Diana Furchtgott-Roth over at Real Clear Markets raises concerns about Section 342 of the pending Dodd-Frank financial regulation bill. This section has not been publicized much at all during the contentious reconciliation process.

Section 342 apparently "declares that race and gender employment ratios, if not quotas, must be observed by private financial institutions that do business with the government. In a major power grab, the new law inserts race and gender quotas into America's financial industry." Through the establishment of at least twenty Offices of Minority and Women Inclusion, this section aims to assure "to the maximum extent possible the fair inclusion" of women and minorities, individually and through businesses they own, in the activities of the agencies, including contracting.

Toomre Capital Markets LLC ("TCM") applauds the broad diversity goal that this section attempts to address. For far too long, the financial services industry and its service providers have been dominated by white males. It is reassuring to know that my teenage daughter, based solely on her capabilities, might have some possibility of obtaining employment in the investment banking sector should she desire so. In short, females and minorities will have a "fair" chance for opportunities and employment.

The devil is in the details of implementation, though: How does one define "fair"? As Ms. Furchtgott-Roth explains,

John Carney is headed to CNBC as a Senior Editor. The former editor and writer for Business Insider's financial news and gossip vertical, Clusterstock, will now be writing for the blogs section of the CNBC.com website as well as serving as an on-air commentator on the popular business news cable channel.

Toomre Capital Markets LLC ("TCM") has followed Mr. Carney's work since the beginning of the financial crisis when he at that time was writing for the Dealbreaker website, a Wall Street blog that covers the personalities and culture that shape the financial industry. Partly as a result of John Carney's insightful writing for his former employers, both of these Wall Street blogs became among the most popular. Perhaps the CNBC website will also soon become more popular because of John's work? TCM wishes John success with his new position.

The market making results of Goldman Sachs are simply amazing!! According to its recently filed documents with the Securities and Exchange Commission for the first quarter of 2010, Goldman Sachs had zero trading days where it lost money from its trading activities!! Toomre Capital Markets LLC ("TCM") is stunned by this news.

According to the filing, on more than half of the 63 trading days in the quarter, it recorded more than a hundred million dollars in net revenues for that day!! Further, with the understanding that 76% of the firm's $9.7 billion in revenues came from trading activities, the average net revenue for each day was approximately $117 million — and on at least twelve of those days, the net revenues were north of $160 million!!

The chart to the left is from the Zero Hedge blog and their post Unfuckingbelievable: Goldman Has Zero Trading Loss Days In Last Quarter. As that post states, "The statistic probability of this event is itself statistically undefined." TCM whole-heartedly agrees that these results are unbelievable. Utilizing classic risk management measures, one could even argue that Goldman Sachs was not taking enough risk since it never experienced a penny of loss!!

Goldman Sachs and one of its Structured Finance Vice Presidents, Fabrice Tourre, were sued in civil court by the SEC for fraud on Friday, April 16, 2009 regarding representations that they made in the marketing and offering materials for what is known as a synthetic CDO named Abacus 2007-AC1. This news has sent the Goldman Sachs common stock lower by more than ten percent. It is also significant implications as the investigation is said to be still open and on-going.

Toomre Capital Markets LLC ("TCM") has received several messages looking for more insight on this latest questionable activity in the mortgage and structured finance markets. We have been busy on a detailed review of the detailed Exhibits related to the Examiner's review of the Lehman Brothers bankruptcy. We will shift our focus and hope to shortly have some further insights posted here.

Ahead of President Barack Obama's meeting on December 14, 2009 with senior banking officials from institutions like Goldman Sachs, JPMorgan and Bank of America, The New York Times is reporting Citigroup Nears Deal to Return Billions in Bailout Funds. "Citigroup was close to a deal on Sunday night to be the last of the big Wall Street banks to exit the government’s bailout program, after trying to persuade regulators that it was sound enough to stand on its own. Negotiations between the bank’s executives and senior government officials went into the night and could still collapse."

