The New Robber Barons Read online

  Michael Blum, then Merrill Lynch's head of global asset-backed finance, sat on Ownit's board. (Blum left Merrill in mid 2008 after the securitization was cut back.) When Ownit declared bankruptcy--instead of demanding a fraud audit--Blum faxed in his resignation.

  After the bankruptcy, Merrill continued packaging Ownit's loans. Following a multi-year pattern, Merrill disguised the risk. Merrill packaged Ownit's risky loans in 2007, and failed to disclose that it was Ownit's largest creditor. Within a year, the so-called "AAA" rated tranche was downgraded to a junk rating of B, meaning you are likely to lose your shirt. (A mutual fund was stuck with it.) This meant that "investment grade" tranches below the "AAA" were worthless or nearly worthless, because those investors agreed to take losses before the "AAA" investors.

  Losses were not simply due to fickle market prices. There was permanent value destruction.

  Merrill Lynch further disguised risk by repackaging phony "investment grade" tranches into new investments called CDOs and CDO-squared. Credit derivatives amplified the problem, because one could sell value-destroying investments more than once. This was only obvious to professionals, because some mortgages took a couple of years for payments to reset. By 2007, things were so bad that many loans were total shams and began defaulting almost immediately. This is the classic end of a Ponzi scheme.

  Merrill Lynch did not sell tens of billions of uninsured so-called super-safe "super senior," CDOs, because if it had, in-the-know market players would have discounted them.*** Merrill's employees wanted to continue to earn high bonuses, so they did not sell them, they did not record losses, and they temporarily got away with this fiction. Merrill's accountants--like all of Wall Street's accounting firms--failed in their jobs.

  At the beginning of 2007, the problem was obvious to many alert non-professionals, but the SEC still let Merrill (and other Wall Street firms) get away with it. That year, Merrill Lynch issued 30 CDOs amounting to $32 billion. Within a year, every single CDO had its "AAA" tranches downgraded to junk by one or more rating agencies.

  (Click here for my June 2008 commentary. The third page shows each 2007 CDO, the CDO "manager" involved, and the CDOs' status at the time.)

  By the second quarter of 2007, Merrill's executives still told shareholders things were rosy. Yet Bear Stearns's hedge fund creditors heavily discounted similar investments and put low prices on many of them. Credit derivatives benchmarks began a death spiral. Merrill Lynch failed to take billions of dollars of losses for the second quarter of 2007, despite publicly available information that belied its accounting reports.

  Bank of America struck a deal to acquire Merrill Lynch in September 2008. In January 2009, one month after the shareholder vote on the merger, BofA revealed that Merrill reported more than $15 billion in losses for the fourth quarter of 2008. Even then BofA did not come clean about the exact timing of the losses. BofA claimed the losses occurred in December. I publicly refuted the claim and said most of the losses had probably occurred in November due to trading activities unrelated to subprime or CDOs (Click here for more).

  Bank of America kept shareholders in the dark and took another $20 billion in TARP money. The Slumbering Esquires Club (SEC) may just now file a new complaint to add the charge that Merrill failed to disclose the enormous material losses before the December 2008 shareholder vote.

  Bank of America continues to receive massive subsidies from the U.S. taxpayer without which its level of earnings would not be possible. BofA took $45 billion in TARP money (since repaid), has guarantees of $118 billion against bad assets, and continues to receive massive amounts of taxpayer financing subsidies in various forms.

  Why should Bank of America--or any other firm involved with the debacle--hand out billions of dollars’ worth of cash and stock to employees while pretending its business model and incentives aren't fatally flawed?

  * Bank of America, Merrill Lynch (now part of Bank of America), Washington Mutual (now part of JPMorgan Chase), Wells Fargo, General Electric, JPMorgan Chase, Citigroup, Bear Stearns (now part of JPMorgan Chase), AIG, and Wachovia (now part of Wells Fargo) were participants or are now current owners of the top 20 subprime (or high interest loan) lenders during the period of the worst abuses from 2005 through 2007. In addition, these financial institutions, along with Goldman Sachs and Morgan Stanley, contributed funding through credit lines or sales without which the lending would not have been possible. (Click here for a list of subprime mortgage-backed securities underwriters.)

