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The Poisonous Bailout

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June 10, 2010

The adults in the room have spoken.  The Congressional Oversight Panel – headed by Harvard Law School professor Elizabeth Warren – created to oversee the TARP program, has just issued a report disclosing the ugly truth about the bailout of AIG:

The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace.

Note the present tense in that statement.  Not only did the bailout have a poisonous effect on the marketplace at the time –it continues to have a poisonous effect on the marketplace.  The 300-page report includes the reason why the AIG bailout continues to have this poisonous effect:

The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America‘s largest financial institutions and to assure repayment to the creditors doing business with them.

And that, dear readers, is precisely what the concept of “moral hazard” is all about.  It is the reason why we should not continue to allow financial institutions to be “too big to fail”.  Bad behavior by financial institutions is encouraged by the Federal Reserve and Treasury with assurance that any losses incurred as a result of that risky activity will be borne by the taxpayers rather than the reckless institutions.  You might remember the pummeling Senator Jim Bunning gave Ben Bernanke during the Federal Reserve Chairman’s appearance before the Senate Banking Committee for Bernanke’s confirmation hearing on December 3, 2009:

.  .  .   you have decided that just about every large bank, investment bank, insurance company, and even some industrial companies are too big to fail.  Rather than making management, shareholders, and debt holders feel the consequences of their risk-taking, you bailed them out.  In short, you are the definition of moral hazard.

With particular emphasis on the AIG bailout, this is what Senator Bunning said to Bernanke:

Even if all that were not true, the A.I.G. bailout alone is reason enough to send you back to Princeton.  First you told us A.I.G. and its creditors had to be bailed out because they posed a systemic risk, largely because of the credit default swaps portfolio.  Those credit default swaps, by the way, are over the counter derivatives that the Fed did not want regulated.  Well, according to the TARP Inspector General, it turns out the Fed was not concerned about the financial condition of the credit default swaps partners when you decided to pay them off at par.  In fact, the Inspector General makes it clear that no serious efforts were made to get the partners to take haircuts, and one bank’s offer to take a haircut was declined.  I can only think of two possible reasons you would not make then-New York Fed President Geithner try to save the taxpayers some money by seriously negotiating or at least take up U.B.S. on their offer of a haircut.  Sadly, those two reasons are incompetence or a desire to secretly funnel more money to a few select firms, most notably Goldman Sachs, Merrill Lynch, and a handful of large European banks.

Hugh Son of Bloomberg BusinessWeek explained how the Congressional Oversight Panel’s latest report does not have a particularly optimistic view of AIG’s ability to repay the bailout:

The bailout includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury Department and up to $52.5 billion to buy mortgage-linked assets owned or backed by the insurer through swaps or securities lending.

AIG owes about $26.6 billion on the credit line and $49 billion to the Treasury.  The company returned to profit in the first quarter, posting net income of $1.45 billion.

‘Strong, Vibrant Company’

“I’m confident you’ll get your money, plus a profit,” AIG Chief Executive Officer Robert Benmosche told the panel in Washington on May 26.  “We are a strong, vibrant company.”

The panel said in the report that the government’s prospects for recovering funds depends partly on the ability of AIG to find buyers for its units and on investors’ willingness to purchase shares if the Treasury Department sells its holdings.  AIG turned over a stake of almost 80 percent as part of the bailout and the Treasury holds additional preferred shares from subsequent investments.

“While the potential for the Treasury to realize a positive return on its significant assistance to AIG has improved over the past 12 months, it still appears more likely than not that some loss is inevitable,” the panel said.

Simmi Aujla of the Politico reported on Elizabeth Warren’s contention that Treasury and Federal Reserve officials should have attempted to save AIG without using taxpayer money:

“The negotiations would have been difficult and they might have failed,” she said Wednesday in a conference call with reporters.  “But the benefits of crafting a private or even a joint public-private solution were so superior to the cost of a complete government bailout that they should have been pursued as vigorously as humanly possible.”

The Treasury and Federal Reserve are now in “damage control” mode, issuing statements that basically reiterate Bernanke’s “panic” excuse referenced in the above-quoted remarks by Jim Bunning.

The release of this report is well-timed, considering the fact that the toothless, so-called “financial reform” bill is now going through the reconciliation stage.  Now that Blanche Lincoln is officially the Democratic candidate to retain her Senate seat representing Arkansas – will the derivatives reform provisions disappear from the bill?  In light of the information contained in the Congressional Oversight Panel’s report, a responsible – honest – government would not only crack down on derivatives trading but would also ban the trading of “naked” swaps.  In other words:  No betting on defaults if you don’t have a potential loss you are hedging – or as Phil Angelides explained it:  No buying fire insurance on your neighbor’s house.  Of course, we will probably never see such regulation enacted – until after he next financial crisis.



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Delaying A Tough Decision

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June 3, 2010

A recent article by David Lightman for the McClatchy Newspapers bemoaned the fact that the Senate took off for a ten-day break without voting on the “Jobs Bill” passed by the House of Representatives (H.R.4213).   Mr. Lightman’s piece expressed particular concern about the fact that a summer jobs program for approximately 330,000 “at-risk youths” has been hanging in the balance between deficit distress and economic recovery efforts.  Of particular concern is the fact that time is of the essence for keeping the youth jobs program alive for this summer:

The longer the wait, the less the program can reduce joblessness among the nation’s most vulnerable population.  Unemployment among 16- to 19-year-olds was 25.4 percent in April.

“Summer’s only so long, and it is a summer youth program,” said Mark Mattke, the work force strategy and planning director at the Spokane Area Workforce Development Council.  More than 5,700 people in Washington state got summer jobs through government programs last year.

