I thought here we go again. Bears Stearns imploded on a Sunday night and so did Lehman. With Lehman, Treasury Secretary Hank Paulson called in the heads of all the major investment banks to try and strike a deal before the following Monday’s opening bell. When the Federal Reserve and Treasury refused to back the toxic portion of Lehman’s book ala Bear Stearns there were no takers and the rest was history. Today word leaked out that its board was talking to potential buyers over the weekend.

MF Global is not an investment bank but its celebrity CEO Jon Corzine had designs of turning it into one. When he discussed his plans with us last year, I found it a little odd because it appeared they were in a pretty competitive spot in the retail futures brokerage world. Given what transpired in recent years, it seemed the retail futures world was a safer, if less sexy, space.

The fate of MF Global has not yet been determined, though it is beginning to appear to be a case of “be careful what you wish for…”

 Apparently MF had exposure to a considerable amount of European sovereign debt. Not your basic retail futures brokerage exposure. Back in February MF Global was approved as a primary dealer by the Federal Reserve Bank of New York. Coincidently I happened to be at a dinner with a couple of MF Global brokers on the night of that announcement. At the time it was news worthy of celebration and evidence that Corzine’s plan to transform the firm was progressing nicely. (Another odd coincidence is that Societe Generale, part owner of futures broker Newedge that is reportedly up for sale, gained primary dealer status at the same time.)

One curious report had Corzine shopping MF Global, or parts of it, to his former firm Goldman Sachs. There are not many synergies between the two firms but Goldman traders are always looking for an edge and may want to put their eyes on some of MF Global client positions. The business itself would not appear to be a target of Goldman.

As for Corzine, this would be a big blow coming less that two years after he was turned out by the people of New Jersey. One report has Corzine set to collect $12 million plus in severance based on an MF Global SEC filing if a deal is struck. If that occurs the Occupy Wall Street crowd will have a new poster boy. Corzine took over MF Global in March 2010, about 18 months ago. At the time, its CEO Bernie Dan had appeared to have righted the ship and stabilized the stock around $8. As of Friday’s close MF Global stock was trading at a buck and change with pretty poor odds it would answer the bell Monday morning.

The question is what would Corzine have gotten if he actually increased shareholder value? By the time most of you read this we should know more about MF Global’s fate.

Recently he made news by investing in— or bailing out depending on your point of view — Bank of America. BofA stock had dropped significantly, to a low of $6.01, due to worries it still had a large exposure to mortgage backed securities and it lacked appropriate capital to back these positions.

Buffett’s firm Berkshire Hathaway, similar to deals he made with Goldman Sachs and GE in the heart of the credit crisis, pumped $5 billion into the struggling bank. Canaccord Genuity provided some details and based on what we have seen, we aren’t any more confident in BofA but we understand how Buffett got so rich.

If the details of the deal are correct it seems to underscore how desperate BofA is and also how Buffett has become so successful.

According to Canaccord Genuity, Buffett will receive a 6% annual dividend for the preferred stock, which BofA can buy back at any time by paying Buffett a 5% premium. Berkshire Hathaway will also receive warrants to purchase 700 million shares of BofA common stock at an exercise price of about $7.14 a share at any point over the 10 years following the closing date of the transaction.

That means if some time in the next 10 years BofA stock rises to say $27.50  per share, roughly half of its pre-crisis high of $55.08, Berkshire Hathaway and Buffet would profit roughly $14 billion. Heck the stock was above $15, more than double the exercise price, at the beginning of 2011.

The deal helped BofA stock rise 40% from its more than two-year low. Despite this BofA appears not to be in the clear as they continue sell off assets and others are seeing the details of Buffett’s investment and drawing similar conclusions.

It is all kind of odd as I never would have thought such a market would be possible. And if a default happens who would pay off? And more important who would bail out those holding the losing position ala AIG’s book of CDSs in September 2008.   

Jeff (Fibonacciman) Greenblatt brings up an interesting point in his weekly technical commentary regarding the potential of default. “There are only two kinds of people in the world. Those who understand how financial markets work and those who don’t.  The problem right here is the fact that those who do understand how financial markets work can’t possibly believe the outcome of this event would fall into the hands of the people who don’t know how the markets work. In other words, the inmates are running the asylum….You see, the really smart people in this industry can’t believe the U.S. would actually come to a self-inflicted default in this situation.”

 Of course it is difficult to say who are the smart people, perhaps other than those folks earning money trading an event that most likely would prevent any economic resolution of those trades if that underlying event occurs.

An interesting aspect of this  is that it is going on while the rules for these products are still being debated.

