November 22, 2024

FDIC Tells Banks California IOU’s Good As Gold

July 8, 2009 by 5 Comments

Bank Have Enough Bad Assets

Yesterday, a group of major banks, including Bank of America, Citigroup, JP Morgan and Wells Fargo,  said that they would stop accepting California IOU’s.  The State of California, virtually out of cash, has been issuing IOU’s, known officially as “individual registered warrants” to creditors in lieu of cash.  The State has promised to pay IOU holders 3.75% interest when the warrants mature on October 2.

With Fitch Ratings dropping California’s debt rating to BBB junk status, it is understandable that the banks do not want to cash the IOU’s.  Allowing warrant holders to cash in their IOU’s would effectively transfer the credit risk of the IOU’s to the banks.  Most major banks already have a mountain of non performing assets and, understandably, do not wish to add California IOUs to the list.

The reality of the situation is that California has already defaulted since they have reneged on their obligations to creditors.   I wonder what the State of California’s reaction will be when their citizens adopt the State’s method of bill payment and start sending in IOU’s instead of cash for tax payments due?  Many of California’s citizen have been placed in a horrendous financial situation by California’s “spend and borrow until we are bankrupt” policies.  If the banks won’t cash in the IOU’s, why would an average citizen or business want the IOU’s?   The IOU’s won’t pay for your groceries or rent and they can’t be converted to cash – what does that say about faith in California’s “promises to pay tomorrow what is due today”?

FDIC Issues Statement On California IOU’s

The FDIC today issued the following statement to its member banks regarding the credit worthiness of California’s IOU’s.

California Registered Warrants
Interagency Statement

Summary: The federal financial institution regulatory agencies are jointly issuing the attached supervisory guidance for financial institutions regarding the regulatory capital treatment for registered warrants issued by the State of California as payment for certain obligations.

Highlights:

  • The Attorney General of the State of California has opined that the registered warrants that the State is issuing as a form of payment for certain of its obligations are valid and binding obligations of the State.
  • The banking agencies’ risk-based capital standards permit a banking organization to risk weight general obligation claims on a state at 20 percent. These warrants, which are general obligations of the State, would, therefore, be eligible for the 20 percent risk weight for risk-based capital purposes.
  • Banks should exercise the same prudent judgment and sound risk management practices with respect to the registered warrants as they would with any other obligation of a state.

It would guess that the FDIC’s statement on the soundness of California’s IOU’s was more politically motivated than financially inspired.  If this is all the support that California is going to get from the Federal Government, the citizens of California have much to be concerned about.

The FDIC is telling the banks that the risk of the  California’s warrants is the same as any other state issued general obligation debt.  Nice try, but apparently, the biggest banks in the country, as well as the credit rating agencies, are not buying this line.  If the banks won’t cash the IOU’s and you can’t spend them, they are effectively worthless today.  Those stuck with California IOU’s may be in for a long wait before they can be cashed in.

Disclosures: None

Filed Under: California, Confidence, FDIC Tagged With: , ,

The Contradiction Of Empty Homes And Rising Apartment Vacancies

July 8, 2009 by 1 Comment

A Housing Surplus

Huge increases in foreclosures have resulted in millions of homes sitting vacant as bank REO managers struggle to sell the empty homes.  Theoretically, people who have been evicted or lost their homes to foreclosures would be new renters.  Consider, however, the increase in apartment vacancies to a 22 year high:

U.S. apartment vacancies rose to their highest in 22 years in the second quarter as job losses cut tenant demand and more units came to market. Vacancies climbed to 7.5 percent from 6.1 percent a year earlier, New York-based real estate research firm Reis Inc. said today. The last time landlords had so much empty space was in 1987,

“Vacancies continued to rise despite what has traditionally been a strong leasing period for apartment properties,” said Victor Calanog, director of research at Reis.

Job losses and falling wages are shrinking the pool of potential renters, defying forecasts that prospective homebuyers would rent rather that purchase as house prices decline. The U.S. unemployment rate rose to a 26-year high in June and U.S. payrolls dropped more than forecast in June, the government said last week.

