Archive for the ‘Lehman Brothers’ Category
What The Lehman Report Proves: Financial Insolvency
March 12th, 2010 | 
Author: What The Lehman Report Proves: Financial Insolvency
Posted by Karl Denninger
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.
Posted in Banks, Ben Bernanke, Corruption, Debt, Economic Crisis, Economy, Federal Reserve, Financial System, Fraud, Lehman Brothers, Money | 
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EXPLOSIVE: Lehman – Where Are The Cops?
EXPLOSIVE: Lehman – Where Are The Cops?
Posted by Karl Denninger
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 AndersonErnst & 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:
-
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.
-
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.
LOLZ Courtesy of LOLFed
Posted in Banks, Ben Bernanke, Corruption, Economic Crisis, Economy, Federal Reserve, Financial System, Lehman Brothers, Timothy Geithner |
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The “Repo 105″ Scam: How Lehman Fooled Everyone (Including Allegedly Dick Fuld) And How Other Banks Are Likely Doing This Right Now
Submitted by Tyler Durden
Presenting a detailed look at “Repo 105″ – the next soundbite sure to fill the airwaves over the next weeks and months, as more and more banks are uncovered to be using this borderline criminal accounting gimmick to make their leverage ratios look better. This is the first time we have heard this loophole abuse by a bank, be it defunct (Lehman) or existing (everyone else). There should be an immediate investigation into how many other banks are currently taking advantage of this artificial scheme to manipulate and misrepresent their cap ratio, and just why the New York Fed can claim it had no idea of this very critical component of the Shadow Economy.
From the report:
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. Repo 105 transactions were nearly identical to standard repurchase and resale (“repo”) transactions that Lehman (and other investment banks) used to secure short?term financing, with a critical difference: Lehman accounted for Repo 105 transactions as “sales” as opposed to financing transactions based upon the overcollateralization or higher than normal haircut in a Repo 105 transaction. By recharacterizing the Repo 105 transaction as a “sale,” Lehman removed the inventory from its balance sheet.
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. 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. 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. Thus, Lehman’s Repo 105 practice consisted of a two?step process: (1) undertaking Repo 105 transactions followed by (2) the use of Repo 105 cash borrowings to pay down liabilities, thereby reducing leverage. A few days after the new quarter began, Lehman would borrow the necessary funds to repay the cash borrowing plus interest, repurchase the securities, and restore the assets to its balance sheet.
Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions, the considerable escalation of its total Repo 105 usage in late 2007 and into 2008, or the material impact these transactions had on the firm’s publicly reported net leverage ratio. According to former Global Financial Controller Martin Kelly, a careful review of Lehman’s Forms 10?K and 10?Q would not reveal Lehman’s use of Repo 105 transactions. Lehman failed to disclose its Repo 105 practice even though Kelly believed “that the only purpose or motive for the transactions was reduction in balance sheet;” felt that “there was no substance to the transactions;” and expressed concerns with Lehman’s Repo 105 program to two consecutive Lehman Chief Financial Officers – Erin Callan and Ian Lowitt – advising them that the lack of economic substance to Repo 105 transactions meant “reputational risk” to Lehman if the firm’s use of the transactions became known to the public. In addition to its material omissions, Lehman affirmatively misrepresented in its financial statements that the firm treated all repo transactions as financing transactions – i.e., not sales – for financial reporting purposes.
And here is the Fed punchline, as it once again implicates Tim Geithner:
From 2003 to 2009, Treasury Secretary Timothy Geithner served as President of the Federal Reserve Bank of New York (“FRBNY”). The Examiner described to Secretary Geithner how Lehman used Repo 105 transactions to remove approximately $50 billion of liquid assets from the balance sheet at quarter?end in 2008 and explained that this practice reduced Lehman’s net leverage. Secretary Geithner “did not recall being aware of” Lehman’s Repo 105 program, but stated: “If this had been a bank we were supervising, that [i.e., Lehman’s Repo 105 program] would have been a huge issue for the New York Fed.”
And even though the Fed should have been fully aware of any shadow transaction be they “matched book” repos or the “105 variety, nobody had any clue. Just who the hell was regulating banks???
Jan Voigts, who was an Examining Officer in FRBNY’s Bank Supervision Department, had no knowledge of Lehman removing assets from its balance sheet at or near quarter?end via a repo trade treated as a true sale under a United Kingdom opinion letter.
Arthur Angulo, who was a Senior Vice President in FRBNY’s Bank Supervision department, likewise was unaware that Lehman engaged in repo transactions at quarter?end, under a United Kingdom true sale opinion letter, where the assets would be returned to Lehman’s balance sheet following the end of the reporting period. Angulo said that the described repo transactions appeared to go “beyond other types of [permissible] balance sheet management.” Angulo also said that he would have wanted to know about off?market transactions where Lehman accepted a higher haircutthan a repo seller normally would accept for a certain type of collateral.
Thomas Baxter, FRBNY General Counsel, had no knowledge of Repo 105 transactions, either by name or design. Baxter was generally aware of firms using quarter?end and month?end “balance sheet window?dressing,” but did not recall this being an issue linked to Lehman specifically.
Stunningly, nobody at the SEC was aware of Lehman’s Repo 105 program. And guess what: NEITHER DID DICK FULD. This is unbelievable – the criminality reaches to the very top, yet the very top denies all knowledge.
Richard Fuld, Lehman’s former Chief Executive Officer denied any recollection of Lehman’s use of Repo 105 transactions. Fuld said he had no knowledge that Lehman treated any kind of repo transaction as a true sale or that Lehman ever removed from its balance sheet assets transferred in a repo transaction. In addition, Fuld did not recall having seen any reports referencing the amount of the firm’s Repo 105 activity. Fuld further stated that he did not know that Lehman removed approximately $49 and $50 billion in inventory off its balance sheet at quarter?end
through the use of Repo 105 transactions in first quarter 2008 and second quarter 2008, respectively. Fuld said, however, that if he had learned that Lehman was temporarily cleansing its balance sheet of assets at quarter?end through Repo 105 transactions, it would have concerned him.
