WONKESS

Banks... Lawsuit... Does not compute...

Interesting:

The federal agency that oversees the mortgage giants Fannie Mae and Freddie Mac is set to file suits against more than a dozen big banks, accusing them of misrepresenting the quality of mortgage securities they assembled and sold at the height of the housing bubble, and seeking billions of dollars in compensation.

The Federal Housing Finance Agency suits, which are expected to be filed in the coming days in federal court, are aimed at Bank of America, JPMorgan Chase, Goldman Sachs and Deutsche Bank, among others...

The suits will argue the banks, which assembled the mortgages and marketed them as securities to investors, failed to perform the due diligence required under securities law and missed evidence that borrowers’ incomes were inflated or falsified.

Fannie and Freddie lost more than $30 billion, in part as a result of the deals, losses that were borne mostly by taxpayers.

In July, the agency filed suit against UBS, another major mortgage securitizer, seeking to recover at least $900 million, and the individuals with knowledge of the case said the new litigation would be similar in scope.

Clearly, I haven't been busy little internet beaver enough this summer, because this is apparently nothing new.  All I know is that I'm pleased that there is at least a little (v. v. little) attempt at holding the banks accountable for something.  Not that this will really go anywhere.  *sigh*

Too Little Too Late (about Too Much Too Soon)...

Gretchen Morgenson wrote this weekend in the New York Times on the Federal Reserve efforts to save the financial sector during the Great Recession, at enormous cost to the taxpayers and little benefit to Main Street.

Based on information generated by Freedom of Information Act requests and its longstanding lawsuit against the Federal Reserve board, Bloomberg reported that the Fed had provided a stunning $1.2 trillion to large global financial institutions at the peak of its crisis lending in December 2008.

The money has been repaid and the Fed has said its lending programs generated no losses. But with the United States economy weakening, European banks in trouble and some large American financial institutions once again on shaky ground, the Fed may feel compelled to open up its money spigots again. (emphasis added)

This is NOT the TARP money bailout that was publicly debated and ultimately Congressionally approved, but additional amounts of money that were lent by the Federal Reserve to large banks (including foreign banks) largely in secret and at minimal interest rates in order to make sure that these banks could meet their minimum liquidity requirements so as to avoid bankruptcy. 

The Fed overnight window is nothing new - the Federal Reserve has long provided short-term liquidity to help grease the wheels of finance.  But the two startling things about these lending programs are (1) the amounts ($1.2 trillion!!!  And we're so worried about our debt problem pshaw!), and (2) the collateral pledged in return for these loans.  Under standard operating procedures, the Fed would only accept bonds with the highest credit grades in return for their cash loans (iow, US treasuries).  So under normal circumstances, the Fed is arguably just swapping almost equivalent goods.  Yes, banks get cash from the Fed, but they are receiving collateral worth as much and almost as liquid. 

Under the 2008 emergency lending programs however, the Fed started accepting all sorts of dreck from the banks.  Stocks, junk bonds, and although not mentioned in the Bloomberg article, I remember they were even accepting asset backed securities, the basically worthless investment vehicles that started all of the big banks' problems in the first place.

Yes, it is true that the Federal Reserve has not (yet) lost money in these lending endeavors, which is what the backers of these programs would argue.  However, think about this practically.  You are the bank.  You are given (as in Morgan Stanley's case) well over $100 billion in cold hard cash.  In return, you give the Fed some paper that you own which, if you had to mark-to-market at that moment (which you didn't, thanks to new accounting rules that came into place at around the same time changing MTM rules), would be worth - for arguments sake - a quarter of that (and maybe less).  If you just invest that money in a basket of S&P 500 stock, you will see returns of 27% and 14% over the next two years.  And even though you can't see the future, your calculations has to run something like this: if I bet big and it pays off, I get to keep all the upside less the 1.1% interest that the Fed is asking for its money.  If the bet doesn't pay off, I lose a bunch of worthless paper (the collateral being held by the Fed) and go bankrupt.  Which I would be anyways, if I didn't take this money. 

