FedUpUSA

The Lehman Report on which I wrote last night regarding deeply troubling issues surrounding the Lehman Bankruptcy, has laid bare some very ugly facts relating to our financial system, corporate governance, and our government’s active complicity not only in the Lehman collapse, but in ongoing balance sheet shenanigans and the current investment picture.

The conclusions I am forced to reach, after much reflection and sleeping on this article overnight, are not pretty.

They compel me to advise that, in my opinion, the market is now trading both technically and on a fundamental basis, exactly as the Nasdaq was in 1999.

I recognize this is a serious charge and has implications that are most unpleasant, in that it implies a probable detonation ahead at some time in the next year – one that will not only destroy all of the gains made since March of last year but go beyond that – indeed, perhaps as far as the banner on The Market Ticker has for the major indices.

The technicals of the last month leave no doubt what’s going on – the market is moving in a parabolic upward fashion, exactly as was the case for the Nasdaq in ‘99, and indeed, we are approaching the sort of gains in the broad market that Nasdaq saw in 1999.

For those who need a refresher, here it is:

Now let’s look at the S&P 500 since the March lows:

And if you need a refresher on what happened to the Nasdaq after it topped in early 2000, here’s that unfortunate reality:

Not only did the entire ramp in 1999 disappear, more than another 50% was lost beyond that.

The seriousness of this cannot be overstated.  Anyone who bought into the start of the decline in 2000 was wiped out by doubling into a decline that took a literal 85% off the NDX from the peak.  Worse, today, nearly a decade later, we remain more than 50% below the peak valuation that the NDX reached.

The Nasdaq is not alone in this behavior.  The Nikkei 225 reached 38.957 in 1989.  Today it trades around 10,000 – a nearly 75% loss from it’s all-time highs, and despite 20 years it has not healed.

An analytical look at history says that when markets rise on fraudulent accounting and false claims - that is, the booking of asset values that is fictional, the claim of profits that were never really made, the hiding of losses off-balance sheet – the losses, when they come, are not recovered for a generation or more.

When this happens to individual companies, they go bankrupt.

When it happens on a broad basis in a market index, the result is utter destruction.

Such happened in the 1930s as well.  The DOW’s high of 1929 was not recovered until more than 20 years later, and due to FDR’s devaluation of the currency it was another decade before, on a purchasing-power basis, your original values were seen again.

So the seminal question for this alleged recovery has been whether or not the recovery is real – that is, whether the asset class at the core of the original problem, the banking system, now has clean balance sheets and it can be reasonably assumed that what is reported in terms of assets, liabilities and earnings is in fact real.

If you cannot be reasonably certain of this then you simply cannot, as an investor, be in this market.  The reason for this is clear on its face – we will, at some point in the not-distant future, have a point where the insolvency of these institutions rises to public consciousness.

When (not if) that happens the market will collapse. 

This is not conjecture.

It has occurred in each case through history where markets have been pumped through fraudulent balance sheets and similar game-playing, and when it happens the typical losses are in the 75-80% range.  Those losses are maintained even a decade or more later.

Now let’s examine the evidence on whether the core of the reason for the collapse – bogus accounting that led to the failure of Bear Stearns and Lehman Brothers – is in fact resolved and no longer present.

Tim Geithner and the Obama Administration understand this risk.  That much was made clear last year when they ran their so-called “Stress Tests.”  The market understood this too, in that the promulgation of those “results” was a large part of the underpinning for the rally in the markets that has followed.

Is that reliance reasonable?

The evidence says it is not.

As was made clear in the article I wrote last night, Lehman failed multiple stress tests internally, and yet they were repeated with ever-looser standards until an internally-conducted test passed – at which point Tim Geithner’s NY Fed proclaimed them healthy:

After March 2008 when the SEC and FRBNY began onsite daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress?testing scenarios to test Lehman’s ability to withstand a run or potential run on the bank.5753 The FRBNY developed two new stress scenarios: “Bear Stearns” and “Bear Stearns Light.”5754 Lehman failed both tests.5755 The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed.5756 However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed.5757 It does not appear that any agency required any action of Lehman in response to the results of the stress testing.

