The Great Financial Circle Jerk

Yes the title is crass, vulgar. Yet the never ending trading of mortgage backed securities, previously titled toxic assets in some game of musical chairs justifies the analogy. Take just this latest revolving door as an example. Did you know a former New York Federal Reserve Official, in charge of overseeing AIG now works for AIG?

The insurance giant has also brought on board Charlie Shamieh as chief actuary; Mark Scully to oversee actuarial functions at its main property and casualty division, Chartis; Sid Sankaran as chief risk officer; and former Federal Reserve official Brian Peters to also help manage risk in an executive position.

Naked Capitalism comments on this little gem in Sleaze Watch:

Now we have another example of unseemly revolving door behavior, this with an even more direct connection between a former official’s old purview and his current role, this time involving AIG and its biggest sugar daddy, the New York Fed.

We were probably remiss in not commenting on the peculiar announcement of AIG’s offer to buy back the bonds in the New York Fed’s Maiden Lane II portfolio for $15.7 billion. The stated reason, that the purchase would “reduce its obligation” to the government is nonsense; it’s astonishing that the press is parroting it. As this Cleveland Fed summary indicates, the latest of a series of restructurings converted the remaining debt payable by AIG to equity; it has paid down all its loan balances. the New York Fed loan to Maiden Lane II is payable by that entity, not by AIG (AIG does have an “equity” position in that portfolio).

AIG can buy plenty of bonds in the marketplace; the only reason for it to offer to buy these bonds in particular is if it believes it can obtain them at a discount, which means that this is yet again another pretty blatant subsidy to the giant insurer. (The only other rationale we could fathom at the time of the announcement of this offer was to justify the government’s continued insistence that all these bailout programs were really great deals. Yes, if you have the Federal Reserve engaging in QE, you can play a three card monte game that makes your older portfolio buys look amazingly astute. But as we discuss below, the evidence has now fallen out conclusively on the side of this move being yet another subsidy to AIG).

Note that if the NY Fed were serious about selling these bonds and maximizing value to the public, the last way you’d do it would be as a single massive portfolio. Big portfolio sales do result in discounts due to the lack of competing bids (think of selling all the artwork in an estate, which included a lot of painting, sculptures, collectable ceramics, and rugs, as a block versus selling the items individually in an auction). The way to fetch a decent price would be to break the portfolio up, in some cases down even to the single bond level, or at least into much smaller homogeneous lots, and work the orders through multiple dealers over time. Admittedly, AIG made its brazen offer back in December and the officialdom failed to respond.

This piece comes on the news the Federal Reserve made record profits and transferred $79 billion to the U.S. Treasury:

Total Reserve Bank assets as of December 31, 2010, were $2.428 trillion, which represents an increase of $193 billion from the previous year. The composition of the balance sheet changed notably. Holdings of U.S. Treasury securities increased $261 billion and holdings of federal agency and government-sponsored enterprise (GSE) mortgage-backed securities (MBS) increased $86 billion. These increases were partly offset by a $96 billion decrease in loans to depository institutions and a $23 billion decrease in loans extended under the Term Asset-Backed Securities Loan Facility, largely due to early repayments by borrowers.

The Reserve Banks' comprehensive income increased $28 billion over the previous year to $82 billion for the year ended December 31, 2010. The increase was primarily attributable to an increase of $24 billion in interest earnings on the federal agency and GSE MBS holdings.

The Reserve Banks transferred $79 billion of their $82 billion in comprehensive income to the U.S. Treasury in 2010, a $32 billion increase from the amount transferred in 2009.

So, the Federal Reserve buys up Treasury bonds, yet magically turns a profit on mortgage backed securities they hold, those infamous worthless securities, and gives back the money...to the U.S. Treasury. Of the $2.428 trillion held at the Fed, $1.275 trillion is in U.S. Treasuries.

Then, the Treasury has announced they will sell $142 billion of Mortgage Backed Securities (MBS), sold in $10 billion allotments. Meanwhile AIG is offering to buy back $15.7 billion in toxic assets held by the New York Fed, which as Naked Capitalism implies, is a way to convert debt into equity, i.e. yet another bail out. Currently there are reports of competitive bids.

Now check this out, AIG, among others just settled a bid rigging lawsuit for only $27 million from a time period of 1998 to 2004. In other words their profits assuredly exceed the cost of the resulting lawsuit from bid rigging on business insurance.

Even more odious, Reuters has a fascinating piece about how the Treasury's annoucement of MBS sales is a technique to not hit the debt ceiling.

The MBS sales will bring in about $10 billion a month to federal coffers over the next year, but the Treasury denied on Monday that the sales were aimed at helping it stay under the $14.294 trillion statutory limit on the government's debt.

It said the sales will not "meaningfully extend" the time before it reaches the debt ceiling -- now projected between April 15 and May 31.

As of March 18, the total public U.S. debt stood at $14.173 trillion, or $121 billion below the limit.

Congress has routinely raised the debt limit every year since 2002, but Republicans want to tie any hike this time to commitments by the Obama administration and Democrats to deeper spending cuts. If the limit were reached, the government could
no longer borrow to fund day-to-day operations, risking a partial shutdown and default on debt payments.

