Only $4 Billion of JPM $13 Billion Settlement Goes for “Consumer Relief”

For assistance in understanding the content of this article and purchasing services that provide information for attorneys and homeowners see http://www.livingliesstore.com.

Josh Arnold has written an interesting article that reveals both realities and misconceptions arising from gross misconceptions. His misperceptions arise primarily from two factors. First he either ignores the fact that JPM was integrally involved in the underwriting, sale and hedging of the alleged mortgage bonds, never actually acquired the loans or the bonds on which they claimed a loss, and made huge “profits” from fictitious trades disguised as “proprietary” trading which was a cover for tier 2 yield spread premiums that were never disclosed to investors or borrowers. The deregulation of those mortgage securities may have provided cover for the fraud that occurred to investors, but the failure to disclose this “compensation” to borrowers violates the truth in lending act and state deceptive lending laws.

Second, the article is based upon a point of view that is not surprising coming from a Wall Street analyst but which is bad for the country. The ideology behind this is clear — Wall Street is there to make money for itself. That has never been true. Wall Street exists solely because in a growing and complex economy, liquidity must be created by breaking up risks into portions small enough to attract investors to the table. Whether they make money or not depends upon their skill in running a company.

Unfortunately in the early 1970’s the door was flung wide open when broker-dealers were allowed to incorporate and go public. Just ask Alan Greenspan who believed the markets would self correct because the players would act rationally in their own self interest. As he he says in his latest book, the banks did not act rationally nor in their own best interest because they were being run by management that was acting for the self interest of management and not the company. Back in the 1960’s none of this would have occurred when the broker-dealers were partnerships —leading partners to question any transaction by any partner that put the partners at risk. Now the partners are remote and distant shareholders who are among the victims of management fraud or excess risk taking.

The effect on foreclosure defense is that, at the suggestion of the former Fed Chairman, we should stop assuming that the broker dealers that are now called banks were acting with enlightened or rational self-interest. The opening and closing statement should refer to the information like this article Quoted below as demonstrating that the banks were openly violating common law, statutory, and administrative rules because the losses from litigation would not be a liability of the actual people who caused the violations.

Any presumption in favor of the foreclosing bank should be looked at with intense skepticism. And in discovery remember to ask questions about just how bad the underwriting process was and revealing the absolute fact, now proven beyond any reasonable doubt, the goal was for the first time NOT to minimize risk, but rather to force applications to closing because of giant profits that could be booked as soon as the loan was sold, since at the time of closing the loans were already part of a reported chain of securitization. Investigation at real banks as opposed to “originators” will reveal two sets of underwriting rules and practices — one for their own portfolio loans in compliance with industry standards and the other for the vast majority of loans that were claimed to be part of a fictitious cloud of securitization that did not comply with industry standards.

In the end my initial assessment in 2007-2008 on these pages is proving to be true. The unraveling of this mess will depend upon quiet title lawsuits and lawsuits for damages resulting from violations of the Truth in Lending Act — where those gross profit distortions at the broker-dealer level are required to be paid to the homeowner because they were not disclosed at closing.
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From Seeking Alpha website, by Josh Arnold —

JPMorgan’s (JPM) legal woes got a lot worse over the weekend with its well-publicized $13 billion settlement. JPM already has much more than that set aside to pay legal claims so it’s really a non-event for the bank; they saw it coming to a degree. I’m not here to debate whether or not JPM’s employees misled investors, including Fannie and Freddie, but what I think the most important, and disconcerting, piece of this settlement is the way it was undertaken by the Administration.

Think back to 2008 when the world as we knew it was ending. Smaller financial institutions were failing left and right and even the larger players, including Lehman, Bear Stearns, Washington Mutual, Wachovia and others eventually found themselves in enormous trouble to the point where distressed sales were the only way to stave off bankruptcy (save Lehman, of course). The federal government, eager to avoid a massive crisis, asked JPM, Wells Fargo (WFC) and others to aid the effort to avoid such a calamity. Both obliged and we know history shows JPM ended up with Washington Mutual and Bear Stearns while Wells purchased Wachovia as it was on the cusp of going out of business. At the time, JPM CEO Jamie Dimon famously asked the government, as a favor for bailing out WaMu and Bear Stearns, not to prosecute JPM down the road for the sins of the acquired institutions. This is only fair and it should have gone without saying as the idea of prosecuting an acquirer for something the acquired company did as an independent institution is preposterous.

However, that is exactly where we find ourselves today with the settlement that has been struck. JPM has said publicly that 80% of the losses accrued from the loans that are the subject of this settlement were from Bear and WaMu. This means that, despite Dimon’s asking and the fact that the federal government “urged” JPM to acquire these two institutions, JPM is indeed being punished for something it had nothing to do with. This is a watershed moment in our nation’s history as the next time a financial crisis rolls around, who is going to want to help the federal government acquire failing institutions? Now that we know that the reward for such behavior is perp walks, public shaming via our lawmakers (who can’t even fund their own spending) and enormous legal fines and settlements, I’m thinking it will be harder for the government to find a buyer next time.