Toomre Capital Markets LLC ("TCM") wonders how much of this drive to repay TARP funds is driven by executive compensation desires. Wall Street is still an incredibly "alpha" environment where most participants judge themselves by how well they are being compensated. With Goldman Sachs having a year very close to the earnings in its 2007 peak year, many "stars" are very much aware of the pay possibilities that exist at firms without the government imposed compensation restrictions. Surely Citigroup must be smarting from being the last major bank to have TARP funds outstanding and hence needing to limit what it can pay its investment banking, sales & trading and investment management employees.

On Thursday January 22nd 2008, UBS announced that it is "finally" restructuring its Fixed-Income, Currencies and Commodities division ("FICC"). Part of the change involves completely closing down its real estate and securitization businesses as well as its exotic Wikipedia.)">structured products operation. These changes are "part of a radical change that is needed to take FICC forward" announced Carsten Kengeter and Jeff Mayer, joint heads of FICC who arrived late in 2008.

As part of the restructuring, Sascha Prinz and David Sacco, global co-heads of the rates business, Chris Ryan, global head of credit, and Todd Morakis, global head of commodities, are leaving the bank. There are part of the changes announced by Jenker Johansson that "will enable us to leverage our core strengths while relying on lower risk and balance sheet utilization."

According to the memo announcing these changes, UBS is repositioning its investment bank, with the overriding strategy about emphasizing client business on "facilitation and flow," as well as providing strategic and tactical solutions with less reliance on the bank's balance sheet. Under the restructuring, the existing products areas in the FICC division are to be consolidated into three new business areas - macro, credit and the workout group.

Toomre Capital Markets LLC (“TCM”) has been quite concerned about the future of mortgage finance in America. Back in July 2008, TCM created the post Fannie Mae, Freddie Mac and Future of Mortgage Finance. The key point of this post was the need for “the critical policy decision on the future of mortgage finance in the United States. TCM has highlighted this critical issue before. Until the late 1980s, the S&L's were the primary holders of mortgage debt. Commercial banks also have owned some mortgage debt (with significant capital haircuts). The relatively lower capital requirements and the ability to ‘turn’ the mortgage origination portfolios led to the rapid growth in securitization and the funding of mortgage debt through investors in the capital markets.”

Some four months later, the GSE’s have effectively been seized by the Federal government. Lehman Brothers has gone bankrupt. Merrill Lynch has agreed to be become part of Bank of America. And both Goldman Sachs and Morgan Stanley have become bank holding companies actively looking to attract deposits. As predicted in that July post, institutional investors have “gone on strike” against mortgage-backed securities (“MBS”). As a result, in the last week both residential and commercial mortgage backed securities have widened to extreme spreads against swap spreads. Those spreads narrowed considerably this week with the announcement that the Federal Reserve will be buying up to $100 billion in GSE debentures as well as $500 billion in agency pass-through securities.

Still, there is little discussion about the future of mortgage finance in America. In order for the American residential mortgage market to stabilize, there needs to be available financing for well-underwritten home mortgage loans. These purchases by the Federal Reserve are a temporary solution. There no longer is a savings and loan industry to provide the long-term holdings of MBS. The community and commercial banks are capital constrained and looking forward to greater losses on many types of loans as the credit crisis worsens becoming perhaps the worst recession since the Great Depression.

Part of the reason for the GSEs conservatorship was that it was deemed that their portfolios were too large for their capital bases, especially given projected future losses due to the decline in residential real estate prices. As mentioned above, the various traditional institutional investors who previously bought securitized MBS and their “sliced and diced derivates” such as CMOs, CDOs, and private pass-throughs are on a “buyer’s strike”. In many cases, these institutional investors also are trying to reduce their exposures to the mortgage sector.

