Author: masaccio

Both Members of This Club by George Bellows (source: National Gallery of Art, Washington DC

This painting by the American George Bellows hangs in the National Gallery; I saw it on a recent trip to DC. I knew this painting from previous visits, but I had forgotten how powerful it is. Both fighters are bunched muscle. One is a panther, all sinuous curves, back muscles flaring like a cobra. One, who has battled mightily, is bent back by the force of the other, his right leg refuses to recognize impending defeat, but his face registers his pain, both physical and mental. The paint is forced onto the canvas with a brutality that mirrors the struggle between the two men. It gives a specific meaning to the title of the work: Both Members of This Club. Yes, the two men were admitted to the club for one day, solely to put on this bout. But long before this day, they were both gladiators, members of a tribe of warriors.

The other people in the painting aren’t like these two. The fighters tower over the assembly, titans compared to those watching them at their work. Bellows only shows their faces, they have no bodies. To the right of the White fighter’s front leg is the face of a man who relishes blood and pain. Look at the doughy face of the man on the far left. These two jump out at you, and you see just what they are. There is one black face in the crowd, under the knee of the Black fighter. He seems to realize that the Black fighter’s win might be dangerous to him, and he is looking for a way out of there.

The frankly racial nature of this painting might have been mildly shocking to the people who saw it in 1909, but the fact that it is set in the underworld makes it palatable. One easy interpretation is that the struggle of African Americans was brutal, but their victory is coming. I think the painting is darker than that. The Black fighter is battling a White fighter, a working guy just like he is. The people watching are the masters. They are too weak to fight, but they love to look at pain, nasty little voyeurs, so they hire a working class White man to fight for them. They don’t care which fighter wins. The exploiting class wins as long as the battle is between workers.

This is one theme of Diane McWhorter’s book, Carry Me Home: Birmingham, Alabama: The Climactic Battle of the Civil Rights Revolution. She says that the rich people of Birmingham figured out that if they could get Catholic and Protestant workers fighting one another, they would never get together in a union, let alone cross racial lines. David Shipler reviewed this book for the New York Times:

Anti-union vigilantism committed by Klansmen on the payroll of U.S. Steel and other corporations set a pattern that lasted for decades. When the barons of business, known as the Big Mules, were no longer willing to dirty their own hands, they used ”the racism they had fomented whenever the have-nots threatened to organize across racial lines,” McWhorter writes. ”Rather than give specific orders to the vigilantes, they would delegate political intermediaries to oversee strategic racial violence.”

Some things don’t change.
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This painting is from the Ashcan School. Tattoo and Haircut, which is at the Art Institute in Chicago, is a much later example of that school.

There are three closely related boxing works by Bellows at the Art Institute, A Stag at Starkey’s, Dempsey and Firpo, and Counted Out.

photo: bitzcelt via Flickr

One of the myths you have to believe if you want to be taken seriously about financial matters is that the Lords of Finance are geniuses at risk management. The Cardinal of Rectitude, Alan Greenspan, taught this at every service he led. When he officiated at the rites of the convocation of the Futures Industry Association in 1999, he told the assembly that market players:

… continually reassess whether their risk management practices have kept pace with their own evolving activities and with changes in financial market dynamics and readjust accordingly…

Of course, he was forced to admit that it was all a lie when he testified before the House Committee on Oversight and Reform in October, 2008:

“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.

You’d think that if the High Cardinal of the Church of the Perfect Market recanted, it would be a problem other true believers, like those at the University of Chicago. In fact, many economists there were stunned, as John Cassidy writes in the New Yorker. One of them is James Heckman, who won a portion of the Nobel Prize in economics in 2000:

Everybody here was blindsided by the magnitude of what happened…. But it wasn’t just here. The entire profession was blindsided.

Blindsided? Apparently the entire profession is stunned to learn that in an empirical test, their theory created a financial catastrophe. Even so, some cling to their theories with a blind passion. Cassidy talked to Eugene Fama, the prime mover behind the Efficient Market Hypothesis. This odd proposition is that markets use all information available to come up with the right price for assets. The efficient market hypothesis depends on market players acting rationally, which would include such things as risk management efforts, efforts to detect fraud, and reviewing mortgage loans. It was the justification for the big deregulation movement. Cassidy asked how Fama thought the EMH did in the Great Crash.

Fama says the EMH did just fine. He says the market was a victim of the recession, not a cause. The problem was the insistence of the federal government that Fanny Mae and Freddie Mac buy up subprime mortgages. This was a governmental failure, not a market failure. Fama doesn’t explain how his efficient markets fed Fannie and Freddie worthless, even fraudulent, mortgages.

Bolstered by the few remaining market fanatics, banks are instructing Congress what regulation they will accept. Jamie Dimon of JPMorgan Chase admits his company didn’t do a stress test on its portfolio that included the possibility that housing prices would fall. Blindsided, no doubt. Now he says he supports regulation and stronger enforcement of existing law. But return to Glass-Steagall? That’s a “quaint notion”, calling to mind another dismal failure, Alberto Gonzales. Lloyd Blankfein agrees that we must be very careful about regulating banks lest we choke off innovation.

Here is a perfect example of that innovation. CitiGroup has invented a derivative that pays out in the event of a financial crisis. Its creators say it tracks liquidity, and other market indicators like bid-ask spreads (of some unstated securities, probably derivatives), and trading volumes. It is based on something called the Sharpe Ratio, which is a simple ratio of historical data, so it offers a wonderful lack of reality in predicting the future. And best of all, it’s easy to trade. There are no upfront costs. This such a bad idea that Risk Magazine, which published the article, finds a scholar to explain the downside. Chris Rogers, chair of statistical science at Cambridge University, says:

This is basically a kind of insurance product. The main issue is: how good is the party issuing it? If it’s going to be paying out huge numbers in the event of a crisis, will it be able to meet it[s] obligations? Insurers can buy reinsurance for their liabilities, but the buck has to stop somewhere – there’s a limit to how much a private insurer can pay out. Only the government can cover unlimited losses ….

It is false that financial businesses will regulate themselves. In fact, they are planning to keep things just as they are, and to take explicit advantage of their size to create even more destructive derivatives. These are the people the President calls “savvy businessmen.”

Home of the good life — for NelNet, Inc. (photo: Thomas Beck Photo via Flickr)

It isn’t enough that Nebraska Senator Ben Nelson wants American taxpayers to pay Nebraska’s Medicaid bill for the foreseeable future. He also wants America’s college students to pay to keep a few jobs and a lot of money for NelNet, Inc., which is headquartered in Omaha. Nelson wants to require the Treasury to guarantee student loans made by private lenders, when it would be cheaper for both taxpayers and college students for the government to make those loans directly. The amazing thing is that NelNet wouldn’t be greatly harmed by getting rid of the guarantee program. Let’s see how NelNet screws over our kids.

NelNet is publicly traded, so we can look at its most recent 10-Q, 9/30/09. The company explains its business very clearly. People interested in the use of swaps for hedging will find the discussion on pages 14-19 very informative. On page 37, the company states that it “generates a significant portion of its earnings from the spread, referred to as its student loan spread, between the yield the Company receives on its student loan portfolio and the cost of funding these loans.” The company has about $26.8 billion in debt. It paid interest on bonds and notes in the first nine months of 2009 of $329 million, which indicates full year interest rate of 1.64%. CitiBank offers Stafford loans at 6.8% (unsubsidized, meaning the government isn ‘t paying the interest while the student is enrolled in school). If NelNet is making comparable loans, it has a current spread of 5.16%.

What happens to that difference? NelNet says that its primary source of income is securitization of loans. As an example, in October, 2009, the company did a $434 million securitization. Here’s how that works. The company forms a new entity, maybe a trust or a limited liability company. It sells a bunch of student loans to the company. The new company gets the money by selling notes to investors. How does it decide what the purchase price of the loans will be?

Here’s an example. Suppose NelNet has a $10,000 loan with a face interest rate of 6.8% and a 10 year term. Payments will be $115.08, consisting of both principal and interest. This loan is secured by a guarantee from the government, so it is almost as safe as a Treasury bill. Seven year Treasury notes pay about 3.12%, so maybe a fair market rate for the notes of the special purpose entity is 4.8%. Then we need to add something to pay for servicing of the loans, say .5%, a total of 5.3%. This loan pays more, so it is worth more. Suppose we sell the loan for $10,701.14. The monthly payments of $115.08 work out to a 5.3% return. That means that when NelNet sells the notes to investors, it pockets $701.14, on top of the origination fees and any other fees it can get out of the borrower. It doesn’t necessarily get the cash, it may keep some of the securities, or it may do something else.

It doesn’t matter how NelNet gets the money. The fact is that this is money is being paid by a bunch of college students, or their families. This is a burden that wouldn’t exist if the government made the loans directly.

NelNet saw the handwriting on the wall: it didn’t think its parasitical behavior could last forever. It has diversified. It is one of the four firms which provides servicing to the Treasury on loans the government makes directly to students. It has other businesses. It won’t make this free money from college kids, and it won’t need the people who plan its derivatives and its securitizations, and it may not be able to pay its CEO $500,000 plus, but it will survive nicely.

It will do much better if Senator Nelson brings it bacon, carved out of the next generation.

The Annunciation and Two Saints, by Simone Martini

What did the people of his time who looked at this Annunciation by Simone di Martini see when they looked at it? You can get a close look at central image using the image viewer at the excellent Artchive Site.

The Annunciation is important in the Catholic Church, celebrated on an appropriate Sunday near March 25. It is one of the Joyful Mysteries, a subject of meditation in recitation of the Rosary. The biblical text is Luke 1:26-38; I put a Catholic translation, the Douay-Rheims Bible at the end of this diary.

The painting is simple: an Angel, bearing an olive branch and wearing olive leaves in his hair, kneels before Mary, his wings arched. Mary sits on a chair, wearing a blue robe and holding a book. Between them is a lily, a symbol of purity. Above them are tiny angels; on either side in a panel are two saints, Margaret and Asano. I imagine St. Asano was associated with the parish for which this work was created, or perhaps the patron who commissioned the work.

Luke says the first words of the Angel are “Hail, full of grace, the Lord is with thee”, in Latin, that would be Ave, gratia plena, Dominus tecum. Those words are in this painting: they are the raised line that moves from the mouth of the Angel towards the Virgin. Mary’s response is natural, she reaches her hand to her throat, she twists away, as if to protect herself. We shouldn’t read a lot into her expression, because this is a stylized form of painting, but it clearly expresses some emotion, maybe distrust or fear. To me the emotion is dismay. It is as if she recognizes the implication of the message, and is upset and slightly miserable. But maybe I am reading to much into the painting because that’s how I would feel.

Paintings like this one were used to teach the Bible and Catholic doctrine to the illiterate masses. I don’t have a clue what the average person of 1333 saw when they looked at this work. I have little in common with those people. In exactly the same way, I don’t see much when I look at Chinese calligraphy like this at the Freer Gallery in DC, which dates from roughly the same period as the Martini. I have no connection whatever to the mindset that created this, no way to gauge its beauty or ordinariness, no context in which to put it. It would take long study just to get an intellectual grip on the work, and I’m sure I could never relate to it emotionally in the same way people of that culture would. Here’s a story that gives some hint of the similarities and differences between us and the people of a small town in France.

Martini comes from the Sienese school. Here is a late work from that school by Sano di Pietro, located at the Duomo of Montepulciano, a hill town in Tuscany. The movie The English Patient was filmed there, and the church appears in the scene where Kip takes Hana on a motorcycle ride. The robe of the Madonna, and the shape of the face is quite similar to the Martini. The Baby Jesus has the sinuous shape of the Madonna. Neither has much expression. But how can you resist the detail of the bird in the hand of the Baby? Or his bright red hair? Were all the local folk redhead? Was the bird the symbol of the local Lord? Did the artist have a boy child with red hair? Did his girl friend keep a bird in a cage?

The Baby Jesus is looking at something other than the artist, and the Madonna looks with him. It reminds me of my own children, who were always looking around at the world and not at the thing I thought was important. Again, who knows what the people saw then?

This painting is dated 1450, and the only significant change in the form from the Martini is that the background isn’t gold. At the same time, dramatic changes in art and life were underway in Italy with the advent of the Renaissance. For a taste of the change, compare the Sano di Pietro to this Expulsion from Masaccio, dated to 1424-8. We don’t feel that separated from this kind of art, so maybe our differences aren’t as great as all that.
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26 And in the sixth month, the angel Gabriel was sent from God into a city of Galilee, called Nazareth, 27 To a virgin espoused to a man whose name was Joseph, of the house of David; and the virgin’s name was Mary. 28 And the angel being come in, said unto her: Hail, full of grace, the Lord is with thee: blessed art thou among women. 29 Who having heard, was troubled at his saying, and thought with herself what manner of salutation this should be. 30 And the angel said to her: Fear not, Mary, for thou hast found grace with God.
31 Behold thou shalt conceive in thy womb, and shalt bring forth a son; and thou shalt call his name Jesus. 32 He shall be great, and shall be called the Son of the most High; and the Lord God shall give unto him the throne of David his father; and he shall reign in the house of Jacob for ever. 33 And of his kingdom there shall be no end. 34 And Mary said to the angel: How shall this be done, because I know not man? 35 And the angel answering, said to her: The Holy Ghost shall come upon thee, and the power of the most High shall overshadow thee. And therefore also the Holy which shall be born of thee shall be called the Son of God.
36 And behold thy cousin Elizabeth, she also hath conceived a son in her old age; and this is the sixth month with her that is called barren: 37 Because no word shall be impossible with God. 38 And Mary said: Behold the handmaid of the Lord; be it done to me according to thy word. And the angel departed from her.

Still no explanation for BNY Mellon's monster-sizing. (photo: daveynin via Flickr)

There are a number of untrue things that serious people have to believe about financial matters. One is that this country needs giant banks to stay competitive in the modern world. This bizarre notion was the central argument made by Goldman Sachs brain boy, Robert Rubin, but that doesn’t make it true. Thanks to reader dosido, we have someone besides our usual targets, Lloyd Blankfein and Jamie Dimon, to explain things to us peasants: His Most Excellent CEOness, Robert Kelly of BNY Mellon.

Paul Solman, the interviewer, gives Kelly the opportunity to explain why banks should be allowed to grow to gargantuan size. Kelly offers two reasons. He notes that many large US corporations need money in large amounts.

Many of them, say, want to raise money in China to be able to be more successful over the long term. Wouldn’t you rather that business go to American banks than to foreign banks?

This is a direct appeal to US chauvinism, particularly delightful because it comes from a Canadian: Kelly is from Nova Scotia and spent most of his career at Toronto Dominion Bank. Kelly doesn’t even try to explain why banks need to be big to make big loans. When banks make big loans, they lay them off on other banks, through syndications, or recently, by securitizing and selling them. One of the big problems of Lehman Brothers was its inability to lay off some of its more bubbly private equity and other loans.

For decades, large stock and bond transactions were syndicated among big underwriters, each taking a piece of the transaction and allocating it among their customers. The cover of the prospectus would list the lead and main underwriters, and in larger deals, more would be listed elsewhere. Similarly, groups of banks would get together to fund giant loans. For customers, the transaction is with one entity, and they don’t really care exactly who is providing the money.

I can’t think of any reason that one bank should make a specific loan, other than keeping all the fees, and making more money laying off the loan in a securitized package, and more money managing the securitized package of loans, and who knows, more money off the bankruptcy.

Then Kelly says that there are economies of scale for giant banks. Solman replies that economists like Simon Johnson say there are no economies of scale once a bank has reached $100 billion in assets. Kelly assures Solman that BNY Mellon was much better off than it would have been as a smaller institution.

Solman asks about the losses in 2008 of $1.5 billion. He might have added that Kelly’s bank wrote off $4.8bn in the third quarter of 2009 alone, trying to put its failed securities investments in some kind of order. 10-Q, third quarter 2009, page 5. Kelly explains how this blunder happened on his watch:

We have to do something with those deposits. And you could buy treasuries that are essentially riskless, or you could buy very high-quality securities, for example. The equities are fairly risky, so we don’t buy stocks. But we do buy bonds.

And we [sic] AAA-rated bonds, which turned — which turned which turned out to be not AAA. If we want to be kind about it, perhaps they were CCC.

Let’s run that through the Bizspeak Translator: We bought a bunch of toxic waste, but it’s really not our fault, those foul rating companies misled us.

Solman displays good form by not laughing out loud. This was a double win for him: Kelly failed to explain why banks need to grow to enormous size; and Solman points out that he failed at managing his bank’s principal job. Of course, Solman can’t spike the mike in celebration of his win. The conventions of business media require him to nod in acquiescence to whatever nonsense Kelly spouts. It has to be enough to let the emperor parade around, clothed only in his moth-eaten mythos (H/T reader knowbuddhau).

One of the many untruths mouthed by all of the Lords of Finance is that financial markets allocate capital to its best use, and that any interference by the government is always disastrous. Here’s an example from Goldman Sachs CEO, Lloyd Blankfein, from the London Times:

“We’re very important,” he says, abandoning self-flagellation. “We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle.” To drive home his point, he makes a remarkably bold claim. “We have a social purpose.”

The facts say otherwise. Most of Goldman Sachs revenue comes from trading securities. See Chart. Very little of Goldman Sachs’ revenue and profit comes from underwriting securities, and what little there is comes from securitizations and debt offerings.

There is little evidence in their financial statements that they raised any capital for wind or solar energy, high tech, or anything that might be an engine of growth for the nation. It is true that GS has invested a few million here and there in clean energy businesses that they buy and sell. But the big picture is that for years, they and all of their Wall Street buddies poured money into the housing markets, betting every which way on the outcome of the bubble.

The U.S.-China Economic and Security Review Commission explained how the Chinese plan to dominate the clean technology industry. FDL covered that report. Now the New York Times offers its take on the subject. China is now the world’s largest maker of wind turbines and solar panels. It is pushing those products into export markets, using the weak Yuan to choke off those industries in the US. According to the Commission, 95% of its solar panel manufacturing output is exported.

China’s domination of wind power turbines and solar panels is a story of government-driven allocation of capital. China has used all of its tools to force development of manufacturing and installation of clean energy machines. One such tool, according to the Commission, is to restrict access to rare earth minerals, used in manufacturing the magnets needed by wind turbines. Another tool is its tight control over its internal market. In Spring 2009, China sought proposals for 25 large contracts to manufacture wind turbines. Six multinational companies bid. All were disqualified. The NYT describes another tool: a renewable energy fee charged to all electricity users. That is used to reduce the cost difference between cheap coal and more expensive renewable energy.

The Commission traveled to Upstate New York to look at the impact of China’s aggressive behavior there.

The New York State government is trying to invest in the clean energy sector and other sunrise technologies and industries, but funding is fragmented and difficult to obtain, and small entrepreneurs and parts suppliers remain almost entirely dependent upon the individual decisions of larger producers and assemblers who outsource much of their operations overseas.

So, there isn’t any money for these new industries, and small businesses are dependent on the giant conglomerates for whatever is left after the jobs of the future are sent to China.

Where are the Lords of Wall Street now that their nation needs jobs in clean industries? Why they’re “manufacturing” credit default swaps, investing in their proprietary trading “industry”, and selling their “products” to each other and their clients in a sterile frenzy.

In the accompanying video, Sherrod Brown points out that Toledo, OH has the nation’s largest solar manufacturing jobs base, but when Oberlin College built a large solar powered building, the solar panels came from Germany. We’re behind, admits the President.

And we’ll stay there if we wait for Wall Street to do something.

photo: dorkula via Flickr

Our Lord Bankers have descended from Davos with news for us peasants: they might accept some meaningless regulation. Yes, there is a pointless regulation that their lackey senators may be allowed to pass that might confuse us mangy serfs into thinking that we can protect ourselves from their failures. But there is a near-riot over the possibility of a fee to pay off the money extorted from taxpayers to salvage them from their failures. The New York Times is allowed to share news of these acceptable and unacceptable laws.

The acceptable and perfectly useless law would limit proprietary trading, whether for the bank or for its clients, by setting a limit on the percentage of business that trading represented. That could be a serious problem for Bank Goldman Sachs, for which trading revenues were 59% of revenues in the third quarter of 2009, according to the Office of the Comptroller of the Currency. (Graph 6b.) Goldman Sachs assures us that less than 10% of its business is proprietary trading for its own account as opposed to trading for the accounts of its clients. Whatever. As one anonymous senior banker told Andrew Ross Sorkin of the Times:

“I can find a way to say that virtually any trade we make is somehow related to serving one of our clients. They can go ahead and impose the rule on Friday, and I can assure you that by Monday, we’ll find a way around it. Nothing will change unless the definition is ironclad.”

We know that. And we know they can make sure the definition isn’t ironclad.

The unacceptable idea, a fee charged to banks to repay the lost TARP money, really has bank CEOs scrambling.

… [M]ore chief executives [are] stepping over their government relations staff to request personal meetings with lawmakers. The big banks, the lobbyists say, have become increasingly alarmed that the legislative process may move in unexpected directions outside their control.

Chief executives of big banks have been in Washington for meetings with White House and Treasury officials and lawmakers on Capitol Hill. Jamie Dimon, chief executive of JPMorgan Chase, had lunch with Mr. Obama last Tuesday, and then met separately on Friday with the Federal Reserve chairman, Ben S. Bernanke, and the Treasury secretary, Timothy F. Geithner.

Laws outside their control? It is to swoon.

Dimon’s JPMorgan is a party to about 20% of all credit default swaps. According to the OCC, in the third quarter, 14% of its revenue was from trading. Or, to put it in dollars, that’s $3.7 billion. (P. 3)

King Dimon is having lunch with the President, and visiting his best buddies, newly confirmed Duke of the Fed Ben Bernanke and Earl of the Treasury Timothy Geithner. Sir Chris Dodd is cutting deals with the devil. Sir Harry Reid is missing in action. Wannabe Harold Ford is falling over himself in his push to defend his banking buddies.

Silly humans, government is for the corporations and their human servants. Work harder and feed them. Blood is good, if you don’t have any money.

Vincent Van Gogh, self-portrait ca. 1887 (source: Chicago Museum of Art)

I must have been 11 or 12 when I first visited the Art Institute of Chicago. My folks ferried me and my many younger siblings to see cultural stuff in Chicago. We charged through the boring rooms full of blown glass and miniature furniture to see the armor. Then we went off in search of lunch, which meant wandering through rooms full of art. We stopped in the room with the Impressionists, and this painting by Vincent van Gogh caught my attention. I stared for a while, and then I saw the half-hidden thing under the large bush. I never told my brothers about it; it felt like a secret between me and van Gogh. I always return to that painting when I go to the museum.

One day after visiting my old friend, I stopped to look at this self-portrait, and found myself mesmerized again, this time by the face of the artist. It was his expression. Wary? Melancholy?

Years later, I looked at another self-portrait (this is an excellent site for looking closely, use the image viewer). There is a bit of the same expression in his eyes, but what struck me was the background. He paints it as if he could see whorls in the very air. That same set of whorls, in a very similar color, is in the jacket. Look again at the details in the face. Very faintly you can see similar whorls and colors.

This made me see the Art Institute self-portrait in a new light. Van Gogh uses little daubs of paint, which makes sense for his tweed jacket, but why in the background? Look at the flow of the daubs, and the colors, the way they form a set of nearly parallel whorls that flow in a spiral through the air, through the coat and back into the air. There are similar daubs, and a bit of spiral in the beard and the face, they seem focus on his left eye.

I wonder if he felt he was part of the air, part of the light, part of the earth, as if the boundary between his body and the universe was indistinct, as if he only existed at a central core, a knot of being in the numinous?

Or was he just practicing his pointillism? There is no reason to believe that he had any such view as mine, or any purpose other than to paint. We can’t see into his mind, we only see the result, and follow where it leads us. That’s where it led me.

At September 30, 2009, JPMorgan Chase was a party to $79.0 trillion in notional value of derivative contracts, against which it had total capital of $1.67 trillion. Table 3 to 9/30/09 Report of Office of Comptroller of the Currency. In his testimony to the Financial Crisis Inquiry Commission, Jamie Dimon devoted a sentence or to two to the risks of derivatives, but said nothing about the past, only proposing to do something in the future. This suggests that he isn’t concerned about JPMorgan’s derivatives. Here are some reasons for concern, and stories about people who didn’t worry enough.

Derivatives include futures, options, forwards, swaps and credit default swaps. Here’s a table showing the total derivatives of the five largest banks and related data:

Table 4. JPMorgan Chase was a party to $6.36 trillion in notional value of credit default swaps, both as a seller and a buyer of protection. Table 2. According to Depositary Trust & Clearing Corporation, four weeks ago there were a total of $15.15 trillion in notional value of credit default swaps outstanding. DTCC only counts one side, so to make these numbers comparable, you have to double DTCC’s figure. You also have to assume that there has not been a great change in the total outstanding since 9/30. With those assumptions, JPMorgan was a party to 21% of all CDSs. The top five banks together were a party to 40% of all CDSs.

One of the major risks in derivatives is called counter-party risk, the risk that the other party to the contract will not perform. The OCC report does not put a figure on this risk. It uses very rough measures, such as gross positive fair value, which is sometimes shown on financial statements as “derivative receivables”. That is the total of all derivative contracts with a positive value, that is, if the contract terminated, the counterparty would owe money to the bank. Then there is gross negative fair value, “derivative payables”, the total of amount the bank would owe if the contracts terminated. These are the only numbers JPMorgan Chase reported in its recent SEC filing. Derivative receivables were $80.2 billion, down from $162.6 billion a year ago. Derivative payables total $60.1 billion, down from $121.6 billion a year ago.

The OCC doesn’t address bankruptcy of counterparties, as in the case of Lehman Brothers. JPMorgan has 75,000 derivative contracts with Lehman. Paragraph 3, page 2 of bankruptcy pleading viewable here, enter “Lehman Brothers Holding in the box for Debtor and 4325 in box for Docket #.

Let’s see what happened to a couple of derivative holders. Aliant Bank of Birmingham, AL, entered into two interest rate swaps with Lehman, and posted a Fannie Mae security with a face value of $5,250,000 as collateral for its (Aliant’s) obligations. The security was held by JPMorgan as agent for Lehman. Lehman’s bankruptcy was an event of default under both swaps. Aliant demanded payment of the amount due it upon default, and demanded return of its collateral. Lehman refused to pay. JPMorgan refused to deliver the collateral, on the ground that it had set-off rights against Lehman. Aliant sued. Dkt. 1726. The matter eventually settled. Aliant got an unsecured claim of $2.8 million, the value of which is unclear, and transferred the claim to JPMorgan. Aliant must have gotten its collateral back, but it took a year.

Here’s another. In 2002, Lehman created the Dante transactions under which AFLAC bought notes. Under a very complex set of documents, Lehman had first call on money from the venture, and AFLAC had second call. The documents provided that if Lehman filed bankruptcy, it lost its first priority for payment, and AFLAC got first call on the money. When Lehman filed, AFLAC filed suit in England for declaratory judgment that it is entitled to the money. AFLAC won, but the English Judge didn’t deal with the effect of the American bankruptcy.

Then Lehman filed a suit in bankruptcy court for declaratory judgment that the shifting of priority for payment could not be enforced against it under bankruptcy law. Lehman asserts that under the Bankruptcy Code clauses in contracts that become effective only when a bankruptcy is filed are unenforceable. Apparently AFLAC filed a motion to dismiss in the bankruptcy case, which was denied,causing a lot of heartburn for investors in similar deals.

Fannie Mae and Freddie Mac lost millions on derivative transactions with Lehman.There are other lawsuits and losses from counterparty risk as a result of the Lehman bankruptcy.

Maybe Mr. Dimon shouldn’t be so quick to assure us that derivatives are safe at his bank.

photo: MyEyeSees via Flickr

In his testimony to the Angelides Commission, JPMorgan Chase CEO Jamie Dimon let slip half of an ugly truth:

“Not to be funny about it, but my daughter asked me when she came home from school ‘what’s the financial crisis,’ and I said, ‘Well it’s something that happens every five to seven years,”’ Dimon said. “We shouldn’t be surprised, but we need to do a better job.”

The other half is that each time they don’t do a better job, they look to the government to bail them out. Maybe it’s a direct transfer of money from government and taxpayer pockets, as TARP; sometimes the Fed revs up the printing press, as the money loaned to AIG to pay off Goldman Sachs and Societé General; and sometimes the government just knocks heads, as happened with the failure of Long Term Capital Management.

Noreena Hertz shows us in her book, The Debt Threat, that at least once, banks got bailed out by the World Bank and the IMF. In 1973, OPEC raised the price of oil 400%. The result was a huge pile of what were called petrodollars, which she pegs at $333.5 billion. Banks were dying to grab that money and lend it out, for the fees and the interest income, and, of course, bankster prestige. There was insufficient demand in the developed world, so the banks went on an orgy of lending to developing nations.

Loan officers crawled all over the officials of potential borrowers, offering extraordinarily favorable terms. The developing countries, particularly those dependent on imported oil, were in dire need, so loans looked like salvation; they wouldn’t have to raise taxes in the short run. The banksters didn’t care what the borrowers did with the money. Much of it was wasted, as in Togo, where the money went to build a steel mill, in a country that had no iron ore. Much of it went to buy military equipment. Other money just went to buy foreign real estate, or directly into bank accounts in Switzerland for the rulers of Latin American countries like Argentina and Venezuela.

Banks did little or no due diligence: “A loan is said to have been granted to Costa Rica in 1973 on the basis of a single Time magazine article on the country.”  (p. 63)  But they made tons of money. A giant French bank, Bank Nationale de Paris, made more from its African affiliates than it did from its large network of French branches.

This frenzy was justified on two grounds. First, the lenders figured that the borrowing nations would never default, regardless of the burden inflicted on their citizens. Second, they expected to be bailed out if things went bad.

Banks who lend too much too fast know there will be a bailout, no question about it,” the officer of a large New York City bank said at the time. “They scoff at bankers who create large loan loss reserves and those who in general are more conservative. They know that come the revolution in Mexico, or wherever, their banks will have the highest earnings and pay the highest dividends, and that they personally will receive the highest bonuses.” (p. 63)

After years of part payments of principal and interest sucked out of the life and health of the workers of the borrower nations, and negotiations and recriminations, the bailout finally came in 1989 under Treasury Secretary Nicholas Brady.

…[T]he Brady Plan called for a total reduction of about 20 percent of the global debt, rather than a restructuring or rescheduling. The IMF and the World Bank offered guarantees for the repayment of the other 80 percent. (p. 71)

Once the debt was guaranteed, investors were willing to buy it. A market developed in that debt, and banks unloaded their previously illiquid loans. That guy who predicted a bailout was right.

The parallels with the causes of the Great Recession are obvious. Banks made stupid loans to people who didn’t have any business borrowing money. They did it because they figured a) homeowners wouldn’t default, even if their houses were grossly underwater; and b) government would bail them out if homeowners defaulted. They figured that the government would give them enough money to hold them together in the short term. They would call on their congressional servants to crush any move to help borrowers. Then they would squeeze borrowers dry with increases in credit card interest rates and fees, refuse to renegotiate home loans, and make a fortune trading stocks and foreign currencies and derivatives. Eventually they return to profitability. It takes time and grit, and it’s working as planned, just as it did on the failed petrodollar loans.

Kind of makes you feel like a worker in one of those developing nations, doesn’t it?

graphic: Mike Licht, NotionsCapital.com via Flickr

Fannie Mae and Freddie Mac have already lost billions on transactions with bankrupt financial services firm Lehman Brothers. Now a new potential Lehman loser has surfaced, Stuyvesant Town, a deal sponsored by real estate giants Tishman Speyer Properties and BlackRock Realty. They are going to turn over the keys, having defaulted on billions of dollars in debt. Tishman Speyer and BlackRock only lose their initial investments of $112 million each, not counting any management or other fees they might have ripped out of the deal. Their investors, on the other hand, are going to eat billions in losses. Among those investors are two California pension plans — CalPERS, $500 million, and CalSTRS, $200  million — and a Florida pension plan, $250 million.

Fannie Mae and Freddie Mac are two of the largest investors, with at least $1.5 billion in commercial mortgage-backed securities, called CMBS. Here’s how the CMBSs were created. The deal was financed in part by Wachovia Bank, which took a $3 billion first mortgage on Stuyvesant Town. Wachovia sold that note and mortgage along with notes and mortgages on other commercial real estate to a single purpose entity (SPE), like a trust. The SPE raised the money to pay for the various notes by selling debt securities to investors. The notes are the only assets of the SPE, and the only source of returns to investors. In this case, there are several different classes of debt securities, which are called tranches, with different rights to payment from the money the SPE gets from the notes. The most senior tranche gets paid before the others, but has a lower interest rate. The other tranches get paid in order after the senior tranche, but have higher interest rates.

Neither Fannie nor Freddie responded to my inquiries about projected losses on the CMBS. According to the Wall Street Journal, Freddie Mac doesn’t expect to lose any money because it holds the most senior CMBS tranche. It’s not obvious that there won’t be a loss. The property is apparently worth no more than $2 billion. We don’t know how the CMBS documents allocate losses to the various slices, so we can’t verify that Fannie and Freddie won’t be eating another loss. Freddie Mac is reportedly willing to finance a new purchaser, which would certainly be one way to prevent the appearance of a loss.

These CMBSs are a legacy from the failed Lehman Brothers, which underwrote this transaction. Fannie Mae also did a bunch of derivative transactions with Lehman, and looks to lose over $120 million on those transactions, net of collateral, according to its proof of claim. Freddie Mac lost $1.2 billion when Lehman defaulted on an overnight loan as it filed bankruptcy. Freddie is in a loss position on derivative transactions with Lehman, to the tune of $17 million. The two also have claims arising from mortgages they bought from Lehman, totaling nearly $2.6 billion.

That last category is instructive. Those claims arise from the contracts between Lehman and Fannie and Freddie. Here’s an example from Fannie’s proof of claim:

Under the [contracts], if and when the aggregate principal balance of the mortgage loans which are ninety (90) days or more delinquent exceeds forty-nine percent (49%) of the aggregate principal balance [Lehman] is obligated to repurchase a sufficient number of delinquent loans to bring the delinquency rate to 49%….

Exhibit A, p. 2. They only protected themselves if half the loans went into default? Stunning. Fannie and Freddie think they will get pennies on the dollar of this debt.

What lessons can we learn?

1. Derivative transactions cost taxpayers a fortune. But bankers are plunging back into that business, so we get another chance to bail them out.
2. It’s okay for Tishman-Speyer and BlackRock to walk away from their mortgages. It’s not okay for homeowners to walk away from their mortgages, even in states where there are no deficiency judgments.
3. It’s okay for government-sponsored entities to buy junk CMBSs so Wachovia and Tishman-Speyer and BlackRock Realty can make money. Helping homeowners creates moral hazard.

I’m sure Ben Bernanke and the other true-believing free marketers will explain why this all makes sense.

Dishes with Oysters, Fruit and Wine by Osias Beert (source: National Gallery of Art)

I saw this painting, Dishes with Oysters, Fruit, and Wine, a painting by Osias Beert the Elder, on a recent trip to the National Gallery of Art in DC. It is the second Beert I have seen, Basket of Flowers is the other. Some of Beert’s work is said to be allegorical; Basket of Flowers has allegorical references, for example, which might require specialized knowledge to grasp. But Dishes isn’t complicated. It is what it shows: the richness of the life of the wealthy burghers of Beert’s time.

When Dishes is discussed, the oysters usually take center stage. From the description on the National Gallery site:

The eleven opened oysters arranged upon the pewter plate are striking examples of this realism: their amorphous forms appear to be so liquid that one can almost imagine the oysters’ easily slipping from their pearly white shells.

And down one’s throat, preferably with a squirt of lemon juice and maybe a dusting of pepper. Indeed they are lovely; here is a detail; I assure you it barely does the painting justice.

Compare the oysters with this detail of a Carribean shell. On close inspection, the shell looks as edible as the oysters, it could as easily be a sugar candy from the kitchens of The Food Channel as the calcified remains of a crustacean. And one more image, a Venetian glass filled with wine. In the museum, this shape glows with a promise of nectar.

Beert picked out each element in this painting, and placed it just so, each oyster is in a specific place, the wine glasses and the Ming Dynasty bowls of fruit and nuts are each in their position. I imagine him moving each piece around, and moving each almond into place, moving the tendrils of vine that hold the raisins into this very position, and checking the lighting on the sugar candies. I understand the “still” part of still life. Each piece is fixed where it is.

I wonder how long it took him to get things just so. I wonder how long he stared at that shell, hours perhaps, so he could feel its strength and its colors through his brush to the panel of wood. It got me to thinking about time. The hours of observation, the hours of arranging, the hours of painting, all to show a single instant of time. The time I have spent thinking about that painting. The notion that a still life is wholly artificial, an arrangement that pleased the artist. The context of a still life, the moment in time it shows, is the cessation of the artist’s arrangements of the models, which begins with a table, bowls and dishes, fruit, candies, nuts, bread, crustaceans, oysters, each moved into position, painted, and then moved again, or eaten, maybe one dish at a time, maybe several. They come into position, are painted, and disappear. Like life.

Federal Reserve Board Chairman Ben Bernanke and other members of the Fed are fond of saying that part of their job is to manage monetary policy for maximum employment, five times in this short speech by Vice Chairman Kohn. It’s true they have this duty. 12 U.S.C. § 225a.

The Fed is also required file a written report to Congress every six months. Let’s see what Bernanke reported last time, July 29, 2009, on the employment front. First we learn that unemployment is rising and production is falling. P. 1. Here is the forecast (P.2):

However, all participants expected that labor market conditions
would continue to deteriorate during the remainder of this year and improve only slowly over the subsequent two years, with the unemployment rate still elevated at the end of 2011.

And what is Chairman Bernanke going to do about employment? Keep reading. Eventually you get to page 31, where we learn that the Fed is going to a) buy up a bunch of Treasuries and Agency Debt, b) buy up a bunch of mortgage backed securities, and c) help fund the TALF, the Term Asset-Backed Securities Loan Facility. The first two are designed to pump money into the financial system, which helps banks survive, but has no direct effect on employment. Instead, it scares the Chicken Littles, who think any increase in the money supply will lead directly to hyperinflation. Indeed, the report devotes over three pages to the steps the Fed will take to unwind the steps taken to deal with the great recession, as if that were the problem, instead of 10% unemployment.

The TALF is supposed to buy securitized consumer loans, like car loans and credit card loans, and loans to small businesses guaranteed by the SBA. It might help consumers buy stuff, which might encourage employment indirectly. Easing securitization of SBA loans could conceivably help. Or not. The Congressional Oversight Panel, chaired by Elizabeth Warren, addressed TALF in its May 2009 report. The COP thinks TALF was poorly designed, and that it didn’t target the real problem. Consumers didn’t want to borrow money, so making that easier wouldn’t really help. The COP says asset-backed securities have never been a significant source of lending to small businesses, so that isn’t going to help.

And, that’s it. The full extent of the Fed’s efforts to increase employment was a program to pour money into banks and minimal help with consumer spending and small business lending. Meanwhile, bank lending fell all year at giant banks like JPMorgan Chase (P. 2) and was flat to lower at Bank of America (P. 35).

There were things he could have done. He could have used his supervisory powers to insist on increased lending to small businesses, by telling the Fed’s examiners to look at small business loans that weren’t renewed, and applications that weren’t granted and treat that as part of their examination report. That would have forced banks to justify their failure to lend. He could have increased the Fed’s inflation target, which Scarecrow points to as a good step on the employment front.

Under Bernanke, the Fed hasn’t thought of anything that would actually help on the employment front. It hasn’t done anything to meet its statutory objective of assuring maximum employment. But it sure has shown it can help banks recover their profitability and their bonuses.

I know Bernanke has the all-important support of Alan Greenspan; and I know that there is a good chance that if he isn’t confirmed, the world will come to an end. Just ask Senator Dodd, Senate Banking Committee chairman, who

… renewed his support for the Fed chief today. He said rejecting him would send the “worst signal to the markets right now” and produce an economic “tailspin.”

Here’s a real world signal for the “markets”: the entire country has been devastated by your greed and incompetence. It’s infuriating that you failures can hold us hostage while you buy Lamborghinis with your bonuses.

photograph courtesy of pingnews