Not only is the subject of this legal settlement and the very nature of the way it has been conducted suspect, but even the fines themselves as part of the settlement amount to nothing more than tax revenue. The $13 billion is split up as follows: $9 billion in penalties and fees and $4 billion in consumer relief. The penalties and fees are ostensibly for the “wrongdoing” that JPM must have performed in order to be subject such a historic settlement. These penalties and fees are for allegedly misleading investors in these securities and misrepresenting the strength of the underlying loans. The buyers of these securities, however, were all very sophisticated themselves, including the government sponsored entities. These companies had analysts working on these securities purchases and could very well have realized that the underlying loans were bad. However, Fannie and Freddie blindly purchased the mortgages and were eventually saddled with large losses as a result. But instead of the GSE’s taking responsibility for bad investment decisions, the government has decided to simply confiscate $13 billion from a private sector company while Fannie and Freddie have claimed zero responsibility whatsoever for their role in the losses.

The other $4 billion is earmarked for “consumer relief” but the worst part of this is that these loans were sold to institutions. This means that this consumer relief is simply a bogus way to confiscate more money from JPM and the alleged reason has no basis in reality. The consumer relief portion would suggest that JPM misled the individual consumers taking the loans that were eventually securitized but that is not what the settlement is about. In fact, this is simply a way to redistribute wealth and the Administration is taking full advantage. In order for the redistribution of wealth to make the alleged victims whole it would need to be distributed among the institutions that purchased the securities. So is this part of the settlement, under the guise of “consumer relief”, really just another tax levy? Or is it going to consumers that had absolutely nothing to do with this case? Either way, it’s confiscatory and doesn’t make any sense. Based on reports about this consumer relief portion of the settlement, this money is going wherever the Administration sees fit. In other words, this is simply tax revenue that is being redistributed and given to consumers that have absolutely zero to do with this case.

Even the $9 billion in penalties and fees is going to be distributed among various government agencies and as such, this money is also tax revenue. Otherwise, the money for these agencies would eventually come from the Treasury but instead, JPM is going to foot the bill.

I’m not against companies that have done something wrong being punished. In fact, that is a necessary part of a fair and open capitalist system that allows the free world the economic prosperity it has enjoyed over history. However, this settlement is a clear case of the federal government confiscating private assets in order to redistribute them among government operations and consumers that had absolutely nothing to do with the lawsuit. I am extremely disappointed in the way the Administration has handled this case and other banks should be on notice; it doesn’t matter what you did or didn’t do, if you’ve got the money, the government will come after you.

In terms of what this means for the stock, JPM has already set aside $23 billion for litigation reserves so when the bill comes due for this settlement, JPM has more than enough firepower available to pay it. In fact, this settlement is likely a positive for the stock. Since this is likely to be the largest of the fines/settlements handed down on the Bank of Dimon, the fact that the uncertainty has been lifted should alleviate some concern on the part of investors. In addition to this, since JPM still has a sizable reserve, $10 billion or so, left for additional litigation, investors may be surprised down the road if JPM can actually recoup some of that litigation expense and boost earnings. Not only would that remove a multi-billion drain on book value but it could also increase the bank’s GAAP earnings if all litigation reserves weren’t used up. In any event, even if that is not the chosen path, JPM could still recognize higher earnings in the coming quarters if it sees it needs less money set aside each quarter for litigation reserves. Again, this is very positive for the stock but for more tangible reasons.

The bottom line is that JPM got the short end of the stick with this settlement. Not only is the bank paying for the sins of others but it is paying very dearly and sustaining reputational damage in the process. I couldn’t be more disappointed with the way the Administration’s witch hunt was conducted and the end result. But that is the world we apparently live in now and if you want to invest in banks you need to be prepared to deal with confiscatory fines and levies against banks simply because they can’t stop the government from taking it.

However, JPM is better positioned than perhaps any of its too-big-too-fail brethren to weather the storm and I think that is why there was virtually no movement in the stock when the settlement became public. JPM has been stockpiling litigation reserves when no one was looking and has done well in doing so. With the looming threat of this settlement now come and gone, investors can concentrate on what a terrific money making machine JPM is again. Trading at a small premium to book value and only nine times next year’s earnings estimates, JPM is the safe choice among the TBTF banks. Couple its very cheap valuation with its robust, nearly 3% yield and the largest settlement against a single company in our country’s history behind it and you’ve got a great potential long term buy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Share this ArticleComments(8)

Don Dion
Oct 23 07:49 AM
Josh,

Great article. See also http://seekingalpha.co…

Don

Reuters: Central Banks Worldwide: Past, Present And An Uncertain Future

COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary SEE LIVINGLIES LITIGATION SUPPORT AT LUMINAQ.COM

EDITOR’S NOTE: The farce of preserving the huge plume of vapor that was created by Wall Street is starting to come home to roost. Central Bankers, are in conflict and politicians are using their influence on what is now a highly politicized sector that SHOULD have been regulating and restricting. The “Too Big to Fail” banks are acting as if they won. Nothing has changed. Perhaps they are right.

