The New Robber Barons Read online

  Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff, P. 295, Christine Richard (Wiley, 2010).

  It's time to bring back Black and resolute regulators like him. Our proposed "financial reform" bill is a sham, and the health of our society and our economy is at stake. ("William Black Warns That Financial Reform Bill Won't Stop the Wall Street Crime Wave," Dan Froomkin, HuffPo, April 21, 2010)

  Failed Regulators Are Still in Charge

  Our financial "investigations" aim to miss. First, the media writes breathless articles portraying Washington's financial "investigators" as "tough." Each new commission is billed as our "Pecora" moment. The "investigators" hire teams of staffers who badger people like me for charity with insightful questions like: "What's a CDO?" Treasury, Federal Reserve, and Wall Street notables loudly complain about "unfair" and "harsh" investigators. Then everyone marches to the Hill where the committee pelts Wall Street executives with verbal marshmallows. Here are just four examples:

  The FCIC: Phil Angelides, Chairman of the Financial Crisis Inquiry Commission, had Robert Rubin, Citigroup's former senior advisor (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. He failed to question them about Citigroup's sales of complex CDOs and a $200 million loan to the failed Bear Stearns hedge funds, even though it was public information and a classic situation for securities fraud. ("Congress's FCIC Nearly Nailed Citigroup Executives to the Wall--Then Blew It," Tavakoli, HuffPo, April 8, 2010)

  The SEC: The SEC filed a recent complaint of alleged fraud in a civil lawsuit against Goldman Sachs. The complaint did not mention that Goldman may have used the subprime mortgage-linked security at issue to unload other complex bonds it created. The complaint strikes me as an SEC publicity stunt. Wall Street banks had deep ties (and often ownership) with corrupt mortgage lenders and created phony securities that funded loan fraud. Corrupt finance--enabled by the SEC's multi-year failures--amplified the problem. The SEC (rating agencies, and more) behaved as collaborators, and now they seem to want credit for bringing one seemingly incomplete complaint against a sapling, while the forest fire rages on. ("Abacus Might Have Had Other Benefits for Goldman," Matt Goldstein, Reuters, April 23, 2010, "Goldman Sachs: Spinning Gold," Tavakoli, HuffPo, April 7, 2010.

  Senate's Permanent Subcommittee on Investigations - "Trial by Email": The leak of Goldman's emails suggests that shorting as a hedge is the same thing as betting against clients. ("Blankfein E-Mail Shows Firm Profited Betting Against Mortgages," Christine Harper, Bloomberg, April 24, 2010.) It's not necessarily so.** Even if facts show it is true, there is a much bigger issue. Wall Street banks bet against our entire society when they created and sold phony securities that fueled fraudulent mortgage lending. That activity was profitable for some firms (Goldman) and unprofitable for others (Lehman, Citigroup, Merrill Lynch, and more). Yet in every case, it was control fraud. CEOs and bankers grew rich while the financial institutions that employed them often imploded. The agents of the fraud prospered while American society and the American economy were massively damaged. ("Wall Street's Fraud and Solutions for Systemic Peril, " Tavakoli, TSF, September 29, 2009)

  TARP "Investigations": Unintentionally or otherwise, the TARP Inspector General's November 17 "SIGTARP" Report appeared to be evasive action or just plain whitewash. Ten days before that particular SIGTARP report was released I disclosed key information that the SIGTARP report didn't even mention. With better access, a budget, a mandate, greater staff, and more time, the "investigator," did a poor job, yet is lauded in much of the media and in Washington as "tough." After damaging facts become public, SIGTARP "catches up." It's an embarrassment. ("Goldman's Undisclosed Role in AIG's Distress," Tavakoli, TSF, November 10, 2010.)

  I urge the President to play the race card--the human race card. The Founding Fathers sought to protect the Republic from this tyranny of private interests. This was meant to be a place where all members of the human race have a fair opportunity to thrive.

  These show trials and faux 'investigations" distract us from the real job of reform and protect Wall Street's interests. It's time to bring back Black--or regulators like him--and truly give us our "Pecora" moment.

