The more I think about the issue of Goldman Sachs (GS) being charged by the SEC for questionable business practices, and hauled in front of Congress for a big show, the more I think it is Congress that is at fault for the whole financial mess and should be answering questions.

It is not that Wall Street had no hand in the entire debacle, but it started with Congress and they magnified the damage by failing to correct their critical mistakes. I will get back to this later, but first I want to discuss the recent hearings and the fact that Goldman Sachs management was actually too easy on Congress.

What a way to go into the holiday weekend, eh? On Thursday, seven banks were shut down by authorities, which pushed the total of failed banks for 2009 to 52 -- which more than doubles the number of bank failures in 2008. Six of the seven banks seized were located in Illinois and the other was in Texas, according to the Federal Deposit Insurance Corporation (FDIC).

According to the federal group, the Illinois failures are interlinked, as all six banks were controlled by one family and used a similar business model. The FDIC noted that this model "created concentrated exposure in each institution." This model left the banks heavily exposed to collateralized debt obligations and other loan losses. The six banks brings the total of failed banks in Illinois to 12.

As for the Texas bank failure, it was the first in the state this year.

Will derivatives be eventually regulated? At the moment, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are drafting legal language to submit to Congress on the details of regulating the derivatives markets. Just which agency will take the lead in overseeing these markets is not clear at this writing. The SEC is the older of the two agencies.

There had been some talk about merging the two agencies, but political pressure has all but ruled this out. It now looks like they will share the oversight responsibilities.

Everyone is trying to figure out the roots of the current financial crisis. You can trace it back to one man, Mr. Li, and a formula that was very misused by Wall Street. Let me start by telling you a story that took place some 30 years ago.

I was sitting in my statistics class and the professor walked in and said, "Today we are going to learn about correlations." He explained that correlation is very simple. It is a single number that describes the degree of relationship between two variables, and that there was a formula in our book we could use. "But right now," he said " it's more important that you learn the concept that a correlation is a single number that describes the degree of relationship between two variables," he repeated, as professors often do. "Your answer will therefore always range between -1 and +1."

If you thought the bailout of the banks is over and solved, forget about it.

Citigroup (NYSE:C) is now back in the limelight. Like AIG, Citigroup has a portfolio of CDO's (collateralized debt obligations) that are being held "off the books." These transactions are hidden from investors and the public. The US Treasury Department met on Friday and came up with a new wrinkle. It would give Citigroup $20 billion dollars and set up a new insurance program. It would guarantee up to $5 billion dollars for the purpose of assuming a "loss protection" on certain assets. Again there is no definition of which assets would be covered nor is the amount of loss protection specified. It leaves the details to the discretion of the Treasury Department. We can't even find out what happened to first $350 billion dollars. Here we go again with another cloak and dagger operation. I don't know why we, ordinary Americans, can't get answers from the banks as to how the money was spent.

Treasury says the program would strengthen the economy, protect American jobs, savings and retirement security. What a grand scenario.

Can you figure out how to get answers from the banks about how the first $350 billion dollars was spent?

The government takeover of American International Group (NYSE: AIG) is going swimmingly -- for AIG's top brass. They got an $85 billion bridge loan in exchange for an 80% equity stake last month. AIG has already spent $61 billion of that $85 billion and will now get another $37.8 billion.

But wait -- there's more. AIG executives spent $440,000 for a spa vacation at the St. Regis resort in Monarch Beach, CA after they got our $85 billion. If you clicked on the link to the St. Regis, you know that AIG goes in style. That's why it came as no surprise that it was planning another ritzy affair for its insurance brokers. That event, at the Ritz Carlton in California's Half Moon Bay, was going to "motivate and educate" 150 independent agents who sell AIG coverage. (Update: They planned a big sales conference at the Ritz-Carlton in Half Moon Bay, but just cancelled it after public complaints). See how well reverse-Robin-Hood economics works?

Is there any business reason for AIG to be burning through so much of our cash? It claims that it needs the money because of its securities lending business, which lent securities to hedge funds and got the value of the securities and a fee in exchange. AIG then used the cash to buy mortgage-backed securities (MBS).

Bloomberg reports on the career struggles of former structured finance professionals who have now found themselves unceremoniously dumped on the street as the products they built wreak havoc on the global economy. According to Bloomberg, the investment world has shed 76,670 in the past year.

One former vice president in credit strategy at Bear Stearns is setting up her own company to provide birthday parties and cupcake cooking lessons for children. A Bank of New York asset backed securities trader has left the world of high finance to open a discount hair salon with his wife. Others are becoming teachers.