I would think betting against a default would make sense but it all depends on the margin rules as CDSs are binary products. That mean they are all or nothing and while commodity futures can’t go to zero these can and as futures industry veteran  Neal Kottke pointed out in an interview, the appropriate margin for such a product really should  be 100%. So while it might be a good bet that the U.S. Government won’t default — either a week from now or next year if a temporary increase in the debt ceiling is passed and we have to do this all over again in six months — the CDS market may price in a much higher likelihood of such an event and those betting against it may face a huge margin call or increase in their capital requirements to hold onto to those bets.

In our futuresmag.com poll question we ask whether a deal would be struck. The options we provided are basically: yes, no and yes but not before the market puts a scare into Congress and the President. With no deal in sight and less than a week to go that scare could be coming at any moment.

While this is nothing to toy with I kind of wish there could be a temporary default forcing a margin call on the investment banks making a market in the product. Once they are forced to take a loss a debt ceiling deal could be announced. That would be sweet justice. Of course the government would have to bail out those banks again on those losses.

There hasn’t been a piece of legislation so debated, maligned and blamed for negative consequences prior to most of the underlying elements of it going into affect since, well since the Obama Heath Care reform, the 2010 Patient Protection and Affordable Care Act, or PPACA.  

Implementation of many Dodd-Frank provisions has been delayed until the end of the year and legislation has been passed that would push implementation further out. But here we are in mid-2011 and most of the reforms passed by Congress to address regulatory failures have not been enacted. With 2012 being an election year — when major progress rarely gets done — it is possible that relatively few changes will be made in our financial structure despite the 2008 meltdown.

It is a sign of a sick political culture. While it is fair to criticize parts of any legislation, which we have done here, the idea that we could go a whole four-year cycle without significant progress after a meltdown the size and scope of the credit crisis is down right sad. That is true whether you blame the legislation itself or opposition to it. This was the type of event that called for action. That called for the ordinary political posturing to be laid down and leaders to address the core problems that led to this disaster.  Or at least to the bailout. Perhaps a simpler solution would have been to force a breakup of all the so called “too big to fail” institutions, ensuring no institution would be too important to have to face the consequences of their poor decisions.

Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler stated today in testimony before the Senate Banking Committee, “The 2008 financial crisis occurred because the financial system failed the American public. The financial regulatory system failed as well.” 

I have a feeling he likes to remind that to folks who are keen to overturn or defang Dodd-Frank. It is good to remember what happened.

Perhaps the problem is that most of the really bad things that could have occurred did not. Kind of like the current debt ceiling crisis. So after the dust settles and the banks got bailed out, perhaps some folks wondered what was the big deal?

Unfortunately, the decision makers are the ones that failed and they are listening to the people who were bailed out. For them there were some tense moments but the banks are back in the black, thanks to government and Federal Reserve largesse, though the rest of the economy is faltering. These folks are far removed from the current economic wreckage caused by the crisis.

The banks immediate needs were met and now they are spending considerable money to prevent changes to the way they do business.

It is an ominous thought as we slip closer to the Aug. 2 debt ceiling deadline, but anger over the bailout could cause folks to ignore the warnings of impending disaster. No bailout should have been passed without a plan to prevent it in the future. Dodd-Frank probably attempted to do too much.

This comes on the heels of a possible Moody’s downgrade announcement a day prior. “Moody’s Investors Service has placed the Aaa bond rating of the government of the United States on review for possible downgrade given the rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on U.S. Treasury debt obligations.”

S&Ps CreditWatch indicates a substantial likelihood of taking rating action in the next 90 days.

It is ironic because what brought this to a head is the credit crisis and resulting great recession, which is ongoing despite technically being out of it for more than a year. And while there were many culprits, right at the top of the list has to be the aforementioned credit ratings agencies. It was them who chose to slap AAA ratings on massive amount of collateralized debt obligations (CDOs) and other mortgage backed securities. It is them who were compensated by the very investment banks that were creating these products as quickly as mortgage lenders could write bad loans and sell them off to be bundled in various mortgage backed securities. The shocking conflicts of interest of how these ratings agencies operate is arguably public enemy #1 in the crisis.

The very nature of most of these products—subprime mortgages—meant they were higher risk products. Nothing wrong with that if they were labeled as such but they were not, and they were not because the banks who created the products needed the AAA ratings to sell their CDOs to the widest group of investors, many of whom are restricted from investing in things not rated as investment grade.

Bottom line is the banks paid for the ratings.