Unfortunately the precise same practice took place with all of the other major institutions when Geithner ran the famous “stress tests” that were hung out in front of investors to “bring them confidence.” 

It was physically impossible for The Federal Reserve to actually perform the testing on its own – so instead, they provided metrics to the firms and asked them to run them.

This is the precise same process that was used to produce a “passing” grade by Lehman after the Bear Stearns failure and that process was administered by the same person who was responsible for the false Lehman outcome.

Now add to this that Diane Olick of CNBC has confirmed what I’ve been saying since the crisis began: If the banks really accounted for all the losses in the home loan market, they’d all be insolvent.

Wait a second.  If the “stress tests” were valid, then the capital raises that were done were sufficient and none of the banks are insolvent. 

Indeed, Diane Olick called this exactly as I have:

That’s why the Obama Administration has created this kind of shell game in the first place.

Shell game?

Further, the fact that these loans have no economic value isn’t just mine.  It’s also Barney Frank’s, who is the lead guy in Congress on the House Financial Services Committee.  He said:

Many second liens have little value because of the plunge in home prices, Rep. Frank wrote, adding: “Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans.”

Accounting rules that Congress caused FASB to modify by literally pointing a gun at them.

I’m sorry folks, but the weight of the evidence is overwhelming on this point.

Whatever gains you think you’re chasing in the stock market at this point in time, you’re doing so against a risk of an 85% loss.  The idea that Government can prevent this sort of collapse if it initiates is fanciful – remember that in the summer of 2008 the common belief was that we’d never see a crash right in front of an election, as “they” would not allow it to happen.  If you bought into that belief, you lost half your money.

The risk here is even more severe.  If, in point of fact, those “Stress Tests” provided false confidence (and I believe the evidence is strong that they have) then it is simply a matter of when the market comes to realize that these losses in the large banks are still present but being hidden.

If we apply the FDIC’s own metrics to the expected losses from such a revelation that would “immediately appear” we get a number between $2 and $3.5 trillion that would have to be paid to depositors of the failed institutions - equal to somewhere around one full year’s Federal Budget and dramatically exceeding what the FDIC and Treasury could cover – by more than 10 times.

The consequence of such an event would be literally catastrophic. Having squandered over $3 trillion in the last two years in new borrowing by The Federal Government to prop up the economy (instead of clearing this bad debt through resolving the bankrupt financial institutions) it is highly unlikely that The Government would be able to, on short notice, raise another $3 trillion.

I’m out of all long positional trades as of this morning and will not be back in them until this issue is resolved.  Even if there is a potential 10 or 20% advance that I will miss by doing so, the downside risk of 85% is so extreme and the facts that we now have available strongly suggest that not only are all the large banks insolvent but that the government has been and is complicit in covering it up – not just temporarily, but as an ongoing practice, just as occurred with Lehman.

I’m sure many will call me crazy for this analysis. 

We will see if you still think so in a year or two.

Sarbanes-Oxley was supposed to prevent crap like this:

From the paper:

Lehman employed off-balance sheet devices, known within Lehman as “Repo 105” and “Repo 108” transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm’s financial condition in late 2007 and 2008.2847

Oh yeah, that’s legal?  It’s not supposed to be!

Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet.2850  Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt.2851  Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios.

Isn’t that special?

It gets better, as you might expect.

The Examiner concludes that colorable claims of breach of fiduciary duty exist against Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of professional malpractice exists against Arthur Anderson Ernst & Young.2915  (strikethrough mine, not in the original)

It is stated that Government Regulators (FRBNY and The SEC) had “no knowledge” of these practices.  Perhaps true.  But this calls into question why we’re hearing of this just now, and whether other firms have or are at present doing the same sort of thing.

