The New Robber Barons Page 32

  It remains to be seen whether this failure to disclose permitted additional segregated funds to be improperly transferred.

  Throughout this time, the firm and its employees were under the direction and control of MF Global management. Transfers of customer funds effectuated by MF Global for the benefit (of the firm) constitute very serious violations of our rules and of CFTC regulations.

  A very good summary of Terry Duffy's testimony and its implications can be found at National Hog Farmer. It provided the best early financial coverage on this topic.

  Allowable Rehypothecation: Problematic, But A Different Problem Than MF Global's

  There has been a lot of misinformation about rehypothecation, and old term that seems to have been newly rediscovered by bloggers. To be clear, allowable rehypothecation is not the dark question that has been raised about MF Global. Filching funds as I described above is illegal. Writing rubber checks is illegal.

  My favorite rehypothecation story involves Henry Jarecki, then head of Mocatta Metals and current head of Gresham Partners LLC. I'm sure he'll tell the story better and give you more details than I. But here is the basic story, and it is a parable of this problematic but legal practice.

  Around 1979, Mocatta Metals owned 30 million ounces of silver that Jarecki leased to industrial users. He was long silver outside the exchanges, and he hedged by being short silver on the exchanges using futures contracts. But all the price action was on the exchanges where prices were soaring. Jarecki used cash to meet margin calls. People started getting nervous and rumors circulated, because most people were unaware he owned a huge silver position.

  Meanwhile, the Hunts had borrowed $50 million from Mocatta to buy more silver and had deposited 10.7 million ounces with Mocatta as collateral for the loan. Jarecki rehypothecated the Hunts' silver, meaning he used it as collateral for his own borrowing. This wasn't prudent, but it was definitely legal. After the Hunts posted the silver as collateral with Mocatta, the price of silver tripled. The Hunts were nervous after hearing the rumors about the cash margin calls for Mocatta's futures hedges, and they showed up in Henry Jarecki's office in a very bad mood.

  The Hunts knew the value of their collateral at then market prices far exceeded the cash value of their loan, and they wanted the loan size increased so they could buy more silver. Jarecki agreed to a bigger loan, but the increase wasn't big enough increase to satisfy the Hunts, who became suspicious that Jarecki was in financial trouble. The Hunts then said they wanted to prepay the loan and take back their silver. Jarecki responded that the loan terms didn't allow for early repayment. Now the Hunts were afraid and angry.

  If Jarecki had to buy the Hunts silver in the open market or if he had to cancel his futures trades with no offset to meet the Hunts' demands, it would have created a liquidity crisis for Mocatta. Instead, Jarecki solved everyone's problems. He arranged an exchange of futures for physicals (an EFP to cancel out his and the Hunts' futures positions in exchange for a special agreement on the silver) and sold the Hunts 23 million ounces of silver for cash at what was then the top of the silver market.

  Honest People Don't Look for Malicious Loopholes

  At all times the Hunts had cash in exchange for their assets, there was a full accounting, and Mocatta Metals was good for its obligations. In fact, Mocatta Metals immediately satisfied the Hunts' demands. Even better, it sold the Hunts more silver, which the Hunts wanted. Honest people don't exploit customers by citing malicious loopholes, they come up with creative solutions to more than satisfy customers.

  Mocatta used creativity to prevent a liquidity crunch. Even in its best form, rehypothecation can create a liquidity crisis and panic due to the basis risk. Mocatta averted that and everyone was satisfied. It's poetic justice that Mocatta was also lucky in its timing in the silver market.

  But as I said at the outset, allowable rehypothecation is not what has everyone up in arms about the missing money at MF Global.

  Congresswoman Marcy Kaptur Confronts MF Global and Wall Street

  December 26, 2011

  On October 31, MF Global went bankrupt under circumstances that suggest a classic situation for fraud. MF Global's Chairman of the Board and CEO was Jon Corzine, former Goldman Sachs CEO, former U.S. senator (D., New Jersey), and former governor of New Jersey. On November 4, 2011, Corzine resigned as head of MF Global. Customer money to the tune of $600 million to $1.2 billion is still missing. JPMorgan was MF Global's largest secured creditor. Corzine either can't or won't explain what happened. He offers neither a theory nor an expert opinion.

  Jon Corzine was a huge fundraiser, a "bundler" accumulating contributions from other people for campaigns for the Democratic Party. The Center for Responsive Politics reported that Corzine and his first and second wives contributed a combined $917,000 to Democratic committees and candidates over a 20-year period. Since April 2011, Corzine bundled in excess of $500,000 for President Obama's re-election campaign.

  On December 24, 2011, it was announced that President Obama returned direct contributions of $70,000 from Corzine and his wife, Sharon Elghanayan. They had each given the maximum allowable amount of $30,800 to the Democratic National Committee (DNC) and $5,000 to President Obama's campaign.

  Of course the DNC and President Obama can't distance themselves fast enough from Jon Corzine now. But if this is to be more than a political stunt, they should toss back the $500,000 that Corzine raised from his friends on Wall Street.