Rents paid by tenants, also known as effective rents, fell 0.9 percent from the previous quarter to $975, said Reis. Effective rents were 1.9 percent lower than a year earlier.

“New buildings coming online over 2009 and 2010 will face higher initial vacancy levels, and will work to increase the pressure on leasing managers,” Calanog said.

The brutal economic fact is that those losing their homes cannot afford to rent.  In many cases dispossessed adults are now sharing homes with children, friends or relatives.  In addition, USA Today reports  children are moving back into their parents’ homes:

Matthew Costigan is young, single and a recent college graduate.

So what does he do? He gives up his nice pad in the trendy Shadyside neighborhood of Pittsburgh and moves in with mom and dad. To his boyhood home. In the suburbs.

Costigan and many others in the most educated generation of young adults are seeking refuge under their parents’ roofs from skyrocketing housing prices, mounting college debts and a tight job market.

A survey of 2004 college graduates shows that 57% planned to move back in with their parents. MonsterTRAK, an online job site for college students and young alumni that conducted the survey, found that 50% of 2003 graduates are still living at home and 35% are still looking for work.

The Families and Work Institute for the first time asked 3,504 employed adults whether they have grown children living at home. The findings were surprising, says Ellen Galinsky, president of the New York research group. “Fully 25% of employed parents have children from 18 through 29 years of age living at home at least half of the time,” she says.

Forced by economic hardship, children are moving back in with parents and parents are moving in with their children.   Meanwhile, apartments and homes sit vacant, causing bank losses on homes and commercial loans.

Foreclosed empty homes and increasing rental vacancies are just one more sign of an over leveraged, cash poor consumer.  Forecasts predicting an economic recovery based on increased consumer spending are certain to be wrong.  Major job losses and wealth destruction of the past two years are forcing consumer to do what they must to survive.  With job losses increasing and unemployment reaching depression levels, an economic recovery remains a fantasy at this point.

Filed Under: Deleveraging, Economy, Have Nots, Housing Tagged With: , ,

Geithner’s Pump And Dump Scheme

July 8, 2009 by Leave a Comment

Pump and Dump

According to the SEC website, a pump and dump scheme is one of the most common investment frauds and works as follows:

First, there’s the glowing press release about a company, usually on its  financial health or some new product or innovation.  Then, newsletters that purport to offer unbiased recommendations may suddenly tout the company as the latest “hot” stock.  Messages in chat rooms and bulletin board postings may urge you to buy the stock quickly or to sell before the price goes down. Or you may even hear the company mentioned by a radio or TV analyst.

Unsuspecting investors then purchase the stock in droves, pumping up the price. But when the fraudsters behind the scheme sell their shares at the peak and stop hyping the stock, the price plummets, and innocent investors lose their money.

If all of this sounds familiar it should, since we have probably just witnessed one of the biggest pump and dump schemes ever perpetrated at the expense of witless bank share investors.

Consider the scenario: The Pump

Early this year, the financial system is in a panic as banks announce ever greater losses and talk of nationalizing the banking system is rampant.  Public officials fear a full blown banking collapse if worried depositors start a run on the banks.  Public opposition to bank bailouts is intense.

To stop the growing banking panic, the Fed and Treasury announce that the major banks are too large to fail and will not be allowed to collapse.

An easy to pass “stress test” of the biggest banks is announced to prove to the public that the banking industry is sound.

After a cursory examination of the largest banks, they all pass and are told to raise additional capital just to be on the safe side.

Investors start to buy the bank stocks en masse causing many bank stock shares to double and triple in price.

Over $200 billion in new capital is obtained from investors eager to get in at depressed prices.

Treasury Secretary Geithner states that “this transparent, conservatively designed test should result in a more efficient, stronger banking system”.

Witless commentators at CNBC pile on with predictions that the banks will soon be earning billions in profits.

No less a luminary than Warren Buffet adds to the buying panic by stating that he would put his entire net worth into Wells Fargo.

