Friday, July 31, 2009

AIG: New Sources of Possible Rot

Okay, we all knew AIG's financial products division was a rogue, out-of-control actor that ended up bringing the giant to its knees. But at least, in the heart of the insurer's operations, everything was just splendid, solid as a rock.

Oops. Make that a sand hill.

The New York Times says:
State regulatory filings ... show that A.I.G.’s individual insurance companies have been doing an unusual volume of business with each other for many years — investing in each other’s stocks; borrowing from each other’s investment portfolios; and guaranteeing each other’s insurance policies, even when they have lacked the means to make good. Insurance examiners working for the states have occasionally flagged these activities, to little effect.
More ominously, many of A.I.G.’s insurance companies have reduced their own exposure by sending their risks to other companies, often under the same A.I.G. umbrella.

Ah, Jeez. Here we go again. Two interesting elements that emerge from this article: (1) State insurance regulators were impotently flagging concerns but couldn't get their arms around the magnitude of the problem so we might ask ... where the hell is a federal regulator for AIG? Can't we at least get one of those up and running while we're dithering on health care reform and waiting for the stimulus package to kick in all the way? (2) AIG is making cooing noises of unconcern ... where have we heard that before? Oh yeah: a certain employee, a Joe Cassano, said that the chances of his financial products division losing even a nickel were practically zero. Guess how that turned out?

So who owns this mega-turd called AIG? Umm, that would be ... the ... U.S. taxpayer! Wow. We really are suckers. This is the metaphor I keep thinking of for the U.S. government: He's a fat kid. A rich kid. You recognize him on the playground immediately and run over to him. Why? Because he's such a great guy? No, because change is always spilling out of his pockets. Or he's buying something ridiculous and you just can't believe it. "He paid Jim $40 for that dead cricket? He bought ten boogers off Lester for $10? I wonder what he'll give me for this dirty candy bar wrapper?"

I think Obama made a big misjudgment on this financial crisis. I think he thought he could skate through, not shake too many trees and not upset too many people, and thus be well-fortified politcally to deal with other pet issues, such as health care reform. I think he made a big mistake by not clearing the decks and taking this first year of his term just to sort out the many, many problems of this financial crisis and help sculpt a much more robust system going forward.

Wednesday, July 29, 2009

High-Frequency Trading: MUST READ!

Congrats to Mike, who is using his considerable economics training to good ends now over at the Atlantic's business blog section. He has an introduction to high-frequency trading that may be a bit of a slog for the novice, but it is a VERY IMPORTANT read for any stock market investor.

I've been watching the attention focused on high-frequency trading bloom rapidly over the last month or two -- sort of like a slow-motion explosion -- from Zero Hedge's initial ominous entries on the subject, to a New York Times piece that followed surprisingly quickly, to Mike now ... and I think this will be the next scandal in the stock markets, assuming enough people are bright enough to understand what's going on. They certainly should care.

What's happening: there is the market for the big boys with the high-powered computer algorithms, the Goldman Sachses and all ... and there is the market for the rest of us. My naked assessment so far, based on admittedly limited information: the rest of us are getting screwed. Or should I say, any little guy who trades stocks, is invested in a retirement fund that trades in and out of stocks, or has a 401(k) that's making buys and sells, is getting screwed.

It seems that ultra-fast computers can do a number of bad, manipulative things to stock prices. They can scrape a few pennies, or fractions of pennies, off lots of trades (those pennies are coming out of your, or your mutual fund's, pocket). Pretty soon we're talking real money.

But please, read what Mike has to say. He has a very smart, incisive, well-reasoned posting on this. He shreds the argument that the computers are simply providing liquidity. He also highlights the real issue, beyond the fact that we're getting ripped off: this is distorting how the market is supposed to work. Prices on stocks are supposed to move based on perceptions of the underlying value of the company, not because of smokes and mirrors and rotten ruses.

