New names for Wall Street’s old games

You remember how Wall Street was going to reform itself? Stop with the loans to borrowers who couldn’t pay them back and so on. Well, before you can say subprime lending bites it, some of Wall Street’s oldest games are back with some brand new names and games, for consumers, corporations and investors, sort of an equal opportunity casino, where everyone gets screwed.

For instance, some of old Wall Street’s good old gamers, Bank of America (BofA), Citigroup and JPMorgan Chase, have unveiled some lines of credit tied to those complicated, unpredictable things called derivatives. Not to be outdone, Wells Fargo and Fifth Third are rolling out payday-loan programs for cash-poor consumers, just making it paycheck to paycheck. Imagine that. What will they think of next? Well, others are pitching new, highly risky “structured notes” to small investors. Ain’t that swell?

I mean it’s not a done deal that these instruments are built to fail, ahem. That is, if the economy supposedly keeps “moving forward,” whatever that means, then the financial gismos could work out for buyers and sellers alike. Or not! And not will not be pleasant.

What scares regulators, lawmakers and consumer advocates though is a whole other ball of wax: that Wall Street’s big old banks are one more time packaging tricky loans to borrowers who can’t pay them back, and the bankers are peddling poisonous investments to investors who don’t understand the risks, which all could cause trigger trouble in the banking sector and blow another fuse in the economy. So, the banks, it seems, have learned nothing from their past criminal behavior to new and equally destructive games.

Let’s look at some of Wall Street’s new names for the old games. Lenders generally tie corporate credit lines to short-term interest rates. But now Citi, JPMorgan Chase and BofA, to mention a few, are tying credit lines to both short-term rates and the nefarious credit default swaps (CDS that brought down AIG Financial Products which insured them). These are high-risk and intricate derivatives that are supposed to behave like “insurance,” paying off the owners if a company defaults on its debt. Of course the “Too Big To Fail” three declined to comment on resuscitating these lime-pits. But trust them to try them.

In these new deals, when the price of the CDS rises -- which usually is a sign that Wall Street thinks the company’s strength is tanking -- the cost of the loan goes up, too. So it’s double trouble. The weaker the company, the higher the interest rates it has to fork out, which increases the company’s pain, and yours. Of course, the lenders say that these new time bombs, excuse me, products give them more protection. But for the companies, just the opposite will be the real deal. Why7

Managers have to deal now with two layers of volatility, both the short-term interest rates and credit default swaps, whose prices can jump for reasons beyond their control. To make it even worse for corporate borrowers are the high fees. Banks are all raising rates for credit lines, and the new CDS-based credit line costs way more than the old lines. FedEx for instance could arrive at payments of $3.6 million a month if it goes in for a new credit tap to Morgan. FedEx, back when, would have paid a mere $549,000 for it. This is the CDS nightmare redux.

But Business Week says in its August 17 issue, in “Old Banks, New Tricks,” that a lot of companies have few other choices. Corporate credit’s still tight despite the waterfall of federal money. That given, the banks, canny as they are, are steering borrowers born like suckers every minute to the CDS-linked loans. Good luck. In fact, lenders have passed out nearly $40 billion in CDS this year, about 70 percent of the total in credit lines to borrowers in good standing, meaning still standing.

That figure spiked from around 14 percent in 2008. FedEx, UPS, Hewlett Packard, and Toyota Motor Credit have all rolled the dice once more. They never learn, or even seem to care. Just do it, like Nike says, then cry on the government’s shoulder for a bailout. A UPS spokesman shrugged, “It wasn’t our idea,” as if that exonerated it of the responsibility to think about the danger clearly. “The banks pulled back from offering set rates.” Duh, but did you calculate what if rates soared?

At the other end of the borrower rainbow, big banks are offering another pot of controversial gold: payday loans, whose interest rates can zoom as high as 400 percent, yes 400 percent. In the past, the market was characterized by small non-bank lenders (loan sharks), mainly operating in poor urban areas and offering customers advances on their paychecks (and broken kneecaps if they didn’t pay back the vigorish and/or the loan).

But now big lenders Fifth Third and U.S. Bancorp started offering the old games (loans to the strapped), while Wells Fargo works to promote its payday-loan program. In fact, more big banks are jumping in the market as a flurry of recent usury laws broke the smaller players’ backs. Fifteen states, believe it or not, actually have capped interest rates on short-term loans or tossed the lenders from the game.

Ohio has laid down a 28 percent interest rate limit, which is no piece of cake, but better than 400 percent for anyone who can count. But thanks to interstate commerce rules, nationally chartered banks don’t have to follow local rules. They are above them. Just the various state banks have to follow them. How’s that for fair?

Yet after Ohio curbed rates, Cleveland’s Fifth Third, with 400 branches in the state but also operating in 11 other states, came out with an Early Access Loan, with an annual rate of only 120 percent. Argh! Kathleen Day of the advocacy group Center for Responsible Lending said, “These banks are skirting state laws.” Right Kate, but a spokeswoman for Fifth Third retorted, “Our Early Access product fully complies with federal regulations and applicable state regulations.” Why, because you called the old game by a different name?

Lenders claim they’re offering a valuable service for those who need emergency cash. And so does the local shylock. Wells Fargo claims it actually warns customers who use its Direct Deposit Advance that the loan is pricey and offers alternatives. How large of them. A spokesperson says, “We have policies in place to prevent long-term usage of the services.” I guess that’s so you only get ripped off for a short term. U.S. Bancorp didn’t even bother to answer Business Week’s phone calls. So much for full disclosure and transparency which we thought was going to be the new name of the game.

