(BN) Wall Street Proprietary Trading Goes Under Cover: Michael Lewis

October 27, 2010

Wall Street Proprietary Trading Goes Under Cover: Michael Lewis

Oct. 27 (Bloomberg) — A few weeks ago we asked a simple question: Why are the same Wall Street banks that lobbied so hard to dilute the passages in the Dodd-Frank financial overhaul bill banning proprietary trading now jettisoning their proprietary trading groups, without so much as a whimper?

The law directs regulators to study the prop trading ban for another 15 months before deciding how to enforce it: why is Wall Street caving now?

The many answers offered by Wall Street insiders in response boil down to a simple sentence: The banks have no intention of ceasing their prop trading. They are merely disguising the activity, by giving it some other name.

A former employee of JPMorgan, for instance, wrote to say that the unit he recently worked for, called the Chief Investment Office, advertised itself largely as a hedging operation but was in fact making massive bets with JPMorgan’s capital. And it would of course continue to do so. JPMorgan didn’t respond to a request for comment.

The fullest explanation came from a former Lehman Brothers corporate bond salesman named Robert Wosnitzer, who is now at New York University, writing a dissertation on the history of proprietary trading. He’s been interviewing Wall Street bond traders, he said, and they have been surprisingly open about their intentions to exploit one obvious loophole in the new law.

The innocent eye might have trouble spotting this loophole. The Dodd-Frank bill bans proprietary trading (Page 245: “Unless otherwise provided in this section, a banking entity shall not engage in proprietary trading”) and then appears to make it clear what that means (Page 565: “The term ‘proprietary trading’ means the act of a (big Wall Street bank) investing as a principal in securities, commodities, derivatives, hedge funds, private equity firms, or such other financial products or entities as the comptroller general may determine”).

Invitation for Abuse

The big invitation for abuse, Wosnitzer says, lies in the phrase “as a principal.” It falls to the comptroller general – – or, more specifically, the General Accountability Office, which is overseen by the comptroller general — to determine precisely what the phrase means.

And, at the moment, the GAO pretty clearly hasn’t the first clue. (“We’re really too early in the process to speak to how we might define it,” said spokeswoman Orice Williams Brown.)

Never mind: Wall Street is busily defining the term for itself.

Make an Argument

“One trader I interviewed,” Wosnitzer says, “said that from here on out, if he wants to take a proprietary position in a credit, he will argue that he bought the position because a customer wanted to sell the position, and he was providing liquidity; and in order to keep the trade on, he would merely offer the bonds 10 basis points higher than the offered side, so that he will in effect never get lifted out of the position, while being able to say that he is offering the bonds for sale to clients, but no one wants ‘em. When the trade finally gets to where he wants it — i.e., either realizing full profit, or slaughtered by losses — he will then sell it on the bid side, and move on.

Of course, there is all sorts of flawed logic here, but the point is that…there are a hundred different ways to claim to be acting as an agent or for a customer.’’

This ambiguity is no doubt one reason the financial reform bill passed in the first place. Even its clearest prohibitions are couched in language inviting Wall Street to evade them.

But the new game of cat and mouse raises a simple, even naive question: Why do these giant Wall Street firms want so badly to make huge bets with their shareholders’ capital?

Save Us

After all, the point of the ban on proprietary trading is as much to save the banks from themselves as to save us from them. We have just come through a period where putatively shrewd individual bond traders lost not millions but billions of dollars for their firms, by making really stupid bets.

Even before the crisis there was never any reason to think that traders at big Wall Street firms had any special ability to gamble in the financial markets. Anyone with a talent for investing is unlikely to waste it on Morgan Stanley or Bank of America; he’ll use it for himself, or for some hedge fund, which allows him to keep more of his returns.

And if this were true before the financial crisis it is even more true after it, when trading inside a big Wall Street bank will be less pleasant and more fraught with politics.

Yet Wall Street’s biggest firms apparently still badly want their traders to be allowed to roll the bones. Why?

What They Do

One answer — which Wosnitzer points to — is that this is what Wall Street firms now mainly do. Beginning in the mid- 1980s, the Wall Street investment bank, seeing less and less profit in the mere servicing of customers, ceased to organize itself around its customers’ needs, and began to build itself around its own big and often abstruse gambles.