Potentially catastrophic losses on derivatives, commercial real estate, mortgages, off balance sheet assets and credit cards are swept under the rug as frenzied investors pile into a sure thing.

The Dump

Now, however, Geithner’s brilliant scheme seems to be entering the “dump” phase where “prices plummet and innocent investors lose their money”.  Consider the recent price action in major bank stocks:

c

bac

cof

pnc

rf

sti

ms

Most of the bank stocks peaked during May and have already declined substantially or appear to be in a distribution phase.  Nervous investors are considering the latest horrendous employment numbers and increasing defaults in virtually every major loan category.   There’s no harm in jumping into a pump and dump scheme early on for some quick gains.  It just might now be the time to jump back out.

Disclosures:  None

Filed Under: Banking Industry, Geithner, Pump and dump - Geithner version, Wells Fargo Tagged With: , , , , , , , ,

Wells Fargo’s New Zero Down Payment Mortgage Program

July 7, 2009 by 4 Comments

Risk Of No Down Payment Mortgages

There is  longstanding and overwhelming statistical proof that zero down payment home buyers default on mortgages at a far higher rate compared to home buyers who make a down payment.   This matter has lately received more attention than in the past due to the large number of foreclosures related to zero down payment purchases during the housing bubble years.  In 2005, for example, nearly half of all home purchasers were made with zero down payment mortgages.

Zero Down Payments = Foreclosures

FHA Delinquency Crisis

Could FHA’s rising delinquency rate be due to FHA incorporating risky practices that have become standard in the mortgage industry? Since industry experts often cite 100% financing as being a major factor in the mortgage meltdown, let’s take a look at borrower down payment sources:

The delinquency rate clearly rises in tandem with the increase in non-profit funded down payments.

In 2005, HUD commissioned a study entitled “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations”. Later that year, another report titled “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance” was completed by the U.S. Government Accountability Office. Both studies concluded that seller funded down payment assistance increased the cost of homeownership and real estate prices in addition to maintaining a substantially higher delinquency and default rate.

No Skin In The Game
The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home.

Instead, the important factor is whether or not the homeowner currently has or ever had an important financial stake in the house. Yet merely because an individual has a home with negative equity does not imply that he or she cannot make mortgage payments so much as it implies that the borrower is more willing to walk away from the loan.

Rather, stronger underwriting standards are needed — especially a requirement for relatively high down payments. If substantial down payments had been required, the housing price bubble would certainly have been smaller, if it occurred at all, and the incidence of negative equity would have been much smaller even as home prices fell.

No Down Payment

No Down Payment

Courtesy: WSJ

Wells Fargo Initiates Down Payment Assistance Program

Ignoring the overwhelming evidence of high default rates on zero down payment purchases, Wells Fargo (WFC) this week announced a major nationwide down payment assistance program (DAP) to be used for down payment and/or closing costs on FHA, VA and conforming loans.  Incredibly, the program is being advertised as a means of helping low to moderate income applicants achieve the “American dream” of home ownership.

Based on the historical evidence, Wells Fargo is sowing the seeds for the next major crop of foreclosures.  Incredibly, this is being done even as the current foreclosure crisis grows in intensity.  Approving mortgages that immediately put new homeowners at a high risk of default is financial lunacy and a  disservice not only to the homeowner but to a nation already in financial chaos due to defaulting homeowners.

Down Payment Assistance Programs (DAPs)

Help More Low- and Moderate-Income Borrowers Achieve Home Ownership.

Refer your low- to moderate-income applicants to local housing agency contacts and help them achieve home ownership by using one of these Downpayment Assistance Programs (DAPs) approved for use with a Wells Fargo Wholesale Lending first mortgage. DAPs provide financial assistance for qualified borrowers and, depending on the program, may be used for debt reduction, down payment and/or closing costs on FHA, VA and Conforming Conventional loans.

Disclosures: None

Filed Under: FHA Defaults, Housing, Mortgages, Wells Fargo Tagged With: , ,

Profile Of A “Making Home Affordable” Homeowner – Everyone Should Do It

July 7, 2009 by Leave a Comment

Overburdened  Homeowner Subsidized

Home Sweet Home?

