This is a very informative piece on how the shadow banking system works (i.e. the “repo” markets – as in sale and repurchase).   Enjoy

Does the name Cully Stimson ring a bell?

In 2007 Stimson, in his capacity as Deputy Assistant Secretary of Defense for Detainee Affairs, made a series of bizarre statements on NPR criticizing the law firms (many of them among the nation’s best) whose partners or associates were representing detainees, disgracing himself (he subsequently resigned), the legal profession and the very idea of American justice, which requires equality under the law no matter how unpopular the defendants.  This bizarre rant of Stimon’s prompted a very pointed response co-authored by Neal Katyal, the Georgetown Law Professor who represented Salim Hamdan in the landmark Hamdan v Rumsfeld, and former solicitor general Theodore Olsen:

With the war on terror, which unfortunately may go on for generations, America doesn’t have any margin for error. The legal issues that surround this war are enormously intricate and don’t lend themselves to sloganeering-based solutions. When government officials are called “war criminals” and when public-interest lawyers are called “terrorist huggers,” it not only cheapens the discourse, it scrambles the dialogue. The best solutions to these difficult problems will emerge only when the best advocates, backed by weighty resources, bring their talents to bear. And the heavy work of creating solutions for these complicated issues can only move forward when the name-calling ceases.

I have to assume that the stunads* esteemed writers at the Weekly Standard failed to get this memo because not only does Thomas Joscelyn’s obnoxious hit piece stoop to the sort of playground shit talk that has no place in complex legal debates but he also fails to demonstrate even a remedial understanding of the issues.  Take this passage, where he attacks a Slate article written by Katyal that criticizes the Military Commissions Act of 2006 (“MCA”):

Katyal has made some other questionable comments about Hamdan and the military commissions as well. In a piece for Slate in December 2007, Katyal started off by lamenting the fact that Hamdan was not being tried in a regal Washingtonian court, but instead in a “rickety courtroom at Guantanamo.” Katyal then compared Hamdan to your average green-card holder in America…Katyal is flat out wrong when he says that the Bush administration’s military commissions were the “first time” America has attempted to dispense “justice” in such a manner. Military commissions (tribunals) have a long history in this country dating back to the founding. The Obama administration is even using them to try Gitmo detainees. What’s worse is that Katyal didn’t seem to understand that the “them” are al Qaeda. And only someone who cannot tell the difference between us and our terrorist enemies would compare al Qaeda members to “green-card holders.”

Set aside the fact that the last part of this quote is nothing more than useless political conjecture that makes the author look like a bona fide stunad polemicist.   Joscelyn trots out an old talking point about the use of military commissions throughout our country’s history.  This was not the issue in the Hamdan case.  The argument Katyal made to the Supreme Court in Hamdan was that the Executive Branch alone was not authorized by the Constitution to establish military tribunals (which actually would be a break from the long history of military commissions in this country).  Katyal writes:

The longstanding restrictions on commissions are not such disposable niceties. Rather, they are time-tested barriers to the dangerous seepage of martial law into our civilian order. To fail to enforce these limits would be to allow a dangerous and unprecedented expansion of Executive authority whose legal premise must be that the fight against terrorism justifies a reallocation of constitutional power. There would be no principled way to prevent that precedent from becoming the edifice upon which any number of actions could be grounded, even against U.S. citizens, from surveillance to indefinite detention, on the mere allegation that they are affiliates in that “war.” If fighting terrorism requires such a basic shift in our legal order, it is for Congress, not the Executive, to sayso; and Congress must say so in the most explicit of terms.

Katyal’s position and understanding of this issue was shared by a sizable portion of the legal community. For anyone interested, more amicus briefs on the constitutionality of the Executive Branch unilaterally establishing military tribunals can be found here.

Joscelyn also fails to grasp one of the most controversial portions of the MCA as written.  The statute was not only formulated to strip the ability of detainees to challenge their detention in federal court, but it also explicitly forbids resident aliens in the United States from doing so as well (more here).  A Chinese national in the United States, legally protected as a resident alien, could be detained, designated by the Executive Branch as an unlawful enemy combatant, and transferred to military custody without a chance to challenge this detention in federal court***.  An American citizen faced with the same situation would not have his or her habeas rights revoked.  Therefore, the statute did create a two-tiered system of “us” and “them” because under the law, both detainees at Guantanamo Bay and foreigners in the United States were unable to access federal courts to challenge their detentions.  Apparently, Joscelyn never bothered to read the statute or attempt to understand the law as it was written.

