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Mary Schipari Put In Charge: Now The SEC Will Save America. Just Hurry Up Please!

Stock-Markets / Market Regulation Sep 18, 2009 - 09:15 AM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticleBig picture, the status right now is that The Fed has pledged to find enough money to keep what they consider to be enough banks in the USA working; in order for the economy to work. For anyone who wants to know where they will find the money (and did), or how much they will eventually need, well the simple answer is, "Don't ask"!

You can ring your hands as much as you like, but until a universally accepted and reliable method of valuing toxic debt is found no one will know how much money will get pumped into that hole. And insofar as that goes nothing yet has emerged to replace the childish rules of thumb that purported to be "valuations" that the bonus-boys and their accomplices (the rating agencies), used, not TARP not PPIP and certainly not "mark-to-fantasy".

Whether bailing out incompetent bankers and the like is a good thing or not, is irrelevant, it happened, and that's just the way things are; the Fed had the power to print money and throw it at the fire and that's what the Fed did.

By the same token, precisely what shenanigans The Treasury played to "prove" that the banking system is solvent, are also irrelevant, an edict went out that banks are solvent  (more or less), so, problem solved. There is now the implicit and in some ways explicit guarantee by the US Government to that effect, and if you are worried about what the effect of the word "unlimited" will have on Mary Lou and Joe The Plumber, long term: well there again, "Don't Ask"!

But just throwing money on the fire solves nothing, that simply allows bankers who foolishly lent money to people who didn't pay it back to pay their creditors, (and don't forget they geared up their loses by up to 30:1), so the system can keep working (sort of). That doesn't solve anything; it just allows incompetent bankers to live another day and prevents competent bankers from emerging and capturing market share.

The worry earlier this year was that enough money and smokescreens could not be found, but that moment has past, now the smoke and mirrors are in place, the printing presses are on full alert, and the plan, insofar as anyone can see, is that the banks are going to make so much money out of the yield curve that they will be able to "earn" their way out of the hole they dug for themselves. That might work, assuming that the trigger for the CDS nuclear bomb is carefully monitored, but that's hush-hush!

There is of course the "risk" of inflation, although until the banks actually start passing on the extraordinarily lenient terms that they get money for, to their customers, that's not going to happen. And until that happens unemployment will grow inexorably.

Then there is the Financial Regulation Plan proposed by Secretary Geithner. Of course that suffers from two problems, the good news is that it probably won't get passed into Law anytime soon; the bad news is that even if it does it won't solve the problem, more like it will simply create yet another layer of bureaucracy that will prevent people who matter from seeing the wood from the trees (Geithner admitted as much when he was asked in his first presentation of the plan; "if this plan had been in place before would the crisis have been avoided", to which he answered  (I paraphrase)  "probably not").

So Who Matters?
In a nominally free-market economy, which America purports to be (although the credibility of that notion is starting to look decidedly tarnished), the people who matter are investors. In the context of a financial system those are what are commonly called the "customers"; and they have been very badly treated.

There seems to be a lingering idea that at some point there will be a return to the flawed assumption that the Fed can control the economy by playing with interest rates, which basically means deciding how much profit banks can make lending money, with the (also flawed) assumption that if they can make a lot more money writing more loans (sensibly this time is the idea), that will encourage them to lend more and that will increase the money supply and boost (a) inflation (bad) and (b) economic activity (good). That of course is a very dangerous idea; one doesn't have to look any further than the most recent failed experiment in "inflation targeting" to see why.

There also seems to be an idea surfacing that the government can take over from the free market, and that it can finance it's wasteful extravagances (all governments are corrupt, incompetent, and wasteful, it's simply a matter of degree) by borrowing (rather than by collecting taxes), as if that has no risks. It does have risks, the correct word for that is "Banana Republic", or "bananas" for short.

In the grand scheme of things the Fed controls the money supply to the economy, and the Treasury controls the money supply to the government. Those interests are in conflict with the free market, i.e. with the "people who matter" like the "customers".

Why are "customers" important to a financial system?
The idea of attracting investors to put their money at the disposal of an economy, whether they are foreign investors or not, is not a new idea. That's the reason stock markets were invented (in Amsterdam), the same goes for insurance markets (Lloyds of London), and securitization (that started with covered bonds in Germany).

What happened this time (and it happened before, this is not new), was that clever people, mainly in America, found innovative ways to the corrupt something that had served the world financial system reasonably well for hundreds of years. A bit like a clever new system to rob banks, which is precisely what the credit crunch was, except this time the management of the banks were complicit in the robbery, which is why, to this day, no one is quite sure how much the clever robbers got away with.

The worry going forwards is (a) that the people tasked with making sure that investors' money is safe from innovative scams, don't appear to have figured out how the last one worked and (b) the investors know that. Which is why the Fed and the Treasury have to create money out of thin air to keep the whole show on the road.

