JPM Dimon Gets $23 Million, Losing Money While Jiang Jianqing at ICBC Gets $308,000, Most Profitable Bank

JP Morgan, because he can, gets $23 Million for mismanaging a bank with fake assets and losing money hand over foot, while the head of the most profitable bank in the world gets paid $308,000. That means Dimon makes 70 times what a good bank manager makes. The worse you get, the more you get paid. That is our system. And Dimon still gets to sit as the industry “expert” on the NY Federal Reserve Board. Any more questions about our dysfunctional financial system? Why do stockholders stand for this?
This shows that the banks are being managed for management and against the interests of the shareholders . This is the tip of the iceberg. Having diverted hundreds of billions of dollars through off shore transactions in Bermuda, the managers of our banks are able to pick and choose when and if to repatriate that money. In China, where the most profitable bank in the world pays it’s top manager 3% of what Jamie Diamond, they would not be ignoring the PONZI scheme, they would not be ignoring the diversion of funds from investors into “off balance sheet” transactions controlled through layers of entities ultimately responding to Dimon and other key players personally. No, they would not ignore these people. They would most likely shoot them in the back of the head, like the old Soviet days when someone’s hands were found in the cookie jar.
This time the cookie jar contains our life blood. Without seizure of these assets, neither investors nor homeowners, as victims in the scheme, nor the taxpayer will ever see even a portion of their money back. And this is all known in the public domain and in inner circles. The longer the cover up of the crime, the longer we pretend the assets on the balance sheet of the TBTF banks are real, the deeper we get in our complicity with that crime.
It is time to figure out the right thing to do rather than the politically acceptable alternative, which guarantees that the banks still have the spigots running on taxpayer, investor and homeowner money and if anything will take any action that will enhance the flow of that illegal and unconscionable profit inuring solely the personal profit, wealth and power on the nation’s largest banks.

Without question, Obama’s failure to see the obvious here, combined with his apparent lack of interest in the subject is the major flaw in his economic stewardship, and lacking the resolve to challenge the banks with teeth to claw back those off shore funds, may well be surrendering his second term as President. Because the rest of us — from all sides of the political spectrum already know what Obama is ignoring. We know the banks cheated, lied and stole money and we understand that is a crime. In this case, considering the horrific consequences, it might be treason.

West vs East Banker Pay Comparison: JPM’s Jamie Dimon: $23,000,000; ICBC’s Jiang Jianqing: $308,000
http://www.zerohedge.com/news/west-vs-east-banker-pay-comparison-jpms-jamie-dimon-23000000-icbcs-jiang-jianqing-308000

Dimon Threatens Obama: Investigate and Lose Settlement

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Editor’s Comment: If there was any doubt in your mind about who thinks they run the government, it was dispelled yesterday when Reuters reported that Jamie Dimon, CEO of JPMorgan Chase warned Obama that if the new investigation team actually does anything, there won’t be any settlement.

The sheer arrogance of a possible criminal demanding that the government stop investigating him or else the too big too fail bank won’t participate in settlement talks is unfathomable. It demands a response from Obama and it demands a re-thinking at the White House about its relationships with the big banks.

The real investigations are just getting started, with considerable support from already published instances of robo-signing, surrogate signing, forgery, fabrication and fraud in the foreclosure process.

Dimon reacted because of one major risk: the entire securitization scheme will be revealed as a scam from beginning to end. This would mean that the banks would have enormous liability to virtually all MBS investors, enormous tax liability for the REMICs and potentially to the investors, and enormous liability to homeowners who were duped into thinking that they had been through conventional loan underwriting when in fact it was jsut a marketing scheme to justify the movement of money.

As stated on these pages before, the result will be

  • (1) that investors, as creditors in these transactions are owed 100 cents on the dollar not by the homeowners, but by the Banks, who took investor money and either didn’t invest it all in loans, or invested in loans that they knew ( and were betting on) would fail
  • (2) that potentially trillions of dollars in unreported income went untaxed amounting more than any bailout
  • (3) that the mortgage documentation was so defective as to defy reformation or correction, leaving the loans unsecured and possibly non-existent and
  • (4) that the homeowners who have been foreclosed and dispossessed still own their properties with an unclear debt or obligation that is unsecured.

Dimon is trying to block reality from entering into the picture. Selling the loans multiple times through exotic instruments that looked like hedge products has its consequences. It leaves the creditor or its agents filled with money obtained through multiple payments on the same debt. All this seems counter-intuitive, I know. And it sure puts a crimp on the foreclosure plan that takes homes to satisfy a debt that has already been satisfied multiple times.