  A Few Good Men and Women

  A few members of Congress fight for the rights of taxpayers and for the system of justice we used to expect in the United States before special interest groups bought much of Congress.

  Representative Marcy Kaptur is a fierce fighter for justice not only for her constituents but for all Americans. She's not alone. The MF Global hearings revealed that a mix of Democrats and Republicans stand up for what is right, but there are members of Congress on both sides of the aisle that don't.

  Representative Hayworth: "Goldman Sachs former partners... respect you greatly."

  Financial firms like Goldman Sachs spread their money around and contribute to the campaigns of both Democrats and Republicans.

  During the hearings of the House Financial Services Committee hearing on December 15, 2011, Representative Nan Hayworth (R., New York) treated Corzine like a royal that had misplaced his crown instead of the CEO of a bankrupt company with hundreds of millions or more of customer money missing under suspicious circumstances: "Governor Corzine, Mr. Abelow [former COO of MF Global]... I know Goldman Sachs former partners who know both of you and respect you greatly... I hope... you will employ your talents and your minds to enlightening us as to how we can prevent... this from ever happening again."

  Later she referred to Corzine's career as "rather stellar... to say the least." If she had spoken to customers of MF Global that found money missing from their "segregated" accounts, she would have heard a different point of view.

  In the two previous Congressional hearings both Corzine and Abelow had stonewalled and dodged. These aren't the guys to ask about prevention, unless Representative Hayworth wants their advice on how not to run a financial firm. Corzine was chairman, CEO, and initiator of an enormous risky trade, a net "off-balance-sheet" position of $6.3 billion in sovereign debt disclosed in MR Global's March 2011 annual report. He was in a position to overrule any risk manager. He got rid of one risk manager critical of his trades and installed another. Corzine is the poster child for worst practices in controls and corporate governance.

  Representative Huizenga: "Thousands feel cheated"

  In the December 15 hearings, Representative Bill Huizenga (R. Michigan) pressed Corzine and got him to admit he was a detail guy "in markets and client activities." Corzine said that in areas of his expertise he is "very hands on."

  Huizenga pointed out that the commingling of customer funds is serious. People lose law licenses and real estate brokerage licenses over it. "That's why you're seeing such anger and hostil
ity over this." He challenged Corzine's claiming that he didn't recall details and said it "doesn't ring true."

  Huizenga continued: "This certainly doesn't feel or look like you were caring for those other people's money in the way that you should have or certainly were expected to." None of Corzine's money was at risk in these accounts. The representative summed up: "You've got thousands of hard working people around this country that feel cheated."

  Are the Congressmen From New Jersey Going Easy on Corzine?

  The three Congressional hearings investigating the MF Global bankruptcy have so far had no teeth. During the Senate Agriculture Committee hearings on Tuesday, December 13, 2011, Senator Mike Johanns (R. Nebraska) expressed his disbelief at the representations made by officers of MF Global. The officers had claimed ignorance of the circumstances of the missing money.

  Senator Johanns responded: "There must have been many many [sic] people who knew that money was being drained out of client accounts... do you realize how incredible [your claim of ignorance] sounds to this committee?"

  Yet Senator Robert Menedez (D., New Jersey) later said: "After three hearings, I don't know what more we'll learn that we don't know today." Menendez is on the Senate banking committee, which hasn't held any hearings. This is strange, because the Senate banking committee is the only one that oversees MF Global's regulators. The senator took the seat vacated by Jon Corzine when he became governor of New Jersey. Menendez is a good politician, since he didn't rule out a Senate banking committee hearing if new facts come up. But it is the purpose of investigations and robust hearings to uncover the facts in the first place.

  When it comes to fraud, if you don't look for it, you don't find it, because when it comes to fraud, there is always a cover-up.

  Representative Kaptur on MF Global: "I believe most of us would call that theft."

  Representative Marcy Kaptur is not on any of the aforementioned committees, but she has been following the hearings in both the House of Representatives and the Senate. She read her special order into the Congressional Record:

  "The fact that 'customer accounts were not intact,'' as [CFTC] Commissioner Sommers described it, means that someone took other people's money. I believe most of us would call that theft. Even if some of the money is recovered by the bankruptcy process, that does not alter the fact that the process by which customer accounts were violated broke the law." Excerpt from Representative Marcy Kaptur's Special Order on MF Global December 14, 2011.

  A Rigged Financial System and Another Former Goldman Sachs CEO

  Representative Kaptur has experience debunking Wall Street's spin. Bank of America's officers withheld material information from shareholders concerning losses and bonus payments related to its takeover of Merrill Lynch during the 2008 financial crisis. Bank of America wildly overpaid for the acquisition and taxpayer bailouts were needed as the extent of losses became apparent. Bonus payments of $3.6 billion were given to Merrill Lynch executives as the firm imploded and was sold to Bank of America. Merrill lost $27 billion in 2008.