Toomre Capital Markets LLC has long suspected that the securitization process will be key to answering this quandary about where longer-term mortgages should be financed in America. There is a critical problem that has been displayed in how that business was conducted prior to the current credit crisis. As a loan moved from the mortgage originator to the mortgage wholesaler to a warehouse facility to Wall Street and eventually on to institutional investors (blessed of course with a high-grade by one or more of the rating agencies), no one had a vested interest in the quality of the underlying mortgage loan. For several months now, it has been clearly understood that for the securitization process to restart, each part of the process will need to have some “skin in the game.”

On Wednesday November 26th 2008, President-elect Barack Obama announced that former Federal Reserve Chairman Paul Volcker will head up the newly formed President’s Economic Recovery Advisory Board. This panel will be comprised of officials from a variety of business sectors outside of government and will be tasked with providing Mr. Obama independent advice for how to jumpstart the economy and stabilize the financial markets. This new board will be modeled on the Foreign Intelligence Advisory Board that gave President Dwight Eisenhower independent opinions on intelligence issues. Austan Goolsbee, another key Obama adviser, will serve as the economic board's staff director and chief economist, Obama also announced.

Mr. Obama called the 81-year-old Paul Volcker a voice that he knows well and trusts. "Paul has been by my side throughout this campaign, providing a deep understanding of financial markets, extensive experience managing economic crises and keen insight into the global nature of this particular crisis," Obama said at his Chicago news conference announcing the appointment. This was the President-elect's third news conference in as many days focused on trying to demonstrate to the American electorate that he is trying to do something about the current credit crisis.

Paul Volcker was appointed as the Federal Reserve Chairman in 1979 and served two terms ending in 1987 when he was succeeded by Alan Greenspan. Volcker is famous for throttling the economy to crush inflation in the 1980s at one point raising short-term interest rates as high as twenty percent. According to the Wikipedia (which at times has inaccurate information, particularly regarding controversial public figures),

The above also is the title of a November 21st 2008 editorial by The Editors of Scientific American. The editorial's sub-title is "Overreliance on financial software crafted by physics and math PhDs helped to precipitate the Wall Street collapse". This editorial is well worth reading both today and in the months and years to come, as all parties consider the form and regulation of global financial markets after we get through the current credit crisis.

The editorial begins:

If Hollywood makes a movie about the worst financial crisis since the Great Depression, a basement room in a government building in Washington will serve as the setting for a key scene. There investment bankers from the largest institutions pleaded successfully with Securities and Exchange Commission (SEC) officials during a short meeting in 2004 to lift a rule specifying debt limits and capital reserves needed for a rainy day. This decision, a real event described in the New York Times, freed billions to invest in complex mortgage-backed securities and derivatives that helped to bring about the financial meltdown in September.

In the script, the next scene will be the one in which number-savvy specialists that Wall Street has come to know as quants consult with their superiors about implementing the regulatory change. These lapsed physicists and mathematical virtuosos were the ones who both invented these oblique securities and created software models that supposedly measured the risk a firm would incur by holding them in its portfolio. Without the formal requirement to maintain debt ceilings and capital reserves, the commission had freed these firms to police themselves using risk tools crafted by cadres of quants.

The staff at Toomre Capital Markets LLC has long admired this publication, partly since both Lars and Aldon started in technical fields before moving to Wall Street in the 1980s. Immediately before starting at Lehman Brothers, Lars Toomre was at M.I.T. and Aldon Hynes was at what then was one of the Mecca's of industry research, Bell Labs.

Where did we work in Lehman Brothers? We each started work in the mortgage department focusing on the very software that let Lehman Brothers and other investment banks slice and dice pools of assets into various classes (or tranches) of debt securities then known as Collateralized Mortgage Obligations ("CMOs") and now as Collateralized Debt Obligations ("CDOs"). We were two of the first quants hired by Lehman Brothers' fixed-income division working on some of the early software that this editorial targets!

While doing further investigation on what has been the root cause of the 30-year swap inversion, Lars Toomre came across an interesting article published by Reuters on Monday November 17th 2008. In that article,

In recent days, another type of hedging emerged, according to UBS analysts.