I gotta be honest. For a long time I used to preach that the smartest investment was the stock market, where you just put your money in an index fund and left it alone. No hassle! Returns were, what, ten percent on average a year? But I've really soured on the market. Stocks have performed absymally over the last 10 years. I've personally lost thousands of dollars.

Now someone might argue: Well, just stick with it. They'll bounce back. But I'm starting to smell rot in the system itself. Companies juice immediate profits to pad bonus checks. The historical returns ain't looking so hot either: what are they now, about 8 percent? Hell, you can get a good 5 percent in a safe bond fund. And now we have this high-frequency trading revelation: if the stock market didn't resemble a casino before, it sure as hell does now. And the guy next to you at the table, whether you know it or not, may have an edge at the game of chance -- at your expense.

I'm very discouraged about fairness in markets right now. I'm starting to edge toward the belief that the United States is a deeply corrupt country. I use the word "deeply" not in the sense of arrant corruption -- I don't believe that is the case. Rather, I think we have a system that is profoundly corrupt in that it appears to be democratic and free, but is increasingly controlled by special interests and powerful entities that do their worst behind the cloak of a free market ideology.

Tuesday, July 21, 2009

A Sad Day in Blogland

Mike, creator of the Rortybomb blog, is no longer anonymous ... on July 20, 2009, he came out, revealing his true name to be ... Percy Fraddlehapper ... no, no, his real name is actually ...

Mike. That's right. He was already halfway out of the blogger's closet of Hidden Identity anyway. His full name: Mike Konczal.

What's more, it looks like he just turned 30 and we forgot to send the virtual cake with the electronic candles. Drat. Anyway, Mike has been on a tear lately, churning out some top-notch content and raising his profile in a lot of places.

And now, like the character in the Jim Croce song, Mike can croon, "I Got a Name."

That leaves a dwindling number of us Resolutely Anonymous Bloggers. There's Cassandra does Tokyo (does anyone else get a little tired of the witty but de trop prose style?) and George Washington's Blog (now, in the great tradition of rebranding for knowing simplicity, titled just "Washington's Blog") ... and me.

Not to worry: I'm not coming out anytime soon. When you suggest that hungry and unemployed Americans fill their empty bellies by eating Goldman Sachs bankers, you really do have to stay in the shadows.

Friday, July 17, 2009

Annals of Cluelessness, Hank Paulson Edition

Is it just me or is anyone else thinking: How totally clueless was Hank Paulson?

I mean, Paulson now reveals that the Bush administration was discussing how to feed U.S. citizens in the event of a breakdown in law and order, had commerce and banking collapsed during the financial panic last fall. This, from the Independent:
Making his first appearance on Capitol Hill since leaving office, the former Treasury secretary Hank Paulson said it was important at the time not to reveal the extent of officials' concerns, for fear it would "terrify the American people and lead to an even bigger problem."
Four months before the Lehman implosion/AIG meltdown/freakout sirens started wailing, Paulson was saying this: "In my judgment, we are closer to the end of the market turmoil than the beginning." (May 16, 2008) Two months later, he's still blissfully optimistic: "It's a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation." (July 20, 2008)

Okay, that last quote is from July ... a month passes ... two months ... and then everything goes tits up and suddenly he and other top Bush officials are huddled in a secret meeting room, talking about how to feed 300 million Americans once the wide-scale looting begins.

To me, that reveals a staggering degree of cluelessness. Bear Stearns craps out in mid-May, the nation is sitting on a teetering pile of dicey lending, and Paulson just blithely goes about his business, until things get really bad, and then he shifts from "What, me worry?" to "Holy s***, the sky is falling and how are we going to feed all of America when outlaws overrun the country?"

If Webster's is looking for an illustrative margin photo for the word "clueless" for their next dictionary, I've got a suggestion ...

