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The Goldman Fallout

April 19th, 2010 Posted in Uncategorized

Apr, 19 2010

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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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Financial Crisis Inquiry Disappointment

April 15th, 2010 Posted in Uncategorized

Apr, 15 2010

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April 15, 2010

The Financial Crisis Inquiry Commission (FCIC) has been widely criticized for its lame efforts at investigating the causes of the financial crisis. As I pointed out on January 11, a number of commentators had been expressing doubt concerning what the FCIC could accomplish before the commission held its first hearing. At this point — just three months later — we are already hearing the question of whether it might be “time to pull the plug on the FCIC”. Writing for the Center for Media and Democracy’s PRWatch.org website, Mary Bottari posed that question as the title to her critical piece, documenting the commission’s “lackluster performance”:

The FCIC is a 10-person panel assembled to report on the meltdown to President Obama later this year. The New York Times reported last week what was becoming increasingly obvious: the commission was in shambles. The commission waited eight months before having its first hearing. A top investigator resigned due to delays in hiring staff, no subpoenas have been issued and partisan infighting means few new documents have been released that would aid reporters in piecing together the crime scene, even if FCIC investigators are not up to the task. Worse, it seems like the majority of staff have been borrowed from the complicit Federal Reserve.

These problems were on full display in last week’s hearings. The three days of hearings were marked by some heat, but little light.

The FCIC’s failure to issue any subpoenas became a major point of criticism by Eliot Spitzer, who had this to say in a recent posting for Slate :

The Financial Crisis Inquiry Commission has so far been a waste. Some momentary theater has been provided by the witnesses who have tried to excuse, explain, or occasionally admit their role in the cataclysm of the past two years. While this has ginned up some additional public outrage, it hasn’t deepened our knowledge about what critical players knew or did. There is a simple reason for this: The commission has not issued a single subpoena. Any investigator will tell you that you must get the documentary evidence before you examine the witnesses. The evidence is waiting to be seized from the Fed, AIG, Goldman Sachs, and on down the line. Yet not one subpoena.

Rather than accept Robert Rubin’s simple disclaimers about Citigroup, why hasn’t the FCIC combed through the actual communications among the board, the executive committee, the audit committee, and the risk-management committee? Why hasn’t the FCIC collected AIG’s e-mails with the Fed and Goldman Sachs? Unless the subpoenas are issued, we will lose the chance to make the record.

As Binyamin Appelbaum pointed out in The Washington Post back on January 8, if a financial reform bill is eventually passed, it will likely be signed into law before the mid-term elections in November – one month before the FCIC is required to publish its findings. As a result, there is a serious question as to whether the commission’s efforts will contribute anything to financial reform legislation. Given the FCIC’s unwillingness to exercise its subpoena power, we are faced with the question of why the commission should even bother wasting its time and the taxpayers’ money on an irrelevant, ineffective exercise.

Although Mary Bottari’s essay discussed the possibility that the FCIC might still “get its act together”, the cynicism expressed by Eliot Spitzer provided a much more realistic assessment of the situation:

Americans have been betrayed by Washington over financial reform. Our leaders have failed to get the evidence, failed to push back when clearly inadequate explanations were provided, and failed to explore the structural reforms that will work. Pretend tears will drip from bankers’ eyes after the consumer protection agency is created. Then their wolfish teeth will slowly break into a grin, the pure delight that Washington has failed to do anything meaningful to restructure the banking sector.

Just when it was beginning to appear as though we might actually see some meaningful financial reform find its way into law, we have been reminded that Washington has its own ways – which benefit the American public only by rare coincidence.

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Financial Reform Might Actually Happen

April 12th, 2010 Posted in Uncategorized

Apr, 12 2010

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April 12, 2010

The long-overdue need for financial reform is finally getting some serious attention in Washington. As banking lobbyists continue to grease palms in the Senate, we are beginning to hear a number of novel ideas from some clever commentators, focused on preventing another financial crisis.