I'm not sure how I feel about this. Can't these washed up masters of the universe just collect unemployment and live off their investments, and leave the world alone? They've already crashed the housing market and led to hundreds of billions in write downs. Now they're going to go mess with cupcakes? Is nothing sacred?

We can take some comfort in the fact that they're taking a pay cut. Wall Street salaries averaged $399,360 in 2007. That's a lot of cupcakes and $12 haircuts.

Lately, there's been lots of dire talk about the private equity world. Returns are likely to be much lower and perhaps there will be many firms that shut down.

Indeed, such things may turn out to be true.

However, whenever there is extreme turbulence and a pervasive credit crunch, there are also big opportunities to make money. Just look at Apollo Management and Cerberus Capital. Both firms made a killing during the rough early 1990s.

Fast forward to today, and we may be seeing something similar with one of the top beneficiaries possibly being Lone Star Funds. Yes, this week the fund purchased a collateralized debt portfolio from Merrill Lynch & Co. (NYSE: MER) at 22 cents on the dollar [subscription required]. The face value on it? About $30.6 billion.

This is not a one-off deal as it looks like Lone Star is hungry for high-risk debt. For example, the firm recently purchased the mortgage division of CIT Group Inc. (NYSE: CIT) and acquired Bear Stearn's mortgage segment. There was also the purchase of Accredited Home Lenders Holding Co. for $295 million.

TheStreet.com's Jim Cramer says as long as there are other buyers of the paper, look for other similar deals.

Merrill's (NYSE: MER) (Cramer's Take) deal with Lone Star gives the first real stab of the private market value of this paper, 22 cents on the dollar. But when you add in the financing you can argue that it is about half that.

Why so low? Because even after a year and a half of stress, we still can't publicly value this stuff.

Remember the deal with Lone Star is a private one, where the investors have to wait five years for the paper to mature. We don't really know what a CDO is worth, you just know what they may have paid.

This is despite the fact that for years now, this stuff has existed, no one has come out and said "this CDO has a lot of Florida, so it is bad," or "this piece of paper has a 90% default rate," or "this debt is hindered by bad HELOC."

Without that info, we can't price it. Lone Star knows more than most, but basically had to put up very little. In this deal, Merrill said "here, we will pay you to take these off our hands."

Reuters reports that Merrill Lynch (NYSE: MER) reported worse than expected results for the second quarter. Merrill lost $4.9 billion and is selling $8 billion in fresh assets to raise capital.

Merrill's news is the latest of the asset write-down capital raising dances that have taken place in the last year. This dance pairs the write-down of mortgage-backed securities that nobody wants to buy with a desperate effort to raise capital to keep its capital ratios from collapsing. To that end, Merrill took $9.4 billion of write-downs of repackaged debt, including CDOs, as well as exposure to bond insurers. And it raised $4.425 billion from selling its 20% stake in Bloomberg. Merrill may also sell a controlling interest in Financial Data Services for $3.5 billion.

Its loss of $4.42 a share was more than twice the $1.94 loss that analysts had expected. There is not likely to be an end to this asset write-down capital raising dance until people are willing to trade CDOs. And that's the optimistic scenario. If CDOs remain illiquid, it will be ever more difficult to raise capital. And in that case, the prospect of bankruptcy or government bailout loom large. Meanwhile, Merill's stock lost 7.3% in after-hours trading.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

Fortune -- which shares parent Time Warner (NYSE: TWX) with BloggingStocks -- provides a clue about how big of a write-down Lehman Brothers Holdings (NYSE: LEH) needs to take in order to account accurately for its Collateralized Debt Obligation (CDO) portfolio. By my estimate, that write-down could total roughly $4 billion -- wiping out 20% of Lehman's $20 billion in capital.

How so? I calculated $4.07 billion worth of write-downs -- $1.63 billion of the write-off is from worthless BB and below rated CDOs and another $2.44 billion is from the remaining CDOs that are worth about half their stated value. This is based on Fortune's report that Lehman has $6.5 billion worth of CDOs. The 25% that are rated BB or below it believes are worthless. The remaining 75% it figures are worth 50 cents on the dollar.

But wait, there's more. Lehman has $39 billion worth of Commercial Mortgage Backed Securities (CMBSs) which have lost value. A key index has declined in the last quarter -- but I don't know how much. Assuming the decline was 25%, Lehman would need to write down an additional $9.8 billion. If Lehman needed to take the $9.8 billion write-down plus the $4 billion for the CDOs, its capital would decline 75%.