Hmmmm.... hard choice.

As far as I'm concerned, the Fed gave the financial sector carte blanche to play fast and loose with a whole lotta taxpayer cash.  Yes, this time it "worked out", but given that the reason for this weekend's NYT article is the fact that there are hints that the spigots are about to be turned on again, just how lucky does the Fed feel?

Do you feel lucky?  Well, do you, Bernanke?

Read the excellent Bloomberg article here and its associated data here.

Cross-posted at Momocrats.

Nekked Shorting...

So I caught this bit of arguing between Matt Taibbi and Clusterstock yesterday.  Taibbi, he of GS = vampire squid fame apparently has a new article coming out about the Bear/Lehman failures of last year.  According to this blog entry, some amount of the article will focus on the practice of naked short selling (and presumably, its contribution to said major bank failures).  

Naked short-selling is a kind of counterfeiting scheme in which short-sellers sell shares of stock they either don’t have or won’t deliver to the buyer...  The real significance of the naked short-selling issue isn’t so much the actual volume of the behavior, i.e. the concrete effect it has on the market and on individual companies — and that has been significant, don’t get me wrong — but the fact that the practice is absurdly widespread and takes place right under the noses of the regulators, and really nothing is ever done about it.

Taibbi goes on to talk about an impending (today, apparently) round table being held by the SEC to address the naked short-selling issue, and in particular, the heavy lobbying efforts being exerted by Government Sachs in advance of the round table.

Last Friday I got a call from a Senate staffer who said that Goldman had just been in his boss’s office, lobbying against restrictions on naked short-selling. The aide said Goldman had passed out a fact sheet about the issue that was so ridiculous that one of the other staffers immediately thought to send it to me. When I went to actually get the document, though, the aide had had a change of heart.

Which was weird, and I thought the matter had ended there. But the exact same situation then repeated itself with another congressional staffer, who then actually passed me Goldman’s fact sheet.

So then Clusterstock had to get all medieval on Taibbi's ass, first, on how much Taibbi doesn't understand short-selling (and, specifically, it's pro-shareholder benefits):

Much of the fear of naked shorting seems to be based on a very simple mistake. People assume that most naked short sellers are momentum traders accelerating the decline of a troubled company. That’s actually not true at all. The overwhelming amount of naked shorting takes place when companies announce abnormally positive results and contrarian traders scramble to fight the tape. They aren’t seeking to manipulate the market—they’re betting against the crowd...  naked short sellers promote efficient markets by providing liquidity, risk-bearing, and selling stocks they view as overpriced.

Taibbi likely thinks that he is sticking up for the ordinary investor against manipulative hedge funds by attacking naked short selling. But again this is almost exactly wrong. Far from being a pro-shareholder move, cracking down on naked short selling would damage shareholders by making the markets less efficient and penalizing the best corporate watchdogs around. Short-sellers called the destruction of Enron, Fannie Mae and Lehman Brothers before the broader markets or regulators caught on.

And then, on how Taibbi's yet to be unveiled conspiracy w/r naked shorts and Lehman is pure delusion:

Naked short selling played no role in the downfall of Lehman Brothers. We know this is true because the government and the New York Stock Exchange measure naked shorting in order to implement a rule called Reg SHO. And Lehman never showed up on the list of stocks subject to large amounts of naked shorting...  [T]here's a very good reason for this. Stocks typically only become difficult to borrow when there is heavy buying activity, which is why most naked short sales occur following good news about a company. In the final week of the life of Lehman Brothers, there was no problem locating stocks to short. Plenty of people were willing to sell to people who had shorted the stock earlier.

There was a surge in fails to deliver in the very last days of Lehman Brothers, but it didn't last long enough to wind up on the Reg SHO list. As many as 32.8 million shares in the company were sold and not delivered to buyers on time, according to data compiled by SEC. But the company's bankruptcy intervened and shares stopped trading.  The bankruptcy of Lehman wasn't driven by the stock price but the fact that no one would lend to Lehman over that fateful weekend in 2008.

