Monthly Archives: April 2013

Why Support the Brown-Vitter Act?

Simon Johnson Wall Street

As we’ve covered before, Senators Sherrod Brown and David Vitter have cosponsored a bill to end “too big to fail.” Here’s why it’s worth supporting:

You know how most banks require customers to put money down before they’ll lend them money? It’s only logical: banks want a buffer in case the loan goes bad, and so the banks (if they’re smart) will require customers to pay a hearty portion, say 20%, of the loan upfront to be safe.

What’s irritating is that the Wall Street banks don’t want the same standard for themselves when they borrow money. Most Wall Street banks, in fact, only put down about 3% of their own money when they borrow. This means that a loss of just 3% will wipe out the bank’s own money (technically called “equity”).

That leads to bankruptcy and demands for bailouts, and that is exactly what happened on Wall Street in 2008. Since the Wall Street banks had so little equity, so little of their own money involved when they borrowed, a downturn of only 3% completely wiped many of them out. You know what’s sort of insane? By international accounting standards the Wall Street banks still only have about 3% of their own money involved when they borrow today (see footnote).

The Brown-Vitter Act, then, says enough is enough. It says that the six Wall Street banks have to raise their equity to 15% so that in event that a downturn occurs the bank will have to foot the bill with their own money instead of relying on the taxpayer. In other words, the likelihood of a bailout will diminish considerably.

It should go without saying that Wall Street hates this bill and is already fighting hard to stop it. It also should go without saying that the bill is only fair, after all, since the banks require the same thing when customers borrow from them.

We just joined hundreds of people in signing this petition to support the Brown-Vitter Act, and we think you should too.

Footnote: Look at the International Financial Report Standards (IFRP) column in yellow here (pdf), which shows that most banks only had about 3% down as of fourth quarter 2012.

Foreclosure Settlement Fiasco: 5 Key Details

Key details from the foreclosure settlement fiasco:

1. From 2009-2010, nearly 4 million foreclosure proceedings contained bank errors (robosigning, lost paperwork, typos etc.) from Wall Street banks.
2. These errors led to illegal foreclosures for some and years of added stress and financial losses for others.
3. In 2013, finally, regulators made Wall Street pay for their errors, but the banks got to choose who would be placed in each compensation category and so 70% of compensated households were to receive a mere $300 to $500 (see graph below).
4. When the first wave of checks were sent out, many checks bounced.
5. When the second wave of checks were sent out, nearly 100,000 checks were for the wrong amount or had been sent to the wrong address.

What’s wrong with this picture?

Wall Street got bailed out in 2008 and then proceeded to approach foreclosures with an overwhelming sloppiness. When they got caught for what they did, regulators joined them in the sloppiness at the expense of the homeowners.

In a sentence: The whole fiasco is a symbol of a broader system that has its priorities mixed up, one that decidedly favors those who, like Wall Streeters, have the most money and political influence.

It’s a system that calls for us to reform it piece by piece. We can start by openly boycotting the banks involved with this fiasco, including Bank of America, Citi, and Chase. Citizens who stay with such banks risk being ground up by them the same way these other homeowners have been.

foreclosure crisis graph

Derivatives Timeline: A History of Financial Fiascos

Note: Derivatives weren’t the sole cause of the financial crisis, but they were one crucial factor. The evidence in the timeline below demonstrates that without change, we’re bound to see more derivatives-ignited fiascos. If too many of these fiascos occur at once, we’ll risk experiencing another crisis.

Critics might take issue that we use the word “gamble” here, but given the uber-speculative nature of these transactions, we feel it’s merited. We also recognize that there are many types of derivatives and that the timeline here only focuses on the more dangerous types.

derivatives timeline

As we’ve stated elsewhere, we’re not calling for endless pages of regulation and red tape. The financial industry has been flooded with thousands of pages of regulation—much of which ends up hurting smaller lenders. Instead what we need are a few simple reforms to make derivatives transparent. We also need to ban a few of the more egregious derivatives trades (including credit default swaps).

While all derivatives aren’t harmful, the sheer scale and opacity of this market means that our economic future will continue to be fragile unless we demand reform and protest firms that engage in these practices by switching from them.