The Fed is the ultimate regulator of financial institutions. It is part of the growing orthodoxy that the banks must be saved rather than restricted in their activities. It is a prescription for disaster. It won’t admit its ownership claim in the loans and mortgages, it hasn’t divulged the details of the mortgage bond purchases that would in turn reveal the fictitious nature of the entire securitization scheme that has been and will always be empty, and it has not uttered a word about the behavior of the banks because on a grand scale, it IS the banks.

Central Banks Global Policy

By Paul Carrel, Mark Felsenthal, Pedro da Costa, David Milliken and Alan Wheatley

FRANKFURT/WASHINGTON – On a warm, Lisbon day last May, Jean-Claude Trichet, the ice-cool president of the European Central Bank, was asked whether the bank would consider buying euro zone governments’ bonds in the open market.

“I would say we did not discuss this option,” Trichet told a news conference after a meeting of the ECB’s Governing Council. Four days later, the ECB announced that it would start buying bonds.

Trichet’s U-turn was part of an emergency package with euro zone leaders to stave off a crisis of confidence in the single currency. By reaching for its “nuclear option”, the ECB had also helped rewrite the manual of modern central banking.

That’s happened a lot over the past three years. Since the early days of the financial crisis in 2008, the European Central Bank, the U.S. Federal Reserve and the Bank of England have all been forced to adopt policies that just a few years ago they would have dismissed as preposterous. And the Bank of Japan responded to the Sendai earthquake and tsunami by doubling its own asset-purchase programme, to keep the banking system of the world’s third-largest economy on an even keel.

For a generation, the accepted orthodoxy has been to focus on taming inflation. Financial stability has taken something of a back seat. Now, whether mandated to do so or not, western central banks have bought up sovereign debt to sustain the financial system, printed money by the truckload to stimulate their economies, sacrificed some of their independence to coordinate monetary policy more closely with fiscal decisions, and contemplated new ways of preventing asset bubbles. Some — such as Bank of England Governor Mervyn King — have joined wider political protests at commercial banks that are still behaving as if they are “too big to fail”, and as if being bailed out is just a hazard of business.

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In the measured world of central banking, it amounts to nothing short of a revolution. Otmar Issing, one of the euro’s founding fathers and a career-long monetarist hawk, told Reuters that in buying government bonds the ECB had “crossed the Rubicon”. The question now for the ECB — and for its counterparts in Britain, the United States and elsewhere — is what they’ll find on the other side.

EXTRAORDINARY CIRCUMSTANCES

Don Kohn, a former vice-chairman of the Federal Reserve, realized central banking was changing forever at a routine meeting of his peers in Basel, Switzerland, in March 2008. The shockwaves from the U.S. subprime mortgage meltdown had begun rocking banks around the world and Kohn, a 38-year veteran of the U.S. central bank, listened as one speaker after another described the fast-deteriorating economic conditions.

“It was terrible,” Kohn said. “One of the people at the meeting used the phrase, ‘It’s time to think about the unthinkable’.”
Kohn left the meeting early to return to Washington, but the line stuck in his head. He would use it a few days later to justify his support for a Federal Reserve decision to spend $29 billion to help J.P. Morgan buy investment bank Bear Stearns, which was teetering on the edge of bankruptcy.

That financial meltdown caused a credit crunch that triggered a severe recession and, in countries such as Greece, a sovereign debt crisis. After slashing interest rates practically to zero, central banks desperate to prevent a new global depression had no choice but to expand the volume of credit, rather than its price, by reaching for the money-printing solution known as “Quantitative Easing” (QE). In the eyes of critics, Federal Reserve Chairman Ben Bernanke was living up to his nickname of “Helicopter Ben” — a reference to a speech that he gave in 2002 in which he took a leaf out of the book of the renowned monetarist economist Milton Friedman and argued that the government ultimately had the capacity to quash deflation simply by printing money and dropping it from helicopters.

Until that point, the Fed was a lender of last resort for deposit-taking banks. By invoking obscure legislation from the Great Depression, it also became a backstop for practically any institution whose collapse could threaten the financial system. Kohn and others at the Bear Stearns meeting had just done the unthinkable.

“When the secretary of the (Fed) Board was reading off the proposals … my heart was racing,” Randall Kroszner, a Fed governor at the time, says of the decision.

An academic economist from the conservative, free market-oriented University of Chicago, Kroszner was instinctively against intervention. At the same time, he knew that a decision by the Fed to stay above the fray would trigger financial panic. Before the meeting Kroszner had chatted with Bernanke, another scholar of economic history, about a historic parallel in which financier J.P. Morgan — the person, not the company — opted against stepping in to save the Knickerbocker Trust, precipitating a financial panic in the first decade of the 20th century.

“I couldn’t believe that we were faced with these questions, and I couldn’t believe that I could support them,” Kroszner told Reuters in February. “In these extraordinary circumstances, it was very risky to just say no.”

