http://www.huffingtonpost.com/2012/05/03/michael-lewis-the-volcker_n_1474848.html?ref=business
Showing posts with label The Big Short by Michael Lewis. Show all posts
Showing posts with label The Big Short by Michael Lewis. Show all posts
Friday, May 4, 2012
Michael Lewis!
The greatest interview of 2012...on CNBC yesterday.
http://www.huffingtonpost.com/2012/05/03/michael-lewis-the-volcker_n_1474848.html?ref=business
http://www.huffingtonpost.com/2012/05/03/michael-lewis-the-volcker_n_1474848.html?ref=business
Saturday, April 23, 2011
Sunday, June 6, 2010
Naked Lady Just Walked Across Piazza in Barcelona
photo (c) 2010 Rebecca Abel Worple and OwenEmma.com(c) 2010 F. Bruce Abel
Beautiful lady, too. Men applaud.
Saturday, May 29, 2010
The Man Himself Writes!
(c) 2010 F. Bruce Abel
Michael Lewis.
http://www.nytimes.com/2010/05/30/opinion/30lewis.html?pagewanted=all
Michael Lewis.
http://www.nytimes.com/2010/05/30/opinion/30lewis.html?pagewanted=all
Saturday, May 15, 2010
Wednesday, April 28, 2010
Goldman Sachs -- "Sociopaths"
(c) 2010 F. Bruce Abel
The best comment yet on the Goldman hearings earlier this week, from "KT NY":
(Who else ever started a piece with the word "telling?" Very effective.)
April 28th, 2010 10:51 am
Telling to me was the fact that, although they most certainly had been warned by their attorneys to treat the hearing seriously and the Senators respectfully, the Goldman Sachs crew exuded contempt and smugness from every pore. "Our net worth is higher than yours," they seemed to be saying, "So you're stupid and we win."
What to do about these lunkheads? Clearly, it will not help to explain to them that not all smart people choose to devote their lives to making money: some design the Hadron Collider, identify the gene that causes breast cancer, write symphonies, and even become U.S. Senators. It will not help to explain, because to these guys, competition and its rewards -- status and cash -- are all that matter in life. Period. They're built that way, psychologically, and we're not going to change their minds.
What we can do, however, is recognize that while Wall Street culture -- the Goldman Sachs syndrome -- does in fact add value to our society, by allowing money to move through the system to those who need money to run businesses, that culture must be contained. That's because, as we saw in the Senate hearings yesterday, those who excel at the art of the deal are basically sociopaths, with few moral values and no ethical brakes. Their contributions to society might be analogized to nuclear energy: we build reactors, and the reactors make electricity. Yet those reactors have to be carefully monitored and controlled. If we let them blow up, we all die.
Because of its erroneous, free market ideology -- not to mention the money that it collects from Wall Street -- the Republican Party is incapable of recognizing that letting Wall Street operate without restraints is like building a nuclear reactor in Times Square and yelling "Let 'er rip!" In its own way, the GOP is as blind, and clueless, as the Goldman Sachs traders. That is why regulation is not merely needed, but will occur only if the public starts calling Senators -- like tomorrow -- to make its will known.
There is an election coming up. It's time to let your Senators know that the Era of the Poopy Deal must come to an end.
Globular and Mailer
(first the link to the New York Times article and comments above; too lazy to reformat above the title):
http://community.nytimes.com/comments/www.nytimes.com/2010/04/28/opinion/28dowd.html?scp=3&sq=sociopaths&st=cse
And some good from the Globe & Mail, especially the comments after the article, in today's Business section:
http://www.theglobeandmail.com/globe-investor/markets/markets-blog/the-casino-analogy/article1549918/?cid=art-rail-marketsblog
The best comment yet on the Goldman hearings earlier this week, from "KT NY":
(Who else ever started a piece with the word "telling?" Very effective.)
April 28th, 2010 10:51 am
Telling to me was the fact that, although they most certainly had been warned by their attorneys to treat the hearing seriously and the Senators respectfully, the Goldman Sachs crew exuded contempt and smugness from every pore. "Our net worth is higher than yours," they seemed to be saying, "So you're stupid and we win."
What to do about these lunkheads? Clearly, it will not help to explain to them that not all smart people choose to devote their lives to making money: some design the Hadron Collider, identify the gene that causes breast cancer, write symphonies, and even become U.S. Senators. It will not help to explain, because to these guys, competition and its rewards -- status and cash -- are all that matter in life. Period. They're built that way, psychologically, and we're not going to change their minds.
What we can do, however, is recognize that while Wall Street culture -- the Goldman Sachs syndrome -- does in fact add value to our society, by allowing money to move through the system to those who need money to run businesses, that culture must be contained. That's because, as we saw in the Senate hearings yesterday, those who excel at the art of the deal are basically sociopaths, with few moral values and no ethical brakes. Their contributions to society might be analogized to nuclear energy: we build reactors, and the reactors make electricity. Yet those reactors have to be carefully monitored and controlled. If we let them blow up, we all die.
Because of its erroneous, free market ideology -- not to mention the money that it collects from Wall Street -- the Republican Party is incapable of recognizing that letting Wall Street operate without restraints is like building a nuclear reactor in Times Square and yelling "Let 'er rip!" In its own way, the GOP is as blind, and clueless, as the Goldman Sachs traders. That is why regulation is not merely needed, but will occur only if the public starts calling Senators -- like tomorrow -- to make its will known.
There is an election coming up. It's time to let your Senators know that the Era of the Poopy Deal must come to an end.
Globular and Mailer
(first the link to the New York Times article and comments above; too lazy to reformat above the title):
http://community.nytimes.com/comments/www.nytimes.com/2010/04/28/opinion/28dowd.html?scp=3&sq=sociopaths&st=cse
And some good from the Globe & Mail, especially the comments after the article, in today's Business section:
http://www.theglobeandmail.com/globe-investor/markets/markets-blog/the-casino-analogy/article1549918/?cid=art-rail-marketsblog
Sunday, April 18, 2010
Where Was Lynn A. Stout When Her Information Was Needed?
(c) 2010 F. Bruce Abel
Where was Lynn A. Stout when her information was needed?
http://roomfordebate.blogs.nytimes.com/2010/04/16/what-goldmans-conduct-reveals/#lynn
Over and over again there is nobody to present the other side of legislation that enabled the system to be destroyed. That's because there is nobody funding that side. Nobody called an expert to research the issue and report to Congress.
So as clear as Lynn A. Stout's piece is to us, where was she in 2000 when this information would have been relevant?
The information:
Sunday, April 18, 2010
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April 16, 2010, 3:31 pm What Goldman’s Conduct Reveals
By THE EDITORS
The Securities and Exchange Commission filed a civil lawsuit against Goldman Sachs for securities fraud on Friday, charging the bank with creating and selling mortgage-backed securities that were intended to fail.
According to the complaint, Goldman let John Paulson, a prominent hedge fund manager, select mortgage bonds that he wanted to bet against because they were most likely to lose value and packaged those bonds into the “Abacus” investments, which were sold to investors like foreign banks and pension funds. As those securities plunged in value, the Paulson hedge fund made money on the negative bets, while the Goldman clients who bought the investments lost billions of dollars.
Is this chain of events surprising? The S.E.C. is suing Goldman Sachs, but could regulation or monitoring of these financial instruments have prevented such losses? What kind of regulatory structure would need to be put in place?
Lynn A. Stout, professor of corporate and securities law, U.C.L.A.
Michael Greenberger, former commodities regulator
Nicole Gelinas, Manhattan Institute
Yves Smith, financial analyst
Nomi Prins, senior fellow, Demos
Edward Harrison, banking and finance specialist
Douglas Elliott, Brookings Institution
Megan McArdle, Asymmetrical Information
William K. Black, former banking regulator
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The Natural Result of Deregulation
Lynn A. Stout is the Paul Hastings professor of corporate and securities law at U.C.L.A. and an expert on corporate governance.
If the allegations against Goldman Sachs are true, then much of the blame for investors’ losses in the Abacus deal can be laid at the feet of an obscure statute passed by Congress in 2000, the “Commodities Futures Modernization Act.”
If we allow the unscrupulous to buy fire insurance on other people’s houses, the incidence of arson would rise sharply. In one dramatic move, that act eliminated a longstanding legal rule that deemed derivatives bets made outside regulated exchanges to be legally enforceable only if one of the parties to the bet was hedging against a pre-existing risk.
This traditional derivatives rule against purely speculative derivatives trading has a parallel in insurance law, because insurance, like derivatives trading, is really just a form of betting. A homeowner’s fire insurance policy, for example, is a bet with an insurance company that your house will burn down.
Under the rules of insurance law, you can only buy fire insurance on a house if you actually own the house in question. Similarly, under the traditional legal rules regulating derivatives trading, the only parties who could use off-exchange derivatives to bet against the Abacus deal would be parties who actually held investments in Abacus.
By eliminating this centuries-old rule in the name of “modernization,” Congress created enormous problems of moral hazard in the off-exchange derivatives market. Imagine, for example, if we allow the unscrupulous to buy fire insurance on other people’s houses; the incidence of arson would rise dramatically.
Similarly, by allowing an unscrupulous hedge fund to use derivatives to bet against an Abacus investment vehicle it didn’t own, the Commodities Futures Modernization Act invited that hedge fund to work with Goldman Sachs to make sure that Abacus would indeed fail — as it did.
Sadly, greed is a constant in human nature. We’re not likely to eliminate it soon. But we can at least keep it in check. It’s time for Congress to address the problem of moral hazard in derivatives betting by repealing the Commodities Futures Modernization Act.
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Accountability, at Long Last
Michael Greenberger is a professor at the University of Maryland School of Law and a former director of trading and markets at the Commodity Futures Trading Commission.
If Sept. 15, 2008, the day Lehman Brothers was allowed to fail, marks the Pearl Harbor or widely acknowledged onset of the present Great Recession (in Franklin Roosevelt’s words “a date which shall live in infamy”), April 16, 2010 may be deemed the equivalent of the U.S. victory in the crucial Battle of Midway in 1942 or the day the U.S. neutralized the Japanese fleet.
If the fall of Lehman was Pearl Harbor, the S.E.C.’s case against Goldman may be the Battle of Midway — a crucial victory.
.On April 16, 2010, the S.E.C. announced its enforcement action against Goldman Sachs alleging the improper marketing of what the S.E.C. alleges was the sale of two evenly matched, but highly conflicting, investments: essentially bets for and against the proposition that subprime (non-creditworthy) mortgage borrowers would pay back their loans. Goldman is alleged to have profited substantially from those who bet against subprime repayment while aggressively marketing to its other customers bets in favor of repayment.
Let’s be clear. Goldman Sachs vigorously denies the S.E.C.’s allegations, and doubtless it will fight the action with the utmost vigor. It is certainly entitled to do so.
Read more…
However, what makes the S.E.C. enforcement action a landmark is that it responds to a widely held desire on the part of the American taxpayer: accountability.
The underpinnings of that desire is that the present crisis, including high unemployment and devastating economic insecurity accompanied by skyrocketing deficits, was not caused by the average American. But, it is the average American who has had to foot the bill for restoring the economy.
What is especially aggravating is that those who unmistakably did cause the crisis, i.e., the “pillars of Wall Street,” are now stronger and more profitable than ever before. And the impression is that Wall Street has returned to “business as usual,” once again using the same investment strategies that brought on the fall 2008 deluge.
The case against Goldman shows that savvy insiders knew the financial crisis was coming, and profited from it.
.So the key question from Main Street is: where is the accountability? If the average American fails miserably in a business or professional enterprise, there are consequences, e.g., firing or bankruptcy. Up to today, it appeared that those traditional hallmarks of failure did not apply to Wall Street or those who were responsible for regulating Wall Street.
Just last week, Alan Greenspan, the former Fed chairman, and Robert Rubin, the former Treasury Secretary and Citigroup officer, said they were not to blame for the meltdown even though both prevented regulation of the kind of bets Goldman Sachs is now accused of misusing.
More galling is the constant refrain from both Wall Street C.E.O.s and former regulators that no one could have predicted the crisis. However, the S.E.C. allegations are premised on the fact that hedge funds and Goldman Sachs itself were so convinced of cataclysmic failure that they were looking for investment vehicles that would profit each time a homeowner defaulted on his or her mortgage.
In other words, there were competent and smart people making billions because they could foresee the obvious: people with poor credit would not be able to repay their home loans.
In short, it was not that no one knew. Savvy insiders knew.
We do not know the success of the S.E.C.s actions today. But, if successful, you can be sure that this will be the beginning of what those average Americans suffering during this Great Recession are desperately seeking: accountability.
As Winston Churchill said after early Allied victories in World War II: “This is not the end or even the beginning of the end; but it is the end of the beginning.” We may now be at the beginning of rewarding competence and sanctioning ineptness or worse.
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A Third Party Problem
Nicole Gelinas, a contributing editor to the Manhattan Institute’s City Journal, is the author of “After the Fall: Saving Capitalism from Wall Street — and Washington.”
The government’s charges against Goldman and its employees — if true — are not shocking. People lie. The Securities and Exchange Commission can do better at enforcing the laws that make liars think twice. But policing fraud cannot be our first line of defense against financial excess.
It’s simple: the German bank that bought the mortgage securities shouldn’t have relied on a consultant.
.The S.E.C. says that Goldman, in early 2007, told mortgage-bond buyers that the consultant who helped create their securities had their best interests at heart. The consultant was taking advice, at Goldman’s behest, from another investor who would profit when the securities went bust.
Synthetic collateralized debt obligations are hard, but dishonesty with clients is easy. Raking through the details of the case uproots far deeper problems, though.
Read more…
First, the obscure third parties that helped Goldman and other big banks sell complex deals encouraged investors to suspend necessary skepticism.
The German bank that bought the mortgage securities, IKB Deutsche Industriebank, fancied itself a sophisticated firm. So why did it rely on a Goldman consultant, ACA Management, as a “portfolio selection agent?” And why did sophisticated investors need third parties to “insure” the securities?
Just as Bernie Madoff’s investors would have done better not to rely on advisers to tell them that Bernie was O.K., IKB would have been better off performing its own analysis of American mortgage markets.
But obscure third parties were the spawn of Washington’s bank bailouts starting in the 1980s. The expectation of government support artificially fed Wall Street growth — so there was plenty of cheap money to trickle down from the too-big-to-fail banks to the ever-more-creative little guys.
Second, applying old trading and capital rules to new financial markets would have reduced hanky-panky.
Goldman was able to “customize” securities, allegedly committing fraud under cover of the opacity that customization provided, because the securities did not trade on a public marketplace. Such a marketplace would have demanded simplicity from Goldman in creating the securities. Thousands of investors, rather than a few hand-picked third parties, could have analyzed and priced them.
The same is true in credit-derivatives markets. Opacity serves only the banks, which reap higher fees from customers who remain in the dark.
Enforcing justice is vital to markets. But Washington should help investors, too, by reducing opportunities to thwart justice. We need a return to simplicity. Congress should direct regulators to impose trading, disclosure and capital rules consistently across financial firms and instruments — so that markets can smash the repositories for secrets that imperil the economy.