Whenever the dollar has weakened at or below 97 yen since late October, sellers of Power Reverse Dual Currency Notes (PRDCs) have been keen buyers of 30-year swaps, they said. PRDCs are structured so Japanese investors can obtain a higher yield of the dollar Libor curve but receive the cash flows in yen.

When the dollar breaks below 97 yen, it lengthens the duration of PRDCs and forces sellers to receive 30-year fixed-rate cash flows via 30-year swaps, UBS analysts said.

What the heck are Power Reverse Dual Currency Notes? Just from the name, it reminds Lars of the incredible swap that Bankers Trust sold to Proctor and Gamble and which caused such major losses during the 1994 increase in short-term interest rates.

Lars Toomre of Toomre Capital Markets has been actively involved in the credit markets ever since he was moved from the investment banking division to the Lehman Brothers fixed-income trading floor late in 1983. As a result, he has witnessed many the upheavals in the bond markets including the 1986 rally due to $9 per barrel oil, the 1987 stock market crash, the S&L meltdown of 1990, the Asian currency crisis of 1997 and the Long-Term Capital Management ("LCTM") crisis of 1998. During that period, Lars never witnessed a day like Thursday, November 20th 2008.

The bench-mark 30-year Treasury bond is now trading at a yield of 3.43 percent down from 3.95 percent yesterday. This single-day move of 52 basis points and increase of nine points in price rivals the incredible moves in the flight to Treasuries (at the exclusion of all else) during the 1987 crash and the LTCM crisis. Just a week ago on Thursday, November 13th 2008, this same benchmark security was auctioned by the United States Treasury Department and the stop out rate on that auction was 4.30 percent. This particular Treasury bond ended the trading day on Tuesday with a yield of 4.13 percent.

However, as stunning as the rally in the bench-mark 30-year bond has been, the performance of the 30 year swap has been even more impressive. Unbelievably, the 30 year swap rate is now 2.84 percent. Apparently it has dropped approximately 80 basis points on the day and now trades at about 60 basis points rich to the benchmark 30-year Treasury security. Yes, the 30-year swap is now trading almost 60 basis point through Treasuries!!

Remember a swap spread is the yield differential between Treasury bonds and the fixed leg of a fixed-floating interest rate swap. Also, remember that any interest rate swap has to have a bank or other financial institution standing in the middle. With the world excessively concerned over counter-party risk, how is this spread at all-time negative spreads to United States guaranteed Treasury Bonds!?! Why are investors so willing to buy the 30-year swap with all of the attendant long-term credit issues at a lower yield than the underlying 30-year reference Treasury? This implies investors are somehow reckoning that they are more likely to be paid back by a private counterparty than by the government.

To gain a better sense of this stunning 30-year swap move, this swap closed last week at approximately -15 basis points. On Monday of this week, this swap was at approximately -19 basis points. On Tuesday, it closed at approximately -27 basis points and yesterday it closed at -33 basis points. Today it closed at -60 basis points!! Ten basis points in the 30-year Treasury are worth approximately 58 32nds of a point in price (or 1.8125% in price). Since Tuesday's close, the 30-year swap has moved from 3.80% to 2.84% or alternatively has appreciated approximately 17.4% in price!!! Simply amazing!!!

As many readers of the Toomre Capital Markets LLC ("TCM") no doubt are aware, there is an on-going populist revolt on-going against the "fat cats" of Wall Street. The national politicians are responding to the deep-rooted anger of their constituents about how the $700 billion TARP program was urgently needed to "bail out" the major American global and investment banks. Hence, there is considerable rhetoric about "Main Street" vis-à-vis "Wall Street".

Much of the populist anger has centered on the large amount of pay and bonus compensation that the Wall Street investment bankers and traders receive, which is multiple times what professionals in other non-finance industries receive. The general thrust seems to be "What work exactly do these investment bankers do that is so special that these professionals are 'entitled' or 'deserve' to receive bonuses that are hundreds of thousands or even multiple millions of dollars?"

