First, in the category of being constructive we have a couple of names for candidates for Treasury and/or the Federal Reserve Bank of New York:

For Treasury, if not now perhaps next in line, we hear the name of Roger Ferguson, former Federal Reserve Board Vice Chairman and now President and Chief Executive Officer of TIAA and CREF. One of the smartest people on the planet, Ferguson has the professional and intellectual credentials to command respect from everybody in the room - including Larry Summers, who he knows very well through his seat on the Harvard Board of Overseers.

For the FRBNY, we urge the Board of the Federal Reserve Bank of New York to select from people either now serving, such as Terrence J. Checki, Executive Vice President and Head of the Federal Reserve Bank of New York's emerging markets and international affairs group and William Rutledge, likewise head of the bank's Bank Supervision function. Or consider an outsider who's a member of the Fed family and who could easily serve at the Fed of NY or as Treasury Secretary: Brian Roseboro, former Under Secretary of the Treasury for Domestic Finance and now at JPMorgan Chase focused on public policy. A former head currency trader at the FRBNY and later worked in the private options industry in Chicago, Roseboro has the technical knowledge and market experience to understand the complex financial issues facing the US economy.

Tested professionals like those we highlight above are not alone within the Fed system. Christine Cumming, the Fed of NY's First VP and de facto CEO, is another good candidate. Point is, the Board of the Fed of New York, which is dominated by Wall Street insiders, should look at them all and first, before going outside in the search for candidates. Remember, their predecessors like Paul Volcker and Gerry Corrigan were inside hires. It's high time for the Fed to select from among its own ranks to broaden the pool of experience within the Fed's Board of Governors and also within the Federal Open Market Committee. The Board of the NY Fed can do this by moving away from political patronage appointments and selecting from people with actual operational and financial skills that meet the needs of the public, as required by law. And no more academic economists please!

We also want to take note of the fine job being done by the DTCC in the world of credit default swaps or CDS, both in terms of providing actual back office services and providing information about same. The information on the DTCC web site on OTC Derivatives is worth perusal, especially the information regarding "Misconceptions About CDS."

So for example, the outstanding CDS net of the dealer positions is now reckoned to be only $34 trillion instead of $50 trillion something. And DTCC says that, were they to go bankrupt, Chrysler would result in about $2.3 billion in net CDS payouts; Ford Motor, about $2.9 billion; and General Motors, about $3.4 million. No problem, right?

Our friends at Financial Week quote CreditSights as saying that: "We believe that, despite all the worries to the contrary, the CDS market is capable of withstanding auto-related defaults, assuming that counterparty risk is disseminated in similar fashion as in the past."

Those last few words encapsulate our continuing worry, namely that the particular flow of payments and not the net amounts reported by DTCC are where the risk is and further disclosure need occur. Those sounds of rending metal and splintering wood are the damage being done to the balance sheets of funds and financial institutions around the world as default rates rise and CDS payments are required.

Note the news reports about rising corporate default rates and the OCC data on re-defaults of modified mortgages. Yes, thank you, it is good to know that the "net" notional CDS is only $34 trillion. But we still have the same basic concerns about the cost of performing on these contracts in a high default rate environment. Over the next 12-18 months, we certainly will find out if CDS works as advertised and at what cost!

Speaking of costs, we'd like to see CDS fail data from DTCC and also concentration data, both for single names and other contract types. Then we'll start "getting happy." But great sloppy kudos to DTCC for shining a light and hopefully ever more public disclosure on CDS will come. It took a crisis and the dedication of the DTCC and a lot of other people to get this done, but at least it is getting done.

Finally, on Friday we issued a challenge to Treasury Secretary designate Tim Geithner to debate on us on the bailout and what model of political economy should apply going forward. Click here to see the original story in TheBigPicture and our letter to Mr. Geithner.  We think that the bailout of Bear and AIG were horrible errors and that these two names should be in bankruptcy along with Lehman Brothers. The idiocy of the Fed and Treasury rescuing Bear, but then letting Lehman go bankrupt and finally propping up AIG is monumental. At the time we felt bad for Bear, but now that $10 per share seems like quite a gift. We think these and other issues deserve discussion.

And then there is the other brand of wishful thinking coming from Washington, namely loan modification as a means to prevent home foreclosure. Some of you will recall the conversations we had with Josh Rosner over the past couple years and his focus on the poor results of loan modification in terms of re-default rates as well as the social good aspects of these policies. See "A Global House of Cards: Interview with Josh Rosner."

According to the OCC, more than a third of borrowers that received modified loans during the first quarter fell back into default within three months, 53 percent redefaulted within six months and 58 percent within eight months. The results were worse for loans modified in the second quarter. Within three and six months, Dugan said 39 percent and 58 percent of those loans were delinquent.

The high rate of redefault on modified loans surprised federal bank regulators, and "not in a good way,'' U.S. Comptroller of the Currency John C. Dugan said during a panel discussion. Maybe if Mr. Dugan spent more time reading the ample research produced in the regulatory community on this subject and less time traveling around the globe on government-paid PR trips, he would not be so surprised by the tendency of modified loans to redefault. For the record, most people we know in the regulatory community are not surprised by these results.

As the interview with Eric Hovde that we will be featuring in a future issue of The IRA makes clear, the only way out of the current mess is to resolve insolvent banks and rebuild the banking system by putting new capital behind solvent institutions, which means no more capital infusions for the top three banks. This is what we call the Prime Solution. We'll be supporting same in the coming months by publishing a classical version of our Bank Stress Index, in a 1-5 quintile format, in 2009. Stay tuned.

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