Beyond that, it provides a blueprint for correcting the corruption of the title registries across the country. Once the loans are shown to be defective beyond recognition, and once securitization is shown to be a word and a plan that was never actually executed, the whole thing boils down to one simple fact: there were loans but there were no mortgages. Papers was signed that meant nothing, disclosed nothing and violated every industry practice in place for hundreds of years.

There is no greater fiscal stimulus to the economy than returning ill-gotten gains to the investors and homeowners who were victims of this scheme. It will save pensions and allow people to recover the wealth that was siphoned out of the economy instead of the job Wall Street was meant to fulfill — pumping liquidity into the economy for expansion, innovation and prosperity. The answer is right there in front of us. The Banks have attempted to place false ideology in front of the requirements of law. The only question is whether the government will let that happen.

See Full Story on Reuters

JPMorgan Chase & Co Chief Executive Jamie Dimon said President Barack Obama’s decision to expand investigations into home lending and sales of mortgage securities could stop settlement talks with the states over foreclosure practices.

“It has a pretty good chance of derailing it,” Dimon said in a televised interview with CNBC from Davos, Switzerland on Thursday.

Obama, in his State of the Union address Tuesday, said he has asked his attorney general to create a special unit of prosecutors to expand investigations into home lending and packaging of mortgage-backed securities. It is not clear how the new unit will be different from earlier investigations.

JPMorgan is the largest U.S. bank and one of the larger servicers of mortgage loans. JPMorgan, Bank of America, Wells Fargo & Co, Citigroup and Ally Financial Inc have been in talks with state attorneys general for months about settling allegations of foreclosure abuses.

The banks and states have been discussing a plan that would have the banks pay $25 billion to homeowners through reductions in principal on mortgage loans.

“I think it would be better for America if that settlement took place,” Dimon said. “If this thing derails that, so be it.”

(Reporting by David Henry; editing by John Wallace)

 

DELUSION IS AN IRONCLAD DEFENSE

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Biggest Fish Face Little Risk of Being Caught

EDITOR’S NOTE: There is only one reason why there are not over 1,000 prosecutions that would successfully land the perps in jail — the reason is that the perps are the ones actually in charge. This is not rocket science. It is complex but it is not abstract requiring the intellect of Einstein. It takes elbow grease but not brilliance to make the case for fraud.

ANY COMMON CITIZEN — A POTENTIAL JURY MEMBER —- CAN MAKE THE CONNECTION BETWEEN WHAT HAPPENED ON WALL STREET AND WHAT HAPPENED ON MAIN STREET. IT WAS ALL PART OF ONE TRANSACTION. THE MONEY CAME FROM WALL STREET TRANSACTIONS AND WAS USED IN BITS AND PIECES ALL THE WAY DOWN TO USING PART OF THE INVESTOR MONEY TO FUND MORTGAGE LOANS. WHAT DO YOU THINK WE SHOULD DO?

By JOE NOCERA

NY TIMES

So much for Angelo Mozilo taking the fall for the financial crisis.

Late last week, word leaked out that Mr. Mozilo, who had co-founded Countrywide Financial in 1969 — and, for nearly 40 years, presided over its astonishing rise and its equally astonishing fall — would not be prosecuted by the Justice Department. Not for insider trading. Not for failing to disclose to investors his private worries about subprime loans. Not for helping to create a culture at Countrywide in which mortgage originators were rewarded for pushing fraudulent loans on borrowers.

In its article about the Justice Department’s decision, The Los Angeles Times said prosecutors had concluded that Mr. Mozilo’s actions “did not amount to criminal wrongdoing.”

Just months earlier, the Justice Department concluded that Joe Cassano shouldn’t take the fall for the financial crisis either. Mr. Cassano, you’ll recall, is the former head of the financial products unit of the American International Group, a man whose enthusiasm for credit-default swaps led, pretty directly, to the need for a huge government bailout of A.I.G. There was a time when it appeared that there was no way the government would let Mr. Cassano walk. But it did.

And then there’s Richard Fuld, the man who presided over Lehman Brothers’ demise. Though he was the subject of an investigation shortly after the Lehman bankruptcy, it appears that prosecutors are moving on.

Most of the other Wall Street bigwigs whose firms took unconscionable risks — risks that nearly brought the global financial system to its knees — aren’t even on Justice’s radar screen. Nor has there been a single indictment against any top executive at a subprime lender.

The only two people on Wall Street to have been prosecuted for their roles in the crisis are a pair of minor Bear Stearns executives, Ralph Cioffi and Matthew Tannin, whose internal hedge fund, stuffed with triple-A mortgage-backed paper, collapsed in the summer of 2007, an event that anticipated the crisis. A jury acquitted them.

Two and a half years after the world’s financial system nearly collapsed, you’re entitled to wonder whether any of the highly paid executives who helped kindle the disaster will ever see jail time — like Michael Milken in the 1980s, or Jeffrey Skilling after the Enron disaster. Increasingly, the answer appears to be no. The harder question, though, is whether anybody should.