By the time the $600 billion second round of quantitative easing wraps up in June, the central bank will have spent a staggering $2.3 trillion — more than 15 percent of GDP — buying bonds. It has also created new lending windows to channel funds to financial institutions and investors and expanded its financial safety net for everything from money market mutual funds to asset-backed securities and commercial paper. The Fed argues that its loans have been repaid without any cost to taxpayers, and that the beginning of a recovery in the U.S. economy and the fading of the threat of deflation, which gnawed at Bernanke, justify its bold improvisation.

But some experts, including a number of Fed officials themselves, believe the central bank is paying a big price. Some critics say the Fed’s open-ended provision of next-to-free money is encouraging more reckless risk-taking by banks and speculators. Others say the Fed has exceeded its remit and encroached on the turf of politicians. Some Republicans, in particular, want to curtail the Fed’s powers.

The United States has not been alone. In Britain, the Bank of England has run its own programme of quantitative easing, spending 200 billion pounds (about 14 percent of GDP) mostly on UK government securities, and has introduced a scheme for financial institutions to swap mortgage-backed securities for UK Treasury bills. The ECB took three main steps: adjusting its money market operations to offer unlimited amounts of funds, lowering standards on the collateral it accepts in such operations, and buying bonds. The bond buying, though amounting to 1.5 percent of euro zone GDP, is less radical than the Fed’s because the bank absorbs back the money that its purchases release. But its initiative is still highly controversial.

Issing, the ECB’s chief economist from 1998 to 2006, calls the bond-buying dangerous. But he also concedes that the problems of the past few years have required extreme measures. “It is difficult to justify within the context of the independence of the central bank,” says Issing. “But, on the other hand, the ECB was the only actor who could master the situation. What matters now is that it finalizes this programme and gets out.”

BLOWING UP THE ORTHODOXY

Central banks have historically often been subordinated to governments, but the high inflation and slow growth that followed the oil price shocks of the 1970s ushered in a relatively simple orthodoxy: their goal should be to keep inflation in check. Maintaining a slow and steady pace of price rises became the overriding aim of central bank policy, and independence from political pressures came to be seen as a pre-requisite for achieving this. Starting with New Zealand in 1989, central banks in more than 50 countries adopted explicit, public targets for inflation.

Western governments claimed this was responsible for the Great Moderation, a two-decade period of relatively stable growth in developed economies. It still has many proponents, but the credit crisis has made a mockery of that overriding simplicity, exposing serious flaws in how central banks defined their mission and operated. One flaw: they did little to prevent the build-up of the asset bubbles that triggered the financial crisis, such as the boom in U.S. subprime mortgages. Another: the obsession with inflation blinded them to dangerous trends in banking. After all, what is the point of keeping inflation low if lax lending and feckless financial supervision threaten to tip the economy into the abyss?
“The problem was not that the Fed lacked instructions to avoid a crisis,” says James Hamilton, a professor of economics at the University of California, San Diego and visiting scholar at the central bank on multiple occasions. “The problem was that the Fed lacked the foresight to see the crisis developing.”

Fed Chairman Bernanke doubts central banks can know for sure that an asset bubble has formed until after the event, and feels monetary policy is too blunt a tool to arrest any worrisome developments. At the same time Bernanke, former vice-chairman Kohn and others agree that the central bank might be able to employ broader tools to prevent asset prices from getting too frothy. For example, the Fed regulates margin requirements for buying equities with borrowed funds; it could use these to rein in a galloping stock market.

“The simplicities of extreme inflation targeting — which said if you meet your inflation target and keep inflation stable the rest of the economy would look after itself — have been blown apart,” Sir John Gieve, who was deputy governor at the Bank of England from 2006 to 2009, told Reuters. “The Bank’s objectives have become a lot more complicated. Some people have been quicker to realize this than others. If you talk to the Japanese, they would say they have been doing this for a while.”

ANY ANSWERS?

Could the Fed and its counterparts in Britain and Europe learn from Asian central banks, many of which limit the proportion of deposits that banks can extend as loans? Should they insist that a home buyer make a sizeable deposit when taking out a mortgage — a practice that might have tempered the U.S. housing bubble? Central banks in some emerging economies outside Asia already appear to be adopting such methods – known as ‘macroprudential’ steps – to complement traditional interest rate policy. Turkey has been raising commercial banks’ reserve ratios while simultaneously cutting interest rates, and Brazil signaled this month it would rely more on credit curbs and less on rate increases to fight inflation.

Or should they look closer to home, for example to the central banks of Australia and Canada? Both are inflation-targeters, but they sailed through the global crisis without having to resort to extreme measures. A history of conservative banking regulation in those countries meant they never faced severe credit problems.

“Prior to the crisis a lot more people were of the view that if it’s not broke don’t fix it,” said Dean Croushore, professor of economics at the University of Richmond in Virginia and a former economist at the Philadelphia Federal Reserve. “Policymakers didn’t react, particularly with respect to housing. Maybe being a bit more proactive is a good thing.”
Then again, some Republican lawmakers want the Fed, which has a dual mandate to keep inflation low and maximize employment, to focus exclusively on the first task. They contend that monetary policy is not the right tool to create jobs.
Buying up bonds and bailing out failing firms does indeed blur the boundaries between monetary and fiscal policy. Critically, it also suggests that supposedly autonomous central banks are doing the bidding of politicians.