The outsized gains (and losses), the huge individual paychecks, the growing ability of traders to bounce from firm to firm from one year to the next, the tolerance for complexity that doubles as opacity: all of the signature traits of modern Wall Street follows from the willingness of the big firms to allow small groups of traders to make giant bets with shareholders’ capital, which the shareholders themselves don’t and can’t understand.

The new way of life began at Salomon Brothers in the early 1980s, right after it turned itself from a partnership into a publicly traded corporation; but it soon spread to the others.

‘‘That was the particular moment when a new culture of finance crystallizes,” Wosnitzer says. “And it restructures all of finance. All of a sudden it’s ‘I made X, pay me X minus Y or, screw you, I’m leaving.’”

Keep It Simple

There’s a simple, straightforward way for the GAO to construe the Dodd-Frank language, and it would reform Wall Street in a single stroke: to ban any sort of position-taking at the giant publicly owned banks. To say, simply: You are no longer allowed to make bets in the same stocks and bonds that you are selling to investors.

If that means that Goldman Sachs is no longer allowed to make markets in corporate bonds, so be it. You can be Charles Schwab, and advise investors; or you can be Citadel, and run trading positions. But if you are Citadel you will be privately owned. And if you blow up your firm, you will blow up yourself in the bargain.

(Michael Lewis, most recently author of the best-selling “The Big Short,” is a columnist for Bloomberg News. The opinions expressed are his own.)

To contact the writer of this column: Michael Lewis at mlewis1

To contact the editor responsible for this story: James Greiff at jgreiff

Find out more about Bloomberg for iPhone: http://m.bloomberg.com/iphone/

Objects sent from this iPhone are more intelligible than they appear.


NYTimes: Group Texting Grows Up, With Features That Appeal to Adults

October 21, 2010

From The New York Times:

APP SMART: Group Texting Grows Up, With Features That Appeal to Adults

Free smartphone applications have emerged to make group texting easier and smarter for adults.


Get The New York Times on your iPhone for free by visiting http://itunes.com/apps/nytimes

Objects sent from this iPhone are more intelligible than they appear.

SPY Fell 9.6% Today At the Close to 106.46, WTF?

October 18, 2010

I was stunned today to see the SPY, which I had been watching only a few minutes earlier show a “print” at the close of 106.46, when it was trading over 118 and change just moments before.  I quickly checked after market trading on the SPY and saw that it was in the 117 range.  Time and sales showed no trades at that price, at the time.  I assumed the 106.46 number must have been an “anomaly”.  I don’t know what the official word will be used to describe the error, but it certainly compounds any remaining concern over the stability and validity of equity markets since the flash-crash in May.

I was at least relieved to see that someone besides myself noticed the error.  Sound like some lucky/unlucky buggers got to buy the SPY at 106.46, albeit for a moment as it looks like the trades were “busted”.

An explaination from Bloomberg is below in its entirety.  More sadly, there have been a number of anomalies since the May flash-crash.  Me thinks the gerbils running the wheel in the old mainframe need to stop smoking pot before 4:30PM.

Oh, and yes I have screen shots, but I left them at work, I will post tomorrow for posterity.  (Update: I’ve posted the screen shots at the bottom.)

NYSE Breaks Trades of S&P 500 ETF at 9.6% Below Opening Price

By Michael P. Regan and Nina Mehta – Oct 18, 2010

A software update at NYSE Euronext’s Arca platform triggered what appeared to be a 9.6 percent plunge in an exchange-traded fund that tracks the Standard & Poor’s 500 Index, a drop that would have erased $7.9 billion from one of the most popular securities in the U.S.

Data published by the electronic venue at 4:15 p.m. New York time showed the SPDR S&P 500 ETF Trust at $106.46 compared with its opening price of $117.74. The apparent plunge in price involved 7.2 million shares in the closing auction on NYSE Arca, according to data compiled by Bloomberg at 4:30 p.m. The S&P 500 rose 0.7 percent to close at 1,184.71 today.

The glitch in the exchange-traded fund, which has a market value of $83.3 billion, comes as federal regulators are trying to restore confidence to equity markets following the May 6 crash that erased $862 billion of share value in 20 minutes. Data showing the decline appeared just as Apple Inc. and International Business Machines Corp. were releasing quarterly profit statements.