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Immoral, Destructive Behavior
Yves Smith writes the blog Naked Capitalism. She is the head of Aurora Advisors, a management consulting firm, and the author of “Econned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.”
Strange as it may seem, the Securities and Exchange Commission’s lawsuit against Goldman Sachs for selling collateralized debt obligations (C.D.O.) designed to fail illustrates what a long and difficult haul it will be to reform the financial services sector.
This case should be a slam-dunk, but years of deregulation have narrowed the ground for lawsuits.
.Goldman allowed hedge fund manager John Paulson to sponsor a C.D.O. The sponsor can influence how the C.D.O. is constructed, the notion being that the sponsor will act in ways that help all the other investors. But this C.D.O. was allegedly a Trojan horse for Mr. Paulson to take a large short position, betting against the very same C.D.O. he was creating.
But his intent was not disclosed. And, not surprisingly, the deal was a complete wipeout, with Mr. Paulson collecting a billion dollars of winnings at the expense of investors who had been kept in the dark and would almost certainly have turned down the deal if they had had the full picture.
By any common sense standard, this case should be a slam-dunk. However, despite tough talk by the Obama administration on financial reform, it is not mounting a criminal case against Goldman.
Read more…
Moreover, the S.E.C. has long had a difficult time winning complex financial fraud cases. While critics like to argue that the S.E.C. is not up to the task, the situation is more complex. Years of deregulation have narrowed the ground for lawsuits considerably. What’s more, structured credit is a new area of litigation. Thus the S.E.C. is also mounting its case in an arena where there are few precedents to rely upon.
If the S.E.C. loses its case against Goldman, it will be too easy to draw the wrong conclusion: not that the S.E.C. failed, but that the financial services industry succeeds all too well in its campaign to tear down the rules needed to make markets safe for investors.
No matter what happens to this particular lawsuit, it’s critical not to lose sight of the fact that immoral, destructive behavior has become deeply entrenched on Wall Street, and it will take concerted action to root it out.
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Smelling the Deception
Nomi Prins is a senior fellow at Demos. She is the author of “It Takes a Pillage: Behind the Bailouts, Bonuses and Backroom Deals from Washington to Wall Street” and “Other People’s Money: The Corporate Mugging of America.” She was a managing director at Goldman Sachs.
It’s probably no coincidence that Goldman Sachs took such great pains to deliver a decisive “we don’t bet against our clients” statement right before the S.E.C. levied its charge that the firm “defrauded” its clients through “misstating and omitting key facts.”
The entire nature of the C.D.O. business invites firms to act for certain clients and against others.
.Indeed, under the particulars of this complaint, Goldman didn’t bet against its clients directly, it merely acted on all possible angles of a deal that facilitated one huge client betting against other clients, while obfuscating the specifics of its enabling and fee-taking role in the triangle.
That’s why it is dangerous to single out one member of Goldman (where the title of vice president is low on the totem pole) as the culprit. Collateralized debt obligations were very lucrative for everyone involved. The bad apple approach enforces an inaccurate representation of two main problems.
Read more…
First, it took the S.E.C. nearly three years to wake up and smell the deception. This was a large deal involving a major investment house and major hedge fund. Having some sort of priority examination of such deals would have been prudent.
Second and more important, is the lax regulatory structure itself. In our current regulatory framework, any issuing bank can act on all sides of a C.D.O. (or other complex security) — as creator, trader, hedger and seller. This inevitably means there will be conflicts of interest because the bank in the middle gets paid (handsomely) for all its services, no matter what the outcome of the deal’s performance. Plus, it has the benefit of insider knowledge.
Even without putting together a C.D.O. portfolio on behalf of the same client whose interest is served by shorting it as is the case here, the entire nature of the C.D.O. business invites firms to act for certain clients and against others. There is always the possibility of stuffing the worst assets into a C.D.O. and marketing them as the best.
Risk is shuffled around the market from those in the know (like Goldman or Paulson) to those who have far less access to information or fancy analytics (like pension fund buyers.)
That’s how spread, or profit, is created. And, as we’ll see if more such deals get investigated for their unique conflicts, that’s how loss is deferred to others, too. The best protection is to isolate securities creation from distribution.
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Is This Political?
Edward Harrison is a banking and finance specialist at the economic consultancy Global Macro Advisors. He is also the principal contributor to the financial Web site Credit Writedowns.
When Lehman Brothers collapsed in a heap in 2008, the financial world was thrown into turmoil. The financial calamity was entirely foreseeable for those who chose to look. Reckless borrowing, lending and speculation were an integral part of the breakdown in our financial system. But so too was fraud.
It seems unlikely that the Goldman legal case is better than a potential legal challenge to Lehman’s use of ‘Repo 105.’
.Since at least 2004, when the FBI warned of a mortgage fraud “epidemic,” it has been clear that deception, predatory lending and outright fraud have been rampant in the financial services industry. Yet regulators did nothing. Therefore, my initial reaction to the fraud charges against Goldman Sachs for misleading clients is largely positive. I have long felt that the government was treading lightly against large U.S. banks, perhaps for fear of our economy’s fragile state.
But, Goldman Sachs has often been accused of looking after its own interests rather than that of its clients. Allegations that Goldman bet against its own clients in derivatives deals involving American municipalities and European countries are examples of the purported double dealing. It is no wonder that former Washington Mutual Kerry Killinger recently testified before Congress that he was wary of engaging Goldman Sachs as an adviser for just this reason. To date, most of this behavior could have been construed as legal but unethical.
Read more…
Goldman Sachs may be the first major Wall Street firm to face criminal charges because it has been a lightning rod of populist discontent. Moreover, they do not fulfill a significant deposit-taking function. But, it strikes me as odd that Goldman has been charged when Lehman Brothers had a $150 billion hole in its balance sheet that, at a minimum, represented a potential Sarbanes-Oxley violation. To this non-lawyer, it seems unlikely that the Goldman legal case is better than a potential legal challenge to Lehman’s use of an accounting device, known as “Repo 105,” to temporarily move assets.
Much of this is likely political. I see the timing of the Goldman announcement as an attempt by President Obama to at once tell Americans that he is serious about financial reform and banks that he will resist their efforts to deter reform by any means necessary.
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The Current Regulatory Battle
Douglas Elliott, a former investment banker, is a fellow in the Initiative on Business and Public Policy at the Brookings Institution.
We will not know for some time how important this is, because it depends on the strength of the government’s case and the extent to which this is a forerunner of lawsuits against other firms.
This case will raise the level of public anger and help move the financial reform proposals through the Senate.
.It is important to remember that complicated securities fraud cases can be difficult to prove. But this could be a watershed event if the S.E.C. has a strong case and follows this suit with broadly similar lawsuits against other banks.
In the short run, the suit is likely to strengthen the hand of the Democrats who are pushing financial reform legislation. This case will raise the level of public anger still further, providing fuel to move the proposals through the Senate.
Read more…
I already thought the odds of passage were high; this increases the odds further. However, politics is always difficult to forecast. For example, the Democrats could overplay their hand and succeed in completely uniting the Republicans, leading to a successful filibuster that kills the bill, at least for now.
If Democrats play their hand right, though, the suit will make it harder for Republicans to hold all 41 members in a Senate filibuster vote or to break away one or more Democrats. This is not a good time for a politician to be seen as defending Wall Street.
It is not clear that a different regulatory structure would have made a difference in this case. If the S.E.C.’s allegations are correct, the actions were illegal under current law. The S.E.C. could, perhaps, have done a better job of catching such actions earlier, but that is a matter of execution not broad structure.
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Undermining Trust in Markets
Megan McArdle is the business and economics editor for The Atlantic.
In one respect, this is not shocking at all. Goldman Sachs is publicly perceived to have not merely weathered this crisis well, but to have actually profited by it. Public anger is high. It was only to be expected that prosecutors and regulators would go head-hunting. But the details of these particular charges are rather surprising.
Minimize insider dealing by pushing more transactions onto central clearinghouses and exchanges.
.If the allegations are true, Goldman Sachs allowed a third party with a material economic interest to determine the structure of securities it sold. By itself, this is not worrisome — but according to the S.E.C., Goldman did not disclose this relationship, instead allowing investors to think that it had been structured by a disinterested analyst.
One side of the transaction had dramatically more information than the other — a situation which most market regulation is supposed to prevent. If the S.E.C. is correct, this isn’t merely evidence of a crime, but of a distressingly cavalier attitude toward basic rules of market conduct.
Read more…
Critics have long accused the bulge-bracket banks of using their market position to self-deal at the expense of ordinary investors. But these charges suggest that heavy-handed use of market muscle may have slipped over the line into outright fraud.
It’s clear that the sort of thing described in the complaint shouldn’t happen. It’s less clear how we can prevent them. This sort of insider dealing is extremely difficult to police. We will never get to a market so well-regulated that bankers can’t cut deals for favored clients with a nudge and a wink.
What we can do is minimize the opportunities for such activity by pushing as many transactions as possible onto central clearinghouses and exchanges. These are no panacea — just witness the deals that equity desks were able to cut for special clients in the late 1990s. But the less transparency there is, the easier it is to cut special deals for favored clients at the expense of other investors.
This isn’t just bad for the investors; it’s corrosive to the trust that markets need to function well. It also erodes the public trust in the major investment banks. Those banks have fought fiercely against regulation designed to lessen their market power. As Congress moves towards passage of comprehensive financial reform, they, and the bankers, would do well to remember that without strong trust in markets, we’d all be a lot worse off.
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So Much We Don’t Know
William K. Black, an associate professor of economics and law at the University of Missouri–Kansas City, is a former top federal financial regulator. He is the author of “The Best Way to Rob a Bank is to Own One.”
It’s been a bad two weeks for our most elite financial leaders. Citicorp’s top mortgage credit officer, Richard Bowen, testified before Financial Crisis Inquiry Commission on April 7 that while Citi represented to Fannie and Freddie that the toxic mortgages it was selling them were “conforming” — 60 percent were not.
Why have there been no criminal charges?
.He warned Citi’s top managers, including Robert Rubin. They jumped right on the problem (which will cost the taxpayers hundreds of billions of dollars) — by allowing things to get worse.
The Senate Banking Committee released the findings from its investigation of Washington Mutual — the largest savings and loan and largest bank failure. My research specialty is “control fraud,” which involves fraudulent accounting. Lenders optimize accounting fraud through extreme growth; making bad loans at high interest rates; extreme leverage and trivial loss reserves. The Senate Banking Committee’s findings show that WaMu’s business operations followed this recipe.
Read more…
Lehman led the parade with the recent release of the bankruptcy examiner’s report. The report shows that Lehman had billions of dollars of losses on bad assets. But Lehman’s financial statements did not recognize the losses. In addition to this first-stage cover up of its losses, Lehman entered into huge quarter-end repurchase agreement transactions to further cover up its crippling losses. Both cover-ups could lead to criminal liability.
Now, we learn that the S.E.C. charges that Goldman Sachs should be added to the list of elite financial frauds.
It is a tale of two (unrelated) Paulsons. Hank Paulson, while Goldman’s chief executive, had Goldman buy large amounts of collateralized debt obligations backed by “liar’s loans” (low-grade mortgages). He then became U.S. Treasury Secretary and launched a successful war against securities and banking regulation. His successors at Goldman realized the disaster and began to “short” C.D.O.s.
It designed a rigged trifecta: (1) it turned a massive loss into a material profit by selling toxic C.D.O.s it owned, (2) helped make John Paulson, head of a huge hedge fund, a massive profit and (3) blew up its customers that purchased the C.D.O.s.
The S.E.C. complaint says that Goldman defrauded its own customers by representing to them that the C.D.O. was “selected by ACA Management.” ACA was supposed to be an independent group of experts that would “select” nonprime loans “most likely to succeed” rather than “most likely to fail.” The SEC complaint alleges that the representations about ACA were false.
The question is: did John Paulson and ACA know that Goldman was making these false disclosures to the C.D.O. purchasers? Did they aid in what the S.E.C. alleges was Goldman’s fraud? Why have there been no criminal charges? Why did the S.E.C. only name a relatively low-level Goldman officer in its complaint?
Goldman used American International Group to provide the insurance on the synthetic C.D.O. deals, and Hank Paulson used our money to bail out Goldman when A.I.G.’s scams drove it to failure. As we — Eliot Spitzer, Frank Partnoy and I — asked in our Op-Ed in the Times on Dec. 19, 2009 — why haven’t the A.I.G. e-mails and key deal documents been made public?
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How to Prevent Adoption Disasters
.151 Readers' CommentsPost a Comment ».All CommentsHighlightsReaders' RecommendationsReplies..OldestNewest of 7Next ..1.R. Law
Texas
April 16th, 2010
4:32 pmIntegrity of the markets is sacrosanct to capitalism, on a pedestal equal to fiduciary responsibilities.
Firrms in charge of making markets and spreading the gospel of capitalism are doubly-charged with protecting both tenets.
Recommend Recommended by 53 Readers .2.Tom
Midwest
April 16th, 2010
4:33 pmConsidering the Republicans, maintaining their status quo, today unanimously vowed to oppose financial reform while at the same time President Obama vowed to veto any legislation that did not include regulation of derivatives which I believe are at the core of the financial collapse and problems. The Democrats, rightly or wrongly are proposing specific legislation while the Republicans propose nothing. That explains everything to me in a nutshell. Now tell me again which party is more beholden to the big financial companies and banks? The Republicans keep driving me farther and farther from the party I used to support. They used to have ideas, now they have only no.
Recommend Recommended by 303 Readers .3.greenmountain boy
burlington, vt
April 16th, 2010
4:33 pmLynn Stout has it exactly right. Bankers and investors will always be greedy. Trying to police a market of synthetic cdos is a waste of time. The traditional rule that you should only be hedging against your own actual risks needs to be reinstated.
Recommend Recommended by 151 Readers .4.Arin
Buffalo, NY
April 16th, 2010
4:37 pmThe politics of this plays very well. This lawsuit comes on the very day that the Republicans have unified to prevent debate of the financial reform bill in the Senate. It will hopefully shape the message of the Democrat party, that the Democrats stand for Main Street, and the Republicans stand for Wall Street. Whatever the outcome of this lawsuit, its intent has already paid dividends (no pun intended)
Recommend Recommended by 92 Readers .5.Mark O
Boston
April 16th, 2010
4:38 pmI was under the impression that the Federal government was in thrall to Goldman Sachs because the firm has until now been allowed to seek bilk the financial system with impunity. This lawsuit is both shocking and refreshing evidence of the government's independence.
Recommend Recommended by 65 Readers .6.jimmy
san francisco
April 16th, 2010
4:38 pmI think Professor Stout cleared it up for those on Wall Street. They burned the house down insured at 100 cents on the dollar with our bail out tax money in the hundreds of billions of dollars to AIG and they'll do it again. How can this not make anyone just completely sick. How many lives and careers have they ruined? And Obama says he's not out to get the bankers? I hope he was lying.