  ** Countrywide was renamed Bank of America Home Loans in February 2009. Separately, BofA bought Merrill Lynch, which bought First Franklin from Nat City in September 2006. First Franklin was one of the top four subprime lenders with more than $68 billion in loans from 2005 to the end of 2007. The operation was closed in March 2008.

  *** Merrill Lynch could not find enough demand from bond insurers to disguise its risk. AIG stopped insuring Merrill's CDOs before the end of 2006. Merrill insured other CDOs with other bond insurers: ACA (now bankrupt) and municipal bond insurer MBIA, which was since downgraded from AAA to junk.

  JPMorgan’s Losses From Indecent Exposure

  August 9, 2010

  JPMorgan Chase's fixed-income revenue fell almost 28% to $3.6 billion in the second quarter, down from $5.5 billion in the first quarter, and down from $4.9 billion for the same period last year. JPMorgan blamed an interest rate squeeze and bad results in the credit markets and the commodities markets.

  There were no details of its significant loss from unwise, gigantic, wrong-way wartime coal bets. The bank took a short position so enormous that it was oversized relative to the global coal market, and second quarter losses reportedly were in the hundreds of millions of dollars.

  Financial Reform Failure

  Blythe Masters, managing director in charge of JPMorgan's global commodities group, spent time lobbying in Washington to dilute financial reform. By her own admission, JPMorgan's recent speculation in coal wasn't client driven; the risk was taken on JPMorgan's behalf. The Dodd-Frank Financial Reform Bill does nothing to prevent a repeat -- or even a potentially worse -- debacle.

  The commodities division isn't the only area in which JPMorgan is vulnerable. Credit derivatives, interest rate derivatives, and currency trading are vulnerable to leveraged hidden bets. Ambitious managers strive to pump speculative earnings from zero to hero.

  Instead of transparent and regulated markets, we have dark markets, hidden leverage, proprietary speculative trading, lax regulation and oversized risks.

  "Scared Sh*tless"1

  Blythe Masters told her remaining employees that competitors are "scared sh*tless" of JPMorgan's commodities division. She claimed the layoffs of 10% of front office staff are not a sign of JPMorgan "panicking" and called the risk taking in coal trading that left JPMorgan wide-open to a massive short squeeze a "rookie error."

  For individual traders, JPMorgan doesn't follow the Wall Street maxim: He who sells what isn't his'n, must buy it back or go to pris'n. The U.S. can count on JPMorgan to continue both long and short market manipulation and take its winnings and losses from blind gambles. Shareholders, taxpayers, and consumers will foot the bill for any unpleasant global consequences.

  Physical oil traders from JPMorgan's brand new RBS Sempra Commodities LLP acquisition (JPMorgan paid $1.7 billion) left of their own accord to join smaller firms with less capital. Masters said these were "very interesting career decisions."

  The defections were all the more interesting, because Masters began her career as a JPMorgan commodities trader. RBS Sempra's oil traders gave Masters a vote of no confidence. Their flight was a loss of "key people," whom she said she needs to replace.

  Masters is poised for more debacles:

  "All it's going to take is a little pop to the upside. We could be producing a 30 to 35 percent ROE and looking like gods."

  Good luck with that. Masters also noted that this potential windfall might come at the expense of others:

  "We've got too
many banks chasing too little volume and margins have compressed."

  The United States is trying to pull out of the greatest financial tailspin in its history. Dice-rolling braggadocio by a key officer at one of the nation's largest banks is exactly the kind of thing Congress, taxpayers, and voters should find scary. Arianna Huffington explains the consequences for middle class Americans, who pay a disproportionate share of the bill in her upcoming book, Third World America. 2

  Ramp up Risk and Cross Your Fingers

  Big unanticipated market moves always result in big winners and big losers among big gamblers. After the fact, most winners claim they were smart--not just lucky.