Thursday, July 16, 2009

I Smell Something ... Anti-Goldman ... In the Air

Even Lucifer himself, endowed with powers to shake the heavens and earth, couldn't counter the amount of bad publicity that the entity some perceive to be the financial anti-Christ (and that others simply call Goldman Sachs) has been getting lately. Recently Bloomberg TV commentators were taking potshots at Wall Street's most gilded survivor of Meltdown 2008, asking a very reasonable and quite pointed question: What the hell was Goldman doing with computer programs capable of manipulating markets (which an employee allegedly stole, prompting swift FBI action)?

But wait, there's more. Sure Matt Taibbi may be prone to working himself into an overwrought state about Goldman, with his "vampire squid" and "blood funnel" metaphors, but now Janet Takolivi has an opinion piece at CNN where she blasts Goldman's bloated earnings quarter and drops in a colorful bit of imagery that we'll probably see again in days to come.
Wall Street's "financial meth labs," including Goldman's, massively pumped out bad bonds and credit derivatives that have melted down savings accounts, pension funds, the municipal bond market and the American economy.
So it's not just Taibbi who's swinging a sharp sword. If you're Goldman, you have look out on all sides ... including your backside. The Wall Street Journal, a newspaper fond of capitalism draped with muscle, adorned with sashes of gold, goes after the giant investment bank too, amazingly enough. Here's the money paragraph:
Goldman will surely deny that its risk-taking is subsidized by the taxpayer -- but then so did Fannie Mae and Freddie Mac, right up to the bitter end. An implicit government guarantee is only free until it's not, and when the bill comes due it tends to be huge. So for the moment, Goldman Sachs -- or should we say Goldie Mac? -- enjoys the best of both worlds: outsize profits for its traders and shareholders and a taxpayer backstop should anything go wrong.
Wow. Sentiment is really starting to swing, in a big way, against Goldman Sachs.

And Edward Harrison Gets It As Well

The blogger behind Credit Writedowns wrote, in a post about Wells Fargo selling distressed assets for 35 cents on the dollar (and that was twice what most hedge funds were offering!):
To me, this explains very well why the PPIP program was a failure: if banks can sell distressed assets quietly over time to private bidders, they might be able to delay taking writedowns. But, the price discovery involved in the PPIP program would be a blood bath for banks already capital-constrained. This is why the program has failed.
Yup. As I wrote on March 23, in "Five Reasons Why U.S. Banks are Secretly Terrified of Geithner's Plan":
2. Your game of vastly over-marking assets grinds to a halt.

Once your impaired bank assets are put in pools for private investors to bid upon, and real market bids result, you will be under enormous pressure to revalue huge swaths of your holdings. You can maintain that fictive price of $80 only if you keep the assets cloistered away, locked in a high tower away from judgmental eyes. Once you invite bids, you invite price discovery that, even if you reject the sale, will force you into what could be a crippling re-evaluation of how financially sound you are.

Wednesday, July 15, 2009

The New York Times Figures It Out Too

This NYT editorial pretty well sums up what I've been saying for a while about the dying quail that is Geithner's plan to buy up toxic banking assets:
The Obama administration has largely shelved, for now, its plan to finance the purchase of banks’ toxic assets, ostensibly because of the banks’ recent success in raising capital. An alternative explanation is that the banks won’t sell. Recent accounting changes make it less painful for them to keep bad assets on their books. Why admit to losses if you don’t have to?
Exactly. What I love about this bit of succinct truth-telling in the NYT is that it's not muddied by a lot of other pseudo-reasons, such as "investors don't want to partner with the government, fearful of being demonized or having the rules changed on them in midstream." Let's face it: that's just a smokescreen. If there's a big fat pile of money up for grabs in the middle of the floor, Wall Street will jump on it, damn the bad P.R. But if the banks don't offer up any assets, there is no big fat pile of money and Geithner's plan just ... dies.