“Things cannot change in a measured way,” said European Central Bank policy maker Axel Weber earlier this month. He is also head of Germany’s Bundesbank, but last month he stood down as a candidate to succeed Trichet at the ECB. His outspoken opposition to the bank’s bond-buying underlined the rift between the traditional approach to central banking and the political expediency born of the crisis. “There will have to be fundamental change … If institutions are too big to fail, they are too big to exist,” Weber said, echoing comments by King at the Bank of England.

MORE INTRUSIVE

The shift is already happening. “Bond investors are not facing a future change; they are living through a change,” said Gieve, the former Bank of England deputy governor. Inflation remains very important, and I have no doubt my colleagues at the Bank of England take it very seriously … But they are also aware of the need to stabilize the financial system. They need to get the economy on a sustainable growth track.”

Of course the Fed has never operated in a vacuum. Greenspan swiftly cut interest rates after the Black Monday stock market crash in October 1987 and again in September 1998, after the Fed had to organize a $3.5 billion rescue of LTCM, a big hedge fund. But some experts, including Stephen Roach, Morgan Stanley’s non-executive chairman in Asia, have long argued that an explicit financial stability mandate would force the Fed — and other banks — to pay closer attention to looming bubbles and weak links in the system rather than simply mopping the mess up later.

Legislators are giving central banks more powers to keep an eye on financial — as distinct from monetary or economic — trends. Academics have also broadened their reach in that direction, with the Federal Reserve’s prominent Jackson Hole conference last summer featuring a paper arguing that policymakers should pay closer attention to financial variables in their macroeconomic assessments.

That’s exactly the direction things are headed. Since the beginning of this year, ECB boss Trichet has chaired something called the European Systemic Risk Board (ESRB) — a body designed to take a bird’s eye view of Europe’s financial system and flag up emerging problems so the relevant authorities can act. In Britain, the government has decided to disband the Financial Services Authority and give the Bank of England the job of preventing any build-up of risk in the financial system, on top of its monetary policy role. And in the United States, newly enacted legislation gives the Fed a leading role in financial regulation as part of the Financial Stability Oversight Council.

“From a regulatory standpoint, we’ll be more aware and more intrusive in monitoring institutions that are systemically critical,” Dallas Fed President Richard Fisher told Reuters in an interview.

POLITICS, OF COURSE

With those expanded roles comes a greater need for central banks to explain their actions to citizens, markets and politicians alike. Investors will no longer be able to anticipate how policy makers will act just by tracking inflationary trends as they did for a generation before the Great Financial Crisis.

Bernanke made it a priority from the start of his tenure in 2006 to improve communications. He didn’t have to do much to improve upon his oracular and sometimes opaque predecessor, Alan Greenspan, who famously said, “if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”

But the crisis exposed the Fed to withering fire. “It’s hard to maintain mystique when there have manifestly been a series of policy errors, not just at the Fed but in many branches of government,” says Maurice Obstfeld, a professor of economics at the University of California at Berkeley.

Even harder, when the big central banks themselves have yet to work out how they will implement their new powers. The new rules in the United States, for instance, give regulators more leeway to wind down global financial institutions deemed too large to fail in case they touch off a catastrophic domino effect as loans are called in. But how that will work in practice remains to be seen.

“At the end of the day it comes down to whether or not the too-big-to-fail resolution mechanisms are robust. There’s still some thinking to be done on that,” David Altig, research director at the Atlanta Fed and a professor at the University of Chicago’s Booth School of Business, said in a telephone interview.

To judge by comments by Weber and King, that’s a big, unanswered, politically charged question. The BoE chief has been vocal in complaining that the concept of “too important to fail” has not been addressed, and that bankers continue to be driven by incentives to load up on risk.

Then there’s the fact that deciding which firm should live and which not is an intensely political process. Look no further than the furor over the U.S. authorities’ decision to bail out insurer AIG and car maker GM, but to let investment bank Lehman Brothers go to the wall months after arranging a rescue of Bear Stearns.

With an expanded awareness of their mandates, wouldn’t central banks be forced to take into account such dilemmas when they are setting interest rates?

“It’s a risk, but one has to be aware of the risk and to avoid it,” says Issing, the former ECB chief economist. “It’s macroeconomic supervision; it’s not micro control of individual banks. But if the European Systemic Risk Board identifies systemic risk, it must be solved with tools of regulation and not by lax monetary policy.”

A FACT OF LIFE

In truth, central banking, by its nature, has always been an intensely political enterprise. To pretend otherwise is naive. War, revolution, depression and calamity have always subjugated central banks to political necessity, and most are still state-owned. Like a country’s highest court, a central bank cannot — no matter how vaunted its independence — be unaware of the political and social mood. The Fed chairman and the U.S. Treasury secretary worked hand in glove during the financial crisis and have the freedom to discuss a range of topics when they meet informally every week.

