For consumer advocates, housing a new agency to protect Americans from financial-product abuse within the Federal Reserve would be a defeat after lobbying for an independent body. For banks, it would represent a victory.

The Obama administration's proposal for a consumer protection agency is part of the biggest overhaul of financial regulation since the 1930s. Putting it inside the Fed, instead of creating a standalone bureau, was a compromise proposed by Senator Bob Corker, a Tennessee Republican, and Banking Committee Chairman Christopher Dodd, a Connecticut Democrat.

Barney Frank, Chairman of the House Financial Services Committee, called a Senate plan to house the proposed Consumer Financial Protection Agency at the Fed "a joke." Shielding consumers from harmful financial products is "the most conspicuous failure by the Fed," Frank said in an interview yesterday.

And this coming from Barney Frank, who's bill in the House of Representatives to create the same type of oversight agency is hardly any better!

"We have all sorts of individual agencies that protect Americans, and none of them is subservient to the regulator that is in charge of looking out for the industry," said Lauren Saunders, managing attorney at the National Consumer Law Center in Washington. "This agency has to be independent so that it can fix the problems the banking regulators failed to fix."

And none other than George Soros is agreeing with Barney Frank!

The Fed has an "innate conflict of interest" in trying to protect consumers while fulfilling its mission of safeguarding the rest of the financial system, billionaire George Soros said at a conference in New York today. "When Barney Frank called it a joke, I think he's right," Soros said.

By the way, that conference which Soros attended was called the "Make Markets. Be Markets" conference, which took place here in New York two days ago:

Nobel laureate Joe Stiglitz, Chief Economist for the Roosevelt Institute, urged us not to give up the fight to fix our broken financial system. Rob Johnson, Director of the Institute's Project on Global Finance, charged a do-nothing Administration with endangering our future as The Animals' "We Gotta Get Out of This Place" played in the background. TARP overseer Elizabeth Warren denounced credit card companies for preying on the little guy and plunging hard-working families into debt.

They were from academia. And from the private sector. They were lawyers, judges, former regulators -- and even billionaires, like the famed financier George Soros. They were people like financial analyst Josh Rosner, one of the first to call the subprime mortgage crisis -- and who now says that the securitization market is stalling our economy like a broken car transmission. And Simon Johnson, who warned of a financial 'Doom Cycle' that will spiral out of control if we don't wake up very soon. And Roosevelt fellow Mike Konczal, who forcefully showed how investment banks' risky business puts the entire economy in jeopardy.

Over and over, the participants warned that the banks -- bigger and more dangerous than ever -- are calling the shots. They have not been reigned in. And they are fighting with everything they've got to do things their way. "We've gone from 'we the people' to 'I the banks'", said Lynn Turner, former Chief Accountant of the SEC.

Go to the "Make Markets. Be Markets" site for video of the conference and all the coverage on this crucially important topic about financial reform.

It's simply ludicrous to give the Fed more power to oversee the banking sector when they had plenty of power to regulate and control the subprime bomb ticking away in the early part of the last decade and failed to use it. Alan Greenspan sat on many of the proposal to regulate the banks and is directly responsible for letting things get out of control:

"We were yelling at them in 2001 and 2002" to use their authority, says Michael Calhoun, president of the Center for Responsible Lending in Durham, North Carolina, and the current chairman of the Fed Board's Consumer Advisory Council. "It wasn't like people didn't know this stuff was going on."

Edward Gramlich, a Fed Governor from 1997 to 2005, proposed that the Fed use its bank holding company authority to examine subprime lending subsidiaries. The proposal was opposed by then-Chairman Alan Greenspan, he said, and never went to the Board of Governors.

Most Americans are unaware of this issue and do not realize that the agency most responsible for reigning in the excesses of the banking industry - The Federal Reserve - is on the cusp of getting even more power to regulate the industry. Do you really think they'll use that power now? It's almost like the fox guarding the hen house...

"Between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are at present "underwater" -- that is, the borrower owes more than the underlying property is currently worth. Commercial property values have fallen more than 40 percent since the beginning of 2007. Increased vacancy rates, which now range from eight percent for multifamily housing to 18 percent for office buildings, and falling rents, which have declined 40 percent for office space and 33 percent for retail space, have exerted a powerful downward pressure on the value of commercial properties.

"The largest commercial real estate loan losses are projected for 2011 and beyond; losses at banks alone could range as high as $200-$300 billion. The stress tests conducted last year for 19 major financial institutions examined their capital reserves only through the end of 2010. Even more significantly, small and mid-sized banks were never subjected to any exercise comparable to the stress tests, despite the fact that small and mid-sized banks are proportionately even more exposed than their larger counterparts to commercial real estate loan losses."

Got that? There's a $1.4 trillion commercial real estate bomb about to go off in this country. The only good part of this story is that it won't explode all at once:

Commercial Real Estate (CRE) is another of the several reasons the Federal Reserve will remain committed to its very low interest-rate policy for an "extended period." We believe that means all of this year and most if not all of next year. Our forecast is that the short-term interest rate in the US will be between zero and 1 percent during that period. In the case of CRE, the Fed does not have the policy of subsidy and support in place that it has for the federal housing finance agencies.

It also means more muddling along in this jobless recovery. Sheesh...

What's even crazier is this:

In its annual update of the taxes paid by the 400 best-off taxpayers, who aren't identified, the IRS also said that only 220 of the top 400 were in the top marginal tax bracket. The 400 best-off taxpayers paid an average tax rate of 16.6%, lower than in any year since the IRS began making the reports in 1992.

The average tax rate was only 16.6%? ...Really?

And how much do you have to earn in order to make it into the top 400?

To make the top 400, a taxpayer had to have income of more than $138.8 million. As a group, the top 400 reported $137.9 billion in income, and paid $22.9 billion in federal income taxes.

And finally, why did these rich families only pay an average of 16.6% of their income to the IRS?

About 81.3% of the income of the top 400 households came in the form of capital gains, dividends or interest, the IRS data show. Only 6.5% came in the form of salaries and wages.

There are many conservatives and liberals (including our president) that think the capital gains rate should go down! Think about these numbers the next time you hear someone claim that the capital gains tax rate should be reduced.

In the digital marketplace, the most effective price is no price at all, argues Anderson (The Long Tail). He illustrates how savvy businesses are raking it in with indirect routes from product to revenue with such models as cross-subsidies (giving away a DVR to sell cable service) and freemiums (offering Flickr for free while selling the superior FlickrPro to serious users).

Can creative people survive in an environment where content is given away for free?

More than a third of the streetlights in Colorado Springs will go dark Monday. The police helicopters are for sale on the Internet. The city is dumping firefighting jobs, a vice team, burglary investigators, beat cops -- dozens of police and fire positions will go unfilled:

The parks department removed trash cans last week, replacing them with signs urging users to pack out their own litter.

Neighbors are encouraged to bring their own lawn mowers to local green spaces, because parks workers will mow them only once every two weeks. If that.

Water cutbacks mean most parks will be dead, brown turf by July; the flower and fertilizer budget is zero.

It's soooo easy to just lower taxes. It's the benefits from those taxes that are taken for granted. Sure, everyone something for nothing, right? But over at The Inverse Square, Thomas Levenson writes how anti-tax, small-government supporters never seem to comprehend that services that we all pay for - together - through taxes, "include a bunch of stuff essential for a sound economy and any chance of achieving what is commonly thought of as the American way of life."

Not too long ago, a magazine in Manhattan invited me, by e-mail, to interview for a job. After meeting with me, the managing editor and the director of human resources asked me to take home the standard editing test and return it ASAP. I dutifully obliged.

And then I waited. One day. Two days. A week. A month. Two months. Three … well, you get the picture.

So...what did this writer do?

I have grown weary of this kind of "dissing." People who seem to go blind, mute and limp when all you are seeking are a few keystrokes in reply. Prospective employers whose computers appear to crash when asked to give something resembling a definitive answer, one way or the other.

Annoying e-mail messages plague all of us, but those of a more legitimate nature are surely deserving of a simple reply. Unfortunately, basic e-courtesy is in short supply. So, having been burned in the past by e-boors, I decided that enough was enough. The magazine had left me in limbo. I was going to have my revenge.

Now check out what he does:

Sitting down at my computer one morning, I e-mailed the managing editor to say that I had happily accepted the job. More specifically, I wrote that I was "delighted to learn that I will be joining the editorial team!" I went on to say that "the salary and vacation are fine and I will report for duty bright and early Monday morning."

...and this is where it gets delightful:

Whereupon, after the prolonged cold shoulder I had received, I was immediately bombarded with urgent e-mail messages, accompanied by the online equivalent of bells and whistles -- the red exclamation point. Urgent messages were left on my answering machine, demanding that I call Human Resources at once. It was just too delicious.

When I finally did call back, the H.R. director was beside herself. "Who authorized this?" she demanded breathlessly. "Who was it that told you? There must have been some mistake. Nobody cleared this with me. I don’t get it."

"Well," I said sweetly, "I spoke to the editor in chief and he told me I’ve been hired, so I'll be there first thing Monday. And, let me tell you, I am truly excited about joining your team!"

"But … but … but …" she sputtered.

Revenge...sweet revenge, indeed:

"Listen, lady," I told her, "when you ask someone to come in for an interview, take a test and physically return it to you, and you can't be bothered after three months to let that person know where he or she stands, much less acknowledge even receiving the test back, you are nothing but rude, thoughtless, unprofessional amateurs."

Huffily, she started to give me the stock speech about "our hiring procedures," until I abruptly cut her off with the appropriate barnyard epithet. Then I barked: "Do you get it now? Well, do you?"

Meekly, she conceded, "Yes, I get it."

Now that's the way you handle an e-snub!

Time was, Americans would do anything to pay their mortgage -- forgo a new car or a vacation, even put a younger family member to work. But the housing collapse left 10.7 million families owing more than their homes are worth. So some of them are making a calculated decision to hang onto their money and let their homes go. Is this irresponsible?

Businesses -- in particular Wall Street banks -- make such calculations routinely. Morgan Stanley recently decided to stop making payments on five San Francisco office buildings. A Morgan Stanley fund purchased the buildings at the height of the boom, and their value has plunged. Nobody has said Morgan Stanley is immoral -- perhaps because no one assumed it was moral to begin with. But the average American, as if sprung from some Franklinesque mythology, is supposed to honor his debts, or so says the mortgage industry as well as government officials.

Which is exactly his point. Why should the average American be treated any different from the average corporation when it makes a business decision?

And yet multi-gazillion-aire Hang Paulson wants us to act differently:

Former Treasury Secretary Henry M. Paulson Jr. declared that "any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator -- and one who is not honoring his obligation." (Paulson presumably was not so censorious of speculation during his 32-year career at Goldman Sachs.)

Imagine how the banks would act if we average Americans walked out all together? Think they would re-negotiate the terms of the contract?

Homeowners operate under a "powerful moral constraint" while lenders are busily trying to maximize profits. More important, it might get the system unstuck. If lenders feared an avalanche of strategic defaults, they would have an incentive to renegotiate loan terms. In theory, this could produce a wave of loan modifications -- the very goal the Treasury has been pursuing to end the crisis.

Voila! Treat the housing market like the business it really is, and suddenly you'd get a much quicker return to normalcy.

Listen up bankers! You won't know what hit you once us customers get our acts together!!

The link between success and luck is stronger than many people think. Analysis of this connection provides a useful framework for weighing the issues raised around the country at recent "tea parties," where orators in high dudgeon bemoaned their "crippling" tax burdens. Responding to President Obama's plan to let the Bush tax cuts for top earners expire in 2010, one protester's placard read, "Spread your own damn wealth around!"

Other protesters contended that the tax system already strains the vital connection between individual effort and reward and warned that further tax increases might destroy it.

But these accusations don't withstand scrutiny. The current system is much fairer than many people believe, and the president's proposal will make it both fairer and more efficient.

Contrary to what many parents tell their children, talent and hard work are neither necessary nor sufficient for economic success. It helps to be talented and hard-working, of course, yet some people enjoy spectacular success despite having neither attribute. (Lip-synching members of boy bands? Money managers who bet clients' retirement savings on subprime-mortgage-backed securities?)

This seems particularly accurate:

Although people are often quick to ascribe their own success to skill and hard work, even those qualities entail heavy elements of luck. Debate continues about the degree to which personal traits are attributable to environmental and genetic factors. But whatever the true weights of each, these factors in combination explain nearly everything. People born with good genes and raised in nurturing families can claim little moral credit for their talent and industriousness. They were just lucky. And they are vastly more likely to succeed than people born without talent and raised in unsupportive environments.

For instance, as Frank points out from Malcolm Gladwell's book, "Outliers":

A disproportionate number of pro hockey players owe their success to the accident of having been born in January, which made them the oldest, most experienced players in every youth league growing up. For that reason alone, they were more likely to make all-star teams, receive special coaching and eventually become professionals.

And there's this:

As a Peace Corps volunteer in Nepal long ago, I hired a cook who had no formal education but was spectacularly intelligent and resourceful. Beyond preparing excellent meals, he could butcher a goat, thatch a roof, plaster walls, resole shoes and fix broken alarm clocks. He was also an able tinsmith and a skilled carpenter. Yet his total lifetime earnings were less than even a very lazy, untalented American might earn in a single year. Well-paid Americans owe an enormous, if rarely acknowledged, debt to the social investments that supported their success.

Egg-zactly...

Which leads us to the phase-out this year of Bush's tax cuts for the wealthy, enacted 10 years ago:

The president's proposal is modest: raising the top marginal tax rate from 35 percent to 39.5 percent, its level when Bill Clinton left office and well below the corresponding level in most other industrial countries. There has never been a shortage of talented people willing to work hard for success -- even in countries with top rates much higher than 50 percent. And the president's proposal would not cause such a shortage in 2010.

Let's keep the following in mind the next time we see those Tea Baggers huffing and puffing:

Financially successful tax protesters seem blissfully unaware of how incredibly fortunate they are. To borrow from the late Ann Richards and her description of the first President Bush, they were born on third base and thought they'd hit a triple.

On November 6th, President Obama signed the Worker, Homeownership and Business Assistance Act of 2009 into law, extending unemployment benefits by 20 weeks and renewing the first-time homebuyer tax credit until next April.

So far so good.

But tucked inside the law was another prize: a tax break that lets big companies offset losses incurred in 2008 and 2009 against profits booked as far back as 2004. The tax cuts will generate corporate refunds or relief worth about $33 billion, according to an administration estimate.

Not necessarily a bad thing if in fact that money went towards hiring laid-off workers.

Before the bill became law, the so-called look-back on losses was limited to small businesses and could be used to counterbalance just two years of profits. Now the profit offset goes back five years, and the law allows big companies to take advantage of it, too. The only companies that can’t participate are Fannie Mae and Freddie Mac and any institution that took money under the Troubled Asset Relief Program.

OK...so a program that was originally created to help small businesses is now benefitting any sized company? No matter if they don't need the money? According to the reporter, Gretchen Morgenson of the NY Times:

Among the biggest beneficiaries are home builders, analysts say. Once again, at the front of the government assistance line, stand some of the very companies that contributed mightily to the credit crisis by building and financing too many homes.

And how much tax payer money are they likely to receive?

Pulte Homes, which will receive refunds exceeding $450 million under the new law, has $1.5 billion in cash and cash equivalents on its balance sheet, according to its most recent financial statement.

Hovnanian Enterprises is another big beneficiary of the tax break. It anticipates a refund of $250 million to $275 million next year. It had $550 million in cash in its most recent quarter.

Smaller recipients include Standard Pacific, which is poised to reap cash refunds of $80 million under the new tax break. According to its most recent financial filing, Standard Pacific held $523 million in cash and cash equivalents.

Finally, Beazer Homes told investors that it expects to receive a refund of $50 million. The company reported cash and equivalents of $557 million at the end of September.

Did you tally the amount these four companies are scheduled to receive? Just these four companies alone will get over $800 million in tax-loss carry-back refunds!!

And for what exactly are they planning on using this money? It's hard to tell:

Ken Campbell, the chief executive of Standard Pacific, said the money would allow his company to continue buying land. "Will we build more houses or will there be more people employed in the first quarter? Probably not," he said. "Will employment accelerate when the market starts to grow? It will."

Caryn Klebba, a spokeswoman for Pulte Homes, said in a statement that the company planned to use the funds it receives "to support its current operations and, when market conditions improve, fund future growth and expansion."

As Morgenson states, it's very obvious that "job creation does not seem imminent, notwithstanding the claims of the administration or those in Congress who supported the giveaway. Pretending to promote job creation, the government is dispensing cash to companies that either do not need it or need it precisely because they didn't run their businesses prudently. Isn’t there something wrong with that picture?"

Post-script: Check out the return on investment to these companies' lobbying efforts:

Among individual companies, Lennar spent $240,000 lobbying while companies affiliated with Hovnanian Enterprises spent $222,000. Pulte Homes spent $210,000 this year. That's some return on investment. After spending its $210,000, Pulte will receive $450 million in refunds. And Hovnanian, after spending its $222,000, will get as much as $275 million.

In September 2008, multiple U.S. financial institutions had failed or were on the brink of failure as a result of an escalating crisis in the financial markets. By September 2008, bankruptcy loomed for AIG, in part because AIG was unlikely to be able to raise the capital needed to meet additional calls for large collateral payments in the case of an anticipated downgrade in its credit rating by credit rating agencies. On the afternoon of September 15, 2008, the three largest credit rating agencies -- Standard and Poor's Financial Services, Moody's Investors Service, Inc., and Fitch Ratings Ltd. -- downgraded AIG. On September 16, 2008, because of concerns that an AIG bankruptcy could cause systemic risk to the entire financial system and the American retirement system, the Federal Reserve Board, with the support of Treasury, authorized the Federal Reserve Board of New York (FRBNY) to lend up to $85 billion to the firm. Despite this initial Government assistance, AIG's financial difficulties continued, and there were concerns that a further downgrade was forthcoming. Additional downgrades, among other things, could trigger requirements for AIG to make additional collateral payments (referred to as "posting collateral") to AIG's counterparties. The downgrades could thus exacerbate the liquidity drain and the payments to swap counterparties.

Thus began all the fun (so to speak):

The Federal Reserve Board authorized FRBNY to create a special purpose vehicle ("SPV") called Maiden Lane III and to lend it up to $30 billion to buy collateralized debt obligations ("CDOs") underlying the credit default swaps from AIG's counterparties.

And who exactly were these counterparties? The eight largest were: Societe Generale, Goldman Sachs, Merrill Lynch, Deutsche Bank, UBS, Calyon, Barclays and Bank of America. A complete list of these counterparties can be found here. And this page gives the timeline leading up to the creation of Maiden Lane III.

As AIG's financial condition was deteriorating, FRBNY was monitoring the situation because they knew that if AIG failed, it would be a far bigger disaster for the economy. Lehman Brothers had just gone bankrupt, and it was clear that the repercussions of that failure were ringing far and wide, and Lehman Brothers only had about $8 billion in commercial paper that was exposed. By contrast, AIG had $20 billion in commercial paper outstanding that was owned by institutional investors and money market funds that would likely have taken losses had AIG failed. In fact, one of the biggest ramifications of the Lehman bankruptcy was that mutual funds that were supposedly risk-free suffered when their holdings in Lehman bonds and commercial paper went to zero:

Federal Reserve and Treasury officials discussed whether a default on AIG's commercial paper could lead to further "breaking-of-the buck" for money market funds. Money market funds are considered among the safest investments and maintain a net asset value of $1 per share. When the fund falls below $1 per share, it is known as "breaking the buck," an event that had not occurred in many years. After Lehman filed for bankruptcy, the Reserve Primary Fund, the oldest money market fund in the United States, was forced to write off debt issued by Lehman (about $785 million). As a consequence, on September 16, 2008, the Reserve Primary Fund dipped below $1.00 per share, thereby "breaking the buck," which further aggravated the credit crisis

This was the single-most significant (and terrifying) moment of the financial crash of 2008:

The resulting market anxiety contributed to a run on the Reserve Primary Fund in which investors attempted to withdraw their money quickly. In addition, large-scale redemptions caused money market mutual fund companies to hoard cash rather than invest in funding markets, such as commercial paper and certificates of deposit. In the final analysis, the Federal Reserve and Treasury believed that the risks of not rescuing AIG outweighed the risks associated with rescuing the troubled insurance company, and on September 16, 2008, the Federal Reserve Board authorized an $85 billion credit facility for AIG.

The report then takes a step back from there and analyzes the private efforts to rescue AIG that were being orchestrated by the FRBNY. It shows that many of these so-called "expert" financial gurus had no idea what the true underlying value of the CDOs really were. In fact, AIG had previously retained BlackRock Solutions (BRS) to evaluate AIG's swap portfolios and underlying CDOs, because they weren't sure what these things were actually worth. To make matters worse, the FRBNY had no idea what the true value of these toxic assets were. When the private consortium opted not to bail out AIG and the FRBNY stepped in with their decision to rescue AIG, they hadn't even developed a plan for the bailout and had to rely on the BlackRock plan!

When the consortium declined to assist AIG and the three largest credit rating agencies downgraded AIG on September 15, 2008, the Federal Reserve and Treasury made the decision, within a matter of hours, that FRBNY would provide $85 billion in financing to AIG. FRBNY did not develop a contingency plan in the event that the private financing did not go through and did not conduct an independent analysis regarding the appropriate terms for Government assistance to AIG; instead it used in substantial part the economic terms of the private sector deal, albeit for $85 billion instead of the $75 billion prepared by JPMorgan Chase for the unsuccessful private sector solution.

So, FRBNY had no contingency plan and they had no idea what these CDOs were worth. So what did they do?

A senior vice president of FRBNY confirmed with SIGTARP that BRS's knowledge of the portfolio and their analytical work were important to FRBNY's efforts to rescue AIG. As a result, FRBNY decided to hire BRS to assist FRBNY in its evaluation of AIG's liquidity needs. A BRS managing director noted that AIG's swap exposure was complicated for two reasons:

First, each swap contract had a different credit event that would trigger a collateral posting under the contract. Second, the counterparties had different mark-to-market valuations for the underlying CDOs than AIGFP, therefore making the swap exposures difficult to track. For example, AIGFP could have marked a CDO at 85 cents on the dollar while the counterparty could have marked the CDO at 70 cents on the dollar on its own books, which, among other things, created potential disputes with the counterparties as to the amount of collateral owed. In late September, FRBNY asked BRS to help them analyze a portfolio of multi-sector CDOs that would eventually become Maiden Lane III.

In addition to the complexities of valuing these multi-billion dollar CDOs, the original terms of the $75 billion private consortium bailout that the FRBNY adopted from JPMorgan and BlackRock included an onerous 11% interest payout from AIG to the government. It became quickly evident that those terms would increase the likelihood of AIG going bankrupt:

An FRBNY official told SIGTARP that, by September 17, 2008 -- the day after FRBNY provided initial assistance to AIG and two days after AIG's downgrades -- it was clear that the rating agencies were planning another downgrade of AIG because of the deteriorating financial condition of the company and the impact the $85 billion FRBNY loan could have on AIG's capital structure, including the high interest rate payments AIG would have to make to FRBNY. FRBNY's General Counsel emphasized in an interview with SIGTARP that FRBNY "inherited the bank consortium deal," that the interest rate was too high, and that FRBNY recognized the need to restructure the deal by making it less onerous to AIG soon after the agreement was signed.

And hence we get to the second core part of this story: The Federal Government had in place ZERO oversight of this conglomerate, they knew nothing about these toxic assets, and were therefore completely and woefully unprepared to deal with this monstrosity. The FRBNY didn't "inherit the bank consortium," they simply had no plan of their own!

FRBNY had not purchased these toxic assets yet, but it was clear that as they were decreasing in value, the amount that AIG had to cough up to pay their counterparties on their insurance policies that they had purchased was going to drive AIG into bankruptcy. And it became very clear, after repeated efforts by FBRNY to re-negotiated the terms of these insurance policies with AIGs counterparties wer rebuffed, that the only solution was for FBRNY to purchase these toxic CDOs (thereby creating Maiden Lane III) and to terminate the insurance policies. And this is where the valuation issues came into play.

The counterparties (Goldman, Society General, Merrill Lynch, et. al) refused to take less than 100% on the dollar of their insurance policies. They wanted AIG to make them whole - the same as if your car was totaled and GEICO said that they couldn't reimburse you for the value of the car, you would just say, "no, I'm entitled to 100% of the value of my car." If GEICO went bankrupt, you'd be out of luck, right? It was the same with AIG going out of business, except that its counterparties knew that they held the upper hand. They didn't have to negotiate with the government because they knew that the FBRNY would never let AIG go bankrupt, as that would lead to the complete cratering of the entire economy.

Now, according to the Barofsky report (starting here), the government did try to negotiate with the counterparties to settle on some value whereby they would take a loss on the insurance policies they purchased from AIG in exchange for taking those toxic assets off their hands. All but one gave a big fat middle finger to the government, and the only one that didn't - UBS - said that they would only be willing to take a measly 2% haircut (loss) on their insurance policies. What did the FBRNY do? They decided to compensate them effectively at Par Value - thereby making all of them whole on their insurance policies - an incredible outcome considering that the company they purchased insurance from was basically bankrupt (think GEICO going bankrupt the day you total your car and the government steps in and pays you 100% of the value of your now-worthless automobile).

On November 6 and 7, 2008, FRBNY assistant vice presidents, vice presidents, senior vice presidents, and executive vice presidents contacted eight of AIG's largest counterparties (Societe Generale, Goldman Sachs, Merrill Lynch, Deutsche Bank, UBS, Calyon, Barclays and Bank of America) by telephone. They described a proposal under which each counterparty was asked to accept a haircut from par. Seven of the eight counterparties told FRBNY officials that they would not voluntarily agree to a haircut. The eighth counterparty, UBS, said that it would accept a haircut of 2 percent as long as the other counterparties also granted a similar concession to FRBNY. FRBNY officials told SIGTARP that their concerns about credit rating downgrades limited the time available for negotiation about reductions in payments. According to an FRBNY senior vice president, the counterparties that FRBNY approached that resisted being paid anything less than the equivalent of par in exchange for terminating their credit default swap contracts cited several reasons for this (which can be found here).

For instance:

Goldman Sachs had approximately $22.1 billion of notional amount of outstanding credit default swap contracts with AIG, approximately $20 billion of which were against an underlying portfolio of CDOs. According to Goldman Sachs, it had one telephone conversation with FRBNY staff in which the possibility of concessions was mentioned. Goldman Sachs has since explained that it did not agree to concessions because it would have realized a loss if it had.

Not only did they not want to incur a loss, they claimed that they had already hedged their exposure and couldn't lose anymore, so hence, they didn't need to negotiate with the government. The facts don't bear this argument out, though:

Notwithstanding the additional credit protection it received in the market, Goldman Sachs (as well as the market as a whole) received a benefit from Maiden Lane III and the continued viability of AIG. First, in light of the illiquid state of the market in November 2008 (an illiquidity that likely would have been exacerbated by AIG's failure), it is far from certain that the underlying CDOs could have easily been liquidated, even at the discounted price of $4.3 billion. Second, had AIG collapsed, the systemic implications on other market participants might have made it difficult for Goldman Sachs to collect on the credit protection it had purchased against an AIG default, although Goldman Sachs stated that it had received collateral from its counterparties in those transactions. Finally, if AIG had defaulted, Goldman Sachs would have been forced to bear the risk of further declines in the market value of the approximately $4.3 billion in CDOs that it transferred to the Maiden Lane III portfolio as well as approximately $5.5 billion for its credit default swaps that were not part of the Maiden Lane III portfolio; Maiden Lane III removed any risk for the $4.3 billion within that portfolio, and continued Government backing of AIG provided Goldman Sachs with ongoing protection against an AIG default on the remaining $5.5 billion.

So why didn't the FRBNY intervene and make them take a haircut? They cite 7 main reasons listed here, two of which were:

As a policy matter, FRBNY was unwilling to use its leverage as the regulator for several of the counterparties to compel concessions, in part because in the negotiations it was acting as a creditor of AIG and not as the counterparties' primary regulator.

Also as a policy matter, FRBNY was uncomfortable with violating the principle of
sanctity of contract.

Do these two reasons hold up under further scrutiny,let alone the other five?

While there can be no doubt that a regulators' inherent leverage over a regulated entity must be used appropriately, and could in certain circumstances be abused, in other instances in this financial crisis regulators (including the Federal Reserve) have used overtly coercive language to convince financial institutions to take or forego certain actions. As SIGTARP reported in its audit of the initial Capital Purchase Program investments, for example, Treasury and the Federal Reserve were fully prepared to use their leverage as regulators to compel the nine largest financial institutions (including some of AIG's counterparties) to accept $125 billion of TARP funding and to pressure Bank of America to conclude its merger with Merrill Lynch. Similarly, it has been widely reported that the Government, while arguably acting on behalf of General Motors and Chrysler, took an active role in negotiating substantial concessions from the creditors of those companies.

There's one last chapter to this saga which is important to note. The Federal Reserve for many months refused to reveal the identities of the firms listed above who received the bailout vis a vis Maiden Lane III:

On March 5, 2009, Federal Reserve Vice Chairman Kohn testified before Congress about the decision to pay effectively par value to the counterparties, but refused to reveal the identities of the counterparties or payments made. Kohn expressed his judgment that "giving the names would undermine the stability of the company and could have serious knock-on effects to the rest of the financial markets and the government's efforts to stabilize them."

Ten days following the Senate hearing, and approximately four months after the first of Maiden
Lane III's payments to counterparties, AIG, in consultation with the Federal Reserve, released
the identity of the counterparties, as indicated in Table 2.

It does not appear that the disclosures had any of the negative consequences that Vice Chairman Kohn anticipated on AIG or on the markets generally.

At the end of the report, it details what comprises these toxic assets and how the value of this $20+ billion portfolio has changed in the past year:

** As of December 31, 2008, the fair value of the portfolio was $27.1 billion. ** As of March 31, 2009, the fair value of the portfolio was $20.7 billion. ** As of June 30, 2009, the fair market value of the portfolio was $22.4 billion. ** As of September 30, 2009, the fair market value of the portfolio was $23.5 billion.

And according to the report, as of September 30th, the balance of principal and interest owed to FRBNY was $19.9 billion, while the portfolio was worth $23.5 billion, netting a profit so far of $3.6 billion to tax payers. Not bad, but will we get our money back? The report says that if all goes well, and Maiden Lane III continues to pay back the loan at the same rate, it will take another 4-5 years to repay us taxpayers.

Keep in mind, though, that AIG still had $302 billion worth of exposure in credit default swaps on its books at the beginning of the year. They have been winding down this exposure over 2009, reducing by $96 billion (or 32%), to $206 billion, its exposure to these credit default swaps, most of which aren't nearly as toxic as those that exist in Maiden Lane III. Still, there remains exposure to these swaps, so if the economy were to crater again, we might have to revisit this nightmare with AIG.

The conclusion of this report can be found here and sums up the crux of this matter nicely:

Questions have been raised as to whether the Federal Reserve intentionally structured the AIG counterparty payments to benefit AIG's counterparties -- in other words that the AIG assistance was in effect a "backdoor bailout" of AIG's counterparties. Then-FRBNY President Geithner and FRBNY's general counsel deny that this was a relevant consideration for the AIG transactions. Irrespective of their stated intent, however, there is no question that the effect of FRBNY's decisions -- indeed, the very design of the federal assistance to AIG -- was that tens of billions of dollars of Government money was funneled inexorably and directly to AIG's counterparties.

The intent in creating Maiden Lane III may similarly have been the improvement of AIG's liquidity position to avoid further rating agency downgrades, but the direct effect was further payments of nearly $30 billion to AIG counterparties, albeit in return for assets of the same market value. Stated another way, by providing AIG with the capital to make these payments, Federal Reserve officials provided AIG's counterparties with tens of billions of dollars they likely would have not otherwise received had AIG gone into bankruptcy.

And there we have it, folks! The Fed stepped in and whether they were trying to save the economy or hooking up their buddies at Goldman, et. al, the end result was the same: a massive $30 billion bailout for firms that purchased insurance against losses from toxic assets from a firm that should have gone bankrupt. All because they thought AIG was "Too Big to Fail."

Lessons Learned

In the postscript of the report, we have some very valuble guidance of where to go from here:

First, AIG stands as a stark example of the tremendous influence of credit rating agencies upon financial institutions and upon Government decision making in response to financial crises. In the lead-up to the crisis, the systemic over-rating of mortgage-backed securities by rating agencies was reflected in the similarly over-rated CDOs that underlied AIGFP's credit default swaps. Once the financial crisis had come to a head, the credit rating agencies downgrades of AIG itself and of the underlying securities played a significant role in AIG's liquidity crisis as those downgrades and the related market declines in the securities required AIG to post billions of dollars in collateral. All of these profound effects were based upon the judgments of a small number of private entities that operate, as described in SIGTARP's October 2009 Quarterly Report, on an inherently conflicted business model and that are subject to minimal regulation.

Second, the now familiar argument from Government officials about the dire consequences of basic transparency, as advocated by the Federal Reserve in connection with Maiden Lane III,
once again simply does not withstand scrutiny. Federal Reserve officials initially refused to
disclose the identities of the counterparties or the details of the payments, warning that disclosure of the names would undermine AIG's stability, the privacy and business interests of the counterparties, and the stability of the markets. After public and Congressional pressure, AIG disclosed the identities. Notwithstanding the Federal Reserve's warnings, the sky did not fall.

Indeed, the sky did not fall. Although it sure looked like it would...and it still may.

Post-post script:

Make sure you read the responses of the Federal Reserve and The Treasury to this report. They are almost as important as the report itself. For instance, in The Treasury's response, they write:

Given the size and interconnectedness of AIG, it should never been allowed to escape tough, consolidated supervision at the holding company level. Due to loopholes in the bankholding company act, it was treated as a thrift holding company -- with limited consolidated supervision and no capital requirements at the holding company level.

How did that happen and what's the story behind that one?

A must-read follow-up, as well, is Gretchen Morgenson's take on this report at the NY Times.. She's been following this story like a hawk, so it's always important to get her take on these matters.

Rep. Bart Stupak's amendment did not make abortion illegal. And it did not block the federal government from subsidizing abortion. All it did was block it from subsidizing abortion for poorer women.

Stupak's amendment stated that the public option cannot provide abortion coverage, and that no insurer participating on the exchange can provide abortion coverage to anyone receiving subsidies. But as Rep. Jim Cooper points out in this interview, the biggest federal subsidy for private insurance coverage is untouched by Stupak's amendment. It's the $250 billion the government spends each year making employer-sponsored health-care insurance tax-free.

And where does all the $250 billion go?

That money, however, subsidizes the insurance of 157 million Americans, many of them quite affluent. Imagine if Stupak had attempted to expand his amendment to their coverage. It would, after all, have been the same principle: Federal policy should not subsidize insurance that offers abortion coverage. But it would have failed in an instant. That group is too large, and too affluent, and too politically powerful for Congress to dare to touch their access to reproductive services. But the poorer women who will be using subsidies on the exchange proved a much easier target. In substance, this amendment was as much about class as it was about choice.

How many Americans think of this subsidy this way? No religious leader who's against a Woman's Right to Choose thinks of this way, that's for sure. And yet, there's no difference. Whether the government gives a direct subsidy for a service, or gives that service to a citizen at a discount, it's the exact same thing. When will America wake up to this fact?

Save for Santa Claus, no icon is more recognized by our children than Ronald McDonald. This might not be so bad if the intention of the clown was not to hook our children on unhealthy food for a lifetime. With the rates of diet-related childhood health conditions soaring we are setting out to expose all the ways McDonald's uses Ronald to get close to our kids.

So goes the message from the "Stop Corporate Abuse" website of Corporate Accountability International. You, too, can get involved with their "Track Down the Clown" campaign:

McDonald's CEO Jim Skinner says "Ronald has never sold food to kids in the history of his existence," but you can help us expose the truth. Send us photos of Ronald at your local McDonald's or a video of the clown at a local event and help us build a powerful record of where and how McDonald's uses this marketing icon. Once you get started, you'll see how even the most informed and vigilant parents face an uphill battle to make sure their children eat healthy -- so much of McDonald's marketing aims to bypass them entirely!

You can also check out their general fact sheet detailing how corporations target our children, or their more specific one on how to get Ronald out of our children's lives.

So get crackin' and start to Trackin' Down the Clown!

The four biggest U.S. banks by assets may have to take writedowns on $55 billion of mortgage-collection contracts after marking them up by $11 billion in the second quarter, casting a shadow over earnings.

Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. wrote up the value of the contracts, known as mortgage-servicing rights or MSRs, by 26 percent in the quarter as mortgage rates climbed by about 0.35 percentage point. The four banks control 56 percent of the market for the contracts, according to Inside Mortgage Finance, a Bethesda, Maryland-based newsletter that has covered the industry since 1984. Servicers collect payments from borrowers and pass them on to mortgage lenders or investors, less fees. They also keep records, manage escrow accounts and contact delinquent debtors. Net gains on the contracts added more than $1 billion to Wells Fargo's record earnings in the quarter and $1 billion to JPMorgan's first-quarter profit.

It's those "net gains" that are highly questionable, and yet without them, these big banks would not have been able to show any positive earnings last quarter, which helped drive up this stock market over the past 3-6 months:

The value of the rights depends largely on the expected life of the mortgage, which ends when a borrower pays off the loan, refinances or defaults. When rates drop and more borrowers refinance, MSR values decline. Banks typically hedge those movements using interest-rate swaps and other derivatives.

Under U.S. accounting rules in place since 1995, banks are supposed to report the value of their mortgage-servicing rights on a fair-market basis, or roughly what they would fetch in a sale. A bank must record a loss whenever it sells MSRs for a price below where they're marked on the books.

Because there's no active trading in the contracts (italics ours), there are no reliable prices to gauge whether banks are valuing the rights accurately, analysts said. Banks say there is no liquid market for the securities, as the volatility of the rights has pushed some smaller firms out of the market and record delinquencies have led others to shun mortgage assets. The banks list the rights as Level 3 assets, an accounting term for securities whose value is unclear, and they rely on internal models to determine their value.

"About 75 percent of residential MSR assets are owned by 10 firms, so when you've got that supply-demand dynamic that changes, there's not going to be a whole lot of trading," said Daniel Thomas, a managing director in asset sales at Mortgage Industry Advisory Corp. in New York. "When the market is dry like it is as far as trading volume, these guys have a lot of latitude for a Level 3 input valuation."

In fact, the banks say the same thing themselves!

"The valuation of MSRs can be highly subjective and involve complex judgments by management about matters that are inherently unpredictable," San Francisco-based Wells Fargo said in its second-quarter regulatory filing.

WTF!! So essentially, these banks get to price these securities at whatever level they think is "fair." And so, how much did these untraded securities add to each bank's bottom line last quarter? Since they hedge their exposure to losses in these securities, you have to count up the value of the hedges. If the MSR goes up in value, adding to earnings, the value of their hedges goes down, reducing their earnings, and the net difference makes up whether their holdings in MSRs adds or subtracts to earnings. Last year, you had these results:

Bank of America, which lowered the value of its rights last year by $6.7 billion, still added $2 billion to its earnings as hedges outperformed the declines. JPMorgan's hedges earned $1.5 billion more than the $6.8 billion it took in writedowns on its collection contracts in 2008.

And last quarter they had these results:

Wells Fargo wrote up the value of its MSRs by $2.3 billion in the quarter, the result, it said, of model inputs and assumptions. The hedges it used to offset the movement of the servicing rights fell $1.3 billion, resulting in a net gain of $1 billion to its $3.2 billion second-quarter profit.