Financial expert, Janet Tavakoli, recently wrote an essay for The Huffington Post, discussing the cause-and-effect relationship between hard economic times and the crime rate.  With municipal budget cutbacks reducing the ranks of our nation’s law enforcement personnel, a failure to extend unemployment benefits, as provided by the Jobs Bill, could be a dangerous experiment.  Ms. Tavakoli discussed how the current recession has precipitated an increase in Chicago’s street crime:

Last summer gang violence ruled the night at Leland and Sheridan, a neighborhood in the process of gentrifying.

In the upscale Lincoln Park area, just a little further south of this unrest, men alone at night were accosted by groups of three to six men and severely beaten, robbed, and hospitalized.  Seven muggings occurred in a five-day period from July 30 to August 4, 2009.

This kind of activity was unusual for these areas of Chicago until last summer.

Current Escalating Violent Crime and Chicago’s Prime Lakefront Areas

Shootings are way up in Chicago, and ordinary citizens — along with shorthanded police — are angry.  Chicago has a gun ban, yet on Wednesday, May 19, Thomas Wortham IV, a Chicago police officer and Iraq War veteran, was shot when four gang members attempted to steal the new motorcycle the officer had brought to show his father, a retired police officer.  Shots were fired, and his father saw the skirmish, ran for his gun, and managed to get off a few rounds.  Two gang members were shot while two sped away dragging his fallen son’s body some distance in the process.

Nine people were shot on Sunday night (May 24), and Chicago is currently in the grips of a massive crime wave that has overwhelmed our under funded police force.

Gangland violence and shootings now occur up and down Chicago’s lakefront.

*   *   *

This escalation and geographical spread of violence is new, and I believe it is related to our Great Recession and budget issues.  I don’t believe that Chicago is alone in its budget problems.  If new patterns in Recession-related-violence have not yet affected other major cities in the U.S. the way they have affected Chicago, they may affect them soon.  It is also likely that crime is being underreported as crime-fighting budgets are cut.

Given the current momentum for deficit hawkishness, the Senate’s break before the vote on this bill could be advantageous.  After all, the bill barely passed in the House.  Our Senators need to carefully consider the consequences of the failure to pass this bill.  David Leonhardt of The New York Times presented a reasoned argument to his readers from the Senate on June 1, recommending passage of the Jobs Bill:

It would still add about $54 billion to the deficit over the next decade. On the other hand, it could also do some good.  Among other things, it would cut taxes for businesses, expand summer jobs programs and temporarily extend jobless benefits for some of today’s 15 million unemployed workers.

*   *   *

Including the jobs bill, the deficit is projected to grow to about $1.3 trillion next year (and that’s assuming the White House can persuade Congress to make some proposed spending cuts and repeal the Bush tax cuts for the affluent).  To be at a level that economists consider sustainable, the deficit needs to be closer to $400 billion.  Only then would normal economic growth be able to pay it off.

So Congress would need to find almost $900 billion in savings.  By voting down the jobs bill, it would save more than $50 billion by 2015 and get 7 percent of the way to the goal.  That’s not nothing.  In a nutshell, it’s the case against the bill.

*   *   *

Of course, even if the bill is not very expensive, it is worth passing only if it will make a difference.  And economists say it will.

Last year’s big stimulus program certainly did.  The Congressional Budget Office estimates that 1.4 million to 3.4 million people now working would be unemployed were it not for the stimulus.  Private economists have made similar estimates.

There are two arguments for more stimulus today.  The first is that, however hopeful the economic signs, the risk of a double-dip recession remains. Financial crises often bring bumpy recoveries.  The recent troubles in Europe surely won’t help.

The second argument is that the economy has a terribly long way to go before it can be considered healthy.  Here is a sobering way to think about the situation:  If the next four years were to bring job growth as fast as the job growth during the best four years of the 1990s boom — which isn’t likely — the unemployment rate would still be higher in 2014 than when the recession began in late 2007.

Voters may not like deficits, but they really do not like unemployment.

Looking at the problem this way makes the jobs bill seem like less of a tough call.  Luckily, the country’s two big economic problems — the budget deficit and the job market — are not on the same timeline.  The unemployment rate is near a 27-year high right now.  Deficit reduction can wait a bit, given that lenders continue to show confidence in Washington’s ability to repay the debt.

Remember that by way of Maiden Lane III, “Turbo” Tim Geithner, as president of the New York Fed, gave away $30 billion of taxpayer money to the counterparties of AIG – even though most of them didn’t need it.  A “clawback” of that money from those banks (including Goldman Sachs – a $19 billion recipient) could pay for more than half the cost of the Jobs Bill.   If the $30 billion wasted on Maiden Lane III can be so easily forgotten – why not spend $54 billion to avoid a “double-dip” recession and a hellish increase in street crime?



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The Goldman Fallout

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April 19, 2010

In the aftermath of the disclosure concerning the Securities and Exchange Commission’s fraud suit against Goldman Sachs, we have heard more than a little reverberation of Matt Taibbi’s “vampire squid” metaphor, along with plenty of concern about which other firms might find themselves in the SEC’s  crosshairs.

As Jonathan Weil explained for Bloomberg News :

As Wall Street bombshells go, the lawsuit that the Securities and Exchange Commission filed against Goldman Sachs Group Inc. is about as big as it gets.

At The Economist, there was a detectable scent of schadenfreude in the discussion, which reminded readers that despite Lloyd Blankfein’s boast of having repaid Goldman’s share of the TARP bailout, not everyone has overlooked Maiden Lane III:

IS THE most powerful and controversial firm on Wall Street about to get the comeuppance that so many think it deserves?

*   *   *

The charges could hardly come at a worse time for Goldman.  The firm has been under fire on a number of fronts, including over the handsome payout it secured from the New York Fed as a derivatives counterparty of American International Group, an insurer that almost failed in 2008.  In a string of negative articles over the past year, Goldman has been accused of everything from double-dealing for its own advantage to planting its own people in the Treasury and other agencies to ensure that its interests were looked after.

At this point, those who criticized Matt Taibbi for his tour de force against Goldman (such as Megan McArdle) must be experiencing a bit of remorse.  Meanwhile, those of us who wrote items appearing at GoldmanSachs666.com are exercising our bragging rights.

