The New Robber Barons Read online

  **The price can be adjusted for interim principal and interest payments, as applicable.

  Show Bernanke and Geithner the Door

  January 22, 2010

  Both the United States and the United Kingdom have had a coordinated non-response to financial reform. If a drunk driver killed your neighbors and crashed the car into your house, you wouldn't expect a police officer to hand the offender a bottle of whiskey and the keys to a bigger, faster, and more powerful car. You would be outraged if the officer said he would only impose a fine, and then made you lend the drunk the money to pay the fine. Yet this is the modus operandi of our financial system, and now financial drunk drivers refuse blood tests and huff that their seat belts were fastened.

  Both Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner missed the critical warning signs of our recent financial crisis. In April of 2009, Steve Forbes called Geithner "the most formidable impediment to an economic recovery." Ben Bernanke repeats past mistakes and hands out cheap money with insufficient conditions or regulation. Both economists have been economical with the truth. There were alternatives to their actions during the crisis that are based on sound financial principles and do not violate the spirit of democracy.

  President Obama has proposed a baby step towards financial reform. He proposes to limit ill-defined proprietary trading, limit banks' borrowings, and prevent banks from investing in hedge funds and private equity funds. Banks' lobbyists and PR spin-doctors are already working overtime to thwart him.

  Mainstream financial media got it badly wrong when it said that the proposal was based on populist anger. It may have motivated President Obama to (only partly take) Paul Volcker's advice, but sound financial principles back that advice.

  Some bank stocks fell in price after the President's remarks yesterday. That was because savvy investors knew that speculators might no longer be able to report high risk-based earnings subsidized with taxpayer dollars. In this case, a fall in stock prices for banks driving down Wall Street should be viewed as a healthy sign. A few bank stocks rose, because they rely on traditional banking backed by sound financial principles.

  Goldman Sachs's stock went down a few percentage points. It became a newly created "bank," to get on the taxpayer give-away gravy train. JPMorgan Chase claims only 1% of its revenue comes from proprietary trading, yet even before its merger with Bear Stearns, JPMorgan's market share of credit derivatives was greater than 50% for U.S. banks. That meant you could combine the credit derivatives of all other domestic banks, and JPMorgan's positions were greater. Those are just two examples. Banks' "non-proprietary" trading desks are often invisible hedge funds.

  Taxpayers currently subsidize banks with cheap money supplied by the Federal Reserve. Even banks that nearly crashed our economy borrow at nearly zero interest rates, while some consumers pay nearly 30% on credit card debt.

  Banks enjoy a Term Asset-Backed Securities Loan Facility (TASLF) that allows them to borrow against problem assets. New banks have each issued tens of billions in FDIC guaranteed debt through the Temporary Liquidity Guarantee Program (TLGP). Banks get interest payments on the excess reserves they keep with the Fed. Accounting rules were changed in March 2009, so banks make up their own prices for assets and more easily hide losses. These are only a few of many newly-created hidden subsidies.

  Taxpayers are paid only peanuts in fees for these massive subsidies while being squeezed with high interest rates and mortgage foreclosures--after our economy was devastated chiefly by several banks' malicious mischief.

  What has the financial crisis taught us? Among other things, we should show Bernanke and Geithner, enablers from the previous administration, the door. Paul Volcker is right to ask for a return to Glass-Steagall. It worked until it was eroded over several decades by bank lobbying. Banking and speculative trading activities--even when done for "customers"--don't mix.

  "Financial innovation" must be limited, since much of it in recent years was the financial equivalent of card cheating. Banks should not be allowed to sponsor hedge funds and private equity funds, and furthermore, they should not be allowed to lend to them through prime brokerage units or other means. Financial institutions must be allowed to fail. Hedge funds require regulation. Malfeasance should be investigated and prosecuted. Credit derivatives should be traded and cleared through exchanges and made transparent. Compensation and financial incentives at banks must change. Bank employees cannot continue to reap huge rewards at no personal risk while shoving risk into the global financial system.

  President Obama promised us change, and he should seize this opportunity to demand sweeping financial reform.

  Congress Exposes Profiteering in AIG’s Deals: Delay Enabled Cover-Up

  January 28, 2010

  Yesterday the House released some missing details of the AIG bailout. (Click here to see the unredacted pages of the March 2009 SEC filing.) The public knew that the Fed paid 100 cents on the dollar to AIG's trading counterparties to resolve its credit default swaps, but the details of the assets behind the trades were kept secret.

  Plenty of Time to Renegotiate AIG's Contracts

  The first bailout of AIG occurred in September 2008 when the FRBNY extended an $85 billion credit line to AIG. By the September 2008 initial bailout, Goldman Sachs had extracted $7.5 billion in collateral from AIG, and other banks that bought Goldman's CDOs also extracted billions from AIG (click here for details).

  Goldman CEO Lloyd Blankfein claims he had no idea AIG had trouble producing collateral. I knew AIG was headed for grave trouble more than a year before the September 2008 bailout and raised the issue with both Warren Buffett and JPMorgan Chase CEO Jamie Dimon. Goldman Sachs claims to be a superior risk manager, yet asks the public to believe that it was clueless about AIG's distress, even though Goldman itself was a key contributor to it.

  Then Treasury Secretary Henry Paulson was CEO of Goldman Sachs at the time it put on these trades with AIG. Lloyd Blankfein was (and remains) CEO of Goldman and was the only Wall Street CEO at one of Paulson's bailout discussions. Stephen Friedman, then Chairman of the NY Fed, also served on Goldman's board.

  Details That Could Anger the Public

  An analysis of the previously secret details shows that at the time of the November 2008 buyout, some CDOs had implied prices of around 60 cents on the dollar. Others had implied prices of around 20 cents on the dollar.

  Not revealed by the new report is that many of the assets backing some of the CDOs have a high risk of severe or total principal loss (many have actual losses). These CDOs have "cliff risk," as in falling off of one. (There is currently no reliable secondary market, and similar CDOs have traded as low as one penny.) One such CDO is Davis Square IV, a CDO on which French bank Societe Generale bought protection from AIG. The CDO is a poster child for Wall Street's key contribution to a financial crisis that devastated the U.S. economy.

  Goldman Sachs created and closed Davis Square IV in April of 2005. The CDO was managed by Trust Company of the West (TCW). (Click here for a list of assets of Davis Square IV from the time period around January 2008). The original portfolio included mortgage-backed securities from Goldman Sachs Alternative Mortgage Products, Merrill, and problem mortgage lenders Countrywide, New Century, Novastar, First Franklin, and Fremont (among others). Assets include home equity loans, midprime loans, subprime loans, and adjustable rate mortgages. The CDO also includes other CDOs.

  AIG's Joe Cassano said AIG was basically out of the business of guaranteeing mortgage product at the end of 2005, yet the report shows around 14% of the CDOs on which AIG sold protection appear to be from 2006, 2007, or 2008 representing around 30% or $19 billion of the $62.13 billion notional amount purchased by the Fed. Furthermore, CDOs from 2006 and 2007 are buried within the portfolios backing the original CDOs. For example, TCW traded mortgages from 2006 and 2007 vintages into the portfolio backing Davis Square IV. These "assets" are among the worst of the lot.

  CDO managers may discl
ose conflicts of interest, but a conflict of interest shouldn't mean that new assets "managed" into your portfolio are highly likely to do you harm. TCW and Goldman Sachs had a relationship that benefited TCW, which earned fees from deals like Davis Square IV. Davis Square IV included several tranches of Goldman's Abacus deals, including $53.5 million from 2006. By September 2008, Goldman's CDO, Abacus 2006-12, was already downgraded from AA2 to Ca, a junk rating--it means you are likely to lose your shirt. Another part of this CDO in Davis Square IV's portfolio was downgraded from A3 to Ca. Three of Goldman's slices of Abacus 2006-15 also made their way into Davis Square IV, and they were also all downgraded to Ca, a junk rating, by September 2008.

  Among other eyebrow raising assets in Davis Square IV, one finds a CDO called Pinnacle Point Funding 2007-a. This CDO was managed by Blackrock. It closed June 7, 2007, and went into acceleration (not a good sign) on December 13, 2007. Davis Square IV's "investment" was originally rated triple-A. By the time of AIG's September 2008 bailout, it was already downgraded to C, a junk rating, by Moody's. Yet the Fed awarded no-bid contracts to Blackrock to manage the assets it bought from AIG.

  Profiteering and Track-Covering: Possible Reasons for Redaction

  The financial windfall conferred by AIG's bailout, the self-serving claim that the crisis prevented negotiation, and the subsequent cover-up of details were very much to the benefit of Goldman Sachs and its current and former officers involved in the bailout discussions.

  In the example above, I show the Davis Square IV portfolio as of January 2008. One would need similar snapshots of all the CDOs to figure out who did what to whom. The fact that the Fed and SEC suppressed potentially explosive facts is bad enough, but the delay in making the information public has given interested parties a window of opportunity to cover their tracks by dumping the worst of the assets, thus hiding them forever from public view.

  Suppressing the details of AIG's trades made it easier for AIG's counterparties to cover-up profiteering and then exploit public funds. If details of these trades had been made public in September 2008, a reasonable negotiator would have demanded that the billions of dollars that had been extracted from AIG (including the $7.5 billion Goldman extracted by then) should be recharacterized as a loan.

  Instead, the Fed gifted tens of billions of dollars to banks that supplied the financing for bad loans that damaged the U.S. economy. More than that, these banks engaged in suspect deals that covered up losses and allowed them to continue to report apparent "profits" and pay inflated bonuses. Meanwhile, their securitization activities continued to harm the economy during a period when the United States was at war.

  Goldman is not solely responsible, but it had a large role in AIG's crisis and a unique position of conflicted interest and influence over the terms of the bailout. Now that the crisis is over, this issue should be reopened, and billions in collateral should be clawed back to pay down public debt, before Goldman Sachs pays more than $16 billion in taxpayer subsidized bonuses to its employees.

  Congress’s FCIC Nearly Nailed Former Citigroup Executives to the Wall—Then Blew It

  April 8, 2010

  Phil Angelides, Chairman of the Financial Crisis Inquiry Commission, had Robert Rubin, former senior advisor Citigroup (also former Treasury Secretary under President Bill Clinton, and former Co-Chair of Goldman Sachs), and Chuck Prince, former CEO of Citigroup, in the palm of his hand today. He asked them why they weren't alarmed for Citigroup in May of 2007, when the Bear Stearns hedge funds ran into trouble. He recalled they imploded in June 2007 and joked that it happened around the time of his birthday. Rubin and Prince shrugged it off, and Rubin that he didn't know about Citigroup's CDO troubles until the fall of 2007.

  Separately, Tom Maheras, then a top fixed income executive at Citigroup, said in the fall of 2007 that Citigroup's "super senior" CDOs were worth 100 cents on the dollar.

  Angelides may not have realized it, but there were facts in the public domain that tie Citigroup very closely to the fate of Bear Stearns's hedge funds. Either these top people from Citigroup didn't ask their subordinates about their exposure -- and the nature of their exposure to the Bear Stearns hedge funds -- or the controls in Citigroup broke down. Rubin testified today: "I don't think Citi is too big to manage." Yet, these events suggest something is seriously amiss.

  In my book on the financial meltdown, Dear Mr. Buffett, I explain how I knew Citigroup was in trouble and its involvement in value-destroying CDOs purchased by Bear Stearns Asset Management's imploding hedge funds. At the time, I spoke to investigative reporters Matthew Goldstein ("Bear Stearns's Subprime IPO," BusinessWeek, May 11, 2007. Goldstein is now with Reuters.) and Jody Shenn ("Bear Stearns Funds to Transfer Subprime-Mortgage Risk with IPO," Bloomberg News, May 11, 2007) about Bear Stearns and the disturbing assets, including some created by Citigroup, revealed by an SEC filing it made in May 2007 for a proposed initial public offering (IPO):

  I went to the SEC's web site, and as I scanned the document I thought to myself: Has Bear Stearns Asset Management completely lost its mind? There is a difference between being clever and being intelligent. I was surprised to read that funds managed by BSAM invested in the unrated first loss risk (equity) of CDOs. In my view, the underlying assets were neither suitable nor appropriate investments for the retail market.

  I did not have time for a thorough review, so I picked a CDO investment underwritten by Citigroup in March of 2007 bearing in mind that if the Everquest IPO came to market, some of the proceeds would pay down Citigroup's $200 million credit line.* [Emphasis added] Everquest held the "first loss" risk, usually the riskiest of all of the CDO tranches, and it was obvious to me that even the investors in the supposedly safe "triple-A" tranches were in trouble. Time proved my concerns warranted, since the CDO triggered an event of default in February 2008, at which time Standard & Poor's downgraded even the original safest "triple-A" tranche to junk.

  All the banks that lent to Bear Stearns Asset Management's (BSAM) two problematic hedge funds pressured the managers to mark down the prices of their assets by late May and early June 2007 -- even the prices of "AA" and "AAA" rated assets. Before the hedge funds went under, BSAM circulated bid lists for the assets, and the prices were atrocious.

  How is it that given Citigroup's huge loan and creation of CDOs that these two funds bought didn't draw the attention of Citigroup's senior management? Citigroup was deeply involved, and there was obvious danger to its own balance sheet.

  Chairman Angelides was apparently unaware that Citigroup had reason to be deeply alarmed by the events that caused the Bear Stearns hedge funds to implode. He missed a golden opportunity to ask Citigroup's former executives about their seeming obliviousness to this enormous risk.

  More to the point, Angelides might ask these executives why Citigroup's officers made rosy public statements and why Citigroup's financial filings with the SEC did not show huge accounting losses for the second quarter of 2007 (and earlier).

  Note: After the negative publicity, the Everquest IPO did not come to market.

  * Offering Circular for Octonion I CDO, Ltc. Octonion I CDO Corp., March 16, 2007. Most of Everquest's assets were priced as of December 31, 2006, but there were some 2007 additions to the portfolio. For example, it owned some of the "first loss" equity risk of a CDO named Octonion I CDO (Octonion), a deal underwritten by Citigroup in March 2007. If the IPO came to market, some of the proceeds from Everquest would pay down Citigroup's $200 million credit line. Octonion's prospectus disclosed an inexperienced CDO manager with conflicts of interest with the CDO investors. It used 95% credit default swaps referencing BBB rated asset backed securities including subprime assets. This CDO appeared to be a very risky investment for investors in the AAA or AA rated tranches. The equity, 48% of which was owned by Everquest, may have been entitled to the residual cash flow of the deal, even if they did not, the tranches looked high risk, undeserving of an investment grade rating. Time proved my concerns warranted, since Octonion triggere
d an event of default in February 2008, at which time even the original senior-most AAA tranche was downgraded to CCC by S&P (it was still AAA by Moody's). By the summer of 2008, the senior-most "AAA" had been downgraded to Caa3 by Moody's and CCC- by S&P.

  President Obama: Bring Back William Black

  April 25, 2010

  William K. Black, a regulator during the dark days of the Savings & Loan Crisis, gave the most sensible testimony about the financial crisis heard in Washington so far.* Fraud thrives and spreads in a regulatory free, highly paid, criminogenic environment. Cheaters prosper driving honesty out of the market.

  "Firms such as Citigroup and Merrill Lynch [and others] were able to create complex securities backed by recklessly underwritten [often fraudulent] mortgages, knowing that they could pass the risk along to someone else who had less information about the underlying loans. [The] $62 trillion credit derivatives market allowed Wall Street to lend without having confidence in the men and women it lent to. Wall Street hedged away the risk of lending and in the process undermined the entire system."