This issue was making its way through the courts in  Al Marri v Spagone., where a resident alien was transferred to military custody after being designated an unlawful enemy combatant, held indefinitely without being charged and was forbidden from challenging his detention in a federal court (the Fourth Circuit Court of Appeals ruled in favor of al Marri).  The Supreme Court would have heard the case, but it was dismissed as moot when the Obama Administration transferred Al Marri back to civilian custody to be tried on charges unrelated to terrorism.

Josceyln’s lack of legal knowledge is bad enough.  Worse still is the way he ends his piece:

Now, we don’t know what assignments these lawyers have taken on inside government. But we do know that they openly opposed the American government for years, on behalf of al Qaeda terrorists, and their objections frequently went beyond rational, principled criticisms of detainee policy.

Here, Joscelyn says everything he needs to say about his lack of respect of the rule of law, the Constitution and the American justice system.  Joscelyn, like Stimson, can’t bring himself to accept the notion that American justice means suspects, whether tried in a civilian court or a military court, are entitled to the best defense possible, regardless of popularity.  It is through this system, where the best on both sides advocate their positions to the fullest extent, that the rule of law prevails, whether it is John Adams defending the British soldiers accused of participating in the Boston Massacre or Neal Katyal representing clients suspected of terrorism.

That Josceyln suggests Katyal went beyond “rational, principled” criticism of the MCA is a classic case of the pot calling the kettle black.   No one “openly opposed” the American government.  Lawyers raised specific legal issues based on laws or policies perceived to be dubious either on statutory or constitutional grounds.  In many significant cases, the Supreme Court did not side with the Executive Branch (would Joscelyn suggest that the Supreme Court, in siding with “terrorists,” is also opposing our government?).  Between the series of court defeats and the redactions of a number of other legal positions maintained by the Bush Administration until the very end of the second term (memos and here and here), it seems to me that criticism of the last Administration’s positions was very warranted and quite rational.  That Joscelyn disagrees does not make Katyal irrational or unprincipled.

Olsen and Katyal conclude their article by arguing that patriotism requires a belief that the American legal system will reach the right results.  The editors and writers of the Weekly Standard should take that to heart and reconsider this shameful stance.

The same also goes for the yokels running Keep America Safe, who Walter Dellinger takes to task in today’s Washington Post.

Shameful indeed.

*** I am operating under the assumption of the majority opinion in Boumediene v Bush in that the procedures the MCA set forth to guarantee detainees an adequate substitute for a habeas challenge in a federal court were inadequate.

Brief update: the term “stunad” is Italian slang for stupid person.

Rortybomb takes on shadow banking and why the proposed Volcker Rule falls short.  Be sure to follow the links. He’s got a lot of good information and the illustrations are very accessible to a lay audience.

…wind, that is.

John Carney has some interesting commentary on the first day of the Financial Crisis Inquiry Commission hearings.  He writes:

A structured credit product—whether its as simple as a mortgage backed security or a complex CDO—is not necessary flawed if it produces losses. Even enormous losses. Indeed, it might be perfectly well-designed but still deliver the buyers losses.

The point of creating structured financial products is to create exposures to certain risks and opportunities. A mortgage backed security, for instance, might be designed to expose buyers to subprime mortgages. If it is well-structured it will expose its owners to the upside and downside of the mortgages pooled within it.

Of course, a financial product can be badly designed. It could fail to track the performance of the mortgages it was meant to. This tracking failure is one of the big critiques of many ETFs, some of which are poorly designed. This was not the problem with the credit products sold by Goldman—they went down when the housing market collapsed and the mortgages backing them went sour.

When Goldman was selling the financial products, it wasn’t necessary telling the buyers that these were great investments. It was telling them that they were investments that would give them the exposures they were looking for. If you were bullish on the mortgage market and a skeptic of the Bubble Thesis—a thesis that Goldman had very publicly embraced—then buying mortgage backed securities from Goldman was a way to put that bullishness into action.