Evidence, however, suggests that Fuld is blatantly lying:
Fuld’s denial of recollection must be weighed by a trier of fact against other evidence. Fuld recalled having many conversations with his executives about reducing net leverage and emphasized to the Examiner how important it was for Lehman to reduce its net leverage. The night before the March 28, 2008 Executive Committee meeting, Fuld received materials for the meeting, including an agenda of topics including “Repo 105/108” and “Delever v Derisk” and a presentation that referenced Lehman’s quarter?end Repo 105 usage for first quarter 2008 – $49.1 billion. The materials also were forwarded by Fuld’s assistant to other Lehman executives. It appears that Fuld did not attend the March 28 meeting, but Bart McDade recalled having specific discussions with Fuld about Lehman’s Repo 105 usage in June 2008. Sometime that month, McDade spoke to Fuld about reducing Lehman’s use of Repo 105 transactions. McDade walked Fuld through the Balance Sheet and Key Disclosures document (reproduced in part below) and discussed with Fuld Lehman’s quarter?end Repo 105 usage – $38.6 billion at year?end 2007; $49.1 billion at first quarter 2008; and $50.3 billion at second quarter 2008.
Based upon their conversation, McDade understood that “Fuld knew, at a basic level, that Repo 105 was used in the firm’s bond business” and that Fuld “was familiar with the term Repo 105.”3524 McDade recalled that when he advised Fuld in June 2008 that Lehman should reduce its Repo 105 usage to $25 billion, “Fuld understood that this would put pressure on traders.”3525 McDade also recalled that “Fuld knew about the accounting of Repo 105.”
Combing through the Appendix on what collateral was actually “sold” (only to be promptly bought back) in Repo 105s:
Most securities Lehman used in Repo 105 transactions were “governmental” in nature, implying a certain level of liquidity. While representing a relatively small percentage of Lehman’s total Repo 105 assets/securities, at times the nominal amount of non?”governmental” securities Lehman used in Repo 105 transactions was quite large. For example, as of February 29, 2008 (the end of Lehman’s first quarter 2008), Lehman utilized over $1 billion of highly structured securities, i.e., CLOs and CDOs, private RMBS, CMBS and asset?backed securities, in Repo 105 transactions. In the market environment that existed for Lehman in early 2008, these structured securities were likely relatively illiquid as indicated by declines in origination volumes, wider bid?offer spreads, and higher margin requirements.
In August 2008, just before it was over, the firm allowed $55 million, or seven securities, rated CCC to be included in a Repo 105 transaction.
The next chart makes it evident it that 105s were used simply to game the firm’s assets into quarter end (yellow highlights), by reducing overall asset for leverage ratio calculations.
That this scam was going unsupervised (just who the hell were the counterparties?) for many years, and that many banks are likely using it right now to fool investors, regulators, rating agencies, and the idiots at the FRBNY (who certainly also know about this), is beyond criminal. Yet that nobody will go to jail for this is as certain as the market going up another 10% tomorrow. A full investigation has to be conducted immediately into whether existing Wall Street firms, and in particular those who use Ernst & Young as auditors, are currently abusing public confidence via such transactions.
Full report
Repo 105
Lehman Part II
Presenting The Lehman Bankruptcy Examiner Report
Submitted by Tyler Durden
We present the first two volumes (out of 9) of the massive 2,200 page compendium that represents the just declassified examiner’s report in the Lehman bankruptcy case. We will post the other volumes shortly. Below are the key findings from a quick perusal of Anton Valukas’ report, which we will be combing through over the next week. Pay particular attention to the Repo 105 scam which allows banks to materially misrepresent their leverage ratios whenever they so choose, thank you FASB, corrupt auditors (in this case E&Y) and Federal Reserve.
Some observations:
Lehman actively misrepresented its capital ratio with the benefit of Fed complicity, because instead of using traditional Repo transactions, it used “Repo 105″ which allowed repos to be treated as asset sales instead of financings. Will someone please ask uberregulator Fed how many other banks are using this borderline illegal accounting scheme RIGHT NOW to misrepresent their net leverage ratios?
- Lehman was forced to announce a quarterly loss of $2.8 billion – resulting from a combination of write?downs on assets, sales of assets at losses, decreasing revenues, and losses on hedges – it sought to cushion the bad news by trumpeting that it had significantly reduced its net leverage ratio to less than 12.5, that it had reduced the net assets on its balance sheet by $60 billion, and that it had a strong and robust liquidity pool.
- Lehman did not disclose, however, that it had been using an accounting device (known within Lehman as “Repo 105”) to manage its balance sheet – by temporarily removing approximately $50 billion of assets from the balance sheet at the end of the first and second quarters of 2008. In an ordinary repo, Lehman raised cash by selling assets with a simultaneous obligation to repurchase them the next day or several days later; such transactions were accounted for as financings, and the assets remained on Lehman’s balance sheet. In a Repo 105 transaction, Lehman did exactly the same thing, but because the assets were 105% or more of the cash received, accounting rules permitted the transactions to be treated as sales rather than financings, so that the assets could be removed from the balance sheet. With Repo 105 transactions, Lehman’s reported net leverage was 12.1 at the end of the second quarter of 2008; but if Lehman had used ordinary repos, net leverage would have to have been reported at 13.9
- Lehman did not disclose its use – or the significant magnitude of its use – of Repo 105 to the Government, to the rating agencies, to its investors, or to its own Board of Directors. Lehman’s auditors, Ernst & Young, were aware of but did not question Lehman’s use and nondisclosure of the Repo 105 accounting transactions. [And why should auditors question anything even remotely shady? After all they need to feed the monkey too.]
The case for why the Fed would be a truly horrible systemic regulator. Here is what happened at Lehman according to Valukas
- Lehman decided to exceed the firm?wide risk appetite limit at several junctures.
- First, though Lehman dramatically increased the limit for fiscal 2007, Lehman nevertheless approached the new limit by May 2007.
- Then, in early October 2007, when Lehman’s risk appetite excesses were at their peak, at least some members of Lehman’s senior management discussed the limit breaches and decided to grant a temporary reprieve from the limits based on the difficult conditions in the real estate and leveraged loan markets.
- Rather than reduce its risk usage, Lehman cured its risk appetite overages by increasing the firm?wide risk appetite limit yet again.
The firm cooked its books:
- Lehman also failed to apply its balance sheet limits in late 2007. Application of these limits would also have restricted Lehman’s risk?taking. Instead, Lehman dramatically increased the size of its balance sheet, and used increasingly large volumes of Repo 105 transactions to create the appearance that the firm’s net leverage ratio remained within a reasonable range of such ratios established by the rating agencies.