The political nature of central banking was brought home last month when Weber decided to stand down early. He had judged that he did not have enough political support from the 17 members of the euro zone, and his relationship with German chancellor Angela Merkel was also rocky. He will hand over to Jens Weidmann, Merkel’s economic adviser. Critics of the appointment — and there is no shortage of them in a country that likes its central bankers tough and independent — worry that Weidmann will weaken the Bundesbank’s statutory freedom from political influence.

That misses the point completely, says David Marsh, co-chair of the Official Monetary and Financial Institutions Forum, which brings together central banks, sovereign wealth funds and investors. Marsh says the launch of the euro in 1999 was a political act itself, one that has already led to a much more politicized regime of monetary management.

“The interplay with governments — whatever the statutes say about the supreme independence of the European Central Bank — is a fact of life,” he says. “The mistakes and miscalculations of the last 12 years show how monetary union has to be part of a more united political system in Europe. That is not loss of independence. That is political and economic reality.”

It is against this backdrop that Trichet’s apparent conversion on the road from Lisbon to Brussels last May must be seen.

Niels Thygesen, a member of the committee that prepared the outline of European Economic and Monetary Union in 1988-9, says the euro zone debt crisis forced the ECB to show some flexibility by agreeing to the bond-buying programme. “It is a departure relative to the original vision for the European Central Bank, which was supposed to be a bit isolated from dialogue with the political world,” he says. “On the other hand, I never thought that was quite a tenable situation.”

Thygesen, now a professor at the University of Copenhagen, said he did not particularly like the idea but acknowledged that the ECB might in fact have gained some clout by agreeing to the bond-buying plan. Trichet helped rally euro zone leaders into arranging standby funds and loan guarantees that could be tapped by governments in the currency bloc shut out of credit markets — relieving the ECB of some of the burden of crisis management. “It was part of a bargain and I’m sure Mr Trichet bargained very hard and in a way successfully,” says Thygesen. “The ECB has stood up well and gained substantial respect for its political clout in bringing about actions on the part of governments, which otherwise might not have taken place.”

LESSONS FROM JAPAN

It doesn’t always work out that way. Just ask the Bank of Japan.

The BOJ embarked on quantitative easing as far back as 2001. But a decade on, it has still failed to decisively banish the quasi-stagnation and deflation that has dogged Japan’s economy since the early 1990s. Only once in the past decade, in 2008, has Japan experienced inflation of more than 1 percent — the central bank’s benchmark for price stability.

When the global crisis hit, the BOJ revived a 2002 scheme to buy shares from banks and took a range of other unorthodox steps to support corporate financing. But its actions failed to placate critics who view it as too timid. Senior figures in the ruling party and opposition parties talk of watering down the BOJ’s independence and forcing it to adopt a rigid inflation target.

“The government tends to blame everything on the BOJ,” Kazumasa Iwata, a former BOJ deputy governor, told Reuters. Makoto Utsumi, a former vice finance minister for international affairs, defended the bank’s current set-up, saying it would be “absurd” and “unthinkable” for a developed country like Japan to make its central bank a handmaiden of the government.

The bank’s prompt response to the devastating March 11 earthquake and tsunami has since earned it widespread plaudits. The BOJ poured cash into the banking system, doubled its purchases of an array of financial assets and intervened in the foreign exchange market in coordination with the central banks of other rich nations to halt a surge in the yen that was hurting Japan’s exporting companies.

Charles Goodhart, a professor at the London School of Economics who was on the Bank of England’s Monetary Policy Committee from 1997 to 2000, believes a measure of central bank independence can be preserved, even if cooperation with ministers is needed to keep the banking system stable. “I think trying to maintain the independent role of the central bank in interest rate setting remains a very good idea,” he told Reuters. “When it comes to financial stability issues, at any rate under certain circumstances and at certain times, there will have to be a greater involvement of the government.”
How to achieve that balance is the subject of a whole other debate. “None of this is going to be quite in the separate boxes it has been in the past,” says Gieve, the former Bank of England deputy governor. “If you have inappropriate monetary policy, all the macroprudential instruments in the world will find it very difficult to push water up hill.”

IMPORTING INFLATION

As if the political dimension was not enough of a headache, central bank rate-setters seem to be finding it harder to nail down the sources of the inflation they are tasked to fight. One reason is globalization.

Central banks have traditionally turned a blind eye to a one-off rise in prices stemming from, say, an increase in consumption taxes, a sharp drop in the exchange rate that boosts import costs or, as now, a spike in oil. As long as the price jolt does not change inflationary expectations or worm its way into the broader economy by prompting workers to ask for higher wages, policy makers have usually felt comfortable in keeping their eye on underlying cost pressures at home.

That remains the consensus, as demonstrated by the Bank of England, which has failed to keep inflation down to its 2 percent target for much of the past five years.

But in a world of integrated supply chains, can inflationary impulses be neatly attributed to either domestic or international forces? Does it now make sense, as some analysts argue, to estimate how much spare capacity there is globally, not locally?

The answers to those questions will have huge implications for monetary policy.