Also see: What are derivatives and why are they dangerous.


Wendy Gramm (source for quote)
Nick Leeson
Larry Summers (quote #1quote #2)
Brian Hunter
Alan Greenspan (quote #1quote #2)
Joe Cassano (source for quote)
Howie Hubler
Bruno Iksil

Lehman Brothers
MF Global

What Are Derivatives and Why Are They Dangerous?

As we recounted in the preface to our derivatives timeline, though derivatives were not the sole cause of the financial crisis, they were a crucial factor.

What are derivatives?

Derivatives are financial instruments whose value is derived from an underlying asset (stocks, bonds, commodities, etc.). Traders can swap interest rates, take bets on whether a firm will go bankrupt, safeguard against future asset price increases, etc—all under the ugly umbrella term derivative. The concept of a derivative has been around for centuries, but their use has recently exploded, as demonstrated in our timeline and in the images below.

derivatives jpmorgan chase bank of america citi

Worldwide Derivatives

Derivatives are recorded in what’s termed as notional value, which just equals the value of the underlying asset on which the derivative is based. So if the underlying asset equaled $500 million, the notional value would be $500 million even though the megabank doesn’t actually trade $500 million. They just trade the derivative. It’s complicated if you’re totally unfamiliar with this market, but at least you can see why the global notional value for the derivative market can reach into the hundreds of trillions as shown above. It’s because the megabanks are recording the notional value.

Some traders don’t think people should worry about the notional value since it’s not referencing what is actually being traded. But the notional value matters because if the underlying asset turns toxic, then the derivative itself does too.

We saw this in the 2007-08 crisis: when underlying mortgages went bad, then all the derivatives contracts on top of those mortgages also went bad, and this worsened the crisis tremendously. So the notional value of derivatives matters, and you can see from the charts above that Wall Street in 2012 is a completely different world compared to Wall Street in 2000 (when the total notional amount was less than $100 trillion). In other words, the dangers of the derivatives market are still very much with us.

So, why are derivatives dangerous?

1. Derivatives allow for phony accounting

Charlie Munger once asserted that “to say that derivative accounting is a sewer is an insult to sewage.” Well said, Munger. Derivatives allow firms the option to record profits today that will supposedly come tomorrow. This way a firm can put on a good pony show today and get a better stock price. All is well—unless tomorrow’s profits don’t arrive as expected (because of an unforeseen fiasco). If this happens a seemingly healthy firm can suddenly implode, all because of phony accounting—as happened with Barings Bank, Enron, and Lehman Brothers.

2. Derivatives obscure the market

Several derivative contracts can be written on a single underlying asset, a feature which adds enormous complexity to financial markets. A derivative contract on one asset might be traded in Asia and the US, while another contract on the same asset might be traded in Europe. What’s more, the majority of derivatives are over-the-counter, meaning they aren’t standardized or traded on public exchanges. So the terms of each contract can vary greatly and so the implications and interconnectedness of this market can be impossible for regulators and traders to see clearly. When markets melted during the 2007-08 crisis trading halted in part because market players couldn’t readily discern which firms were on the brink of collapse and which firms were safe. This was partly because of all the derivatives contracts on top of the crumbling mortgage market.

3. Derivatives concentrate risk

Four US megabanks—JPMorgan, Bank of America, Citi, and Goldman Sachs—have a notional amount of $214 trillion in derivatives exposure. That’s more than 30% of the worldwide amount just in four US banks. When firms have such concentrated derivatives exposure, they leave themselves open to surprise losses like last year’s $6 billion London Whale loss at JPMorgan Chase.

4. Derivatives allow megabanks to take on more debt

Megabanks trade risk via derivatives contracts to another firm while keeping the underlying asset on their books. This way they can bypass capital requirements and take on more debt. This in turn allows them to make more trades, but it also means that if a sudden downturn surfaces in the markets, the firm which borrowed way beyond their means may quickly go bankrupt. Lehman Brothers experienced this after they’d borrowed 30 times more money than they had in reserve. In that case a relatively small loss of 3% meant that Lehman no longer had reserves (i.e. capital), and they therefore collapsed.