Angelides, the former California state treasurer, just has too much of paternalistic world view to understand that it is possible to sell a financial product without believing the buyer’s rationale for buying it.

This really is the heart of the matter. Angelides thinks it is wrong for Goldman to underwrite financial products that create exposures it does not want for itself. As long as Goldman wasn’t lying to clients or over-hyping the financial products—and so far, no one has shown any evidence of this—there’s nothing really wrong with what Goldman was doing. If sophisticated investors want to take on risk, they should be permitted to.

There is nothing wrong with a firm selling exposure to assets that it does not want (the crux of the securitization business) or the idea that good products with good collateral behind them can be money-losing investments.

However, I do not find John’s defense of Goldman or his assault on Philip Angelides’ regulatory acumen convincing, not because of his principles, which, for the most part, I agree with.  Instead, I think that thesubprime mortgage business and the manner in which those loans originated, were acquired, securitized and sold was a significant abandonment of those principles.

If it is well-structured it will expose its owners to the upside and downside of the mortgages pooled within it

Qualitatively neutral descriptions of what structured products should or should not do, while helpful to those without a financial background, are not helpful in this particular instance.   As housing prices rose and subprime mortgage lending dramatically increased in volume, the business became rotten to the core.  Mortgage fraud rose dramatically.  Lending standards vanished.  Loans were made to just about anyone who had a pulse and could sign their name to a sheet of paper (i.e. the strawberry picker making $14,000 per year getting a $720,000 home).  Home values were rising to unprecedented levels.  Collateral from this storm was piling into these products.  Wall Street firms were buying these loans in massive quantities.

The firms did little due diligence on the quality of these loans.  Furthermore, the firms tasked with evaluating the loan pools were 1) working in an environment where the incentive was to sign off on as many loans as possible (quantity vs. quality) and 2) evaluating a representative sample of the total pool (the sellers were able to impose this condition because of the competitive environment for their product).  This is all detailed in Chain of Blame by Paul Moulo and Matt Padilla.   Investors were clamoring for product and Wall Street simply churned it out from whatever source they could acquire with little to no regard for the underlying quality.

The banks didn’t know (or worse, didn’t care) what they were piling into these securities and then strong-armed the rating agencies into giving these securities the coveted AAA ratings so that the pool of possible investors would be as large as possible.  So no, they did not just create securities to fill a market demand.  They were also working to present the most optimistic risk picture possible.

Given what happened to the mortgage markets, I see nothing paternalistic about grilling the banks about how this business was carried out for mortgage products.  Angelides’ words may have been poorly chosen, but this doesn’t get the banks off the hook for their role in the securitization crisis, even if their actions were technically legal.

Greg Mankiw says that it’s not a sure thing, despite the large deficits and rapid growth in our money supply.

Cry me a river. Furthermore, do Wall Street firms complaining that compensation ratios are at historically low levels not realize that the problem is with bankers receiving bonus compensation in the first place?

I do not expect Chicago School economists to favorably review the Obama Administration’s economic policy, but to suggest that those economic policies, not only those which have been passed (The American Recovery and Reinvestment Act) but those which have yet to pass or are simply on its wish list are hindering an economic recovery – a claim made by Gary Becker, Steven J. Davis and Kevin Murphy in this WSJ Op-Ed piece – without providing any real evidence to support your claim is weak.  Call it a serious case of putting the cart before the horse manure.  Here’s an excerpt from their op-ed:

In terms of discouraging a rapid recovery, other government proposals created greater uncertainty and risk for businesses and investors. These include plans to increase greatly marginal tax rates for higher incomes. In addition, discussions at the Copenhagen conference and by the president to impose high taxes on carbon dioxide emissions must surely discourage investments in refineries, power plants, factories and other businesses that are big emitters of greenhouse gases…

Even though some of the proposed antibusiness policies might never be implemented, they generate considerable uncertainty for businesses and households. Faced with a highly uncertain policy environment, the prudent course is to set aside or delay costly commitments that are hard to reverse. The result is reluctance by banks to increase lending—despite their huge excess reserves—reluctance by businesses to undertake new capital expenditures or expand work forces, and decisions by households to postpone major purchases.

