Economics can be the study of how people have outwitted each other, often outwitting themselves in the process. We have an example in recent settlements of cases characterized as either fraud or misleading representations. Deutsche Bank has settled a case brought by the National Credit Union Administration on behalf of five failed credit unions. This recovered $165 million. Deutsche Bank, like Citigroup earlier, has not admitted wrongdoing.

A previous settlement by Citigroup cost them $285 million, but only a fraction of this was an actual fine. The judge in that case asked the SEC to explain why this was smaller than the $535 million settlement Goldman-Sachs made last year. Other civil suits have been filed against J.P. Morgan-Chase and Royal Bank of Scotland. These are all gilt-edged financial institutions.

Direct losses resulting from the collapse of financial institutions are way up in the billions. Losses due to the loss of confidence in the value of assets held by financial institutions would have to be counted in the trillions of dollars. A shortage of lenders willing to take risks is behind the crisis currently affecting the Eurozone. Those institutions which survived did better than the ones that did not, but all are now in trouble because no one knows what to believe.

Part of the hypocrisy in these settlements is that every major institution originating these financial instruments deliberately employed groups of bright people with computers to game the models used by ratings agencies in putting together those packages called Collateralized Debt Obligations (CDOs). Concern for possible default had already been removed from those originating mortgage loans. Now responsibility was being passed on to credit rating agencies far smaller than the institutions they were said to be rating. Sometimes the institutions originating the CDOs had information concerning the contents of these packages it would have been difficult for rating agencies to acquire. Whatever might have been possible, those agencies failed to evaluate true risks. The risks were passed on to buyers with much less ability to evaluate them.

We have yet to unravel the tangled skein of transactions created by MF Global Holdings, that must be considered among coming attractions. We may confidently expect it to have made use of sophisticated "repo financing". Exactly how assets were distributed between management, operating and holding companies will take time to understand. Then we can get on to post-graduate study of possible special purpose vehicles, special investment vehicles and conduits. The date when we understand what an actively traded firm was worth at any previous point in time will be years in the future. This raises the question of what information was used by those making investments in the firm.

The main distinction I draw between high finance and casino operation is the value of inside information. In a well-regulated casino, randomness will dominate any inside information you might acquire. The house always wins in the long run, but their take can be reliably calculated by regulators. High finance clearly falls short of this ideal.

My next post will concern the relevance these discoveries about past behavior have for important and immediate concerns of international finance.


How would you classify a news item which both TEA party and Occupy Wall Street agree about? The problem is less with the named $13 billion than the fact that even the strongest banks needed far more than we knew to stay in business.

With a Federal judge insisting the Citigroup fraud case go to trial, I wouldn't bet on them getting anything as easy as the $285 million settlement worked out with the SEC.

Another aspect is that Timothy Geithner, then head of the New York Fed., is now Secretary of the Treasury. This item will make waves.
Nearly 8 trillion dollars recently propping up USA banks? The argument that breaking up the banks or heavily regulating them will cost money just got a lot weaker. Most of that 8 trillion is loans I gather, so not losses, but what are the actual losses. My guess is that breaking up and regulating the banks will cost, yes, but the increased stability will produce more gains than losses - its only the banker's salary bonuses that will take a real and sustained nosedive. Bye, Alex

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