"After hopefully things settle down..."

"Pull!"

In "Throwing the bank babies out with the bath water" I pondered today's Global Market Meltdown, the Net Capital Requirement rule and wondered who in the *&%$# had been responsible for changing it.

I just couldn't believe that there would be ANYBODY that ...irresponsible.

Well, I found her. Yep. I found the person involved in the change of the Net Capital requirement rule on Wall Street. Unh-huh. And if she says she wasn't the one? Then why was she bragging all over the place about throwing it out the window, including in her official interview with the SEC Historical Society???

And who knew there even was such a thing as an SEC Historical Society. Did you? Me neither. Go figure. But back to our special someone. That special someone making my blood boil right about now.

Ms. Annette Nazareth, former SEC Commissioner.

Ms. Nazareth served as the Commission's Director of the Division of Market Regulation, a position she held from March of 1999 until August of 2005. As Director, Ms. Nazareth had primary responsibility for the supervision and regulation of the U.S. securities markets, principally through the regulation of brokers and dealers, exchanges, clearing agencies, transfer agents and securities information processors. Significant initiatives adopted by the Commission during her tenure include: execution quality disclosure rules, implementation of equities decimal pricing, short sale reforms, implementation of a voluntary regime for consolidated supervision of broker-dealer holding companies and modernization of the national market system rules. (Editor's note: i.e. The Consolidated Supervised Entity System)

True, Ms. Nazareth probably still has to go a ways to catch up with good old "Typhoid Jamie Gorelick" After all, Ms. Gorelick has her fingerprints all over BOTH 9/11 AND the Fannie-Freddie crisis! Talk about a one woman wrecking crew! Keep her out of the stables with Mrs. O'Leary's cow! But, it's early days yet and I've just started in on Ms. Nazareth when it comes to the google scratching, so we shall see what place she ends up in this Mistress of Disaster bake-off we're conducting.

The good news. It looks like someone in DC IS paying attention to the net capital oversight problem. Senator Chuck Grassley instigated an investigation into the collapse of Bear Stearns back in April and the SEC Inspector General reports were just issued on September 26. In the summary of their results, what do we find, first on the list, front and center?

The Consolidated Supervised Entity Program:

The audit noted that the Trading and Markets division (TM) failed to act in the face of potential red flags regarding Bear Stearns' "concentration of mortgage securities, high leverage, shortcomings of risk management in mortgage-backed securities and lack of compliance with the spirit of certain" international standards.

Specifically, among the Inspector General's findings were:

The CSE program's capital and liquidity requirements may not be adequate, given the collapse of Bear Stearns despite compliance with the capital and liquidity limits.

TM failed to limit Bear Stearns' mortgage securities concentration, despite being aware of the growing concentration of such securities beyond Bear Stearns own internal limits. TM should have required a leverage ratio limit on CSE firms, and should have forced Bear Stearns to reign in its leverage. Despite having knowledge of them, TM failed to encourage Bear Stearns to address serious deficiencies in their risk management and pricing models.

TM concurred with 20 of the 23 relevant recommendations.

What is the Consolidated Supervised Entity program? That's what replaced the Net Capital Requirement Law of 1975 and was the SEC program created to monitor market risk in it's place.

What does that mean? It means the division of the SEC responsible for monitoring firms leverage and risk and exposure and all that stuff? Well, their models were crap and then even when they kind of saw everything spiraling out of control at Bear Stearns? They didn't say anything!!!!

How do you like them apples?

But back to our woman of the hour, Ms. Nazareth. Here on the SEC Open Meeting Agenda for April 28, 2004 we find this little nugget:

Item 3: Alternative Net Capital Requirements for Broker-Dealers that are Part of Consolidated Supervised Facilities and Supervised Investment Bank Holding Companies.

The Commission will consider whether to adopt rule amendments and new rules under the Securities Exchange Act of 1934 ("Exchange Act") that would establish two separate voluntary regulatory programs for the Commission to supervise broker-dealers and their affiliates on a consolidated basis.

It goes into a bunch of other stuff that is venturing off into the tall weeds for now, but I'm not done with this thing yet and will report back. Perhaps I will attempt to contact Ms. Nazareth's former underlings at the SEC who worked on this project for further information:

For further information, please contact Linda Stamp Sundberg at (202) 942-0073, Bonnie Gauch at (202) 942-0765, Rose Wells at (202) 942-0143, David Lynch at (202) 942-0059, or Matt Comstock at (202) 942-0156.

But right now there are more pressing matters about Ms. Nazareth to address. For instance her view on the Net Capital Requirement Law of 1975 as expressed to the SEC historian, Kenneth Durr:

AN: "...everybody over the years had come saying we really have to do some sort of net capital reform, that the net capital rule needed updating."

KD: Explain that a little.

AN: We had a rule in place that, given modern risk management techniques, was considered somewhat rudimentary or antiquated. We imposed high capital charges for securities positions that did not take into account things like portfolio margining and value at risk analysis and the like, and there were a lot of people on Wall Street who believed that the Commission should be moving more in that direction as the banks had done with the Basel Accord. There was a lot of pressure to do that. It's a very, very complicated issue and we did ultimately make some significant changes, but something that I thought would be easy was not easy and I can say it took us nearly seven years to do it, I think if I hadn't been here so long it wouldn't have gotten done."

There you have it my friends, out of the mouths of SEC Commissioners. Which brings me to my next questions: Who were these "lot of people on Wall Street?" What were the real forces behind the move to emulate the Europeans and the Basel Accord, and why? Who was applying the pressure to move away from a regulatory requirement that had seemed to be working just fine up to this point? More questions than answers at this point possums. For now.

But this is really what I wanted to share. You'll be happy to know that Ms. Nazareth, a Democrat, is no longer with the SEC. (A screen capture is provided just in case the article starts to disappear like these Democrat things sometimes do.)

Okay - are you sitting? Have you swallowed your beverage to avoid screen spew? Good.

Get this. So now, Ms Nazareth, the one SEC Commissioner and DEMOCRAT that most certainly had a hand in lighting the fuse on this financial crisis is now going to work for "the most visible (law) firm on the front lines of the financial crisis."

How Barney Frank of her. I swear, just looking at her face and reading this makes my head want to explode.

Davis Polk fortifies its ranks: With Davis Polk the most visible firm on the front lines of the financial crisis — repping Freddie Mac, the Fed, the Treasury Dept and Citi — you wouldn’t think they need anymore firepower. But they’re getting it. Former SEC Commissioner Annette Nazareth (Brown, Columbia law) is joining the financial-regulation practice at Davis Polk, where she used to be an associate. Here’s the WSJ report.

“Right now my role is helping people navigate through this crisis and keeping them abreast of the changing landscape,” said Nazareth, 52. “There will be a big role going forward, after hopefully things settle down, with the restructuring of the financial-regulatory architecture.”

"After hopefully things settle down," she says. Like she was in Montserrat the whole time or something. It's just unconscionable.

Now, don't get me wrong. I know she isn't the ONLY one responsible for this fiasco but come on.... you name it, you claim it. If something like this had happened on my watch, I would be sitting in my room with a shaved head, drinking diet pepsi, wearing sack cloth and ashes....

Does this woman have no shame whatsoever?

I'd be remiss if I didn't comment on the Bear Stearns meltdown today

It was a cold, gray day here in Colorado. A cold front moved in from the west and we had snow flurries all day,so it was the perfect weather to stay in and blog. So blog I did. I also watched the meltdown of Bear Stearns with a sense of sad deja vu.

I went through something similar during my days at Salomon Brothers and watching this spectacle brought back a lot of memories. It was during the days of the Treasury Auction Scandal. Our lines started drying up, customers started unwinding positions, corporate finance sphincters started tightening. It was really frightening. Much more frightening than the crash of 87. I remember talking to my contacts in the cage during the run on the firm's financing structure. It was like watching someone's lifeblood ooze away. Everybody was scared. It was palpable. You could feel it in the air. From the lowly clerks, to the Managing Directors. It was very close...but somehow, by the grace of God we were able to pull it out and lived to deal another day...today, Bear Stearns didn't.

Another of the old firms bites the dust.

Some links discussing the fall of Bear Stearns can be found beneath the fold in case you're interested.

I got the chills reading this. Man, it brought it all back.

How feverish market pulled lifeline from falling giant.

The Prime Broker business is a firm's lifeblood.

Hedge funds fleeing Bear's prime broker business.

Wall Street: Where men have big balls...(but they are nothing compared to our troops. Although, I did know a couple of ex-Marines who traded bonds...)

Surprise punt on Wall Street could cost billionaire $750 million.

About the bail out...it's the biggest bailout since 1998 when more than a dozen lenders provided $3.6 billion to save Long-Term Capital Management. Oddly enough, I knew a couple of the guys at Long Term Capital, too.

Bear Stearns in $3.2 billion bailout fund.

The question is - will it be enough? Bear Stearns still struggles after receiving big bailout.

The Chaos trade

In the end financial markets are nothing more than a massive confidence game fueled by information and smart young things in fine suits and expensive shoes. (Don't get me wrong - I loved every minute of it.)

When you trade, your word is your bond. And you are only as good as your last trade.

So when the whispers questioning Bear's solvency drowned out the word of their traders on the street, the jig was up.

And Wall Streeters all gossip like old ladies. You'd be surprised.

And that is what ultimately brought down Bear Stearns.

Interestingly enough, the source of all this chatter on the street, the mortgage desk, had turned a profitable first quarter - thanks to the chaos trade. (Basically the chaos trade is the Wall Street version of the Clinton campaign "kitchen sink" strategy. You crunch the numbers and throw everything but the kitchen sink at it. It's a massive crapshoot.)

Another oddity in this deal centers on Bear's mortgage trading desk. While much has been justifiably made of that desk's central role during the wide-ranging global credit collapse - it was perennially the first- or second-biggest underwriter on Wall Street - the embattled desk actually made money in the first quarter, Bear execs said.

Over the previous three months, Bear's mortgage and asset-backed trading desks shifted a portion of their capital into a series of proprietary trades designed to profit from the ongoing maelstrom. Notionally called hedges, in reality they were a series of free-standing bets that Bear executives dubbed The Chaos Trade, given the current climate.

The trades were bets pretty far afield from the standard trading of standard Freddie Mac and Fannie Mae guaranteed securities. The trades speculated on the decline of value in specific tranches of mortgage securities, futures on bond indexes, the shape of the yield curve and individual brokerage and bank bonds.

The payoff for Bear from the so-called chaos trade was impressive: $1.9 billion in one quarter, nearly off-setting the $2.5 billion write-down, Bear execs said. On top of that, one senior Bear executive told Fortune that in the quarter, the firm made $800 million on a series of other mortgage trades, giving its desk a profit for the quarter. The senior Bear executive declined to characterize the nature of the trades.

Read all about it here: JP Morgan and the Fed inherit the chaos trade.

Could they have pulled it out? Maybe. Maybe not. If I knew the answer to that I wouldn't be fighting the jihad in my pajamas, I'd be swilling champagne and flying in my G-5 to my private island in the Caribbean for a few days. I do know that this post subprime market is a boil that needs lanced. And that's what we're seeing. The good news. The markets are working. Confidence in the market held. For today. Stocks and treasurys rallied. The dollar held. Oil advanced and retreated. The bad news: It's not over yet: MF Global is causing a stir and will be closely watched. Lehman and Goldman are reporting tomorrow and they will be important. Citibank, Washington Mutual are also on the rumored list. No doubt there are more lurking out there. Another Fed action is expected Tuesday and the Captain still has the seatbelt sign illuminated, possums.
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The Art of the Deal

Sometimes you eat the bear, sometimes the bear eats you.

blackhedd (now, there's a nic for you) over at RedState has put up an excellent series of articles on recent events in the US financial markets. If you loved Chaos Trade , Pay Attention to the Signs and Bear Stearns Meltdown you will dig: More on the Federal Reserve's St. Patrick's Day Massacre. The comments are illuminating and entertaining, as well. Definitely click-worthy.

Here's a sampling to get you started:

I now have much more information on what this deal is all about. I guessed quite wrong about the deal structure. The $30 billion loan is not a term repo as I originally thought. Nor is it likely to generate monetary losses for taxpayers. (In fact, the opposite is true.)

But it is something bold and different that's worth understanding. In fact, it's a major milestone event in the monetary and financial history of the United States.

Before I launch into this, let me set the context by reminding you why all this financial mumbo-jumbo is important: it's because of politics. Even before the full effects of the credit crisis make themselves felt, we're already deeply into a paroxysm of "the sky is falling! What is the government going to do about it?" I'll be posting as much as I can on this subject in the coming days and weeks, because there is at least as much danger to the real economy from a mad dash toward new regulations and Federal involvement, as there is from the financial-system disorders themselves.
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Again, I would be remiss...if I didn't mention the Bear in the living room

and if I didn't comment upon JP Morgan Chase's tendering an offer in principle to acquire Bear Stearns for $2.00 per share. The offer is shockingly low, and it's sad to see such an ignominous ending to a long-time scrappy player on the street. Lots of whispers about the long term viablility of Goldman Sachs and Lehman. This would truly be shocking as Goldman and Lehman are two of the last of the old time, white shoe investment firms on the street.

The signs are bearish.

I also don't remember the last time the Fed cut rates on a Sunday. The formation of a new lending facility for broker dealers is big news, too. Way.

Buckle up, possums. Monday looks like it could be a bumpy one. Japan stocks slide 4%, credit fears abound.
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Throwing the Bank babies out with the bathwater...

You scrub my back, I'll scrub yours.

We have a good deal of comfort about the capital cushions at these firms at the moment.” — Christopher Cox, chairman of the Securities and Exchange Commission, March 11, 2008.

I've been sitting here this week watching this whole market mess, scratching my head and trying to figure something out. How did these damn banks get so over-leveraged in the first place? I distinctly remember our firm having to comply with a net capital rule that required us to maintain levels of capital based on our trading positions. $ that would serve as a cushion in the event of market craziness or unexpected market downturns. This would have gone a long way in preventing the collapse of the investment banks and the current condition of the commercial banks.

It's been bugging me so I did a little google scratching and I found out why John McCain was calling for the head of Chris Cox, the chairman of the Securities and Exchange Commission. And why John McCain probably has a valid point.

The SEC threw that rule out the window and with it went any hope that sanity would prevail on Wall Street.

More about the net capital rule:
"The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers, or companies that trade securities for customers as well as their own accounts. It requires that firms value all of their tradeable assets at market prices, and then it applies a haircut, or a discount, to account for the assets' market risk. So equities, for example, have a haircut of 15%, while a 30-year Treasury bill, because it is less risky, has a 6% haircut. The net capital rule also requires that broker dealers limit their debt-to-net capital ratio to 12-to-1, although they must issue an early warning if they begin approaching this limit, and are forced to stop trading if they exceed it, so broker dealers often keep their debt-to-net capital ratios much lower."

What happened when the rule got thrown out the window:
The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.

How the rule got thrown out the window. (Why on Earth would we be following the EU's lead in this matter? I'm sure it had something to do with competition, but I still find it curious.)
In 2004, the European Union passed a rule allowing the SEC's European counterpart to manage the risk both of broker dealers and their investment banking holding companies. In response, the SEC instituted a similar, voluntary program for broker dealers with capital of at least $5 billion, enabling the agency to oversee both the broker dealers and the holding companies. This alternative approach, which all five broker-dealers that qualified — Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley — voluntarily joined, altered the way the SEC measured their capital. Using computerized models, the SEC, under its new Consolidated Supervised Entities program, allowed the broker dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1. (gadzooks!) It also removed the method for applying haircuts, relying instead on another math-based model for calculating risk that led to a much smaller discount.The SEC justified the less stringent capital requirements by arguing it was now able to manage the consolidated entity of the broker dealer and the holding company, which would ensure it could better manage the risk.

Well, it looks like they were wrong. Another case of bad mathematical modeling and even worse judgment. To further complicate matters:

The SEC said it has no plans to re-examine the impact of the 2004 changes to the net capital rule, and last week, it put out a proposal to revise the rule once again. This time, it is looking to remove the requirement that broker dealers maintain a certain rating from the ratings agencies.

Now, I'm sure this is because of some pissing match between the SEC and the ratings agencies but this action even FURTHER erodes controls. (The failures of the rating agencies throughout this debacle are a WHOLE OTHER STORY, but that is getting off in the tall weeds for Dinah).

Look for this rule change to be the focus of the Dem show trials against the Repubs. You know they're coming. I'm starting to wonder if John McCain saw this handwriting on the wall and called for Chris Cox's head as a pre-emptive strike. If W would have gone along with him - it would have taken the issue off the table for the Dems. Or at least given John a leg to stand on when it comes up - and you know this is going to come up. You can already see the vague outlines taking shape in the Dems squawking points about DEREGULATION. I hate to admit it - but in this case they're right.

It was sheer lunacy to unleash the capital requirement constraints from these guys. And now I'm wondering who was behind the push for the rule change to begin with. Hmmm. Time to do more google scratching.

If you're still interested in learning about this clusterphuk, a more indepth article can be found here.

Does the Oracle of Omaha know something we don't?

Okay, I was feeling pretty cool, calm and collected about this whole market meltdown until I heard that Warren Buffett, aka the Oracle of Omaha, was pumping $3 billion cash into General Electric in advance of a $12 billion stock offering because GE is having trouble raising money in the capital markets. Hearing this gives me pause, possums. General - freaking - Electric people!

General Electric Co. (GE) announced an offering of "at least" $12 billion in common stock as the economic bellwether joined a number of other financial giants that have been forced to raise capital in recent weeks.

In addition, Warren Buffett's Berkshire Hathaway (BRKA BRKB) again slid into the role of a rescuer as it agreed to buy $3 billion in perpetual preferred stock from GE in a private offering.

The moves come as the conglomerate, whose finance arm brings in nearly half its revenue, has joined the broad financial sector in recent weeks in seeing its stock get pummeled by investors' worries amid the credit crisis.

But until last week, the company had held strong that its finance arm was having no troubles.

That changed last week as the company cut its third-quarter and full-year earnings guidance, citing "unprecedented weakness and volatility in the financial-services markets," and announced a number of major moves -- including suspending stock buybacks and likely not having a dividend increase for the first time since the 1970s -- to strengthen its capital and liquidity.

Shares of GE were recently down 3.8% to $24.51. The stock has fallen 34% year to date. Credit default swaps for General Electric Capital Corp., the financing arm, tightened dramatically on the news. It now costs $500,000 to protect $10 million of bonds for five years, down from $650,000 prior to the announcement, according to Phoenix Partners Group. The debt-protection costs had hit as high as $740,000 earlier Wednesday as anxiety swirled over GE's ability to access commercial paper and other debt markets.

I've been bailed out by Warren Buffett before. Yep. Remember the 1991 Treasury Auction scandal? Probably not, it was limited to a single firm - mine, and it was the presence of Warren Buffett that pulled the firm I worked back from the precipice of doing a Lehman or a Bear Stearns.

There had been hanky-panky at the Fed Auction, two top execs knew it, didn't do anything about it and the firm got caught. It was a devastating blow to our major business and our name became mud with pretty much everyone, prime brokers, the feds, the banks, the customers. Everybody. When they lost confidence in us, we lost our credit, without credit we couldn't finance our massive positions. Almost overnight our whole business began slipping away. Enter Warren Buffett. If it hadn't been for him we would have gone under. (Sound familiar? Hanky panky, loss of confidence, loss of credit, out of business. Multiply that by the whole global financial network instead of one firm and you get an idea of the magnitude of this magilla.)

That's why I'm a little concerned about this latest investment. First Goldman, now GE? It looks like Warren is instituting a bailout program of his own. I assure you, Mr. Buffett is not doing this out of the goodness of his heart (He put the hammer to them on the terms.) and I just hope he's doing it because he thinks he will make money, not because he is afraid of this sucker going down.

After all, he does have quite a bit to lose if it does. You can understand why he would be throwing cash at this problem.

The deal’s terms are practically identical to the ones Buffett got last week in making a $5 billion investment in Goldman Sachs. Buffett will buy preferred shares paying a rich 10% dividend and redeemable by the issuer at a 10% premium. Berkshire also gets warrants to buy an equal amount of common stock at a discount to recent prices.

Will he end up being the JP Morgan of the Banking Panic of 2008.

From: Lessons of the Panic of 1907. (Finally, a Wall Street meltdown older than Dinah!)

On Oct. 17, 1907, panic began to spread on Wall Street after two men tried to corner the copper market. In the months preceding the panic, the stock market was shaky at best; banks and securities firms were contending with major liquidity problems.

By mid-October, Wall Street was paralyzed; for days, there were runs on several large banks. Millions of dollars were withdrawn, and banks closed their doors. New York City was on the brink of bankruptcy. By 1908, there was a severe but short-lived recession. The man who saved the day was J.P. Morgan, who brought together leading financiers and banks to bail out the ailing market.