes the catastrophe to the confluence of these shocks. But the Fed, which was established after a succession of financial panics in the 19th and early 20th centuries -- precisely to prevent their recurrence -- failed in that narrower mission.
That failure, as Meltzer keenly describes, was a result of misguided policies and political infighting. Policy was ruled by the (wrongheaded) conventional wisdom of the day, that said that the collapse of the 'Thirties was necessary to purge the excesses of the 'Twenties. The Fed was to restrict itself to providing credit solely to meet the private sector's needs -- by buying only "real bills" and not purchasing government securities, which supposedly only pumped up speculative credit, according to the prevailing notion of the time. The reestablishment of the gold standard in the 1920s was considered a success then, but Meltzer describes how it sowed the downturn's seeds. Britain needed to deflate while France and the U.S. had to inflate, so all resisted. New York Fed President Benjamin Strong, who de facto ran policy in the 'Twenties, eased to help the pound. But his jealous counterparts would posthumously blame him for inflating the bubble that burst in 1929.
More important, Meltzer details the dithering that prevented the Fed from taking the most basic monetary action -- large-scale purchases of government securities to add liquidity to the banking system. Fed officials thought policy already was easy because interest rates were near zero and banks didn't borrow from the Fed, ignoring the rise in real interest rates caused by deflation and the contraction in the money stock.
The Bank of Japan repeated those blunders through most of the 'Nineties. The Fed, having learned from history, has not been doomed to repeat it. The U.S. central bank already has slashed its key interest rate target 12 times since January 2001 to a nearly irreducible 1 1/4%. And in a speech last November that still reverberates, Fed Governor Ben Bernanke pointed out that the central bank hasn't run out of monetary bullets even if it runs out of basis points. Even at 0%, the Fed still has a magical device -- the printing press. With a steward of the dollar trumpeting the power to debase it, is it any wonder that gold has rallied and the spread between TIPS (Treasury inflation-protected securities) and fixed-return Treasuries has widened?
Yet the circumstances of the bursting of the bubbles of the 'Twenties and the 'Nineties were markedly different. Ahead of the '29 Crash, the Fed was actively trying to curb speculation. Greenspan & Co. claim no part in the recent bubble, with the Maestro contending that actions to curb the inflation in asset prices posed risks to the economy.
His protest, however, ignores the role played by the Fed in encouraging soaring asset inflation. As previously noted in Barron's, the central bank provided the monetary fuel for the Nasdaq bubble and then throttled it back ("Fed Inflated, Then Burst IPO Bubble," Dec. 11, 2000). Investors and traders also comforted themselves with the notion that the central bank would (and could) rescue the financial markets if they collapsed. That belief, which gained currency especially after the Long Term Capital Management debacle of 1998, came to be known as "The Greenspan Put" -- a get-out-of-jail-free card for speculators.
Now, even though the world enjoys expanding international trade and growth in output and income-exactly the opposite of the 'Thirties -- the Fed still worries about deflation and depression. Moreover, every indicator -- money supply, negative real rates, a steeply sloped yield curve, a weakening dollar and rising commodity prices -- is full-tilt expansionary. Indeed, William Silber of New York University's Stern School recently wrote in the Financial Times that the Fed may not act to curb inflation soon enough -- its blunder of the 1970s. How the Fed failed to foster stable prices after 1951 should be the basis of Meltzer's second volume, which I eagerly await.
RANDALL W. FORSYTH is an assistant managing editor at Barron's
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