“It was a mess and it was alarming that it could happen,” said Andrew Ross, a partner and global equity trader for First New York Securities LLC, who trades ETFs. “People were very focused on after-market trading because of IBM and Apple earnings so it was very confusing when the price discrepancy happened. But people quickly recognized it was a bad print.”

Auction Glitch

NYSE Arca said the ETF’s official closing price will be recorded as $118.28, a 0.5 percent gain from its Oct. 15 close. The exchange operator said its 4 p.m. closing auction in securities listed on NYSE Arca was delayed for 15 minutes because of an issue with a software release. Auction prices occurring at 4:15 p.m. will be the official closing price for all other securities except for the SPDR S&P 500 ETF.

NYSE Arca will “bust” all the $106.46 trades, according to an e-mail from exchange spokesman Raymond Pellecchia. The fund managed by State Street Global Advisors is one of the most heavily traded securities in the U.S., averaging 112.2 million shares a day this year, data compiled by Bloomberg show.

“The issue has been resolved,” Pellecchia said in an interview. “Operations will be normal tomorrow.” Marie McGehee, a spokeswoman for State Street Corp., declined to comment.

Trading in another security linked to the S&P 500, the E- Mini futures contract traded on the Chicago Mercantile Exchange, helped start the May 6 crash that briefly sent the Dow Jones Industrial Average down 998.5 points, according to regulators. A mutual fund company’s automated sale of the contract without regard to price and “hot potato” trading by computer-driven firms set off the rout, according to the Securities and Exchange Commission and Commodity Future Trading Commission report.

Algorithmic Trading

The 104-page study released Oct. 1 said trading software known as an algorithm linked the rate at which it traded the E- Mini contract to overall market volume. The initial sales spurred a flurry of buying and selling among high-frequency traders, which in turn led the algorithm to sell faster.

SEC Chairman Mary Schapiro is trying to protect investors in a fragmented U.S. stock market while maintaining liquidity on exchanges dominated by firms that profit from computerized trading. The May crash prompted exchanges to implement circuit breakers that pause trading in more than 1,300 securities during periods of volatility. Uniform policies for canceling trades and eliminating stub quotes, or bids and offers at prices far away from the stock’s last sale, have also been proposed or adopted.

Other Busted Trades

Nasdaq canceled more than 50 trades in Progress Energy Inc. on Sept. 27 after the shares plunged 90 percent, triggering stock circuit breakers imposed after the May 6 crash. The exchange cited an “inaccurate limit price entered by a trading firm” for the mistaken transactions.

Two weeks earlier, a 100-share order for Nucor Corp. that triggered a 99.98 percent decline was canceled by the CBOE Stock Exchange. Nucor fell from $35.71 to 1 cent on the voided purchase, data compiled by Bloomberg show.

About 200 trades in Core Molding Securities Inc. were canceled on Aug. 26 after the stock plunged from above $4 to below a penny in two seconds after going untraded for the first 4 1/2 hours of the day. NYSE Amex, the Nasdaq Stock Market and Nasdaq’s BX platform canceled all trades at or below $3.94.

To contact the reporters on this story: Michael P. Regan at mregan12@bloomberg.net; Nina Mehta in New York at nmehta24@bloomberg.net.

To contact the editor responsible for this story: Chris Nagi at chrisnagi@bloomberg.net

October 18, 2010 SPY After the Close (from Google)

October 18, 2010 SPY After the Close (from Google)

October 18, 2010 SPY After the Close (from Yahoo)

October 18, 2010 SPY After the Close (from Yahoo)

October 18, 2010 SPY After the Close (from Finviz)

October 18, 2010 SPY After the Close (from Finviz)

(BN) Fed Considers Raising Inflation Expectations as Means to Encourage Growth

October 13, 2010

Fed Considers Raising Inflation Expectations to Boost Economy

Oct. 13 (Bloomberg) — Federal Reserve policy makers may want Americans to expect inflation to accelerate in the future so they spend more of their money now.

Central bankers, seeking ways to boost flagging growth after lowering interest rates almost to zero and buying $1.7 trillion of securities, are weighing strategies for raising inflation expectations as well as expanding the balance sheet by purchasing Treasuries, according to minutes of the Fed’s Sept. 21 meeting released yesterday.

Some Fed officials are concerned that expectations of lower inflation will become self-fulfilling, damping demand by increasing borrowing costs in real terms, the minutes said. By encouraging Americans to believe prices will start rising at a faster pace, the Fed would reduce inflation-adjusted interest rates and stimulate the economy. Chairman Ben S. Bernanke said in 2003 that Japan could beat deflation by using a “publicly announced, gradually rising price-level target.”