  When bank managers take a big gamble and lose hundreds of millions of dollars, they don't call it reckless; they spin it as an error of "judgment." The directive is to "put on risk" and "generate results." This may be why Masters cautioned employees:

  "I don't want us talking to the outside world, neither about successes nor about failures."

  JPMorgan is making big bets and crossing its fingers in a dangerous and volatile market.

  Masters takes "pleasure" in the "ballsiest" business, and she wants her traders to get lucky. Moreover, she's engaged in internal spin control and plans a "deep dive" with the Board and the CFO. This may reduce her chances of walking Wall Street.

  No one should be concerned for the job security of managers like Masters at JPMorgan, and that is precisely the problem. Delusional risk-taking and lack of transparency at Too-Big-To-Fail banks -- especially in the areas most vulnerable to rampant speculation -- were ignored by so-called financial reform.

  1 All words in this article in quotation marks are from Business Week's (Bloomberg News) major scoop after the leak of a tape of an internal JPMorgan July 22 conference call: "Blythe Masters Says 'Don't Panic' as Commodities Slip," by Dawn Kopecki, August 3, 2010.

  2 Based on my reading of an advance copy of Arianna Huffington's new book: Third World America: How Our Politicians Are Abandoning the Middle Class and Betraying the American Dream, Crown Books, September 2010.

  Jamie Dimon and Robert Rubin: Evasive on "Fraud as a Business Model"

  November 12, 2010

  Foreclosure fraud isn't about losing paperwork or having incorrect paperwork. It is about committing fraud and trying to manipulate the U.S. legal system. No one -- not even a bank -- can show up in court with phony evidence.

  State Attorneys General decry foreclosure fraud, because among other things, people signed affidavits making representations that were untrue. This is fraud on the court. All of these foreclosures may be vacated.

  Corrupt people in Congress and corrupt regulators cannot intervene for the banks this time. Banks have to face state courts, and many Attorneys General are happy to take them on.

  Banks that committed fraud on the court do not get a do-over. Even if they can show up later with correct documents, it does not erase the original crime of fraud on the court. Anyone who presented phony documents as evidence in court broke the law.

  Former Ohio Attorney General Richard Cordray advised banks that engaged in fraud on the courts (by submitting falsified affidavits) to negotiate meaningful loan modifications.

  Jamie Dimon's Evasion

  Jamie Dimon, CEO of JPMorgan Chase, said that JPMorgan did not foreclose on people who didn't deserve it. Dimon was dismissive saying JPMorgan might have to pay some penalties, but it should just carry on with foreclosures.

  JPMorgan's third quarter 2010 report contradicts its CEO: "But the financial statement itself proved the lie. The bank said it was carefully checking 115,000 mortgage affidavits. It set aside a whopping $1.3 billion for legal costs. And it put an extra $1 billion into a now $3 billion fund for buying back bunk mortgages and mortgage products." (“Too Big to Fail Rears its Head Again," by Annie Lowrey, Washington Independent, October 14, 2010.)

  JPMorgan's role in alleged foreclosure fraud had already been made public when Dimon made these ill-considered statements.

  In a CNBC interview, Former Ohio Attorney General Richard Cordray retorted to baseless claims made by Ally Bank, formerly known as GMAC Bank, which was bailed out by TARP. Ally said that it didn't know of instances of improper foreclosures. Cordray shot back that every foreclosure done with falsified affidavits was improper. It's fraud on the courts. He stated that as yet, no one knows the scope, but it could be tens of thousands or hundreds of thousands of instances of fraud on the court.

  The fact that this happened repeatedly doesn't make it more excusable, it makes it worse. Ally Bank, Bank of America, and JPMorgan have admitted to this practice. Apparently they had "fraud as a business model."

  The good news for banks is that Richard Cordray was not reelected to the post of Ohio's Attorney General. The bad news for banks -- and the good news for Ohio -- is that Cordray may become an Ohio Supreme Court Justice.