On April 9, John Mauldin published a thought-provoking essay entitled, “Reform We Can Believe In”. At one point in the piece, Mauldin considered the question that has been hanging over our heads for the past eighteen months:

What happens if we do nothing?

What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen? It will be a body blow to many banks, especially in Europe. Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.

That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk. In the next crisis, we will not have the tools available to stem the tide that we did the last time. Rates are already low. Do you think we could pass another TARP? The Fed’s balance sheet is already bloated. It could get much worse unless we get financial reforms that have some bite.

All this debating about a consumer protection agency and where it should be and all the other trivia is wasting time. Fix the big things. Credit default swaps. Too big to fail. Leverage. Then worry about the details.

Although I left out Mauldin’s suggestion to “leave the Fed alone” from that last paragraph, his essay contains a fantastic explanation of how the Federal Reserve System is organized. Best of all, Mauldin spent plenty of time reflecting on Milton Friedman’s suggestion that we program a computer to set monetary policy, instead of leaving that authority with the Fed:

Let me be clear. There are a lot of things not to like about the Federal Reserve System. I think it was Milton Friedman who said we would be better off with a computer determining monetary policy. A quote from an interview with him is instructive. When asked “Do you still think it would be a good idea to have a computer run monetary policy?” he answered:

“Yes. Of course it depends very much on how the computer is programmed. I am not saying that any computer program would do. In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year. There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.

“In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions. One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge. We have seen that in the history of our own Federal Reserve System.

Another perspective on financial reform came from Jim McTague in the April 12 edition of Barron’s. He began with the remark that both the House and Senate reform bills lack adequate measures for “efficient and intelligent policing”. Nevertheless, the solution he embraced was simple:

The aptly named Richard Vigilante, who recently co-wrote a book called Panic with Minneapolis-based hedge-fund legend Andrew Redleaf, suggests this approach: Force all firms managing other people’s money to publish their investment positions in detail before the market opens; this would include hedge funds. Then, the short sellers could punish ineptness before it spreads by betting heavily against a particular institution’s stupid decisions.

“Bankers would hate it. It’s their worst nightmare,” says Vigilante, whom I met with at Firehook bakery on Washington’s Farragut Square. If the system had been in place in 2006, short sellers would have stamped out the smoldering subprime mania before it had a chance to spread, he asserts.

His suggestion is both brilliant and a model of simplicity — it could protect consumers against all kinds of risky financial products — but it will never become reality.

Bankers would scream about the need to protect their proprietary-trading information. And, as was the case with health-insurance “reform,” Congress is bent on ramming a bill, no matter how flawed, through the legislative sausage works in order to mollify an uncommonly angry electorate before Nov. 2. To entertain new ideas at this juncture, even good ones, would upset the ambitious timetable.

Like health care, the new financial regulatory regime is built atop the cracked masonry of the old one. The same flatfoots who were on patrol when the subprime caper went down will be given larger beats to walk. They will be overseen by a brain trust, a Council of Regulators, culled from their ranks, who, like chemical sniffers, would seek to uncover systemic threats to the volatile financial system. In fact, COR is the core of the whole scheme.

The proposal for a Council of Regulators has drawn a good deal of criticism, primarily because it would be chaired by the Treasury Secretary. Matthew Bishop and Michael Green, authors of The Road From Ruin, had this to say about a Council of Regulators in a recent Huffington Post piece:

Indeed, with the Treasury Secretary in the chair, would this council really face down the political leaders and try to stop an emerging bubble spreading a feelgood factor across the nation (as bubbles do, before they burst)? Even in his pomp Alan Greenspan knew that a Fed chairman couldn’t risk being too gloomy about the economy and keep his job. What chance then of a Treasury Secretary, a cabinet member, being so bold?