The complaint filed against Goldman by the SEC finally put to rest the tired old lie that nobody saw the financial crisis coming.  The e-mails from Goldman VP, Fabrice Tourre, made it perfectly clear that in addition to being aware of the imminent collapse, some Wall Street insiders were actually counting on it.  Jonathan Weil’s Bloomberg article provided us with the translated missives from Mr. Tourre:

“More and more leverage in the system.  The whole building is about to collapse anytime now,” Fabrice Tourre, the Goldman Sachs vice president who was sued for his role in putting together the deal, wrote on Jan. 23, 2007.

“Only potential survivor, the fabulous Fab …  standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!”

A few weeks later, Tourre, now 31, e-mailed a top Goldman trader:  “the cdo biz is dead we don’t have a lot of time left.”  Goldman closed the Abacus offering in April 2007.

Michael Shedlock (a/k/a Mish) has quoted a number of sources reporting that Goldman may soon find itself defending similar suits in Germany and the UK.

Not surprisingly, there is mounting concern over the possibility that other investment firms could find themselves defending similar actions by the SEC.  As Anusha Shrivastava reported for The Wall Street Journal, the action in the credit markets on Friday revealed widespread apprehension that other firms could face similar exposure:

Credit markets were shaken Friday by the news as investors tried to figure out whether other firms or other structured finance products will be affected.

Investors are concerned that the SEC’s action may create a domino effect affecting other firms and other structured finance products.  There’s also the worry that this regulatory move may rattle the recovery and bring uncertainty back to the market.

“Credit markets are seeing a sizeable impact from the Goldman news,” said Bill Larkin, a portfolio manager at Cabot Money Management, in Salem, Mass.  “The question is, has the S.E.C. discovered what may have been a common practice across the industry?  Is this the tip of the iceberg?”

*  *  *

The SEC’s move marks “an escalation in the battle to expose conflicts of interest on Wall Street,” said Chris Whalen of Institutional Risk Analytics in a note to clients.  “Once upon a time, Wall Street firms protected clients and observed suitability …  This litigation exposes the cynical, savage culture of Wall Street that allows a dealer to commit fraud on one customer to benefit another.”

The timing of this suit could not have been better – with the Senate about to consider what (if anything) it will do with financial reform legislation.  Bill Black expects that this scandal will provide the necessary boost to get financial reform enacted into law.  I hope he’s right.



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Getting It Reich

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April 8, 2010

Robert Reich, former Secretary of Labor under President Clinton, has been hitting more than a few home runs lately.   At a time when too many commentators remain in lock-step with their favorite political party, Reich pulls no punches when pointing out the flaws in the Obama administration’s agenda.  I particularly enjoyed his reaction to the performance of Larry Summers on ABC television’s This Week on April 4:

I’m in the “green room” at ABC News, waiting to join a roundtable panel discussion on ABC’s weekly Sunday news program, This Week.

*   *   *

Larry Summers was interviewed just before Greenspan. He said the economy is expanding, that the Administration is doing everything it can to bring jobs back, and that the regulatory reform bills moving on the Hill will prevent another financial crisis.

What?

*   *   *

If any three people are most responsible for the failure of financial regulation, they are Greenspan, Larry Summers, and my former colleague, Bob Rubin.

*   *   *

I dislike singling out individuals for blame or praise in a political system as complex as that of the United States but I worry the nation is not on the right economic road, and that these individuals — one of whom advises the President directly and the others who continue to exert substantial influence among policy makers — still don’t get it.

The direction financial reform is taking is not encouraging.  Both the bill that emerged from the House and the one emerging from the Senate are filled with loopholes that continue to allow reckless trading of derivatives.  Neither bill adequately prevents banks from becoming insolvent because of their reckless trades.  Neither limits the size of banks or busts up the big ones.  Neither resurrects the Glass-Steagall Act. Neither adequately regulates hedge funds.

More fundamentally, neither bill begins to rectify the basic distortion in the national economy whose rewards and incentives are grotesquely tipped toward Wall Street and financial entrepreneurialism, and away from Main Street and real entrepreneurialism.

Is it because our elected officials just don’t understand what needs to be done to prevent another repeat of the financial crisis – or is the unwillingness to take preventative action the result of pressure from lobbyists?  I think they’re just playing dumb while they line their pockets with all of that legalized graft. Meanwhile, Professor Reich continued to function as the only adult in the room, with this follow-up piece:

Needless to say, the danger of an even bigger cost in coming years continues to grow because we still don’t have a new law to prevent what happened from happening again.  In fact, now that they know for sure they’ll be bailed out, Wall Street banks – and those who lend to them or invest in them – have every incentive to take even bigger risks.  In effect, taxpayers are implicitly subsidizing them to do so.

*   *   *

But the only way to make sure no bank it too big to fail is to make sure no bank is too big.  If Congress and the White House fail to do this, you have every reason to believe it’s because Wall Street has paid them not to.

Reich’s recent criticism of the Federal Reserve was another sorely-needed antidote to Ben Bernanke’s recent rise to media-designated sainthood.  In an essay quoting Republican Senator Jim DeMint of South Carolina, Reich transcended the polarized political climate to focus on the fact that the mysterious Fed enjoys inappropriate authority:

The Fed has finally came clean.  It now admits it bailed out Bear Stearns – taking on tens of billions of dollars of the bank’s bad loans – in order to smooth Bear Stearns’ takeover by JP Morgan Chase.  The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed.  The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout.

The losses from those deals still total tens of billions, and taxpayers are ultimately on the hook.  But the public never knew.  There was no congressional oversight.  It was all done behind closed doors. And the New York Fed – then run by Tim Geithner – was very much in the center of the action.

*   *   *

The Fed has a big problem.  It acts in secret.  That makes it an odd duck in a democracy.  As long as it’s merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk — choosing winners and losers in the capitalist system — its legitimacy is questionable.