“The Fed is on the verge of actively targeting a higher inflation rate,” said Dan Greenhaus, chief economic strategist at Miller Tabak & Co. in New York. U.S. stocks advanced, sending benchmark indexes to five-month highs, the dollar fell and gold declined for the first time in three days after the minutes were released.

Trying to raise inflation expectations is untested in the U.S. The policy may backfire if actual inflation drifts higher than the Fed would like, potentially eroding gains won in the early 1980s by former Fed Chairman Paul Volcker, who raised interest rates as high as 20 percent to subdue prices.

‘Elegant’ Theory

“The theory is elegant, but it’s unclear in practice whether short-term moves in inflation expectations really drive real growth,” said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York and a former Fed researcher.

Jim O’Sullivan, global chief economist at MF Global Ltd. in New York, said in a Bloomberg Television interview that the biggest risk is “boosting long-term inflation expectations more than they lower real interest rates.”

Bernanke on Oct. 15 will deliver a speech on “Monetary Policy Objectives and Tools in a Low-Inflation Environment” at a conference at the Fed Bank of Boston. Some of the panels at the conference will deal with Japan’s experience of deflation.

The Sept. 21 statement saying the Fed “is prepared to provide additional accommodation if needed” was meant to accord “with the members’ sense that such accommodation may be appropriate before long,” the minutes said. The Standard and Poor’s 500 index is up 2.6 percent since Sept. 21 and rose 0.4 percent yesterday to 1,169.77.

Consumer Confidence

The Thomson Reuters/University of Michigan consumer confidence survey showed consumers expect an inflation rate of 2.2 percent over the next 12 months in September, the lowest in a year and down from 2.7 percent in August.

The Fed gave several options for raising short-term price expectations, including providing more information on the inflation rate policy makers consider consistent with their long-term goals and targeting a path for the price level. For the first time, the Fed said it could also target a path for nominal gross domestic product, which isn’t adjusted for inflation.

“The minutes are one of their key communication tools, but it’s not clear what that approach will be,” Maki said.

The report provides more detail on the timing and components of potential easing actions without giving the amount of any additional asset purchases by the Fed. Since the meeting, weaker-than-forecast job growth in September and comments by policy makers, including New York Fed President William Dudley, have fueled speculation that the central bank will soon start a second wave of unconventional easing.

Projection for Purchases

Goldman Sachs Group Inc. economists are projecting that the Fed will announce $500 billion of purchases at the next meeting Nov. 2-3.

“They’re still ironing out the details,” said Chris Low, chief economist at FTN Financial in New York. At the same time, “if we don’t get an announcement in the next meeting I think we’d see quite a bit of disappointment in the bond market and the stock market,” Low said.

Bond traders expect the Fed’s actions to generate higher prices. Their inflation expectations for the next five years, measured by the breakeven rate between nominal and inflation- indexed bonds, rose to 1.47 percent from 1.2 percent on Sept. 20, the day before the Fed’s meeting. Gold prices hit a record $1,366 an ounce on Oct. 7.

Removing Punch Bowl

“The bottom line is, they are trying to reflate, and the market is concerned that historically they have always been late in removing the punch bowl,” said Richard Schlanger, a vice president at Pioneer Investments Inc. in Boston who helps oversee $18 billion. “We are going to be very judicious in our asset allocations here.”

Moderate growth and 9.6 percent unemployment are curbing price gains, prompting U.S. central bankers to warn for the second time in a decade that inflation is too low.

Inflation, measured by the personal consumption expenditures price index, minus food and energy, has been below the Fed’s goal for five consecutive months. The price measure rose 1.4 percent for the 12 months ending August. Prices excluding food and energy have gained at a 1 percent annual pace in the three months through August.

The European Central Bank and Bank of England are among central banks that target an inflation rate through monetary policy. The Fed, by contrast, has no formal inflation objective; instead, Fed officials state a long-run inflation rate they see as consistent with achieving the legislative mandates of stable prices and maximum employment.

Inflation Target

The FOMC could adopt a combination of inflation targeting and price-level targeting to get inflation expectations up, said Mark Gertler, a New York University economist and research co- author with Bernanke.