When I think about how Lehman is not the only one to hold these dodgy securities, it becomes clear that our financial system is resting on a very shaky foundation.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

Some fairly simple math indicates that it wouldn't take much to wipe out the capital of the banks and hedge funds. And this simple math helps explain why the popular delusion that 'liquidity' = 'capital' is so dangerous. That mental equation works just as easily to create the illusion of prosperity as it does to eliminate the capital that is supposed to stand as bulwark against bad lending decisions.

That's because investment banks and hedge funds combined have borrowed $10.9 trillion on a sushi-thin slice of equity of $340 billion. Newsweek reports that on average, the ratio of borrowed money to underlying capital for investment banks and hedge funds is about 32-1. It reports that in 2006, investment banks had an estimated $280 billion in capital. At 32-1, the investment banks are borrowing $8.96 trillion. Meanwhile, hedge funds manage $1.9 trillion worth of assets – which would represent $60 billion in equity and $1.94 trillion worth of debt.

What would it take to gobble up that little piece of sushi? Well, collateralized debt obligations (CDO) represented a $6.1 trillion market. I say 'were' because I am guessing that this figure refers to the value of the CDOs when they were issued. And CDOs seem to be worth some amount below that now. I have seen estimates that they are worth 20 cents to 40 cents on the dollar of their original value.

But if investment banks and hedge funds had used all their money to buy these CDOs, then it would take a mere 6% decline in their value to wipe out that $340 billion in capital. Obviously investment banks and hedge funds have invested in other things besides CDOs. But when you borrow $32 for every dollar in capital, there's not much room for error.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

As we read of writedowns, impending bankruptcies, and the faltering U.S. consumer, it's interesting to get a glimpse at the players behind this whole snafu.

The Wall Street Journal published an article today about Magnetar Capital, a fund started by a star trader from Citadel Investment Group. Magnetar was a key player in the structuring of CDOs, or collateralized debt obligations. Magnetar acted as a "lynch-pin investor" in over $30 billion of these syndicated bundles of subprime mortgages and derivatives, according to the article.

In spite of the losses being racked up on Wall Street, the fund, with about $9 billion in assets, made about 25% returns last year.

According to the article, "Magnetar swooped in on securities that it believed could become troubled but were paying big returns. CDOs are sliced based on risk, with the riskiest pieces having the highest yield but the greatest chance of losing value." Magnetar concentrated its trading on these riskiest pieces.

The research arm of Goldman Sachs (NYSE: GS) is predicting that Citigroup (NYSE: C) will have to cut its dividend by 40% due to CDO write-offs of $18.7 billion. Goldman believes that Citi will need the cut to raise $6.2 billion in additional capital.

According to Bloomberg, the Goldman report said "It will be a couple of quarters before the current credit crisis is fully digested by the markets."

Keeping the dividend high makes little sense. The yield on Citi's stock is now over 7%. But, very few investors would put money into such risky shares to get a long-term high yield. An announcement of more significant trouble at the big bank could certainly drop the shares another 10% or 20%, making gains from the dividend appear modest.

Citi is no longer a stock that investors look to for a pay-out. It is a volatile investment which could gain a stockholder 30% over a quarter if the company sold a large division or had better-than-expected earnings.

Cut the dividend to get some dry powder.

Douglas A. McIntyre is an editor at 247wallst.com.

BBC News reports that municipal and state bond insurer MBIA Inc. (NYSE: MBI) disclosed a previously hidden and salient fact -- it guarantees $31 billion worth of complex, subprime mortgage related securities known as Collateralized Debt Obligations (CDOs). One consequence of the surprise announcement is that MBIA's stock fell 26% to a 20-year low.

But the bigger fear is the repercussions of a serious ratings downgrade of MBIA. Fitch has threatened to cut its top-notch AAA-rating on fears that its capital base was not sufficient to cover its liabilities. That's because $2 trillion worth of insured securities held by mainstream investors, such as pension funds and local governments are at risk if MBIA and its peers lose their top tier credit ratings.

Once again, as I posted yesterday, the future of global capital markets rests in the hands of ratings agencies. In fact, Fitch's warning of a ratings downgrade seems to be a bit conservative. If MBIA had to pay out $31 billion to cover the guarantees on those CDOs, its $6.5 billion worth of capital could be wiped out. Meanwhile, any mainstream investor -- who owns MBIA insured CDOs -- will need to write them down and or sell them if MBIA loses its AAA rating.

The result could be a rise in interest rates paid by city and state governments and a cut in services or increase in taxes to balance those city and state budgets.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in MBIA securities.