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Mon

27

Aug

2007

Who's Got a Turd in His Briefcase?
Monday, 27 August 2007 07:54
by James Petras

The Great Financial Crisis

All the major financial analysts claim the ongoing and deepening financial crisis is in large part the result of investor uncertainty. This is because the investment banks, derivatives and hedge funds placed high risk, sub-prime mortgages and junk bonds, along with other more reliable debt paper into packages and sold them to institutional and private bankers who in turn 'retailed' them around the world.

The rating agencies, who are paid by the sellers, all gave top billing (AA, AAA) to these hybrid securities, mortgages and junk bonds, encouraging investment advisers to push them on to risk-averse client looking for higher returns than Treasury notes. Most of the investors do not know whose and what paper they are holding, nor how much their hedge funds are losing or have lost. Those who can, have pulled out. The banks are reticent to loan to any applicant. Leverage funds are a dirty word among lenders. Hedge funds are either selling assets to pay loans or not telling what they own or owe. Derivatives have been deflowered. Central Banks in the US, Japan and the European Union have poured (and keep pouring) over $250 billion to the private banks hoping to create liquidity but the banks won't lend — because, as one prominent banker in Palm Springs told me "Nobody knows who's got a turd (worthless investments) in his brief case."

Meanwhile, Goldman Sach, Bear Stearns and Lehman Brothers are all closing down bankrupt investment funds or trying to prop them up. The Fed props up all the worst speculators in the name of 'saving the financial system' - in a way that it would never prop up the failing American health system. The financial system has the 'runs' and infusions of Fed funds have failed to block the 'run for cover'.

"Everybody for himselfand don't look back', is the watchword of leading equity bankers. The Democrats are calling for the usual inconsequential Congressional hearings about what went wrong. Congressmen Levin and Barney Frank will ask the wrong questions to the wrong people — going after the weakest fall guys — the rating agencies — for overrating the fraudulent deals, not the dealmakers themselves. The 'turds' in the briefcases are big and smelly but no one knows how big: $250 billion or $500 billion. There are a lot of bankers and hedge fund billionaires walking around with invisible clothespins on their noses.

Where is Greenspan, since he started the whole scam with his low interest, deregulated financial markets? The homely hero of all hedge-derivatives-innovative financial scamsters sanctioned, approved and promoted the pyramid swindles. He's off advising Deutsch Bank and suckering the international bankers for $100,000 fees for his failed financial recipes. But for those speculators who made a bundle and left, Greenspan is not part of the emerging turd culture. For them he is still the financial genius who made their fortunes.

So unless the fund directors come clean, empty their brief cases and open their balance sheets we won't know who are carrying the turds: The great unknowns include the unredeemable bonds, the worthless mortgages and the illiquid hedge funds. Without knowledge of the size and scope of the turds, the great uncertainty has frozen most investments and loans — it is paralyzing the financial system. Even Fannie Mae and Freddie Mac (the federally-funded mortgage companies) can't come in and buy up the 'turds' (otherwise known as 'bad debts'), no matter how many hundreds of billions of US taxpayers' money they are willing to spend.

All the financial wizards, the super-smart scientific, mathematical, guaranteed 30% per year investment advisers have less credibility than a street corner con man. The most arrogant, pretentious, scientific speculators have been humbled; especially those oracles who practiced what is call among the insiders as 'Quantitative investment'.

Quantitative investing (QI), the use of complex computer models in making investment decisions, was used and promoted by some of the reputedly smartest and highest regarded 'gurus' of Wall Street. For a decade the complex mathematical modeling produced extraordinary profits for Renaissance funds, Goldman Sachs and numerous other asset managers and hedge funds. With the massive sell-offs of assets to pay debts and the desperate drive for liquidity, all the assumptions of the QI went out the window. "The Model" cannot account for any crisis which calls into question 'historical trends'. The best and the brightest are baffled. At first, the QI geniuses said the crisis was a localized problem for the sub-prime bottom-dwelling speculators. But as their own funds dropped they blamed hysterical investors who over-reacted. "A problem of perceptions", they psychologized. But their funds continued to decline: the Market wasn't acting as their 'model' dictated. Hearsay flourished, skeptics surged.