You probably thought that Ron Paul was the only one who spoke that way about the Federal Reserve.  Fortunately, when people such as Robert Reich speak out concerning the huge economic and financial dysfunction afflicting America, there is a greater likelihood that those with the authority to implement the necessary reforms will do the right thing.  We can only hope.



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Everyone Knew About Lehman Brothers

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March 19, 2010

A March 18 report by Henny Sender at the Financial Times revealed that former officials from Merrill Lynch had contacted the Securities and Exchange Commission as well as the Federal Reserve of New York to complain that Lehman Brothers had been incorrectly calculating a key measure of its financial health.  The regulators received this warning several months before Lehman filed for bankruptcy in September of 2008.  Apparently Lehman’s reports of robust financial health were making Merrill look bad:

Former Merrill Lynch officials said they contacted regulators about the way Lehman measured its liquidity position for competitive reasons.  The Merrill officials said they were coming under pressure from their trading partners and investors, who feared that Merrill was less liquid than Lehman.

*   *   *

In the account given by the Merrill officials, the SEC, the lead regulator, and the New York Federal Reserve were given warnings about Lehman’s balance sheet calculations as far back as March 2008.

*   *   *

The former Merrill officials said they contacted the regulators after Lehman released an estimate of its liquidity position in the first quarter of 2008.  Lehman touted its results to its counterparties and its investors as proof that it was sounder than some of its rivals, including Merrill, these people said.

*   *   *

“We started getting calls from our counterparties and investors in our debt.  Since we didn’t believe the Lehman numbers and thought their calculations were aggressive, we called the regulators,” says one former Merrill banker, now at another big bank.

Could the people at Merrill Lynch have expected the New York Fed to intervene and prevent the accounting chicanery at Lehman?  After all, Lehman’s CEO, Richard Fuld, was also a class B director of the New York Fed.  Would any FRBNY investigator really want to make trouble for one of the directors of his or her employer?  This type of conflict of interest is endemic to the self-regulatory milieu presided over by the Federal Reserve.  When people talk about protecting “Fed independence”, I guess this is what they mean.

The Financial Times report inspired Yves Smith of Naked Capitalism to emphasize that the New York Fed’s failure to do its job, having been given this additional information from Merrill officials, underscores the ineptitude of the New York Fed’s president at the time — Tim Geithner:

The fact that Merrill, with a little digging, could see that Lehman’s assertions about its financial health were bogus says other firms were likely to figure it out sooner rather than later.  That in turn meant that the Lehman was extremely vulnerable to a run.  Bear was brought down in a mere ten days.  Having just been through the Bear implosion, the warning should have put the authorities in emergency preparedness overdrive.  Instead, they went into “Mission Accomplished” mode.

This Financial Times story provides yet more confirmation that Geithner is not fit to serve as a regulator and should resign as Treasury Secretary.  But it may take Congress forcing a release of the Lehman-related e-mails and other correspondence by the New York Fed to bring about that outcome.

Those “Lehman-related e-mails” should be really interesting.  If Richard Fuld was a party to any of those, it will be interesting to note whether his e-mail address was “@LehmanBros”, “@FRBNY” or both.

The Lehman scandal has come to light at precisely the time when Ben Bernanke is struggling to maintain as much power for the Federal Reserve as he can — in addition to getting control over the proposed Consumer Financial Protection Agency.  One would think that Bernanke is pursuing a lost cause, given the circumstances and the timing.  Nevertheless, as Jesse of Jesse’s Cafe Americain points out — Bernanke may win this fight:

The Fed is the last place that should receive additional power over the banking system, showing itself to be a bureaucracy incapable of exercising the kind of occasionally stern judgment, the tough love, that wayward bankers require.  And the mere thought of putting Consumer Protection under their purview makes one’s skin crawl with fear and the gall of injustice.

They may get it, this more power, not because it is deserved, but because politicians themselves wish to have more power and money, and this is one way to obtain it.

The next time the financial system crashes, the torches and pitchforks will come out of the barns and there will be a serious reform, and some tar and feathering in congressional committees, and a few virtual lynchings.  The damage to the people of the middle class will be an American tragedy.  But this too shall pass.

It’s beginning to appear as though it really will require another financial crisis before our graft-hungry politicians will make any serious effort at financial reform.  If economist Randall Wray is correct, that day may be coming sooner than most people expect:

Another financial crisis is nearly certain to hit in coming months — probably before summer.  The belief that together Geithner and Bernanke have resolved the crisis and that they have put the economy on a path to recovery will be exposed as wishful thinking.

Although that may sound a bit scary, we have to look at the bright side:  at least we will finally be on a path toward serious financial reform.



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Deceptive Oversight

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March 17, 2010

March 16 brought us a few more provocative essays about the Lehman Brothers scandal.  The most prominent subject discussed in the reactions to the Valukas Report has been the complete lack of oversight by the Federal Reserve Bank of New York — the entity with investigators in place inside of Lehman Brothers after the collapse of Bear Stearns.  The FRBNY had the perfect vantage point to conduct effective oversight of Lehman.  Not only did the FRBNY fail to do so — it actually helped Lehman maintain a false image of being financially solvent.  It is important to keep in mind that Lehman CEO Richard Fuld was a class B director of the FRBNY during this period.  Does that sound like a conflict of interest to anyone besides me?  The Securities and Exchange Commission (under the direction of Christopher Cox at the time) has become another subject of scrutiny for its own dubious semblance of oversight.