Tuesday, July 14, 2009


There is a near consensus about derivatives (structured products included)being one of the culprits to blame for causing the financial meltdown that no one know for sure how the world can get out. Bailouts, tightening regulations, rescue plans, extra deposit guarantee schemes: all have being pursued but still there has been no clear sign that things are actually better. The last we heard was about a number of banks and brokerage firms thathad been banned by the Singaporean authority from further marketing structured financial products that have caused investors there millions in losses due to the toxic investment schemes. Luckily some have been partly compensated. But still we are not able to understand why there are many proponents of derivatives among the growing number of Islamic finance practitioners as if they have turned a blind eye on the devastating effects of such products that even the conventional players and regulators themselves have admitted. The main reason given in support of the so-called Islamic derivative products is that they are needed for risk management purpose i.e for hedging. Everyone knows that in the world of modern financial markets the distinction between hedging and speculation is not easy to be made. After all, once a door is opened, there is no assurance that only good guys will come in. The truth is that risk management is embedded in the Islamic law of contract and financial transactions such that if they are truly implemented as provided, there is actually no real need to address the issue of risk the way it is pursued in the conventional sense. Hence the biggest question to answer here is whether all that need to be followed in term of Shariah rules are actually implemented. Some concerned observers have expressed their serious dismay at the ways and manners Islamic finance has been practiced of late... Coming back to Islamic view on derivative: for those who want to read more on this please get a copy of a very well-researched book (in Arabic) on Islamic view on derivatives written originally based on a request of OIC Fiqh Academy. ( Al-Mushtaqqat al- Maliyyah: dirasah muqaranah bayna al-nuzum al-wadi'yyah wa ahkam al-shariah al-islamiyyah,-by Dr. Samir Abdel Hamid Radwan, 2005, Dar al-Nashr li'l Jamiaat, Cairo.). Notes: The author at the end of the book swear in God's name that to the best of his knowledge, based on the research conducted to prepare for the book, his finding is that derivatives, as they are, are far from being shariah compliant. It is worth-noting also that the OIC Fiqh Academy had issued similar resolution several years ago.

Friday, July 10, 2009

Hungry? Eat a Goldman Sachs Banker

You've lost your job. The kids are staring at you from the next room with those gaunt faces and soulful eyes. The unspoken question on their lips: after paying the utility bills and hospital expenses for Timmy's chemotherapy, can we afford to eat?

My answer: of course you can! Just stroll on down to Wall Street, find yourself a Goldman Sachs banker, get a roasting spit at Wal-Mart, squirt some lighter fluid on a bed of backyard briquets, and voila! Goldman Sachs bankers have plenty of fat on their bones -- it's hard to vouch for their nutritional value beyond that, but a nice, filling high-fat meal (the corpulent bankers might last a week and the funky leftover pieces can be turned into soup stock) can go a long way toward dispelling those recession blues.

How do I know they have fat on their bones? Check this out: the average Goldman employee is making almost $700,000 a year (and that includes the mailroom guys and the bubble-cracking receptionists, so you know the bankers are making a LOT more). So if you've been reduced to eating Saltines with a thin smear of butter, you can bet they're getting something much better, like Melba crackers slathered with sturgeon roe.

Okay, some of you are probably thinking: Wait a minute, won't Goldman protest if enough Americans take to heart this eat-a-Goldman-banker advice, thus depleting their ranks? You would think that, but Goldman has a famously civic sense of responsibility. They're so interested in helping America that they're practically running the U.S. government! Of course the company doesn't mind if you eat some of their bankers. (Just keep it within reason: I'm sure you're all aware of the concept of "overfishing;" we do need to allow time for the stock to replenish.)

Now you may be puzzled when you get to Goldman's headquarters on Broad Street, ask to see a banker, and he's relatively thin with a vulpine stare and a well-toned body. This is not one of the ones you'll want to eat! He's into his Stairmaster, Pilates, or some such. Don't leave with this guy. Get one of the soft, scrumptious, fleshy ones, and believe me, you should have plenty to choose from.

Now you're probably thinking: Hold on. Some Goldman banker isn't going to just walk out of the building with me, climb into a waiting vehicle, and let me conk him on the head. After all, they're known for being the smartest guys on Wall Street. And this is very true. So you need to have a strategy. First, you must blend in. If you're hunting deer, you don't head into the woods dressed like Disco Stu! So you need to put on a fairly sharp, well-tailored dark suit. Make a good impression on your prey.