5. Derivatives deceive smart people into thinking they’ve eliminated risk

It keeps happening, over and over. “The smartest men in the room” think that they’ve figured out some way to eliminate risk completely through the use of derivatives. One amazing example of this is the tragedy of Long-Term Capital Management. A group of highly intelligent economists and traders created a hedge fund in the late 1990s centered around a formula which supposedly hedged risk completely. For the first few years, the fund made enormous returns and the creators of the formula even won the Nobel Prize for economics. But then they borrowed more and more money thinking they were safe in doing so (similar to Lehman), and when a series of unpredictable events occurred in world markets, they lost billions of dollars and put US markets in danger. Their downfall should have been a warning sign about the dangers of derivatives-related risk, but several other firms suffered similar fates in the following decade. If things remain the same, we’ll see the same results.

Interested in learning more? See our derivatives timeline.

FRONTLINE: The Retirement Gamble

frontline retirement gamble

Last night on their program The Retirement Gamble, FRONTLINE exposed how median-income, two-earner households lose $155,000 over the course of their lifetimes to 401(k) fees, and how Wall Street is behind those fees.

Watch it here. The first half explains the basics of our complex retirement system. The second half explains how that system is tied to Wall Street markets.

Here’s what is so surprising about the relative lack of outrage about Wall Street. People lost an enormous portion of their retirement in the financial crisis and saw the value of their house plunge, and yet many people seem to think that it was all chance—just bad luck, like ugly weather. But these things weren’t a matter of chance. People are being duped by Wall Street and they don’t even know it. If you want to see how to properly prepare for retirement in a way that cuts Wall Street out of the equation, watch the FRONTLINE documentary.

You can also read a good review of the documentary here. An excerpt:

Having worked for a major Wall Street firm for many years, I can tell you that the folks like Mr. Falcon, who run big divisions of these large institutions, are very savvy and highly trained with respect to making media appearances.  They’re the best of the best, and they never fumble. His awkward response to the question underscores the fact that this industry has run virtually unquestioned.

We don’t mean to pick on Mr. Falcon, the fact is that there is no intelligent way for anyone in his shoes to defend the punitive nature of investment-related fees and expenses.  The mainstream media, or more specify the financial media, wouldn’t dream of asking a high profile industry executive these kinds of “gotcha” questions.  If they embarrass their industry guest they will be boycotted, and no major financial firm will allow their firms to be exposed like this. These media outlets also risk losing large advertising clients if they alienate the industry.

Visual Proof Wall Street Is Planting the Seeds of Another Crisis

NYTimes Graph, emphasis on '05 and '13 ours  Everyone understands that the housing market tanked in 2007-08. What's harder to grasp is how Wall Street was involved with it all.  It's complicated.  But essentially it boils down to the fact that, as Nate Silver points out in The Signal and the Noise, "for every dollar that someone was willing to put in a mortgage, Wall Street was making almost $50 worth of bets on the side."  The boring, technical name for these bets is "mortgage-backed securities."  The NYTimes chart above shows that mortgage-backed securities are currently being issued at the same rate they were issued in early 2005,meaning that now that the housing market is showing slight signs of recovery Wall Street is eager to get back to making money off it.  After all, the Wall Street banks that were savvy in screwing over dumb financial institutions (see: AIG, Lehman), ended up with a good deal, especially since they got to keep the profits they made in the good years and get bailed out in the bad. Why wouldn't they want to repeat history, when history was good to them? They'll just say things are different this time because they've learned how to properly manage these bets.  We shouldn't have trusted Wall Street prior to the last financial crisis, and we shouldn't trust Wall Street now.   Move your money from the Wall Street banks that issue mortgage-backed securities (Citi, Chase, Bank of America, etc.). Don't support institutions that continue to put world markets at risk for personal accumulation. NYTimes Graph, emphasis on ’05 and ’13 ours

Everyone understands that the housing market tanked in 2007-08. What’s harder to grasp is how Wall Street was involved with it all.

It’s complicated.

But essentially it boils down to what Nate Silver pointed out in The Signal and the Noise:

For every dollar that someone was willing to put in a mortgage, Wall Street was making almost $50 worth of bets on the side.