The Fed could restate its commitment to keep inflation rising annually at around 1.7 percent to 2 percent. At the same time, the FOMC could announce some tolerance for inflation above that goal to make up for recent undershooting of those rates, Gertler said.

That would help convince the public that the Fed wasn’t going to raise rates rapidly if inflation moved above 2 percent, he said. Such a strategy “tells the market that the farther we undershoot, the more aggressive we are going to be,” he said.

A nominal GDP target is “a pretty unlikely outcome,” Gertler said. “I don’t think it is on the table as a serious proposal.”

Attends Meeting

The Fed’s consideration of price-level targeting may draw on research co-written by Gauti Eggertsson, a New York Fed researcher, and Michael Woodford of Columbia University. Eggertsson attended the FOMC meeting last month, his second since joining the Fed in 2004.

Eggertsson and Woodford said in a 2003 paper that a publicly announced price-level target is better than targeting the rate of inflation as a way to increase expectations. Bernanke cited their work in a 2003 speech about monetary policy in Japan.

Woodford said in an interview it would be “desirable” for the Fed to commit to keep rates low to ensure prices rise along a path identified by the central bank.

If people expect higher inflation, “that’s a reason to spend more,” said Woodford, who as a professor worked with Bernanke in the Princeton University economics department.

Japan Policy

Japan, by contrast, tied its low-rate policy last decade to an inflation rate instead of the price level. Woodford declined to discuss his talks with Fed officials.

Dudley, who serves as FOMC vice chairman and is the only regional Fed president to vote at every meeting, said in an Oct. 1 speech that, for example, “if inflation in 2011 were 0.5 percentage point below the Fed’s inflation objective, the Fed might aim to offset this miss by an additional 0.5 percentage- point rise in the price level in future years.”

“There’s some evidence that inflation expectations are playing a role both in limiting demand and keeping prices low,” FTN’s Low said.

“You look at housing now and one of the reasons people aren’t buying is they expect they can get a better price if they wait,” he said. “If that behavior spreads into other markets, it could be a real problem.”

To contact the reporter on this story: Scott Lanman in Washington at slanman Joshua Zumbrun in Washington at jzumbrun .

To contact the editor responsible for this story: Christopher Wellisz at cwellisz

Physics Porn: Carl Sagan Explains the 4th Dimention and the Cosmos

October 9, 2010

This is absolutely mind-bending and incredibly well described.  A blast from the past, that I just discovered for the first time.

In Bonds We Trust

October 1, 2010

There has been more than a  lot of talk on the seemingly perpetual interest in bonds, the reasons why they may or may not be over priced, and whether or not we are in or are creating a new credit bubble.  So it only seems fair to ask how much debt are we really talking about?

As aggregated by The Securities Industry and Financial Markets Association, and sorted by category of the type of debt, below is an estimate of total US Debt outstanding as of March 31, 2010.  Total debt in the United States at the end of the first quarter 2010 was over $35 Trillion Dollars.   By clicking here you can be taken directly to the excel data source from SIFMA.

Outstanding U.S. Bond Market Debt in Billions $ (Source: SIFMA)

Outstanding U.S. Bond Market Debt in Billions $ (Source: SIFMA)

The elephant in the room is that total debt outstanding has tripled from about $12 Trillion in 1996 to nearly $36 Trillion in 2010. A quick check for inflation using the BLS Inflation Calculator and the $12.265 Trillion that was outstanding in 2006 is equal to about $17.065 Trillion in 2010.  Thus in real terms the amount of debt outstanding has still effectively doubled.  There is certainly a deeper question as to why, but the easy answer certainly is why not?  So long as folks have been making their interest payments, and can be perceived to keep doing so, it shouldn’t really matter.  One may argue that we were terribly under levered in 1996, not sure if that person would be me, though.  Nonetheless, the chickens came home to roost back in 2008 when it was more than apparent that vast amounts of this debt would never be repaid in full.

The “good” news I suppose is that since 2007 (arguably the last full year before the US went into crisis mode), is that total debt levels have “only” risen an additional 9% over three years from $32.3T to $35.2T.  I say “only” because in fact that is really much slower than debt levels were growing between 1996 and 2005.  Take a look at the chart below which illustrates the year-over-year growth rates in each column.