  * Statement by William K. Black, Associate Professor of Economics and Law, University of Missouri - Kansas City before the Committee on Financial Services, United States House of Representatives regarding "Public Policy Issues Raised by the Report of the Lehman Bankruptcy Examiner." April 20, 2010. William K. Black is also the author of The Best Way to Rob a Bank is to Own One: How Corporate Executives and Politicians Looted the S&L Industry (University of Texas Press, 2005).

  ** When banks sell short, it is often to hedge their risks. Sometimes hedges result in a net loss, and sometimes they result in a profit. Some hedge funds ethically sold short shares in companies with sham-based-accounting earnings. Short sellers were often the only people sounding the alarm as Pershing Square head Bill Ackman did with bond insurer MBIA. Christine Richard's just released book, Confidence Game (Wiley, 2010) is the gripping account of how he tried in vain for years to get regulators to listen. Meanwhile MBIA, at first an apparently healthy company, was a financial mirage and within a few years the "AAA" rated company sank like a stone. Short sellers were not responsible for the death of Lehman Brothers. My book on the meltdown, Dear Mr. Buffett (Wiley, 2009) is exculpatory evidence for anyone who shorted the stock or bought puts on the shares of Bear Stearns, Lehman, Merrill Lynch, Citigroup (and more) prior to the financial crisis. This type of short selling is very different from shorting a healthy company and spreading false rumors. It is also different from selling short while withholding damaging information.

  CHAPTER 12

  MEDIA CIRCUS

  ProPublica’s (and NY Times’) “Untold” Magnetar Story Creates Excuses for Wall Street and Washington

  April 19, 2010

  ProPublica, Planet Money, and radio show This American Life recently carried stories about Magnetar, a hedge fund that profited from the housing crisis. Unfortunately, many thought it was a fresh revelation. Magnetar wasn't a previously unknown hedge fund. Magnetar did not create the synthetic CDO structure, and the magnitude of Magnetar's role in the subprime crisis has been overblown.

  The New York Times recently wrote that the synthetic CDO story has only begun to emerge in recent months, and referenced the ProPublica story. ("A Wall Street Invention Let the Crisis Mutate," April 16, 2010. I was mentioned as an early critic of synthetic CDOs.)

  Yet, more than two years ago the Wall Street Journal featured Merrill Lynch, Magnetar, N.I.R. and others involved in a failed synthetic CDO called Norma in a PAGE ONE investigative report on December 27, 2007, and followed up with another article on Magnetar's strategy. Even earlier, on December 17, 2007, WSJ had a front page article in its markets section reporting a potential legal battle involving MBIA, Wachovia, Deutsche and UBS for the cash of Sagittarius, a synthetic CDO (in which Magnetar had also invested) that had declared an event of default. The Wall Street Journal had done many investigative articles on value-destroying CDOs, some even earlier.*

  The Wall Street Journal did some brilliant investigative reporting in the fall of 2007, and Washington did nothing. The reports were early enough to plan for the worst, take corrective action, and minimize damage. The news appeared before Bear Stearns imploded in March 2008, and the financial crisis came to a head in September 2008.

  [I was quoted in all the WSJ articles referenced in this commentary, which is why the links were handy. WSJ also published many other synthetic CDO exposes as did other financial media. See also my endnote on Magnetar.]

  Classic and Massive Ponzi Scheme

  My book on the financial crisis, Dear Mr. Buffett (Wiley 2009), explains how Wall Street banks were the key architects of the largest Ponzi scheme in the history of the capital markets. Phony debt packages (RMBS, CDOs) supplied the money for unwise--often predatory
and fraudulent--mortgage lending. Banks had close business relationships with (and often direct investments in) mortgage lenders and mortgage loan servicers.

  Wall Street banks stuffed bad loans and bad loan packages into even more complex packages--including synthetic CDOs--to disguise problems and continue to earn bonuses. As everything started to fall apart, banks accelerated the scheme. They produced the most complex value-destroying deals in the shortest period of time. These are the classic characteristics of a Ponzi scheme, which is illegal.

  Washington Ignored Pre-Crisis Media Reports

  Synthetic CDOs made the financial crisis worse. Many types of financial entities were involved, and the following media warnings are only two examples that should have spurred Washington and regulators to act.