Okay, then how do you lure a Goldman employee out of his lair? Let's take a tip from Matt Taibbi, who did a close-up study of these creatures for the latest issue of National Geographic, er, Rolling Stone. Here's what the great financial zoologist observed: "The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

Got that? I know it sounds scary: "vampire squid," "blood funnel." But just remember, the average Goldman banker is busily trying to smell money. He won't jam that blood funnel down your throat; your esophagus or stomach lining doesn't interest him in the least. But your money does, so keep your wallet in your pants AT ALL TIMES or this could end badly!

Once you've located a portly Goldman banker, you can take advantage of your knowledge about his feeding habits to lure him away. The Goldman culture is a bit secretive, so you should lower your head and start mumbling something like, "Synthetic CDOs ... single-name credit default swaps ... millions in profits ... my house." The "millions in profits" will probably activate and possibly engorge the blood funnel. This is a good sign! You've got the banker where you want him, thirsting for a good feed. Get him into a taxi, keep mumbling to keep him interested, get him home, and ker-pow! I don't think I need to go into a long lecture about how to prepare meat.

NOTE: For all those who are easily offended, this is meant to be satire. For all those who are cannibals, when your court date comes up, I don't know you.

Saturday, July 4, 2009

Always Taking the Path of Least Resistance

That could be the motto of Washington for its interventions into the financial markets. If you can either (a) Solve a crisis by directly confronting insolvent banks and taking measures that will cause some short-term pain but ensure a better future or (b) Roll the currency printing presses all night and flood the system with money and hope that that eventually works, over say five years or a decade or whatever ...

What do you do? (b) of course. (b) doesn't rile up the banking lobby, get any Congressional noses out of joint, threaten to anger any populist groups. (b) isn't leadership either, but leadership is a quaint notion these days. Let's face it: it's not that America is pain-averse. It's worse: we're discomfort-averse.

So, continuing our multiple choice test, if you can either try to resolve the housing foreclosure problem by either (a) Knuckling down on the banks and persuading them (through legislation, if need be) to renegotiate mortgages so that both the homeowner and the bank take a hit, but at least the homeowner has an incentive to start paying the bill again or (b) Flood the system with cheap money and hope the problem goes away ...

What do you do? (b) of course. It's the path of least resistance.

But now comes evidence that this approach, while convenient and non-controversial, unfortunately has a little drawback: it doesn't work. Check out this commentary by economics professor Stan Liebowitz in the WSJ:
What is really behind the mushrooming rate of mortgage foreclosures since 2007? The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house. This means that most government policies being discussed to remedy woes in the housing market are misdirected.

More specifically:
The Obama administration's "Making Homes Affordable" plan focuses on having the government help lower obligation ratios (the share of income devoted to house payments) down to 31% from levels somewhat above 38%. But my analysis finds that mortgages having such obligation ratios at closing did not later experience high foreclosure rates. This suggests that reducing these ratios is not likely to significantly improve the foreclosure problem.

So here's what this means, and it's very common sensical: Your biggest asset is a house. You're paying on it for another 10, 20 years. If you owe say $200,000 on it, but it's worth $250,000, you'll want to keep paying off your mortgage. But if you owe $250,000 and it's worth $200,000, you're more likely to say, "Bleh. I'm staring at a $50,000 loss. Sayonara house."

It's abundantly obvious what should be done. Washington needs to find a way to facilitate the renegotiation of mortgages for homeowners who are underwater. Or, of course, it can take the path of least resistance: throw a few trillion at the problem and hope it goes away.