New York-based JPMorgan, which wrote up its MSRs by $3.83 billion in the quarter, reported a $3.75 billion loss on its hedges, leaving it with an $81 million profit. Bank of America (BOA) based in Charlotte, North Carolina, gained $3.5 billion on the increase in value of its collection contracts. The bank didn't disclose the performance of its hedges. Citigroup, which marked up the value of its rights by $1.3 billion, also didn't disclose its hedges.

And why exactly didn't Citigroup and BOA report the value of their hedges? Are they hiding something? Could be:

"Nobody wants to point out that the emperor has no clothes," said FBR Capital Markets analyst, Paul Miller (who thinks Wells Fargo stock should be trading around $15, down from its current price of almost $30). "They all took massive hedging losses over the last quarter, mainly coming out of May, when rates shot up 150 basis points, and mysteriously MSRs were written up to match those losses." A basis point is 0.01 percentage point.

These MSRs provide a huge amount of earnings to these banks, though:

Servicing rights provide a steady stream of income. The four banks collected about $4.1 billion from fees in the second quarter. Much of that revenue, about $3.2 billion, was already accounted for in the valuations of the rights.

And the irony is that because 26% of homes across the U.S. are underwater (what's owed on their homes is greater than the value of their property), more and more folks are unable to sell their residencies, which means the fees for these MSRs will continue:

"Either because people are underwater, which means it's unlikely they are going to jump out of that mortgage, or they just aren't moving around as much, those mortgages are going to last a lot longer, and that would help the valuations," said Ray Pfeiffer, chairman of the accounting department at Texas Christian University's Neeley School of Business.

But that number - 26 percent of borrowers owe more than their home is worth (according to Karen Weaver, global head of securitization research for Deutsche Bank Securities in New York) is simply stunning, and is what really popped out in this story. In parts of California, Florida and Nevada, it's as high as 75 percent. Yikes!

It seems like the real estate meltdown has a long way to go until it's resolved, regardless of which way the stock market seems to be heading.

Exelon, one of the country's largest utilities, said Monday that it would quit the United States Chamber of Commerce because of that group’s stance on climate change. It was the latest in a string of companies to do so, perhaps a harbinger of how intense the fight over global warming legislation could become.

But this is the money quote:

"The carbon-based free lunch is over," said John W. Rowe, Exelon's chief executive. "Breakthroughs on climate change and improving our society’s energy efficiency are within reach."

Could it be a new movement, or is it just an isolated case?

A wave of departures from the chamber has been building for weeks. It was heralded Monday by some Congressional Democrats and environmentalists as a sign that the business community’s opposition to global warming legislation is weakening. In their view, that improves the chances that a global warming bill that narrowly passed the House in June might also pass the Senate.

Once we get passed the health care reform debate, stay tuned for the real battle on climate change legislation. Paul Krugman's got his eye on this one, here at "Cassandras of Climate" and "It's Easy Being Green."

The warning was ominous: "Massive global wealth destruction."

That's what Lehman Brothers Holdings Inc. executives predicted before they filed the biggest bankruptcy in U.S. history. "Impacts all financial institutions," read one bullet point in a confidential memo prepared for government officials obtained by Bloomberg News. "Retail investors/retirees assets are devastated."

Thus starts the column, interspersed with tales of the effects on normal workers around the world:

Willard Scolnik, a 78-year-old retired architect in Palm Harbor, Florida, who said he had $400,000 in Reserve Primary that he needed to help pay for a lung transplant for his son, was one of the unlucky ones. He couldn't get his money out.

Boulder County was forced to write off $687,000, its share of the trust's losses, according to Bob Hullinghorst, the county treasurer. That would have paid for 20 new health-care employees, he said.

"It makes me mad," Hullinghorst said. "We thought our money was safe."

Sun Kwan, 58, a retired parks worker, said he invested $285,000, most of his life savings, in Lehman minibonds. He was among an estimated 43,000 in the city who bought $1.8 billion of the notes, according to the Hong Kong Monetary Authority. Sun lost it all and has taken part in protests since October, rain or shine, trying to get his money back.

On the otherwise uninhabited Atlantic Ocean island of West Caicos, work stopped in October on the Molasses Reef Ritz- Carlton Hotel and Residences, where cottages were priced at $6.5 million. About 400 Chinese employees of an Israeli construction firm, Ashtrom Properties Ltd., didn't get paid, according to Jonathan Siegel, New York-based managing director of the project for Logwood Hotel Development Co. Some of them protested, surrounding the temporary housing occupied by their supervisors, preventing them from leaving until they received their money.

Of course the bankers in New York were oblivious to stories like these:

The bankers who gathered at the New York Fed last September anticipated little of this. Instead, their meetings were filled with confusion, false starts and dust-ups.

That article, along with another from McClatchy are must reads this month to understand what happened and the extent of the damage that has occurred. From the Washington McClatchy bureau:

One year after the near collapse of the global financial system, this much is clear: The financial world as we knew it is over, and something new is rising from its ashes.

Historians will look to September 2008 as a watershed for the U.S. economy.

On Sept. 7, the government seized mortgage titans Fannie Mae and Freddie Mac. Eight days later, investment bank Lehman Brothers filed for bankruptcy, sparking a global financial panic that threatened to topple blue-chip financial institutions around the world. In the several months that followed, governments from Washington to Beijing responded with unprecedented intervention into financial markets and across their economies, seeking to stop the wreckage and stem the damage.

One year later, the easy-money system that financed the boom era from the 1980s until a year ago is smashed. Once-ravenous U.S. consumers are saving money and paying down debt. Banks are building reserves and hoarding cash. And governments are fashioning a new global financial order.

And on it goes...and on it goes...