Aficionados of financial crises like to point to the savings-and-loan debacle of the 1980s as perhaps the high-water mark in prosecuting executives after a broad financial scandal. When the government loosened the rules for owning a thrift, the industry was taken over by aggressive entrepreneurs, far too many of whom made self-dealing loans using savings-and-loan deposits as their own personal piggy banks.

In time, nearly 1,000 savings and loans — a third of the industry — collapsed, costing the government billions. According to William K. Black, a former regulator who teaches law at the University of Missouri, Kansas City, “There were over 1,000 felony convictions in major cases” involving executives of the thrifts. Solomon L. Wisenberg, a lawyer who writes for a blog on white collar crime, said, “The prosecutions were hugely successful.”

That is partly because the federal government threw enormous resources at those investigations. There were a dozen or more Justice Department task forces. Over 1,000 F.B.I. agents were involved. The government attitude was that it would do whatever it took to bring crooked bank executives to justice.

The executives howled that they were being unfairly persecuted, but the cases against them were often rooted in a simple concept: theft. And as prosecutors racked up victories in court, they became confident in their trial approach, and didn’t back away from taking on even the most well-connected thrift executives, like Charles Keating, who owned Lincoln Savings — and who eventually went to prison.

Today, Mr. Black says, the government doesn’t have nearly as many resources to pursue such cases. With the F.B.I. understandably focused on terrorism, there isn’t a lot of manpower left to dig into potential crimes that may have taken place during the financial crisis. Fewer than 150 of the bureau’s agents are assigned to mortgage fraud, for instance. Several lawyers who represent white collar defendants told me that outside of New York, there aren’t nearly enough prosecutors who understand the intricacies of financial crime and know how to prosecute it. It is a lot easier to prosecute people for old-fashioned crimes — robbery, assault, murder — than for financial crimes.

Which leads to another point: as Sheldon T. Zenner, a white collar criminal lawyer in Chicago, puts it, “These kinds of cases are extraordinarily difficult to make. They require lots of time and resources. You have some of the best, highest-paid and most sophisticated lawyers on the other side fighting you at every turn. You are climbing a really high mountain when you try to do one of these cases.”

Take, again, the one big case that prosecutors have brought, against Mr. Cioffi and Mr. Tannin. The Bear Stearns executives had written numerous e-mails expressing their fears and anxieties as the fund began to sink. Prosecutors viewed those e-mails as smoking guns, proof that the men had withheld important information from their investors. Thanks largely to those e-mails, prosecutors saw the case as a slam dunk.

But it wasn’t. For every e-mail the executives wrote predicting the worst, they would write another expressing their belief that everything would be O.K. Besides, expressing such fears publicly would have doomed the fund, because liquidity would have instantly vanished. Instead of viewing Mr. Cioffi and Mr. Tannin as crooks, the jury saw them as two men struggling to make the best of a difficult situation. By the time the trial was over, the e-mails, in their totality, made the defendants seem sympathetic rather than criminal.

It seems safe to say that the government’s failure to convict those two Bear Stearns executives has caused prosecutors to shy away from bringing other cases. After all, the case against Mr. Cioffi and Mr. Tannin was supposed to be the easy one. By contrast, a case against Angelo Mozilo would have been, from the start, a much harder one to win.

Although the Justice Department never filed charges against Mr. Mozilo, one can assume that its case would have been similar to the civil case brought earlier by the Securities and Exchange Commission. (On the eve of the trial date last fall, the S.E.C. blinked and settled with Mr. Mozilo.) One of the S.E.C.’s charges was insider trading — that Mr. Mozilo sold nearly $140 million worth of stock after he knew the company was in trouble. But the defense countered by pointing out that Mr. Mozilo was selling his stock under an automatic selling program that top corporate executives often use — thus mooting the insider trading accusation.

Like the Bear Stearns executives, Mr. Mozilo had written his share of e-mails expressing worries about some of Countrywide’s loan practices. He called one of Countrywide’s subprime products “the most dangerous product in existence, and there can be nothing more toxic.” The government argued that Mr. Mozilo had a legal obligation to share that information with investors.

But this case, too, would have been awfully difficult to make. Countrywide’s descent into subprime madness was hardly a secret. It made all sorts of crazy adjustable rate mortgages that required no documentation of income; its array of products was also well known and disclosed to investors. Indeed, Mr. Mozilo was quite vocal and public in saying that the housing market was due to fall, and fall hard. But he always assumed that whatever its losses, Countrywide was so strong that it would be one of the survivors and would feast on the carcasses of its former competitors. No internal e-mail he wrote contradicted that belief.