I dunno.  First of all, I'm not sure why this is an issue.  I'm willing to wait to read Taibbi's article and see if he's got any good dirt.  But naked short selling is already illegal.  It's (as Clusterstock points out) regulated by Reg SHO, which I can't imagine is actually effective because (1) the SEC is the regulator and (2) it is effectively a hindsight based regulation.  It seems that only if you happen to be very bad at playing the naked shorting game will you get caught out, and by then, you're probably bankrupt anyways.

Furthermore, I'm kinda sick of the whole - oh yeah, these financial innovations are good for the market because they enable maximum price discovery and efficiency.  Yeah, that is, until they don't anymore.  Or until they have so destabilized the system that they almost cause the entire system to implode (which would actually, from a completely libertarian, free-market POV, be completely OK, since that kind of creative destruction is necessary to remove pent-up inefficiencies that come from monopolistic domination or regulatory capture or whatever - but please, don't have the taxpayers bail it out then).

I'm personally much more upset about naked CDSs.  (See here for continuing coverage of this amazing saga).  But hey, that's just me, and WTF do I know?

Anyways, it's also funny to me that Clusterstock doesn't hit at what Taibbi is actually talking about in his post: specifically, the apparently frantic? (I guess GS doesn't do frantic?  How about deliberate persuasion?) pursuit of politicians when its interest are even mildly threatened?  And mildly threatened them must be, for as we are now noting for a third time... NAKED SHORTING IS ALREADY ILLEGAL!

Whatev.  It's not like I know what I'm talking about anyways.

P.S.  Argh!  They killed Kenny!  You bastards!

Let's Talk About Bankruptcy, Baby...

Forgot to get this up earlier this week.  There was an editorial in the NYT proposing changes to the bankruptcy code that would allow for a controlled resolution of financial institutions.

Since the collapse of Bear Stearns just over a year ago, the government has bailed out financial institutions whose failures threatened the broader financial system (with the exception of Lehman Brothers). In explaining this approach, federal regulators have said that they lack the tools to prevent disorderly failures of such institutions. Bailouts have been the only alternative to bankruptcy filings that can have dangerous effects on the rest of the economy.

But why not adopt an approach that would, where necessary, allow the controlled failure of a major financial institution?

To limit the disruption such an event might cause in the broader market, the government could announce that it would support the institution — for example, by guaranteeing its trading obligations — for, say, 60 to 90 days. During this period, the institution’s creditors and counterparties would not be permitted to cancel their contracts and demand immediate repayment, or force the institution to pony up additional collateral...

In return, the institution requesting government assistance would be required to ask its creditors and counterparties to reduce or defer their claims in order to restore the institution to solvency. It would also be required to commence plans for a possible bankruptcy at the end of the support period; make all material information about itself available to prospective buyers; and cooperate with counterparties that wish to enter into arrangements among themselves that would smooth an eventual bankruptcy, if one cannot be avoided.

If at the end of the support period enough creditors and counterparties have agreed to reduce or defer their claims so that the institution can stay afloat, or a third party has agreed to acquire it, then it would resume normal business.

I'm not a bankruptcy expert, in fact, I know only the barest minimum about bankruptcy law.  What I do know is that our current bankruptcy regime seems ridiculously unfit for handling the problems in our financial industry, which is why we keep avoiding the subject. 

Especially egregious is the fact that due to what I suspect must be serious lobbying efforts on behalf of the financial industry, certain derivatives are not actually subject to the "automatic stay" (or freeze) that all other claimants of the bankrupt entity are subject to (this was part of the 2005 bankruptcy "reform", arguably one of the most corrupt piece of legislation ever put into place).  I believe (though again, would love correction if otherwise) that this is why having a large financial institution going directly into bankruptcy is considered generally undesirable.  From Lehman's example, once a financial entity is pushed into bankruptcy, the counterparties to derivatives with the bankrupt entity have a huge incentive to pull out as fast and recklessly as possible, leaving other stakeholders in the financial institution holding nothing.