There also appears to be a colorable claim that Lehman Management was fully-aware of what was going on:

Although interview statements given to the Examiner were inconsistent at times, no reasonable dispute exists that each of Lehman’s Chief Financial Officers from late 2007 to September 2008 possessed some knowledge of and/or involvement with multiple aspects of Lehman’s Repo 105 program, including the existence of firm-wide Repo 105 limits, the volume of Repo 105 activity Lehman engaged in at quarter?end, and Lehman’s efforts to manage its balance sheet using Repo 105 transactions.

Well that’s special.

But we’re just getting warmed up.

Remember, The Feral Reserve is supposed to by the “uber-regulator” and the “safety and soundness” manager for the financial system.

They did a great job, right?  Well…

For example, when

the Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.

True?  Let’s see what the Examiner had to say:

Although various Government agencies had information that raised serious questions about Lehman’s reported liquidity and about the sufficiency of its capital and liquidity to withstand stress scenarios, the agencies generally limited their activities to collecting data and monitoring.

Oh.  They looked but didn’t act.  I see.

Indeed, they looked pretty closely….

After March 2008 when the SEC and FRBNY began onsite daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress?testing scenarios to test Lehman’s ability to withstand a run or potential run on the bank.5753 The FRBNY developed two new stress scenarios: “Bear Stearns” and “Bear Stearns Light.”5754 Lehman failed both tests.5755 The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed.5756 However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed.5757 It does not appear that any agency required any action of Lehman in response to the results of the stress testing.

So let’s see what we got here.  They ran two sets of stress tests and the firm failed both.  Not satisfied with the results they then designed a third set, which the firm also failed (we can reasonably presume the third had less stringent requirements than the other two!)

Instead of applying any of these three, FRBNY, which was run by one MR. TIMOTHY GEITHNER, NOW OUR TREASURY SECRETARY WHO REPORTED TO ONE BEN BERNANKE, instead took Lehman’s word that all was ok and did nothing.

Wait a minute. In the spring of 2009 we were told that all the big banks ran “Stress Tests” of Geithner’s design.  But Treasury didn’t actually run them and didn’t actually get and process the data – they told the banks to do so. 

Uh, that’s exactly what Lehman did, right?  And Lehman passed its own “internally computed” stress test but failed all three of the externally-computed ones.

Do you still accept that all these other banks are solvent?  What about the facts we do know – such as the inconvenient fact that between them the “big banks” have something like $150 billion of Home Equity lines behind an underwater and delinquent first mortgage, which is, by the way, worth zero yet being carried at or near full value……

Nor did it end there.

The SEC inspection revealed significant problems at Lehman. The SEC found that Lehman’s Price Valuation Group was understaffed; and it found that Lehman’s asset pricing function was overly “process driven.”5761 But the SEC did not release its findings or formally present them to Lehman prior to Lehman’s demise.

So The SEC knew, and they too did nothing.

It’s worse.  While Geithner is implicated as being “concerned” about Lehman in the paper, the most-troubling part the narrative is here:

The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in “collateral damage” by demonstrating weakness and exposing “air” in the marks.5823

Air?

Uh, that’s an apparent admission that FRBNY and Tim Geithner specifically knew that the marks that these banks were taking on their assets was materially and intentionally false.

Where have we seen this of late?  Oh yeah – in all those banks that have failed of late, with 25-40% discounts to their claimed balance sheet values when the marks are actually reduced to losses to the deposit fund by the FDIC!

So let’s see here.  We now have:

1. Geithner, and presumably everyone under him, knew the marks on these assets were fictions months before Lehman failed, yet they intentionally concealed this fact from the market and took no action (nor did the SEC) to disclose this intentional misdirection.

2. The misdirection and false claims in this regard are almost certainly continuing today, as evidenced by the FDIC seizures literally on an every-week basis.

How about Bernanke?  While he maintains (as did Geithner) that primary responsibility lay with the SEC, he also said:

Our concern was about the financial system, and we knew the implications for the greater financial system would be catastrophic, and it was.”