Was there outright fraud at Countrywide? Of course there was. That is a large part of the reason that Bank of America, which bought Countrywide in early 2008, has struggled so mightily with the legacy of all the Countrywide loans now on its books. But most of the fraudulent actions at Countrywide took place at the bottom of the food chain, at the mortgage origination level. It has been well-documented that mortgage brokers induced borrowers to take loans that they never understood, and often persuaded them to lie on their loan applications. [EDITOR’S NOTE: THEY STILL DON’T GET IT. WHO DO THEY THINK WAS GIVING THE INSTRUCTIONS? IN AN INDUSTRY THAT INVENTED THE TERM DUE DILIGENCE IS THERE ANY POSSIBILITY THAT MOZILO AND OTHERS DIDN’T KNOW EXACTLY WHAT WAS GOING ON? WHY NOT LET A JURY DECIDE?]

That kind of predatory lending is against the law — and it should be prosecuted. But going after small-time mortgage brokers isn’t nearly as satisfying as putting the big guy in jail, especially a big guy like Mr. Mozilo, who symbolizes to many Americans the excesses and wrongdoing embodied in the subprime lending mess. The problem is that Mr. Mozilo, though he helped create the culture that made such predatory lending acceptable, never made the fraudulent loans himself. Legally, if not morally, he’s off the hook.

A few days ago, I listened to a recording of a lengthy interview with Mr. Mozilo conducted by investigators working for the Financial Crisis Inquiry Commission and posted recently on the commission’s Web site. It was a remarkable performance; Mr. Mozilo expressed no regrets and no remorse. He extolled subprime loans as a way to allow lower-income Americans to get a piece of the American dream and “really build wealth” — just like people used to do during the housing bubble. He bragged that Countrywide, unlike the too-big-to-fail banks, never took a penny of government money. He said that Countrywide had helped put 25 million Americans in homes.

His voice rising passionately, he said finally, “Countrywide was one of the greatest companies in the history of this country.”

Which is a final reason Mr. Mozilo would have been difficult to prosecute. Delusion is an iron-clad defense.

LOCAL GOVERNMENTS UNDERWATER: TIME TO CORRECT PRINCIPAL BALANCES

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We now have a growing group of unlikely bedfellows — investors, homeowners and local governments who were all duped and whose claims are being treated as though each one was unique when in fact the entire plan was a highly organized crime. Add the Federal government to that group who has also demanded “buy-back” of fake mortgages and fake mortgage bonds, although it is highly probable that the government was complicit, certainly in the BUSH administration when the Government and the Fed started all these bailout programs whose total seems to exceed the total of ALL credit that was extended in the original transactions!?!

MY QUESTION IS WHETHER DIMON IS RIGHT: DOES HE LIVE IN A COMPLETELY RISK-FREE ENVIRONMENT OR ARE WE GOING TO APPLY THE LAW TO HIM? GOD HELP US IF HIS ASSUMPTION IS CORRECT.

THE MORE IMPORTANT QUESTION IS WHETHER WE ARE FINALLY GOING TO MAKE THE OBVIOUS CORRECTION OF AN OBVIOUS LIE ABOUT THE VALUE OF THE PROPERTIES AND THE ELABORATELY CONSTRUCTED ILLUSION OF “GROWTH” ? IT ISN’T “PRINCIPAL REDUCTION” TO CUT IT DOWN TO THE REAL FIGURE THAT SHOULD HAVE BEEN USED — IT’S PRINCIPAL CORRECTION.

STATES, COUNTIES, CITIES, TOWNS, INVESTORS AND HOMEOWNERS CAN ONLY GET OUT FROM UNDER THE ILLUSION OF DEBT BY ACKNOWLEDGING THE OBVIOUS — IT ISN’T REALLY THERE IF YOU APPLY THE LAW. IT’S ONLY THERE IF YOU APPLY UNBOUNDED POWER.

EDITOR’S COMMENT: Time for local government to start seeking debt relief and doing those securitization reports and research. Whether they received money from the banks or not, officials in local government are being forced to face the reality that they are presiding over the collapse of our social system for lack of money.

They are in debt — and the amount of debt so vastly exceeds their ability to pay or any prospect to pay that defaults are inevitable — including strategic defaults and bankruptcies where the debt is modified downward. In other words, they are in the same boat as the homeowners.

Actually they are worse off because Wall Street had the nerve to sell local governments triple-A rated mortgage bonds that were worthless, putting them both in the same boat as homeowners and the same boat as other investors.

And if you dig deeper you will connect the dots — the appraisal fraud and other misleading information led these municipalities, towns and counties into planning and for phenomenal growth in demand for services over wider geographical areas, each local government believing that their revenue stream and population would grow at a rate that was both unprecedented and unsupported by any economic fundamentals. They are now stuck with debt to pay for services, they won’t deliver, roads they won’t build, and buildings that are being abandoned or sold.