"What's the problem: The Market or the Model?", one QI practitioner asked his colleagues.

The answer from the Market: "It's the model stupid: All the QI use historical models that extrapolated past patterns into the future as if capitalism is a crisis-free system which changed incrementally and in which investors borrowed rationally to leverage purchases in line with their capacity to pay back any losses. That's Main-Street folklore for retail brokers and the daily fare of American Enterprise ideologues."

Scientific mathematical modeling in the Great Casino predictably turned out to be as fallible as numerology spun by Shamans to explain the life cycle.

No one's going out of the window of the upper stories of high rise offices — yet. What's keeping the suicide rate down is precisely what's keeping investors running: no one knows how many hundreds of billions in worthless paper is being held. With the demise of the mathematical modeling speculative science, we are now in the period of the Mystical Black Hole. The big investment houses and hedge funds are holding back on revelations, hoping that investment confidence will return if investors are kept in the dark about how much they lost. This is a step below Voodoo Economics. How can investor confidence return if they don't know if the big turds are in the briefcase of the Renaissance Funds, Goldman Sachs, First Quadrant or any one or all of a thousand and one Ali Baba hedge funds?

Let them lose their pants, writes orthodox Market pundits like Marty Wolf in the Financial Times. "In order to value risk, they should lose properly. To bail them out", they argue, "is a moral hazard." Meaning of course, that if the hype and scam speculators are covered by a Federal Bank bail out, they lose nothing, and will repeat swindling in the future. Bailouts are a formula for financial scam recidivism. So much, alas, for the advice of orthodox market experts. European Central Banks and the US Federal Reserve know what class they represent: Real existing speculator plungers, not textbook risk-calculating value-oriented entrepreneurs, are their reference group. The risk of letting the bad boys sink is that there are too many of them, working in most of the most powerful investment houses, managing too many funds, for the most powerful financiers.

"There are no good financiers and bad speculators", one philosophically inclined fund manager (who is likely carrying a turd) put it, "We are all in this together, if we sink so does the whole financial system." Is this a self-interested plea for financial solidarity, a closet Marxist or a prophet of doom? Nobody knows till we delve into the Black Hole of the financial crisis. That won't happen till the brief cases open.

James Petras, a former Professor of Sociology at Binghamton University, New York, owns a 50 year membership in the class struggle, is an adviser to the landless and jobless in brazil and argentina and is co-author of Globalization Unmasked (Zed). His new book with Henry Veltmeyer, Social Movements and the State: Brazil, Ecuador, Bolivia and Argentina, will be published in October 2005. He can be reached at: jpetras@binghamton.edu
 
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Karolus said:

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Bad deals do not absolve rating agencies from their injurious conduct
October 2007.

To the Economic and Monetary Affairs committee of the European Parliament.


Madam Chairman,
Vice-chairmen and members of the Economic and Monetary Affairs committee,

In the current market turmoil Commissioner McCreevy is examining the activities of the credit rating agencies with a view to assessing their impact on financial markets. He has asked the Committee of European Securities Regulators (CESR) to specifically examine areas of possible conflicts of interest, such as the fact that the agencies are paid by the very institutions they rate. This matter has been raised before, and one of the lines of defence usually taken by the agencies is to remind operators and regulators that the ratings they issue always reflect the information which has been made available to them. I believe this particular affirmation to be obviously false, as illustrated in the examples outlined below.

I am raising this subject with you because your committee is launching its own examination into the activity of the rating agencies.

As a French holder of several issues of defaulted Russian government bonds presently listed on the official Paris stock exchange list named 'Eurolist by Euronext', I wish to respectfully bring to your attention the rating of the Russian Federation, which I believe provides a good example of how a conflict of interest can result in the attribution of unjustifiably high quality ratings to defaulted sovereigns, despite the agencies' full knowledge of that default.

In 1918 the Bolshevik government unilaterally defaulted on all Paris-quoted russian bonds and since then the successive internationally recognised governments of Russia have refused all contact with their bona fide creditors, in flagrant violation of accepted principles of international law.