New York Attorney General Andrew Cuomo appears ready to proceed to beyond mere populist rhetoric. Using his authority under New York State's fraudulent conveyance legal code, he recently has written to each of the banks that have recently received capital infusions under the TARP program. He has demanded to receive information about executive compensation and how their 2008 bonus pools were calculated as well as information on the 2006 and 2007 bonus pools. He has ominously warned "We will have grave concerns if your expected bonus pool has increased in any way as a result of your receipt or expected receipt of taxpayer funds from TARP."

Partly as a result of this political pressure, the top seven executives at Goldman Sachs recently announced that each of them will be receiving no bonus at all for 2008. UBS quickly followed suit for its top executives as have Deutsche Bank AG and Barclays Plc subsequently. Other banking institutions receiving TARP funds are being pressured to likewise eliminate 2008 senior executive bonuses in the coming weeks.

With senior executive bonuses being eliminated or likely to be, the next challenge is what to do with the bonus pools for the lower levels of each of these banking institutions. Clearly, the bonus pools will shrink in size. However, the key question is by how much? Should they shrink to zero like many populists want? Or should the bonus pools be compressed only to the point where they can hope to retain their most important assets – their people? And if the latter is the objective, how much of a decline will be sufficient to prevent those "star" investment bankers and/or traders from moving to one of their competitors, a hedge fund or an asset manager?

Clearly, if Bank A pays zero percent of previous year's bonuses and its competitors pay about half of the previous year's amounts, the most talented personnel at Bank A will tend to move to competitors with better compensation, thereby hurting the future earnings prospects of Bank A. Likewise, if Bank A pays about half of the previous year's amounts and its competitors are at zero percent, Bank A will receive incredible political rhetoric and potentially legal inquiries by New York Attorney Andrew Cuomo. Hence, the board of directors and senior managements at each of these institutions are in a difficult position.

On Wednesday November 19th 2008, The Wall Street Journal printed the article Top Traders Still Expect the Cash written by Ann Davis. The sub-title of the story is "Wall Street CEOs Are Giving Up Pay, but Hotshots Are Another Story." The gist of this article is that there are a small group of Wall Street traders, primarily trading commodities, currencies and/or interest-rate products, who have had extremely profitable years and these traders expect to be compensated for excellent, if not career, years in terms of profitability.

Back in late May and early June 2008, Toomre Capital Markets LLC ("TCM") wrote about Bradley Birkenfeld and the UBS private banking business serving wealthy American clients. Mr. Birkenfeld, an American citizen based in Geneva, was an mid-level UBS private banker who subsequently pled guilty to helping American clients avoid tax liabilities through various tax-avoidance schemes.

Billionaire real-estate developer Igor M. Olenicoff was a client of Mr. Birkenfeld. In late 2007, he pled guilty to charges about avoiding to pay income taxes on some $200 million in assets hidden at one point with UBS in Switzerland. As a result of this guilty plea, federal prosecutors focused on Mr. Birkenfeld's role and secured an indictment of both him and his co-conspirator, a Mario Staggl, a Liechtenstein citizen and employee of a trust bank located in that secretive country. As part of the federal investigation, Martin Liechti, a top private banker at UBS overseeing the Americas region, was detained for a period by federal authorities in Florida as a material witness.

After Mr. Birkenfeld pled guilty in June, attention shifted to just what role UBS as an organization had in facilitating tax avoidance by American citizens. Over the summer, Congress held formal hearings about the matter. In the opening remarks by Senator Carl Levin on July 18th, he declared "UBS has an estimated 19,000 so-called “undeclared accounts” for U.S. citizens with an estimated $18 billion in assets that have been kept secret from the IRS." Partly as a result of such political and prosecutorial focus, UBS announced that "it would stop offering offshore banking services to clients in the United States". The investigations into UBS's private banking practices have continued through the summer and fall.