  "Bank of America agreed to pay a $33 million fine to the SEC but -- you guess it -- admit no wrongdoing. A heroic U.S. district judge, Jed Rakoff, refused to rubber-stamp the deal, which he called a breach of 'justice and morality' that 'suggests a rather cynical relationship between the parties.'" Third World America P. 154

  The SEC and Bank of America then cooked up a $150 million settlement. This is a classic negotiation ploy among the captured "regulators" at the SEC whose next job is often a lucrative position dependent on Wall Street for revenues. It's called lowballing. You set the expectations so low that you can increase your initial offer by multiples and it will still be a bad-faith joke on the party with whom you settle. Judge Rakoff reluctantly accepted the new settlement of only $150 million, since he felt bound by judicial restraint.

  Congresswoman Marcy Kaptur (D., Ohio) took on this issue and more when she grilled then Secretary of the Treasury Henry ("Hank") Paulson and former CEO of Goldman Sachs:

  "Your orchestration yielded... an unprecedented dumping of private sector losses on the U.S. taxpayer. History will show that the U.S. government and you knew about Wall Street's growing losses long before the Bank of America / Merrill merger. In fact, Bank of America's purchase of Countrywide in January 2008 was but another positioning of private sector interests in preparation for what I call the greatest Hail Mary pass of all time in taking those Wall Street losses and placing them on the next three generations. What interests me is who you helped and who you didn't."

  Goldman Sachs was a major beneficiary of bailouts and continued to pay its employees high bonuses. Warren Buffett got a sweetheart deal for injecting $5 billion into Goldman Sachs. Taxpayers injected $10 billion into Goldman Sachs -- among other extremely lucrative ongoing benefits -- and got a vastly inferior deal with timing of the unwind controlled by the borrower, Paulson's former firm, Goldman Sachs.

  CHAPTER 15

  BANANA REPUBLIC:

  THIS TIME IT’S IN ENGLISH

  Anchored Under Water

  June 26, 2009

  I recently spoke with a senior member of Congress who feels the American consumer needs to gust wind in the sails of the economy. He insisted the Americans with jobs should be spending more: “We want people to save 10% [he may have meant to say 5%], but they don’t need to save more. Why aren’t people spending money?”

  I’ll get to that answer in a minute, but first the Americans who are out of work deserve a mention. More than 9.4% of Americans are out of work, and there are others who aren’t reporting. Some unofficial estimates put the unemployment rate as high as 15%. Perhaps more banks should have held onto their TARP money, because we have been using both hook and crook to prop up our mortgage loan numbers. Now the credit card charge-offs are kicking in. Forbes points out that credit charge offs are at record highs of 10.4% ("New Highs for Credit Card Charge-Offs,” Forbes, June 24, 2009). The charge-offs are right on schedule as beleaguered consumers walk away from credit card debt with the highest interest rate charges (see Transcript: Janet Tavakoli, Forbes, April 27, 2009), and these are the charge-offs that will have the largest impact on banks’ profit margins.

  What about the rest of Americans? They can often get good deals in our (temporarily) deflationary environment, and since we are anticipating high inflation to come, one might think this would be a good time to buy. Yet, the average consumer is not spending nearly enough to stimulate the economy, and many appear to be saving more than ever. Even consumers that are free of fear for their economic futures are anchored to their past notion of their former net worth.

  The economy is still deleveraging a high average consumer debt load. This creates continued downward pressure on the housing market. Even fiscally responsible Americans have already seen the values of their homes decline, the value of their pensions deteriorate, and the value of their personal investment portfolios plummet. Portfolios are under water compared to past higher values anchored in the minds of investors. The negative wealth effect has had a huge psychological impact (see Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street).

  Those with jobs are trying to save their way back to their former notion of a higher net worth. The old number is stuck in their minds like a barnacle. We have a long wait before American consumers again say “Anchors Aweigh!”

  Stranguflation: Deflation and Inflation Where It Hurts America Most

  August 3, 2010

  The U.S. is suffering from high unemployment combined with too much consumer debt in a weak economy. Current stock market exuberance reflects earnings increases at selective companies that benefited from sputtering stimulus programs. In late 2007 through the fall of 2008, our economy had an appendix attack, and Congress issued potent addictive painkillers instead of fixing our problems.

  Meanwhile, the financial system has strangled U.S. growth by parasitically growing from 3% of GDP in 1965 to 7.5% of GDP currently. As Jeremy Grantham pointed out in his qua
rterly letter to investors, financial services were sufficient for the economy when they were 3% of GDP, but that sector grew by strangling GDP growth elsewhere. The nation's GDP growth slowed from 3.5% in 1965 to 2.4% between 1980 and 2007, and the slowdown occurred before our current crisis.

  In other words, our bloated financial sector has been sucking the life-blood out of the U.S. economy for years, and recent decisions insure it will continue to feed off taxpayers, while the host economy struggles for life.

  Jobless "Recovery"

  Unemployment exceeds 10%, counting the underemployed it is closer to 20%, and the figures soar beyond that when one counts our unemployed youth. The recovery is being strangled in its crib by low job creation, high consumer debt, high local government debt, high federal government debt, and falling tax revenues. [Update August 6, 2010: Official figures for overall unemployment as of July, announced August 6, held at 9.5%.]