In plain language, the argument that the crisis grew from greedy homeowners must also be extended to greedy politicians who intentionally bankrupted their cities and towns in the misguided attempt to make a fast buck. Few people will argue whether people are greedy, whether they are homeowners or politicians, but the argument that they would intentionally put themselves in a position of drowning in debt is absurd. There is only one reason this all happened — Wall Street sales machine went to work selling people on “concept” and funding it with other people’s money to create a vast illusion for which we are all paying whether we  participated or not.

The astonishing reversal of fortune for virtually all Americans (except a select few who continue to lie about what they did and when they knew what they were doing) and all their societal structures, governments and government services (police, fore, medical, education etc) is in stark contrast to the massive profits and bonuses that continue to be reported and paid on Wall Street. The entire country has been tilted past the tipping point, so that everything of value went from the the nation as a whole to Wall Street.

In a NY Times Magazine article on Jamie Dimon he continues the BIG LIE strategy that Moynihan over at BofA is using: we had didn’t realize the extent of the lying on stated income loans. He’s staying on message because it is working. As a group, most of us still want to believe and do believe that our system will not break down, but it IS breaking down. The process is already underway. Dimon’s current lie is intended to distract us from considering that the lie was created by him and his officers and employees. The lie works because you must take the time away from your job-hunting and ask yourself how all those applications were filled with bad information without anyone knowing about it. “Due diligence,” a term coined on Wall Street for inspecting the chicken before you buy it, is NEVER overlooked.

Countrywide, Chase, Citi, Goldman and others lied about the quality of the loans and the values of the real property and the documentation of the loans, notes and mortgages because they could. They controlled the entire apparatus. The sheer size made it look “institutionalinstead of organized crime. Of course they knew, but they were acting in a totally risk-free environment because they were using other people’s money — investors to whom they lied with the same lies that were told to borrowers — we have reviewed the application, verified the data, verified the value of the property, and the loan meets with underwriting standards. The loan is approved. Or in the case of local government, the bond is approved, the underwriting and selling of it shall begin.

We now have a growing group of unlikely bedfellows — investors, homeowners and local governments who were all duped and whose claims are being treated as though each one was unique when in fact the entire plan was a highly organized crime. Add the Federal government to that group who has also demanded “buy-back” of fake mortgages and fake mortgage bonds, although it is highly probable that the government was complicit, certainly in the BUSH administration when the Government and the Fed started all these bailout programs whose total seems to exceed the total of ALL credit that was extended in the original transactions!?!

MY QUESTION IS WHETHER DIMON IS RIGHT: DOES HE LIVE IN A COMPLETELY RISK-FREE ENVIRONMENT OR ARE WE GOING TO APPLY THE LAW TO HIM? GOD HELP US IF HIS ASSUMPTION IS CORRECT.

THE MORE IMPORTANT QUESTION IS WHETHER WE ARE FINALLY GOING TO MAKE THE OBVIOUS CORRECTION OF AN OBVIOUS LIE ABOUT THE VALUE OF THE PROPERTIES AND THE ELABORATELY CONSTRUCTED ILLUSION OF “GROWTH” ? IT ISN’T PRINCIPAL REDUCTION TO CUT IT DOWN TO THE REAL FIGURE THAT SHOULD HAVE BEEN USED — IT’S PRINCIPAL CORRECTION.

STATES, COUNTIES, CITIES, TOWNS, INVESTORS AND HOMEOWNERS CAN ONLY GET OUT FROM UNDER THE ILLUSION OF DEBT BY ACKNOWLEDGING THE OBVIOUS — IT ISN’T REALLY THERE IF YOU APPLY THE LAW. IT’S ONLY THERE IF YOU APPLY UNBOUNDED POWER.

LLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLL

Mounting State Debts Stoke Fears of a Looming Crisis

By MICHAEL COOPER and MARY WILLIAMS WALSH

The State of Illinois is still paying off billions in bills that it got from schools and social service providers last year. Arizona recently stopped paying for certain organ transplants for people in its Medicaid program. States are releasing prisoners early, more to cut expenses than to reward good behavior. And in Newark, the city laid off 13 percent of its police officers last week.

While next year could be even worse, there are bigger, longer-term risks, financial analysts say. Their fear is that even when the economy recovers, the shortfalls will not disappear, because many state and local governments have so much debt — several trillion dollars’ worth, with much of it off the books and largely hidden from view — that it could overwhelm them in the next few years.

“It seems to me that crying wolf is probably a good thing to do at this point,” said Felix Rohatyn, the financier who helped save New York City from bankruptcy in the 1970s.