The boring, technical name for these bets is “mortgage-backed securities.”

The NYTimes chart above shows that mortgage-backed securities are currently being issued at the same rate they were issued in early 2005, meaning that now that the housing market is showing slight signs of recovery Wall Street is eager to get back to making money off it.

After all, the Wall Street banks that were savvy in screwing over dumb financial institutions (see: AIG, Lehman), ended up with a good deal, especially since they got to keep the profits they made in the good years and get bailed out in the bad. Why wouldn’t they want to repeat history, when history was good to them? They’ll just say things are different this time because they’ve learned how to properly manage these bets.

We shouldn’t have trusted Wall Street prior to the last financial crisis, and we shouldn’t trust Wall Street now.

Move your money from the Wall Street banks that issue mortgage-backed securities (Citi, Chase, Bank of America, etc.). Don’t support institutions that continue to put world markets at risk for personal accumulation.

Ten Hedge Fund Managers Made More Combined Than 250,000 Teachers

 Hedge fund managers make more than teachers Yankees
The Problem With Hedge Fund Managers

Author Les Leopold wrote an explosive piece last week about the problem with hedge fund managers in the United States. We recommend reading it in full, and we agree with both his complaints about hedge funds (that they manipulate markets and thrive on insider trading), as well as his suggestions to fix the system (by implementing the Robin Hood Tax and full disclosure laws).

Hedge funds play in the same markets as the Wall Street banks, and they often use the same shady strategies to siphon money off the top of a otherwise productive economy. Here’s an excerpt from the Leopold piece:

We also are told that these guys (and yes, they are all guys) make big bucks because they’re terrific gamblers, the very best poker players in the financial world. But that’s a misleading analogy. Evidence suggest that many are more like card sharks. They don’t really want to gamble. Instead they always seeking to bet on a sure thing. Better yet, they would prefer to create a rigged bet. Sounds far fetched? I’d wager that the financial maneuvers I’m about to list understate the severity of hedge fund cheating.

Liberty and Justice For All? This Chart Shows Why It’s No Longer the Case

liberty and justice

Liberty and Justice For All?

The ongoing foreclosure fiasco and the recent repeal of the STOCK Act (which was supposed to keep Congress from insider trading) have only proven that two-tiered justice is still with us. NPR has the story:

The White House cited the independent report in explaining why the president signed the bill. And a spokesman for Cantor said the House and Senate were simply following recommendations of the study. But Lisa Rosenberg, a lobbyist for the Sunlight Foundation, which advocated for the STOCK Act, says Congress went too far.

“It’s really shocking that they used basically the situation of questions about whether some language in the bill was overbroad to just gut the bill — to gut the transparency measures that apply to themselves,” she says.

Read the full piece here.

We can help end it by refusing to support corrupt businesses. Find a local lender that doesn’t “lose paperwork” and illegally foreclose on customers. Boycott Wall Street.

An Open Letter to President Obama From the 99%

president obama Elizabeth Warren

Letter to President Obama

Dear President Obama,

There are a lot of us, and we don’t agree on everything. Republican, Democrat, Libertarian, Independent, whatever. Some of us have been foreclosed on, some have lost jobs, some can’t find jobs. But we all agree that our current political system is skewed in favor of a group of Wall Street and Washington insiders, and that it seems bent on hurting the rest of us—the 99%.

When you were re-elected, many of us wondered if you’d finally speak out forcefully for us. We wondered if you’d put an end to Wall Street favoritism, and if you’d reform corrupt lobbying practices. We wondered if you’d officially end insider trading in Congress, or at the very least end our two-tiered justice system, which prosecutes someone for stealing a soda from a gas station but does nothing to prosecute Wall Streeters who illegally foreclose on and ultimately steal the homes of their “customers.”

But those who hoped for these changes were disappointed.

And yet it didn’t have to be this way. You didn’t have to appoint Mary Jo White, a former client of Wall Street, to regulate Wall Street. You didn’t have to sign the bill yesterday repealing key aspects of the STOCK Act. You still could join a bipartisan group of Senators (3 Republicans and 3 Democrats) who want to officially end “too big to fail.” You still could fire Eric Holder, and replace him with someone who is serious about prosecuting Wall Street. Any number of options for defending the 99% are open to you.