Lorenzo Bini Smaghi, one of six members of the ECB’s Executive, has warned that sharper rises in the prices of commodities and goods imported from emerging economies will push up euro zone inflation unless domestic prices are controlled. “A permanent and repeated increase in the prices of imported products will tend to impact on inflation in the advanced countries, including the euro area,” he said in Bologna in January.

St. Louis Fed President James Bullard admits the United States could not consider its own inflation outlook in complete isolation from the rest of the world.

“Perhaps global inflation will drive U.S. prices higher or cause other problems,” he told a business breakfast in Kentucky in February. The ties that bind global banks and the ease with which capital flows across borders mean that central banks have to be more aware than ever of the international consequences of their policy actions.

Because the dollar is the dominant world currency, the Fed came under widespread fire for its second round of bond buying. Critics in China and Brazil among others charged that dollars newly minted by the Fed would wash up on their shores, stoking inflation and pumping up asset prices.

“How do we conduct monetary policy in a globalised context?” asks Richard Fisher, the Dallas Fed president. “How do we regulate and supervise and develop our peripheral vision for those that we don’t supervise in a formal way, in a globalised context? Not easy.”

Structural shifts in the world economy also raise questions about how long central banks should give themselves to hit their inflation goals — further blurring the picture for investors.

“The central bank always has the choice of the time horizon over which it hits its inflation target,” Thygesen, the Copenhagen professor, said. “As the Bank of England is now learning, it may have to extend that horizon somewhat in particularly difficult circumstances. There may be good reasons for doing it, but that is where the element of discretion lies.”

The Bank of England expects inflation to remain above target this year before falling back in 2012. The ECB, which seeks medium-term price stability, is resigned to inflation remaining above its target of just below 2 percent for most of 2011. In the last 12 months, it stood at 2.3 percent.

It all adds up to a significant shift in the environment in which central banks operate. Policy-making is a whole lot more complicated. With a broader mandate for keeping the banking system safe comes increased political scrutiny. With fast-expanding export economies like China becoming price setters instead of price takers, offshore inflation and disinflation are of growing importance. If the rise in oil prices is due to increased demand from developing nations, for instance, can western central banks still play down ever-higher energy bills as transient?

That all means it will become tougher for central banks to preserve their most precious asset, credibility.

“Look at the ’90s and the early years of this century — central banks were at the peak of their reputation worldwide, and I was already saying at that time that we know from experience that the risk is highest when you are on top,” Issing says. “Central banks have to take care to restore their reputation, if it has been lost. I think this is a difficult situation for central banks worldwide.”

(Paul Carrel reported from Frankfurt, David Milliken from London and Mark Felsenthal and Pedro Nicolaci da Costa from Washington; Additional reporting by Rie Ishiguro in Tokyo; Writing by Alan Wheatley; Editing by Simon Robinson and Sara Ledwith)

MORTGAGE BACKED SECURITIES: LEGAL COUNTERFEITING

COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary

EDITOR’S NOTE: If you want to get the FEEL of what just happened in our world of finance and the ensuing effects on our economy, you might be better off reading a book like “Moneymakers: The Wicked Lives and Surprising Adventures of Three Notorious Counterfeiters” (Penguin, $27.95), Ben Tarnoff. It might come as some surprise that proprietary issuance of currency was all the rage in this country and was used not only legally and illegally, but as an instrument of warfare. Ben Franklin and others saw the “moral hazard” of allowing for paper money because the paper had no intrinsic value — unlike the universal perception of gold or silver.

Eventually in 1862 the U.S. Government made government issued currency “legal tender” but there were so many loopholes that while it had an effect, it has yet to take hold 150 years later.

Banks issued their own Banknotes in early U.S. History and lately, for the past 20 years, they have returned to the same practice calling them derivatives, mortgages backed securities and other exotic names. The Bank Notes, as observed by many during that period had no value except that they supposedly DERIVED their value from the gold that the bank had on deposit. They were not the first “derivatives” but they were the most important up to that point in history.

In a 1996 article Alan Greenspan articulated the free market view that the value of those bank notes or proprietary currency would be resolved in a free market as people found out which banks were issuing more bank notes than they could support. In fact, he predicted that proprietary currency would take over as a the principal currency stock of the world — hardly a difficult prediction since it had already happened by the time he wrote that article.

Now for every monetary unit of value issued by any government in the world, the private sector has issued 12 units. In other words the proprietary currency volume is 12 times as big as the fiat currency — fueled largely by the use of derivatives that derived their value from credit instruments, most of which were loans that were supposedly backed by notes and mortgages and which now are like rare earths when it comes to producing one in the flesh.

In 1998, Congress passed and Clinton signed into law the death knell of the American economy. The law specifically excluded this proprietary currency from regulation of ANY sort from government. In short, they created a sovereign country out of the oligopoly that controlled Wall Street and hence the world of finance. Counterfeiters are usually put in jail. But certain types of counterfeiters have prospered as this article and the book it reviews shows clearly.