And, in fact, national regulators are noticing no-no’s. The Office of Thrift Supervision claims it’s “looking into” two institutions offering the high-interest loans. Wow, two. That’s fantastic. “We need to make sure there’s no predatory lending and also ensure that there are no risks to the institutions,” says an OTS spokesman. Well, golly.

On the investment front, guess what, the Wall Street casinos (excuse me again), investment banks are wrapping their arms around more risk. Risk is so dangerously appealing, so warm, so perfumey, so profitable, so backed by government bailouts.

Big brokerage bordellos like Morgan Stanley Smith Barney and UBS are trotting out new forms of “structured notes,” mmm, a type of debt instrument. Wall Street sold $15 billion of these honeys in the second quarter, up from $13 billion in the first, according to StructuredRetailProducts.com. So things are looking up, as long as they don’t go down. Know what I mean? Some of the new notes have a minimum investment of only $1,000 to play. So get your investment Viagra out to keep them up.

Structured notes are mainly derivatives for small investors (probably insane), but may make sense for those who truly, truly understand how they work. Basic structured notes allow buyers to benefit from the growth in stock, bond, or currency prices while offering a degree of loss protection. Like how much? Also, it’s no surprise that many of the new games are highly complex and may not, guess what, pay off all the risk. Surprise!

Buyers “have to have the [financial] experience to be able to evaluate the risk,” says Gary L. Goldsholle, general counsel at the Financial Industry Regulatory Authority (which is not a contradiction in terms necessarily), the securities industry’s self-governing organization (if that’s possible).

Yes, all in all, the new debt investments offer attractive rates, sometimes actually guaranteeing double-digit returns for the first couple of years. But when those old teaser rates disappear, watch out, the big ball comes very fast. And investors face huge pie-in-the-face-like losses over the life of the “instrument.”

A Morgan Stanley spokeswoman says the firm “services a broad range of products for retail and ultrahigh-net-worth clients,” including structured products. It even “offers training to financial advisers to assist them in making suitability determinations,” like whose too damn dumb or naïve too buy one. UBS, wisely, declined to comment. They’re in enough trouble already with dodging taxes for clients’ deposits in off-shoring outlets.

The risks, to say the least, can be tough “to tease out” of the prospectus. But you can get yourself one of those magnifying lens with the light that you use in dark restaurants to see the credit card bill and pay it. Like a July offering from Morgan promises 10 percent interest for the first two years. But after that it pays 10 percent when short-term interest rates and the Standard & Poor’s 500-stock index both stay within certain ranges, and the moon has a certain purple glow to it in August, also if your teeth hurt. If the first two don’t, the investment, guess what, pays nothing. Hey ho, you in or out, bro?

The prospectus says the second scenario was a rare event over the past 15 years, but hey, you never know, and as the recent market chaos shows, history’s models aren’t always reliable, or even have clean lips, even with lipstick on these pigs. Investors in similar notes got fried last year when Lehman Brothers burned and sank.

Says Bob Williams, a broker at Delta Trust Investments in Little Rock, a man who has often pitched such “investments”: “I’m not convinced half the brokers in this country, much less their clients, understand these products.” The truth is that these instruments are not designed to be understood. They’re cooked up in mathematical double-talk by a variety of math geeks.

Coda

And if that’s not enough from Biz Week, here’s a note on Derivative Risks from the August 10, a week earlier than the “Old banks, New Tricks” pieces. It says, more or less, and I’ll try to ease the pain, that in the wake of recent financial havoc, the Financial Accounting Standards Board thought it would be a great idea to ask the big banks’ about their exposure to derivatives.

The first quarter of 2009 was the first time they had to do that, imagine, and the results are in. So hold onto your wallet and grab your seat: Exposure is extremely concentrated in the “too big to fail” institutions. In fact, “A Fitch Ratings study of 100 banking and investment firms said that 80 percent of the derivative assets and liabilities carried on the companies’ balance sheets belonged to just five outfits: Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, and Morgan Stanley.”

Well doesn’t that take the cake? Aren’t these the major money-suckers of the previous bailouts? Yes, they are. “What’s more, those firms hold 96 percent of the credit derivates.” Ninety-six percent! Well then, get ready as the economy sinks like the Titanic II in the murky waters of night, the thought of “forward movement” in this déjà vu economy an impossibility. Even the lifeboats are leaking. The frightened are throwing women and children overboard, the poor and the aged, the forgotten workers of a generation, all those on the losing end of the debt bonanza.

But then, for those on the winning end, the stars are shining on their Rolexes and the cash is blowing into their bonus accounts; the high times are getting higher like old times. Yes sir, and that’s what’s great about the old games and the new names or the new games with the old names. Yup, that’s what’s great about America’s Wall Streeters. They just don’t give up hustling and conning people 365 days a year. So maybe it’s time we take the gamers down, even as that iceberg gleams like a giant diamond sucking in the greedy with its seductive glow. Because if we, the everyday people up from the lower decks, don’t grab the boats, the oars and lifesavers, the fat cats will send us to the bottom with them one more time, maybe this time for good.

By Jerry Mazza
Jerry Mazza is a freelance writer living in New York City. Reach him at gvmaz@verizon.net. His new book, “State Of Shock: Poems from 9/11 on” is available at www.jerrymazza.com, Amazon or Barnesandnoble.com.

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