The SEC was aware of the BS going on at Lehman:
- Lehman’s stress tests suffered from a significant flaw. Although Lehman made a strategic decision in 2006 to take more principal risk, Lehman did not modify its stress tests to include the risks arising from many of its principal investments – including its real estate investments other than commercial mortgage backed securities (“CMBS”), its private equity investments, and, during a crucial period, its leveraged loan commitments.
- The SEC was aware that Lehman’s stress tests excluded untraded investments and did not question the exclusion, because historically it had been the norm to limit stress tests only to traded positions.
The firm overindulged in speculative garbage LBO loan positions:
- Lehman’s principal investment strategy also included participating in leveraged loan transactions. This business grew spectacularly in 2006 and the first half of 2007. Many of these loans were made to private equity firms, or sponsors, who were purchasing companies as part of leveraged buy?outs.
- These transactions were risky for Lehman because they consumed tremendous amounts of capital, were made on terms that strongly favored the borrowers, and often involved bridge equity or bridge debt that Lehman hoped to distribute to other financial institutions (but was committed to keep for itself if it was unable to do so).
Lastly, Lehman directors can sleep well. Once again, nobody in the world is guilty for the biggest corporate bankruptcy in history:
- The Examiner Does Not Find Colorable Claims That Lehman’s Senior Officers Breached Their Fiduciary Duty to Inform the
Board of Directors Concerning the Level of Risk Lehman Had Assumed - The Examiner Does Not Find Colorable Claims That Lehman’s Directors Breached Their Fiduciary Duty by Failing to Monitor
Lehman’s Risk?Taking Activities - Lehman’s Directors are Protected From Duty of Care Liability by the Exculpatory Clause and the Business Judgment Rule
- Lehman’s Directors Did Not Violate Their Duty of Loyalty
- Lehman’s Directors Did Not Violate Their Duty to Monitor
On the much prevalent conflict of interest of selling portfolios that one has originated (especially as pertains to Goldman’s assorted CDOs held by AIG):
- In one memorandum, Lehman’s Head of Global Strategy expressed the concern that “the team responsible for selling down these positions is the same one that originated them.”628 But several witnesses denied there was any incentive not to sell down the portfolio because they knew that no one in GREG would be getting a 2008 bonus
Attached are Volume one of the report (just the first 240 pages, including the 45 page table of contents) and Volume two. We will upload the remainder shortly.
| Attachment | Size |
|---|
| Attachment | Size |
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| Lehman Valukas 1.pdf | 1.31 MB |
| Valukas Volume 2.pdf | 2.62 MB |
WHY AREN’T PEOPLE BEHIND BARS FOR THIS?!! Timothy Geithner knew about this. Dick Fuld knew about this. Our Treasury Secretary (then head of the New York Federal Reserve) looked the other way while this fraud went on and KNOWINGLY transferred this obligation to the taxpayers!
Posted in AIG, American International Group, Banks, Book Value, Corruption, Economic Crisis, Economy, Federal Reserve, Financial Accounting Standards, Financial System, Fraud, Lehman Brothers, New York Fed, Ratings Agencies, Timothy Geithner |
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Ex-Lehman Bankers Getting Billions In Bonuses
The following was translated from the German publication Spiegel:
Ex-Lehman Bankers Getting Billions in Bonuses
The collapse of U.S. investment bank Lehman Brothers sparked the global financial crisis. But now, according to SPIEGEL information, 2,500 employees of the bankrupt company received billions in guaranteed bonuses from their new employer – ironically for the crisis years 2008 and 2009.
2,500 Ex-Lehman employees in Europe have collected guaranteed bonuses for the crisis years 2008 and 2009 amounting to two billion dollars. While the bankruptcy of their bank has caused the world financial crisis, they got on average about 400,000 dollars – per person, according to Spiegel.
On 15 September 2008, the U.S. investment bank Lehman Brothers collapsed – and thus brought a devastating chain reaction. The global financial system was nearing collapse, the world suffered a property loss of at least 15 trillion U.S. dollars.
The bankers were taken over in October 2008 by the Japanese finance house Nomura, and persuaded to stay by guaranteeing them bonuses. Many guarantees only expire in March this year. Most London-based investment bankers are also not affected by the penalty tax by the British Government in the amount of 50 percent.
The guaranteed bonuses would be taxed as fixed income, was given as an explanation. Christian Meissner, the former European head of Lehman and now head of Nomura Europe, also sues the liqudator of his former employer for 17.3 million U.S. dollars which were promised to him in his four years at the U.S. bank but not yet disbursed.
Posted in Banks, Corruption, Economic Crisis, Economy, Financial System, Lehman Brothers |
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The Biggest Financial Deception of the Decade
The Biggest Financial Deception of the Decade
By Jeff Clark
01/12/10 Stowe, Vermont – Enron? Bear Stearns? Bernie Madoff? They’re all big stories about big losses and have hurt a lot of employees and investors. But none come close to getting my vote for the decade’s most dastardly deception…
First came Enron, with $65.5 billion in assets, going belly-up and becoming the largest bankruptcy in US history at that time. The stock went from a high of $84.63 in December 2000 to a whopping 26¢ one year later. And what had we been told by the media? Fortune magazine dubbed Enron “America’s Most Innovative Company” for six consecutive years.
Next came WorldCom filing for bankruptcy in 2002, their assets of $103.9 billion dwarfing Enron’s. Tyco, Adelphia, Peregrine Systems…also made headlines for their acts of fraud and mismanagement.
A few years later, Bear Stearns set us all up for the Big Meltdown of 2008. It was B.S. (no, I mean Bear Stearns) that pioneered the asset-backed securities markets, and we all know how that turned out. Later we learned that as losses mounted in 2006 and 2007, the company was actually adding to its exposure of mortgage-backed assets. With net equity of $11.1 billion supporting $395 billion in assets, Bear leveraged itself up to an astonishing 35-to-1.
And during it all, Bear Stearns was recognized as the “Most Admired” securities firm in a survey by Fortune magazine (there’s that Lower Manhattan tabloid darling again). Frequent sightings of company executives on country club fairways assured the public that all was well. And CEO Alan Schwartz told us there was “no liquidity crisis for the firm” and insisted he “had the numbers to back it up.” His company was sold four days later to JPMorgan Chase at $10 per share, a 92% loss from its $133.20 high.