Outstanding U.S. Bond Market Debt YoY Growth in % (Source: SIFMA)

Outstanding U.S. Bond Market Debt YoY Growth in % (Source: SIFMA)

The rate of growth in total debt outstanding actually started coming to a screeching halt in 2007 and 2008.  It was clear even before the bubble burst that we could not securitize endless amounts of debt and that there might in fact be a limit to the supply of Asset Backed and Mortgage Backed securities folks might want to buy.  Of course Wall Street used alchemy (think synthetic CDOs) to try to propel the debt bubble a little further, but when the house of cards began to unravel, there was neither an abundance of credit worthy borrowers, or enough unsuspecting investor appetite to continue the growth trajectory of the prior decade.

In fact, and almost suspiciously, total debt levels stopped growing as quickly back in 2006.  Anyone who has read “The Big Short”, “Too Big to Fail” or any of the other post crisis tell-all books knows that the “smart money” was well aware of the impending doom.

Comparing pre-crisis debt levels to the most recent data, it is no surprise that Treasury Obligations have ballooned from 2007 levels by nearly 60%.  More surprisingly is that Money Market Obligations have contracted dramatically from 2007 to 2010 declining by about 29%.  Less surprising considering how much cash has been yielding.

Other interesting observations:

-The largest gain in total debt outstanding was in the Asset Backed Security Marketplace which grew 500% between 1996 and 2009, thanks if full part to the securitization marketplace (Wall Street’s Alchemy).

-The next largest gain from 1996 to 2009 was of course in Mortgage Backed Securities which nearly quadrupled growing by 270%.  Again thanks to Wall Street’s Alchemy.

-The gains in Treasury Obligations outstanding ironically have increased the least, in percentage terms, but the most in dollar terms with Treasuries more than doubling, growing by 108%.

-If Money Market flows are in fact cyclical (not enough data here to prove anything), it might reason that we could actually be closer to a recovery than the bears believe.  The reason being that Money Market balances actually decreased over the three years during the recession in 2001-2003, and then precipitously rebounded when the economy gained steam.  We are now at another three-year period where Money Market balances have dropped dramatically.  While it is this might be indicating that the low yield on cash has in fact been helping prod investment, it’s probably better to reason that a large part has gone into US Treasuries instead.

-Mortgage related debt levels seem to have hit a ceiling.  This is likely bad news for the housing market, as mortgage debt is essential for pervasive home ownership.  What is not told here is the size of bad debt outstanding (rough estimates are about 10%).  This bad debt ultimately is likely to end up written down at some point in the future.  The faster this happens the better it is for the housing market, but ironically the worse it will be for the economy.  Nonetheless, we likely have seen the highest levels of home ownership in the years past than we will ever see in our lifetimes in the years ahead.  The good news, is that holders of quality mortgage-backed securities will likely benefit from a fairly permanent reduction in supply (or at least ceiling on growth).

-With all the rhetoric on Municipal Issuer defaults, and concerns for mounting state and city debt levels, it looks as if Municipal Debt levels have slowed dramatically, at least a positive sign of prudence.

-The biggest beneficiaries of historically low interest rates, as measured by the two sets of issuers with the largest increases in debt outstanding since 2007 have been the US Treasury and US Corporations.  In fact, the outstanding issuance of Mortgage Related, Federal Agency, Money Markets, and Asset-Backed Debt have all been in decline.  One interpretation is that the average Joe has not been able to access the current low rate environment, but that those rates have been reserved for the largest and most “credit worthy” borrowers.

Now take a look at the same date, in “Common Size” form, where each amount is represented as a percent of total debt outstanding in the year reported.

Outstanding U.S. Bond Market Debt in % of Total Debt by Year (Source: SIFMA)

Outstanding U.S. Bond Market Debt in % of Total Debt by Year (Source: SIFMA)

Other than the changes in Mortgage Related, Treasury and Asset Backed debt outstanding, the other columns have experienced modest changes from 1996 to 2010.  Note that what looks like a dramatic decline in Treasury Debt relative to total debt outstanding is deeply obfuscated by the fact that the US Government is effectively guaranteeing the two largest mortgage companies in Freddie Mac and Fannie Mae, not to mention the large amounts of Asset Backed securities that still reside on the federal balance sheet.  In fact if you add those three columns (Treasury, Mortgage Backed & Asset Backed) and compare the totals between 1996 and 2010 you get 53.5% and 55.4% respectively.