This has never been the intention of bankruptcy law, which was always meant to allow the orderly unraveling of insolvent institutions, with due attention to certain fairness considerations (the priority issues we've heard so much about w/r Chrysler, and don't get me started on how insane it is that the Obama administration decided to simply ignore these considerations when negotiating the Chrysler bankruptcy).

Srsly, sometimes I wonder if the American government isn't acting like the poor schlub who thinks that if he puts his overdue bills in a drawer, they cease to exist.

Given that we currently have one of the country's foremost expert on bankruptcy knee deep in this crisis (Elizabeth Warren, chair of the Congressional Oversight Panel overseeing TARP), I don't understand why this isn't on the agenda.

What Paulson Said...

From Vanity Fair:

Henry Paulson, secretary of the Treasury: I easily could imagine and expected there to be financial turmoil. But the extent of it, O.K., I was naïve in terms of—I knew a lot about regulation but not nearly as much as I needed to know, and I knew very little about regulatory powers and authorities. I just had not gone into it in that kind of detail. This’ll be the longest we’ve gone in recent history without there being turmoil, and given all the innovation in the private pools of capital and the over-the-counter derivatives and the excesses around the world, we figured that when there was turmoil, and these things were tested for the first time by stress, it would be more significant than anything else.

I said at the time, I have a concern that every rally we’re going to have in the financial markets will be a false rally until we break the back of the price correction in real estate. And these things are never over until you have a couple of institutions go that surprise everyone. Bear Stearns can hardly be a shock.

But having said that, it’s one thing to see it intellectually and it’s another to see where we are.

I gotta wonder, what exactly does Paulson mean by "breaking the back" of the price correction in real estate.

The Little House that Could (until it couldn't)...

So yesterday, S&P/Case-Shiller released their monthly Home Price Indices for January.  And here's some commentary around the drop, most importantly, the problem that the "stress tests" that are being performed by the government (to figure out the solvency of the banks) are reflecting a situation that is less adverse than reality.



I'm not a home-owner, so I don't feel these issues as keenly as others.  All I know is that I'm still priced out of the market, so there is inevitably more falling to go.

This is one rollercoaster ride that I'm not going to get on anytime soon.

Il y a longtemps que j'ai eu peur...

Wolfgang Münchau's not all that optimistic even given the few positive points of data from last week.  From the FT:

So you think you can see the green shoots of recovery? You draw comfort from the recent stabilisation of forward-looking indicators such as new home sales in the US? Or you think the stock market rally marks the end of the crisis? Of course, economic growth rates are bound to improve soon for technical reasons. Otherwise, not much would be left of the global economy by the end of the year.

Even if a recovery were to start early in 2010, as some optimistic forecasters believe, most of the pain of the recession is still ahead of us: unemployment and default rates will rise sharply everywhere. Most of the pain in the financial sector is also still ahead of us. This will feel like a depression long after it has ceased to be one.

I am more worried now than I was a month ago. The main problem is that the feedback loops between the real economy and the banking sector are truly scary. Remember that all the public and private sector forecasters are still busy adjusting their 2009 economic projections downwards. The latest downward revision for Germany came from Commerzbank last week, which now projects 2009 growth at a negative 6-7 per cent for this year.

At this rate of contraction, the number of private and corporate defaults is likely to increase massively beyond some of the stress-test assumptions made by the banks themselves. After the crisis caused by toxic securitised assets, the financial industry is now hit by another crisis of potentially similar magnitude. This looks to be one of the worst credit cycles in living memory.