What does all this say about the stability of things now?

Yeah, I know, everyone’s “too big to fail.” 

But what if the truth is that they’re “too big to bail“, for instance, if one of the “big four” was to get in trouble today due to a recognition in the marketplace that not only is this what blew up Bear Stearns and Lehman Brothers, but that the same chicanery with “asset values” is continuing even today, and as such one cannot be reasonably certain that liquidity provided today will be repaid tomorrow?

Why is it that if the implications would be catastrophic (and they were), both the SEC and FRBNY knew that Lehman had insufficient liquidity long before the collapse (and they did) neither the SEC, The Federal Reserve or FRBNY did a damn thing to blow the whistle on this crap and put a stop to it?

This report sets out a damning case against the pseudo-government and government actors, who it is alleged were well-aware of critical weaknesses in Lehman’s risk controls and liquidity months before it collapsed, yet none of them did a damn thing about it until days before the bankruptcy filing.

Why should any of the clown-car riders who clearly knew that this situation existed for literal months before it blew up, yet did nothing, still retain their jobs and, in Geithner’s case, obtain a promotion?  These people are unqualified for supervisory positions involving anything more complicated than handing out towels in the men’s room.

The key question facing the nation this evening is not, however, the past.  It is the future.  We have over 100 literal instances in which banks have been seized by the FDIC since Lehman blew up in which their balance sheet “asset values” have been shown by the FDIC’s own DIF loss projections to be abject fictions, yet none of these institutions have been flagged to investors or the public, no indictments or civil complaints have been brought by the SEC or Department of Justice, and they have remained operating for months with these bogus values exhibited for bank examiners and regulators to see.

IF – and I stress IF – these fictions are also present in our large banking institutions, and there is NO REASON TO BELIEVE THEY ARE NOT, it is simply a matter of time before one or more of them detonates in a similar if not identical fashion.  Since these firms are all much larger than Lehman and neither the FDIC or Treasury has a spare $500 billion laying around for the potential payout to depositors that might be necessary in such an instance, we cannot reasonably assume that the risk of financial Armageddon has in fact passed until we know for a fact that all fictional balance sheets are excised and all off-sheet exposures accounted for.

Now comes the banksters with their lobbyists and bribes, er, “campaign contributions” to say that:

A proposal by former Federal Reserve Chairman Paul Volcker to limit bank’s proprietary trading will be either be dropped or significantly modified in the Senate, lawmakers and staffers told dealReporter.

Senate Banking Committee ranking member Richard Shelby (R-AL) said he opposes the so-called Volcker rule and the Obama administration’s call to levy a USD 90bn tax on banks.

…

A Dodd staffer said the senator is likely to quietly drop or modify many of the recommendations in the Volcker rule to ensure Republican support for regulatory reform.

Well it ain’t gonna be quiet no more!

These goons on Wall Street think they can keep this up.  They might want to pay attention to the fact that there’s this thing called “an Election” coming in November, and the people are pissed, as noted in this Bloomberg article:

Feb. 1 (Bloomberg) — Politicians under pressure from angry voters to show progress on financial reform are losing patience with bankers waiting to reach global harmony on new rules.

Yep.

The people are still short of endorsing clanedestine neck tie parties, but I suspect it’s not by much.  When President Obama said that he was “all that was standing between the banksters and people with pitchforks and torches” he wasn’t kidding.

The idea that the people of this nation will simply sit still while the looting continues is somewhat of a fantasy on the part of those on Wall Street.  Thus far the retaliatory actions have been both peaceful and lawful – mostly – such as “Move Your Money” and the like.

But there’s no guarantee that will remain the case, and the simple reality is that much of what went on during the 2000s was not “an error” or “bad judgment”, it was a blatant heist, and the people are wising up to what really happened.