[Read more →]

Was Best Buy really telling customers that their optimization program would increase processor speeds by 200% for $39.99 as this article claims?  This is an amusing story about the Geek Squad’s abilty to fuck up errr tweak PCs and the performance enhancements that result.  Best to do it yourself I think.

Fed Chairman Ben Bernanke gave a speech to the American Economic Association yesterday.  In it, he argued that the Fed’s interest rate policy circa 2003 played virtually no role in the financial crisis and the causes were due to regulatory failures (Speech here)

What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk-management practices without necessarily having had to make a judgment about the sustainability of house price increases. [Read more →]

Brother Mark and I generally tend to agree on most constitutional matters, including his September post .  I may hold a constitutional viewpoint that tends towards a textualist or originalist interpretation but it is senseless to make those arguments when modern constitutional doctrine is anything but.  The ship known as the doctrine of enumerated powers sailed away by the mid 1930s.  Attempts to pull back at the margins (specifically 1995’s United States v Lopez and 2000’s United States v Morrison) were effectively forestalled in 2005’s Gonzales v Raich and, I would argue, 2007’s Gonzales v Carhart.

At the end of the day, Mark could be right when he suggests that an individual mandate, especially one that is not being described publicly as a tax, could pass constitutional muster.  However, I tend to be a little more skeptical.  Mark writes (my emphasis added):

My opposition notwithstanding, I suspect that even if the mandate is not a “tax” within the meaning of the Constitution, it would still withstand Constitutional muster under post-New Deal case law.  But it would be a much closer issue, particularly in light of the apparent death of the public option (for real this time!).  Such an argument would necessarily hinge on Congressional authority to regulate economic activity under the interstate commerce clause, but there is a counterargument to be made that a decision not to purchase something cannot be an “inherently economic activity” since it involves no activity whatsoever.  Moreover, it is possible to distinguish a health insurance mandate from Social Security or Medicare Part A because the mandates in those two programs require participation in government-run programs, whereas with the death of the public option, the health insurance mandate will require participation in privately-run insurance programs.  I don’t think this distinction is enough to make the mandate unconstitutional, but it is at least arguable that it is…

…Again, I think ultimately an individual health insurance mandate would likely pass Constitutional muster under post-New Deal precedent whether or not it is characterized as a tax.  The decision not to purchase health insurance clearly has an aggregate effect on interstate commerce in a way that even cases like Raich, where the Court upheld a federal law’s applicability to medical marijuana dispensaries even though the convoluted alleged effect on interstate commerce was merely a post-hoc rationalization for the law, rather than the law’s actual purpose, as would be the case with an individual health insurance mandate.  But it would be a much closer issue than if the mandate were deemed a tax, and there would be enough of a distinction with existing precedent that it would at least be possible for a Justice Kennedy to divine a rule under which the mandate is unconstitutional in a way that the legislation in Raich was not.

I would like to expand upon this a bit and suggest that regulating economic activity, as I understand it in the context of the Commerce Clause, provides the federal government with the authority to regulate an industry in the sense that it sets the rules of the playing field so to speak (or determines whether such a playing field is allowed to exist).    Participants in a given market can enter and exit at their own free will insofar as they follow the rules of the game.  Assuming the mandate is not seen as a tax, this has a different feel to it.   Mandating that individuals enter into a private market that they may not have otherwise chosen to enter and purchase an insurance plan that they may not have otherwise purchased would be Wickard v Fillburn on steroids.  Even in our most far-reaching Commerce Clause cases, cases like Wickard and Raich, the decisions were aimed at the prevention of certain activity from taking place because such activity impacted interstate commerce.  Even with our very broad reading of the Commerce Clause, upholding a law that effectively forces people to engage in transactions they may not have otherwise participate in the sense that 1) it is not a tax  and 2) relates to purely private sector activity is unprecedented and, in my opinion, does push the envelope a bit.

I can’t predict which way that question will be decided; however, it is worth mentioning that if a law of this nature is upheld on Commerce Clause grounds, then we are moving into new legal territory.

Barry Ritholtz has a table comparing the bull market rallies in 1982 and 2009.  One has the support of sound fundamentals and one does not.  See for yourselves.