The New Robber Barons Page 2
Congresswoman Marcy Kaptur Confronts MF Global and Wall Street - December 26, 2011
CHAPTER 15
Banana Republic: This Time It’s In English
Anchored Under Water (the American Consumer) - June 26, 2009
Stranguflation: Deflation and Inflation Where It Hurts America Most – August 3, 2010
How to Thwart the Assassins of the American Dream - August 15, 2010
Third World America: “Fast Tracking to Anarchy” - August 25, 2010
In Third World America, You Can’t Buy a Ream of Paper on Minimum Wage - December 18, 2010
Third World America 2011: Forget Fast Tracking to Anarchy” We’ve Arrived – June 8, 2011
The Middle Class is Drowning in Debt and Choking on Lies - June 24, 2011
Why Some Housing Prices Are Still Falling and Subprime Loans Are Still Sliding - June 27, 2011
Investing: Bad News, Good News, and What’s Next - August 22, 2011
CHAPTER 16
China: Our Debt, Her Debt
China Defaults, Currency Basket Threatens Dollar - October 6, 2009
Clear and Present Danger - October 31, 2011
Chanos Crash: Timing China’s Financial Meltdown - December 6, 2011
China 2012: The Year of the Bull (Rogers) or the Bear (Chanos)? - January 9, 2012
About Janet Tavakoli
Preface
My last book, Dear Mr. Buffett, explained the events leading to the ongoing global financial crisis that first became transparent to most people in September 2008. I described in advance the biggest credit bubble in world history, how the world could have avoided this disaster, and how we can prevent it from happening the next time.
Dear Mr. Buffett left off shortly after Fannie Mae and Freddie Mac were put into conservatorship and just after Lehman Brothers and AIG imploded. My expose ended just before Warren Buffett made his deal to invest in Goldman Sachs on much better terms than U.S. taxpayers received for their TARP money.
The bubble was fueled by cheap Fed money and corrupt lending practices in a widespread interconnected Ponzi scheme that nearly crashed the global financial market. I named names, and cited cases. I explained the role in this disaster of investment banks, CDO “managers,” credit rating agencies, monoline insurance companies, mortgage brokers, Congress, and “regulators.”
My earlier book, Structured Finance and Collateralized Debt Obligations, details the complex and opaque securitizations that enabled fraudulent lending in the United States by acting as a money train from debtors to unwary investors while culprits like law firms, investment banks, CDO “managers,” hedge fund “managers,” and others pocketed unprecedented fees along the way.
The entire financial system has made a mockery of Sarbanes-Oxley as executives that signed off on materially misleading financial statements were excused. Often the providers of cover stories were the overseers in Congress that were supposed to be performing investigations. As a result, preventable disasters keep coming.
MF Global’s October 31, 2011, bankruptcy delivered a hard punch in the gut to the global futures market. Farmers and manufacturers that used the futures market to hedge price risk feel profoundly betrayed. Their confidence in the futures market has been irrevocably shaken.
Banks that mismanaged their institutions and took excessive risk were bailed out—and are continually bailed out with cheap taxpayer funds from the Fed, as banks try to earn their way out of the holes in their balance sheets. MF Global’s customers did nothing wrong. But there are no bailouts for them. They have been thoroughly mistreated. Some customers received only a partial return of funds; others do not have access to their funds.
Customers of MF Global that supposedly had segregated accounts found their money was used to fund risky bets made by former MF Global CEO Jon Corzine, a former head of Goldman Sachs, former Governor of New Jersey, former Senator of New Jersey, and recent campaign finance bundler for President Obama.
MF Global customers’ money was stolen twice. MF Global diverted money from “segregated” customer accounts in a futile attempt to avoid disaster in its own proprietary transactions as it tried to sell assets and sell part of the company. Then the bankruptcy was structured to serve the interests of powerful creditors including JPMorgan Chase, one of the beneficiaries of the taxpayer funded temporary salvation of the global financial system in 2008. Absent bailouts, JPMorgan Chase would have taken a huge hit along with its counterparties and trading partners.
MF Global’s regulator, the U.S. Commody Futures Trading Commission (CFTC), stood by while customers of MF Global were disadvantaged in the way the bankruptcy was handled. Customers should have had clear priority over funds, but creditors fought to usurp customers’ priority status when it came to the distribution of funds.
MF Global customer money didn’t “vaporize,” as naïve Wall Street Journal reporters recounted. It is all traceable.
Nothing has been fixed.
In the United States, local government services have been curtailed, the cost of staples has risen, and unemployment remains stubbornly high. Europe is on the brink of its own deflationary debt implosion. China is grappling with the global slowdown, internal inflation, and local real estate bubbles. Central Banks are madly printing money. The world sees food, energy, and health care costs jump, while housing values have plummeted.
Investors earn comparatively nothing on “risk free” U.S. government obligations as interest rates are kept low. Investment income stagnates at low levels while the price of everything people want and need for survival soars. The U.S. economy is in the grips of stranguflation.
Meanwhile, banks, hedge funds and powerful interest groups have thwarted reform.
This book is a compilation of selected articles written after September 2008 and ending in 2012, a few months after the implosion of MF Global. It’s a selective chronicle of how the New Robber Barons prospered—and continue to prosper—at the expense of those without government connections.
All of these articles are available on my web site www.tavakolistructuredfinance.com, at least for now. Most of the articles after 2010 have appeared on the web courtesy of the Huffington Post. This book assembles the articles by topic and makes it easier to see the pattern of how interested groups exploited our financial crisis, and how they continue to exploit it.
In the years since the Great Bailout of 2008, no meaningful prosecutions have occurred. Congress, “regulators,” and the judicial system have dragged their heels. We now approach the statute of limitations for widespread financial crimes. Justice delayed is justice denied.
Big money controls the U.S. Congress and influences presidential campaigns. It’s no coincidence that top campaign bundlers include financiers. The U.S. hasn’t kicked big money interests out of politics, because the current power structure loves it this way. Every year since the financial crisis, government has become less representative of its electorate. Government has become a service industry to its money raising cronies.
Investors may not be able to change this corrupted system. But investors can emulate sports and play the conditions.
My upcoming book, The Money Book, picks up where this chronicle ends. I explain what’s next and the investment strategies to consider for the various scenarios to come. But to better appreciate that, it is useful to understand how we got here. The New Robber Barons helps explain our general financial, economic, and political situation.
CHAPTER 1
Bailouts for the Oligarchs
Proposed Alternative to (the Various Versions) of the Paulson Plan
(The Emergency Economic Stabilization Act of 2008)
September 25, 2008 (Updated Oct 2008)
In a letter to the Financial Times on September 29, 2008, I wrote: “Rather than adopt any form of the Paulson plan, which uses billions of US taxpayer dollars and forces risk and potential losses on taxpayers – rather than those who enjoyed the gains – I advocate an alternative.”
Creditors includi
ng credit default swap counterparties failed to renegotiate terms when they had the chance. Financial institutions did not recapitalize when it was easier (within the past 2 years) and now they cannot because no one trusts the value of the assets.
Now we do not have time for Chapter 11 in which either 1) creditors agree to discount debt in exchange for warrants (for potentially viable enterprises) or 2) creditors agree to transform (possibly discounted) debt into new equity (a new capital structure in which former shareholders are wiped out).
The Paulson Plan uses billions of taxpayer dollars and forces risk and potential losses on taxpayers—instead of those who enjoyed the gains. I advocate an alternative.
We can force creditors to accept a restructuring plan (this was done during the Great Depression). Creditors (debt holders) including credit default swap counterparties would be compelled to accept a restructuring plan. That requires partial forgiveness of debt in many cases and/or a debt for equity swap.
If we are determined to violate personal property rights, I prefer it be done through a forced debt forgiveness and a forced capital restructuring (debt for equity swaps), rather than through a massive bailout (any of the various forms of the Paulson Plan). The Paulson Plan destroys capitalism (those who stood to gain--and already made off with large gains--should bear the risk) and violates the spirit of democracy established by the Founding Fathers of the United States.
The Act extends the SEC's authority to suspend mark-to-market accounting (FAS 157) when it is "in the public interest and protects investors." Do not expect a thaw in the market freeze. The Act buries problems and prolongs price uncertainty. This is a huge mistake. FASB board members support mark-to-market accounting, especially in illiquid markets. Warren Buffett supports mark-to-market accounting (see below). The SEC should, too.
This provision in the Act is ridiculous and seems meant to promote hold-to-maturity pricing for credit derivatives trading books and CDO portfolios. The danger is that Federal portfolio managers can claim they are making money on carry trades while the assets are declining in value due to defaults or permanent value destruction of collateral. This situation can continue for a long time to create the false appearance of profitability. In other words, U.S. taxpayers can be told they are making money on their $700 billion investment, when in reality they are losing money. I would rather know the market price, even if the news is bad news.
Warren Buffett came out strongly in favor of mark-to-market accounting for the bailout in an interview with Charlie Rose (and Warren Buffett) on October 1, 2008 and CNNmoney on October 2, 2008. He proposed another viable alternative to the Bills floating in Congress. He proposes to let private equity investors put up 20%. The U.S. Treasury will put up 80% with the following terms: it gets paid back first, receives interest on its investment, and gets a share of the profits.
This is a way of ensuring market pricing and allowing the banks to delever while the Treasury—the only source of a large enough balance sheet—levers up with the protection of a 20% cushion and mark-to-market pricing. This proposal is a good one for viable banks.
Endnote: The way the bailouts occurred was a perversion of capitalism and the principles upon which The Republic was founded. This was the result of influential interested parties reaching into the U.S. Treasury with no accountability. Capitalism doesn't call for bailouts, instead investors take losses. Shareholders in failed financial institutions should have been wiped out, debt holders would have had to accept discounts combined with debt for equity swaps, and financial institutions would have then been recapitalized without taxpayers footing the bill. Instead banks lobbied for relaxed accounting and ineffective "financial reform." No one, including bank managers, can tell how much capital is truly needed, and taxpayers' ongoing heavy subsidies give these financial institutions the appearance of stability.
Selling Democracy On the Cheap
September 30, 2008
Treasury Secretary Henry Paulson was unsuccessful in his first attempt to grab absolute power, but he tried again. His revised draft included this in Section 8: “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”
I told Bloomberg TV this is the most dangerous bill to come before Congress in my lifetime. “We are selling democracy on the cheap.”
New bailout plans include “Enron” accounting, which effectively thwart oversight. [In April 2009, banks got their way and accounting rules were relaxed.] A lot of work has been done in the past couple of days to give Congress a bad education. If Paulson is allowed to use “hold to maturity” pricing, excessively high prices can be paid, and assets that have permanent losses can be easily covered up—just as investment banks covered up their permanent losses on securitized assets for many quarters.
In other words, if you do not use mark-to-market accounting, it is much easier to lie.
Therefore I recommend that we make it more difficult for anyone to lie to American taxpayers, and say we should adopt mark-to-market accounting. If we absolutely had to sell, what would we get for our money? We have a right to know.
It is not in the interests of U.S. citizens and taxpayers to abandon mark-to-market accounting for a proposal in which taxpayer funds are being used. If we would have to sell the assets at a loss due to downward moves in market prices, we have a right to know that. If the assets have permanent losses so that even if we hold to maturity we would have losses, we have a right to know that too. At any given time, we have a right to know what our “investment” is worth (but I am in the group that feels this “investment” should not be made and we should pursue this alternative). Congress seems to have decided that U.S. citizens cannot handle the truth.
The proposed Act released on September 28 (and voted down) extends the SEC's authority to suspend mark-to-market accounting (FAS 157) (P. 88) when it is "in the public interest and protects investors."
Do not expect a thaw in the market freeze. The proposed Act buries problems and prolongs price uncertainty. This bill did not pass, but future versions may include this provision. This a huge mistake. FASB board members support mark-to-market accounting, especially in illiquid markets. The SEC should, too. This provision promotes hold-to-maturity pricing for credit derivatives trading books and CDO portfolios.
The danger is that Federal portfolio managers can claim they are making money on carry trades while the assets are declining in value due to defaults or permanent value destruction of collateral. This situation can continue for a long time to create the false appearance of profitability. In other words, U.S. taxpayers can be told they are making money on their $700 billion investment, when in reality they are losing money.
I would rather know the market price, even if the news is bad news.
Ponzi Schemes and Stress Tests
May 8, 2009
Now that we are stress testing banks that have merged with entities involved in the housing and municipal bond market debacles, we should also revisit the Ponzi scheme. But first, I'll digress to comment on how we will handle the results of the "stress test" , since that is how we will claim we have solved the banks' problems. While the government will convert preferred shares to voting common shares, this is otherwise simply an accounting game.
Credit derivatives were used for this nonsense in Europe, and we have a name for it: regulatory capital arbitrage. This time the U.S. will dilute shareholder value and claim banks have new capital. Moreover, the "stress tests" are anything but that. The "stress" scenario used in the "test" is my probable base case. You'll recall in August of 2007, Ben Bernanke said subprime losses would only be $50 billion to $100 billion, and I called for more than triple that amount. It turns out I was too optimistic. I was in the right direction then, and I am in the right direction now. Our government is in the habit of telling the truth much too slowly.
We need fiscal stimulus and need to strengthen banks. I believ
e, however, that we should experience more pain now to gain a better future. Specifically, we should put some banks into receivership and not continue to bail out bank creditors with public money. Likewise we need to enforce controls on securitization (shadow banking) to restore credibility to this powerful tool. Until we confront the fact that global confidence in securitization was shattered by a massive Ponzi scheme, we cannot fix the securitization industry and unfreeze the capital markets. Global investors are waiting for us to clean up our own backyard.
Pundits claiming this was merely a bubble or merely a case of bad models do the industry no favors. There were no black swans or swans of any other color. There were simply Black Barts imitating the highwayman that engaged in bloodless robbery. I just ran across this article in The Deal, which suggest I may be confusing a bubble with a Ponzi scheme. That is not the case. While there was a bubble, it was inflated by a Ponzi scheme. While apologists for our industry may wish otherwise, I explain it again in Dear Mr. Buffett for those who missed it the first time in my book for industry professionals, Structured Finance.