Some of the same people who warned of the looming subprime crisis two years ago are ringing alarm bells again. Their message: Not just small towns or dying Rust Belt cities, but also large states like Illinois and California are increasingly at risk.

Municipal bankruptcies or defaults have been extremely rare — no state has defaulted since the Great Depression, and only a handful of cities have declared bankruptcy or are considering doing so.

But the finances of some state and local governments are so distressed that some analysts say they are reminded of the run-up to the subprime mortgage meltdown or of the debt crisis hitting nations in Europe.

Analysts fear that at some point — no one knows when — investors could balk at lending to the weakest states, setting off a crisis that could spread to the stronger ones, much as the turmoil in Europe has spread from country to country.

Mr. Rohatyn warned that while municipal bankruptcies were rare, they appeared increasingly possible. And the imbalances are so large in some places that the federal government will probably have to step in at some point, he said, even if that seems unlikely in the current political climate.

“I don’t like to play the scared rabbit, but I just don’t see where the end of this is,” he added.

Resorting to Fiscal Tricks

As the downturn has ground on, some of the worst-hit cities and states have resorted to fiscal sleight of hand to stay afloat, helping them close yawning budget gaps each year, but often at great future cost.

Few workers with neglected 401(k) retirement accounts would risk taking out second mortgages to invest in stocks, gambling that the investment gains would be enough to build bigger nest eggs and repay the loans.

But that is just what Illinois, which has been failing to make the required annual payments to its pension funds for years, is doing. It borrowed $10 billion in 2003 and used the money to invest in its pension funds. The recession sent their investment returns below their target, but the state must repay the bonds, with interest. The solution? Illinois sold an additional $3.5 billion worth of pension bonds this year and is planning to borrow $3.7 billion more for its pension funds.

It is the long-term problems of a handful of states, including California, Illinois, New Jersey and New York, that financial analysts worry about most, fearing that their problems might precipitate a crisis that could hurt other states by driving up their borrowing costs.

But it is the short-term budget woes that nearly all states are facing that are preoccupying elected officials.

Illinois is not the only state behind on its bills. Many states, including New York, have delayed payments to vendors and local governments because they had too little cash on hand to make them. California paid vendors with i.o.u.’s last year. A handful of other states, worried about their cash flow, delayed paying tax refunds last spring.

Now, just as the downturn has driven up demand for state assistance, many states are cutting back.

The demand for food stamps has been rising significantly in Idaho, but tight budgets led the state to close nearly a third of the field offices of the state’s Department of Health and Welfare, which take applications for them. As states have cut aid to cities, many have resorted to previously unthinkable cuts, laying off police officers and closing firehouses.

Those cuts in aid to cities and counties, which are expected to continue, are one reason some analysts say cities are at greater risk of bankruptcy or are being placed under outside oversight.

Next year is unlikely to bring better news. States and cities typically face their biggest deficits after recessions officially end, as rainy-day funds are depleted and easy measures are exhausted.

This time is expected to be no different. The federal stimulus money increased the federal share of state budgets to over a third last year, from just over a quarter in 2008, according to a report issued last week by the National Governors Association and the National Association of State Budget Officers. That money is set to run out next summer. Tax collections, meanwhile, are not expected to return to their pre-recession levels for another year or two, given that the housing market and broader economy remain weak and that unemployment remains high.

Scott D. Pattison, the budget association’s director, said that for states, next year could be “the worst year of this four- or five-year downturn period.”

And few expect the federal government to offer more direct aid to states, at least in the short term. Many members of the new Republican majority in the House campaigned against the stimulus, and Washington is debating the recommendations of a debt-reduction commission.

So some states are essentially borrowing to pay their operating costs, adding new debts that are not always clearly disclosed.

Arizona, hobbled by the bursting housing bubble, turned to a real estate deal for relief, essentially selling off several state buildings — including the tower where the governor has her office — for a $735 million upfront payment. But leasing back the buildings over the next 20 years will ultimately cost taxpayers an extra $400 million in interest.

Many governments are delaying payments to their pension funds, which will eventually need to be made, along with the high interest — usually around 8 percent — that the funds are expected to earn each year.

New York balanced its budget this year by shortchanging its pension fund. And in New Jersey, Gov. Chris Christie deferred paying the $3.1 billion that was due to the pension funds this year.

It is these growing hidden debts that make many analysts nervous. States and municipalities currently have around $2.8 trillion worth of outstanding bonds, but that number is dwarfed by the debts that many are carrying off their books.

State and local pensions — another form of promised debt, guaranteed in some states by their constitutions — face hidden shortfalls of as much as $3.5 trillion by some calculations. And the health benefits that state and large local governments have promised their retirees going forward could cost more than $530 billion, according to the Government Accountability Office.