  Robert Rubin Dodges Responsibility

  The Economist's Buttonwood Gathering in New York on October 25 featured Robert Rubin, former senior advisor of Citigroup (also former Treasury Secretary under President Bill Clinton, and former Co-Chair of Goldman Sachs) as head of the first panel. He led a role-play about what might happen if one of the United States defaulted on its debt in the year 2013.

  States cannot declare bankruptcy, but neither Rubin nor any other panel member mentioned it. Instead of putting states on notice now that they have to get their budgets in order -- even if it means cutting back on promises -- the panel suggested that the Federal Government should bail out the states.

  When it came time for Q&A, I asked the first question and framed it by pointing out the irony of this panel discussing a potential state default and systemic risk. While many states have been fiscally irresponsible, their distress is now acute due to fraudulent lending further damaging the economy leading to reduced tax revenues.

  Moreover, weak states also have higher borrowing costs, since municipal bond insurers' credit ratings imploded after they sold credit default swap (CDS) protection on value destroying securitizations (CDOs).

  Rubin's Citigroup bought credit default swap protection from Ambac, one of the two largest municipal bond insurers, on Citi's value destroying mortgage backed securitizations.

  During Rubin's watch as Citigroup's "risk wizard," Ambac sold protection on Citi's toxic CDOs including Diversey Harbor ($1.875 billion), Ridgeway Court Funding I ($1.57 billion), Ridgeway Court Funding II ($1.95 billion), Adams Square II ($510 million), 888 Funding ($500 million), Class V Funding III ($500 million). Citi settled many of these contracts with Ambac for deep discounts. (The Fed did not have taxpayers' interests in mind when it settled AIG's transactions with Goldman Sachs and others for 100 cents on the dollar.)

  Ambac filed for Chapter 11 bankruptcy on November 8, 2010, two weeks after Rubin's shameful performance on this panel.

  Robert Rubin didn't express an ounce of regret (or context) for his role in the crisis. On the contrary, he was insufferably smug. In his opening remarks, Rubin self-servingly asserted that no one could foresee the crisis in 2007, despite ample public evidence to the contrary. Citigroup and Ambac never came up. (See also "Congress's FCIC Nearly Nailed Former Citigroup Executives to the Wall -- Then Blew It," Huffington Post, April 8, 2010.)

  The Biggest Headache for Investors in Groupon and Facebook

  March 3, 2011

  Groupon makes its money by selling coupons for goods and services. It partners with local merchants. When you buy a coupon for a merchant's discount on Groupon, it reportedly takes a 50% cut in the U.S.

  Groupon has had a few embarrassments. On Valentine's Day, FTD's flowers were priced lower than Groupon's "deals" and the online discounter had to apologize to customers. Moreover, merchants often put conditions and restrictions on Groupon discounts that dilute the value of the deal, similar to restrictions on redeeming air miles. Even so Groupon's valuations have ranged from $1.2 billion to $6 billion to $15 billion all in the space of a year. What's it really worth? More on that later.r />
  Facebook is free and "always will be." It makes its money from ads and revenues from games (if users don't block them), albeit phone apps so far do not display ads. Michael Arrington at Techcrunch reported that Facebook is secretly building its own phone to control its own operating system. He noted that Li Ka-Shing is a Facebook investor, and he is an investor in the rumored INQ and Spotify phone project. While Facebook may remain free, it would have to figure out a way to get users to pay their phone bills.

  Facebook has tremendous potential to exploit its 500 million users. In fact, one of Facebook's fundraisers is a genius at exploitation. Goldman Sachs, the Great and Powerful Oz of Finance (just don't look behind the curtain), has already opined on Facebook's value. In January 2011, it valued Facebook at $50 billion when it sought to raise $1.5 billion in Facebook financing.

  Rich Teitelbaum of Bloomberg News reminded the financial world that Goldman Sachs Asset Management's anemic track record suggests that Goldman may not be the best go-to source for putting a value on an asset. Despite Goldman's public relations hype that it employs the "best and brightest," it trailed the average return of its peer group in every category. Goldman has an incentive to dangle a high valuation on Facebook in front of clients: