Jurgen Stark Sparks More Euro Jitters

I'm writing this post on Monday afternoon, while listening to some really serious black crepe-paper hanging on Bloomberg concerning Europe's debt problems. Yesterday's latest Euro-panic was apparently sparked by the resignation from the ECB of Germany's Jurgen Stark.

Here's what the weekend edition of the Wall Street Journal reported on the subject,

"Germany's top representative on the European Central Bank resigned in an apparent protest Friday, dealing a severe blow to the steward of Europe's common currency amid the Continent's worsening debt crisis.



The ECB said Jürgen Stark, its chief economist, was resigning for "personal" reasons with nearly three years remaining in his term. But people familiar with the matter said his decision was driven by frustration over the bank's expanding role in backstopping the region's finances.


The surprise exit of Mr. Stark—the second senior German official to depart the ECB over ideological differences in recent months—jolted markets in Europe and the U.S., as concerns over the stability of the central bank's senior leadership added to fears about Greece and Europe's banks. The euro suffered its biggest one-day drop in two months, finishing at $1.3657, its lowest finish since February.



ECB officials have taken pains in recent weeks to counter growing criticism that the bank is overstepping its charter and assuming untold financial risk with its actions. Such worries are strongest in Germany, where the country's own central bank, the Bundesbank, is firmly rooted on the principle of independence from politics. Many Germans believe that tradition is at the core of their country's own economic success and worry that it is now being undermined.



"From a German perspective, this is not a very good sign," said Kai Karstensen, an economist at Ifo Institute in Munich.


The resignation is fueling a debate in Germany about whether the euro will become a less-stable currency thanks to the escalating euro-zone debt crisis. Such a debate could indirectly make it harder for Chancellor Angela Merkel to justify expensive government policies to prop up the euro.


"Stark is the second German central banker to leave the ship because he sees that the German stability culture can't be upheld in Europe," says Thorsten Polleit, economist at Barclays Capital in Frankfurt. "There's a clear potential now that the German public will become increasingly disenchanted with the euro project."


That disenchantment is already being expressed by leading politicians. German President Christian Wulff, whose position is largely ceremonial, has called the ECB's bond purchases "politically and legally questionable." The head of German's center-left SPD party, Sigmar Gabriel, has also denounced the purchases.



There are worries within Germany that vulnerable countries in Southern Europe will soon have a stranglehold on ECB decision-making. That impression could further undermine Germans' confidence in the euro at a time when their country is being asked to foot much of the bill to bail out the flagging members.


In an op-ed for the German business daily Handelsblatt, released late Friday, Mr. Stark wrote that government efforts to save the euro zone have fallen short. He called for a "far-reaching reform of the mechanism for decisions and sanctions."



"We find ourselves in a situation in which massive sustainability risks in public budgets are eroding financial stability," he wrote. "


The ECB, like the US Fed, is supposed to be apolitical. But, just as our Fed has shamelessly returned to the financing of Treasury debt since 2008, so, too, is the ECB working closely with the the EU by purchasing sovereign debt of countries in trouble. Now, however, it's clear that those countries include Spain and Italy. Two countries whose economic size will almost surely doom any Euro-wide attempt to rescue them. Italy is, in fact, the third-largest sovereign debt issuer in the world. Spain's economy is no Greece- it's substantial and it's in serious difficulty.

Yesterday afternoon's Bloomberg discussion rather bluntly included predictions of failure for many large European banks. Parallels to the situation of the US financial markets and banks just three years ago this month were explicitly made.

Don't forget that on several occasions, business media such as the Wall Street Journal have reported that US money market funds have significant positions in European bank commercial paper. Guess what happens if those banks become insolvent.

The Euro-funding crisis which is spreading from their sovereign debt to their private sector banks will arrive quite quickly on US shores in the form of 'broken-buck' money market funds which will then need...surprise, surprise....another Fed bailout!

Somehow, it seems truly ironic that eighty years after Hitler's Germany provoked such fear in Europe, the countries of that region are now running to (back) to Germany for financial rescue from their subsequent sovereign economic and financial mistakes. Who'd have guessed that the Germans would ultimately dictate the future of Europe not from the strength of their military, but from the strength of their economy?

FASB Blinks On 'Mark To Market' Methodology At Last

Earlier this week, the Wall Street Journal published an article reporting on FASB's late, halting steps to modify 'mark to market' accounting for financial sector firms- banks and life insurers.

In the piece, the Journal reporters wrote,

"Accounting watchdogs are fast-tracking an effort to provide a small dose of "mark-to-market" relief for financial firms, as banks and life insurers continue grappling with deteriorating investment holdings.

The Financial Accounting Standards Board last week began steps to loosen a rule regarding when financial firms must book losses on a narrowly defined subset of lower-rated mortgage-backed securities, commercial-backed securities and certain other structured securities.

For those financial firms that hold the relatively small group of securities at issue, managements and their auditors would have more leeway to put off a potential write-down that would clip net income. That could help bolster their regulatory capital.

The possible rule revision falls far short of what banking and insurance executives were seeking because they wanted relief that would give them greater leeway in valuing a wider range of securities. But it illustrates how aggressive they have become in trying to stave off paper losses. Analysts are still trying to figure out which companies might own the particular securities at issue."

Unfortunately, the move seems to be coming as far too little, too late. If, some fourteen months ago, FASB had allowed performing securities to be marked at their economic value, rather than the instantaneous trading value, which might be zero, much of the last year's carnage could have been avoided.

However, by waiting too long, intangible losses became tangible writedowns, which restricted credit, investment and, eventually has led to a reduction in real economic activity.

Talk about the tail wagging the dog....

Disbelief and Denial On "Wall Street"- Or What's Left of It

I read Dennis Berman's piece in yesterday's Wall Street Journal, entitled "On the Street, Disbelief and Resignation," with great interest, and more than a little surprise.

Berman wrote, in part,

"Inside what's left of Wall Street, investment bankers are doing all they can to cope with a business that is disappearing before their eyes. Yes, there are tens of thousands of people still with jobs. They just don't have much work. Debt and stock markets are virtually shut, merger volume is down by 28%, and whole lines of structured finance are closed for good.

This would appear a moment of natural self-reflection. Perhaps the time to consider a career move out of New York, or pursue an abandoned passion. Oddly, few of the senior bankers seemed to be able to accept the basic reality of their own profession: that an overleveraged world created an excess of bankers, too.

It is a testament to Wall Street's inherent optimism -- and exactly why the boom-and-bust cycles will continue -- that bankers remain so committed. As the Goldman banker summed it up: "People are busy. They're just not getting paid."

Here's what I don't get.

Ten, five, even a year ago, these whiz kids were supposed to be able to out-think corporate CEOs and CFOs, identify mergers, create novel financing approaches, and, generally so it was presumed, add value.

How can a group of largely kids, with a few adults riding herd on them, be so currently misguided, blind, and clueless, yet be in a position to 'assist' US companies with financial consulting and engineering?

We're dealing with global deleveraging. A serious pollution of the world's financial markets by toxic securitized waste. Credit is being retracted, or only extended in rollovers at very high rates of interest.

Underwriting is probably headed back to the stone age, since nothing glitzy will be trusted by most investors for maybe a decade. There is no 'Wall Street' anymore, simply corporate finance and M&A divisions of commercial banks.

I was around in the 1980s, when investment bankers and corporate raiders routinely merged companies, engineered leveraged buyouts, and purged hundreds, sometimes thousands of employees from the affected companies.

Guess whose turn it is now?

Thaaaat's riiiiiight! Investment bankers, M&A mavens, and traders, both buy and sell sides.

The underlying markets and demand for much of what these typically-younger, well-educated, highly-financially aspirational financial service workers are gone. Vanished. Vaporized.

Thus, so are the jobs serving those vanished markets and demands. And they likely will not ever return. Period. It is a new era. Publicly-held investment banks are gone, and will not return.

It's revealing to see how, when it is now apparent to all who understand these markets and sectors, that there has been a one-way sea change in employment opportunities and careers in investment banking and trading, these young worthies still cling to the hope that there will be a dawn following this night.

If this represents their considered business judgment, that's just another reason for the once-vibrant, overheated investment banking sector to have vanished as publicly-held companies.

Regarding Criticism of President Bush's Economic Team

President George Bush and his economic team have been getting all sorts of bad press for the past few months.

First it was Congressional Democrats and Presidential candidates all referring, with various riffs on the main theme, to 'failed economic policies' of the Bush years. And 'deregulation.'

Then, in the weeks since the election, there has been a sudden, mewling outpouring of sentiment that the newly-elected President 'will have a plan,' whereas the Bush administration's team have, to use words of a pundit I heard Monday morning,

'...been working weekends to contain financial market damage. You wonder what new event in financial markets will have occurred to greet you when you awake on any Monday morning.'

I think these criticisms, particularly the latter ones, widely miss the point of governmental action in the face of plummeting consumer or investor confidence and the early stages of a contagion among heretofore-untested linkages between abstruse financial instruments.

For example, I have had many discussions with experienced, educated friends, among whom is my business partner, regarding steps that 'should have' or 'could have' been taken as far back as August of 2007.

For example, my own perfect response, in retrospect, would have included:

-July, 2007: modify 'mark to market' valuation by executive order, in response to the two Bear Stearns' funds collapse due to failure to rollover debt of leveraged funds as the assets failed to find priceable markets.

-August, 2007: no Fed rate cuts, but an announcement of increased audits by all Federal oversight agencies with respect to mortgage loan paperwork, criteria, and loan performance status.

I contend that these two steps, and especially the first, would have avoided the worst of the vaporization of market-valued capital due to the senseless insistence that a lack of current market prices for held-to-term structured financial instruments, necessitated their near-total markdowns. This large-scale vaporization caused the hundreds of billions of dollars of bank asset writedowns, irrespective of the actual performance of the securities, which triggered the credit contraction and led to the ability of the CDS market to wreck AIG and the investment banks.

If these steps had not worked, I'd have preferred Treasury and the Fed to have begun an organized nationalization of the banking sector by early this year.

Most of my friends, however, believe such radical, early steps would have triggered even more panic and loss of confidence in financial markets. They contend that early, large-scale steps would have led to investors having a reaction something like,

'Oh my God! If Bernanke and Paulson are pulling out such radical, sector-shaping solutions NOW, this must be one of the worst financial/economic crises since the Great Depression!'

And, of course, amidst a Presidential election, the out-of-power party would have trumpeted precisely this message. Which it did, anyway, but with much less actual evidence.

As a result, it's clear that Bush, Paulson, Bernanke and Bair preferred to handle each new problem incrementally.

Once the lending functions has seized, as I discussed in this recent post,

"Since leverage, a function of debt, implies confidence in the future returns of loans placed with various enterprises, its unwinding corresponds to a loss of such confidence. The forced reduction in this leverage began, understandably, with the short-term borrowing instruments of both financial and non-financial instruments- commercial paper, most notably.

As this massive de-leveraging of fixed income instruments occurred, the simultaneous drop in real estate values and equity market values caused several consequences.

First, large-scale losses in US, and other nation's market, i.e., societal capital stocks, valued notionally, plunged. Those who previously owned the capital suffered large losses. In the US, the Treasury and Fed moved to support the Federally-registered banks via direct preferred equity purchases and, separately, takeovers of Fannie Mae, Freddie Mac and AIG."

Again, with each new institution's survival in doubt- Bear Stearns, Fannie, Freddie, AIG, Lehman, Merrill, WaMu, Wachovia, Citigroup- Bush's team moved to contain the damage a failure might create.

If, at any time, they had come forth with a stated list of criteria, upon which some action would be taken, you can be sure that large-scale investors, including hedge funds, would promptly take short positions in suspect firms, then drive the criteria over the trigger points, in order to reap their gains.

Anyone who fails to understand this, does not understand markets.

People who criticize Bush's team for 'having no plan,' fail to realize that, in financial markets, such a plan would only result in investors rushing to make the plan reality, while profiting on the downside from having done so.

Amity Schlaes and other researchers have noted that, without Hoover's tentative steps to lessen the damage from the financial market crash and resulting economic recession/depression in 1929-32, FDR could never have launched his massive, but ultimately failed socialistic agenda in 1932-38.

In that same sense, the newly-elected President's team has both an easy target at which to take shots, and a considerable base of effective actions on which to build, thanks to the Bush team's quick responses to each emerging shock in the financial markets during the past eighteen months.

I write 'effective,' because, as of the date of this post, we have avoided the actual rerun of the Great Crash and Depression.

Equity markets are not dead. Banks did not have a 'holiday.' An orderly liquidation of various weak institutions prevented an unchecked spread of loss of confidence in: money market funds, bank deposits, and commercial paper.

I'm quite sure, were the roles reversed, the incoming President would have acted with no more of a long-term plan to 'solve the crisis' than Bush has. Just like the current administration, you can bet that the newly-elected Democrat's team, too, would have acted step by step to minimize each new threat's effect on the nation's financial markets and banking system.

The fact is, unveiling an explicit plan, either last August, or now, to nationalize the banking system and provide a wholesale redesign of the US financial sector, while it is under threat of unraveling, is simply unrealistic.

Bush's team did a good job in an unforeseen, novel situation. And let's be clear, unless Hank Greenberg, Hank Paulson, John Thain or some other financial luminary is elected President, you can be sure that the sitting President is never the one dreaming up the solutions for our financial sector's ills.

This is one area where the President's role as CEO is paramount, in that s/he must wisely choose an effective, intelligent and experienced team of cabinet and other agency officials to advise her/him on what actions to take.

But don't think, for a second, that the incoming President has any more sense of what's going on in financial markets or the banking sector than does our current President, George Bush.

The US Banking System's Nationalization Proceeds with Citigroup's "Rescue"

It's official. The US government has formally nationalized Citigroup by taking a larger equity position than the today's net worth of the bank.

Further, as taxpayers, we've agreed to absorb the losses, beyond $29B, on some $306B of the bank's questionably-valued assets.

With this action, which is very similar in effect to Paulson's original plan of buying troubled assets with the TARP, Citigroup has been rewarded for its inept and inappropriate lending, buying and securitization behavior of the past few years under ex-CEO Chuck Prince.

The moral hazard risk has been completely removed with this act, in an attempt to prevent worries that the bank's equity would become of such little market value as to leave the bank in violation of various regulatory capital requirements and, of course, subject to further speculation, both verbal and financial, that it would shortly be bankrupt.

Then, this morning, Henry Paulson also announced the TALP for government purchase of shorter termed assets for which markets are currently 'frozen,' including car and student loans.


Back in October, I wrote this post regarding the past and probably nationalized future of US banking.

In that post, I contended, in part,

"Simply put, you cannot have a system dependent upon an illusive, nearly non-existent resource: the well-informed, experienced, competent bank CEO. There simply are not sufficient, qualified business people available to staff each of hundreds of US banks. So allowing that many banks to exist is to invite the next financial panic, courtesy of thousands of bad credit and investment decisions on the part of hundreds of inept, boneheaded, mediocre small- and medium-sized bank CEOs.

Far better to so rigorously nationalize core banking via draconian regulation of allowable businesses, lending standards, etc., and government ownership of preferred shares, as to reduce this sector to a barely-disguised government-guaranteed conduit for safekeeping savings and making consumer mortgage and revolver loans.

Further, each of the classical Glass-Steagall era bank functions can be largely reduced to automated, pre-determined, quantitative standards with little or no room for subjective judgment.

To achieve a truly safe, well-regulated US core banking system, I believe you need the following (there are more, I've just included one for this post):

-Federal government guarantee of all core banking businesses, i.e., deposits, credit card balances, mortgage balances, trust accounts. In short, by forcible, draconian regulation of lending and deposit-investment practices, the government will be able to insure all banking activity, because it will all be reduced to ultra-safe, near-riskless levels.

That's a financial sector in which you could place trust. Core banking functions would be safe, heavily-regulated and totally guaranteed by society, i.e., our government. Riskier financial functions would be totally firewalled from core banking and well-capitalized. Trading of financial instruments would be safely confined to exchanges."

And that is nearly where we are. The strict confinement of trading important, widespread instruments, such as mortgages, mortgage securities and CDSs still require exchanges. But, other than that, Paulson, Bernanke and Bair have pretty much arrived at my prediction in just a month.

Will these steps be eventually retracted by the next administration, or a subsequent one?

I doubt it. Like a new stake in a garden supporting plant growth, new financial services structures will develop around these programs, necessitating their continuing existence.

Whether we ever formally identify these steps as nationalization of the US banking sector, it's what we've done. And, as I argued in that linked post, and others, probably a good thing.

A Strange Duality: Government Bailout of Banks Which Shorted Each Other's Equities

Rick Santelli of CNBC raised a very interesting point this morning regarding today's Wall Street Journal front page piece on the bear raid on Morgan Stanley in September.

Without trying to recount all the detail in the very long and well-written story, suffice to say that it has now been shown that Morgan Stanley's equity price was, indeed, affected by a sort of squeeze created by hedge funds and other investment banks buying credit default swaps, CDSs, on Morgan Stanley debt, along with shorting or buying puts on the firm's equity.

This activity pre-dated the TARP, and Treasury investments. However, Santelli noted the parallel of Morgan Stanley's troubles with those of Citigroup's recent problems, and wondered aloud how much taxpayer money was engaged in far-from-transparent speculation and similar squeezes on Citigroup's shares.

Upon being challenged by Squawkbox's Joe Kernen for suddenly being for more regulation, Santelli sensibly replied, to paraphase him (since I can't recall his exact words),

'Free and fair market capitalism doesn't mean no regulation. You need some regulation to keep things fair, and avoid insider and crony capitalism. We read today about the goings-on regarding Morgan Stanley's CDSs and equity in September. How about some transparency for today's activity in Citgroup instruments?'

As I wrote here last Thursday, in reference to AIG's troubles, the swaps market needs to become far more transparent, via a regulated, explicit exchange. Santelli raises an equally-valid reason for such an exchange.

As tools for squeezing and manipulating markets have multiplied, the old regulatory model of the 1930s is hopelessly, laughably outdated. The Journal piece indicated how a small purchase of CDSs to drive their prices up would yield outsized gains on short positions or puts of the same company's equity. Yet the former markets is completely opaque, consisting of phone calls and even IMs as its method of operating.

Santelli's concluding point was that, with taxpayer money in practically every large, remaining commercial bank, we can no longer risk having these institutions use 'our' money to engage in the activities which nearly triggered Morgan Stanley's demise and, certainly, forced its conversion to a Federally chartered commercial bank.

CNBC's Continuing Irresponsible Behavior

Every day, it seems, the online staff at CNBC's various daily financial news programs ask the same repetitious questions of their guests:


'Will the market sell off today?'


'Will we see a rebound today?'


'Will the market test new lows today, then rebound?'


You get the idea.

Is it me, or is this not just about the most asinine, improper and irresponsible behavior in which CNBC could engage?

Now, more than ever, most retail investors should be on the sidelines, or simply hunkered down with their current portfolio allocations. The last thing they should be doing is looking for advice on how to time daily market moves.

Of course, since most retail investors can't watch CNBC all morning/afternoon, this 'advice' is probably wasted on them. Thank God.

As for institutional investors, who might actually watch and trade, you and I had better hope they don't constitute a roaming herd of buyers or sellers, hanging on every word of some other portfolio manager talking his book on CNBC. Or some pundit giving his opinion on the random intra-day and closing market performance for the day.

Further evidence of how much CNBC engages in pure entertainment programming, to the exclusion of responsible business and financial market analysis.

What About Those Swaps?

Last week's Wall Street Journal of Wednesday, November 12, sounded an alarm regarding AIG's continuing credit default swaps positions.

However, just this week, a Journal article contended that, of all the malfunctioning fixed-income markets, the CDS market had actually done remarkably well during the past few months, including settling the now-defunct Lehman positions.

According to the editorial, CDS pricing now provides a better, more continuous measure of the value of debt of many firms than their own, non-trading debt does.

Even so, I can't help but believe that the CDS market would do better in the future if two things were changed, as I have suggested in prior posts: create a formal exchange, and; restrict the leverage allowed for entities holding and trading CDS.

The first change would provide greater transparency for many aspects of the CDS market, including gross and net outstanding volumes, trading volumes, and a better identification of the major players who, therefore, are exposed to risk in the market.

The second change would limit the damage to the CDS market and, by extension, to other markets, by assuring the availability of equity for CDS positions which require more collateral, as could be required by the exchange on an intra-day basis.

Together, these improvements would limit the likelihood that another mess like that which consumed AIG could occur. Exchanges monitor the financial ability of members to fulfill their obligations to other members, which would have provided a more public warning regarding AIG's over-extension in CDSs.

I don't doubt the CDS market is vital. But leaving it to exist as an over-the-counter market with no clear rules or standard clearing mechanisms invites another disaster by another firm as inept as AIG was at correctly assessing its risks under the many billions of dollars worth of securities price protection it sold as CDSs.

What Has TARP Accomplished?

Back at the end of September, as I note from this post at the time, Congress was wrestling with the passage of the then-claimed, absolutely necessary $700B TARP legislation.

September's S&P return was -8.9%. Clearly, the deteriorating equity market and cessation of lending and markets for structured instruments lit a fire under Treasury, the Fed and FDIC to do something.

As economist Art Laffer noted in a Wall Street Journal article, about which I wrote, here,

"Then we have this administration's panicked Sarbanes-Oxley legislation, and of course the deer-in-the-headlights Mr. Bernanke in his bungling of monetary policy.

Whenever people make decisions when they are panicked, the consequences are rarely pretty."

So, here's my question, inspired by a comment from CNBC's Rick Santelli this morning.

If the TARP was so necessary, and was the right, or an effective solution to our financial turmoil, why did the S&P decline by a further -16.7% in October? That's almost twice September's decline!

Santelli's insightful comment was, as usual, in response to a typically nonsensical utterance by CNBC's Steve Liesman. The latter insisted that the TARP was absolutely essential to the health of the financial system.

Santelli calmly noted that, in contrast to Liesman's description of the September market free fall, we now have 'slow fall.'

Whether fast, or slow, Santelli's point was, I believe, that the TARP's existence has, if anything, apparently accelerated, and certainly failed to halt further market deterioration.

That's when I was inspired to go to my own files and retrieve the monthly S&P performance for September and October. Not only did the TARP have no positive effect, but our current equity market situation is, by some measures, a reflection of the lowest level of confidence in those markets in many, many years.

For example, one of my equity long/short allocation signals is at its lowest level since 1982. The other, which is the trailing S&P return over a period of fixed length, has never been this low in over 30 years. Which, considering the time periods involved, probably means perhaps not even in the entire time that there has been an S&P500 Index.

Now, with this week's clamoring by Congress to release TARP funds to rescue GM, Chrysler and Ford, we see it has become, predictably, a general-purpose feeding trough for desperate firms, financial or otherwise.

Former Federal Reserve Board member Fred Mishkin warned, in extended comments this morning on CNBC, that including less-regulated, non-financial companies in the TARP is a very, very dangerous step. He noted the necessity of a healthy financial system, most of the players in which are already subject to heavy regulation.

Adding various weak and dying companies on an ad hoc basis, Mishkin noted, is to essentially open the Treasury to anyone who wants help.

Hardly the conditions under or terms on which the TARP was rushed through Congress.

Nassim Taleb's Black Swan Appeared

Nassim Taleb, author of the recent hedge-fund-related book, "The Black Swan," directly influenced the optionization of the equity strategy which my business partner and I have been operating for over a year. In this second Taleb-related post, based upon a Wall Street Journal piece, I noted the likely inconsistency of returns to Taleb's strategy,


"In it, Taleb's approach is described in more detail than prior articles I have read. It reinforced my feeling that his is a very inconsistent strategy. That is, he is constantly buying puts, losing a little money routinely, in hopes of profiting from the really big market meltdowns. This is what I more or less sensed from my prior reading about Taleb's hedge funds.

In the Journal piece on Friday, however, Taleb's performance is discussed. His last fund earned a 60% return in 2000, then lost money in 2001 and 2002, with only low single-digit gains for the next two years. He closed the fund on the heels of such mediocre performance, during years when conventional hedge funds rack up much higher gains.

Thus, Taleb's approach, and, probably, that of the new fund using his ideas, tends to be erratic, and depend upon high volatility to earn large returns."

Of course, the events of September and October, with their double-digit negative monthly returns, provided the once-in-several-decades windfall that is the payoff of Taleb's deep out-of-the-money put strategy.

The question now, of course, is how the Taleb-inspired fund will do in the coming months. Yesterday's Journal piece noted,

"He also helped start a hedge fund, Universa Investments L.P., which bases many of its strategies on themes in the book, including how to reap big rewards in a sharp market downturn. Like October's.

Assets under management at Universa have neared $2 billion since the fund launched early last year with $300 million under management. While Mr. Taleb frequently consults with Universa's traders, the Santa Monica, Calif., fund is owned and managed by Mark Spitznagel, who worked for several years in the 1990s as a pit trader on the Chicago Board of Trade.

The strategy, which keeps more than 90% of assets in cash or cash equivalents such as Treasury bonds, either breaks even or loses small amounts in most months while waiting for periodic, infrequent spikes in volatility.

While the black-swan strategy has paid off handsomely this year, it hasn't always. Mr. Taleb's previous fund, Empirica Capital, which used similar tactics, shut down in 2004 after several years of lackluster returns amid a period of low volatility. The strategy may face another test after the current bout of market turmoil."

The piece goes on to question whether investors will remain with the fund, once the prospect of more deep market downdrafts has lessened.

My partner and I have considered this question, of course. It's a variant the one which was resolved for me years ago by a wealthy private investor during a brief stint doing research with him. A former economics professor who ventured out on his own and made a tidy fortune, he was interested in developing the equity strategy engine for a potential hedge fund group, and wanted to assess my strategy for that purpose.

While not putting it into quite these words, this investor was unequivocal in noting that, in some market conditions, one simply has to be out or short. Long-only strategies get so badly mangled in a downturn like the one of the last two months that they struggle to repair the resulting damage. Especially since most equity strategies which outperform in up markets tend to lose a lot more in serious down markets.

This brings me to Taleb's work, because he has a viable approach for the rare, but spectacularly damaging sudden bear equity market of short duration.

Few investors correctly saw the sudden wind shear-like drop coming, thinking, instead, that the evolving financial markets troubles and looming recession would temporarily dampen equity returns.

Truly, these past two months were the sort of 'black swan' event for which Taleb is so well-known.

The trick to being able to maintain a long-running equity or derivatives strategy is to have functioning approaches for both healthy, upwardly-trending market periods, and the few, dramatically falling periods. Effective transition between these two different types of market conditions is key.

It seems that Taleb's huge gains in short periods of tremendous market declines are not matched by his provision of any type of reasonably competitive long-oriented equity or derivative strategy. But investors will look for either a strategy capable of switching gears to match market conditions, or will simply switch allocations out of such single-market condition funds.

Today's Financial Markets & Wesbury's "Internet Time"

Back in June of this year, I wrote this post concerning an excellent editorial by Brian Wesbury in the Wall Street Journal. Wesbury's focus was that one current Presidential candidate's call for 'change' is, actually disingenuous, given the real economic change all around us.

However, I wanted to highlight something Wesbury noted at the end of his piece,

"Americans have had it so good, for so long, that they seem to have forgotten what government's heavy hand does to living standards and economic growth. But the same technological innovation that is causing all this dislocation and anxiety has also created an information network that is as near to real-time as the world has ever experienced.

Decades ago the feedback mechanism was slow. The unintended consequences of the New Deal took too long to show up in the economy. As a result, by the time the pain was publicized, the connection to misguided government policy could not be made. Today, in the midst of Internet Time, this is no longer a problem. So, despite protestations from staff at the White House, most people understand that food riots in foreign lands and higher prices at U.S. grocery stores are linked to ethanol subsidies in the U.S., which have sent shock waves through the global system.

This is the good news. Policy mistakes will be ferreted out very quickly. As a result, any politician who attempts to change things will be blamed for the unintended consequences right away.

Both Mr. McCain and Mr. Obama view the world from a legislative perspective. Like the populists before them, they seem to believe that government can fix problems in the economy. They seem to believe that what the world needs is a change in the way government attacks problems and fixes the anxiety of voters. This command-and-control approach, however, forces a misallocation of resources. And in Internet Time this will become visible in almost real-time, creating real political pain for the new president."

My own observation regarding Wesbury's contentions was to concisely restate his several points as,

"Thus, Wesbury notes that because of recent rapid change, originally economic-based, in information technology, boneheaded governmental changes will be quickly penalized in the next election cycle, rather than, as in the last century, 30-40 years later."

I thought of this as I watched S&PIndex futures go to limit-down before the market open this morning.

It looks like global understanding of economic repercussions of the recent financial market crises has morphed to 'internet time,' as well. Financial equity markets are now digesting and reacting to economic news in hours, rather than months, as they may have in decades past.

So, as steep and swift as the evaporation of value in the equity markets has been in the past month, it's quite possible that any resulting snap-back, once bad news abates, will be similarly faster and further upward than what has been historically experienced.

I suspect that Wesbury's observation about internet time is influencing how quickly global perceptions of various interdependencies among economic players affect the value of debt and equity.

We haven't seen this sort of speed and volume of reaction in prior financial market crises or the now-probably onset of a recession.

Right now, we're seeing the more-sudden plunge into financial market and economic gloom. Could it be that the ensuing emergence into the light will be just as unexpected and fast?

I suspect so.

More Debate On Glass-Steagall

This past weekend's Wall Street Journal published an editorial by Charles W. Calomiris, a Columbia Business School professor, entitled, "Most Pundits Are Wrong About the Bubble."

In his piece, Calomiris contends,

"As for the evils of deregulation, exactly which measures are they referring to? Financial deregulation for the past three decades consisted of the removal of deposit interest-rate ceilings, the relaxation of branching powers, and allowing commercial banks to enter underwriting and insurance and other financial activities. Wasn't the ability for commercial and investment banks to merge (the result of the 1999 Gramm-Leach-Bliley Act, which repealed part of the 1933 Glass-Steagall Act) a major stabilizer to the financial system this past year? Indeed, it allowed Bear Stearns and Merrill Lynch to be acquired by J.P. Morgan Chase and Bank of America, and allowed Goldman Sachs and Morgan Stanley to convert to bank holding companies to help shore up their positions during the mid-September bear runs on their stocks."

I disagree. Calomiris' retroactive judgment of the repeal of Glass-Steagall suggests that, even if it was a mistake, its absence let the mess which developed in its absence be cleaned up in a manner which would not have been quite so neat without its absence.

Sound like circular reasoning to you? Me, too.

No, as I wrote here in March of this year, the true effects of Glass-Steagall's repeal were slower to observe. But Gerry Weiss, my boss and one-time SVP and Chief Planning Officer of Chase Manhattan Bank for David Rockefeller, noted this in the 1980s. As I wrote in that post,

"My long-ago mentor at Chase Manhattan Bank, then-SVP of Corporate Planning & Development, Gerry Weiss, was fond of saying, when asked about working to remove Glass-Steagall, something like,

'Are you kidding? We'll just find some new ways to lose a lot of money on badly risk-managed positions. Not to mention that, being commercial bankers, once we get into these businesses- M&A, underwriting, equity trading- we'll cut prices to gain share and ruin the business' profitability for all concerned.'

Judging by the behavior of Citigroup and BofA in last summer's CDO, SIV and other fixed income messes, I'd say he was right on the money, as it were, as usual.

Commercial banks appear to be no better off in terms of profitability, risk management or total return after the repeal of Glass-Steagall."

It was this effect of the repeal of Glass-Steagall on the commercial banks, not the investment banks, which began the slide into our current mess.

In fact, to illustrate that investment and commercial banks were misbehaving, and losing money, with respect to mortgages long before our current financial crisis, consider what happened with Norwest Bank's large mortgage business, in conjunction with Salomon Brothers, back in the 1980s.

Norwest ran a huge mortgage lending and securitization pipeline, or 'conduit.' The latter was known as "RFC," for Residential Funding Corporation. Norwest owned RFC, but Salomon distributed the resulting securities because, at the time, it was illegal for Norwest to do the securities underwriting itself.

As such, Salomon enjoyed a sweet margin on the securitization, with no asset risk on the pipeline. But it was largely understood throughout the industry that RFC was structured and operated with guidance from Salomon.

At some point, RFC mishedged its enormous inventory of mortgages, and doubled up on an interest rate bet, rather than hedged it. Subsequent losses sank Norwest as an independent bank, while Salomon managed to scoop up RFC for a pittance.

Calomiris goes on to contend,

"Even more to the point, subprime lending, securitization and dealing in swaps were all activities that banks and other financial institutions have had the ability to engage in all along. There is no connection between any of these and deregulation. On the contrary, it was the ever-growing Basel Committee rules for measuring bank risk and allocating capital to absorb that risk (just try reading the Basel standards if you don't believe me) that failed miserably. The Basel rules outsourced the measurement of risk to ratings agencies or to the modelers within the banks themselves. Incentives were not properly aligned, as those that measured risk profited from underestimating it and earned large fees for doing so."

Once again, I disagree with his contention regarding the effect of deregulation on various activities.

Why do you suppose, prior to the repeal of Glass-Steagall, no investment banks engaged in buying and operating mortgage underwriting banks? Or creating large, highly-leveraged mutual funds investing in mortgage-backed securities?

Again, I point to Weiss' prescience on the consequences of removing that regulatory barrier. The subsequent thinning of investment bank profit margins led to these non-deposit funded companies boosting leverage to previously-unheard-of levels, in an attempt to maintain profit margins and growth.

Ironically, the lenders of this highly-leveraged money were.....commercial bank broker-dealer desks!

So Calomiris is wrong to suggest that all of what has transpired since the repeal could or would have happened anyway.

Structurally, investment banks could always do what commercial banks did, except for having access to the Fed window and offering DDA accounts. The repeal of Glass-Steagall drove the weaker-capitalized players, i.e., investment banks, to take more risks.

Calomiris ends with the contention,

"The single most important reform that is needed is the restoration of discipline in the measurement of risk within the banking system."

He's probably correct in this sentiment. The problem, of course, is how to define, measure and calibrate 'risk' in such a broad context.

Particularly when so much of the time, 'risk' can morph from, say, instrument to counterparty risk in the blink of an eye.

We're a long, long way from being able to rely on risk measurement on the panacea to solve our financial market problems.

Anna Schwartz' Thoughts On The Current Financial Crisis

The weekend Wall Street Journal carried two interesting editorials regarding economics and banking.

The first was a thought-provoking interview with Anna Schwartz, co-author of "A Monetary History of the United States," with the late Milton Friedman.

In the half-page piece, Schwartz, now 92 years old, maintained that current Fed chairman Bernanke is 'fighting the last war,' against illiquidity, when today's problem is counterparty risk and market valuation uncertainty.

What's troubling to me is these passages,

"Ms. Schwartz won't say so, but this is the dirty little secret that led Secretary Paulson to shift from buying bank assets to recapitalizing them directly, as the Treasury did this week. But in doing so, he's shifted from trying to save the banking system to trying to save banks. These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."

Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."
Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.

Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."

It takes real guts to let a large, powerful institution go down. But the alternative -- the current credit freeze -- is worse, Ms. Schwartz argues.

"I think if you have some principles and know what you're doing, the market responds. They see that you have some structure to your actions, that it isn't just ad hoc -- you'll do this today but you'll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what's going on. So I think if you're tough about firms that have invested unwisely, the market won't blame you. They'll say, 'Well, yeah, it's your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you're stuck with assets you can't sell and liabilities you can't pay off?'" But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn't know how to react. Instead of looking principled, the authorities looked erratic and inconstant."

Ms. Schwartz provides a clear counterpoint to the effective message given to investors and banking executives in the past year. That is, rather than consistent, understandable, principled action, Bernanke, Paulson & Bair have seemingly lurched from crisis to crisis.

Viewing the past 15 months in the financial markets from Schwartz's perspective, we should have seen, beginning with the failure of the two Bear Stearns highly-leveraged mutual funds, a concerted, consistent philosophy in action by the Fed, Treasury, FDIC and SEC.

If that philosophy were to let imprudent institutions fail, and this were clearly articulated in advance, maybe counterparty would have remained at levels of early last year. Or, maybe the explicit promise to let institutions fail would have sparked the recent credit freeze-up 15 months ago.

While I personally share Ms. Schwartz's belief that moral hazard has to remain a credible force in financial markets, our current, consolidated banking sector, with its 3-4 super-sized institutions, might not sustain a strict expression of her preferred philosophy.

I do believe, however, that, back in July of last year, the modification- and I stress that word, rather than 'suspension'- of 'mark-to-market' valuation rules would have avoided at least $150B of asset evaporation among securities which were not all non-performing.

But that wasn't done. And Ms. Schwartz's conjecture about Paulson not realizing that buying distressed CDOs at market values would destroy bank capital is truly frightening. Surely this was not a mystery. I even wrote about it in this post, nearly a month ago.

The interview ends with this passage,

"But perhaps this is actually Mr. Bernanke's biggest problem. Today's crisis isn't a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. "I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job." "

It leaves me thinking that Schwartz is right, even if we don't know precisely how her recommendations would have had an impact on the financial markets.

If mark-to-market were modified, but regulators warned of forced closures of insolvent institutions, would this not have provided for the avoidance of needless destruction of value in performing, but untradeable, securities, while also providing a less-capricious process for treating troubled institutions?

Perhaps there would have been a quicker consolidation of overly-leveraged investment banks with commercial banks, while weaker commercial banks would have merged before the regulators closed them.

As Schwartz theorizes, the remaining fewer, stronger institutions might have resulted in the avoidance of a credit freeze, as only healthy institutions remained, with performing assets so valued.

Further, her approach would have required no draconian actions last summer or fall, when the lack of drastic market behaviors would have failed to support a public understanding of a need for radical action.

On this basis, her judgment of the Fed's performance might, indeed, be correct.

Current Market Volatility

Among the readers of my blog, I found that yesterday someone had come from this blog post, written in February of this year. Nevermind the novice level of the author's investing. What caught my eye was his view of my partner's and my development of a market volatility measure for use with options. He wrote, in part,

"I find C Neul’s description of how they found a new indicator of the market direction kind of suspect, in the way that one retrofits and backtests ideas against a particular sample to use as a new indicator of future direction. Then again, I’m not a fan of any kind of technical analysis, which this clearly is. But the surety of how he describes this measure (”standard deviation of daily total returns of the index”) as a way to make predictions about future moves is what I find least appealing — for a “skeptic”, he sure seems pleased with the new measure, that happens to fit his specific sample. Still kind of amazed that professionals do this, but I suppose if everyone took my stance the shell game would fall apart."

I learned quite a few years ago that any successful equity portfolio management process has to have some link to the market. If portfolio management is done in isolation, it inevitably leads to buying and holding equities when there is simply no way to earn positive total returns. Sometimes for periods as long as two or more years.

To avoid emotionally-based decisions, some sort of 'technical' indicator is a good idea.

In our case, we determined that our equity risk management tools were insufficiently sensitive for use with equity options.

Thus, we chose to develop new tools.

The nearby chart displays the recent levels of the trailing standard deviation of daily S&P returns, which we have found to be extremely powerful in predicting certain market conditions of interest to us, as we manage equity derivatives portfolios.

The measure aptly captures the meteoric rise in S&P volatility just since Labor Day. Note, if you will, that we developed the measure in February. Since then, it has continued to capture volatility and work in conjunction with our other risk measure.

So, contrary to the other blogger's contentions, it has worked ex poste, as well as ex ante.

Seeking historical context, I applied our measure to the S&P500 from 1950 to the present in additional research conducted just last month. That nearby chart shows that the crash of 1987 was even more volatile than our current market situation- so far.

Extending the analysis back to 1928, via the Dow Jones Industrial Average, I found that the market volatility for that crash exceeded even that of 1987.

All of which is to state that the current equity market volatility is the third-highest in 80 years.

For our equity derivatives portfolios, that means a change in allocation. Having the historical perspective of this measure since 1928, we were able to calibrate absolute levels of the measure which correspond to allocation decisions for our derivatives strategy.

Further, we have historically-based expectations of how long the current period of extreme volatility is likely to last.

Buckle up for an extended ride.

The US Banking System: Flawed Past, Nationalized Perfect Future?

John Steele Gordon wrote a wonderful little historical piece, entitled "A Short Banking History of the United States," in last Friday's edition of the Wall Street Journal. It's subtitle was, "Why our system is prone to panics."

Among his observations on the post-Civil War financial sector are these,

"Unfortunately state banks did not disappear, but proliferated as never before. By 1920, there were almost 30,000 banks in the U.S., more than the rest of the world put together. Overwhelmingly they were small, "unitary" banks with capital under $1 million. As each of these unitary banks was tied to a local economy, if that economy went south, the bank often failed. As depression began to spread through American agriculture in the 1920s, bank failures averaged over 550 a year. With the Great Depression, a tsunami of bank failures threatened the collapse of the system.

The reorganization of the Federal Reserve and the creation of the Federal Deposit Insurance Corporation hugely reduced the number of bank failures and mostly ended bank runs. But there remained thousands of banks, along with thousands of savings and loan associations, mutual savings banks, and trust companies. While these were all banks, taking deposits and making loans, they were regulated, often at cross purposes, by different authorities. The Comptroller of the Currency, the Federal Reserve, the FDIC, the FSLIC, the SEC, the banking regulators of the states, and numerous other agencies all had jurisdiction over aspects of the American banking system.

The system was stable in the prosperous postwar years, but when inflation took off in the late 1960s, it began to break down. S&Ls, small and local but with disproportionate political influence, should have been forced to merge or liquidate when they could not compete in the new financial environment. Instead Congress made a series of quick fixes that made disaster inevitable.

In the 1990s interstate banking was finally allowed, creating nationwide banks of unprecedented size.

While it will be painful, the present crisis will at least provide another opportunity to give this country, finally, a unified banking system of large, diversified, well-capitalized banking institutions that are under the control of a unified and coherent regulatory system free of undue political influence."

Steele makes two very important points about the US banking system that many people fail to grasp.

First, he notes its historically-rooted structure of many small banks, in contrast to the rest of the world.

As recently as last night, I was discussing the evolving current nationalization of the US banking sector with friends at my fitness club. In one conversation, with an erstwhile 20-year Merrill Lynch veteran, I contended that a rapid, near-total consolidation of core US banking functions- deposit-taking, credit card and mortgage lending, trust, transactions processing and DDA accounts- would be the best thing for this nation's long-term financial health and stability.

Why? Because, as my brilliant former boss, and SVP of Corporate Planning & Development at Chase Manhattan Bank, used to explain,

'Few executives are prepared and equipped to run an entire company, let alone the diverse types of businesses which are part and parcel of a money center bank. We (at Chase) are stuck with, for the most part, ex-lending officers and accounting functionaries, promoted beyond their level of expertise.'

He was right, as I explained in this recent post. And this one, from October of last year.

So we see, courtesy of Mr. Steele's concise historical lesson, that the US relied on the existence of thousands of capable, experienced, seasoned bank CEOs to operate our core banking system.

Unfortunately, we haven't even managed to get those qualities in our average money center bank CEO. How in hell would you have expected, in the past, or expect in the future, this situation to radically change?

It won't.

As long as most of our country's banking assets and business volumes are scattered among even hundreds of banks, with private, risk-taking management, our country will be susceptible to the same financial panics as befell us in 1929 and, again, this year.

Simply put, you cannot have a system dependent upon an illusive, nearly non-existent resource: the well-informed, experienced, competent bank CEO. There simply are not sufficient, qualified business people available to staff each of hundreds of US banks. So allowing that many banks to exist is to invite the next financial panic, courtesy of thousands of bad credit and investment decisions on the part of hundreds of inept, boneheaded, mediocre small- and medium-sized bank CEOs.

Far better to so rigorously nationalize core banking via draconian regulation of allowable businesses, lending standards, etc., and government ownership of preferred shares, as to reduce this sector to a barely-disguised government-guaranteed conduit for safekeeping savings and making consumer mortgage and revolver loans.

Steele's second point involves his articulation of a hoped-for future US banking sector that is well-capitalized, with diversified, large money center banks under coherent, apolitical regulation.

I agree with him on all but the diversification issue. Yes, there is the broad range of businesses inherent in a Glass-Steagall era money center bank- deposits, credit cards, mortgages, installment loans, trust, cash management and transaction processing. But not: brokerage, securities underwriting, proprietary trading, corporate financial advisory.

Further, each of the classical Glass-Steagall era bank functions can be largely reduced to automated, pre-determined, quantitative standards with little or no room for subjective judgment.

To achieve a truly safe, well-regulated US core banking system, I believe you need the following:

-Most US banking assets in a few ultra-large financial utilities: Chase, Wells Fargo, BofA, perhaps Citigroup.

-Heavy regulation which removes any and all risk-sourced profits from the core banking sector.

-Federal government guarantee of all core banking businesses, i.e., deposits, credit card balances, mortgage balances, trust accounts. In short, by forcible, draconian regulation of lending and deposit-investment practices, the government will be able to insure all banking activity, because it will all be reduced to ultra-safe, near-riskless levels.

-All financial instruments which are allowed to be traded will be mandated to be done so via regulated exchanges. As such, counterparty risk, collateral and settlement will be explicitly and transparently managed, to reduce risk of ripple-effects from one counterparty's failure.

-Certain financial instruments would be prohibited, such as the securitization of any collection of underlying assets. Exchange-traded assets of all types would obviate the need for such 'asset backed' securities, when any investor could freely shop an exchange to buy credit card or mortgage assets for diversification purposes.

What's left will be the traditional province of private finance companies, investment banks, private equity shops and fund management companies.

Credit-risk expertise, asset management skill and other uniquely-held financial-service-related skills will be freely marketed in the private sector, either with 100% equity capitalization, or leveraged with private capital.

That's a financial sector in which you could place trust. Core banking functions would be safe, heavily-regulated and totally guaranteed by society, i.e., our government. Riskier financial functions would be totally firewalled from core banking and well-capitalized. Trading of financial instruments would be safely confined to exchanges.

Some Observations On The Current Financial Market Crisis

There is so much one could write about the events of the last week in our financial markets. And, no doubt, in weeks to come, I'll touch on many of them, in retrospect.

This morning, however, I have a collection of reflections I'd like to convey.

The first is my reaction to an article discussing the MUFJ rescue of Morgan Stanley. In this morning's Wall Street Journal, there is a long piece purporting to describe how, now that it has linked itself to MUFJ, Morgan Stanley and it's embattled CEO, John Mack, can go about 'repairing' its financials and 'righting' itself.

C'mon, who are they kidding?

Mack mismanaged the one-time investment bank, now newly-minted commercial bank, into near-oblivion. If Morgan Stanley had been perceived by regulators as the same sort of buccaneers as Lehman, with an equally-dislike able CEO as Fuld, and as narrow a range of businesses, it, too, might already be out of business.