Eliot Spitzer and William Black (a professor of economics and law at the University of Missouri – Kansas City) recently posted a great article at the New Deal 2.0 website.  Among the memorable points from that piece is the assertion that accounting is “the weapon of choice” for financial deception.  The Valukas Report has exposed such extensive accounting fraud at Lehman, it will be impossible for the Federal Reserve Bank of New York to feign ignorance of that activity.  Another memorable aspect of the Spitzer – Black piece is its reference to those “too big to fail” financial institutions as “SDIs” or systemically dangerous institutions.  Here is some of what Spitzer and Black had to say about how the FRBNY became enmeshed in Lehman’s sleazy accounting tactics:

The FRBNY knew that Lehman was engaged in smoke and mirrors designed to overstate its liquidity and, therefore, was unwilling to lend as much money to Lehman.  The FRBNY did not, however, inform the SEC, the public, or the OTS  (which regulated an S&L that Lehman owned) of what should have been viewed by all as ongoing misrepresentations.

The Fed’s behavior made it clear that officials didn’t believe they needed to do more with this information. The FRBNY remained willing to lend to an institution with misleading accounting and neither remedied the accounting nor notified other regulators who may have had the opportunity to do so.

*   *   *

The FRBNY acted shamefully in covering up Lehman’s inflated asset values and liquidity.

The consequences of the New York Fed’s involvement in this scam were discussed in an article by Andrew Ross Sorkin from the March 16 edition of The New York Times.  (You may recall that Andrew Ross Sorkin is the author of the book, Too Big To Fail.)  He pointed out that the consequences of the Lehman scandal could be very far-reaching:

Indeed, it now appears that the federal government itself either didn’t appreciate the significance of what it saw (we’ve seen that movie before with regulators waving off tips about Bernard L. Madoff).  Or perhaps they did appreciate the significance and blessed the now-suspect accounting anyway.

*   *   *

There’s a lot riding on the government’s oversight of these accounting shenanigans.  If Lehman Brothers executives are sued civilly or prosecuted criminally, they may actually have a powerful defense:  a raft of government officials from the S.E.C. and Fed vetted virtually everything they did.

On top of that, Lehman’s outside auditor, Ernst &Young, and a law firm, Linklaters, signed off on the transactions.

The problems at Lehman raise even larger questions about the vigilance of the SEC and Fed in overseeing the other Wall Street banks as well.

The question as to whether similar accounting tricks were being performed at “other Wall Street banks as well” opens a very huge can of worms.  It’s time for the government to step back and assess the larger picture of what the systemic problem really is.  In a speech before the Senate, Delaware Senator Ted Kaufman emphasized that the government needs to return the rule of law to Wall Street:

We all understood that to restore the public’s faith in our financial markets and the rule of law, we must identify, prosecute, and send to prison the participants in those markets who broke the law.  Their fraudulent conduct has severely damaged our economy, caused devastating and sustained harm to countless hard-working Americans, and contributed to the widespread view that Wall Street does not play by the same rules as Main Street.

*   *   *

Many have said we should not seek to “punish” anyone, as all of Wall Street was in a delirium of profit-making and almost no one foresaw the sub-prime crisis caused by the dramatic decline in housing values.  But this is not about retribution.  This is about addressing the continuum of behavior that took place — some of it fraudulent and illegal — and in the process addressing what Wall Street and the legal and regulatory system underlying its behavior have become.

As part of that effort, we must ensure that the legal system tackles financial crimes with the same gravity as other crimes.

The nagging suspicion that those nefarious activities at Lehman Brothers could be taking place “at other banks as well” became a key point in Senator Kaufman’s speech:

Mr. President, I’m concerned that the revelations about Lehman Brothers are just the tip of the iceberg.  We have no reason to believe that the conduct detailed last week is somehow isolated or unique.  Indeed, this sort of behavior is hardly novel.  Enron engaged in similar deceit with some of its assets.  And while we don’t have the benefit of an examiner’s report for other firms with a business model like Lehman’s, law enforcement authorities should be well on their way in conducting investigations of whether others used similar “accounting gimmicks” to hide dangerous risk from investors and the public.

We can only hope that a continued investigation into the Lehman scandal will result in a very bright light directed on those privileged plutocrats who consider themselves above the law.



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The Lehman Fallout

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March 16, 2010

Everyone is speculating about what will happen next.  The shock waves resulting from the release of the report by bankruptcy examiner Anton Valukas, pinpointing the causes of the collapse of Lehman Brothers, have left the blogosphere’s commentators with plenty to discuss.  Unfortunately, the mainstream media isn’t giving this story very much traction.  On March 15, the Columbia Journalism Review published an essay by Ryan Chittum, decrying the lack of mainstream media attention given to the Lehman scandal.  Here is some of what he said:

Look, I know that Lehman collapsed a year and a half ago, but this is a major story — one that finally gets awfully close to putting the crimes in the crisis.  I’ll go ahead and say it:  If you’ve wanted to know about the Valukas report and its implications, you’ve been better served by reading Zero Hedge and Naked Capitalism than you have The Wall Street Journal or New York Times.  This on the biggest financial news story of the week — and one of the biggest of the year.  These papers have hundreds of journalists at their disposal.  The blogs have one non-professional writer and a handful of sometime non-pro-journalist contributors.

I’m hardly the only one who has noticed this.  James Kwak of Baseline Scenario wrote this earlier today:

Overall, I’m surprised by how little interest the report has gotten in the media, given its depth and the surprising nature of some of its findings.

At the Zero Hedge website, Tyler Durden reacted to the Columbia Journalism Review piece this way:

Only a few days have passed since its release, and already the Mainstream Media has forgotten all about the Lehman Examiner Report, with barely an occasional mention.  As the CJR points out, this unquestionably massive story of corruption and vice, is being covered up by powered interests controlling all the major news outlets, because just like in the Galleon case, the stench goes not only to the top, (in this case the NewYork Fed and the SEC), but very likely to various corporations that have vested interests in the conglomerates controlling America’s key media organizations.

One probable reason why the Lehman story is being buried is because its timing dovetails so well with the unveiling of Senator “Countrywide Chris” Dodd’s financial reform plan.  The fact that Dodd’s plan includes the inane idea of expanding the powers of the Federal Reserve was not to be ignored by John Carney of The Business Insider website:

Why do we think these are such bad ideas?  At the most basic level, it’s hard to see how the expansion of the scope of the Federal Reserve’s authority to cover any large financial institution makes sense.  The Federal Reserve was not able to prevent disaster at the firms it was already charged with overseeing.  What reason is there to think it will do a better job at regulating a wider universe of firms?