As noted here at the onset of the crisis all the way back in August 2007, the fact that high risk investments were rated as low risk investments is extremely dangerous because entities used these products as collateral and leveraged off of them as if they were AAA government debt.  

In an upcoming Futures interview with Securities and Exchange Commission (SEC) Chairman Mary Schapiro, the SEC chief talks about the conflicts of interests with ratings agencies and steps she is taking to address it.

Frankly, given there complicity in the crisis, I am surprised the ratings agencies are still around.

This is not to say the Federal government should not get debt under control. The growth path of entitlement programs made the conversation we are having today  on debt inevitable, the financial crisis just moved things forward a bit. However, in the last week I have seen stories from ratings agencies and the heads of several investment banks talking about what the government needs to do. These are the folks that got us into this mess and seemingly got off scot-free.

Don’t know why the government doesn’t just  do what the banks did and pay for their ratings.

What struck me most about the announcement was the source. Frankly, I can’t give much credence to any of the official ratings agencies who arguably are the most guilty entity in our current economic crisis. They are the ones that slapped AAA ratings on the toxic subprime assets behind the crisis and who had conflicts of interests with those that created those securities. Turns out their current analysis may not be much better. Jay Feuerstein talks about how they are off the mark in a recent op ed piece titled “S&P is dead wrong about U.S. debt.”

Feuerstein points out that the U.S. may be in better shape today than after the last credit crisis following the S&L crisis in 1988.

He writes, “According to data from the Treasury Department, interest expense as a percentage of GDP has been steadily declining since the last real estate crisis in 1988. That year, approximately 4.23% of GDP went to pay for interest expense. Today that number is closer to 2.8%. This means the ability of the U.S. to service its debt has increased by nearly 6o% over that time period.”

Don’t get me wrong, our growing debt is a huge problem and our leaders continue to demagogue the issue rather than attack it. We have pointed that out here in numerous posts. A case in point is the compromise to extend tax cuts for the rich as well as extending unemployment benefits out 99 weeks. If our leaders were serious the compromise would have involved each side giving up something important to them in order to decrease the deficit, not increase it.

The government continues to miss the point. This may be illustrated by the fact that there still is an S&P ratings agency. That type of failure should have put them out of that business for good.

While the Fed made sure the banks got theirs, there has been no sign of diligence from the Fed on the rest. Why didn’t  someone ask Ben specifically what have you done to “restore the flow of credit to American families and businesses” or more specifically, why didn’t you make the largesse you offered the banking sector conditioned on restoring that flow of credit.

 The troubled asset relief program (TARP) was passed to a great extent on Bernanke’s urging and one reason certain Congressman voted for it was to preserve home ownership. Neil M. Barofsky, special inspector general for TARP, noted in an op ed piece, “The legislation that created TARP, the Emergency Economic Stabilization Act, had far broader goals, including protecting home values and preserving homeownership. …Treasury promised that it would modify those mortgages to assist struggling homeowners. Indeed, the act expressly directs the department to do just that.”

Obviously this is an issue for Treasury but the Fed chief was paired at the hip with Treasury Secretary Hank Paulson in urging Congress to pass TARP and as mentioned above many in Congress voted for it based on a promise to modify mortgages. Remember the crisis in large part had to do with banks holding toxic assets of bundled below water loans. The banks got a do over but millions are still facing foreclosure based on unrealistic valuations that banks have already been compensated for. Now the banks are making record profits and foreclosures are still a drag on the economy. How could the two not have been tied together?

And any time Ben wants to talk about our “strong dollar policy” and how Fed policy has affected the dollar we will be willing to listen.

A point sharply made in an op ed piece in the New York Times by the retiring Barofsky and a point made here last December.

The wildest most universal and undisputable conclusion was that “Too big to fail institutions” remained; in fact they have only grown and have an uneven playing field, which will ensure that they continue to grow and continue to be too big to fail. Meaning our leaders have failed in the most important mission following the bailout—to ensure it doesn’t happen again.

Darrell Issa, chairman of the House Committee on Oversight and Government Reform, showed slides illustrating the interest rate advantage the five largest banks, who control 50% of total banking assets, have over its competitors and Barofsky added that that didn’t include the perception of too big to fail. Wouldn’t you want your money in an institution that you knew would not be allowed to fail by the government?

This is not a political argument on free market solutions. There was one free market solution—let them fail, after that all bets were off and every effort should have been made to ensure minimal impact on the economy, which should have meant making massive loan modifications quickly so the foreclosure issue wouldn’t be hanging over the housing market like the sword of Damocles for the past two and a half years with no resolution in site. TARP, at least the way it was drawn up, bailed out the banks from the perceived failure of subprime loans. Now they appear to be collecting on them again, double dipping.