Economists and policymakers who wonder how much it will take to recapitalise the banking sector are discovering that rescuing the banks is a much more dynamic exercise than they thought. Whatever you think it costs – and there have been widely different estimates – it is likely to end up costing you a lot more for that precise reason. The economy is trapped in a vicious circle where credit crunch and recession mutually reinforce each other.

Yes, the world needs a new, good plan.  Unfortunately, as Simon Johnson explains, in my must read of the week, we're not going to get one. 

Cash For Trash 2.0...

I have a huge blog-crush on Steve Waldman, and no more than today (emphasis mine): 

I am filled with despair, not because what we are doing cannot "work", but because it is too unjust. This is not my country.

Consider a hypothetical asset manager, PIMROCK. PIMROCK reviews a pool of loans held by the bank J.P. Citi of America, and its analysts determine they are worth 30¢ of par value. The bank holds them at 80¢ on its book. PIMROCK agrees to put down $10B to purchase loans from the pool at 82¢ thrilling stock markets everywhere. It was all just a bad dream!

Under Geithner's plan, PIMROCK's $10B permits a $10B equity investment from the Treasury. Then the FDIC levers the whole thing up, providing $6 of debt for every one dollar of equity. So, $140B of bad loans are lifted from J.P. Citi of America, nearly $90B of which is sheer overpayment to the bank.

Of course, as cash flows evolve, PIMROCK's $10B is wiped out entirely, as is the Treasury's investment. The FDIC gets repaid in a bunch of securities worth about $50B, taking a $70B loss. But, as Calculated Risk, likes to say "Hoocoodanode?" These were real market prices, Geithner or his successor will argue. Our private partners lost everything. There was no subsidy here.

Meanwhile, taxpayers will be out around $80B.

Why would PIMROCK go along with this? Because they feel it is their patriotic duty to work with the government for the good of the financial system, even if that involves accepting some sacrifices. And because they hold $100B in J.P. Citi of America bonds, and they've received assurances that if we can get the nation out of the financial pickle it's in, there will be no haircuts on those bonds. "Shaking hands with the government" means that nothing ever has to be put in writing.

Welcome to America, 2009. Change we can believe in.

When the powers that be are interviewed about why this option, why this incessant fixation on the cash for trash solution (how many misguided iterations must we go through before we change tactics), they always ALWAYS point to the catastrophe that was the failure of Lehman Brothers. 

I am still waiting for a full accounting of what exactly happened after the bankruptcy of Lehman Brothers (other than the rather vague stories of massive outflows of cash from commercial paper and money markets) and why the apparently gigantic whole on Lehman's balance sheet has yet to lead to any sort of fraud investigation.  (Meanwhile, we are dedicating our justice resources on AIG bonuses?  Obscene, yes?  But srsly?)

And there has been this oppressive, seeting anger in me that here we are, half a year after Lehman (and that's only if you don't count Bear Sterns, giving our government the benefit of the doubt) and we have not yet patched up the bankruptcy code so that a "run on the bank" wouldn't happen when another financial firm collapses?

And then this post turned on a light: the government at this point, is beholden to so many bondholders, the PIMROCKS of the world and not to mention CIC (the Chinese investment arm) or the royal families of the Middle East, that bankruptcy is essentially being thought of as a non-option.  BECAUSE THE GOVERNMENT HAS EFFECTIVELY PROMISED THAT ALL THESE INTERESTS WILL NEVER HAVE TO TAKE A HAIRCUT ON THEIR BOND HOLDINGS!

This is not my country (TINMC) anymore either.

Credit Union #FAIL...

So in the continuing saga of #bankfailfriday, two of the nation's largest corporate credit unions failed last week.  From the WSJ (emphasis added):

So, what the heck is a corporate credit union? It’s a middleman of sorts, often taking mortgage and vehicle loans from credit unions, slicing them up, and selling them off to investors. The proceeds are commonly loaned back to credit unions at low rates to help them fund their business, the same way the Federal Reserve’s funds are loaned to banks. There are 28 “corporates” in the U.S., which support the 8,500 or so credit unions that hold about a twelfth of the nation’s $8.3 trillion in deposits, according to Mike Moebs, who runs Moebs Services, a research and consulting firm in Lake Bluff, Ill.