Home Sweet Home?

Loan modification programs have been seen as the answer to preventing foreclosures and allowing the housing market to stabilize.  The programs have become progressively more aggressive as foreclosures continue to mount and housing prices continue to slide.  The current government program, Making Home Affordable, has a dual approach whereby a homeowner not eligible for refinancing (at loan to values up to 125%) can then attempt to have the mortgage modified to lower payments.  Eligibility requirements are quite simple – if the borrower has suffered a hardship (such as reduced income), is having trouble making the payment or simply bought more house than he could afford during the exuberance of the housing mania, relief in the form of lower payments may be available.

Here’s an actual example of a borrower granted mortgage concessions under the US Government’s Making Home Affordable program.

Home owner purchase the home in 2005 for $153,000 with a stated income mortgage, 100% financing.

Home owner refinanced a year later and received $30,000 cash with a stated income $190,000 mortgage at 7.125%.   The home is now worth about $165,000.

Home owner works at a grocery chain and earns $43,000 with limited prospects for increased income.  Credit card debt amounts to $22,000 with monthly payments of $315.

Home owner’s current housing expense and other debt payments result in front end and back end debt ratios of 46/55.   A back end debt ratio is calculated by dividing borrower’s total mortgage payment, taxes, insurance and all other minimum monthly debt payments divided by gross income.  After debt payments and payroll taxes, home owner is left with about $950 per month to cover all other expenses.  Home owner is 45 years old, has minimal savings and a negative net worth of around $50,000.

Home owner is not eligible for the Making Home Affordable refinance program since the debt ratios would still be too high even with a rate reduction to the current prevailing mid 5% mortgage rate.

Homeowner therefore applies for a mortgage modification.  The basic requirements are that you are having trouble paying your mortgage and your front end debt ratio exceeds 31%.   The front end debt ratio is the monthly mortgage payment, taxes and insurance divided by gross monthly income.  Homeowner is approved for a mortgage modification that lowers the rate to 2% fixed for two years, with an increase to 3% in year three, 4% in year four and then fixed in year five at the prevailing conforming rate.   No principal reduction of the loan was granted.   The initial rate reduction lower the home owners debt ratios to 31/40, a ratio that should allow debt payments to be handled without undue stress.

Comments – Who Won and Who Lost?

If the homeowner decides to sell the home, $30,000 cash would be required at closing due to negative equity, commissions due, etc.  Since the homeowner has no cash, a sale of the home would have to be a short sale, with the mortgage holder (or taxpayer) taking the loss.

The homeowner in this case received a mortgage rate that is unavailable to the best A+ borrower.  In addition, there were no closing costs to receive the 2% rate.  The average homeowner pays thousands in closing costs on a refinance.

The taxpayer winds up paying, one way or the other,  for the cost of the mortgage subsidy.

The subsidized 31% debt ratio puts the loan modification  homeowner in a vastly better off position than millions of other homeowners with much higher housing debt ratios who are unable to get a loan modification or a refinance.

The homeowner cited would never have been a homeowner if not for the 100% financing, no income verification programs that prevailed during the housing/mortgage bubble years.

Not everyone was victimized by the liar loans and sub prime lenders.  The homeowner in this example has nothing to complain about.   Besides the $30,000 cash received on the refinance and a zero investment in the property, the homeowner also has a super low 2% government subsidized mortgage rate .

As property values continue to decline, expect ever more costly, aggressive and futile  government efforts to reflate the burst Humpty/Dumpty housing bubble.

Filed Under: Bailout, Have Nots, Housing, loan modification, Making Home Very Affordable, Mortgages, Uncategorized Tagged With: , ,

Elderly Americans Last Refinance – Reverse Mortgages

July 6, 2009 by 1 Comment

Reverse Mortgages – More Easy Lending

As originally conceived, reverse mortgages were designed to fulfill a legitimate borrowing need.  Reverse mortgages were developed for elderly Americans who had a mortgage free home with substantial equity and wanted to cash out their home equity to supplement their retirement income without having to sell the house or face large mortgage payments.

