Five Dumbest Things on Wall Street: April 11

Volcker: fearful Fed Heads; JPM's favored accounting status; Goldman's assets hit Defcon 3; another AOL merger? Really?; Flying the paranoid skies.
By Nat Worden ,

1.

Volcker: Fearful Fed Heads

They don't make

Federal Reserve

chairmen like they used to, at least that's former Fed Chairman Paul Volcker's assessment of his successors..

Ben Bernanke has caved in to the demands of Wall Street at every turn in this credit crunch. And Alan Greenspan's linguistic contortions in explaining why he bears no responsibility for the credit bubble that began when he cranked down interest rates to record lows for years makes many observers long for days of yore, when he gave merely inscrutable answers to the most mundane questions.

Perhaps emboldened by his favorable comparisons, Volcker, a true hero of the Federal Reserve who slew stagflation in the 1970s by imposing unpopular measures, minced no words in a speech at the Economic Club of New York this week.

The 80-year-old Volcker labeled our current economic predicament the "mother of all crises." He laid blame for it directly at the feet of paper-pushers on Wall Street and the enormously complicated, mostly unregulated, little understood and highly engineered financial system they have concocted since he left the Fed with their trillions upon trillions of complex derivative securities. "Simply stated, the bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the marketplace,'' said Volcker.

Intended or not, Volcker's remarks looked like a direct rebuke to Greenspan, who once hailed derivatives as a triumph of financial innovation over risk. Of course, recent events show these "innovations" to be the "financial weapons of mass destruction" that

Berkshire Hathaway's

( BRK-A) Warren Buffett once predicted they would become.

But Volcker also had words for the current shaky hand on the wheel at the U.S. central bank.

Volcker began his speech by harkening back to his early days as the New York Fed president when New York City was unable to finance itself, leading to widespread fears of a systemic financial crisis amid an already weakened economy. There were urgent calls for the Fed to help the city avoid a default by resorting to emergency lending authorities left over from the Great Depression like those used recently for investment banks by Bernanke. But unlike the current Fed chairman, Volcker resisted those calls to "instill discipline." The Big Apple soon recovered and has since flourished as a world financial center.

He said Bernanke's willingness to use government to rescue

Bear Stearns

( BSC) from bankruptcy and provide direct financing to its investment banking counterparts "will surely be interpreted as an implied promise of similar action in times of future turmoil." He also said the Fed's recent actions raised political concerns about "the proper use and allocation of government power" and "embedded economic interests and lobbying."

He noted that the New York financial crisis came after the country had been free from any clear sense of financial crisis for more than 40 years, while today's credit crisis is the culmination of at least five serious breakdowns of systemic significance over the past quarter century.

Dumb-o-meter score: 95. "It seems to me that is warning enough that something rather basic is amiss," said Volcker, who took pains to note that we're now in the midst of a currency crisis and that inflation is a threat again.

2.

JPMorgan Gets Favored Accounting Status

Conventional wisdom on Wall Street holds that

JPMorgan Chase

(JPM) - Get Report

got a bargain with its acquisition of Bear Stearns, even at the renegotiated price of $10 a share. But that 89% discount to where shares of Bear Stearns began the year might not be the best part of this deal.

Reports came out this week that for being a good child, the Fed is now easing the regulatory burdens on JPMorgan in the wake of the deal. To be sure, there are legitimate and practical reasons to cut JPMorgan some temporary slack after it was strong-armed by the Fed into buying an investment bank teetering on the brink of bankruptcy during a credit crisis that has shell-shocked the financial markets.

However, 10 out of nine observers agree that Wall Street is in dire need of stronger, not weaker, oversight after Bear's collapse supposedly brought the financial system to the brink of disaster. And it's not the easy stuff that Morgan's getting the pass on.

According to a letter posted recently on the Fed's Web site, the Fed will allow the bank to exclude certain Bear assets. (Hmm, perhaps the giant portfolio of credit default swaps and other mysterious derivative securities it inherited from Bear?) when it calculates risk-based capital for the bank holding company for 18 months. The amount of Bear assets excluded from the calculation can't exceed a modest $220 billion, and the amount of the exemption will be reduced by one-sixth every quarter until it expires on Oct. 1, 2009.

JPMorgan also will be temporarily exempted from rules that limit the amount of "covered transactions" between a bank and any single affiliate to 10% of the bank's capital stock and 20% for transactions with all affiliates.

Bear Stearns CEO Alan Schwartz told lawmakers on Capitol Hill last week that his firm was brought down by shadowy networks of rumor-mongers and short-sellers. His critics say it was the firm's toxic investment portfolio and high debt levels that brought on its demise.

How JPMorgan performs after it subsumes Bear Stearns may shed some light on who is telling the truth. In the meantime, the investing public has little understanding of exactly what JPMorgan bought, and for the Fed's talk of tough rules on these issues, clarity isn't coming to these doors anytime soon.

