Is This The End Of The Beginning? US Govt versus World's Big Banks; Cascading Risks Multiply

London, UK - 04th September 2011, 08:30 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

Make no mistake about it, history was made on September 2nd, 2011, after the financial markets closed in New York. As Churchill said in 1942, "Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning." What are the unintended consequences of the massive multi-billion-dollar lawsuit in which an independent US Government regulator is suing 17 big banks from the United States, United Kingdom, Germany, Switzerland, Japan and France? As we approach the 3rd anniversary of the collapse of Lehman Brothers on 15th September, 2008, as a result of cascading risks, markets may yet demonstrate extreme volatility once again with fundamentally destabilising consequences.

The end of the beginning?

The billions of dollars in compensation is being sought by the Federal Housing Finance Agency (FHFA) over the big banks' packaging and selling of mortgage backed securities in the run-up to the global financial crisis in 2007. FHFA is the US government conservator overseeing Fannie Mae and Freddie Mac. Specifically, the lawsuit alleges negligent misrepresentation, securities laws violations and common fraud as the big banks issued, bundled and sold Mortgage Backed Securities (MBS) to Government Sponsored Enterprises (GES). When financial markets open again on September 5th/6th, disruptive events are likely to unfold as investors around the world respond spontaneously, in knee jerk fashion, to a multiplying set of cascading risks.

Here is a list of the big banks that have been targeted in the lawsuit and how much money the FHFA argues the toxic assets were worth:

1. Bank of America with Countrywide and Merrill Lynch = $57.4 billion (USA)
2. JPMorgan Chase = $33 billion (US)
3. Royal Bank of Scotland = $30.4 billion (UK)
4. Deutsche Bank = $14.2 billion (Germany)
5. Credit Suisse = $14.1 billion (Switzerland)
6. Goldman Sachs = $11.1 billion (US)
7. Morgan Stanley = $10.6 billion (US)
8. HSBC = $6.2 billion (UK)
9. Ally Financial (GMAC) = $6 billion (US)
10. Barclays = $4.9 billion (UK)
11. Citigroup = $3.5 billion (US)
12. Nomura = $2 billion (Japan)
13. Société Générale = $1.3 billion (France)
14. First Horizon = $0.88 billion (US)
15. General Electric = $0.55 billion (US)

Total = $196 billion

In July, the FHFA sued UBS (Switzerland) for at least $900m for its activities as a securitiser of US mortgages, and the latest lawsuit follows a similar mould albeit on a far larger scale.

Fundamental Questions

1. Euro Crisis: Given the suspension of the troika -- IMF, ECB and eurogroup -- talks in regard to the further bailout of Greece, and the growing reluctance of the Germans and other eurozone members to carry out the bailouts, is the timing of this announcement likely to precipitate a perfect storm, greatly amplifying volatility in global financial markets?

2. Schizophrenia: While Edward DeMarco, legally independent head of FHFA, says his job is to protect taxpayers, could his latest actions undermine the US government’s parallel efforts to shore up the housing market and the broader national economy? If banks are likely to hold more capital in reserve against these new litigation risks, will this not lessen the amount they have available to lend?

3. Paralysis: The resolution of this massive lawsuit is likely to take years with a substantial impact on executive decision making within the big banks. If as a result of this lawsuit, interbank lending and banks' credit supply is paralysed, and liquidity evaporates, wouldn't that damage global economic growth and world trade substantially? Banks have already suffered a massive loss of confidence in the wake of The Great Unwind which began in 2007 and remain incredibly fragile. Could the litigation place further costs and uncertainty on the global banking system, which is critical to the smooth-functioning of the world economy?

4. Complicity: Why did it take so long for Fannie Mae and Freddie Mac to arrive at the revelation that the big banks misled them? Fannie and Freddie took huge losses, but was it partially self-inflicted? Is it plausible that Fannie and Freddie as well as the rating agencies were complicit in the alleged wrongdoing of the big banks?

5. Copycats: What happens when copycat lawsuits commence from major financial institutions who also bought the same mortgage backed securities from the same set of big banks?

Conclusion

1. If the massive lawsuit initiated by the US government regulator FHFA results in a settlement in its favour, the size of Fannie Mae and Freddie Mac's taxpayer bailout will be reduced substantially. If the lawsuit is deemed to be too large by the financial markets, then it could play a part in triggering yet another phase of the global financial crisis.

2. Cascading risks, including this massive lawsuit, might cause one or more Lehman Brothers type events not only in America but potentially within Europe.

3. This complex saga demonstrates organisational failure across an intricate spider's web of key players that involves a distributed matrix of financial institutions, credit rating agencies and regulators, as well as mortgage buyers that together underestimated and did not truly understand the entirety of risks they were carrying at any given time.

4. There may have been self-serving collaboration between some of the major players, as financials looking for higher profits lobbied regulators, while credit-rating agencies took hefty commissions from rating as many securities "AAA" as possible.

5. This new litigation sets in motion larger waves in the global financial system. What happens next? Is this the beginning of the end, or the end of the beginning? We suspect the latter and, perhaps, Sir Winston would agree with us!

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