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Early America, Ripe for Counterfeiters

By NANCY F. KOEHN

NY Times

“THERE is properly no history; only biography,” Ralph Waldo Emerson wrote in 1841. In “Moneymakers: The Wicked Lives and Surprising Adventures of Three Notorious Counterfeiters” (Penguin, $27.95), Ben Tarnoff lends ample credence to that notion. He shows how three con men were able to thrive in America’s early days because of a weak central government, an often-chaotic banking system, a turbulent economy and an entrepreneurial populace.

Few countries, Mr. Tarnoff writes, “have had as rich a counterfeiting history as America.” Creating fake currency, he states, “gave enterprising Americans from the colonial era onward a chance to get rich quick: to fulfill the promise of the American dream by making money, literally.”

Mr. Tarnoff, who graduated from Harvard in 2007 and has worked at Lapham’s Quarterly, focuses on the lives of three counterfeiters who lived in the 18th and 19th centuries. Taken together, he writes, these three biographies “tell the story of a country coming of age — from a patchwork of largely self-governing colonies to a loosely assembled union of states and, finally, to a single nation under firm federal control.”

The first subject of this rollicking good read is Owen Sullivan, an Irish immigrant who was born around 1720 and originally was a silversmith in Boston. In the seven years he was a counterfeiter, he built a loosely organized team called the Dover Money Club.

Like his partners, Sullivan was behind bars several times in the course of his career. Until his final arrest, however, these encounters with the law were small detours on an entrepreneurial journey in pre-industrial crime. When he was hanged in New York City in 1756, he claimed to have forged more than £25,000 worth of colonial money.

Sullivan capitalized on a number of prevailing conditions in the colonies: the collective thirst for liquidity to fuel a growing economy, the often unruly nature of the financial system, and scanty law enforcement.

Underlying these factors was a deep, abiding ambivalence about paper money. Many early Americans, like Benjamin Franklin, recognized the pressing need for paper money as a medium of exchange and a store of value in a world where specie like that made of gold and silver was in short supply.

At the same time, paper money made the economy more mercurial. Unlike precious metals that could be bought and sold as commodities, paper money had no intrinsic value; it could become worthless overnight. Paper money had other dangers, including a greater vulnerability to inflation. Cognizant of all this, the delegates to the Constitutional Convention in 1787 voted against giving the federal government explicit authority to print paper notes, coming down squarely “on the side of a hard currency under national control.”

But the demand for a ready medium of exchange and a recognized measure of value in the burgeoning American economy continued to outstrip the meager supply of precious metals in circulation.

By the early 1800s, paper money in the form of individual bank notes had returned in force. And with it came enterprising counterfeiters like David Lewis (1788-1820), who worked the rural counties of southwestern Pennsylvania forging notes and stirring up populist rage against financial elites.

Lewis became something of a popular hero, known for audacious jailbreaks and sporadic generosity toward strangers. Mr. Tarnoff argues that in the financial panic of 1819, crime acquired a certain status. “Not only was it a way for the dispossessed to make a living, but compared with the perfectly legal frauds perpetuated by the nation’s banks, lawbreaking seemed honest.” Lewis was apprehended for the last time after being shot in the arm and leg. He died from these injuries in a jail in central Pennsylvania.

Finally, Mr. Tarnoff recounts the story of Samuel Upham (1819-1885), a Philadelphia shopkeeper who, in 1862, began printing $5 Confederate notes, which he sold as “mementos of the Rebellion” for a cent each. Along the bottom of each note, he included a strip with the following lettering: “Fac-Simile Confederate Note — Sold Wholesale and Retail by S. C. Upham, 403 Chestnut Street, Philadelphia.”

Backed by heavy newspaper advertising, Upham’s souvenir notes became best sellers, and at some point he must have known that they were no longer being viewed as facsimiles, Mr. Tarnoff says. Borne by Union soldiers, they found their way into the Confederate money supply as counterfeits, and helped fuel rampant inflation and monetary disruption.

As the war progressed, Confederate authorities became convinced that Upham and others were part of a Union campaign to wage economic war on the South. There is no historical evidence that Abraham Lincoln or his administration was involved in such tactics.

But Upham and other moneymakers did play a de facto role in the Union war effort. As Lincoln and his Treasury head, Salmon Chase, understood all too well, the military prospects of either side owed much to the reliability of their respective money supplies. Without a stable, trustworthy form of liquidity, neither combatant could continue to wage war while sustaining its citizens.

Responding to this imperative, Congress in 1862 passed a law that, for the first time since the Revolutionary War, made money printed by the federal government legal tender. A year later, legislation set up federally chartered banks that printed a uniform national currency — making counterfeiting more difficult, though not impossible.

Mr. Tarnoff is an engaging writer who has a fine eye for detail and the relevance of larger, historical forces. But the book ignores a larger question, raised by its description of early American capitalism as an “evolving confidence game” that oscillated “between manic exuberance and total collapse”: Is there something in the speculative nature of the American character and the nation’s economic beginnings that continues to produce people like Bernard Madoff, as well as excessive volatility in the system itself?

Though this and similar questions are unanswered, they do not tarnish the power of the stories that Mr. Tarnoff so delightfully uses to teach us history.

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