SEC Sets Off a New Round of Financial Deleveraging

Posted by Michael A. Kamperman on April 16, 2010

In a shocking move the SEC filed civil fraud charges against Goldman Sachs. They accused the firm of deliberately stuffing subprime CDO’s with bad mortgages, selling them to unsuspecting investors, and then arranging for bets that the mortgages would fail. If true and provable, then I imagine we will finally begin seeing someone go to jail for the massive subprime fraud. For the record Goldman Sachs denied the charges and plans to defend itself vigorously. However, the immediate and semi-permanent fallout for the economy is not good. For starters, these accusations probably just put the final nail in the coffin of the securitization market. The Federal Reserve was hoping to revive this market to bring more liquidity and leverage into the credit markets. Additionally, the enhanced risk this introduces into the market should lead to a new round of further deleveraging. All of this while the Greece sovereign debt debacle remains unresolved. The whole reason the Federal Reserve needed to print money is financial firms were delevering their balance sheets and didn’t have enough money to support the needed creation of credit. So the Fed stepped in and purchased over one trillion dollars worth of mortgages. The Fed just stopped its purchases gambling the markets could handle their exit without too big a hiccup. The SEC just pulled the rug out from under the Fed.

Make no mistake the SEC is doing the right thing. We know the subprime crisis was the result of massive fraud. Life savings have been wiped out. Millions have lost their jobs. We need to make sure those who stole from others are punished. The country will not be able to move past the subprime crisis without justice.

The SEC also just made financial regulatory reform a really hot issue. Despite the suspicions of some I do not believe the charges against Goldman Sachs are politically motivated. The SEC’s action has the very real possibility of throwing the markets into turmoil and ultimately throwing millions of more people out of work. That would not be good for the party in power come election day. Clearly the Federal Reserve wasn’t in the loop when this decision was made. Despite the constant rhetoric that the economy is much stronger than people believe and that we are in a V-Shaped recovery, the truth is consumers and small businesses are still having a very difficult time accessing credit on reasonable terms. It was reported today that the states of California, Florida, Nevada, and Georgia had record unemployment rates in the post World War II era for the month of March. That was just a couple of weeks ago. Foreclosures are continuing to go up, not down. The Obama Administration has been relying on smoke and mirrors to revive the economy. We all remember the stress tests. Well where are the loans to consumers and small businesses? Where are the jobs? This was the situation before the SEC pulled the rug out on the Fed by having the courage to call a spade a spade. It took Bernanke 18 months to start quantitative easing only after the Brits led the way and shamed him into it. Hopefully the Fed will not sleepwalk for so long this time.

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Tags: Goldman Sachs, quantitative easing, SEC

What the Treasury Should do with the Returned TARP Funds

Posted by Michael A. Kamperman on July 17, 2009

We should not have let Goldman Sachs, J.P. Morgan, and the other banks payback the TARP funds until lending returned to near normal levels in the economy as a whole. These companies greatly benefitted at taxpayer risk from the avoidance of a systemic meltdown in the financial system. They are still benefitting from the FDIC guaranteed bonds they issued to secure below market interest rates. And of course, no one benefitted more than Goldman Sachs when they received 100 cents on the dollar for their subprime “hedges” from the AIG bailout. What Goldman Sachs, J.P. Morgan, and the other banks did with the TARP funds was they sat on them. Rather than extending credit to the real economy and taking on some lending risk for the good of the country with the TARP funds, these companies dramatically tightened credit standards for the good of themselves. The banks are now the only lending game in town. They must step up and fill the lending void. You can lead a horse to water, but you can’t make him drink. Now that they are returning the TARP money what should the Treasury Department do with the funds?

No doubt Treasury will continue to prop up the largest zombie banks with some of the funds. But this is not enough to help the economy. The shadow banking system the Treasury has decided to kill off with its decision not to rescue CIT accounted for over 70% of the lending in the U.S. in recent years. Treasury should take the funds and re-acquire Fannie Mae and Freddie Mac and make them a single agency of the federal government once again. Then, Fannie Mae should begin guaranteeing jumbo mortgages of up to $2 million for securitization. Additionally, the new Fannie Mae should enter the auto securitization market and begin to guarantee pools of new and used auto loans. Fannie Mae should require a downpayment and verification of income and assets before guaranteeing a loan. Additionally, in order to reduce foreclosures Fannie Mae should refinance any mortgage in America with no appraisal. Why shouldn’t ordinary Americans who are working hard to make payments on their underwater mortgages not receive the same support the Treasury was so anxious to extend to Goldman Sachs?

Ironically, this proposal would not only benefit the Main Street economy; it would also benefit the Wall Street economy. While I think Treasury has done more than enough at this point for Wall Street, it has not come close to doing nearly enough for Main Street. One other idea to help Main Street would be for the Treasury to partner with private capital and start a brand new well capitalized bank to compete with Goldman Sachs, J.P. Morgan, and the other banks. One of the reasons the banks are not lending is there are not enough lending dollars available for the whole economy. Hence, the banks are able to lend all of the money they need to even with extremely tight credit standards. By starting a new bank with zero legacy issues and FDIC guaranteed bond funding Treasury would place a powerful new competitor in the market that would force the existing banks to loosen their credit standards or lose market share. If Goldman Sachs and J.P Morgan do not want to loan out Treasuries money, then let’s give the money to a new bank that will.