On Tuesday November 11th 2008, The New York Times is reporting more on the status of the various investigations. In an article entitled Indictments Said to Be Possible in UBS Inquiry written by Lynnley Browning, news emerges that "A federal investigation into UBS concerning its sale of offshore private banking services to wealthy Americans is concentrating on senior and midlevel executives and bankers, and could result in one or more indictments." Further, "Investigators are sifting through more than 70 names and related account details of American clients provided by UBS over the last few months to the Justice Department, which has passed the details to the Internal Revenue Service for further scrutiny. The Justice Department and the I.R.S. plan to build both civil and criminal tax-evasion cases against some of the clients."

The really interesting issue is how prosecutors will handle the criminal investigation of the bank itself. "The most severe outcomes could include an indictment, a deferred-prosecution agreement or a plea by UBS of wrongdoing. The Securities and Exchange Commission is also investigating the bank, which owns Paine Webber, over possible violations of securities laws." Apparently, UBS disclosed in third-quarter financial statement on Nov. 4 that "the investigations are ‘focused on the management supervision and control of the U.S. cross-border business and the practices at issue.’ "

On Friday afternoon November 7th 2008, The Financial Times published an excellent article entitled Winding up Lehman Brothers written by Jennifer Hughes. This article is a great summary of what Tony Lomas and his team at PriceWaterhouseCoopers have gone through in starting to wind up the European affairs of Lehman Brothers. This bankruptcy case is likely to continue for many years to come and no doubt there will be further stories about the bankruptcy administrator's conduct.

What emerges from this story is how virtually no one connected with the large investment bank Lehman Brothers (management, employees and clients) expected what then was the fourth largest investment bank to file for bankruptcy on Monday September 15th. Tony Lomas and team were the bankruptcy administrator for Enron's European operations (and still are working on that case some seven plus years later). In that case, they had two weeks to review the operations and prepare for the bankruptcy filing. In the case of Lehman Brothers, the PriceWaterhouseCoopers team had slightly more than twenty-four hours. No wonder from afar the European bankruptcy seemed so chaotic in its first days.

Toomre Capital Markets LLC ("TCM") suggests that any reader in the subject of Lehman Brothers and/or bankruptcy read this article.

On the day after the election of Barack Obama as the next President of the United States, The Washington Post examined why he won in an article entitled Measured Response To Financial Crisis Sealed the Election. The conclusion of the article is that Barack Obama won because of the sudden collapse of Lehman Brothers on September 15th. That bankruptcy filing triggered "the biggest corporate collapse in U.S. history and an international financial meltdown", ultimately transforming the presidential race.

Is it any surprise then on the day after Obama's election, Bloomberg News reports that Lehman Brothers' much vilified Chairman and CEO Dick Fuld will be "terminated" by the bankrupt company by year-end without any bonus or severance pay?

Dick Fuld has been rightly criticized for driving the fourth largest investment bank into the ground and for the seemingly "large" amount of compensation he received over the years. For instance, Dick Fuld was openly criticized at an Oct. 6 hearing by Henry Waxman, chairman of the House Committee on Oversight and Government Reform, for taking excessive pay, which was estimated at $484.8 million since 2000. He is also being investigated long with 12 other individuals by three federal criminal probes focusing on Lehman Brothers.

Surely, Dick Fuld has become a regular punching bag on Wall Street. Both there and on Main Street, Fuld's various failures and excesses have been ridiculed by politicians, the media, and fellow bankers and executives to illustrate what is wrong with the way Wall Street operates. Equally well, Main Street citizens are quite angry about the Wall Street types who made many times the annual compensation of professionals in other lines of work like academics or engineering.

However, does not this vilification of Dick Fuld seem like a bit much? Many on Main Street have little appreciation of how the mortgage securitization process lowered homeowner mortgage rates for many years. That process saved hundreds and sometimes thousands of dollars each month on both residential and commercial real estate. Spread across the many mortgages in the United States this "benefit" to Main Street offsets some of the amazing "profits" that Wall Street rang up in an environment of particularly low volatility and risk premiums.