Dumb-o-meter score: 91. Investors better watch out for those rumors; they'll have as much info as JPM's financials.

3. Goldman's Defcon 3

The Wall Street story line that

Goldman Sachs

(GS) - Get Report

steered clear of the housing bust is getting shaky.

The investment bank has been universally cheered as a standout in that it hasn't suffered crushing losses or massive writedowns on its mortgage-related portfolio. It also avoided the surge in so-called Level 3 assets, or illiquid securities facing a writedown, that sullied its counterparts like Bear Stearns and

Lehman Brothers

( LEH).

That's the case no more.

Goldman's Level 3 tally rose to $96.39 billion, or 13% of total assets at fair value, in the latest quarter, up from $69.15 billion, or 10% of such assets, at the end of November. The Level 3 assets for which it bears economic exposure rose to $82.32 billion, or 11% of total assets at fair value, from $54.71 billion, or 8% of total assets.

Not surprisingly, mortgage-related assets were the biggest source of Goldman's growing pile Level 3 paper in its fiscal first quarter. They totaled $24.99 billion, while private-equity and real estate fund investments accounted for $18.83 billion and bank loans added up to $17.68 billion.

There are scattered signs that Wall Street's credit crisis may be abating, but spreads in the bond market are still alarmingly wide, and Goldman appears to be knee-deep in the swamp. If the media don't stop singing hosannas soon and start reporting reality, it may get caught in the writedown.

Dumb-o-meter score: 85. All hail the geniuses at...

4.

Another AOL Merger? Really??

There's an asset bubble bursting in the financial markets, and America's aging media moguls are swapping Internet assets and trying to close a blockbuster merger that involves AOL.

No, we're not revisiting days of yore, this actually happened this week.

On Thursday,

The Wall Street Journal

reported the latest wrinkles in

Microsoft's

(MSFT) - Get Report

desperate attempt to acquire

Yahoo!

(YHOO)

. An offer made so the two old men could better compete with

Google

(GOOG) - Get Report

. For it's part, while it explores a possible search advertising pact with Google, Yahoo! is also discussing a deal to combine its Internet operations with

Time Warner's

(TWX)

AOL.

This could hardly be what Bill Gates' hapless successor at Microsoft, Steve Ballmer, had in mind when he offered to acquire Yahoo! over two months ago in a cash-and-stock deal once valued at $44.6 billion, or $31 a share. The offer is now worth $29.24, according to the

Journal

, because Microsoft's stock has declined.

"Any definitive agreement between Yahoo and Google would consolidate over 90% of the search advertising market in Google's hands," said Microsoft in a statement. "This would make the market far less competitive."

Perhaps more accurately, such a deal would leave Microsoft far less competitive. Analysts on Wall Street estimate that Yahoo! could boost its cash flow more than 25% annually by outsourcing all its search advertising to Google.

Like all the cyber geeks in Silicon Valley, Yahoo!'s founder Jerry Yang despises Microsoft. So perhaps part of this flailing about ahead is Yang wanting to score trysts with Google and AOL before a forced marriage with the software giant from Redmond, Wash.

For his part, Ballmer has been reduced to groveling at the feet of

News Corp.

(NWS) - Get Report

CEO Rupert Murdoch. The

Journal

reported that Microsoft and News Corp. have each discussed with Yahoo the possibility of a three-way alliance, and News Corp. "might put up some cash as part of the deal."

The alliance would combine three of the Web's most vaunted properties -- News Corp.'s MySpace, Microsoft's MSN and Yahoo! -- just like the ill-fated Time Warner-AOL merger was supposed to create a new media powerhouse with all its "synergies."

Dumb-o-meter score: 79. All of these proposed deals sound synergistic with the worst deal in the history of corporate America.

5.

Flying the Paranoid Skies

Take off your shoes; pour out your liquids; don your surgical mask and enjoy a safe flight. On second-thought, just go home.

American Airlines

(AMR)

, the nation's largest carrier, had, at press time, scrubbed more than 2,400 flights since Tuesday in the latest chapter in the ongoing tale of woe of that is the U.S. airline industry.

Never mind that it's statistically the safest transportation in the history of mankind. In the post-9/11 era, air travel is all about bureaucratic infighting and political grandstanding, leaving any investor with even a shred of sanity no choice but to steer clear at all costs.

The Federal Aviation Administration has been taking fire from Democrats in Congress for being too lax in its oversight responsibilities, so now it's stepping up its reviews and getting all draconian at the expense of its already miserable customer-base.

On Tuesday, federal regulators warned the airline, which is routinely praised in Washington, D.C., for not shipping jobs overseas like its competitors, that nearly half its planes could violate a safety regulation designed to prevent fires.

Daniel Garton, an executive vice president at the airline, apologized for the snafu and vowed to fix the problem.

"We simply cannot put our customers through this again," said Garton.

Dumb-o-meter score: 68. Memo to Garton: Thanks for the empathy, but you've been putting customers through this for years and we expect you'll continue to do so at will.

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