Is it too much to ask people to realize that, despite the fresh capital, the same boneheads are in place at Morgan Stanley? The gang that brought them to the brink of insolvency are now recharged with more billions to squander.

No, I'm not arguing that we tank the international financial system to punish Mack and his mismanagement team.

Rather, let's not all lose perspective with respect to the firm. A large, slow-moving, capital heavy foreign bank has rescued the brand franchise of a once-storied American investment bank. It would be surprising if Morgan Stanley doesn't meet the same fate as its erstwhile competitor, First Boston Corporation, now merely a fragment of CSFB.

The fact is, what were, some twenty years ago, fast-moving, lightly-capitalized underwriters, M&A advisers and corporate financial advisers, with smallish, client-oriented trading operations, became unsustainably-leveraged, thinly-veiled publicly-owned hedge funds.

Don't expect what is left of Morgan Stanley to be anything to write home about when it comes to future performance.

Now to my other thought for this morning.

Roughly 90 minutes ago, President Bush announced the expected headline measures that the US government will take, via the Fed, Treasury and FDIC, to join its European G8 and G20 allies in insuring inter-bank lending, business DDA balances, and forcibly taking non-voting, temporary equity positions in major banks.

Both Bush and his Treasury Secretary, Hank Paulson, emphasized how distasteful it is to them, personally, and, they believe, to most Americans for the government to be owning shares of otherwise-publicly-held companies.

It ostensibly flies in the face of our brand of free enterprise capitalism and free market ideology.

But, before we all visit a Jesuit retreat, self-flagellate, and wear hair shirts, let's remember how we got to this point.

Our financial markets are in the shape they are in because of government intervention and mandates on the free market.

We began nationalizing the financial sector when we created Fannie Mae and Freddie Mac. These institutions implemented Congress' force-feeding of capital markets with low-income borrower, low-quality residential mortgages. As time passed, Congress continually set the goal for securitized low-quality mortgages ever higher. As high as 50% of the GSE's pass-through volumes!

Then we have the CRA. Government mandated commercial banks to lend to poor credit risks for low-income housing. Again, we, through our government, already screwed around with our financial system.

We allowed our government to override private credit risk controls.

This isn't Act One of the nationalization of our financial system.

In reality, it's Act Two: The Cleanup.

What will Act Three be? Exit? Or 'fascism?' And I mean fascism, technically defined.

In any case, before we all moan and groan about this new nationalization of banking by a Republican administration, let's be honest.

Congress and two Presidents- Clinton and Bush- pushed our financial sector to make badly-considered loans for homes to people who were too poor to afford them.

That was the nationalization of our financial system.

Despite what many believe, 'Wall Street greed' simply fed into the system that the government had already set in motion.

Jamie Dimon's Stupid Remarks on "Mark to Market"

I worked for the Chase Manhattan Bank in the late 1980s. During that time, while reporting to the company's chief planning officer, I was fortunate to be exposed to all the Vice-Chairmen, COOs, CEOs and Chairmen of the firm.

Thus, I had close contact with then-Chairman Bill Butcher and President Tom Labrecque. Particularly the latter, as a long-running project necessitated periodic contact with him over several years.

Between my personal interactions with the senior managers of the bank, and its performance during the period, I would say that these were not particularly effective managers. Nor, outside of their original respective areas of competence, did they give any evidence of being smart about managing a large company, let alone a bank.

Butcher had been a corporate lending officer. A salesman. He had no particular expertise in management.

Labrecque had been an accountant at the bank. Apparently judged unsuitable for credit training, he was never a line lending officer, but, rather, a bean counter in a then-obscure funding unit engaged in trading Treasuries. His rise had much to do with some accidents which left positions above him unexpectedly open. And the rise of importance of his unit, as Fed Chairman Paul Volcker took the lid off of interest rates during the Carter era.

My point is, just because a person is the CEO or Chairman of Chase (Manhattan) Bank, or its successor banks, is absolutely no reason, alone, to accord him credibility beyond his actual, original area of business training or practice. Neither Butcher, nor Labrecque were, in the event, smart men when it came to operating one of the nation's largest money center banks.

The nearby chart shows the equity prices of Chase, Citigroup, from where Dimon and his mentor, Sandy Weill, hailed, and the S&P500 Index since 1977.

In that time, neither bank has managed to outperform the index. So much for vaunted wisdom from the CEOs of these two financial giants. Why would you expect brilliance from CEOs of companies that can't manage to outperform the broad index over 30 years?

Especially Chase, which has never outperformed the index?

After many mergers and acquisitions involving more than half of the major banks which existed on the island of Manhattan in 1990, and several in the Midwest, we come to Chase's current CEO, Jamie Dimon. The latest in a line of undistinguished CEOs of the large US money center bank.

There's nothing to indicate he's any smarter than his predecessors, Butcher and Labrecque, or even the undistinguished, though workmanlike head of the Chemical Bank which took over Chase, Walter Shipley.

On Friday, I heard a news story on CNBC alleging that Jamie had come out explicitly in favor of 'mark to market' as a valuation methodology.

Many have claimed this approach, mandated, in its simplest sense, by the Sarbanes-Oxley bill, in a fit of post-Enron pique, is largely responsible for the rapid evaporation of value from the balance sheets of US financial institutions in the past 15 months. In various posts on this blog, I have argued as much, too.

Let's recall from whence Jamie hails, professionally. As I wrote in this post, nearly a year ago,

"If you are familiar with Dimon's mentor, Sandy Weill's origins, then none of this should surprise you. Weill was the original low-cost consolidator of the brokerage industry wire houses in the 1970s and '80s. He was never an investment banker. Rather, his specialty was combining commodity-like retail brokers, combining back offices, sometimes improving technology, and reaping the improved margins. Eventually, he ran out of wire houses to buy and consolidate, so he sold out to American Express.

By the time he was ousted from Citigroup, Weill had demonstrated that he had learned no new tricks since he lost control of ShearsonLehmanBrothers to Amex. Citi's topsy-turvy growth and increased complexity resulted in serious lapses in risk management and attention to business details. Significant growth was not something Citi achieved, sans acquisition, under Weill.

Personally, I doubt that Dimon knows much that he did not learn from Weill. His signal achievement since being tossed out of Citigroup consisted of giving BancOne the "Weill treatment." It is not yet clear he's done anything more at Chase, nor that he is capable of more, either."

Lofty current title notwithstanding, Dimon is, in reality, little more than a fixer's fixer. Sandy Weill's erstwhile young bagman/apprentice.

I believe no credibility whatsoever should be accorded Dimon's pronouncements about anything beyond Chase's next quarter's performance, if that.

He's no leading light of finance, much less business in general. There is absolutely nothing in Dimon's background to suggest or give evidence that he is capable of uttering any sensible words on the concept of valuation and 'mark to market' rules thereof.