Recommend Recommended by 129 Readers .7.Atlanta Guy Making serious dough
Atlanta, GA
April 16th, 2010
4:46 pmWhy is Goldman Sachs only facing a civil suit? The allegation against them is criminal fraud and they should face criminal prosecution. This feeds the long standing view (held by many) that the rich get away with murder while the average joe is held to a higher standard. Though a civil case will indeed be very damaging to GS, it is NOT enough. You deceived investors and nearly destroyed the entire financial system and you're sitting there looking pretty (with billions in profit)
Recommend Recommended by 199 Readers .8.timfenton1
laura
April 16th, 2010
4:47 pmWhy didn't you request comment from Sen. Mitch McConnell who seems determined to sink financial markets reform?
Recommend Recommended by 83 Readers .9.GrammyofWandA
Maine
April 16th, 2010
4:47 pmThe teabaggers will surely point out that the Goldman Sachs employees who allegedly committed the fraud are extremely dedicated workers who should not be subjected to an income tax increase.
Recommend Recommended by 110 Readers .10.mark
Honolulu, Hawaii
April 16th, 2010
4:47 pmThe insurance analogy is spot on! We don't let people bet on whether other people's buildings will burn down for reasons that are so obvious they have been a part of insurance law forever. It's called the necessity of having an insurable interest. What do you think would happen if we allowed the mob to buy insurance on people's lives? When we allowed people to take out insurance without an insurable interest we converted a financial instrument predicated on personal risk avoidance into one predicated on profiting on other people's losses. The results are here in front of us for all to see. We need to reverse the mistake we made and reverse it quickly.
Recommend Recommended by 178 Readers .11.sara
oakland, ca
April 16th, 2010
4:47 pmi am waiting for the apologists for Market Innovation to begin the talking points that will crush litigation and effective reform.
Beneath the Goldman/Magnator shorting of these faulty CDOs with wildly high credit default swap pay-offs lies the RATIONALIZATION. Risk is diluted buy these derivatives, shorting keeps the market honest, capitalizing our realestate market bring poor folk into home ownership....ALL these arguments are either gross distortions of reality or cynical ways to preserve the looting of our economy by shallow wise guys. These short-term profiteers (thru millions in commissions from creating CDOs to the billions collected in crooked swaps as they failed) are now safely stashing away their fortunes; NO LESSON has been learned. And the law blocks retroactive taxation of windfall profits....or does it ?
Recommend Recommended by 37 Readers .12.jjcrocket
New Britain, Conn.
April 16th, 2010
4:48 pmDianna Farrell:
Obama Administration: Deputy Director, National Economic Council
Former Goldman Sachs Title: Financial Analyst
Stephen Friedman:
Obama Administration: Chairman, President’s Foreign Intelligence Advisory Board
Former Goldman Sachs Title: Board Member (Chairman, 1990-94; Director, 2005-)
Gary Gensler:
Obama Administration: Commissioner, Commodity Futures Trading Commission
Former Goldman Sachs Title: Partner and Co-head of Finance
Robert Hormats:
Obama Administration: Undersecretary for Economic, Energy and Agricultural Affairs, State Department
Former Goldman Sachs Title: Vice Chairman, Goldman Sachs Group
Philip Murphy:
Obama Administration: Ambassador to Germany
Former Goldman Sachs Title: Head of Goldman Sachs, Frankfurt
Mark Patterson:
Obama Administration: Chief of Staff to Treasury Secretary, Timothy Geitner
Former Goldman Sachs Title: Lobbyist 2005-2008; Vice President for Government Relations
John Thain:
Obama Administration: Advisor to Treasury Secretary, Timothy Geithner
Former Goldman Sachs Title: President and Chief Operating Officer (1999-2003)
http://the-classic-liberal.com...
Recommend Recommended by 129 Readers .13.Older but Wiser
Dallas
April 16th, 2010
4:48 pmIn a criminal trial most people withhold judgement until the verdict is reached. As civil cases turn far more on interpretations of rules it would be more seemly if the New York Times and its panelists waited until there is a conviction before crowing and trying to tell us what all this means.
Recommend Recommended by 5 Readers .14.smiths
ar
April 16th, 2010
4:48 pmI'm more concerned about Goldmans Sach's ownership of the Obama administration
Recommend Recommended by 95 Readers .15.RS Love
Palo Alto, CA
April 16th, 2010
4:48 pmJust a reminder that Frank Partnoy testified back in 2002 before a Senate committee that Enron was enabled to game and defraud investors using derivatives and that unless the law was corrected, more of the same was coming down the road. No one listened.
The culprit in the Enron crime wave was a recipe of CFMA 2000 mandated deregulation of trading exotics/synthetics, the corporate accountants serving no one, credit agencies for hire and our own lax Federal regulators too.
Roll tape forward to 2010. We are about to ignore the lessons of the past once again. Hard to admit that post-Depression banking legislation actually worked then and it worked up until the recent1990s while both parties dismantled it. There can be no real reform without separating the main street banking businesses from the casino bankers.
The mighty legends are headed to disgrace including Greenspan, Rubin, Summers, our Presidents (from Reagan to Obama), Paulson, Geithner, Gramm and the Senate Republicans who blindly took Wall Street's money; now it's the Democrats turn to pave the next road to financial ruin. They're right on schedule.
Recommend Recommended by 83 Readers .16.BTT
Wilkes-Barre, Pa.
April 16th, 2010
4:49 pmOne other point to Lynn Stout: you can't buy Home Insurance while the house is on fire! America at its worst! How immoral! BTT
Recommend Recommended by 32 Readers .17.Marcel Duchamp
Maine
April 16th, 2010
4:49 pmNext up: criminal prosecutions.
Let's go!
Recommend Recommended by 100 Readers .18.T.L.Moran
Idaho
April 16th, 2010
4:49 pmForget the SEC and its hunt through the dense weeds of microscopic regulatory law.
The attorneys general of many states facing bankruptcy, the many pension funds, university systems, and other public institutions, need only find one instance -- I'm sure there are many -- of death from heart attack or crisis-driven suicide and they have a perfect case against these corporations for depraved-heart murder.
The Wall St. thugs, driven by their addiction to complex scams and outsize profits, have demonstrated 'callous disregard' and 'extreme indifference' to the value of American lives with every million dollar profit they've made, every lavish bonus they've awarded themselves.
Never mind what slimy combination of congressional dopes and financial addicts undermined the laws protecting the country from this kind of daylight robbery. The intentions and the results speak clear: the executives of firms like this set aside all consideration for the continued life, health and happiness of everyday Americans in their adolescent race to see who could be the fastest, biggest looter of our national economy.
If corporations are people (thank you activist neo-con SCOTUS), then they are all guilty of depraved indifference. Prosecute, punish, and GET THIS COUNTRY'S MONEY BACK!
Recommend Recommended by 69 Readers .19.JVM Fan
Hollywood
April 16th, 2010
4:49 pmI just saw a movie on Sunset Blvd. called "Stock Shock" about all this Wall Street corruption and the audience was pretty shocked. It was the same story told through the eyes of Sirus XM investors that nearly went broke because of market manipulation. The movie is now sold on DVD just about everywhere, but cheaper at www.stockshockmovie.com
Recommend Recommended by 7 Readers .20.frank
providence, ri
April 16th, 2010
4:49 pmNone of this is news. Zuckerman in The Greatest Trade Ever (p.179) names Goldman, Bear Sterns, and Deutsche Bank (and others) as working with Paulson to create "controversial" CDO's (meaning this is not news) tailor made to fail. What can also be said it that mostly the banks were betting the other way, which is why they had so much losses, and the argument they were hedging really seems correct. But the fraud is ultimately about charges against an outside rating agencies, that maybe one didn't exist in this trade despite what was said. But all the rating agencies were also pushed and threatened no doubt NOT to rate the CDOs accurately. There is fraud everywhere, of course. The whole system was a fraud.
Recommend Recommended by 46 Readers .21.Docb
denver
April 16th, 2010
4:50 pmCome on folks --there has to be a market for these products...another IB or two or perhaps the street! They all did this created a market-- bought and sold against a fail...Go to the SEC site and pull up the Complaint--there is a firm mentioned , Paulson &Co---Hmmm could it be true? But this is just the tip...the SEC needs to be contacted and reminded that this is not isolated and not a case for fines and wrist slaps...1.888.732.6585 or the Sec of the SEC 1.202.551.5400
Recommend Recommended by 8 Readers .22.Dan
NYC
April 16th, 2010
4:50 pmI disagree with these rosy optimistic analysis of these so-called "experts."
This is the start of new chapter of regulations? Thats BS - These are civil charges, NOT criminal. Sure, Goldman will get hit with a settlement (probably around a million), which might sound big to the "main street average person" but in reality its not big at all to them. They will continue to do what they do and generate much much more money than that. Then, of course, Goldman Sachs will deny any wrongdoing, and Obama will praise the Justice System that we have. Every one wins! Except, of course, the people on main street and the people who GS fleeced.
Do you HONESTLY expect any better when the insane run the asylum?
Recommend Recommended by 55 Readers .23.pstgradny
New York
April 16th, 2010
4:52 pmWhat a shocker...dishonest and greedy investment bankers and traders. Sounds like fodder for a movie that might be entitled, Wall Street. I think Michael Douglas would be perfect for the lead role, and Charlie Sheen would be great as a conflicted young broker/trader. In the aftermath of the recent financial meltdown, this movie could be a huge hit, especially if done in 3D. Cameo performances might include Bernie Madoff, Jeffrey Skilling, Andy Fastow, Bernie Ebbers, Edward S. Digges Jr., etc.
Recommend Recommended by 16 Readers .24.Zenster
Manhattan
April 16th, 2010
5:13 pmIt seems every single person in the country knows for a fact that Goldman Sachs is a criminal organization, a white collar mafia - and still it took this long for the SEC to prosecute - and only this one charge, so amazingly egregious. What about the thousands and thousands of other crimes this giant vampire squid committed?
Recommend Recommended by 60 Readers .25.ron
new orleans
April 16th, 2010
5:14 pmI believe that the current banking crisis started out many years ago in Denver when the Silverado Bank and Neil Bush were bailed out by his father(Bush I) and his friends(Cheney,et al). Instead of starting a new wave of bank regulation at the time, Congress with the support of Bush, et al opened the flood gates to SEC deregulation. Being an optimist, I believe that everything that goes around, comes around. The American public will not be satisfied until the current group of creative criminals are exposed. Once they are indicted, historians should then revisit the first banking crisis.
Recommend Recommended by 63 Readers . of 7 Next ..Post a Comment
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Where was Lynn A. Stout when her information was needed?
http://roomfordebate.blogs.nytimes.com/2010/04/16/what-goldmans-conduct-reveals/#lynn
Over and over again there is nobody to present the other side of legislation that enabled the system to be destroyed. That's because there is nobody funding that side. Nobody called an expert to research the issue and report to Congress.
So as clear as Lynn A. Stout's piece is to us, where was she in 2000 when this information would have been relevant?
The information:
Sunday, April 18, 2010
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April 16, 2010, 3:31 pm What Goldman’s Conduct Reveals
By THE EDITORS
The Securities and Exchange Commission filed a civil lawsuit against Goldman Sachs for securities fraud on Friday, charging the bank with creating and selling mortgage-backed securities that were intended to fail.
According to the complaint, Goldman let John Paulson, a prominent hedge fund manager, select mortgage bonds that he wanted to bet against because they were most likely to lose value and packaged those bonds into the “Abacus” investments, which were sold to investors like foreign banks and pension funds. As those securities plunged in value, the Paulson hedge fund made money on the negative bets, while the Goldman clients who bought the investments lost billions of dollars.
Is this chain of events surprising? The S.E.C. is suing Goldman Sachs, but could regulation or monitoring of these financial instruments have prevented such losses? What kind of regulatory structure would need to be put in place?
Lynn A. Stout, professor of corporate and securities law, U.C.L.A.
Michael Greenberger, former commodities regulator
Nicole Gelinas, Manhattan Institute
Yves Smith, financial analyst
Nomi Prins, senior fellow, Demos
Edward Harrison, banking and finance specialist
Douglas Elliott, Brookings Institution
Megan McArdle, Asymmetrical Information
William K. Black, former banking regulator
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The Natural Result of Deregulation
Lynn A. Stout is the Paul Hastings professor of corporate and securities law at U.C.L.A. and an expert on corporate governance.
If the allegations against Goldman Sachs are true, then much of the blame for investors’ losses in the Abacus deal can be laid at the feet of an obscure statute passed by Congress in 2000, the “Commodities Futures Modernization Act.”
If we allow the unscrupulous to buy fire insurance on other people’s houses, the incidence of arson would rise sharply. In one dramatic move, that act eliminated a longstanding legal rule that deemed derivatives bets made outside regulated exchanges to be legally enforceable only if one of the parties to the bet was hedging against a pre-existing risk.
This traditional derivatives rule against purely speculative derivatives trading has a parallel in insurance law, because insurance, like derivatives trading, is really just a form of betting. A homeowner’s fire insurance policy, for example, is a bet with an insurance company that your house will burn down.
Under the rules of insurance law, you can only buy fire insurance on a house if you actually own the house in question. Similarly, under the traditional legal rules regulating derivatives trading, the only parties who could use off-exchange derivatives to bet against the Abacus deal would be parties who actually held investments in Abacus.
By eliminating this centuries-old rule in the name of “modernization,” Congress created enormous problems of moral hazard in the off-exchange derivatives market. Imagine, for example, if we allow the unscrupulous to buy fire insurance on other people’s houses; the incidence of arson would rise dramatically.
Similarly, by allowing an unscrupulous hedge fund to use derivatives to bet against an Abacus investment vehicle it didn’t own, the Commodities Futures Modernization Act invited that hedge fund to work with Goldman Sachs to make sure that Abacus would indeed fail — as it did.
Sadly, greed is a constant in human nature. We’re not likely to eliminate it soon. But we can at least keep it in check. It’s time for Congress to address the problem of moral hazard in derivatives betting by repealing the Commodities Futures Modernization Act.
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Accountability, at Long Last
Michael Greenberger is a professor at the University of Maryland School of Law and a former director of trading and markets at the Commodity Futures Trading Commission.
If Sept. 15, 2008, the day Lehman Brothers was allowed to fail, marks the Pearl Harbor or widely acknowledged onset of the present Great Recession (in Franklin Roosevelt’s words “a date which shall live in infamy”), April 16, 2010 may be deemed the equivalent of the U.S. victory in the crucial Battle of Midway in 1942 or the day the U.S. neutralized the Japanese fleet.
If the fall of Lehman was Pearl Harbor, the S.E.C.’s case against Goldman may be the Battle of Midway — a crucial victory.
.On April 16, 2010, the S.E.C. announced its enforcement action against Goldman Sachs alleging the improper marketing of what the S.E.C. alleges was the sale of two evenly matched, but highly conflicting, investments: essentially bets for and against the proposition that subprime (non-creditworthy) mortgage borrowers would pay back their loans. Goldman is alleged to have profited substantially from those who bet against subprime repayment while aggressively marketing to its other customers bets in favor of repayment.
Let’s be clear. Goldman Sachs vigorously denies the S.E.C.’s allegations, and doubtless it will fight the action with the utmost vigor. It is certainly entitled to do so.