“Most financial crises happen in unpredictable ways, and they hit you when you’re not looking,” said Jerome H. Powell, a visiting scholar at the Bipartisan Policy Center who was an under secretary of the Treasury for finance during the bailout of the savings and loan industry in the early 1990s. “This one isn’t like that. You can see it coming. It would be sinful not to do something about this while there’s a chance.”

So far, investors have bought states’ bonds eagerly, on the widespread understanding that states and cities almost never default. But in recent weeks the demand has diminished sharply. Last month, mutual funds that invest in municipal bonds reported a big sell-off — a bigger one-week sell-off, in fact, than they had when the financial markets melted down in 2008. And hedge funds are already seeking out ways to place bets against the debts of some states, with the help of their investment banks.

Of course, not all states are in as dire straits as Illinois or California. And the credit-rating agencies say that the risk of default is small. States and cities typically make a priority of repaying their bond holders, even before paying for essential services. Standard & Poor’s issued a report this month saying that the crises that states and municipalities were facing were “more about tough decisions than potential defaults.”

Change in Ratings

The credit ratings of a number of local governments have improved this year, not because their finances have strengthened somewhat, but because the ratings agencies have changed the way they analyze governments.

The new higher ratings, which lower the cost of borrowing, emphasize the fact that municipal defaults have been much rarer than corporate defaults.

This October, Moody’s issued a report explaining why it now rates all 50 states, even Illinois, as better credit risks than a vast majority of American non-financial companies.

One reason: the belief that the federal government is more likely to bail out a teetering state than a bankrupt company.

“The federal government has broadly channeled cash to all state governments during recent recessions and provided support to individual states following natural disasters,” Moody’s explained, adding that there was no way of being sure how Washington would respond to a bond default by a state, since it had not happened since the 1930s.

But some analysts fear the ratings are too sanguine, recalling that the ratings agencies also dismissed the possibility that a subprime crisis was brewing. While most agree that defaults are unlikely, they fear that as states struggle with their growing debts, investors could decide not to buy the debt of the weakest state or local governments.

That would force a crisis, since states cannot operate if they cannot borrow. Such a crisis could then spread to healthier states, making it more expensive for them to borrow, if Europe is an example.

Meredith Whitney, a bank analyst who was among the first to warn of the impact the subprime mortgage meltdown would have on banks, is warning that she sees similar problems with state and local government finances.

“The state situation reminded me so much of the banks, pre-crisis,” she said this fall on CNBC.

There are eerie similarities between the subprime debt crisis and the looming municipal debt woes. Among them:

¶Just as housing was once considered a sure bet — prices would never fall all across the country at the same time, conventional wisdom suggested — municipal bonds have long been considered an investment safe enough for grandmothers, because states could always raise taxes to pay their bondholders. Now that proposition is being tested. Harrisburg, the capital of Pennsylvania, considered bankruptcy this year because it faced $68 million in debt payments related to a failed incinerator, which is more than the city’s entire annual budget. But officials there have resisted raising taxes.

¶Much of the debt of states and cities is hidden, since it is off the books, just as the amount of mortgage-related debt turned out to be underestimated. States and municipalities often understate their pension liabilities, in part by using accounting methods that would not be allowed in the private sector. Joshua D. Rauh, an associate professor of finance at Northwestern University, and Robert Novy-Marx, an assistant professor of finance at the University of Rochester, calculated that the true unfunded liability for state and local pension plans is roughly $3.5 trillion.

¶The states and many cities still carry good ratings, and those issuing warnings are dismissed as alarmists, reminding some analysts of the lead up to the subprime crisis.

Now states are bracing for more painful cuts, more layoffs, more tax increases, more battles with public employee unions, more requests to bail out cities. And in the long term, as cities and states try to keep up on their debts, the very nature of government could change as they have less money left over to pay for the services they have long provided.

Richard Ravitch, the lieutenant governor of New York, is among those warning that states are on an unsustainable path, and that their disclosures of pension and health care obligations are often misleading. And he worries how long it can last.

“They didn’t do it with bad motives,” he said. “Ninety-five percent of them didn’t understand what they were doing. They did it because it was easier than taxing people or cutting benefits. We’re getting closer and closer to the point where we can’t do that anymore. I don’t know where that is, but I know we’re close.”

Regulation and Prosecution on Wall Street

In my opinion, the growing anger at Wall Street is giving Lloyd Blankfein and Jamie Dimon another chance at misdirection. They are using the current popular angst to steer the debate into whether derivatives and synthetic CDOs should be banned. In the end they will win that debate, and they should win it. What they should lose is their freedom in a judicial forum where they are prosecuted like Ken Lay and Bernie Ebbers, and where it is proven beyond a reasonable doubt that they committed criminal fraud and securities fraud.