As a holder of such bonds I am shocked to see that the three main credit rating agencies attribute an "investment grade" rating to that issuer; these agencies have been formally notified of Russia's default on these bonds, and by attributing an "investment grade" rating to that issuer these agencies are, in particular, disregarding one of their own self-imposed metrics, which is to address the issuer's willingness to pay on existing issues.

Since Russia is clearly not willing to pay (and has in fact notoriously defaulted) on the above mentioned Paris-listed issues, while it simultaneously pays both interest and capital on the Russian government bonds listed in Luxembourg, that issuer is quite clearly in "selective default", a situation which is not reflected in the present "investment grade" rating. Present and potential investors are being seriously misled.

This situation is identical to that which prevails concerning the People's Republic of China (PRC) who has also issued Luxembourg-quoted bonds and refuses to honour pre-1949 bonds held by French and US citizens.

I am taking advantage of your present review of credit rating agencies activity to bring to your attention two extremely well researched documents prepared by Sovereign Advisers, a private financial analysis and investment research firm, which highlight the obvious failings of the main rating agencies in properly assessing the PRC's rating, and the probable reasons for their conduct.

The reason I am bringing these documents to your attention is that the same reasoning can be strictly applied to the rating of the Russian Federation. The documents can be found at the following URLs:

1: www.globalsecuritieswatch.org/...pt2007.pdf (8.9 MB)
2: www.globalsecuritieswatch.org/newswire.pdf


Having briefly highlighted the fact that both the Russian Federation and the PRC have been attributed erroneous ratings, not through lack of knowledge but on the contrary despite full knowledge of a "selective default" situation, I would now like to explain why, in my view, this is so.

It is public knowledge that market liberalisation in both countries has resulted in the issue of Russian and Chinese securities on international markets. In particular, Russian and Chinese private and public corporations have been borrowing in increasingly massive quantities over the past years, and the necessary rating process of each issuer (without which foreign investors would be very reluctant to lend) has resulted in massive windfall profits for the rating agencies. It is crucial to understand that it is not the custom to rate a country's private issuer better than that country's government. Thus, no Russian corporation can be attributed a better rating than the Russian Federation itself. Therefore, if the agencies had attributed Russia the rating it quite obviously deserves, i.e. "selective default", they would have forfeited a massive source of revenue and profits since a Russian issuer could not have hoped for a better rating than "selective default" and would therefore have refrained from requesting a requesting a rating, knowing that no foreign investor would be ready to lend on the basis of a "selective default" rating. Since it is the rated entity that pays for the rating, there would have been no revenue for the agencies. The same goes for the PRC and Chinese companies.

Although the matter discussed above - ratings attributed to defaulted sovereign issuers - is somewhat removed from the sub-prime mortgages and asset backed securities ratings causing the current market turbulence I believe that both matters stem from very similar conflicts of interest, that they both have a bearing on hundreds of billions of dollars of outstanding debt, and are therefore both worthy of your immediate attention. I think it relevant to remind you that in Sotchi on September 22nd 2007 President Putin confirmed a 1000 billion dollar modernisation programme, specifying that "in (his) view private investors, both national and foreign, will participate", while Mr. Ivanov, interim deputy Prime Minister, added that "additional tools will guarantee a high level of return on investment". Without a "selective default" rating, investors will be misled into believing the Russian government and its government entities honour their outstanding debt more than they actually do.

As one of the 316,000 French holders of defaulted Russian government bonds, the outstanding value of which is conservatively estimated to be in excess of US$ 90 billion (the outstanding amount owed by the PRC to US citizens being I believe in the hundreds of billions of US dollars), I respectfully urge you to include the matter of the ratings attributed to defaulted sovereigns - and specifically to the Russian Federation and the PRC - in the scope of your examinations, with a view to obtaining that by reflecting the unwillingness to pay, the ratings of defaulted governments and government entities accurately inform the investment community as to the track record of these issuers and the potential risks to which future investors will be exposing themselves, risks which at present are negated by the rating agencies in violation of their own self-imposed metrics, as is made abundantly clear in the first of the two documents mentioned above.

Thank you for your attention.

 
October 22, 2007
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