Lehman Brothers, the 158-year-old investment bank, was next and still today holds the title as the largest bankruptcy in US history. L.B. succumbed to 2007’s Word of the Year, “subprime,” and its $600 billion in assets all went poof! In just the first half of 2008, before the meltdown, Lehman’s stock slid 73%.
And what did CEO Dick Fuld tell us in April of that year? “I will hurt the shorts, and that is my goal.” He must have been referring to the attire of his tennis club buddies, because the ones who actually got hurt were numerous other banks, money market funds, institutions, hedge funds, REITs, brokers, private and public trusts, foundations, government agencies, foreign governments, employees, and investors.
Moving on to the largest US government bailout recipient by far, AIG’s troubles spawned my favorite placard of the decade: seen outside their Manhattan offices stood a sign that simply read, “Jump!” Maybe its creator heard what I did from AIG’s financial products head Joseph Cassano: “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of these [credit default swap] transactions.”
Oops!
Topping off our list of the infamous debacles of the decade is Bernie Made-off (er, Madoff), who scammed $65 billion over 20 years from unsuspecting institutions and wealthy investors…
By now you are probably wondering… What’s bigger than all these debacles? He’s covered the major frauds and scams of the past decade – what could possibly be left?
To quote my favorite sleuth, Hercule Poirot, “When all the facts are laid before me, the solution becomes inevitable.”
Here are a few clues…
Federal Reserve Chairman Ben Bernanke said on July 16, 2008, that Fannie Mae and Freddie Mac are “adequately capitalized” and “in no danger of failing.” Then-Secretary Treasurer Henry Paulson declared on August 10, 2008, “We have no plans to insert money into either of those two institutions.”
– Both Fannie and Freddie were nationalized 28 days later, on September 8, 2008.
Ben Bernanke claimed on February 28, 2008, “Among the largest banks, the capital ratios remain good and I don’t expect any serious problems of that sort among the large, internationally active banks…” Henry Paulson added on July 20, 2008, that “It’s a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation.”
– Since the recession started in December, 2008, 144 banks have failed.
Paulson informed us on April 20, 2007, that “All the signs I look at show the housing market is at or near the bottom.”
– The number of foreclosures skyrocketed shortly thereafter and will now any day surpass those during the Great Depression.
Ben Bernanke announced on June 20, 2007, that “[The sub prime fallout] will not affect the economy overall.”
– Less than one year later, the stock market crashed, losing 53% of its value, and is still down 25% despite one of the biggest bounces in history.
Those in charge of our country’s finances not only failed to see the crises developing and then bungled the handling of the recovery, they’ve deliberately misled us about what they’re doing to our currency. In spite of emphatic promises, flowery speeches, pat-on-the-back assurances, and continual reassurances, here’s what they’ve actually done to the dollar:
- Since September 1, 2008, the monetary base has ballooned from $908 billion to $2.0 trillion. The current monetary base is now equal to bailing out General Motors 23 times.
- Bailout funds in 2008 and 2009 total $8.1 trillion. That’s almost 78 WorldComs. It’s over 123 Enrons.
- US debt has risen sharply, from $6.2 trillion in 2002 to $12.1 trillion today. That’s over $39,000 per citizen.
- David Walker, the comptroller general of the Government Accountability Office from 1998-2008, warned that the US is on the hook for $60 trillion in unfunded liabilities. Independent analysts peg the figure at near twice that. Whatever the number, it is incomprehensibly large. The only way we will meet these liabilities is to print the money and inflate them away.
We’re bailing out corporations that should fail, making financial promises we can’t keep, and adding layers of debt we can’t possibly repay. And the real killer is, if we don’t have the cash, we just print it. It is, by any reasonable account, the “blunder that will plunder” the next several generations. It is changing America permanently, and the problems will persist long after you and I are laid to rest.
Bottom line: after all the bailout programs, housing initiatives, rescue efforts, stimulus schemes, bank takeovers, wars, unemployment benefit extensions, and numerous other promises, the biggest financial deception of the decade is what the US government is doing to the dollar. Nothing else even comes close.
This reckless activity has spooked our foreign creditors, weakened our global standing, diluted our currency, is punishing savers and retirees, and ultimately sets us up for a level of inflation this country has never seen before.
Yet, what is the guardian of our economy and money telling us now?
“Will the Federal Reserve’s actions to combat the crisis lead to higher inflation down the road? The answer is no; the Federal Reserve is committed to keeping inflation low and will be able to do so. In the near term, elevated unemployment and stable inflation expectations should keep inflation subdued, and indeed, inflation could move lower from here.” (Ben Bernanke, December 7, 2009).
This is pure rubbish. If inflation could be controlled by just thinking stable inflation thoughts, then Ben should be able to grow a full head of hair by just thinking scalp follicle thoughts. This is so ridiculous, it’s insulting.
Government actions make a mockery of their words; what they say and what they do are diametrically opposed. It’s clear that inflation is not a question of “if,” but “when.”
Any level-headed individual has to conclude that there will be a steady – and likely accelerating – decline in the dollar’s purchasing power. It’s inevitable.
The great masses don’t quite understand it yet, but they will. There will be no escape from the cold, hard slap in the face citizens will receive when a high level of inflation arrives. And when it does, it will make a mockery of any opposing viewpoint.
So the question before you is simple: Will you be a prepared survivor for what lies ahead, despite what our government leaders tell us, or will you be a complacent victim of the biggest financial deception of the decade?
For me, there’s only one solution. Don’t kid yourself into thinking a man-made asset will protect your purchasing power. This is the time to be overweight gold and silver. I advise letting them serve their purpose for you.