More concretely, the Federal Reserve had regulators in place inside of Lehman Brothers following the collapse of Bear Stearns.  These in-house regulators did not realize that Lehman’s management was rebuking market demands for reduced risk and covering up its rebuke with accounting sleight-of-hand.  When Lehman actually came looking for a bailout, officials were reportedly surprised at how bad things were at the firm.  A similar situation unfolded at Merrill Lynch.  The regulators proved inadequate to the task.

Just think:  It was only one week ago when we were reading those fawning, sycophantic stories in The New Yorker and The Atlantic about what a great guy “Turbo” Tim Geithner is.  This week brought us a great essay by Professor Randall Wray, which raised the question of whether Geithner helped Lehman hide its accounting tricks.  Beyond that, Professor Wray emphasized how this scandal underscores the need for Federal Reserve transparency, which has been so ardently resisted by Ben Bernanke.  (Remember the lawsuit by the late Mark Pittman of Bloomberg News?)  Among the great points made by Professor Wray were these:

Not only did the NY Fed fail to blow the whistle on flagrant accounting tricks, it also helped to hide Lehman’s illiquid assets on the Fed’s balance sheet to make its position look better.  Note that the NY Fed had increased its supervision to the point that it was going over Lehman’s books daily; further, it continued to take trash off the books of Lehman right up to the bitter end, helping to perpetuate the fraud that was designed to maintain the pretense that Lehman was not massively insolvent. (see here)

Geithner told Congress that he has never been a regulator. (see here)  That is a quite honest assessment of his job performance, although it is completely inaccurate as a description of his duties as President of the NY Fed.

*   *   *

More generally, this revelation drives home three related points.  First, the scandal is on-going and it is huge. President Obama must hold Geithner accountable.  He must determine what did Geithner know, and when did he know it.  All internal documents and emails related to the AIG bailout and the attempt to keep Lehman afloat need to be released.  Further, Obama must ask what has Geithner done to favor his clients on Wall Street?  It now looks like even the Fed BOG, not just the NY Fed, is involved in the cover-up.  It is in the interest of the Obama administration to come clean.  It is hard to believe that it does not already have sufficient cause to fire Geithner.  In terms of dollar costs to the government, this is surely the biggest scandal in US history.  In terms of sheer sleaze does it rank with Watergate?  I suppose that depends on whether you believe that political hit lists and spying that had no real impact on the outcome of an election is as bad as a wholesale handing-over of government and the economy to Wall Street.

It remains to be seen whether anyone in the mainstream media will be hitting this story so hard.  One possible reason for the lack of significant coverage may exist in this disturbing point at the conclusion of Wray’s piece:

Of greater importance is the recognition that all of the big banks are probably insolvent.  Another financial crisis is nearly certain to hit in coming months — probably before summer.  The belief that together Geithner and Bernanke have resolved the crisis and that they have put the economy on a path to recovery will be exposed as wishful thinking.

Oh, boy!  Not good!  Not good at all!  We’d better change the subject to March Madness, American Idol or Rielle Hunter!  Anything but this!



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More Super Powers For Turbo Tim

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February 18, 2010

I shouldn’t have been shocked when I read about this.  It’s just that it makes no sense at all and it’s actually scary — for a number of reasons.  On Wednesday, February 17, Sewell Chan broke the story for The New York Times:

The Senate and the Obama administration are nearing agreement on forming a council of regulators, led by the Treasury secretary, to identify systemic risk to the nation’s financial system, officials said Wednesday.

They’re going to put “Turbo” Tim Geithner in charge of the council that regulates systemic risk in the banking system?  Let the pushback begin!  The first published reaction to this news (that I saw) came from Tom Lindmark at the iStockAnalyst.com website:

Only the Congress of the United States is capable of this sort of monumental stupidity.  It appears as if the responsibility for running a newly formed council of bank regulators is going to be delegated to the Treasury Secretary.

Lindmark’s beef was not based on any personal opinion about the appointment of Tim Geithner himself to such a role.  Mr. Lindmark’s opinion simply reflects his disgust at the idea of putting a political appointee at the head of such a committee:

The job of overseeing our financial system is going to be given to an individual whose primary job is implementing the political agenda of his boss — the President of the US.

Regulation of the banks and whatever else gets thrown into the mix is now going to be driven by politicians who have little or no interest in a safe and sound banking system.  As we know too well, their primary interest is the perpetuation and enhancement of their own power with no regard for the consequences.

So there you have reason number one:  Nothing personal — just bad policy.

I can’t wait to hear the responses from some of my favorite gurus from the world of finance.  How about John Hussman — president of the investment advisory firm that manages the Hussman Funds?  One day before the story broke concerning our new systemic risk regulator, this statement appeared in the Weekly Market Comment by Dr. Hussman:

If one is alert, it is evident that the Federal Reserve and the U.S. Treasury have disposed of the need for Congressional approval, and have engineered a de facto bailout of Fannie Mae and Freddie Mac, at public expense.

What better qualification could one have for sitting at the helm of the systemic risk council?  Choose one of the guys who bypassed Congressional authority to bail out Fannie Mae and Freddie Mac with the taxpayers’ money!  If Geithner is actually appointed to chair this council, you can expect an interesting response from Dr. Hussman.

Jeremy Grantham should have plenty to rant about concerning this nomination.  As chairman of GMO, Mr. Grantham is responsible for managing over $107 billion of his clients’ hard-inherited money.  Consider what he said about Geithner’s performance as president of the New York Fed during the months leading up to the financial crisis:

Timothy Geithner, in turn, sat in the very engine room of the USS Disaster and helped steer her onto the rocks.