Read more…
However, what makes the S.E.C. enforcement action a landmark is that it responds to a widely held desire on the part of the American taxpayer: accountability.
The underpinnings of that desire is that the present crisis, including high unemployment and devastating economic insecurity accompanied by skyrocketing deficits, was not caused by the average American. But, it is the average American who has had to foot the bill for restoring the economy.
What is especially aggravating is that those who unmistakably did cause the crisis, i.e., the “pillars of Wall Street,” are now stronger and more profitable than ever before. And the impression is that Wall Street has returned to “business as usual,” once again using the same investment strategies that brought on the fall 2008 deluge.
The case against Goldman shows that savvy insiders knew the financial crisis was coming, and profited from it.
.So the key question from Main Street is: where is the accountability? If the average American fails miserably in a business or professional enterprise, there are consequences, e.g., firing or bankruptcy. Up to today, it appeared that those traditional hallmarks of failure did not apply to Wall Street or those who were responsible for regulating Wall Street.
Just last week, Alan Greenspan, the former Fed chairman, and Robert Rubin, the former Treasury Secretary and Citigroup officer, said they were not to blame for the meltdown even though both prevented regulation of the kind of bets Goldman Sachs is now accused of misusing.
More galling is the constant refrain from both Wall Street C.E.O.s and former regulators that no one could have predicted the crisis. However, the S.E.C. allegations are premised on the fact that hedge funds and Goldman Sachs itself were so convinced of cataclysmic failure that they were looking for investment vehicles that would profit each time a homeowner defaulted on his or her mortgage.
In other words, there were competent and smart people making billions because they could foresee the obvious: people with poor credit would not be able to repay their home loans.
In short, it was not that no one knew. Savvy insiders knew.
We do not know the success of the S.E.C.s actions today. But, if successful, you can be sure that this will be the beginning of what those average Americans suffering during this Great Recession are desperately seeking: accountability.
As Winston Churchill said after early Allied victories in World War II: “This is not the end or even the beginning of the end; but it is the end of the beginning.” We may now be at the beginning of rewarding competence and sanctioning ineptness or worse.
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A Third Party Problem
Nicole Gelinas, a contributing editor to the Manhattan Institute’s City Journal, is the author of “After the Fall: Saving Capitalism from Wall Street — and Washington.”
The government’s charges against Goldman and its employees — if true — are not shocking. People lie. The Securities and Exchange Commission can do better at enforcing the laws that make liars think twice. But policing fraud cannot be our first line of defense against financial excess.
It’s simple: the German bank that bought the mortgage securities shouldn’t have relied on a consultant.
.The S.E.C. says that Goldman, in early 2007, told mortgage-bond buyers that the consultant who helped create their securities had their best interests at heart. The consultant was taking advice, at Goldman’s behest, from another investor who would profit when the securities went bust.
Synthetic collateralized debt obligations are hard, but dishonesty with clients is easy. Raking through the details of the case uproots far deeper problems, though.
Read more…
First, the obscure third parties that helped Goldman and other big banks sell complex deals encouraged investors to suspend necessary skepticism.
The German bank that bought the mortgage securities, IKB Deutsche Industriebank, fancied itself a sophisticated firm. So why did it rely on a Goldman consultant, ACA Management, as a “portfolio selection agent?” And why did sophisticated investors need third parties to “insure” the securities?
Just as Bernie Madoff’s investors would have done better not to rely on advisers to tell them that Bernie was O.K., IKB would have been better off performing its own analysis of American mortgage markets.
But obscure third parties were the spawn of Washington’s bank bailouts starting in the 1980s. The expectation of government support artificially fed Wall Street growth — so there was plenty of cheap money to trickle down from the too-big-to-fail banks to the ever-more-creative little guys.
Second, applying old trading and capital rules to new financial markets would have reduced hanky-panky.
Goldman was able to “customize” securities, allegedly committing fraud under cover of the opacity that customization provided, because the securities did not trade on a public marketplace. Such a marketplace would have demanded simplicity from Goldman in creating the securities. Thousands of investors, rather than a few hand-picked third parties, could have analyzed and priced them.
The same is true in credit-derivatives markets. Opacity serves only the banks, which reap higher fees from customers who remain in the dark.
Enforcing justice is vital to markets. But Washington should help investors, too, by reducing opportunities to thwart justice. We need a return to simplicity. Congress should direct regulators to impose trading, disclosure and capital rules consistently across financial firms and instruments — so that markets can smash the repositories for secrets that imperil the economy.
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Immoral, Destructive Behavior
Yves Smith writes the blog Naked Capitalism. She is the head of Aurora Advisors, a management consulting firm, and the author of “Econned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.”
Strange as it may seem, the Securities and Exchange Commission’s lawsuit against Goldman Sachs for selling collateralized debt obligations (C.D.O.) designed to fail illustrates what a long and difficult haul it will be to reform the financial services sector.
This case should be a slam-dunk, but years of deregulation have narrowed the ground for lawsuits.
.Goldman allowed hedge fund manager John Paulson to sponsor a C.D.O. The sponsor can influence how the C.D.O. is constructed, the notion being that the sponsor will act in ways that help all the other investors. But this C.D.O. was allegedly a Trojan horse for Mr. Paulson to take a large short position, betting against the very same C.D.O. he was creating.
But his intent was not disclosed. And, not surprisingly, the deal was a complete wipeout, with Mr. Paulson collecting a billion dollars of winnings at the expense of investors who had been kept in the dark and would almost certainly have turned down the deal if they had had the full picture.
By any common sense standard, this case should be a slam-dunk. However, despite tough talk by the Obama administration on financial reform, it is not mounting a criminal case against Goldman.
Read more…
Moreover, the S.E.C. has long had a difficult time winning complex financial fraud cases. While critics like to argue that the S.E.C. is not up to the task, the situation is more complex. Years of deregulation have narrowed the ground for lawsuits considerably. What’s more, structured credit is a new area of litigation. Thus the S.E.C. is also mounting its case in an arena where there are few precedents to rely upon.
If the S.E.C. loses its case against Goldman, it will be too easy to draw the wrong conclusion: not that the S.E.C. failed, but that the financial services industry succeeds all too well in its campaign to tear down the rules needed to make markets safe for investors.
No matter what happens to this particular lawsuit, it’s critical not to lose sight of the fact that immoral, destructive behavior has become deeply entrenched on Wall Street, and it will take concerted action to root it out.
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Smelling the Deception
Nomi Prins is a senior fellow at Demos. She is the author of “It Takes a Pillage: Behind the Bailouts, Bonuses and Backroom Deals from Washington to Wall Street” and “Other People’s Money: The Corporate Mugging of America.” She was a managing director at Goldman Sachs.
It’s probably no coincidence that Goldman Sachs took such great pains to deliver a decisive “we don’t bet against our clients” statement right before the S.E.C. levied its charge that the firm “defrauded” its clients through “misstating and omitting key facts.”
The entire nature of the C.D.O. business invites firms to act for certain clients and against others.
.Indeed, under the particulars of this complaint, Goldman didn’t bet against its clients directly, it merely acted on all possible angles of a deal that facilitated one huge client betting against other clients, while obfuscating the specifics of its enabling and fee-taking role in the triangle.
That’s why it is dangerous to single out one member of Goldman (where the title of vice president is low on the totem pole) as the culprit. Collateralized debt obligations were very lucrative for everyone involved. The bad apple approach enforces an inaccurate representation of two main problems.
Read more…
First, it took the S.E.C. nearly three years to wake up and smell the deception. This was a large deal involving a major investment house and major hedge fund. Having some sort of priority examination of such deals would have been prudent.
Second and more important, is the lax regulatory structure itself. In our current regulatory framework, any issuing bank can act on all sides of a C.D.O. (or other complex security) — as creator, trader, hedger and seller. This inevitably means there will be conflicts of interest because the bank in the middle gets paid (handsomely) for all its services, no matter what the outcome of the deal’s performance. Plus, it has the benefit of insider knowledge.
Even without putting together a C.D.O. portfolio on behalf of the same client whose interest is served by shorting it as is the case here, the entire nature of the C.D.O. business invites firms to act for certain clients and against others. There is always the possibility of stuffing the worst assets into a C.D.O. and marketing them as the best.
Risk is shuffled around the market from those in the know (like Goldman or Paulson) to those who have far less access to information or fancy analytics (like pension fund buyers.)
That’s how spread, or profit, is created. And, as we’ll see if more such deals get investigated for their unique conflicts, that’s how loss is deferred to others, too. The best protection is to isolate securities creation from distribution.
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Is This Political?
Edward Harrison is a banking and finance specialist at the economic consultancy Global Macro Advisors. He is also the principal contributor to the financial Web site Credit Writedowns.
When Lehman Brothers collapsed in a heap in 2008, the financial world was thrown into turmoil. The financial calamity was entirely foreseeable for those who chose to look. Reckless borrowing, lending and speculation were an integral part of the breakdown in our financial system. But so too was fraud.
It seems unlikely that the Goldman legal case is better than a potential legal challenge to Lehman’s use of ‘Repo 105.’
.Since at least 2004, when the FBI warned of a mortgage fraud “epidemic,” it has been clear that deception, predatory lending and outright fraud have been rampant in the financial services industry. Yet regulators did nothing. Therefore, my initial reaction to the fraud charges against Goldman Sachs for misleading clients is largely positive. I have long felt that the government was treading lightly against large U.S. banks, perhaps for fear of our economy’s fragile state.
But, Goldman Sachs has often been accused of looking after its own interests rather than that of its clients. Allegations that Goldman bet against its own clients in derivatives deals involving American municipalities and European countries are examples of the purported double dealing. It is no wonder that former Washington Mutual Kerry Killinger recently testified before Congress that he was wary of engaging Goldman Sachs as an adviser for just this reason. To date, most of this behavior could have been construed as legal but unethical.
Read more…
Goldman Sachs may be the first major Wall Street firm to face criminal charges because it has been a lightning rod of populist discontent. Moreover, they do not fulfill a significant deposit-taking function. But, it strikes me as odd that Goldman has been charged when Lehman Brothers had a $150 billion hole in its balance sheet that, at a minimum, represented a potential Sarbanes-Oxley violation. To this non-lawyer, it seems unlikely that the Goldman legal case is better than a potential legal challenge to Lehman’s use of an accounting device, known as “Repo 105,” to temporarily move assets.
Much of this is likely political. I see the timing of the Goldman announcement as an attempt by President Obama to at once tell Americans that he is serious about financial reform and banks that he will resist their efforts to deter reform by any means necessary.
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The Current Regulatory Battle
Douglas Elliott, a former investment banker, is a fellow in the Initiative on Business and Public Policy at the Brookings Institution.
We will not know for some time how important this is, because it depends on the strength of the government’s case and the extent to which this is a forerunner of lawsuits against other firms.
This case will raise the level of public anger and help move the financial reform proposals through the Senate.
.It is important to remember that complicated securities fraud cases can be difficult to prove. But this could be a watershed event if the S.E.C. has a strong case and follows this suit with broadly similar lawsuits against other banks.
In the short run, the suit is likely to strengthen the hand of the Democrats who are pushing financial reform legislation. This case will raise the level of public anger still further, providing fuel to move the proposals through the Senate.
Read more…
I already thought the odds of passage were high; this increases the odds further. However, politics is always difficult to forecast. For example, the Democrats could overplay their hand and succeed in completely uniting the Republicans, leading to a successful filibuster that kills the bill, at least for now.
If Democrats play their hand right, though, the suit will make it harder for Republicans to hold all 41 members in a Senate filibuster vote or to break away one or more Democrats. This is not a good time for a politician to be seen as defending Wall Street.
It is not clear that a different regulatory structure would have made a difference in this case. If the S.E.C.’s allegations are correct, the actions were illegal under current law. The S.E.C. could, perhaps, have done a better job of catching such actions earlier, but that is a matter of execution not broad structure.
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Undermining Trust in Markets
Megan McArdle is the business and economics editor for The Atlantic.
In one respect, this is not shocking at all. Goldman Sachs is publicly perceived to have not merely weathered this crisis well, but to have actually profited by it. Public anger is high. It was only to be expected that prosecutors and regulators would go head-hunting. But the details of these particular charges are rather surprising.
Minimize insider dealing by pushing more transactions onto central clearinghouses and exchanges.
.If the allegations are true, Goldman Sachs allowed a third party with a material economic interest to determine the structure of securities it sold. By itself, this is not worrisome — but according to the S.E.C., Goldman did not disclose this relationship, instead allowing investors to think that it had been structured by a disinterested analyst.
One side of the transaction had dramatically more information than the other — a situation which most market regulation is supposed to prevent. If the S.E.C. is correct, this isn’t merely evidence of a crime, but of a distressingly cavalier attitude toward basic rules of market conduct.
Read more…
Critics have long accused the bulge-bracket banks of using their market position to self-deal at the expense of ordinary investors. But these charges suggest that heavy-handed use of market muscle may have slipped over the line into outright fraud.
It’s clear that the sort of thing described in the complaint shouldn’t happen. It’s less clear how we can prevent them. This sort of insider dealing is extremely difficult to police. We will never get to a market so well-regulated that bankers can’t cut deals for favored clients with a nudge and a wink.
What we can do is minimize the opportunities for such activity by pushing as many transactions as possible onto central clearinghouses and exchanges. These are no panacea — just witness the deals that equity desks were able to cut for special clients in the late 1990s. But the less transparency there is, the easier it is to cut special deals for favored clients at the expense of other investors.
This isn’t just bad for the investors; it’s corrosive to the trust that markets need to function well. It also erodes the public trust in the major investment banks. Those banks have fought fiercely against regulation designed to lessen their market power. As Congress moves towards passage of comprehensive financial reform, they, and the bankers, would do well to remember that without strong trust in markets, we’d all be a lot worse off.
--------------------------------------------------------------------------------
So Much We Don’t Know
William K. Black, an associate professor of economics and law at the University of Missouri–Kansas City, is a former top federal financial regulator. He is the author of “The Best Way to Rob a Bank is to Own One.”
It’s been a bad two weeks for our most elite financial leaders. Citicorp’s top mortgage credit officer, Richard Bowen, testified before Financial Crisis Inquiry Commission on April 7 that while Citi represented to Fannie and Freddie that the toxic mortgages it was selling them were “conforming” — 60 percent were not.
Why have there been no criminal charges?
.He warned Citi’s top managers, including Robert Rubin. They jumped right on the problem (which will cost the taxpayers hundreds of billions of dollars) — by allowing things to get worse.
The Senate Banking Committee released the findings from its investigation of Washington Mutual — the largest savings and loan and largest bank failure. My research specialty is “control fraud,” which involves fraudulent accounting. Lenders optimize accounting fraud through extreme growth; making bad loans at high interest rates; extreme leverage and trivial loss reserves. The Senate Banking Committee’s findings show that WaMu’s business operations followed this recipe.
Read more…
Lehman led the parade with the recent release of the bankruptcy examiner’s report. The report shows that Lehman had billions of dollars of losses on bad assets. But Lehman’s financial statements did not recognize the losses. In addition to this first-stage cover up of its losses, Lehman entered into huge quarter-end repurchase agreement transactions to further cover up its crippling losses. Both cover-ups could lead to criminal liability.