Thus over the 14 years of data here, all that really happened was that we moved (in relative terms) about 10% of national debt off the balance sheet of the Treasury Department into the Private Sector, while simultaneously doubling the total debt outstanding.  In other words you might say we doubled the kids allowances without any proof that they knew how to manage their own money.

Thus the gaffe (and/or Con depending on your appetite for conspiracies) is that the US Government was able to improve its own credit ratings, enhance the global standing of the USD, and sell our debt by off-balance-sheeting new debt to its off-balance sheet entities, Freddie Mac and Fannie Mae.  Like most SPE’s (Special Purpose Entities) Freddie and Fannie were (intentionally or not) able to obscure risks in the mortgage market from to US Goverment’s balance sheet.  As publicly traded private companies, they were of course subject to some forms of regulation, but as separate entities, their risks and liabilities were never directly reported on the balance sheet of the US Government, until of course they were bailed out in 2008.

The irony of this arrangement is that it is effectively no different from what Lehman Brothers and a host of other investment banks did (and still do) to tidy up their finances.  This allows them to issue more debt at lower rates, which of course helps them make more money (until it backfires).

We as a country are certainly at a tipping point.  We have borrowed seemingly beyond our means, and we did so knowingly by hiding our own risks from the world and from one another.  This is not much from the homeowner who goosed his mortgage application, or the mortgage broker who did it for him.  The world of finance, and more importantly the world of credit is based on trust, transparency and the promise of repayment.  When trust is broken, transparency is obfuscated, and loans (bonds) go unpaid, the system as we now know can come to a crashing halt.  Lenders stop lending and even begin to call in loans.  Borrowers go bust.  Trust is difficult and expensive to rebuild.  Imagine if no one trusted the US Government would be solvent enough to guarantee the financial system like they were able to in 2008.

The best thing that came out of the credit crisis is that underwriting standards were set a new highs at least for a while.  This created a drag on the economy, and still does.  However, do we really want to force credit to unworthy borrowers, or find new ways to hide the risks of repayment?

In general, we need to borrow less, earn more, and save more.  As a country, we have been educated on the benefits of borrowing by lenders more than by parents or teachers.  Most lenders are not advertising the pitfalls of being a borrower.  Student loans are sold on the myth of income differentials for those with a higher education.  Campus promotions during freshman year in college lure us in: a chance to have more money than we earn at our disposal.  All we are really shown is a minimum monthly payment, and we think if we avoid late charges, we are doing well.  For many people carrying a credit card balance is a necessity, but for most it begins as an option.  How well do most 18 year understand money and credit, or investing? Those who are not as fortunate to go to college are usually and sadly starting from an even less knowledgeable place as it pertains to building and managing personal debt and finances.

For some of us who are more “privileged”, our parents create a bad habit by giving us their card in our name “for necessities or emergencies”.  All this teaches us is to figure out which merchants won’t raise a flag on our parent’s bill. I distinctly recall friends buying CD’s (before iTunes) at the campus book store specifically because the charge showed up as “books”.

People need to set limits and boundaries for what can and should be financed where interest is being charged.  Moreover, corporations need to be careful offering teaser rates, or even zero interest rates to entice consumers.  Credit issuers need to focus more on margins and less on volume.  Anyone who cannot afford to finance your product is probably not someone you want to lend money to.  Consider the financing wars that helped, at least in part, to bankrupt GM, and nearly bankrupt Ford.  I remember for the years leading up to 2008 being totally floored that you could buy a car with little to no money down, a small monthly payment and no interest.  Of course the car companies did this to goose declining sales, but the net effect was to give cars to people who simply could not afford them, and that was before gas at the pump touched $4 a gallon.

In my opinion, one of the most egregious uses of credit/debt is to pay for food.  I have never understood people who put groceries or dinner on a revolving line of credit so that they can buy more clothing or gadgets.  American’s have been weened, in many cases not at their own fault, on the idea of paying Tuesday for a hamburger today.  This is a dangerous proposition.  Of course it is not a problem if we are able to pay for that hamburger, with interest on time.  Sadly, many forget that we consume a lot more hamburgers than iPods or sneakers and that those little charges add up.  Of course I cannot just blame younger generations, it seems that as far back as the 1950’s our parents may have been covertly corrupted as kids:

Or maybe we’ve just always been a country of moochers!