Credit unions are cooperatives, with members as opposed to customers, and so they have two unique features: they’re not taxed, and they don’t issue preferred stock — which is particularly relevant right now, because it means they’re not eligible for the Treasury’s “bailout” funds. And as last night made clear, the banks aren’t the only ones in need of a bailout.

I don't know much about credit unions, except that there seems to have been a recent perception of them being safer.  I know they are supervised and insured, not by the FDIC, but by the National Credit Union Administration (NCUA).  Deposits with credit unions appear to be insured to the same extent as standard banks.

However, from what I can glean from this article, the fact that credit unions are cooperatives, such that its members are also "owners" of a sort, it should be the situation that (I am assuming) the members get certain disclosures, and have a certain amount of say, about the lending activities of their particular credit unions.  Again, I am totally speculating here, but that is typically the difference between being an owner (as in credit union) and as in a first priority creditor (which is what, effectively, a depositor with a bank is). 

So these are the possibilities for why these two corporate credit unions, which were buying up the loans of the credit union and then packaging them into mortgage backed securities (and perhaps, other derivatives?) for resale, have failed.  (1) They followed the traditional i-bank model, and kept a slice of the riskiest tranches, but weren't sufficiently hedged against the risks of these failing.  However, as the riskiest slice, even if they were based on a better grade of mortgages, there has still been enough defaults at this point to basically wipe out the riskiest tranches.  But this could at least give us hope that the credit unions were functioning as they are supposed to, with self-interested members NOT permitting lending to sub-prime borrowers.  Or (2) in fact, credit unions were engaging in the same kind of pass-through practice of extending loans to the sketchiest of borrowers, but eliminating the risk by selling these loans up to the corporate credit unions, who then bundled the crap loans up and out.  If this is the case, then it won't be long before we see some failures among the credit unions as well.

I'd love to see what sort of disclosure credit unions give to their members. 

And while we're on the subject of credit unions, here is a lovely little piece from the late Tanta about a mysterious credit union failure last year, which suggests that (2) above is the unfortunate reason for failure.  She is much missed.

The Paper Chase...

I’m sure there are others who have talked about this, but I was struck recently by the different treatment of paper gains (or losses) economically and psychologically versus legally. Specifically, I have been thinking about the “value destruction” that has happened since we entered the recession… what… 1 ½ years ago?

So Stephen Schwarzman of Blackstone (ah… silly BX, the fund you love to hate) was nice enough to apprise us of the fact that between 40 and 45% of the world’s wealth has been destroyed in the past year and a half. Certainly, anyone who owns a house, owns a retirement plan, or owns any equity outside of $FAZ has felt this wealth destruction personally and painfully. And the investors with Madoff, who have not seen their investments merely drop off a precipice but have actually seen it burned to a crisp in front of their eyes, would probably laugh at the optimism of a number that is less than 100.

But when you look a little deeper, past the hysteria that is media, you realize that Madoff did not lose the infamous $50 billion. In fact, his losses are probably going to come out to be between $10-$17 billion. Why the discrepancy? Well, it depends on if you are talking about “real” losses or “paper” losses.

Now, don’t get me wrong. Even at its best estimate, $10 billion lost is an unbelievable, horrific number, and I genuinely don’t understand why we don’t have a strict liability rule imposing life sentences (or capital punishment for those who are into that kind of thing) for intentional fraud over… say… $100 million? However, think of the different implications for the Madoff investor who thinks he lost $500,000 versus $100,000 (I’m using the same 5x magnitude of difference between the reported amount Madoff lost and the best estimate of what he lost): $500,000 being the amount that the investor believed owed to him from Madoff’s fund based on the reports that Madoff apparently single-handedly falsified month after month after month, and $100,000 being the amount that the investor actually put into Madoff’s fund over the investing period.