The Treasury has been drawing down a $200 billion Federal Reserve emergency lending account to help avoid hitting the limit, and the account had dwindled to just $25 billion as of Friday.

So, either toxic assets weren't so toxic after all and those arguing against mark-to-market accounting have a point, or do we have the government now in the game of trading worthless assets like baseball cards in a similar rigged game that caused the financial crisis in the first place?

Hard to tell with so many insider trading types of jobs going on here. One thing to note, it's looking bad that eventually the Federal Reserve will be musical chairs odd man out. If inflation increases, which is highly likely, they will take a loss on all of those Treasuries they are holding at minimum.

With record foreclosures, home prices and sales plummeting and the above sales causing mortgage rates to rise, it's hard to comprehend, beyond the assumptions in this title piece, how such toxic assets based on, backed by residential mortgages, could magically become so valuable now.

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Comments

MBS is the Freddy Kruger of financial products

The entire financial rescue mission, aka bailouts, seems like an effort to preserve derivatives. It would make more sense to rescue the economy by having a giant settlement conference and canceling out the insane derivatives market, which is driving entire nations into insolvency. Another burden for the people to carry for the top 1%.

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MBSes, preserving their "value"

We need to find someone or more details on precisely how these MBSes sitting at the Fed/Treasury could magically increase so much in value. I plain do not get it. All last year the "press" acted like the residential real estate collapse was just a blip...
and the corresponding foreclosures, short sales, mortgages underwater was a "trivial amount" ...

I can get how mortgages have become divorced from the actual home values....but I can't get how they can increase so much in value with so many people unable to pay, the foreclosure rates and then the underlying assets now worth so much less.

Even more strange, I cannot find much, even in the financial watchdog, "we don't buy your bullshit", sites analyzing these lastest profit claims.

Your overall assessment that these banks want their derivatives trading among themselves not impeded and preserving this fiction is clearly a goal and beyond lobbyists buying our government, demanding that it be so, I've yet to read a real justification for it all.

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Frame of Reference

To consider your question I think you have to totally change your frame of reference. For instance many people make the assumption that financial institutions in the West are active participating 'counter parties' in a transaction and share risk - say a mortgage transaction (I make the distinction between Western Finance Capital and say the Islamic banking system). They are not as they do not share the risk of the outcome of the transaction. Consequently, they were (and still are) only interested in the transaction fee.

If you are not responsible for something in terms of applying moral or ethical calculus, or there is no regulation in place to restrain behaviour then the outcome will be transactions that make no financial sense as rules are relaxed to bring in the commissions - the underlying driver and motivation. I believe some of the Investment Banks even brought their own products so they could 'hit targets'. The banks can create debt at will - a case of infinite debt creation capabilities with finance capital chasing finite assets - hence a bubble as Americans feverishly brought properties off each other (the velocity of transactions increased as people 'flipped' houses) like they done so in Ireland, the UK, Australia, etc, using more and more debt. Now we view this as irrational behaviour when observed from a longer term perspective as the outcome is collapse and failure but the people that made the money have walked away with no consequences.

The above observation would be true of the whole financial system, which is parasitic as it thrives on fees, transactions, commissions, etc, and is not connected to the real world that the vast majority of the world's population live in. Hence the explosion of the global derivatives market over the last 30 years to around $600 Trillion, I believe, whereas the total real GDP of the world's economy in terms of physical goods and supporting services is around $60Trillion. It is in the bank's interest to create new markets and introduce volatility and create arbitrage positions where there are none (the emergence of 'fast trading' for instance which is a fiction - money begets money) so as to take commissions, etc. Consequently the real economy and markets do not clear properly as price signals are false and driven by asset bubbles - massive amounts of resources can be misallocated as in the case of the US housing market as homes were built in the wrong location, to indifferent standards, etc, whereas these scarce resources could have been invested in productive capacity. It was observed in a UK report that the banks are destroyers of value in the real economy. This observation could also be applied to the US economy.

Accepting that Finance Capital is distinct and apart from the real economy we have to seek a different explanation as to how the 'system' operates and define its parasitic mode of operation. Neoclassical models of economic behaviour are totally inadequate for explaining the operation of the 'system' and the emergence of multiple asset class 'bubbles'. These 'models' are based a simplistic rationalistic view of the way humans behave and how markets clear and that simplistic model is then translated into financial models, albeit complex mathematical models.

We have to do is look at the world not through the prism of mainstream neo classical economics but through political economy which seeks to understand the interplay of the world of commerce with government as well as with the distribution of national income and wealth but most importantly the creation and distribution of surplus value. In this context Marx attempted to explain the disconnect between the real economy, the use and 'leverage' of money and the allocation of value. One book I read that was written in 1985 provided updated view of how financial crisis are formed was written by Alain Lipietz and was called - The Enchanted World: Inflation, Credit & the World Crisis. The word to note is 'enchanted' and the thesis is that the financial system is parasitic and will tend to create multiple bubbles and is not connected to the real economy. Bubbles and financial markets are instruments to extract unearned value and they will tend to a systemic collapse.