Mr. Grantham should hardly be pleased to hear about our Treasury Secretary’s new role, regulating systemic risk.

The coming days should provide some entertaining diatribes along the lines of:  “You’ve got to be kidding!” in response to this news.  I’m looking forward to it!



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Beyond The Banks

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February 4, 2010

I recently saw the movie Food, Inc. and was struck by the idea that there are some fundamental problems that span just about every situation where government corruption and ineptitude have facilitated an industry’s efforts to crush the interests of consumers.  At approximately 36 minutes into the film, Michael Pollan explained how government efforts to prevent abuses in the food industry are undermined by the fact that the government always relies on the “quick fix” or “band-aid” approach, rather than a strategy addressed at solving a systemic problem.  In other words:  government prefers to treat the symptoms rather than the disease.

As I thought about Michael Pollan’s remark, I was immediately reminded of our financial crisis.  In that case, the solution was to bail out the “too big to fail” financial institutions.  As legislative proposals are introduced to address the systemic problems and prevent a recurrence of what happened in the fall of 2008, the lobbyists have stepped in to sabotage those efforts.

There were two other factors discussed in Food Inc. as presenting roadblocks to effective consumer-protective legislation:  the revolving door between the industry and Washington, as well as “regulatory capture” — a situation where government regulators are beholden to those whom they regulate.

We have seen the impact of these two factors in the financial area and they have been well-documented.  The “revolving door” was the subject of two recent essays by John Carney at The Business Insider website.  Carney discussed “The Banking Blob” as a secret club of Senate staffers and Wall Street lobbyists:

Staffers on the powerful Senate banking committee are part of what is known as “The Banking Blob,” a person familiar with the matter told us.  The Banking Blob is made up of current banking committee staffers and former staffers who are now bankers or lobbyists.  They frequently socialize together, often organizing happy hours and parties.

“They move in a pack.  They socialize together,” the person says.  “Hell.  They even inter-marry.”

The Blob is made up of both Republican and Democratic staffers.  Outsiders tend to think the Blob members view themselves as “cooler” than other Capitol Hill staff members.  Often a job on the banking committee leads to a well-paying job for a Wall Street firm or a position at a K-Street lobbyist law firm.

Carney had previously discussed the problem of Senate banking committee staffers who see their job as simply a stepping stone to a lucrative banking job:

The allure of banking is hardly a mystery.  The money is better.  Far better than the government wages paid to Capitol Hill staffers.  After years of toiling in government service, many staffers dream of a better life in one of the leafy neighborhoods that are so posh you cannot get there on DC’s Metro.     . . .

“Everyone talks about people going from Goldman to government.  But the problem is the other way.  Too many staffers go from Capitol Hill to banking.  And even more aspire to make that move.  It corrupts the process,” the staffer told us.

The third problem  — “regulatory capture” — is best epitomized in the person of “Turbo” Tim Geithner.  Joshua Rosner recently dissected Turbo Tim’s often-repeated claim that he has always worked in “public service”.  Rosner demonstrated that the only sector that has been “serviced” by Geithner was the banking industry:

Secretary Geithner can keep repeating his assertion he has worked in public service his whole life.  Never mind that this calls into question his tangible market experience, this claim begs the question:  How does he define working in the public service?

Geithner’s last job, as the President of the New York Fed highlights that question.

*   *   *

The New York Fed is not government-owned.  Most people fail to recognize this fact.  Simply, the Federal Reserve Board (responsible for monetary policy, with a dual mandate of full employment and price stability) is an independent part of the federal government, while the New York Fed is a shareholder-owned or private corporation.  In other words, where the Federal Reserve Board is www.frb.gov, the District Bank is www.newyorkfed.org. Historically, the New York Fed has been among the most profitable shareholder-owned corporations in the world.  Yet it keeps the details of its shareholders’ ownership information private.  What we do know is that its owners include precisely those institutions it is tasked to regulate and supervise and those it has obviously failed to adequately supervise.  Unlike the other District Banks of the Federal Reserve system, which have overseen their banks quite well, the New York Fed’s concentration of the largest banks, coupled with its unique role of managing the market operations of the entire Fed system, has built a culture where it sees itself as a market participant and peer to those firms it regulates.

The President of the NY Fed is chosen by, paid by and reports to the private shareholders of that private institution.  Only three of the nine Directors of the Board of the New York Fed are chosen by the Federal Reserve Board and, until this year, the NY Fed’s Chair — chosen by the Federal Reserve Board in Washington — was a former Chairman of Goldman Sachs who still sits on Goldman’s Board.

*   *   *

In truth, Geithner’s ineffectiveness in his role as NY Fed President and his current political posturing — without any policy substance to directly address too-big-to-fail or the Fed’s flawed powers to bailout firms — seems to have resulted from design rather than accident.

*   *   *

If being a public servant is funneling unreasonable amounts of taxpayer capital, without market discipline, to the largest and most poorly managed banks, then Geithner’s selection as Secretary of Treasury makes sense.

One important lesson to be learned from our government’s inability to do its job regulating the financial sector, is that this failure is primarily caused by three problems:

  • An unwillingness to address a systemic problem by choosing, instead, to focus on “quick fixes”;
  • A revolving door between government and industry;
  • Regulatory capture.

Legislators, consumer advocates and commentators should focus on these three problem areas when addressing any situation where our government proves itself ineffective in preventing abuses by a particular industry.



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The Outrage Continues

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February 1, 2010

The news reports of the past few days have brought us enough fuel to keep us outraged for the next decade.  Let’s just hope that some of this lasts long enough for the November elections.  I will touch on just three of the latest stories that should get the pitchfork-wielding mobs off their asses and into the streets.  Nevertheless, we have to be realistic about these things.  With the Super Bowl coming up, it’s going to be tough to pry those butts off the couches.