Now, we learn that the S.E.C. charges that Goldman Sachs should be added to the list of elite financial frauds.
It is a tale of two (unrelated) Paulsons. Hank Paulson, while Goldman’s chief executive, had Goldman buy large amounts of collateralized debt obligations backed by “liar’s loans” (low-grade mortgages). He then became U.S. Treasury Secretary and launched a successful war against securities and banking regulation. His successors at Goldman realized the disaster and began to “short” C.D.O.s.
It designed a rigged trifecta: (1) it turned a massive loss into a material profit by selling toxic C.D.O.s it owned, (2) helped make John Paulson, head of a huge hedge fund, a massive profit and (3) blew up its customers that purchased the C.D.O.s.
The S.E.C. complaint says that Goldman defrauded its own customers by representing to them that the C.D.O. was “selected by ACA Management.” ACA was supposed to be an independent group of experts that would “select” nonprime loans “most likely to succeed” rather than “most likely to fail.” The SEC complaint alleges that the representations about ACA were false.
The question is: did John Paulson and ACA know that Goldman was making these false disclosures to the C.D.O. purchasers? Did they aid in what the S.E.C. alleges was Goldman’s fraud? Why have there been no criminal charges? Why did the S.E.C. only name a relatively low-level Goldman officer in its complaint?
Goldman used American International Group to provide the insurance on the synthetic C.D.O. deals, and Hank Paulson used our money to bail out Goldman when A.I.G.’s scams drove it to failure. As we — Eliot Spitzer, Frank Partnoy and I — asked in our Op-Ed in the Times on Dec. 19, 2009 — why haven’t the A.I.G. e-mails and key deal documents been made public?
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.151 Readers' CommentsPost a Comment ».All CommentsHighlightsReaders' RecommendationsReplies..OldestNewest of 7Next ..1.R. Law
Texas
April 16th, 2010
4:32 pmIntegrity of the markets is sacrosanct to capitalism, on a pedestal equal to fiduciary responsibilities.
Firrms in charge of making markets and spreading the gospel of capitalism are doubly-charged with protecting both tenets.
Recommend Recommended by 53 Readers .2.Tom
Midwest
April 16th, 2010
4:33 pmConsidering the Republicans, maintaining their status quo, today unanimously vowed to oppose financial reform while at the same time President Obama vowed to veto any legislation that did not include regulation of derivatives which I believe are at the core of the financial collapse and problems. The Democrats, rightly or wrongly are proposing specific legislation while the Republicans propose nothing. That explains everything to me in a nutshell. Now tell me again which party is more beholden to the big financial companies and banks? The Republicans keep driving me farther and farther from the party I used to support. They used to have ideas, now they have only no.
Recommend Recommended by 303 Readers .3.greenmountain boy
burlington, vt
April 16th, 2010
4:33 pmLynn Stout has it exactly right. Bankers and investors will always be greedy. Trying to police a market of synthetic cdos is a waste of time. The traditional rule that you should only be hedging against your own actual risks needs to be reinstated.
Recommend Recommended by 151 Readers .4.Arin
Buffalo, NY
April 16th, 2010
4:37 pmThe politics of this plays very well. This lawsuit comes on the very day that the Republicans have unified to prevent debate of the financial reform bill in the Senate. It will hopefully shape the message of the Democrat party, that the Democrats stand for Main Street, and the Republicans stand for Wall Street. Whatever the outcome of this lawsuit, its intent has already paid dividends (no pun intended)
Recommend Recommended by 92 Readers .5.Mark O
Boston
April 16th, 2010
4:38 pmI was under the impression that the Federal government was in thrall to Goldman Sachs because the firm has until now been allowed to seek bilk the financial system with impunity. This lawsuit is both shocking and refreshing evidence of the government's independence.
Recommend Recommended by 65 Readers .6.jimmy
san francisco
April 16th, 2010
4:38 pmI think Professor Stout cleared it up for those on Wall Street. They burned the house down insured at 100 cents on the dollar with our bail out tax money in the hundreds of billions of dollars to AIG and they'll do it again. How can this not make anyone just completely sick. How many lives and careers have they ruined? And Obama says he's not out to get the bankers? I hope he was lying.
Recommend Recommended by 129 Readers .7.Atlanta Guy Making serious dough
Atlanta, GA
April 16th, 2010
4:46 pmWhy is Goldman Sachs only facing a civil suit? The allegation against them is criminal fraud and they should face criminal prosecution. This feeds the long standing view (held by many) that the rich get away with murder while the average joe is held to a higher standard. Though a civil case will indeed be very damaging to GS, it is NOT enough. You deceived investors and nearly destroyed the entire financial system and you're sitting there looking pretty (with billions in profit)
Recommend Recommended by 199 Readers .8.timfenton1
laura
April 16th, 2010
4:47 pmWhy didn't you request comment from Sen. Mitch McConnell who seems determined to sink financial markets reform?
Recommend Recommended by 83 Readers .9.GrammyofWandA
Maine
April 16th, 2010
4:47 pmThe teabaggers will surely point out that the Goldman Sachs employees who allegedly committed the fraud are extremely dedicated workers who should not be subjected to an income tax increase.
Recommend Recommended by 110 Readers .10.mark
Honolulu, Hawaii
April 16th, 2010
4:47 pmThe insurance analogy is spot on! We don't let people bet on whether other people's buildings will burn down for reasons that are so obvious they have been a part of insurance law forever. It's called the necessity of having an insurable interest. What do you think would happen if we allowed the mob to buy insurance on people's lives? When we allowed people to take out insurance without an insurable interest we converted a financial instrument predicated on personal risk avoidance into one predicated on profiting on other people's losses. The results are here in front of us for all to see. We need to reverse the mistake we made and reverse it quickly.
Recommend Recommended by 178 Readers .11.sara
oakland, ca
April 16th, 2010
4:47 pmi am waiting for the apologists for Market Innovation to begin the talking points that will crush litigation and effective reform.
Beneath the Goldman/Magnator shorting of these faulty CDOs with wildly high credit default swap pay-offs lies the RATIONALIZATION. Risk is diluted buy these derivatives, shorting keeps the market honest, capitalizing our realestate market bring poor folk into home ownership....ALL these arguments are either gross distortions of reality or cynical ways to preserve the looting of our economy by shallow wise guys. These short-term profiteers (thru millions in commissions from creating CDOs to the billions collected in crooked swaps as they failed) are now safely stashing away their fortunes; NO LESSON has been learned. And the law blocks retroactive taxation of windfall profits....or does it ?
Recommend Recommended by 37 Readers .12.jjcrocket
New Britain, Conn.
April 16th, 2010
4:48 pmDianna Farrell:
Obama Administration: Deputy Director, National Economic Council
Former Goldman Sachs Title: Financial Analyst
Stephen Friedman:
Obama Administration: Chairman, President’s Foreign Intelligence Advisory Board
Former Goldman Sachs Title: Board Member (Chairman, 1990-94; Director, 2005-)
Gary Gensler:
Obama Administration: Commissioner, Commodity Futures Trading Commission
Former Goldman Sachs Title: Partner and Co-head of Finance
Robert Hormats:
Obama Administration: Undersecretary for Economic, Energy and Agricultural Affairs, State Department
Former Goldman Sachs Title: Vice Chairman, Goldman Sachs Group
Philip Murphy:
Obama Administration: Ambassador to Germany
Former Goldman Sachs Title: Head of Goldman Sachs, Frankfurt
Mark Patterson:
Obama Administration: Chief of Staff to Treasury Secretary, Timothy Geitner
Former Goldman Sachs Title: Lobbyist 2005-2008; Vice President for Government Relations
John Thain:
Obama Administration: Advisor to Treasury Secretary, Timothy Geithner
Former Goldman Sachs Title: President and Chief Operating Officer (1999-2003)
http://the-classic-liberal.com...
Recommend Recommended by 129 Readers .13.Older but Wiser
Dallas
April 16th, 2010
4:48 pmIn a criminal trial most people withhold judgement until the verdict is reached. As civil cases turn far more on interpretations of rules it would be more seemly if the New York Times and its panelists waited until there is a conviction before crowing and trying to tell us what all this means.
Recommend Recommended by 5 Readers .14.smiths
ar
April 16th, 2010
4:48 pmI'm more concerned about Goldmans Sach's ownership of the Obama administration
Recommend Recommended by 95 Readers .15.RS Love
Palo Alto, CA
April 16th, 2010
4:48 pmJust a reminder that Frank Partnoy testified back in 2002 before a Senate committee that Enron was enabled to game and defraud investors using derivatives and that unless the law was corrected, more of the same was coming down the road. No one listened.
The culprit in the Enron crime wave was a recipe of CFMA 2000 mandated deregulation of trading exotics/synthetics, the corporate accountants serving no one, credit agencies for hire and our own lax Federal regulators too.
Roll tape forward to 2010. We are about to ignore the lessons of the past once again. Hard to admit that post-Depression banking legislation actually worked then and it worked up until the recent1990s while both parties dismantled it. There can be no real reform without separating the main street banking businesses from the casino bankers.
The mighty legends are headed to disgrace including Greenspan, Rubin, Summers, our Presidents (from Reagan to Obama), Paulson, Geithner, Gramm and the Senate Republicans who blindly took Wall Street's money; now it's the Democrats turn to pave the next road to financial ruin. They're right on schedule.
Recommend Recommended by 83 Readers .16.BTT
Wilkes-Barre, Pa.
April 16th, 2010
4:49 pmOne other point to Lynn Stout: you can't buy Home Insurance while the house is on fire! America at its worst! How immoral! BTT
Recommend Recommended by 32 Readers .17.Marcel Duchamp
Maine
April 16th, 2010
4:49 pmNext up: criminal prosecutions.
Let's go!
Recommend Recommended by 100 Readers .18.T.L.Moran
Idaho
April 16th, 2010
4:49 pmForget the SEC and its hunt through the dense weeds of microscopic regulatory law.
The attorneys general of many states facing bankruptcy, the many pension funds, university systems, and other public institutions, need only find one instance -- I'm sure there are many -- of death from heart attack or crisis-driven suicide and they have a perfect case against these corporations for depraved-heart murder.
The Wall St. thugs, driven by their addiction to complex scams and outsize profits, have demonstrated 'callous disregard' and 'extreme indifference' to the value of American lives with every million dollar profit they've made, every lavish bonus they've awarded themselves.
Never mind what slimy combination of congressional dopes and financial addicts undermined the laws protecting the country from this kind of daylight robbery. The intentions and the results speak clear: the executives of firms like this set aside all consideration for the continued life, health and happiness of everyday Americans in their adolescent race to see who could be the fastest, biggest looter of our national economy.
If corporations are people (thank you activist neo-con SCOTUS), then they are all guilty of depraved indifference. Prosecute, punish, and GET THIS COUNTRY'S MONEY BACK!
Recommend Recommended by 69 Readers .19.JVM Fan
Hollywood
April 16th, 2010
4:49 pmI just saw a movie on Sunset Blvd. called "Stock Shock" about all this Wall Street corruption and the audience was pretty shocked. It was the same story told through the eyes of Sirus XM investors that nearly went broke because of market manipulation. The movie is now sold on DVD just about everywhere, but cheaper at www.stockshockmovie.com
Recommend Recommended by 7 Readers .20.frank
providence, ri
April 16th, 2010
4:49 pmNone of this is news. Zuckerman in The Greatest Trade Ever (p.179) names Goldman, Bear Sterns, and Deutsche Bank (and others) as working with Paulson to create "controversial" CDO's (meaning this is not news) tailor made to fail. What can also be said it that mostly the banks were betting the other way, which is why they had so much losses, and the argument they were hedging really seems correct. But the fraud is ultimately about charges against an outside rating agencies, that maybe one didn't exist in this trade despite what was said. But all the rating agencies were also pushed and threatened no doubt NOT to rate the CDOs accurately. There is fraud everywhere, of course. The whole system was a fraud.
Recommend Recommended by 46 Readers .21.Docb
denver
April 16th, 2010
4:50 pmCome on folks --there has to be a market for these products...another IB or two or perhaps the street! They all did this created a market-- bought and sold against a fail...Go to the SEC site and pull up the Complaint--there is a firm mentioned , Paulson &Co---Hmmm could it be true? But this is just the tip...the SEC needs to be contacted and reminded that this is not isolated and not a case for fines and wrist slaps...1.888.732.6585 or the Sec of the SEC 1.202.551.5400
Recommend Recommended by 8 Readers .22.Dan
NYC
April 16th, 2010
4:50 pmI disagree with these rosy optimistic analysis of these so-called "experts."
This is the start of new chapter of regulations? Thats BS - These are civil charges, NOT criminal. Sure, Goldman will get hit with a settlement (probably around a million), which might sound big to the "main street average person" but in reality its not big at all to them. They will continue to do what they do and generate much much more money than that. Then, of course, Goldman Sachs will deny any wrongdoing, and Obama will praise the Justice System that we have. Every one wins! Except, of course, the people on main street and the people who GS fleeced.
Do you HONESTLY expect any better when the insane run the asylum?
Recommend Recommended by 55 Readers .23.pstgradny
New York
April 16th, 2010
4:52 pmWhat a shocker...dishonest and greedy investment bankers and traders. Sounds like fodder for a movie that might be entitled, Wall Street. I think Michael Douglas would be perfect for the lead role, and Charlie Sheen would be great as a conflicted young broker/trader. In the aftermath of the recent financial meltdown, this movie could be a huge hit, especially if done in 3D. Cameo performances might include Bernie Madoff, Jeffrey Skilling, Andy Fastow, Bernie Ebbers, Edward S. Digges Jr., etc.
Recommend Recommended by 16 Readers .24.Zenster
Manhattan
April 16th, 2010
5:13 pmIt seems every single person in the country knows for a fact that Goldman Sachs is a criminal organization, a white collar mafia - and still it took this long for the SEC to prosecute - and only this one charge, so amazingly egregious. What about the thousands and thousands of other crimes this giant vampire squid committed?
Recommend Recommended by 60 Readers .25.ron
new orleans
April 16th, 2010
5:14 pmI believe that the current banking crisis started out many years ago in Denver when the Silverado Bank and Neil Bush were bailed out by his father(Bush I) and his friends(Cheney,et al). Instead of starting a new wave of bank regulation at the time, Congress with the support of Bush, et al opened the flood gates to SEC deregulation. Being an optimist, I believe that everything that goes around, comes around. The American public will not be satisfied until the current group of creative criminals are exposed. Once they are indicted, historians should then revisit the first banking crisis.
Recommend Recommended by 63 Readers . of 7 Next ..Post a Comment
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Wednesday, April 14, 2010
Magnetar -- Remember This Name
(c) 2010 F. Bruce Abel
This posting by James Kwak (skip over the Simon Johnson piece for the moment), is a must, must read.
The Baseline Scenario
--------------------------------------------------------------------------------
Greek Bailout, Lehman Deceit, And Tim Geithner
Posted: 13 Apr 2010 04:53 AM PDT
By Simon Johnson
We live in an age of unprecedented bailouts. The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.
The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures. Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?