If you want more support from us, you could start by treating Wall Street the way Elizabeth Warren treats Wall Street. Boldly and directly. You could reform corrupt lobbying practices that favor the 1% at the expense of the rest of us. You could immediately get to work on revoking your decision to let Congressional insider trading continue. In sum, if you want more support from us, you could start by ending the current two-tiered justice system, a corrupted system which offends every single one of us.

There’s still time for you to change, but that time is running out.

- The 99%

Jeffrey Sachs Says What All Of Us Have Been Thinking About Wall Street, Only Bolder

Jeffrey Sachs Wall Street Pathological
In a recent speech at a Philadelphia Fed conference, Columbia economist Jeffrey Sachs waxed bold about Wall Street. The quality of the speech makes up for the poor video quality:

Here are some more excerpts:

The amount of what I would regard as utter criminality and financial fraud is absolutely enormous. And it’s almost daily—whether it’s the insider trading scandals, or whether it’s the Libor scandal, or whether it’s the Abacus and similar settlements on selling toxic assets by the investment banks.

This is what’s called the American financial system, at the moment. It’s really mind-boggling to me. It is an unregulated, essentially lawless environment.

We have perfected not only this system, but we’ve perfected the system in which these companies are domicile in the Cayman islands, or they’re domicile, or they’re domicile with partners in the Cayman islands, taking away any accountability and further not only masking them from tax liabilities on these earnings but also masking them from many legal liabilities.


I meet a lot of these people on Wall Street on a regular basis right now, and I’m going to put it very bluntly: I regard the moral environment as pathological. And I’m talking about the human interactions that I have. I’ve not seen anything like this, not felt it so palpably.

These people are out to make billions of dollars, and “nothing should stop them” from that. They have no responsibility to pay taxes, they have no responsibility to their clients, they have no responsibility to counterparties in transactions. They are tough, greedy, aggressive, and feel absolutely out of control, in a quiet literal sense. And they have gamed the system to a remarkable extent.

They have a docile president, a docile White House, and a docile regulatory system that absolutely can’t find its voice—it’s terrified of these companies. If you look at the campaign contributions, which I happened to do yesterday for another purpose, the financial markets are the number one campaign contributors in the US system now. We have a corrupt politics to the core, I’m afraid to say, and both parties are up to their necks in this.

It has nothing to do with Democrats or Republicans. It really doesn’t have anything to do with rightwing or leftwing, by the way. The corruption, as far as I can see, is everywhere. But what it’s led to is this sense of impunity that is really stunning, and you feel it on the individual level right now, and it’s very, very unhealthy.

I have waited for 5 years now to see one figure on Wall Street speak in a moral language, and I’ve not seen it once. And that is shocking to me.

It’s consistently amazing, isn’t it?

The Wall Street Journal released a followup interview with Sachs because the speech went viral. Sachs’s answer to the first question in the interview is startling:

Q: What was the reaction to your appearance?

A: An outpouring of emails and notes to me saying you’re right, right on, including from inside Wall Street. People recounting stories, people saying that they were happy to hear it because it was what they had observed as well. Actually (chuckles), no push back, strangely enough. …

[There hasn't been one] major figure in the industry acknowledging this rot, and also calling upon the industry to clean itself up. And I find that amazing because I would’ve expected at least one or two voices that would’ve have played that role and that hasn’t happened yet.

There’s a reason why these ideas from Jeffrey Sachs resonate with so many people. Those of us who’ve followed stories of corruption on Wall Street know that what he’s saying is exactly right. The number of immoral acts in an immoral system is sometimes overwhelming. It’s refreshing to hear someone who is directly familiar with Wall Street and economics and government say what we know needs to be said.

It’s a message worth spreading. If more people understand what’s happening, the political will to change the status quo will only increase, and perhaps soon enough we’ll see the reform we need to restore equal justice for all (even for those on Wall Street).


wall street banks wall street banks wall street banks wall street banks

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