Almost all reverse mortgages are purchased by HUD and insured by the Federal Housing Administration (FHA).  FHA insured reverse mortgages are known as “home equity conversion mortgages” (HECM) and they provide the following advantages to elderly homeowners:

  • Provides supplemental cash income to elderly homeowners.
  • Does not require a monthly payment.
  • Allows the homeowner to remain in his residence until death or sale of the property.
  • Should the borrower decide to sell and move, the  amount of the loan repayment cannot exceed the value of the house.
  • HECM allows the borrower either a monthly lifetime payment (based on value of the home and age at time of mortgage closing) , a lump sum payment, a line of credit or a combination of the above choices.

In theory, the HECM made sense by allowing homeowners to remain in their homes and monetize their equity.  The lifetime HECM payment, along with other retirement income and savings would allow for a more comfortable lifestyle.  The only theoretical loser on the HECM program would be the FHA if property values dropped.

HECM Program – Theory VS Reality

The disadvantages for a borrower of a reverse mortgage are as follows:

HECM rules require a borrower to make a full draw at closing to obtain a fixed rate mortgage.  Most borrowers take the adjustable rate option and a line of credit.  The adjustable rate HECM presently has a low borrower rate of around 3.1% based on a lending margin of 2.75% and a LIBOR index of only .32%.  At some point rates will rise again and rates on the HECM could rise dramatically – the lifetime cap on the loan is over 13%.  Borrowers could see their credit lines reduced and their equity vanish quickly with higher interest rates.

Borrowing money without having to make a loan payment equates to compounding interest working against the borrower since the loan balance increases each month along with interest charges.  Borrowers who later decide to pay off the HECM and sell their homes may find that most of their equity has been lost due to accrued interest.

The HECM is a very complex product.  Despite the fact that HUD requires a potential borrower to receive financial counseling, it is unlikely that most borrowers fully understand the type of mortgage they are taking out.

The HECM is available to all those 62 or older who have sufficient equity in their homes.  HECM program lends without regard to credit or income and is strictly  asset based lending.  Do these lending criteria remind anyone of  past  disastrous mortgage programs, such as  sub prime, ALT A or Pay Option ARMs??

The fees on a HECM are very high and include an upfront and monthly mortgage insurance payment to the FHA, loan origination fees and other closing fees.  Total fees over the life of the loan can reach 12%.

A HECM does not require that the homeowner escrow for taxes  or homeowners insurance.  A known risk factor for default is a non escrowed loan.  The homeowner can face foreclosure  for not properly maintaining the property or for non payment of taxes or insurance.

The most striking feature regarding the use of reverse mortgages by elderly Americans is the large amount of equity that is being extracted upfront, leaving them with only a small future monthly cash payment as can be seen in Exhibit 3 below.

HECM CASH PAY BY YEAR

HECM CASH PAY BY YEAR

Courtesy: HUD.GOV

The reason why borrowers are taking most of their available cash out upfront is because they are using the proceeds to pay off mortgages, consumer debt, medical bills, credit cards, etc.   Borrowers run up large amounts of debt when spending exceeds income, a situation likely to continue  after the borrower taps the last dime of equity from his home.  Since the HECM was the last option available, what happens in a couple of years when the borrower is again overwhelmed by debt?

HECM – Loan Of Last Resort

The number of reverse mortgages has increased tremendously as other borrowing sources have disappeared.  Many of the reverse mortgage borrowers are retirees with limited income who would not qualify for a traditional mortgage loan under current underwriting guidelines.  In the past, many of these borrowers would have taken out a stated or no income verification mortgage.   The  large increase of HECMs starting in 2005 correlates to the time period during which no income verification loans were being discontinued.