But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).
The sharp decline in market confidence last week – marked by the jump in Greek yields – scared the main European banks, and also showed there could be a real run on Greek banks; other Europeans are trying to stop it all from getting out of hand. But there is no new program that would bring order to Greece’s troubled public finances.
It’s money for nothing – with no change in the incentive and belief system that brought Greece to this point, very much like the way big banks were saved in the US last year.
If anything, incentives are worse after these bailouts – Greece and other weaker European countries on the one hand, and big US banks on the other hand, know now for sure that in their respective contexts they are too big to fail.
This is “moral hazard” – put simply, it is clear a country/big bank can get a package of support if needed, and this gives less incentive to be careful. Fiscal management for countries will not improve; and risk management for banks will remain prone to weakening when asset prices rise.
If a country hits a problem, the incentive is to wait and see if things get better – perhaps the world economy will improve and Greece can grow out of its difficulties. If such delay means that the problems actually worsen, Greece can just ask Germany for a bigger bailout.
Similarly, if a too-big-to-fail bank hits trouble, the incentive is to hide problems, hoping that financial conditions will improve. Essentially the management finds ways to “prop up” the bank; on modern Wall Street this is done with undisclosed accounting manipulation (in some other countries, it is done with cash). If this means the ultimate collapse is that much more damaging, it’s not the bank executives’ problem any way – their downside is limited, if it exists at all.
The Greeks will now:
Lobby for a large multi-year program from the IMF. They’ll want a path for fiscal policy that is easy in the first year and then gets tougher.
When they reach the tough stage, can’t deliver on the budget, and are about to default, the Greek government will call for another rapid agreement under pressure – with future promises of reform. The eurozone will again accept because it feels the spillovers otherwise would be too negative.
The Greek hope is that the global economy recovers enough to get out, but more realistically, they will start revealing a set of negative “surprises” that mean they miss targets. If the surprises add to the feeling of crisis and further potential bad consequences, that just helps to get a bailout.
The Greek authorities will add a ground game against the European Central Bank, saying things like: “the ECB is too tight, so we need more funds”. We’ll see how that divides the eurozone.
In their space, big US banks will continue to load up on risk as the cycle turns – while hiding that fact. Serious problems will never be revealed in good time – and the authorities will again have good reason (from their perspective) to agree to the hiding of issues until they get out of control, just as the Federal Reserve did for Lehman Brothers. Moral hazard not only ruins incentives, it also massively distorts the available and disclosed information.
As for Mr. Geithner, head of the New York Fed in 2008 and Secretary of the Treasury in 2009: Those who cannot remember the bailout are condemned to repeat it.
The Cover-Up
Posted: 12 Apr 2010 06:59 PM PDT
By James Kwak
Wall Street is engaged in a cover-up. Not a criminal cover-up, but an intellectual cover-up.
The key issue is whether the financial crisis was the product of conscious, intentional behavior — or whether it was an unforeseen and unforeseeable natural disaster. We’ve previously described the “banana peel” theory of the financial crisis — the idea it was the result of a complicated series of unfortunate mistakes, a giant accident. This past week, a parade of financial sector luminaries appeared before the Financial Crisis Inquiry Commission. Their mantra: “No one saw this coming.” The goal is to convince all of us that the crisis was a natural disaster — a “hundred-year flood,” to use Tim Geithner’s metaphor.
I find this incredibly frustrating. First of all, plenty of people saw the crisis coming. In late 2009, people like Nouriel Roubini and Peter Schiff were all over the airwaves for having predicted the crisis. Since then, there have been multiple books written about people who not only predicted the crisis but bet on it, making hundreds of millions or billions of dollars for themselves. Second, Simon and I just wrote a book arguing that the crisis was no accident: it was the result of the financial sector’s ability to use its political power to engineer a favorable regulatory environment for itself. Since, probabilistically speaking, most people will not read the book, it’s fortunate that Ira Glass has stepped in to help fill the gap.
This past weekend’s episode of This American Life includes a long story on a particular trade put on Magnetar (ProPublica story here), http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going a hedge fund that I first read about in Yves Smith’s ECONned. The main point of the story is to show how one group of people not only anticipated the collapse, and not only bet on it, but in doing so prolonged the bubble and made the ultimate collapse even worse. But it also raises some key issues about Wall Street and its behavior over the past decade.
This will require a brief description of what exactly Magnetar was doing. (If you know already, you can skip the next two paragraphs.) It’s now a cliche that a CDO is a set of securities that “slices and dices” a different set of securities. But it’s slightly more complicated than that. First there is a pile of mortgage-backed securities (or other bond-like securities) that are collected by an investment bank. The CDO itself is a new legal entity (a company) that buys these MBS from the bank; that’s the asset side of its balance sheet. Its liability side, like that of any company, includes debt and equity. There’s a small amount of equity bought by one investor and a lot of debt, issued in tranches that get paid off in a specific order, bought by other investors. The investment bank not only sells MBS to the CDO, but it also places the CDO’s bonds with other investors. Whoever buys the equity is like the “shareholder” of this company. There is also a CDO manager, whose job is to run the CDO — deciding which MBS it buys in the first place, and then (theoretically) selling MBS that go bad and replacing them by buying new ones. The CDO itself is like an investment fund, and the CDO manager is like the fund manager.
According to the story, in 2006, when the subprime-backed CDO market was starting to slow down, Magnetar started buying the equity layer — the riskiest part — of new CDOs. Since they were buying the equity, they were the CDOs’ sponsor, and they pressured the CDO managers to put especially risky MBS into the CDOs — making them more likely to fail. Then Magnetar bought credit default swaps on the debt issued by the CDOs. If the CDOs collapsed, as many did, their equity would become worthless, but their credit default swaps on the debt would repay them many, many times over.
The key is that Magnetar was exploiting the flaws in Wall Street’s process for manufacturing CDOs. Because the banks made up-front fees for creating CDOs, the actual human beings making the decisions did not particularly care if the CDOs collapsed — they just wanted Magnetar’s money to make the CDOs possible. (No one to buy the highly risky equity, no CDO.) Because the ratings agencies’ models did not particularly discriminate between the contents that went into the CDOs (see pages 169-71 of The Big Short, for example), Magnetar and the banks could stuff them with the most toxic inputs possible to make them more likely to fail.
Now, one question you should be asking yourself is, how is this even arithmetically possible? How is it possible that a CDO can have so little equity that you can buy credit default swaps on the debt at a low enough price to make a killing when the thing collapses? You would think that: (a) in order to sell the bonds at all, there would have to be more equity to protect the debt; and (b) the credit default swaps would have been expensive enough to eat up the profits on the deal. Remember, this is 2006, when several hedge funds were shorting CDOs and many investment banks were looking for protection for their CDO portfolios.
The answer is that nothing was being priced efficiently. The CDO debt was being priced according to the rating agencies’ models, which weren’t even looking at sufficiently detailed data. And the credit default swaps were underpriced because they allowed banks to create new synthetic CDOs, which were another source of profits. So here’s the first lesson: the idea that markets result in efficient prices was, in this case, hogwash.
By taking advantage of these inefficiencies, Magnetar made the Wall Street banks look like chumps. This American Life talks about one deal where Magnetar put up $10 million in equity and then shorted $1 billion of AAA-rated bonds issued by the CDO. It turned out that in this deal, JPMorgan Chase, the investment bank, actually held onto those AAA-rated bonds and eventually took a loss of $880 million. This was in exchange for about $20 million in up-front fees it earned.
But who’s the chump? Sure, JPMorgan Chase the bank lost $880 million. But of that $20 million in fees, about $10 million was paid out in compensation (investment banks pay out about half of their net revenues as compensation), much of it to the bankers who did the deal. JPMorgan’s bankers did just fine, despite having placed a ticking time bomb on their own bank’s balance sheet. Here’s the second lesson: the idea that bankers’ pay is based on their performance is also hogwash. (The idea that their pay is based on their net contribution to society is even more absurd.)
So who’s to blame? The first instinct is to get mad at Magnetar. But this overlooks a Wall Street maxim cited by TAL: you can’t blame the predator for eating the prey. Magnetar was out to make money for its limited partners; if it had bet wrong and lost money, no one would have bailed it out. Although I probably wouldn’t have behaved the same way under the circumstances, I have no problem with Magnetar.
I do have a problem with the Wall Street bankers in this story, however. Because losing $880 million of your own company’s money to make a quick buck for yourself is either incompetent or just wrong. And allowing Magnetar to create CDOs that are as toxic as possible — and then actively selling their debt to investors (that’s where the banks differ from Magnetar, in my opinion) — is either incompetent or just wrong. But even so, I don’t think the frontline bankers are ultimately at fault. Maybe they were simply incompetent. Or maybe, they were knowingly exploiting the system to maximize their earnings — only in this case the system they were exploiting was their own banks’ screwed-up compensation policies, risk management “systems,” and ethical guidelines.
In which case the real blame belongs to those who created that system and made it possible. And that would be the bank executives who failed at managing compensation, risk, or ethics, endangering or killing their companies in the process. And that would be the regulators and politicians who allowed these no-money down no-doc negative-amortization loans to be made in the first place; who allowed investment banks to sell whatever they wanted to investors, with no requirements or duties whatsoever; who allowed banks to outsource their capital requirements to rating agencies, giving them an incentive to hold mis-rated securities; who declined to regulate the credit default swaps that Magnetar used to amass its short positions; who allowed banks like Citigroup and JPMorgan Chase to get into this game with federally insured money; and who failed at monitoring the safety and soundness of the banks playing the game.
The lessons of Magnetar are the basic lessons of the financial crisis. Unregulated financial markets do not necessarily provide efficient prices or the optimal allocation of capital. The winners are not necessarily those who provide the most benefit to their clients or to society, but those who figure out how to exploit the rules of the game to their advantage. The crisis happened because the banks wanted unregulated financial markets and went out and got them — only it turned out they were not as smart as they thought they were and blew themselves up. It was not an innocent accident.
This posting by James Kwak (skip over the Simon Johnson piece for the moment), is a must, must read.
The Baseline Scenario
--------------------------------------------------------------------------------
Greek Bailout, Lehman Deceit, And Tim Geithner
Posted: 13 Apr 2010 04:53 AM PDT
By Simon Johnson
We live in an age of unprecedented bailouts. The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.
The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures. Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?
But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).
The sharp decline in market confidence last week – marked by the jump in Greek yields – scared the main European banks, and also showed there could be a real run on Greek banks; other Europeans are trying to stop it all from getting out of hand. But there is no new program that would bring order to Greece’s troubled public finances.
It’s money for nothing – with no change in the incentive and belief system that brought Greece to this point, very much like the way big banks were saved in the US last year.
If anything, incentives are worse after these bailouts – Greece and other weaker European countries on the one hand, and big US banks on the other hand, know now for sure that in their respective contexts they are too big to fail.
This is “moral hazard” – put simply, it is clear a country/big bank can get a package of support if needed, and this gives less incentive to be careful. Fiscal management for countries will not improve; and risk management for banks will remain prone to weakening when asset prices rise.
If a country hits a problem, the incentive is to wait and see if things get better – perhaps the world economy will improve and Greece can grow out of its difficulties. If such delay means that the problems actually worsen, Greece can just ask Germany for a bigger bailout.
Similarly, if a too-big-to-fail bank hits trouble, the incentive is to hide problems, hoping that financial conditions will improve. Essentially the management finds ways to “prop up” the bank; on modern Wall Street this is done with undisclosed accounting manipulation (in some other countries, it is done with cash). If this means the ultimate collapse is that much more damaging, it’s not the bank executives’ problem any way – their downside is limited, if it exists at all.
The Greeks will now:
Lobby for a large multi-year program from the IMF. They’ll want a path for fiscal policy that is easy in the first year and then gets tougher.
When they reach the tough stage, can’t deliver on the budget, and are about to default, the Greek government will call for another rapid agreement under pressure – with future promises of reform. The eurozone will again accept because it feels the spillovers otherwise would be too negative.
The Greek hope is that the global economy recovers enough to get out, but more realistically, they will start revealing a set of negative “surprises” that mean they miss targets. If the surprises add to the feeling of crisis and further potential bad consequences, that just helps to get a bailout.
The Greek authorities will add a ground game against the European Central Bank, saying things like: “the ECB is too tight, so we need more funds”. We’ll see how that divides the eurozone.
In their space, big US banks will continue to load up on risk as the cycle turns – while hiding that fact. Serious problems will never be revealed in good time – and the authorities will again have good reason (from their perspective) to agree to the hiding of issues until they get out of control, just as the Federal Reserve did for Lehman Brothers. Moral hazard not only ruins incentives, it also massively distorts the available and disclosed information.
As for Mr. Geithner, head of the New York Fed in 2008 and Secretary of the Treasury in 2009: Those who cannot remember the bailout are condemned to repeat it.
The Cover-Up
Posted: 12 Apr 2010 06:59 PM PDT
By James Kwak
Wall Street is engaged in a cover-up. Not a criminal cover-up, but an intellectual cover-up.
The key issue is whether the financial crisis was the product of conscious, intentional behavior — or whether it was an unforeseen and unforeseeable natural disaster. We’ve previously described the “banana peel” theory of the financial crisis — the idea it was the result of a complicated series of unfortunate mistakes, a giant accident. This past week, a parade of financial sector luminaries appeared before the Financial Crisis Inquiry Commission. Their mantra: “No one saw this coming.” The goal is to convince all of us that the crisis was a natural disaster — a “hundred-year flood,” to use Tim Geithner’s metaphor.
I find this incredibly frustrating. First of all, plenty of people saw the crisis coming. In late 2009, people like Nouriel Roubini and Peter Schiff were all over the airwaves for having predicted the crisis. Since then, there have been multiple books written about people who not only predicted the crisis but bet on it, making hundreds of millions or billions of dollars for themselves. Second, Simon and I just wrote a book arguing that the crisis was no accident: it was the result of the financial sector’s ability to use its political power to engineer a favorable regulatory environment for itself. Since, probabilistically speaking, most people will not read the book, it’s fortunate that Ira Glass has stepped in to help fill the gap.
This past weekend’s episode of This American Life includes a long story on a particular trade put on Magnetar (ProPublica story here), http://www.propublica.org/feature/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going a hedge fund that I first read about in Yves Smith’s ECONned. The main point of the story is to show how one group of people not only anticipated the collapse, and not only bet on it, but in doing so prolonged the bubble and made the ultimate collapse even worse. But it also raises some key issues about Wall Street and its behavior over the past decade.
This will require a brief description of what exactly Magnetar was doing. (If you know already, you can skip the next two paragraphs.) It’s now a cliche that a CDO is a set of securities that “slices and dices” a different set of securities. But it’s slightly more complicated than that. First there is a pile of mortgage-backed securities (or other bond-like securities) that are collected by an investment bank. The CDO itself is a new legal entity (a company) that buys these MBS from the bank; that’s the asset side of its balance sheet. Its liability side, like that of any company, includes debt and equity. There’s a small amount of equity bought by one investor and a lot of debt, issued in tranches that get paid off in a specific order, bought by other investors. The investment bank not only sells MBS to the CDO, but it also places the CDO’s bonds with other investors. Whoever buys the equity is like the “shareholder” of this company. There is also a CDO manager, whose job is to run the CDO — deciding which MBS it buys in the first place, and then (theoretically) selling MBS that go bad and replacing them by buying new ones. The CDO itself is like an investment fund, and the CDO manager is like the fund manager.