Friday, July 3, 2009


International commodity murabahah and tawarruq are the two topics that have being raised quite prominently these days especially after the Islamic Fiqh Academy of OIC issued its resolution on tawarruq in April. The use of murabahah concept in transactions involving sales of goods and assets, when used in its correct form is not a controversial topic in itself because murabahah in its classical form is recognised as valid by the majority of Muslim jurists right from the earliest days of Islamic law.
Conceptually in order to have a valid Murabahah there must be two sales involved: the first being between a supplier of goods and a seller in murabahah while the second leg is between the murabahah seller ( who is himself a buyer in the transaction with the supplier) and the murabahah buyer. In order for the second contract of sale to be valid, the murabahah seller must have obtained full title and ownership of the goods sold in the first contract with the supplier in a full Shariah compliant manner: meaning that the goods and its economic/ ownership risk has been fully transferred to the murabahah seller. This will only happens when the goods has been actually or constructively delivered to the possession of the murabahah seller such that if anything should happen to the goods after that possession, loss is to be borne by the murabahan seller as a new owner. When this requirement is fulfilled, there is no question as to the right of the murabahah seller to sell the same goods to the murabahah buyer in the subsequent sale. This is obvious due to the Shariah rule that provides only an owner or his agent can affect a valid sale contract.
The issue as far as the current confusion as to the validity or otherwise of transactions involving either commodity murabahah or tawarruq is not so much of the conceptual aspect of the sales but more of whether the current practices adhere or not to rule as explained. In practice, most financial institutions that utilises both of the above concepts have been dealing with international commodity exchanges that are in fact, more often than not, parties involved in future commodity markets rather than normal physical markets. One such metal exchange that the present writer has access to some published information, states clearly that in practice as far as this metal exchange is concerned, only 1 % of their commodity (future) contracts ends up with physical delivery of the relevant metals. This is not surprising given the fact that such an exchange is known to be one of the many similar exchanges that are involved in commodity future market. So the big issues here is how come the Islamic financial institutions did not realise this fact as many of them are likely to be aware of several earlier resolutions by the OIC Fiqh Council that had disallowed involvement in future markets which was declared as non-shariah compliant in its current format.
The recent resolution by IFA does not mention this point directly but the concern can be understood by implication when the resolution mentions about the absence of genuine sales in tawarruq as currently practiced. Buy right the resolution should have reiterated its earlier resolutions concerning future market to support its present resolution on tawarruq. Perhap it is worth noting also that in the past few years or so there have been calls by concerned parties including Shariah scholars for Islamic financial institutions to use local commodities in their murabahah or tawarruq transactions. The reason given was that in the case of local commodity markets, there should be no difficulty in ensuring the existence of the relevant commodities and the truthfulness of the sales. So in short the major concern that underlines the Fiqh Academy resolution is so directly tied up to the way the relevant transactions are carried out, and not their conceptual acceptance from Shariah perspective. This is understandable considering what the Shariah says about sales as allowed in Islam where they must mean true sales and not money lending in disguise: hence when sale are intended it must be clear that transfer of ownership together with economic risk has taken place as between the parties in the first transaction before the second sale can take place. After all, in Shariah it is sale and only true sale that can be taken as justification for profit. So when the existence of true sale is doubtful, then there is no reason for the relevant transaction to be considered valid or Shariah compliant. Hence the biggest question posed indirectly by the resolution is how many of those so-called Islamic finance practitioners are sincerely willing to wear the title of genuine traders in their activities, and not as money-lenders in disguise.

Isn't Revisionism Fun? The Geithner Plan Revisited

The New Republic's Noam Scheiber catches up with a "Deep Throat" from the Treasury Department as the Geithner plan, or PPIP, begins to spiral downwards faster, heading toward a near-certain death. You'll see a flurry of reasons tossed about for its demise, but if you get right down to brass tacks, there's only one that really matters: the banks don't want to play. They don't want to accept low auction prices for their bad assets. They want to pretend those holdings are worth more, for as long as possible, and postpone the day of financial reckoning.