Reverse Mortgage Volume

Reverse Mortgage Volume

Here’s an actual example of a HUD approved HECM.  Borrower has a home worth $525,000 and owes $290,000 in mortgages and other debt which will be paid off with a $350,000 HECM.  Homeowner is left with about $60,000 at closing.  Borrower has an abysmal credit score of 510 and  is 90 days past due on his current mortgage.  Income is unknown since HUD doesn’t care about the borrowers income.

Based on the credit profile and debt levels incurred prior to his approval of a HECM, what are the odds that the borrower’s finances turn around after his refinance?  My guess is that within a few short years, borrower is in heavy debt again, unable to pay the property taxes or maintenance on the property and thus facing a potential foreclosure.  Since HUD will not be throwing senior citizens out of their homes, expect a mortgage modification program for reverse mortgages and further losses to the taxpayer on another mortgage program gone bad.

More on this topic

Smarter planning would probably eliminate the need to borrow when retiring.   Bob Adams writes an informative and thoughtful blog on the challenges of successful retirement – a site worth bookmarking.

Filed Under: FHA, FHA Defaults, Housing, loan modification, Mortgages, refinance, Reverse Mortgages Tagged With: , , ,

The Perfect Health Care Plan For The Legendary 46 Million

July 2, 2009 by Leave a Comment

Another Government Solution At Zero Cost

Congress has been working hard lately as one trillion dollar legislative decree after another has “solved” the banking crisis, the global warming crisis and the foreclosure crisis.  In between all of this, an almost trillion dollar stimulus plan was passed to solve the economic crisis of declining GDP growth and job losses.    (See Cost of Easy Money – $14 Trillion and Counting).

Now, as we enter the month of July, Congress is eager to pass  another multi trillion dollar piece of legislative fiat, this time to solve the health care crisis.   We are also told that solving the health care crisis will be achieved at zero cost due to offsetting “savings”.

The goal of providing unrationed, free and universal health care may be more difficult and complex than anticipated.   Health care spending comprises almost 20% of our GDP and involves millions of jobs and hundreds of thousands of varied health care providers all intertwined in a complex network.  Simplistic solutions put together during the frenzied atmosphere of  “let’s get it done this month” are likely to produce many unintended adverse consequences.  Public opinion polls reveal the confusion regarding what should be done to improve the US health care system.

Confused US Has Lots To Say About Health Care

Americans are passionate and confused about it — and their opinions are all over the lot.

A CNN-Opinion Research poll found that 51 percent of Americans favor Obama’s health-care plan, but a Wall Street Journal-NBC poll found that only 33 percent think it is a “good idea.” A New York Times-CBS News poll found that nearly six in 10 would be willing to pay higher taxes so that all could be insured, but a Kaiser poll found that 54 percent would not be willing to pay more to increase the number.

A Quinnipiac University poll found that a majority — 54 percent — believe that reducing health-care costs is more important than covering those who lack coverage, while the Times-CBS poll found that 65 percent thought that insuring the uninsured was a more serious issue. A Washington Post poll found that 57 percent of Americans are dissatisfied with the health-care system — but 83 percent are satisfied with the quality of their own care.

In short, when it comes to health care, the state of the union is confused. The confusion won’t be cleared up by the complexity of the debate, with all the jargon about community ratings and insurance exchanges and risk adjustments and guaranteed issues.

Reading some of the latest commentary on health care reform, our national leaders have tried to dumb down the issue and provide simplified answers for confused Americans.

Here are the promises:

Obama vows that health care reform will not add one dime to the federal budget deficit.  The plan to provide government insurance to those who cannot obtain private health insurance will be paid for by collecting premiums from the newly insured.

Drastic cuts in Medicare and Medicaid reimbursements to specialists and other health care providers can be used to pay for the cost of providing medical services to the uninsured.

The legendary 46 million uninsured people in America will have the unlimited health care they are entitled to.

In order to achieve universal and affordable health care, time is of the essence and Congress needs to quickly approve legislation by the end of July.

Here are the realities:

The Congressional Budget Office estimates the cost of health care reform at $1.6 trillion over the next ten years.   Based on the routine cost overruns of every government program, expect this number to be at least twice the estimate.