Rather than another layer on top of the dysfunctional existing regulatory system, America needs to sweep away its absurd proliferation of regulators and replace them with a powerful super regulator, independent of day-to-day politics and empowered to do the job properly.

Regardless of what the final product will include – one thing is becoming increasingly likely: Some semblance of financial reform legislation will eventually become enacted. It won’t be perfect but anything will be better than what we have now. (Well, almost anything . . .)

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Getting It Reich

April 8th, 2010 Posted in Uncategorized

Apr, 08 2010

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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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Building A Consensus For Survival

March 29th, 2010 Posted in Uncategorized

Mar, 29 2010

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March 29, 2010

In my last posting, I focused on the fantastic discourse in favor of financial reform presented by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, in a speech before the U.S. Chamber of Commerce. In addition to Hoenig’s speech, last week brought us a number of excellent arguments for the cause that is so bitterly opposed by Wall Street lobbyists. On the same day that Thomas Hoenig delivered his great speech to the U.S. Chamber of Commerce, Deputy Treasury Secretary Neal Wolin also addressed that institution to argue in favor of financial reform. I enjoyed the fact that he rubbed this in their faces:

That is why it is so puzzling that, despite the urgent and undeniable need for reform, the Chamber of Commerce has launched a $3 million advertising campaign against it. That campaign is not designed to improve the House and Senate bills. It is designed to defeat them. It is designed to delay reform until the memory of the crisis fades and the political will for change dies out.

The Chamber’s campaign comes on top of the $1.4 million per day already being spent on lobbying and campaign contributions by big banks and Wall Street financial firms. There are four financial lobbyists for every member of Congress.

Wolin’s presentation was yet another signal from the Treasury Department that inspired economist Simon Johnson to begin feeling optimistic about the possibility that some meaningful degree of financial reform might actually take place:

Against all the odds, a glimmer of hope for real financial reform begins to shine through. It’s not that anything definite has happened — in fact most of the recent Senate details are not encouraging – but rather that the broader political calculus has shifted in the right direction.

Instead of seeing the big banks as inviolable, top people in Obama administration are beginning to see the advantage of taking them on — at least on the issue of consumer protection. Even Tim Geithner derided the banks recently as,

“those who told us all they were the masters of noble financial innovation and sophisticated risk management.”

Yep. That was our old pal and former New York Fed President, “Turbo” Tim Geithner, making the case for financial reform before the American Enterprise Institute. (You remember them — the outfit that fired David Frum for speaking out against Fox News and the rest of the “conservative entertainment industry”.) Treasury Secretary Geithner made his pitch for reform by reminding his conservative audience that longstanding advocates of the “efficient market hypothesis” had come on board in favor of financial reform:

Now, the recognition that markets failed and that the necessary solution involves reform; that it requires rules enforced by government is not a partisan or political judgment. It is a conclusion reached by liberals and by conservative skeptics of regulation.

Judge Richard Posner, a leader in the conservative Chicago School of economics, wrote last year, that “we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails.”

And consider Alan Greenspan, a skeptic of the benefits of regulation, who recently said, “inhibiting irrational behavior when it can be identified, through regulation, . . . could be stabilizing.”

No wonder Simon Johnson is feeling so upbeat! The administration is actually making a serious attempt at doing what needs to be done to get this accomplished.

Meanwhile, The New York Times had run a superb article by David Leonhardt just as Geithner was about to address the AEI. Leonhardt’s essay, “Heading Off the Next Financial Crisis” is a thorough analysis, providing historical background and covering every angle on what needs to be done to clean up the mess that got us where we are today — and to prevent it from happening again. Here are some snippets from the first page that had me hooked right away:

It was a maddening story line: the government helped the banks get rich by looking the other way during good times and saved them from collapse during bad times. Just as an oil company can profit from pollution, Wall Street profited from weak regulation, at the expense of society.

* * *

In a way, this issue is more about human nature than about politics. By definition, the next period of financial excess will appear to have recent history on its side.