As we all know, success has many fathers, but failure is an orphan. So does that mean the Geithner plan, which would have paired public and private investment to buy toxic assets, is an about-to-be orphaned failure? Au contraire, Mr. Nameless Insider insists:
If you had asked--I don’t want to speak for the secretary--what’s problem number one? I think he (Geithner) would say capital. Problem two? Capital. Problem three? Capital. Everything was in the service of that view. The legacy loans program was meant to help clean balance sheets. It was not an independent good in itself. It was seen as friendly to equity raising. Now people say the legacy loans thing is not gaining as much traction, so is that a failure? But because we had a good outcome in terms of raising equity, they [the banks] were able to raise equity without shedding assets ... you should be okay with that.
Ah. So PPIP was really all about the ability of banks to raise capital, and now that they seem to have solved that on their own, PPIP becomes expendable. Hmmm. Very interesting. But it does leave some unanswered questions.

1. If PPIP was all about (1) capital, (2) capital and (3) capital, why wasn't it sold to us that way?

Here's the Treasury Department's own summary paragraph on the Geithner plan from March 23:
Despite these efforts, the financial system is still working against economic recovery. One major reason is the problem of "legacy assets" – both real estate loans held directly on the books of banks ("legacy loans") and securities backed by loan portfolios ("legacy securities"). These assets create uncertainty around the balance sheets of these financial institutions, compromising their ability to raise capital and their willingness to increase lending.
Okay, Treasury does mention capital, but it also mentions lending, and look at the larger context. These assets create uncertainty around the balance sheets. And that has changed how? The assets are still creating unwanted uncertainty around balance sheets. Further, the Treasury had this to add at the time about its plan:
This approach is superior to the alternatives of either hoping for banks to gradually work these assets off their books or of the government purchasing the assets directly. Simply hoping for banks to work legacy assets off over time risks prolonging a financial crisis, as in the case of the Japanese experience.
Now the Treasury wants to pretend that the pile of dreck in the back room doesn't really matter after all.

2. If PPIP assumed capital was the problem, why was it structured in such a way that assumed liquidity was the problem?

PPIP is an awfully queer way to solve a capital problem. PPIP essentially would have pumped in a lot of cheap money to give private investors enough funds to buy the banks' toxic assets. PPIP made sense in a world where liquidity is scarce and investors need a little help from their friends (the U.S. government) because of the onerous cost of borrowing on the open market.

PPIP basically bought into the bankers' mythology: They couldn't sell their impaired assets at a fair price because of tight credit; no one could get money because the lending markets had seized up. Of course this was a lie, but Treasury went ahead and diligently built a whole plan (PPIP) around the lie. Now if PPIP had worked, then Treasury and the banks would have been correct: it was just a liquidity crisis. But now that PPIP is floundering badly, instead of admitting defeat, Treasury decides it's time for revisionist theater.

3. What happens to those banks that supposedly no longer need PPIP when the government jerks away the various crutches for the financial markets?

The major banks are still sitting on tens of billions of dollars of bad "legacy" assets. They are able to raise capital, but not because they're any healthier or smarter. Consider: (1) The banks were handed billions of dollars under TARP. (2) The government has made cheap funds available to them through an alphabet soup of lending facilities. (3) The government has said none of the 19 stress-tested banks would be allowed to fail. (4) The banks were allowed to twist accounting rules to their advantage, starting in April, to enable them to look healthier even if they're not.

Is it any surprise then that they are capable of raising capital? Investments don't get much juicier than this. The government will backstop losses, while the banks keep the profits. Hey, I'd lend ten bucks to a junkie who was getting $1,000 weekly welfare checks. But what happens when the government tries to fold up the Bailout Nation Tent? Also, Mark Thoma makes an interesting point: what if investments were made in the banks on the assumption that they would be getting rid of their toxic assets when they're not? Does that constitute a federally sanctioned double cross?

A few things to ponder. I think the summer will be full of PPIP revisionism as the Geithner Team tries to make excuses for the plan's failure.