The fact that we had a bad experience with derivatives is not a reason to ban them. The fact that they were abused and that people were cheated and that the entire financial system was undermined is another story.

There is nothing wrong with any transaction if the playing field is relatively level and if the imbalances are addressed by law and regulation. That is what the Truth in lending Act is all about and the Real Estate Settlement Procedures Act is meant to address.

When the big guys use their superior knowledge to trick consumers into deadly transactions, the big guys should pay the price. We have the SEC to take care of that on the other end protecting investors. Licensing laws and administrative sanctions against those licensed by state or federal agencies are well-equipped to step in and deal with these abuses. But they didn’t.

Complaints sent to the Federal Trade Commission, Office of Thrift Supervision and Office of the Controller of the Currency have gone unheeded even to this day. The only answer you get is similar to the answer we get from sending short or long Qualified Written requests or Debt Validation Letters — short shrift of legitimate complaints that by law are required to be investigated, verified (not just restated) and corrected.

The inconvenient truth is that our regulators were not employing the tools given to them. Everyone knew it. In part it was because of undue influence and in part it was because they were deferring to larger “smarter” institutions like the Federal Reserve. But the biggest reason the Federal and state agencies didn’t do their job is that we, as a society, bought into the non-regulation philosophy which has failed so spectacularly. We didn’t support appropriate funding, training and resources for these agencies. If we had done what we should have done — elect people who were committed to government protecting and serving the people — this mess would never have mushroomed to the point where Wall Street issued proprietary currency equal to 12 times times the amount of government currency — all in a span only 25 years.

The simple truth is that there was nothing inherently wrong about securitizing residential mortgages. In theory, spreading the risk out created much greater liquidity for small and large consumers of credit. What was wrong and remains wrong is that the use of these instruments was for an illegal purpose — to defraud investors and borrowers alike. And they did it in an illegal manner — by denying and withholding information essential to the decision-making on both sides of these transactions.

On one side you had a creditor who was willing to loan money for residential mortgages under terms and conditions that were “explained” in mind-numbing prospectuses and guaranteed by “insurance” that wasn’t really insurance and which was appraised by government licensed rating agencies who issued investment grade appraisals that were so wrong that it strains credibility to assume they didn’t know they were part of a larger criminal enterprise. This creditor lent money and received a bond, whose terms referenced other documents in the securitization chain that imposed conditions, co-obligors, and protections to the intermediaries that completely changed the loans that were signed by borrowers far, far away.

On the other side, you had borrowers, homeowners, who put their largest or only investment in the world at risk in a transaction that they could not understand because the information required to understand it was withheld. But even Alan Greenspan admitted he didn’t understand the transactions with the help of 100 PhD’s. These borrowers relied upon the sanctity of an underwriting process that no longer existed. Verification of property value, quality, affordability etc. were no longer in the mix.

These borrowers undertook an obligation to repay and signed a note that was evidence of the obligation but was payable to someone other than the party(ies) who loaned the money. That note was only a tiny part of the obligation to the creditor as evidenced by the mortgage backed bond they received.

The creditor was bilked out of a dollar and contrary to the expectations of the creditor, less than 2/3 of each dollar was actually used to fund mortgages. The creditor never actually received or even saw the note but ownership of the note was conveyed to the investor along with many other terms — terms that were entirely different from the note the borrower signed as to interest payments, principal, fees etc.

In between were the dozens of intermediaries who treated the documentation like a hot potato because nobody wanted to be stuck with it — knowing that misrepresentation and bad appraisals were the root of the instruments signed by creditors and debtors. These intermediaries kept possession of the note, kept the security instrument and kept the money and most of the insurance proceeds, received the federal bailout and now are proceeding to repackage the junk they already sold and through “resecuritization” are selling them again.

In my opinion there is nothing theoretically wrong with anything described above except for one thing — they lied. Fraud is fraud. If they had educated the creditors and debtors, if they had complied with local property and contract law, if they had been transparent disclosing everything much the same way as the prospectus in an IPO, then two things are true: (a) transactions that were completed would have been done because both sides knew the risks and were willing to take the loss and (b) transactions that were NOT completed (which would have been nearly all of them) would been rejected because the costs were too high, the risks were too high, and the consequences too dire.

But none of that happened because we allowed our regulators to be co-opted by the industries they were supposed to regulate. So tell your legislators and government agencies that you’ll allow them the resources to properly regulate and that you expect to hold them and the elected officials who put them there fully accountable.

Don’t throw the baby out with the bathwater. It isn’t derivatives that are wrong it is the people who used them and the way they were used that is wrong. Killing derivatives would lead to stagnation of what once was our greatest asset — the engine of liquidity for access to capital that has kept our economy growing.


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