* * *

One way to deal with regulator fallibility is to implement clear, sweeping rules that limit people’s ability to persuade themselves that the next bubble is different — upfront capital requirements, for example, that banks cannot alter. Thus far, the White House, the Fed and Congress have mostly steered clear of such rules.

Congratulations to David Leonhardt for putting that great piece together. As more commentators continue to advance such astute, sensible appeals to plug the leaks in our sinking financial system, there is a greater likelihood that our lawmakers will realize that the economic risk of doing nothing far exceeds the amounts of money in those envelopes from the lobbyists.

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The Best Argument For Financial Reform

March 26th, 2010 Posted in Uncategorized

Mar, 26 2010

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March 26, 2010

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, spoke out in favor of financial reform on Wednesday in a speech before the U.S. Chamber of Commerce. The shocking aspect of Hoenig’s speech is that it comes from the mouth of a member of the Federal Reserve’s Open Market Committee (FOMC) which sets economic policy. Beyond that, Hoenig brutally criticized what has been done so far to tilt the playing field in favor of the megabanks, at the expense of smaller banks. Here are some choice bits from what should be mandatory reading for everyone in Congress:

As a nation, we have violated the central tenants of any successful system. We have seen the formation of a powerful group of financial firms. We have inadvertently granted them implied guarantees and favors, and we have suffered the consequences. We must correct these violations. We must reinvigorate fair competition within our system in a culture of business ethics that operates under the rule of law. When we do this, we will not eliminate the small businesses’ need for capital, but we will make access to capital once again earned, as it should be.

* * *

The fact is that Main Street will not prosper without a healthy financial system. We will not have a healthy financial system now or in the future without making fundamental changes that reverse the wrong-headed incentives, change behavior and reinforce the structure of our financial system. These changes must be made so that the largest firms no longer have the incentive to take too much risk and gain a competitive funding advantage over smaller ones. Credit must be allocated efficiently and equitably based on prospective economic value. Without these changes, this crisis will be remembered only in textbooks and then we will go through it all again.

Hoenig’s speech comes at a time when the Senate is considering a watered-down version of financial reform that has been widely criticized. Economist Simon Johnson pointed out how any approach based on U.S. authority alone to “resolve” or break up systemically dangerous banks would be doomed because “there is no cross-border agreement on resolution process and procedure — and no prospect of the same in sight”.

Blogger Mike Konczal expressed his disappointment with what has become of the Financial Reform Bill as it has been dragged through the legislative process:

It’s funny, I know what a good financial reform bill becoming a bad financial reform bill looks like through this process. I’ve seen bribes and more bribes and last-minute giveaway changes.

The notion that bribery has been an obstacle to financial reform became a central theme of Karl Denninger’s enthusiastic reaction to Hoenig’s speech:

All in all it’s nice to see Thomas Hoenig wake up. Now let’s see if we can get CONgress to stop opening the bribe envelopes, er, ignore the campaign contributions for a sufficient period of time to actually fix this mess, forcing those “big banks” to get that leverage ratio down to where it belongs, along with marking their assets to the market.

Thomas Hoenig provided exactly the type of leadership needed and at exactly the right time to give a boost to serious financial reform. We can only hope that there will be enough responsible, ethical people in the Senate to incorporate Hoenig’s suggestions into the Financial Reform Bill. If only . . .

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Dumping On Alan Greenspan

March 22nd, 2010 Posted in Uncategorized

Mar, 22 2010

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March 22, 2010

On Friday, March 19, former Federal Reserve chair, Alan Greenspan appeared before the Brookings Institution to present his 48-page paper entitled, “The Crisis”. The obvious subject of the paper concerned the causes of the 2008 financial crisis. With this document, Greenspan attempted to add his own spin to history, for the sake of restoring his tattered public image. The man once known as “The Maestro” had fallen into the orchestra pit and was struggling to preserve his prestige. After the release of his paper on Friday, there has been no shortage of criticism, despite Greenspan’s “enlightened” change of attitude concerning bank regulation. Greenspan’s refusal to admit the Federal Reserve’s monetary policy had anything to do with causing the crisis has placed him directly in the crosshairs of more than a few critics.

