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VRS and the Derivatives Craze

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An AFL-CIO tweet yesterday jogged the memory. During the conclusion of Frontline's series on the financial meltdown, the sorry tale of Larry Langford and Jefferson County, Alabama's dance with derivatives had already created a question. With all of Delegate Purkey's huffing about VRS, he's never mentioned this.

Readily available information is insufficient to determine if future Virginia retirees should consider themselves fortunate, but they seemed to have dodged the bullet during a flight to risk taken by their pension trust. Standard accounting and reporting procedures have changed since the meltdown of 2008, but what is clear is that at the end of the last available reporting period (June 30, 2011) the fund had unwound itself from a derivatives position of nearly $7 billion reported in 2009 to a much more reasonable (but not necessarily justifiable) $1.3 billion.

What Delegate Purkey (R-Virginia Beach) has claimed is the result of his committee's hand on the steering wheel, The Virginia Retirement System reported a one year return on investment of 19.1% last year. But what the fund holds in assets is an amount less than that reported three years earlier: $51.3 vs $51.7 billion. So a three year decline of half a billion dollars. Not bad at all, considering the turmoil during that time.

But here are some questions:

  • What was the net return on the derivatives?
  • Was the risk inherent in the derivatives justified?
  • If the return has justified the risk, why unwind?
  • Would a flight to quality have provided a similar return without the risk?

One other question: Will Bob McDonnell repay VRS with the 33% two year gain the funds would have earned had they been paid when obligated?

The Financial Crisis Redux: JP Morgan

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Frontline's third episode of Money, Power, and Wall Street concludes: the financial crisis never ended. Last Friday that became more evident. Firing three executives at JP Morgan solves nothing. The time for "Old Testament Justice" is past. But Congress seems powerless against the bank lobby.

Three years ago, in the midst of a home grown global financial crisis, President Obama erred on the side of caution. Instead of systemic changes to the financial sector, he and his team chose a course of confidence building, a course advocated by Secretary of the Treasury Tim Geithner who argued against "Old Testament Justice." Others close to Obama, like Larry Summers and Christina Romer, called for a more dramatic course: heads should roll.

It is clear now, and hindsight is always more vivid, that in the midst of the crisis the opportunity for substantive change was lost. The fight to keep the markets afloat fatigued the new administration with other irons in the fire. The success of the bailout was the enemy of any regulatory structure designed to avoid bailouts including eliminating banks "Too Big to Fail." Flush with cash from the Obama policy success, banks successfully lobbied for the status quo.

Now, on its own, JP Morgan has managed to lay out the case for regulation following another episode of the malfeasance that precipitated the economic disaster of 2008.  

Money, Power, and Wall Street: Have We Learned A Thing?

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The Frontline series final segment frames the culture on Wall Street as it was and as it continues to be despite imperatives to reform. The American economy was driven to the edge of an abyss but rescued; for the moment. We remain at the precipice of financial catastrophe.

Every year in December, bankers find out if the bets they made that year have paid off. It is Christmas on Wall Street. By some measures, 2011 was a dismal year to be a banker. Stocks took a nosedive. But this year, banks set side $20 billion in bonuses. Since the crash of '08, banks have paid out more than $80 billion in bonuses. While officials in Washington focus on rule-making, nothing really seems to have changed the culture of Wall Street. A culture some feel, has simply lost its bearings.

John Fullerton is a former banker who says it all began when banks started trading for their own gain and not for their customers'. It was the rise of trading that shifted the culture, he says, and with that came this much more short term, profit generating, competitive mentality. It was a cult of "more, more, more...grow, grow, grow" making the culture on Wall Street fundamentally unhealthy. Fullerton began to believe it was beginning to change his own values.

"I grew less happy about my work and what I was doing every day. Candidly, I felt it was beginning to change my own values. You know, how I looked at myself and how I valued myself." - John Fullerton

Cathy O'Neill, a mathematician, came to Wall Street in 2007 after beginning her career in academia. Undergraduate at UC Berkeley, graduate work at Harvard then on to MIT, she applied to work at a hedge fund and got the job. She was a "quant." Quants use statistical methods to look for patterns in markets. Her work was used to predict when big pension funds would buy or sell, so that her firm could jump in ahead of their trades.

"I just felt like I was doing something immoral. I was taking advantage of people I don't even know whose retirements were in these funds. We all put money into our 401ks and Wall Street takes this money and just skims off like a certain percentage every quarter. At the very end of somebody's career, they retire and they get some of that back. This is this person's money and it's just basically going to Wall Street. This doesn't seem right". - Cathy O'Neil, DE Shaw, 2007 - 2009

Obama Campaign Appeals for Intellectual Indulgence

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These past three years, the anti-Obama contingent has cheered at every shred of bad economic news and bureaucratic misstep. The wild-eyed charges of an ideological war carried on by an administration bent on Marxist objectives are all aimed at obscuring the sad results of three decades of "supply-side" economic mischief.

"Larry Summers and I were both on the side of 'we need a more definitive clean-up of the financial system.' And the question was if somebody, you know, really wasn't solvent, do you need the government to put in capital, realize the losses, clean it up, and then put it back into private hands?" - Christina Romer, White House Economic Advisor 2009 - 2010

Any serious study of this administration's policies reveals a most pragmatic response by Obama at almost every turn. From the selection of Treasury Secretary Tim Geithner and many other establishment appointees, to the decision not to seize or take the banks to the woodshed, Obama has erred on the side of caution and market reassurance rather than a confrontation with forces that would flirt with a stalemate leading to economic stagnation or catastrophe. It is essential that the story be told clearly and that we rely on the accomplishments. That looks to be the approach the Obama campaign will employ based upon the message from the campaign thus far. The facts are more than embarrassing for the right's apologists.

Republicans, Deregulation, and Ruin

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In 2008, free-wheeling, unfettered markets toppled, erasing $11 trillion of American's net worth and 8.5 million jobs. Right, don't blame Bush; blame the entire bankrupt, oversimplified "conservative philosophy" and its blind eye to history. It all will become clearer in this election year, the bad hand Barack Obama was dealt.

Yet another reason for Republicans to attack public broadcasting: Frontline's series: Money, Power, and Wall Street is helping set the record straight. Incompetence, malfeasance, and reliance on an economic philosophy that rationalizes policy rather than providing safeguards against illegitimate market action are the underlying themes. All of this complements of Republican and private sector influence.

The first episode of this "Election 2012 Special Event" provides an engaging glimpse into the development of a new unregulated market in the securities sector built on an instrument that spread like poisonous kudzu throughout the financial world. From humble beginnings at JP Morgan in an effort to abate the risk exposure to an Exxon line of credit following the Exxon-Valdez disaster, credit default swaps (a kind of derivative that insures a loan against default) became common instruments even in the predatory lending galaxy, usually insulated and isolated in the legitimate financial universe. The stage was set.