According to the story, in 2006, when the subprime-backed CDO market was starting to slow down, Magnetar started buying the equity layer — the riskiest part — of new CDOs. Since they were buying the equity, they were the CDOs’ sponsor, and they pressured the CDO managers to put especially risky MBS into the CDOs — making them more likely to fail. Then Magnetar bought credit default swaps on the debt issued by the CDOs. If the CDOs collapsed, as many did, their equity would become worthless, but their credit default swaps on the debt would repay them many, many times over.
The key is that Magnetar was exploiting the flaws in Wall Street’s process for manufacturing CDOs. Because the banks made up-front fees for creating CDOs, the actual human beings making the decisions did not particularly care if the CDOs collapsed — they just wanted Magnetar’s money to make the CDOs possible. (No one to buy the highly risky equity, no CDO.) Because the ratings agencies’ models did not particularly discriminate between the contents that went into the CDOs (see pages 169-71 of The Big Short, for example), Magnetar and the banks could stuff them with the most toxic inputs possible to make them more likely to fail.
Now, one question you should be asking yourself is, how is this even arithmetically possible? How is it possible that a CDO can have so little equity that you can buy credit default swaps on the debt at a low enough price to make a killing when the thing collapses? You would think that: (a) in order to sell the bonds at all, there would have to be more equity to protect the debt; and (b) the credit default swaps would have been expensive enough to eat up the profits on the deal. Remember, this is 2006, when several hedge funds were shorting CDOs and many investment banks were looking for protection for their CDO portfolios.
The answer is that nothing was being priced efficiently. The CDO debt was being priced according to the rating agencies’ models, which weren’t even looking at sufficiently detailed data. And the credit default swaps were underpriced because they allowed banks to create new synthetic CDOs, which were another source of profits. So here’s the first lesson: the idea that markets result in efficient prices was, in this case, hogwash.
By taking advantage of these inefficiencies, Magnetar made the Wall Street banks look like chumps. This American Life talks about one deal where Magnetar put up $10 million in equity and then shorted $1 billion of AAA-rated bonds issued by the CDO. It turned out that in this deal, JPMorgan Chase, the investment bank, actually held onto those AAA-rated bonds and eventually took a loss of $880 million. This was in exchange for about $20 million in up-front fees it earned.
But who’s the chump? Sure, JPMorgan Chase the bank lost $880 million. But of that $20 million in fees, about $10 million was paid out in compensation (investment banks pay out about half of their net revenues as compensation), much of it to the bankers who did the deal. JPMorgan’s bankers did just fine, despite having placed a ticking time bomb on their own bank’s balance sheet. Here’s the second lesson: the idea that bankers’ pay is based on their performance is also hogwash. (The idea that their pay is based on their net contribution to society is even more absurd.)
So who’s to blame? The first instinct is to get mad at Magnetar. But this overlooks a Wall Street maxim cited by TAL: you can’t blame the predator for eating the prey. Magnetar was out to make money for its limited partners; if it had bet wrong and lost money, no one would have bailed it out. Although I probably wouldn’t have behaved the same way under the circumstances, I have no problem with Magnetar.
I do have a problem with the Wall Street bankers in this story, however. Because losing $880 million of your own company’s money to make a quick buck for yourself is either incompetent or just wrong. And allowing Magnetar to create CDOs that are as toxic as possible — and then actively selling their debt to investors (that’s where the banks differ from Magnetar, in my opinion) — is either incompetent or just wrong. But even so, I don’t think the frontline bankers are ultimately at fault. Maybe they were simply incompetent. Or maybe, they were knowingly exploiting the system to maximize their earnings — only in this case the system they were exploiting was their own banks’ screwed-up compensation policies, risk management “systems,” and ethical guidelines.
In which case the real blame belongs to those who created that system and made it possible. And that would be the bank executives who failed at managing compensation, risk, or ethics, endangering or killing their companies in the process. And that would be the regulators and politicians who allowed these no-money down no-doc negative-amortization loans to be made in the first place; who allowed investment banks to sell whatever they wanted to investors, with no requirements or duties whatsoever; who allowed banks to outsource their capital requirements to rating agencies, giving them an incentive to hold mis-rated securities; who declined to regulate the credit default swaps that Magnetar used to amass its short positions; who allowed banks like Citigroup and JPMorgan Chase to get into this game with federally insured money; and who failed at monitoring the safety and soundness of the banks playing the game.
The lessons of Magnetar are the basic lessons of the financial crisis. Unregulated financial markets do not necessarily provide efficient prices or the optimal allocation of capital. The winners are not necessarily those who provide the most benefit to their clients or to society, but those who figure out how to exploit the rules of the game to their advantage. The crisis happened because the banks wanted unregulated financial markets and went out and got them — only it turned out they were not as smart as they thought they were and blew themselves up. It was not an innocent accident.
Friday, April 9, 2010
Rubin -- How to Read My Blog on Him
I will continue to build on my first recent blog, "Rubin -- Are You Nothing But a Sandwich?" So when you enter my blog today and the following week or so go back to that blog item.
Thursday, April 8, 2010
Rubin -- Are You Just a Sandwich?
(c) 2010 F. Bruce Abel
If you were to ask me ten years ago to name my heroes in a quick moment Robert Rubin would be one of them -- out of a very few. Today before Congress Rubin is just a sandwich.
Of course this is troubling. Our world is so complicated that Robert Rubin can be paid by his company $100 million (as he was during the relevant time) and have no idea that his company is on the verge of bringing not just itself down, but the entire financial system down, with all that this implies.
We at this high level could not have been expected to get involved with the "granularity" of the bank's dealings, he says today to Congress.
This man saved the government from Newt Gingrich's plan to shut down government one weekend.
Was this done without "granularity?"
My Gawd.
This man saved Mexico through slogging through our debt package.
Was this done without "granularity?"
Maybe after all it was simply Young Goldman Sachs Men Looking Cool on the Beach. Robert Rubin is now not so young and he can't carry out on the granularity things?
Speaking of carry-out, Robert Rubin, here's a "granularity" assignment that would at least take care of lunch. Would you go down to Izzys and tell them to spread slices of bread with 1000 Island dressing; top each with 1 tablespoon sauerkraut and corned beef, lay cheese on top. Put in broiler and grill until hot ...
Meanwhile, mixing metaphors if not mega-phors, and, as Woody Allen would say,
"You are Citigroup; What are we, chopped liver?"
OK, put aside the above and read a stunningly good piece from the Washington Post by Ezra Klein:
Ezra Klein
The complexity problem
Earlier in the crisis, the line was that "too big to fail" was too big to exist. I'm coming around to an altogether more radical view: What if "too complex to understand" is too complex to exist?
Listen to Robert Rubin -- the former co-chairman of Goldman Sachs, celebrated secretary of the treasury and director of Citibank -- tell the Financial Crisis Inquiry Commission that
"All of us in the industry failed to see the potential for this serious crisis. We failed to see the multiple factors at work.”
Listen to Alan Greenspan -- former Federal Reserve chairman, holder of the nickname "The Oracle" -- say that we need regulations that kick in "without relying on the ability of a fallible human regulator to predict a coming crisis."
If you're an investment bank, the stock market has become a bit of a bummer. It's so transparent and user-friendly that there's really no place for a middleman to make major profits. That's normal: Efficient markets reduce margins. To put it another way: It's hard to make money doing simple things in a competitive market unless you have a monopoly. But Wall Street has leveraged incredible levels of complexity into something that's more like a monopoly than a market.
The really neat trick was that this worked even after the market crashed. Because no one could understand it, the people who crashed the place were also given a major role in the rescue effort. And that wasn't just true at the top level. Think back to the AIG employees threatening to quit and make it (theoretically) impossible to unwind the company's financial products division if they didn't get their retention bonuses. Their retention bonuses!
It would be one thing if this complexity had done great things for the country. But not so much, as we all know. Some innovations (pdf) have been good. But the opaque complexity that gave rise to credit default swaps and collateralized debt obligations and risk profiles that no one understood turned out to be almost unimaginably bad. Complexity helped bankers bully ratings agencies and regulators into signing off on products they didn't understand, it helped mortgage lenders entice consumers into contracts that they couldn't fulfill, and it's now helping Wall Street beat back necessary regulations because Congress is nervous about mucking with an industry they don't really grasp. And beyond all that, the complexity that allowed Wall Street to become a more profitable and significant segment of the economy also sucked talent away from other sectors.
How does this translate into regulation? I'm not really sure. It's not like there's a standard measure of unnecessary complexity or useless opacity. But watching these Wall Street titans tell the FCIC that they didn't understand what the banks were doing is making me a lot less sympathetic when their lobbyists tell Congress that Washington simply doesn't understand what the banks are doing.
By Ezra Klein April 8, 2010; 5:07 PM ET
Categories: Financial Crisis , Financial Regulation
Comments (not by me):
Restricting complexity ultimately translates into restricting interconnectedness.
Fundamental properties of structures in computer science and mathematics called graphs* show that at a certain level of interconnectedness, the corporate graph will show cyclical dependencies that are fairly intractable in terms of answering the questions we want to ask.
Compound this with the fact that you'll only be aware of a subset of the data structure at any time, and any densely interconnected financial system will be "too complex to understand".
*Note, this is very different from a plot or your common bar graph,
Posted by: zosima April 8, 2010 5:35 PM Report abuse
Ezra: I hope you do follow the TED conference and their videos. Two key speakers talks about the need to reduce complexity whether it's legal or societal.
http://www.ted.com/talks/alan_siegel_let_s_simplify_legal_jargon.html
http://www.ted.com/talks/barry_schwartz_on_our_loss_of_wisdom.html
Posted by: AD1971 April 8, 2010 5:48 PM Report abuse
From reading Michael Lewis it is clear that the subprime/CDO/CDS stuff was really complex--so much so that one had to have Asperger's and spend 6 months at it to understand it. It was way, way too complex, and deliberately so. Moreover, the Rubins and Princes didn't ask someone to explain the products to them. There were people in their firms who understood the level of risk, or at least how the products worked. In addition, there were people gaming the ratings agencies who knew that the towers of mortgages and derivatives were largely sh*tpiles. But no one wanted to upset the applecart, and the people with responsibility never wanted to inquire very far.
So what did Rubin do to warrant his $20 million? Provide access? Cachet? He ought to give most of it back.
Greenspan also won ;t acknowledge the role that low interest rates played in (1) fueling the housing boom and (2) encouraging savers/investors to look for higher yields in products like CDOs.
If we want to encourage genuine savings, higher yields were needed, and it would have provided a margin for easing when things went bad. Now, of course, we need low rates. But still. It is a hell of an environment for savers.
Posted by: Mimikatz April 8, 2010 6:05 PM Report abuse
This combined size and complexity is not manageable or controllable in a democracy.
We face very hard choices that we are not socially/politically prepared to make.
There are many aspects that need radical redos:
- numbers and types of biz's that financial firms are allowed to participate in
- max. size of a organization allowed before a anti-trust/anti-complexity trigger is hit that results in breakup into smaller pieces.
- regulators that are tailored to various segments of biz that are created after monoliths are outlawed.
- no financial innovation that isn't fully studied and pre-prescribed remedies are enacted to automatically kick in when inevitably things go awry in one of the newly arranged segments/sectors.
It is almost a fool's errand to think about this, since the beast controls the keeper in multiple ways. We haven't and won't learn from our mistakes. Denial is the order of the day. A return to democratic control of our society is probably now impossible.
Learn to love your financial masters, because they are now your destiny.
Posted by: JimPortlandOR April 8, 2010 7:01 PM Report abuse
The key to regulation is to make CONSUMER PROTECTION paramount. If rules are made with consumer protection in mind AT ALL LEVELS then it will eliminate most of the cheats frauds and loan sharks.
Especially if we take a broad definition of consumer protection to include pension funds and 401Ks. Protecting consumers by cracking down on loan sharks would have prevented the housing bubble.
Trying to regulate the banksters directly is unlikely to work. What can work is to protect small investors and the types of products that can be marketed. The cost of regulation will be small compared to the huge inefficiencies created by the cheats frauds and loan sharks.
Posted by: bakho April 8, 2010 8:01 PM Report abuse
I always though we should just make it a criminal offense to lose $X billion when you can't cover it with assets. Financial meltdowns causes much more societal damage than any particular single criminal act from drug use to trespassing to murder.
You designate a CEO and/or CFO or whoever to be responsible. If the losses include contracts made under a previous CEO, you include him or her.
This is effectively a leverage ratio of 1, but only coming into place when you leverage near the limit. Say, X = $50 billion dollars. I can leverage $4 billion in assets at 13:1 and still make it under the "cap" if it goes bad (4 x 13 - 4 = 48).
But I can only leverage $10 billion at just under 5:1, or else risk 20 years in prison.
But the best part is that no one has to calculate it until after the fact if it goes bad and it motivates people to get it right in the first place. The creditors will act as the police and bring it to everyone's attention because they are making the claims.
Not that I've worked out every aspect of this. You can mitigate sentences for bad luck or duped CEOs.
We used to throw people in jail for debts but got rid of it because it was inhumane for the poor. They can't leverage assets however, so they would just go bankrupt before they reached the limit.
I don't think debtors prison is inhumane for rich CEOs, though.
Posted by: JasonFromSeattle April 8, 2010 8:20 PM Report abuse
RobRub?
Posted by: pj_camp April 8, 2010 8:56 PM Report abuse
Post a Comment
© 2010 The Washington Post Company
If you were to ask me ten years ago to name my heroes in a quick moment Robert Rubin would be one of them -- out of a very few. Today before Congress Rubin is just a sandwich.
Of course this is troubling. Our world is so complicated that Robert Rubin can be paid by his company $100 million (as he was during the relevant time) and have no idea that his company is on the verge of bringing not just itself down, but the entire financial system down, with all that this implies.
We at this high level could not have been expected to get involved with the "granularity" of the bank's dealings, he says today to Congress.
This man saved the government from Newt Gingrich's plan to shut down government one weekend.
Was this done without "granularity?"
My Gawd.
This man saved Mexico through slogging through our debt package.
Was this done without "granularity?"
Maybe after all it was simply Young Goldman Sachs Men Looking Cool on the Beach. Robert Rubin is now not so young and he can't carry out on the granularity things?
Speaking of carry-out, Robert Rubin, here's a "granularity" assignment that would at least take care of lunch. Would you go down to Izzys and tell them to spread slices of bread with 1000 Island dressing; top each with 1 tablespoon sauerkraut and corned beef, lay cheese on top. Put in broiler and grill until hot ...
Meanwhile, mixing metaphors if not mega-phors, and, as Woody Allen would say,
"You are Citigroup; What are we, chopped liver?"
OK, put aside the above and read a stunningly good piece from the Washington Post by Ezra Klein:
Ezra Klein
The complexity problem
Earlier in the crisis, the line was that "too big to fail" was too big to exist. I'm coming around to an altogether more radical view: What if "too complex to understand" is too complex to exist?