Thursday, July 2, 2009

Before answering the question, it is best to consider the concept of modern corporations or companies in the light of the major rules and regulations as practised today. Although these corporation have some similarities with Islamic sharikah by virtue of the fact that they all can come into being when at least two individuals "form" the company or sharikah, and have them registered with the Registrar of Companies, yet once established and registered with the relevant authority these modern companies are recognized by the law as separate legal entities distinct from their shareholders.
In the context of Islamic sharikah however, the shariah envisages the role of the partners as individuals who are to carry out their business activities jointly with a view of making profit. This furthermore boils down to whether what is formed is a mufawadah or inan structure: in the case of the former the partners are agents and guarantors among themselves, whereas in the later case, they are only agents. Hence in the context of Inan, a partner is considered to be acting personally with regard to his portion of the equity of the sharikah, and at the same acting as an agent with regard to his partner’s portion. It is a requirement in Islamic law however that all partners need to put their capitals in an indistinguishable form in a common fund or account separated from their other assets. Nevertheless the liability of the parties in the context of their business dealings with third parties is not necessarily limited to their shares in the sharikah as any act carried out properly in accordance with the agency will bind the respective partners, although loss is to be shared in proportion to their capital contribution.
But if we look closer at modern corporations it will become clear that the purpose or objective of the separate legal entity is to allow for a separate account be created for the entities so that it will be made possible to identify their assets and liabilities because those need to be treated independently from the assets or liabilities of their shareholders. These entities can sue and be sued in the course of their business dealings with outsiders. In a company limited by shares however the liability of the shareholders are limited to the number of shares of certain value subscribed by them precisely because the law consider these corporation as different from their shareholders. Given this position one may think of a mudarabah structure in Islamic law, where the manager is supposed to be different from the capital provider meaning that this mudarib is a different or separate legal entity distinct from the entity of the capital provider. Hence can we consider modern corporations as individual managers/mudaribs in the context of their dealing with the shareholders?
In the case of Islamic mudarabah, it is provided that the rabulmal is going to be held liable up to the amount of the capital he actually contributed and duly handed over to the mudarib. He will not be made answerable for any liability of the mudarabah in excess of the capital so contributed. However in modern company structure, it is the requirement that a shareholder must pay up all shares that he owns but he is not duty bound to pay up for the share until a call is made by the company, and he will be imposed with interest charge in favour of the company if he fails to do just that after the call. This effectively means that he is considered indebted to the company by not obliging to the demand of the call, hence a debt is thus created for which interest is charged.
From an Islamic perspective in the context of mudarabah and musharkah all capitals must be passed on to the account of the mudarabah or partnership otherwise the contract is compromised in term of effectiveness and validity. Because a party in mudarabah if he a capital provider, is free to withdraw from the mudarabah, non payment of the capital to the account of the mudarabah will practically end the agreement as this contract is in the nature of non-binding contract, or at least the mudarabahis to be valid only up to the amount of capital actually contributed. Similarly in the context of sharikah it is part of the requirement of the Islamic scheme that the capital is to be pooled together to create common ownership available for all partners to utilize in the name of the musharakah in line with the concept of mutual agency as between all the partners. However if one party refuses to provide the capital in such a manner, he can be considered as to withdraw from the sharikah since to effectively establish the partnership all capitals contributions must be actually made and not just promised. Like in the case of the parties in mudarabah, partners also can withdraw from the sharikah as a matter of general rule if they so wish.
From a different perspective, practically the operation of modern companies and corporations is not necessarily in line with the rules and conditions of the Islamic sharikah . Modern companies issue shares and loan capitals of various kinds, some of which are subject to interest. Debentures, for instance, are resorted to by modern companies when they want to raise additional money through debt instruments, which are, in essence, interest-based and thus not approved by Islam. They may also issue securities (loan stocks) that pay a fixed rate of return to holders - a process which is also contrary to Islamic law. Then there are the issues of preference share that gives more priority to a certain class of shareholders in relation to profits or returns and the right to repayment of capital upon dissolution of the companies. Therefore, there are many issues that need to handled if the companies and modern corporations are to achieve Shariah compliant status. Not only that they must avoid dealing in haram goods and services, they also need to ensure that their setup and structure are Shariah compliant.