The problem is, people truly believe in their paper gains, and they make all sorts of decisions based upon these gains. There are people who decide to retire early, rather than continuing to work for an extra (or 5) years. More insidious is the fact that people agree to reward their money managers based upon year to year paper gains. For example, the infamous 2 and 20 of hedge funds, where they collects a yearly 2% fee and 20% of the profits off paper profits made on their investments.

Until recently, the lucky ones were translating these paper profits into real profits. In other words, they were cashing out. If you think of the Madoff example, the investigators believe that Madoff lost all that money in 2 ways: (1) obviously, he was skimming plenty off the top for himself and (2) by paying out real money to redeeming investors (who basically converted fake paper gains into real gains). And since these investors had every right to believe that money was theirs, I believe that the authorities are admitting that they will have an almost nonexistent case for clawing back any of these redeemed amounts.

Similarly, this is why so many pundits and bloggers have been commenting on the fact that outside of Madoff, much of what has pulled us into this recession has been one, giant, global ponzi scheme. The housing bubble was exacerbated by a whole lot of easy credit premised on fake paper gains. Again, back to the way that paper gains affect decision making – it isn’t necessarily illogical to take out a 2nd mortgage or a HELOC if you get a yearly appraisal showing an increase in the value of your house of $10,000 one year, $20,000 the next.

The problem with Stephen Schwarzman’s observation of the destruction of wealth is… can you really have a destruction of wealth when so much of it was illusory to begin with?

Think of the incongruity of the financial system we’ve been living in for the past few decades versus the good old tax code. Under U.S. federal income, an individual does not have to pay taxes on their gains or losses until those gains/losses are realized. So if you have invest $100 in stocks, watch those stocks zoom up to $500 and then collapse to $10, you never have to pay taxes on that $400 gain that you theoretically had while the stocks were on an upward trajectory. The taxman knows not to take from you until you’ve locked in your own gains.

So why do we allow money managers to get away with it?

I know that there are market cheerleaders out there that will argue that simple diversification takes you out of this risk. Although this may be true 90, or even 99% of the time, it’s hard to take this argument seriously when we are in the midst of one of those perception changing black swan events. It’s like the various pooled payment stream securities, the CMBS, ABS, CDO…. Diversification can only work if failure risks are not correlated. What we are discovering is that, given enough leverage, and enough of an asset bubble based upon paper gains, failure risks are shockingly closely correlated.

I think we need a new design for safety. I learned this from my family, who learned it by having to deal with the turmoil that was/has been China for most of the first half of the 20th century. Invest. And when that investment has increased by 50% (and the % can be adjusted), take out 1/3 of the investment (or 50% of the initial investment). Do this until you have recovered 100% of your initial investment. The rest can stay in the investment for growth. In this situation, no matter how bad the situation gets, the principal is safe.

I understand that this is not a recipe for growth… in fact, it may be very much a growth anti-recipe. And let’s not go down the inquiry of where you can put your initial investment safely besides under your mattress (even then, not that safe if there is inflation… or zombies). But it is a strategy for us tin-foil hat folks, who just don’t want to be the suckers in a crooks game anymore.

Update (3/11 @ 10:50AM) According to this @NYT article, apparently, the court appointed trustee handling the Madoff dissolution has to try to recover past withdrawals by investors above and beyond their initial investment.

Update (3/13 8:02PM) NPR's Planet Money did a funny podcast about the very issue of exacly how much money was lost in Madoff's ponzi scheme.  My favorite part was Harvey Pitt (former SEC chief) arguing that the amount lost should include the opportunity cost of the money invested with Madoff.  Except with the global assets market in such a bust, one has to wonder what exactly was the opportunity cost lost.  (And no, I'm not suggesting that people would have lost even more had they invested outside of Madoff, because I'm fairly certain that it would have been hard for the majority of these folks to lose more than 100% of their investment.)