Where the line resides is not something I can accurately predict.  I can only note our Founding Fathers seemed to have a good grasp of things in The Declaration:

…all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable than to right themselves by abolishing the forms to which they are accustomed.

Indeed we have tolerated far more than we probably should have.  But then The Founders warned….

But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.

Where and when does that line get crossed?  How many people get thrown out of their homes, have 30% credit card interest rates, watch the banksters literally grab over a trillion dollars in printed money and claim “profits” for themselves of over $100 billion in bonuses, evade mandates on long-term holding of those bonuses in the form of stock to prevent cashing out before the sustainability of their practices can be proved up and more?

I do not know where the line is.

I only know that history says that it exists, that no man, no bankster and no government knows exactly where it is, but that once crossed it cannot be “un-crossed” just as an egg cannot be unscrambled.

We need solid, real financial reform.  We must renounce “bubble-nomincs.”  We must shut down the fraud-laced “securitization” machine permanently, prosecute those who have unlawfully concealed risks and lied about asset quality and return our economy to stable, productive output instead of financial speculation.

The Banksters all claim that if we were to do this that society would collapse and that our economy could not survive.

They’re wrong, just as Henry Paulson was wrong when he said he had “no choice” when, allegedly (according to his book) the Chinese and Russians threatened to collapse Fannie and Freddie.

Hank had a choice, assuming he’s not lying of course.  He could have told the Russians and Chinese to bite him – on national television, with George Bush at his side.  He could have told them that if they tried it that the United States Treasury would, by executive order, declare their Treasury Holdings worthless. 

Yes, that would have stopped the “gravy train” of being able to spend more than we make in the government.  Yes, this would have forced immediate austerity and facing of the truth. 

Is that bad?

What have we done since?  Added what – $2 trillion+ to the national debt – more debt we don’t have and can’t pay?  Emitted another budget proposal, just today, to add $1.6 trillion more?  Built yet another artifice – another fraud – on top of the previous ones?  Written more “Option ARMs” on our children and grandchildren’s backs to prop up a cabal of banksters on Wall Street who then fawn all over The Senate with their “campaign contributions” so they can keep skimming off huge parts of our economic structure for a few thousand residing on Wall Street?

How’s that going to work out folks? 

How will we settle up and ultimately pay this debt load down?

We won’t, of course.  Neither will anyone else.  Greece, Spain, the UK – all are lessons for us, if we choose to learn them before we get to live them.

Watch those nations.  If you think this is just about Greece you’re nuts.  The public employee pensions there are ridiculous.  Guess what – they’re ridiculous here too.  In the closest “little city” to here there are many retired police officers and firemen who have pensions north of $100,000/year.  There are many places where six-figure pensions are considered “normal” or “reasonable” – for public safety workers and teachers.  We don’t have the money, we can’t afford to gold-plate the steering wheels of the cop cars and despite all the bleating the fact remains that the primary function of the police department is to write traffic tickets and take a report after you are burglarized, raped or robbed.

Are these functions important?  Yes.  Do they call for better than a middle-class wage?  Nope.  Is a middle-class wage $100,000 a year?  Nope.  The 2008 Median Household income for California is $61,021.  For Florida, $47,778.  For New York, $56,033.

So why are we paying out pensions of double that to what should be middle-class employees in retirement?

Let’s face the facts folks – we can either stop the plundering across society – by both banksters and public employees – or we will face a crisis similar to what Greece is dealing with now.

It will be more pleasant for us to take our medicine voluntarily rather than having it forced down our gullet, but doing so starts with chaining the banksters and their penchant for offloading risk to others and, for those who refuse, jailing them outright, lest the public get ahold of them and not bother with the pleasantries (and constitutional right) of a trial by jury before handing up a sentence.

At the same time we must fix the public employee entitlement mentality, by firing them and replacing them with unemployed Americans if necessary.  We have 1 in 5 working-age men between 25 and 54 out of work - there is no shortage of available people to take these jobs.

It is time to pay the check folks, before we are literally forced to eat it.