Regards,
Jeff Clark
for The Daily Reckoning
Posted in AIG, Banking System, Banking industry, Bear Stearns, Corruption, Economic Crisis, Economy, Fannie Mae, Federal Reserve, Financial System, Fraud, Freddie Mac, Lehman Brothers, banking fraud |
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Study Finds That Of All Factors Determining The ‘Bailoutability’ Of Crappy Banks, Ties To The Federal Reserve Are Most Critical
Adam Smith, Charles Darwin and George Washington are not only rolling in their graves, they are dancing the macarena. A new study by the UMich School of Business has found what everyone has known since the crisis began, if not centuries prior: that the biggest, crappiest banks were guaranteed to get more bailout funding the more political ties they had (and more kickbacks they had offered). Is this sufficient to claim that capitalism in its purest sense has been corrupted beyond repair, courtesy of political intervention and constant pandering? Probably not, but it sure makes a damn good argument. In any case, the data is sufficient for all bears to start keeping a track of which banks are increasing their lobbying efforts and funding: those are the ones where the greatest weakness is likely still to be uncovered (if it hasn’t already). And while the political relationship probably is not a big surprise to any realistic readers, another finding of the study makes a solid case for abolition of the “apolitical” Federal Reserve:
A new study by Ross professors Ran Duchin and Denis Sosyura found that
banks with connections to members of congressional finance committees
and banks whose executives served on Federal Reserve boards were more
likely to receive funds from the Troubled Asset Relief Program, the
federal government’s program to purchase assets and equity from
financial institutions to strengthen its financial sector.
The unsupervised Federal Reserve gets to make or break banks, presumably under the gun of its one and only master, Goldman Sachs, which has already destroyed its major historical competitors: Bear Stearns and Lehman Brothers. This is a sufficient condition to not only audit the central bank but to immediately seek its abolition, and also to commence anti-trust proceedings against Goldman Sachs which is not only a monopoly, but by extension has veto power over the very regulatory mechanism that is supposed to keep it “fair and honest.” The system is truly broken.
More findings from the study:
Further, their research shows that TARP investment amounts were
positively related to banks’ political contributions and lobbying
expenditures, and that, overall, the effect of political influence was
strongest for poorly performing banks.
Can someone reminds us what the core premise of capitalism is again, and why we pretend to live in anything other than a hard core socialist society?
One of the professors of the study had this to say:
“Our results show that political connections play an important role in
a firm’s access to capital. The effects of political ties on federal capital investment
are strongest for companies with weaker fundamentals, lower liquidity
and poorer performance — which suggests that political ties shift
capital allocation towards underperforming institutions.”
The US financial system now need a new four letter acronym: everyone knows TBTF. We hereby annoint the Too Blatantly Briby To Fail (TB2TF) category of financial institutions. We posit that in 5 years there will be two banks in the former group: JP Morgan and Goldman Sachs, while every single other bank will make up the latter.
Among the specific data findings:
The researchers used four variables to measure political influence: 1)
seats held by bank executives on the board of directors at any of the
12 Federal Reserve banks or their branches (the Federal Reserve is
involved in the initial review of CPP applications from the majority of
qualified banks); 2) banks with headquarters located in the district of
a U.S. House member serving on the Congressional Committee on Financial
Services or its subcommittees on Financial Institutions and Capital
Markets (which played a major role in the development of TARP and its
amendments); 3) banks’ campaign contributions to congressional
candidates; and 4) banks’ lobbying expenditures.They found that a board seat at a Federal Reserve Bank was
associated with a 31 percent increase in the likelihood of receiving
CPP funds, while a bank’s connection to a House member on key finance
committees was associated with a 26 percent increase, controlling for
other bank characteristics such as size and various financial
indicators.
The last data point is truly troubling: while it is one thing to pander to corrupt politicians, at least when their transgressions are made public they can and will be booted out. Yet what checks and balances exist to punish current and former Fed staffers who endorse near-bankrupt companies, in self-evident conflict of interest acts, for enhanced survival? As the Fed is accountable to nothing and nobody, save Goldman Sachs, one can argue that Goldman decides the fate of the very core of the US financial system: which firms get the thumbs up and down treatment. This is an unbelievalbe travesty of both the constitutional and the tenets of capitalism and must be rectified immediately. It certainly helps that the president, being a Constitutional law professor, will surely get right on it.
“Our findings also suggest that qualified financial institutions were
more likely to receive an investment from CPP if they were bigger and
had lower earnings and lower capital,” said Duchin, U-M assistant
professor of finance. “This is consistent with an investment strategy
seeking to support systematically important institutions experiencing
financial distress.”
If this study’s finding are confirmed and repeated independently by other research teams, it is safe to say that any pretense America has to being an efficient capitalism system (where those who can no longer compete, disappear) can be used to wipe the nation’s collective backside. Between this, and a choice of US dollars and Treasuries, Cottonelle is starting to see some serious competition.
h/t Geoffrey Batt
Posted in America, Anti-Trust, Audit, Bailout, Banks, Bear Stearns, Ben Bernanke, Capital Markets, Capitalism, Corruption, Economy, FED, Factors, Fail, Federal Reserve, Financial System, Geoffrey Batt, Goldman, Goldman Sachs, JP Morgan, Key, Lehman, Lehman Brothers, Markets, Monopoly, Performance, Results, TARP, TBTF, US, funding, research |
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Dubai: Floating on an Island of Debt
By Economic Forecasts & Opinions
Stock markets around the world cracked on Friday with the Dow Jones industrial average down more than 150 points (Fig. 1), and commodities plunging as Dubai debt woes unnerved investors, and sent tremors of uncertainty throughout all markets.
Concerns that a government-backed investment company risked default ripped through world markets. Investors read it as a sign of yet another sovereign implosion after Iceland and Ireland, and recoiled from risk and piled into dollars.
Deutsche Bank estimates that Dubai’s property prices, both commercial and residential, have halved since August last year, and could fall a further 15-20% this year.
U.S. Banks Less Exposed
Most analysts believe U.S. banks are probably less exposed than European rivals to a potential debt default by Dubai World, but a lack of transparency and the interconnection of the modern financial system make it difficult to know which institutions are ultimately exposed.
Dubai World’s largest creditors are reportedly domestic banks in Dubai and Abu Dhabi. MarketWatch noted data from the Bank for International Settlements which put cross-border banking exposure for the UAE as a whole at $123 billion at the end of June. Of that total, European banks hold 72%, with the United States and Japan only holding 9% and 7% of the exposure, respectively. The United Kingdom is by far the biggest creditor with a share of 41%.
Reminder of Other Risks
As pointed out in my previous article that the commercial real estate sector posed a much greater threat than the over-hyped “mother of all carry trades.” The Dubai debt crisis further reinforces this viewpoint.