  In May 2007, ten months before Bear Stearns imploded, Business Week's cover story exposed value-destroying synthetic CDOs in Bear Stearns Asset Management's hedge funds. (Bloomberg News also covered the story). The hedge funds imploded in June 2007, and Bear Stearns absorbed the hedge funds' "assets." In March 2008, JPMorgan Chase bought Bear Stearns to save it from collapse. Citigroup created synthetic CDOs with the failed Bear Stearns hedge funds. Citigroup also gave the hedge funds a $200 million loan, so it's remarkable none of this came up in last week's FCIC hearings. [See embedded articles here: "Congress's FCIC Nearly Nailed Citigroup Executives to the Wall--Then Blew It"]

  In a Wall Street Journal article in August 2007, I asserted AIG failed to write down losses for its credit derivatives linked to synthetic CDOs. In early October 2007, the Wall Street Journal wrote about a value-destroying synthetic CDO involving now-debased bond insurer MBIA. In the WSJ's January 14, 2008 article on Magnetar's strategy, Calyon was identified as the underwriter of a synthetic CDO called Cetus. Calyon was one of AIG's trading partners involved with other CDOs (unrelated to Magnetar)--including some done jointly with Goldman Sachs--that were purchased in the AIG bailout. AIG should never have been bailed out without pre-conditions. (see "Goldman Sachs: Spinning Gold")

  Officials did nothing while the banks damaged the economy, but they acted very quickly when they needed to save the banks. In the months preceding the crisis, officials said the problem could be contained, but main stream media articles already showed they needed to perform investigations and institute financial reform.

  The following video (C-Span April 2009) explains how cheap money, wide-spread bad (often predatory) lending, phony securities, credit derivatives, and Wall Street banks' massive over-borrowing led to our current financial crisis. Yet there is still no meaningful reform.

  * The Wall Street Journal's Serena Ng and Carrick Mollenkamp wrote a front page about Merrill, Magnetar, and others involved in a CDO called Norma. "Wall Street Wizardry Amplified Credit Crisis," December 27, 2007 This was a PAGE ONE article. On January 14, 2008 the Wall Street Journal's Serena Ng and Carrick Mollenkamp explained Magnetar's strategy, "A Fund Behind Astronomical Losses."

  The Wall Street Journal's Aaron Lucchetti wrote about the complexity of the final payouts for a value-destroying synthetic CDO called Sagittarius (MBIA (LaCrosse Financial Products), Deutsche, Wachovia, UBS ended up in a dispute over the cash): "CDO Battles: Royal Pain Over Who Gets What" December 17, 2007. This article appeared on the front page of the Markets (C1) section.

  Susan Pulliam, Randall Smith, and Michael Siconolfi wrote a PAGE ONE article on serious CDO pricing issues including shenanigans such as trades with various hedge funds to inflate marks and gimmicks to temporarily disguise the risk (I was quoted in the article). This was before Lehman's famous gimmick of REPO 105. "Investors Face an Age of Murky Pricing," Wall Street Journal, October 11, 2007.

  End Note: Synthetic CDOs were well-known to professionals years before Magentar got involved. Synthetic collateralized debt obligations, which use credit derivatives technology, made the mortgage crisis worse by enabling the cover-up of losses. In 2003, I wrote a book on the dangers of synthetic CDOs, called "Collateralized Debt Obligations & Structured Finance." It includes the structure used by Magnetar and other hedge funds in the recent mortgage debacle, but the example used corporate credit risk (Wiley, 2003, Chapter Pp. 181, 194-196 in particular, combined with short mezz Pp. 261-265). I don't know the first person to use that structure, but it wasn't new. The second edition released in 2008 explains the role of structured finance in the subprime crisis in more detail. Synthetic CDOs and many other new structures were used. [I sent gratis copies of each edition to the head of every branch of the Federal Reserve system when they were first published. I also sent a copy to the Chairman (Greenspan and later Bernanke) and received an acknowledgement.]