 An important point made by Barofsky was that TARP was only able to pass due to language that ensured that it would be in the words of the Fed, “conducted to…, restore the flow of credit to American families and businesses, and support economic recovery and job creation in the aftermath of the crisis.”

Barofsky notes, “These Main Street-oriented goals were not, as the Treasury Department is now suggesting, mere window dressing that needed only to be taken “into account.” Rather, they were a central part of the compromise [which convinced] reluctant members of Congress to cast a vote that in many cases proved to be political suicide.”

But shortly after it passed Treasury decided to fund banks directly rather than purchase toxic assets. But no conditions to meet the broader mandates of TARP were included. Why?

Before TARP was passed we pointed out that it was akin to buying deep out-of-the-money options but paying the price of deep in-the-money options. We asked what premium we were receiving for that cost. The answer was to restore the flow of credit to American families and businesses. It didn’t happen.

More to come.

The occasion was yesterday’s action where Portugal’s parliament rejected the government’s austerity budget, which led  to the government’s collapse as the Prime Minister resigned and new elections will be forthcoming.

Futures spoke to El-Erian in our January issue where he said, “European officials failed to get ahead of the crisis,” and intimated that the threat of contagion existed.

His more recent analysis indicates that they are no closer to a solution. “Over a year into the debt crisis, the collective designing Europe’s response has managed to limit disorderly debt contagion but is yet to come up with an approach that solves the problems of the highly indebted peripheral economies,” El-Erian wrote, adding, “The longer Europe persists with a policy approach that has visibly failed to improve conditions … the greater the probability of cascading costs and risks.”

El-Erian derided ECB officials for kicking the can down the road, something of an epidemic on both sides of the pond. FX Concepts Chairman and CEO John Taylor weighs in as well on the health of the Eurozone in our current issue.

What appears to be clear — and not just regarding Europe and the peripheral Eurozone countries — is that while a specific day of reckoning was averted through the various bailouts by the Federal Reserve and other central banks, the underlying weakness that brought world economies to the brink is still with us and still needs to be addressed. And at some point we will run out of road.

“The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again…. It falls to us to make different choices if we want different results.”

These are the words of the task force that wrote the Financial Crisis Inquiry Report released in January. These 10 commissioners were tasked by Congress to determine what caused the 2008 financial meltdown. After hearing about possible exemptions of certain firms from the Dodd-Frank Act by those in Congress, I read this report. It irks me that some of those responsible are the loudest naysayers of reform. Even the task force notes: “Some on Wall Street and in Washington with a stake in the status quo may be tempted to wipe from memory the events of this crisis….” So let’s have at it…what were the group’s main conclusions?

1) The financial crisis was avoidable. “The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public.” The main instigator? The Federal Reserve Bank and “its pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards.”

2) Widespread failure in financial regulation and supervision. “The sentries were not at their posts…more than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve Chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the financial industry at every turn, had stripped away key safeguards, which could have helped avoid the catastrophe.” Regulators highlighted for sleeping on the job: Securities and Exchange Commission, Federal Reserve Bank of New York and those keeping an eye on the mortgage industry. One suggestion on how it was weakened: The financial industry spent about $4 billion in lobbying and campaign contributions from 1999 to 2008.

3) Failure of corporate governance and risk management at key financial institutions. “Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding.” Further, compensation focusing on short-term gain added to the long-term problems.

4) A combination of excessive borrowing, risky investments and lack of transparency led to the crisis. Everyone was overleveraged, especially Fannie Mae and Freddie Mac. Both Wall Street and Main Street incurred debt levels unseen before.

5) The government was ill-prepared and its inconsistent response added to the uncertainty and panic. They rescued Bear Stearns, then put Fannie and Freddie into conservatorship, then let Lehman fail and then bailed out AIG.

6) There was a systematic breakdown in accountability and ethics. You think?

7) Contributing to the meltdown was a collapse of mortgage-lending standards, unchecked OTC derivatives and credit rating agencies that didn’t do their jobs.

My synopsis just skims the report; this group dug in and even got philosophical. “These conclusions must be viewed in the context of human nature and individual and societal responsibility…. It was a failure to account for human weakness that is relevant to this crisis.” It does hold accountable public officials, specifically in the Clinton and W. Bush administrations, and sort of blames us for allowing these officials to do what they did to the system. So what’s the takeaway? Learn from the past, heal thyself, and blame Alan Greenspan.