Basically, the justification is that the financial system operates to extract value and it does not matter if the reason for the transaction makes any sense - these is no apparent consequence. My guess would be that the vast majority of 'derivatives' have served their purpose as they have already earned the bankers commissions. The reality is that the vast majority could never be settled as no one would take on, or be able to understand the counterparty risk so the US government takes them on, takes the loss and the banks recycle at cents in the dollar. In essence it is one gigantic financial illusion (ponzy) whose rules do not need to make sense as that is not the objective of the game. The end result (end game) will be economic collapse as Finance Capital assumes no end of growth, bubbles, endless resources, etc, where as the reality is the opposite.

It has taken us 60 or so years to get to this point and we have missed the opportunity to kill the parasites. Like one of the other commentators noted - derivatives could be netted out as a financial exercise and this could have been done if the banking system had been closed down and resolved the conflict between the financial elites and nation states. Instead now the 'enchanted world' is impacting negatively on the real world (sovereign debt, inflation, etc) and has the potential to impact global food production, supply chains, etc, if the means of exchange is destroyed. Financial transactions do not need to make sense as long as they earn commissions, etc.

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hence the post title

These MBS evaluations really don't add up to me and I've yet to find any spreadsheet, evaluation or explanation that tells me I am wrong.

Great analysis Nexus, as always.

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History: we've been there (here) ... but did what?

I understand Nexus' phrase "operates to extract value" through the fundamental axiom of the so-called 'Austrian' (von Mises) school of economics, namely, that the proper definition of 'good' (or 'utility') is the creation of accumulations of capital. That these ideas have been proclaimed as neoclassical or libertarian or in any way related to the great founder of a true libertarian school of economics, Henry C. Simons, is so offensive to history as to be downright foul.

The basic premise of Simons was simply to ask the question "What economic system is (or would be) most compatible with individual liberty?" The answer is that such an economic system can only be based on an understanding of the necessity (for individual liberty) of the breaking up of concentrations of power. Since great concentrations of wealth are inherently also great concentrations of power, the ideas of Henry Simons -- although initially admired by anti-collectivists of all kinds -- were discarded and selectively ignored by everyone from J. M. Keynes to F. D. Roosevelt and finally to the late Milton Friedman (ultimately sacrificing the ideals of his mentor on the altar of globalism) and Alan Greenspan.

Another way of looking at the problem (and solutions) is to recall that the Constitution empowers Congress to mint and print the currency. Not that Congress should do that directly. And, to be sure, there is a threat of concentration of power in any central bank. Simons recommended a stable monetary policy through a government-owned central bank, regulated by a relatively inflexible legal code rather than by the whims or genius of anything like a Federal Reserve or Chairman thereof. It is a question, for Simons, of a necessary monopoly. I think it's also possible, computers and networks being what they are, to think in terms of another old and mostly forgotten idea -- mutual banking.

Anyway you look at it, the key to success is honesty and probity. Without that ... where are we? Well, here we are.

It is heartening to see, after all these years, a renewal of interest in the original Chicago Plan after so many years of what ultimtely amounts to betrayal by the so-called 'Chicago School' (e;g., Milton Friedman) or the so-called 'Austrian School' (Ludwig v. Mises and the Institute). For example, here is an excellent summary about this from --

Blog entry at Chris Martenson forums

Disclaimer: I am not associated with Chris Martenson or his blog, and neither endorse nor dismiss his writings, which can stand on their own. Similarly, I neither endorse nor dismiss publications of the American Monetary Institute or of Stephen Zarlenga, although I do think that the way forward for survival of the U.S.A. lies in the direction indicated.

'Nexus' in comment titled "Frame of Reference" --

To consider your question I think you have to totally change your frame of reference.- ...

Accepting that Finance Capital is distinct and apart from the real economy we have to seek a different explanation as to how the 'system' operates and define its parasitic mode of operation. Neoclassical models of economic behaviour are totally inadequate for explaining the operation of the 'system' and the emergence of multiple asset class 'bubbles'. These 'models' are based [on] a simplistic rationalistic view of the way humans behave and how markets clear and that simplistic model is then translated into financial models, albeit complex mathematical models.

[What] we have to do is look at the world not through the prism of mainstream neo classical economics but through political economy which seeks to understand the interplay of the world of commerce with government as well as with the distribution of national income and wealth but most importantly the creation and distribution of surplus value. ... Bubbles and financial markets are instruments to extract unearned value and they will tend to a systemic collapse.

Basically, the justification is that the financial system operates to extract value ...

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great comment

I have been wondering "where now brown cow" so much lately since we cannot get corruption out of government and thus our private institutions.

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Fed Denies AIG on MBS buy back

AIG was basically denied a subsidy by the Fed, which is good on their plan to buy maiden lane II a pool of MBSes taken over by the Fed, for $15.7 billion.

You should see AIG rant, as if they were shocked, finally the Fed didn't let them have some more free money (in the link).

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