As commercial property values fall, debt defaults rise. The $3.4 trillion outstanding in debt backed by commercial real estate poses a real threat to the recovery. Trepp LLC reported that last month, delinquencies on U.S. commercial real estate loans that were packaged into commercial mortgage-backed securities reached 4.8%, more than six times the year earlier level. Hotel loans, at 8.7% distressed, have begun falling into delinquency faster than any other kind of commercial real estate debt.
Write-downs and losses at banks around the world have risen to more than $1.7 trillion since 2007 as the credit crisis undermined the value of assets owned by financial institutions, according to data compiled by Bloomberg. Any further deleveraging and the resulting credit tightening from commercial real estate would impede the financial sector and probably derail the U.S. economy sending it into another recession.
Housing Market Mortgage Crisis
Based on a study released by Zillow.com, the foreclosure crisis has moved beyond subprime mortgages and into the prime mortgage market. (Fig. 3) While subprime borrowers are still a factor in the current foreclosure epidemic, it’s becoming increasingly apparent that the weak labor market is the driving force behind the mortgage crisis we face today.
According to the Mortgage Bankers Association, one in seven U.S. home loans was past due or in foreclosure as of Sept. 30, putting that quarterly delinquency measure at its highest level since the report’s inception, 1972, and up from one in ten at the beginning of the year.
The continued surge in delinquencies suggests that a recovery in the housing market could be hindered by the weak job market as well as by further fallout from the easy money and loose lending practices of the past. The foreclosures and delinquencies are expected to keep rising well into 2010, not leveling off until the unemployment rate starts to moderate.
In a study by First American CoreLogic found that one in four of all U.S. mortgage-borrowers owe more than the value of their properties in the 3rd quarter. And many experts didn’t expect U.S. home prices to hit bottom until early 2011, perhaps falling another 5-10%, as more foreclosures get pushed onto the market.
Negative equity is another outstanding risk hanging over the mortgage market.
Dubai Is No Lehman
The circumstances behind Dubai’s moves are murky, making it hard to gauge the exact risk to the pertaining bonds and Dubai’s own general creditworthiness. UBS cautioned that Dubai’s overall debt “might be higher than the generally assumed $80 billion to $90 billion, due to potential off-balance sheet liabilities. These could include unlimited and unquantifiable amount of credit default swaps (CDS) and other derivatives against the underlying assets, and once unraveled, could potentially erupt into a subprime-like crisis.
The current expectation; however, is that there’s a good chance that Dubai’s problems will probably prove a local issue. Most likely, Dubai, or its neighboring emirate, Abu Dhabi, won’t risk tarnishing their images and reputation further, and will come up with a reasonable resolution.
Even if Dubai goes into sovereign default, the amount is probably not enough on its own to threaten the financial system since any actual losses would be a fraction of the total. So, the problems in Dubai are unlikely to be as serious as last year’s Lehman Brothers collapse, nor is it a reflection on the ability of emerging markets to lead a global economic recovery.
Rational Expectations?
But Dubai could well spur a broader crisis of investor confidence in overly leveraged economies as market confidence world-wide is still fragile from the severity of the financial crisis. The debts of many emerging markets have risen even further as the countries governments have fought the ravages of the global recession by issuing more stimulus debt to fill the gap voided by private investment.
The spread of credit-default swaps on developing-nation’s bonds jumped 14 basis points after the Dubai news broke, the most in a month, to 3.24 percentage points, according to JPMorgan Chase & Co.’s EMBI+ Index. There is also a clear sign of potential contagion effects of global risk aversion on basically all risky assets, with the dollar and yen being the prime beneficiaries.
Rational expectations or not, for now, the Dubai crisis is simply a reminder that the severe global recession has relegated much debt to near junk status, and there still remains a high degree of uncertainty as to the percentage recoverable on all outstanding debt which is going to be coming due over the next 5 years.
Despite some seminal signs of green shoots in the news headlines during this 9 month liquidity driven rally in many asset classes around the globe, we should be reminded that all that glitters is not gold, and that the global economic recovery is still on shaky ground.
Posted in Banks, Bloomberg, CDS, Collapse, Commercial Mortgage-Backed Securities, Commercial Real Estate, Commodities, Corruption, Credit Crisis, Credit Default Swaps, Creditors, Debt, Defaults, Delinquencies, Derivatives, Dollar, Dow Jones, Dow Jones Industrial Average, Dubai World, Economic Recovery, Economy, Financial Crisis, Financial System, Foreclosures, GDP, Gold, Green Shoots, Gross Domestic Product, Iceland, Ireland, Japan, Las Vegas, Lehman, Lehman Brothers, Markets, Money, Moody's, Mortgage Bankers Association, Mortgage-Backed Securities, Mortgages, Nakheel, Oil, Recession, Sovereign Default, Stimulus, Subprime, Subprime Mortgages, Swaps, TREPP, Transparency, UAE, UBS, Unemployment, United Kingdom, United States, Yen, abu dhabi, bonds, chase, dubai, housing market, lending, loans, losses, mortgage, off-balance sheet, prices, recovery, risk, securities, war |
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The Real Reason the Giant, Insolvent Banks Aren’t Being Broken Up
Why isn’t the government breaking up the giant, insolvent banks?
We Need Them To Help the Economy Recover?
Do we need the Too Big to Fails to help the economy recover?
No.
The
following top economists and financial experts believe that the economy
cannot recover unless the big, insolvent banks are broken up in an
orderly fashion:
- Nobel prize-winning economist, Joseph Stiglitz
- Nobel prize-winning economist, Ed Prescott
- Dean
and professor of finance and economics at Columbia Business School, and
chairman of the Council of Economic Advisers under President George W.
Bush, R. Glenn Hubbard
- MIT economics professor and former IMF chief economist, Simon Johnson (and see this)
- President of the Federal Reserve Bank of Kansas City, Thomas Hoenig (and see this)
- Deputy Treasury Secretary, Neal S. Wolin
- The President of the Independent Community Bankers of America, a Washington-based trade group with about 5,000 members, Camden R. Fine
- The head of the FDIC, Sheila Bair
- The leading monetary economist and co-author with Milton Friedman of the leading treatise on the Great Depression, Anna Schwartz
- Economics professor and senior regulator during the S & L crisis, William K. Black
- Economics professor, Nouriel Roubini
- Economist, Marc Faber
- Professor of entrepreneurship and finance at the Chicago Booth School of Business, Luigi Zingales
- Economics professor, Thomas F. Cooley
- Former investment banker, Philip Augar
- Chairman of the Commons Treasury, John McFall
Others, like Nobel prize-winning economist Paul Krugman, think that the giant insolvent banks may need to be temporarily nationalized.
In addition, many top economists and financial experts, including Bank of Israel Governor Stanley Fischer – who was Ben Bernanke’s thesis adviser at MIT – say that – at the very least – the size of the financial giants should be limited.
Even the Bank of International Settlements – the “Central Banks’ Central Bank” – has slammed too big to fail. As summarized by the Financial Times:
The
report was particularly scathing in its assessment of governments’
attempts to clean up their banks. “The reluctance of officials to
quickly clean up the banks, many of which are now owned in large part
by governments, may well delay recovery,” it said, adding that
government interventions had ingrained the belief that some banks were
too big or too interconnected to fail.
This was dangerous because it reinforced the risks of moral hazard
which might lead to an even bigger financial crisis in future.
If We Break ‘Em Up, No One Will Lend?
Do we need to keep the TBTFs to make sure that loans are made?
Nope.
Fortune pointed out
in February that smaller banks are stepping in to fill the lending void
left by the giant banks’ current hesitancy to make loans. Indeed, the
article points out that the only reason that smaller banks haven’t been
able to expand and thrive is that the too-big-to-fails have decreased
competition:
Growth for the nation’s smaller banks
represents a reversal of trends from the last twenty years, when the
biggest banks got much bigger and many of the smallest players were
gobbled up or driven under…
As big banks struggle to find a way forward and rising loan losses
threaten to punish poorly run banks of all sizes, smaller but well
capitalized institutions have a long-awaited chance to expand.
BusinessWeek noted in January:
As big banks struggle, community banks are stepping in to offer loans and lines of credit to small business owners…
At a congressional hearing on small business and the economic
recovery earlier this month, economist Paul Merski, of the Independent
Community Bankers of America, a Washington (D.C.) trade group, told
lawmakers that community banks make 20% of all small-business loans,
even though they represent only about 12% of all bank assets.
Furthermore, he said that about 50% of all small-business loans under
$100,000 are made by community banks…Indeed, for the past two years, small-business lending among community
banks has grown at a faster rate than from larger institutions,
according to Aite Group, a Boston banking consultancy. “Community banks
are quickly taking on more market share not only from the top five
banks but from some of the regional banks,” says Christine Barry,
Aite’s research director. “They are focusing more attention on small
businesses than before. They are seeing revenue opportunities and
deploying the right solutions in place to serve these customers.”
And Fed Governor Daniel K. Tarullo said in June:
The
importance of traditional financial intermediation services, and hence
of the smaller banks that typically specialize in providing those
services, tends to increase during times of financial stress. Indeed,
the crisis has highlighted the important continuing role of community
banks…For example, while the number of credit unions has declined by 42
percent since 1989, credit union deposits have more than quadrupled,
and credit unions have increased their share of national deposits from
4.7 percent to 8.5 percent. In addition, some credit unions have
shifted from the traditional membership based on a common interest to
membership that encompasses anyone who lives or works within one or
more local banking markets. In the last few years, some credit unions
have also moved beyond their traditional focus on consumer services to
provide services to small businesses, increasing the extent to which
they compete with community banks.
Indeed, some very smart people say that the big banks aren’t really focusing as much on the lending business as smaller banks.
Specifically
since Glass-Steagall was repealed in 1999, the giant banks have made
much of their money in trading assets, securities, derivatives and
other speculative bets, the banks’ own paper and securities, and in
other money-making activities which have nothing to do with traditional
depository functions.
Now that the economy has crashed, the big banks are making very few loans to consumers or small businesses because they still
have trillions in bad derivatives gambling debts to pay off, and so
they are only loaning to the biggest players and those who don’t really
need credit in the first place. See this and this.
So we don’t really need these giant gamblers. We don’t really need JP Morgan, Citi, Bank of America, Goldman Sachs or Morgan Stanley. What we need are dedicated lenders.
The Fortune article discussed above points out that the banking giants are not necessarily more efficient than smaller banks:
The
largest banks often don’t show the greatest efficiency. This now seems
unsurprising given the deep problems that the biggest institutions have
faced over the past year.
“They actually experience diseconomies of scale,” Narter wrote of
the biggest banks. “There are so many large autonomous divisions of the
bank that the complexity of connecting them overwhelms the advantage of
size.”
And Governor Tarullo points out some of the benefits of small community banks over the giant banks:
Many
community banks have thrived, in large part because their local
presence and personal interactions give them an advantage in meeting
the financial needs of many households, small businesses, and
agricultural firms. Their business model is based on an important
economic explanation of the role of financial intermediaries–to
develop and apply expertise that allows a lender to make better
judgments about the creditworthiness of potential borrowers than could
be made by a potential lender with less information about the
borrowers.A small, but growing, body of research suggests that the financial
services provided by large banks are less-than-perfect substitutes for
those provided by community banks.
It is simply not true
that we need the mega-banks. In fact, as many top economists and
financial analysts have said, the “too big to fails” are actually
stifling competition from smaller lenders and credit unions, and
dragging the entire economy down into a black hole.
The Giant Banks Have Recovered, And Are No Longer Insolvent?
Have the TBTFs recovered, so that they are no longer insolvent?
Negatory.
The giant banks have still not put the toxic assets hidden in their SIVs back on their books.
The tsunamis of commercial real estate, Alt-A, option arm and other loan defaults have not yet hit.
The
overhang of derivatives is still looming out there, and still dwarfs
the size of the rest of the global economy. Credit default swaps have arguably still not been tamed (see this).
Indeed, Nobel prize winning economist Joseph Stiglitz said recently:
The
U.S. has failed to fix the underlying problems of its banking system
after the credit crunch and the collapse of Lehman Brothers Holdings
Inc.
“In the U.S. and many other countries, the too-big-to-fail banks
have become even bigger,” Stiglitz said in an interview today in Paris.
“The problems are worse than they were in 2007 before the crisis.”
Stiglitz’s views echo those of former Federal Reserve Chairman
Paul Volcker, who has advised President Barack Obama’s administration
to curtail the size of banks, and Bank of Israel Governor Stanley
Fischer, who suggested last month that governments may want to
discourage financial institutions from growing “excessively.”
While the big boys have certainly reported some impressive profits in the last couple of months, some or all of those profits may have been due to “creative accounting”, such as Goldman “skipping” December 2008, suspension of mark-to-market (which may or may not be a good thing), and assistance from the government.
Some
very smart people say that the big banks – even after many billions in
bailouts and other government help – have still not repaired their
balance sheets. Tyler Durden, Reggie Middleton, Mish and others have looked at the balance sheets of the big boys much more recently than I have, and have more details than I do.
But the bottom line is this: If the banks are no longer insolvent, they should prove it. If they can’t prove they are solvent, they should be broken up.
The Government Lacks the Power to Break Them Up?
Does the government lack the power to break up the TBTFs?
Wrong.
One of the world’s leading economic historians – Niall Ferguson – argues in a current article in Newsweek:
[Geithner is proposing that] there should be a new “resolution
authority” for the swift closing down of big banks that fail. But such
an authority already exists and was used when Continental Illinois failed in 1984.
Indeed, even the FDIC mentions Continental Illinois in the same breadth as “too big to fail” banks.
And William K. Black (remember, he was the senior regulator during the S&L crisis, and is a Professor of both Economics and
Law) – says that the Prompt Corrective
Action Law (PCA), 12 U.S.C. § 1831o, not only authorizes the government
to seize insolvent banks, it mandates it, and that the Bush and Obama administrations broke the law by refusing to close insolvent banks.
Whether or not the banks’ holding companies can be broken up using the PCA, the banks themselves could be. See this
And no one can doubt that the government could find a way to break up even the holdign companies if it wanted.
FDR seized gold during the Great Depression under the Trading With The Enemies Act.
Geithner
and Bernanke have been using one loophole and “creative” legal
interpretation after another to rationalize their various
multi-trillion dollar programs in the face of opposition from the
public and Congress (see this, for example).
And the government could use 100-year old antitrust laws to break them up.
So
don’t give me any of this “our hands are tied” malarkey. The Obama
administration could break the “too bigs” up in a heartbeat if it
wanted to, and then justify it after the fact using PCA or another
legal argument.
Is Temporarily Nationalizing the Giant Banks Socialism?
Many argue that it would be wrong for the government to break up the banks, because we would have to take over the banks in order to break them up.
That
may be true. But government regulators in the U.S., Sweden and other
countries which have broken up insolvent banks say that the government
only has to take over banks for around 6 months before breaking them up.
In
contrast, the Bush and Obama administrations’ actions mean that the
government is becoming the majority shareholder in the financial giants
more or less permanently. That is – truly – socialism.
Breaking
them up and selling off the parts to the highest bidder efficiently and
in an orderly fashion would get us back to a semblance of free market
capitalism much quicker.
The Real Reason the Giant Banks Aren’t Being Broken Up
So what is the real reason that the TBTFs aren’t being broken up?
Certainly, there is regulatory capture, cowardice and corruption:
- Joseph Stiglitz
(the Nobel prize winning economist) said recently that the U.S. government is wary of challenging the
financial industry because it is politically difficult, and that he
hopes the Group of 20 leaders will cajole the U.S. into tougher action
- Economic historian Niall Ferguson asks:
Guess
which institutions are among the biggest lobbyists and campaign-finance
contributors? Surprise! None other than the TBTFs [too big to fails].
- Manhattan Institute senior fellow Nicole Gelinas agrees:
The
too-big-to-fail financial industry has been good to elected officials
and former elected officials of both parties over its 25-year life span
- Investment analyst and financial writer Yves Smith says:
Major financial players [have gained] control over the all-important over-the-counter debt markets…It is pretty hard to regulate someone who has a knife at your throat.
- William K. Black says:
There has been no honest examination of the crisis because it would embarrass C.E.O.s and politicians . . .
Instead, the Treasury and the Fed are urging us not to
examine the crisis and to believe that all will soon be well. There
have been no prosecutions of the chief executives of the large nonprime
lenders that would expose the “epidemic” of fraudulent mortgage lending
that drove the crisis. There has been no accountability…The Obama administration and Fed Chairman Ben Bernanke have
refused to investigate the nature and causes of the crisis. And the
administration selected Timothy Geithner, who with then Treasury
Secretary Paulson bungled the bailout of A.I.G. and other favored “too
big to fail” institutions, to head up Treasury.Now Lawrence Summers, head of the White House National Economic
Council, and Mr. Geithner argue that no fundamental change in finance
is needed. They want to recreate a secondary market in the subprime
mortgages that caused trillions of dollars of losses.Traditional
neo-classical economic theory, particularly “modern finance theory,”
has been proven false but economists have failed to replace it. No
fundamental reform can be passed when the proponents are pretending
that there really is no crisis or need for change.
- Harvard professor of government Jeffry A. Frieden says:
Regulatory
agencies are often sympathetic to the industries they regulate. This
pattern is so well known among scholars that it has a name: “regulatory
capture.” This effect can be due to the political influence of the
industry on its regulators; or to the fact that the regulators spend so
much time with their charges that they come to accept their world view;
or to the prospect of lucrative private-sector jobs when regulators
retire or resign.
- Economic consultant Edward Harrison agrees:Regulating Wall Street has become difficult in large part because of regulatory capture.
But there is an even more interesting reason . . .
The number one reason the TBTF’s aren’t being broken up is [drumroll] . . . the ‘ole 80’s playbook is being used.
As the New York Times wrote in February:
In
the 1980s, during the height of the Latin American debt crisis, the
total risk to the nine money-center banks in New York was estimated at
more than three times the capital of those banks. The regulators,
analysts say, did not force the banks to value those loans at the
fire-sale prices of the moment, helping to avert a disaster in the
banking system.
In other words, the nine biggest banks were all insolvent in the 1980s.
And the Times is not alone in stating this fact. For example, Felix Salmon wrote in January:
In
the early 1980s, when a slew of overindebted Latin governments
defaulted to their bank creditors, a lot of big global banks, Citicorp
foremost among them, became insolvent.
So the
government’s failure to break up the insolvent giants – even though
virtually all independent experts say that is the only way to save the
economy, and even though there is no good reason not to break them up – is nothing new.
William K. Black’s statement that the government’s entire strategy now – as in the S&L crisis – is to cover up how bad things are (“the entire strategy is to keep people from getting the facts”) makes a lot more sense.
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