Sewell Chan of The New York Times provided this summary of Greenspan’s paper:

Mr. Greenspan, who has long argued that the market is often a more effective regulator than the government, has now adopted a more expansive view of the proper role of the state.

He argues that regulators should enforce collateral and capital requirements, limit or ban certain kinds of concentrated bank lending, and even compel financial companies to develop “living wills” that specify how they are to be liquidated in an orderly way.

* * *

. . . Mr. Greenspan warned that “megabanks” formed through mergers created the potential for “unusually large systemic risks” should they fail.

Mr. Greenspan added: “Regrettably, we did little to address the problem.”

That is as close as Greenspan came to admitting that the Federal Reserve had a role in helping to cause the financial crisis. Nevertheless, these magic words from page 39 of “The Crisis” are what got everybody jumping:

To my knowledge, that lowering of the federal funds rate nearly a decade ago was not considered a key factor in the housing bubble.

The best retort to this denial of reality came from Barry Ritholtz, author of Bailout Nation. His essay entitled, “Explaining the Impact of Ultra-Low Rates to Greenspan” is a must read. Here’s how Ritholtz concluded the piece:

The lack of regulatory enforcement was a huge factor in allowing the credit bubble to inflate, and set the stage for the entire credit crisis. But it was intricately interwoven with the ultra low rates Alan Greenspan set as Fed Chair.

So while he is correct in pointing out that his own failures as a bank regulator are in part to blame, he needs to also recognize that his failures in setting monetary policy was also a major factor.

In other words, his incompetence as a regulator made his incompetence as a central banker even worse.

Paul La Monica wrote an interesting post for CNN Money’s The Buzz blog entitled, “Greenspan and Bernanke still don’t get it”. He was similarly unimpressed with Greenspan’s denial that Fed monetary policy helped cause the crisis:

This argument is getting tiresome. Keeping rates so low helped inflate the bubble.

* * *

“The Fed wasn’t the sole culprit. But if not for an artificially steep yield curve, we probably would not have had a global financial crisis,” said John Norris, managing director of wealth management with Oakworth Capital Bank in Birmingham, Ala.

“Greenspan and Bernanke are missing the point. It all stems from monetary policy,” Norris added. “If you give bankers an inducement to lend more than they ordinarily would they are going to do so.”

From across the pond, Stephen Foley wrote a great article for The Independent entitled, “For the wrong answers, turn to Greenspan”. He began the piece this way:

The former US Federal Reserve chairman, the wizened wiseman of laissez-faire economics, shocked us all — and probably himself — when he told a congressional panel in 2008 that he had found “a flaw in the model I perceived is the critical functioning structure that defines how the world works, so to speak”. He meant that he had realised banks cannot be trusted to manage their own risks, and that markets do not smoothly self-correct.

But instead of taking that revelation and helping to point the way to a new, post-crisis financial world, he has shuddered to an intellectual halt. It is the same intellectual stop sign that Wall Street’s bankers are at. The failure to move forward is regrettable, dangerous and more than a little self-serving.

These reactions to Greenspan’s paper are surely just the beginning of an overwhelming backlash. The Economist has already weighed in and before too long, we might even see a movie documenting the Fed’s responsibility for helping to cause The Great Recession.

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Everyone Knew About Lehman Brothers

March 19th, 2010 Posted in Uncategorized

Mar, 19 2010

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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

March 17th, 2010 Posted in Uncategorized

Mar, 17 2010

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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

March 16th, 2010 Posted in Uncategorized

Mar, 16 2010

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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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Getting It Reich

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Everyone Knew About Lehman Brothers

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The Lehman Fallout

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