“Savings” obtained by cutting reimbursements translates into reduced jobs and incomes for the companies employing health care workers.

If there are really 46 million people being denied health care in this country, we would literally be tripping over the dead and dying every time we ventured out.  Where are the headlines citing real people who have perished from unavailable health care?  This hyped and unverified figure exaggerates the “health care crisis” for political purposes.

If 46 million people actually have no insurance, the logical question is why?  If  many of the uninsured do not have health insurance because they cannot afford the cost, exactly how is the government going to cover the cost of providing health care to the uninsured by “collecting premiums”?

Health care, essential to all of us,  is an issue for many Americans.   Those who believe that Washington can provide universal health care without “adding a dime to the federal deficit” are in fantasy land.

And this from a major hospital in Connecticut in a letter to their employees:

Tough times continue for “X”  Hospital and for health care overall.  At this time last year, our financials were making a comeback – not so far this year.  As unemployment rises in the local area, we’re seeing more patients with government insurance.  We already know that we will be reimbursed even less for these patients next year.  In our immediate region, Bridgeport, Greenwich, New Milford and Waterbury hospitals have laid off workers to make up for financial losses.

The initial results of government “cost savings” generated by lower reimbursements are resulting in health care job losses and weakening the financial condition of many hospitals and other health care providers.  Given the size of future promised government “savings” from reduced payments to health care providers,  who will be left employed in the health care industry to provide health care?

Filed Under: Government spending, Health care reform, Too Good To Be True Tagged With: ,

Stanford Financial Ponzi Scheme – New Fraud, Old Lessons

June 25, 2009 by 1 Comment

Stanford Free – Does Crime Pay?

On February 17, 2009 Stanford Financial was accused by the SEC of defrauding investors and engaging in a “massive, ongoing fraud”.  The fraud was perpetrated by seducing investors with “improbable if not impossible” returns on their investments, according to the SEC.  The amount swindled from investors is estimated at $7 billion.

The head of Stanford Financial, Allen Stanford, was finally arrested on June 18th and has been in federal custody since that time.  During a court hearing today in Houston, Mr Stanford entered the standard “not guilty” plea and his attorneys argued for his release on bail.

During the course of the court proceedings it was revealed that:

Texas financier R. Allen Stanford controlled a secret Swiss bank account from which he withdrew roughly $100 million last year, and also tapped the account to pay bribes to the firm auditing his Antigua-based bank, federal prosecutors alleged Thursday during a hearing in federal court.

The billionaire and the executives are accused of orchestrating a massive fraud by misusing most of the $7 billion they advised clients to invest in certificates of deposit from the Stanford International Bank, based on the Caribbean island of Antigua.

Also indicted is Leroy King, the former chief executive officer of Antigua’s Financial Services Regulatory Commission. He was taken into custody by island authorities and will now face extradition proceedings, according to a government official who spoke on condition of anonymity because she was not authorized to discuss the case. King is accused of accepting more than $100,000 in bribes to turn a blind eye to irregularities.

Investigators say even as Stanford claimed healthy returns for those investors, he was secretly diverting more than $1.6 billion in personal loans to himself.

The indictment also says Stanford and the other executives misrepresented the Antigua island bank’s financial condition, its investment strategy and how it was regulated.

Prosecutors argued that Mr Stanford should not be granted bail.

At Stanford’s bond hearing, prosecutors argued he should be held without bond because he might have access to billions of dollars in secret funds.

In court documents filed Thursday, prosecutors also said Stanford faces a potential life sentence, has access to a private jet and has an international network of wealthy acquaintances who would help him, including one who recently agreed to give him $36,000 to pay his lease on a Houston apartment for a year.

Each of the most serious counts that Stanford faces carry prison terms of up to 20 years. But prosecutors say sentencing guidelines could increase his total sentence to life in prison.

Despite the huge financial suffering caused by Stanford Financial to 30,000 investors, as well as the flight of risk, the court set bond at a small $500,000 and gave prosecutors until Friday to appeal the decision. How likely is it that anyone with a secret $100 million bank account and facing a life sentence would be concerned about forfeiting a half million bond by fleeing the US to escape justice?  This is no doubt a question that defrauded investors are asking.