The other worry is that this can't go on forever, unless the intention is to create a totalitarian State along the lines of the glorious USSR (ex). Although I have no doubt that if the 43rd President asked nicely, then the nice Mr. Putin would be more than delighted to offer technical assistance to achieve that goal.

Service Quality Management 101: What do the customers want?
This is not economics, that is an art form which involves much verbiage and where you start off with an assumption (for example "if we assume a duck is a donkey"), then you reach conclusions like ("then we can conclude that a donkey is not a rabbit"). Like the art of philosophy there are many "schools".

Service quality management is something else completely, the best starting point in that science (it's not an art), is to find some customers and find out what they want. A good way to do that is to ask them.

A common question that I often hear from "customers" is "Well if I hand over all this money for your project, or your wild scheme; how do I know you will not use it to buy a Ferrarri (or an executive jet), and spend the rest on whisky and girls?" A compromise is normally reached where a commitment is made (a) to tell the customers what you did with their money and (b) to provide them with accurate information on what's happening to it.

That's broadly the problem in America at the moment, the customers (investors who have money), do not believe that the money is not being spent (or won't be spent), on whisky and girls. And the problem there, particularly with banks, and also securitized debt, is that the channels of information about what happened to investors' money has got corrupted, and it still is.

Why the SEC?
The best thing about the SEC is the recent history of the Madof affair. Whereas there are mutterings that the Fed and/or the Treasury might have been incompetent (or worse), no one has yet managed to pin anything on them.

But the Madof Affair was impossible for the SEC to wriggle out of, and the net result is that they have apparently been galvanized  to wake up from their slumber and actually do some work  for a change, which is very good news.

The only complaint that I have is that they are not moving fast enough, although they are most certainly moving in the right direction:

1: The new accounting rules put out (in draft) by FASB (presumably after prodding by the SEC), stipulate that both "Fair Value" and whatever concoction of "Book Face Fantasy" that "management " and their tame auditors comes up with, is reported.

That is a huge step in the right direction (and a much better step than the step taken by IAS (i.e. IFRS) which is simply more muddle). That means that an investor will be informed about TWO possible values for every asset owned by the entities they invest in.

That is a 100% improvement (previously there was only ONE), although it's a long way from the ideal (anybody who knows anything about valuation knows that a toxic asset can in fact have SEVEN values all at the same time (, but that's certainly a positive step forwards, and investors who are inclined to consider re-investing in America (or changing their minds about pulling their money out), are waiting in breathless anticipation for when the magic number (seven) will be achieved.

2: Another positive step is that the SEC is asking banks to provide information that will allow anyone (who knows anything about valuation) to work out what is a reasonable and conservative estimate for the minimum amount of money that they will be able to get for the assets that they hold, when, and that is the kicker, when they might be obliged to sell them (

And as anyone who knows anything about valuation, will tell you, that is in essence a step towards mandating that banks report the "other-than-market-value" as mandated under International Valuation Standards (IVS).

The only thing I can't understand is why they didn't just mandate that IVS were used to value assets, and instead opted to put out a rather clumsy approximation with some rather obvious loopholes?

Although I suppose the Treasury might have had something to do with that since doing that would have exposed the shenanigans that they played with the un-stressful "Stress Tests".  But certainly it is a step in the right direction, and investors, particularly foreign ones, all lining up on Americas shores waiting to take over the heavy lifting that the Fed is doing, are "monitoring the situation carefully", as they say.

3: The third thing that SEC did (there might be more - miracles do happen), was to put up new regulations that mandated that the information used by rating agencies to come up with their ratings should be made (a little bit) more accessible.

Which would have the side effect that a competing rating agency could come up with an alternative rating of the same instrument. Imagine an RMBS with a AAA rating from Moody's, an A+ from Fitch, and a BBB from S&P! And no prizes for guessing who got paid by the arranging bank to do the rating!!

The rating agencies are of course dead against this because they want to have their cake and eat it, on one hand they want to be protected under the Fifth Amendment, where they say that their rating is just an opinion and so that's "Free Speech" and the investor should do his own investigation. On the other hand, they want to be sure that the investor cannot get his hands on the necessary information, which is why the market for securitized debt is well and truly stalled.

If the investor (or a competing agency) was provided as a matter of Law with the necessary information to be able to make a rational and well informed decision about how much money he wanted to pay for the RMBS, then there would be the risk of that ugly and chaotic thing they call a free market, emerging (and an open and transparent one too;  imagine that! Who ever heard of such blasphemy)!

I.e. in other words, the monopoly stranglehold that the ratings agencies had (and still have) over valuations of securitized debt would start to get unraveled.

Of course the SEC doesn't go far enough, the place they need to get to is where all non-confidential information on all loans that are pooled and offered to the public, should be available in a consistent format (downloadable on Excel) to....err, the public. I.e. to the customers.

So far so good
All I can say is "well done so far" and "how about getting a move on before U3 hits 15%"? And good to see they put a woman in charge, now things will really start to happen.

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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