The first effrontery should not come as too much of a surprise.  The Times of London has reported that Goldman Sachs CEO, Lloyd Blankfein (a/k/a Lloyd Bankfiend) is expecting to receive a $100 million bonus this year:

Bankers in Davos for the World Economic Forum (WEF) told The Times yesterday they understood that Lloyd Blankfein and other top Goldman bankers outside Britain were set to receive some of the bank’s biggest-ever payouts.  “This is Lloyd thumbing his nose at Obama,” said a banker at one of Goldman’s rivals.

Blankfein is also thumbing his nose at the American taxpayers.  Despite widespread media insistence that Goldman Sachs “paid back the government” there is a bit of unfinished business arising from something called Maiden Lane III — for which Goldman should owe us billions.

That matter brings us to our second item:  the recently-released Quarterly Report from SIGTARP (the Special Investigator General for TARP — Neil Barofsky).  The report is 224 pages long, so I’ll refer you to the handy summary prepared by Michael Shedlock (“Mish”).  Mish’s headline drove home the point that there are currently 77 ongoing investigations of fraud, money laundering and insider trading as a result of the TARP bank bailout program.  Here are a few more of his points, used as introductions to numerous quoted passages from the SIGTARP report:

The Report Blasts Geithner and the NY Fed.  I seriously doubt Geithner survives this but the sad thing is Geithner will not end up in prison where he belongs.

*   *   *

Please consider a prime conflict of interest example in regards to PPIP, the Public-Private-Investment-Plan, specifically designed to allow banks to dump their worst assets onto the public (taxpayers) shielding banks from the risk.

*   *   *

Note the refutation of the preposterous claims that taxpayers will be made whole.

*   *   *

TARP Tutorial:  How Taxpayers Lose Money When Banks Fail

My favorite comment from Mish appears near the conclusion of his summary:

Clearly TARP was a complete failure, that is assuming the goals of TARP were as stated.

My belief is the benefits of TARP and the entire alphabet soup of lending facilities was not as stated by Bernanke and Geithner, but rather to shift as much responsibility as quickly as possible on to the backs of taxpayers while trumping up nonsensical benefits of doing so.  This was done to bail out the banks at any and all cost to the taxpayers.

Was this a huge conspiracy by the Fed and Treasury to benefit the banks at taxpayer expense?  Of course it was, and the conspiracy is unraveling as documented in this report and as documented in AIG Coverup Conspiracy Unravels.

Mish’s last remark (and his link to an earlier posting) brings us to the third disgrace to be covered in this piece:  The AIG bailout cover-up.  On January 29, David Reilly wrote an article for Bloomberg News (and Business Week) concerning last Wednesday’s hearing before the House Committee on Oversight and Government Reform.  After quoting from Reilly’s article, Mish made this observation:

Most know I am not a big believer in conspiracies.  I regularly dismiss them.  However, this one was clear from the beginning and like all massive conspiracies, it is now in the light of day.

David Reilly began the Bloomberg/Business Week piece this way:

The idea of secret banking cabals that control the country and global economy are a given among conspiracy theorists who stockpile ammo, bottled water and peanut butter.  After this week’s congressional hearing into the bailout of American International Group Inc., you have to wonder if those folks are crazy after all.

Wednesday’s hearing described a secretive group deploying billions of dollars to favored banks, operating with little oversight by the public or elected officials.

That “secretive group” is The Federal Reserve of New York, whose president at the time of the AIG bailout was “Turbo” Tim Geithner.  David Reilly’s disgust at the hearing’s revelations became apparent from the tone of his article:

By pursuing this line of inquiry, the hearing revealed some of the inner workings of the New York Fed and the outsized role it plays in banking.  This insight is especially valuable given that the New York Fed is a quasi-governmental institution that isn’t subject to citizen intrusions such as freedom of information requests, unlike the Federal Reserve.

This impenetrability comes in handy since the bank is the preferred vehicle for many of the Fed’s bailout programs.  It’s as though the New York Fed was a black-ops outfit for the nation’s central bank.

*   *   *

The New York Fed is one of 12 Federal Reserve Banks that operate under the supervision of the Federal Reserve’s board of governors, chaired by Ben Bernanke.  Member-bank presidents are appointed by nine-member boards, who themselves are appointed largely by other bankers.

As Representative Marcy Kaptur told Geithner at the hearing:  “A lot of people think that the president of the New York Fed works for the U.S. government.  But in fact you work for the private banks that elected you.”

The “cover-up” aspect to this caper involved intervention by the New York Fed that included editing AIG’s communications to investors and pressuring the Securities and Exchange Commission to keep secret the details of the bailouts of AIG’s counterparties (Maiden Lane III).  The Fed’s opposition to disclosure of such documentation to Congress was the subject of a New York Times opinion piece in December.  The recent SIGTARP report emphasized the disingenuous nature of the Fed’s explanation for keeping this information hidden:

SIGTARP’s audit also noted that the now familiar argument from Government officials about the dire consequences of basic transparency, as advocated by the Federal Reserve in connection with Maiden Lane III, once again simply does not withstand scrutiny.  Federal Reserve officials initially refused to disclose the identities of the counterparties or the details of the payments, warning that disclosure of the names would undermine AIG’s stability, the privacy and business interests of the counterparties, and the stability of the markets.  After public and Congressional pressure, AIG disclosed the identities of its counterparties, including its eight largest:  Societe Generale, Goldman Sachs Group Inc., Merrill Lynch, Deutsche Bank AG, UBS, Calyon Corporate and Investment Banking (a subsidiary of Credit Agricole S.A.), Barclays PLC, and Bank of America.

Notwithstanding the Federal Reserve’s warnings, the sky did not fall; there is no indication that AIG’s disclosure undermined the stability of AIG or the market or damaged legitimate interests of the counterparties.

The SIGTARP investigation has revealed some activity that most people would never have imagined possible given the enormous amounts of money involved in these bailouts and the degree of oversight (that should have been) in place.  The bigger question becomes:  Will any criminal charges be brought against those officials who breached the public trust by facilitating this monumental theft of taxpayer dollars?



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