Is This Man Smiling?

Is This Man Smiling?

Courtesy: Reuters

Other remarkable aspects of the Stanford Financial fraud are:

  • How long will it take for investors to be suspicious of firms offering guaranteed rates of return far in excess of what is available elsewhere?  No Ponzi scheme would work without the suspension of prudent judgment by investors blinded by ridiculous claims.  Has no one ever heard of “the higher the return the higher the risk”?
  • This is another case that should have caught the attention of the SEC long before Stanford could defraud thousands of people.  Just as with the Madoff fraud, Stanford blatantly and publicly advertised untenable returns, a classic sign of a Ponzi scheme.  The SEC blithely ignored or was oblivious to the obvious warning signs.
  • It took 4 months to arrest Mr Stanford and he is now on bail, free to enjoy his life.  At this rate of justice, Mr Stanford may get to spend the rest of his life immune from punishment and living a lavish life style courtesy of his secret bank accounts.   Defrauded investors, dolefully seeking for perspective on this matter may consider the remarks of William Gladstone who stated that “justice delayed is justice denied”.
Filed Under: Corruption, Fraud, Stanford Financial, Too Good To Be True Tagged With: , ,

Regulatory Reform Implies Cause and Solution To Financial Meltdown The Same

June 22, 2009 by Leave a Comment

The Federal Reserve failed miserably in preventing the meltdown of the American financial system.  Worse yet, the Fed’s loose credit and monetary policies and failure to properly regulate the financial system was arguably one of the biggest causes of the financial meltdown.  Now, based on the Fed’s sterling record of failure, Washington’s answer is to give absolute power to the Fed – what are these nitwits in Washington thinking?

Back in the U.S.S.A. – Peter Schiff

Harry Browne, the former Libertarian Party candidate for president, used to say: “the government is great at breaking your leg, handing you a crutch, and saying ‘You see, without me you couldn’t walk.’” That maxim is clearly illustrated by the financial industry regulatory reforms proposed this week by the Obama Administration.

In seeking to undo the damage inflicted over the past decade by misguided government policies, the new regulatory regime would ensure that the problems underlying our financial system will only get worse.

The underlying problem is that the excessive risk taking which brought about the crisis was not market-driven, but a direct consequence of government interference with risk-inhibiting market forces. Rather than learning from its mistakes and allowing market forces to once again control risks and efficiently allocate resources, the government is merely repeating its mistakes on a grander scale – thereby sowing the seeds for an even greater crisis in the future.

Obama proposes to entrust the critical job of “systemic risk regulator” to the Federal Reserve, the very organization that has proven most adept at creating systemic risk. This is like making Keith Richards the head of the DEA.

Given the Federal Reserve’s disastrous monetary policy over the past decade, any attempt to expand the Fed’s role should be vigorously opposed. Through decades of short-sighted interest rate decisions, the Fed has proven time and again that it is only able to close the barn door after the entire herd has escaped. If setting interest rates had been left to the free market, none of the excesses we have seen in the credit market would have been remotely possible.

The perverse result will be that our government and the Fed gain more power as a direct result of their own incompetence.

With the transition now fully under way, I propose we end the pretense and rename our country: “The United Socialist States of America.” In fact, given all the czars already in Washington, we might as well go with the Russian theme completely: appoint a Politburo, move into dilapidated housing blocks, and parade our missiles in the streets. On the bright side, there’s always the borscht.

ship-of-fools-titanic2Courtesy: The Liberty Voice

Washington constantly employs the same failed tactics to a problem and expects different results and only those outside of Washington understand the implications of such thinking.  Instead of expanding Federal Reserve powers, serious thought should be given to severely restricting the Fed’s ability to destroy what’s left of the American free enterprise system.

More on this topic:

What The Fed Chairman Said At The Onset Of The Credit Bubble

Filed Under: Congress, Federal Reserve, Regulatory Reform Tagged With: ,