  The first edition (2003) was written before subprime lending exploded. In subsequent years, I warned about new growing problems with subprime (ABS CDOs and synthetic CDOs) at CFA conferences, professional conferences, in numerous articles, in main stream media, and at the International Monetary Fund (April 2005). The 2008 edition consolidates some of those warnings and explains the deterioration in the financial markets due to many types of corrupt structured financial products.

  One of the key people at Magnetar, David Snyderman, was in the structured products group at Citadel in August 2004 (and joined Magnetar in mid-2005). At that time, the group he headed asked me to meet with them after reading my CDO book. They said my book gave them the idea to apply the structure to the other loan markets, but banks had already approached many hedge funds with this trade to get around post-Enron accounting issues (among other reasons). The documentation for mortgage loans had already been developed, albeit ISDA didn't issue a template until June 2005; as usual it was behind market practitioners. As I recall, Snyderman did not attend his group's meeting on that day. I declined to get involved, since my book was written as a warning, not a manual for mischief. To the best of my knowledge, the entire group left Citadel shortly thereafter and scattered to various shops.

  [In 1998, I wrote the first public book that explains problems with credit derivatives, Credit Derivatives (Wiley, 1998), before Long Term Capital Management blew up. Banks had a lot of risk to hedge funds using certain types of credit derivatives (total return swaps and esoteric credit derivatives), and I wrote that banks' exposure was too great, because hedge funds were overleveraged and could easily blow up. At the time, I sent gratis copies to the Fed heads.]

  Tavakoli’s Top Ten Business Books (satire)

  December 13, 2010

  1 New Century: Fooling Me All of the Time or Why Improper Practices Only Matter When I'm Short and Not Earning Double-Digit Dividends, by David Einhorn, author of Fooling Some of the People All of the Time.

  2 The Race to Stop the Collapse of Goldman Sachs and Exploit the Crisis, by Henry M. Paulson, author of On the Brink: Inside the Race to Stop the Collapse of the Global Financial System.

  3 The End of Wall Street and the Global Takeover by Financial Oligarchs, by Roger Lowenstein, author of The End of Wall Street.

  4 If Everyone is a Devil, Then No One is Responsible, Particularly not any Wall Street Bank that Your Husband May End Up Getting Paid Big Bucks to Defend, by Bethany McLean and Joe Nocera, authors of All the Devils Are Here.

  5 Blame the Meltdown on Outliers Instead of Outright Liars, by Scott Patterson, author of The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It.

  6 Crybaby Game: I'm Taller than You Are, and My Banking Friends Didn't Instigate Securities Fraud, Those Damn Bond Insurers are to Blame, by Christine Richard, author of Confidence Game: How Hedge Fund Manager Bill Ackman Called Wall Street’s Bluff.

  7 Trust Bernanke To Fund, by Andrew Sorkin, author of Too Big to Fail.

  8 The Big Shortcut: Skip Hard-Hitting Facts and Excuse Fraud as Delusion, by Michael Lewis, author of The Big Short.

  9 The Greatest Trade Ever: It Beats Investigative Journalism, by Gregory Zuckerman.

  10 Buffett Dearest: If You Had a Hot Line to the Treasury, You'd Sell Your Principles Too, by Janet Tavakoli, author of Dear
Mr. Buffett.

  Best All-Time Business Book: The Best Way to Rob a Bank (Again and Again) Is to Own One: How Banking Executives and Politicians Looted the Global Financial System, by William K. Black.

  Kindle Price: $12 Trillion (bail-out costs including government guarantees and back-stops).

  Blame the Victims and Enrich the Perpetrators

  January 13, 2011

  It's outrageous the way subprime borrowers swarmed and solicited unsuspecting lenders and camped out in the offices of investment banks to push them to find ways to finance their insatiable need for capital to purchase homes. It's a scandal the way they got in bed with appraisers to get the home values stated at three to five times market value. It's criminal the way they falsified income to push through the mortgage loans. Oh wait... they didn't. [Hat tip to Nomi Prins, author of It Takes a Pillage.]

  While there were instances of fraud by borrowers, the key drivers of our housing crisis were fraud perpetrated by mortgage lenders and securities fraud -- by some of our most revered financial institutions -- that provided money to fuel fraudulent mortgage lending.