Listen to Robert Rubin -- the former co-chairman of Goldman Sachs, celebrated secretary of the treasury and director of Citibank -- tell the Financial Crisis Inquiry Commission that
"All of us in the industry failed to see the potential for this serious crisis. We failed to see the multiple factors at work.”
Listen to Alan Greenspan -- former Federal Reserve chairman, holder of the nickname "The Oracle" -- say that we need regulations that kick in "without relying on the ability of a fallible human regulator to predict a coming crisis."
If you're an investment bank, the stock market has become a bit of a bummer. It's so transparent and user-friendly that there's really no place for a middleman to make major profits. That's normal: Efficient markets reduce margins. To put it another way: It's hard to make money doing simple things in a competitive market unless you have a monopoly. But Wall Street has leveraged incredible levels of complexity into something that's more like a monopoly than a market.
The really neat trick was that this worked even after the market crashed. Because no one could understand it, the people who crashed the place were also given a major role in the rescue effort. And that wasn't just true at the top level. Think back to the AIG employees threatening to quit and make it (theoretically) impossible to unwind the company's financial products division if they didn't get their retention bonuses. Their retention bonuses!
It would be one thing if this complexity had done great things for the country. But not so much, as we all know. Some innovations (pdf) have been good. But the opaque complexity that gave rise to credit default swaps and collateralized debt obligations and risk profiles that no one understood turned out to be almost unimaginably bad. Complexity helped bankers bully ratings agencies and regulators into signing off on products they didn't understand, it helped mortgage lenders entice consumers into contracts that they couldn't fulfill, and it's now helping Wall Street beat back necessary regulations because Congress is nervous about mucking with an industry they don't really grasp. And beyond all that, the complexity that allowed Wall Street to become a more profitable and significant segment of the economy also sucked talent away from other sectors.
How does this translate into regulation? I'm not really sure. It's not like there's a standard measure of unnecessary complexity or useless opacity. But watching these Wall Street titans tell the FCIC that they didn't understand what the banks were doing is making me a lot less sympathetic when their lobbyists tell Congress that Washington simply doesn't understand what the banks are doing.
By Ezra Klein April 8, 2010; 5:07 PM ET
Categories: Financial Crisis , Financial Regulation
Comments (not by me):
Restricting complexity ultimately translates into restricting interconnectedness.
Fundamental properties of structures in computer science and mathematics called graphs* show that at a certain level of interconnectedness, the corporate graph will show cyclical dependencies that are fairly intractable in terms of answering the questions we want to ask.
Compound this with the fact that you'll only be aware of a subset of the data structure at any time, and any densely interconnected financial system will be "too complex to understand".
*Note, this is very different from a plot or your common bar graph,
Posted by: zosima April 8, 2010 5:35 PM Report abuse
Ezra: I hope you do follow the TED conference and their videos. Two key speakers talks about the need to reduce complexity whether it's legal or societal.
http://www.ted.com/talks/alan_siegel_let_s_simplify_legal_jargon.html
http://www.ted.com/talks/barry_schwartz_on_our_loss_of_wisdom.html
Posted by: AD1971 April 8, 2010 5:48 PM Report abuse
From reading Michael Lewis it is clear that the subprime/CDO/CDS stuff was really complex--so much so that one had to have Asperger's and spend 6 months at it to understand it. It was way, way too complex, and deliberately so. Moreover, the Rubins and Princes didn't ask someone to explain the products to them. There were people in their firms who understood the level of risk, or at least how the products worked. In addition, there were people gaming the ratings agencies who knew that the towers of mortgages and derivatives were largely sh*tpiles. But no one wanted to upset the applecart, and the people with responsibility never wanted to inquire very far.
So what did Rubin do to warrant his $20 million? Provide access? Cachet? He ought to give most of it back.
Greenspan also won ;t acknowledge the role that low interest rates played in (1) fueling the housing boom and (2) encouraging savers/investors to look for higher yields in products like CDOs.
If we want to encourage genuine savings, higher yields were needed, and it would have provided a margin for easing when things went bad. Now, of course, we need low rates. But still. It is a hell of an environment for savers.
Posted by: Mimikatz April 8, 2010 6:05 PM Report abuse
This combined size and complexity is not manageable or controllable in a democracy.
We face very hard choices that we are not socially/politically prepared to make.
There are many aspects that need radical redos:
- numbers and types of biz's that financial firms are allowed to participate in
- max. size of a organization allowed before a anti-trust/anti-complexity trigger is hit that results in breakup into smaller pieces.
- regulators that are tailored to various segments of biz that are created after monoliths are outlawed.
- no financial innovation that isn't fully studied and pre-prescribed remedies are enacted to automatically kick in when inevitably things go awry in one of the newly arranged segments/sectors.
It is almost a fool's errand to think about this, since the beast controls the keeper in multiple ways. We haven't and won't learn from our mistakes. Denial is the order of the day. A return to democratic control of our society is probably now impossible.
Learn to love your financial masters, because they are now your destiny.
Posted by: JimPortlandOR April 8, 2010 7:01 PM Report abuse
The key to regulation is to make CONSUMER PROTECTION paramount. If rules are made with consumer protection in mind AT ALL LEVELS then it will eliminate most of the cheats frauds and loan sharks.
Especially if we take a broad definition of consumer protection to include pension funds and 401Ks. Protecting consumers by cracking down on loan sharks would have prevented the housing bubble.
Trying to regulate the banksters directly is unlikely to work. What can work is to protect small investors and the types of products that can be marketed. The cost of regulation will be small compared to the huge inefficiencies created by the cheats frauds and loan sharks.
Posted by: bakho April 8, 2010 8:01 PM Report abuse
I always though we should just make it a criminal offense to lose $X billion when you can't cover it with assets. Financial meltdowns causes much more societal damage than any particular single criminal act from drug use to trespassing to murder.
You designate a CEO and/or CFO or whoever to be responsible. If the losses include contracts made under a previous CEO, you include him or her.
This is effectively a leverage ratio of 1, but only coming into place when you leverage near the limit. Say, X = $50 billion dollars. I can leverage $4 billion in assets at 13:1 and still make it under the "cap" if it goes bad (4 x 13 - 4 = 48).
But I can only leverage $10 billion at just under 5:1, or else risk 20 years in prison.
But the best part is that no one has to calculate it until after the fact if it goes bad and it motivates people to get it right in the first place. The creditors will act as the police and bring it to everyone's attention because they are making the claims.
Not that I've worked out every aspect of this. You can mitigate sentences for bad luck or duped CEOs.
We used to throw people in jail for debts but got rid of it because it was inhumane for the poor. They can't leverage assets however, so they would just go bankrupt before they reached the limit.
I don't think debtors prison is inhumane for rich CEOs, though.
Posted by: JasonFromSeattle April 8, 2010 8:20 PM Report abuse
RobRub?
Posted by: pj_camp April 8, 2010 8:56 PM Report abuse
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Monday, April 5, 2010
The Big Short
(c) 2010 F. Bruce Abel
Yves Smith's criticism of Michael Lewis's The Big Short is brilliant too -- especially his analogy of the guy who looks on the street like a prime candidate for a heart attack, but to his internist all the tests come back normal -- but, without having read The Big Short yet, I still believe that Lewis knew all the stuff Smith brings up. Lewis is playing a dangerous game of lionizing the key good/bad guys. Smith doesn't "get it."
Yves Smith's criticism of Michael Lewis's The Big Short is brilliant too -- especially his analogy of the guy who looks on the street like a prime candidate for a heart attack, but to his internist all the tests come back normal -- but, without having read The Big Short yet, I still believe that Lewis knew all the stuff Smith brings up. Lewis is playing a dangerous game of lionizing the key good/bad guys. Smith doesn't "get it."
Wow!
(c) 2010 F. Bruce Abel
ed note: The Big Short is now No 1 on the NYT Non-Fiction Best Seller List, the first week it is on-- and the first week it could be on!
-ed note2: my wife, reading the same New York Times Book Review of yesterday, points out that Michael Lewis's "Liar's Poker" is now back on the paperback Best Seller list. So there's a huge recognition of the importance of Michael Lewis's collective work here.
ed note: The Big Short is now No 1 on the NYT Non-Fiction Best Seller List, the first week it is on-- and the first week it could be on!
-ed note2: my wife, reading the same New York Times Book Review of yesterday, points out that Michael Lewis's "Liar's Poker" is now back on the paperback Best Seller list. So there's a huge recognition of the importance of Michael Lewis's collective work here.
The Big Short -- I Like Michael Burry as Portrayed
(c) 2010 F. Bruce Abel
OK, I read the clip from The Big Short which focused on Michael Burry. I like Burry. So this raises the question Do we have a financial system which can be destroyed by one nice guy who comes up with one good idea to make money?
What I like is that one man, sitting alone reading 10K's, can come up with powerful ideas for investing. That's what I used to like to do! (Up to a point; that's like saying I used to like searching titles at the Hamilton County Courthouse, ecch!) And that one man, putting his stock ideas out there on the internet, becomes followed by Wall Street money managers who, unknown to Michael Burry, are making money on his stock ideas.
OK, I read the clip from The Big Short which focused on Michael Burry. I like Burry. So this raises the question Do we have a financial system which can be destroyed by one nice guy who comes up with one good idea to make money?
What I like is that one man, sitting alone reading 10K's, can come up with powerful ideas for investing. That's what I used to like to do! (Up to a point; that's like saying I used to like searching titles at the Hamilton County Courthouse, ecch!) And that one man, putting his stock ideas out there on the internet, becomes followed by Wall Street money managers who, unknown to Michael Burry, are making money on his stock ideas.
Sunday, April 4, 2010
The Big Short
(c) 2010 F. Bruce Abel
Ok, read and enjoy. It's from The Big Short as reproduced in Vanity Fair:
http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004
More Fallout on The Big Short
(c) 2010 F. Bruce Abel
-ed note: The Big Short is now No 1 on the NYT Non-Fiction Best Seller List, the first week it is on-- and the first week it could be on!
-ed note2: my wife points out that Michael Lewis's "Liar's Poker" is now back on the paperback Best Seller list. So there's a huge recognition of the importance of Michael Lewis's work here.
Readers of my blog know to keep checking on older blogs which are of especial interest. My recent posts on The Big Short by Michael Lewis, are the quintessential example of this. Because I will update the older post in order to keep as much information in one piece, for my later convenience, even though it is an older blog post.
Now we have an Op-Ed by the very person who benefitted/caused the credit default crash! Burry. In the New York Times.
So I will post the Burry Op-Ed piece here for ease of reference.
http://www.nytimes.com/2010/04/04/opinion/04burry.html?scp=2&sq=burry&st=cse
This article by Burry is total public relations fluff and a waste of time. What's going on here?
There was a Huffington Post book review which I have posted on my earlier The Big Short blog, and I now post again, http://www.huffingtonpost.com/yves-smith/debunking-michael-lewis-t_b_512542.html which criticizes Michael Lewis for lionizing Burry and the others for being so smart. I think there's a deeper purpose to Lewis's writing -- to expose these people and the system which dredges them up. While at one level appearing to praise them.
Having said the above, I have not yet read The Big Short. I am an admirer/expert in Michael Lewis, however, and have been for a long, long time.
-ed note: The Big Short is now No 1 on the NYT Non-Fiction Best Seller List, the first week it is on-- and the first week it could be on!
-ed note2: my wife points out that Michael Lewis's "Liar's Poker" is now back on the paperback Best Seller list. So there's a huge recognition of the importance of Michael Lewis's work here.
Readers of my blog know to keep checking on older blogs which are of especial interest. My recent posts on The Big Short by Michael Lewis, are the quintessential example of this. Because I will update the older post in order to keep as much information in one piece, for my later convenience, even though it is an older blog post.
Now we have an Op-Ed by the very person who benefitted/caused the credit default crash! Burry. In the New York Times.
So I will post the Burry Op-Ed piece here for ease of reference.
http://www.nytimes.com/2010/04/04/opinion/04burry.html?scp=2&sq=burry&st=cse
This article by Burry is total public relations fluff and a waste of time. What's going on here?
There was a Huffington Post book review which I have posted on my earlier The Big Short blog, and I now post again, http://www.huffingtonpost.com/yves-smith/debunking-michael-lewis-t_b_512542.html which criticizes Michael Lewis for lionizing Burry and the others for being so smart. I think there's a deeper purpose to Lewis's writing -- to expose these people and the system which dredges them up. While at one level appearing to praise them.
Having said the above, I have not yet read The Big Short. I am an admirer/expert in Michael Lewis, however, and have been for a long, long time.
Monday, March 29, 2010
The Big Short
(c) 2010 F. Bruce Abel
April 2, 2010
"How'd they do it? The answer is clearly spelled out in the footnotes to AIG's (nyse: AIG - news - people ) 2007 consolidated financial statement. "In most cases AIGFP (American International Group Financial Products) does not hedge its exposures related to credit default swaps it has written."
My notes from listening to the NPR interview of Michael Lewis by Terry Gross with Michael Lewis about 13 days ago:
The Big Short
[verbatim as much as possible]
So much written and reported about the collapse is through the eyes of the people "who had no idea" -- the Treasury Secretary, the Chairman of the Federal Reserve, the heads of the investment banks -- as the crisis was gathering force.
[Lewis got to "Ground Zero" and, in his own words, found that a handful of people were not clueless and were themselves the cause of the crash, after (supposedly--ed note) they tried to warn Wall Street and the NYT and the WSJ.]
"Everybody was working with same set of facts."
The vast majority of people in the markets painted a “very pleasant” picture from the set of facts.
"We 'see' what we want to see."
Michael Burry
Had been studying to be a doctor, was a resident on his way to being one.
Instead went full-time into investing. Formed a hedge fund. Began studying the bond mkt.
Had/has asberger’s syndrome. Didn’t know it at the time.
Having asberger's he studied the prospectuses of mortgage companies.
2003-2004, early 2005
saw the phenomenal growth of interest-only mortgages and negatively amortizing mortgages
“the lending couldn’t get any worse”
he saw the "end of the madness" coming and wanted to bet against it, but didn't know how.
he begins to bet against the subprime mortgage market
the bond mkt is "the wild west;" it's much less regulated and for the investor it's much easier to get ripped off; he’s aware of that. In corporate bond mkt there were a credit default swaps and had been for 10 years. He felt that Wall Street was "bound" to invent them on subprime mortgage bonds.
Michael Burry pesters Wall Street to create credit default swaps for subprime mortgage bonds
He is Ground Zero; "Patient No 1;" March to May 2005
Makes the "bet" (with GS) in March; gets a written contract in May.
GS – why willing? GS had persuaded AIG to sell GS
AIG had unlimited appetite. In a few months $20 billion, at very low prices; close to free,
GS took some on as a bet. Turned around and multiplied price by 10 and sold to Michael Burry.
All of sudden a big institution in the picture.
GS was already thinking along these lines. In other words it wasn't just Michael Berry.
AIG had been insuring corporate bonds for almost a decade.
In 2004 and 2005 GS comes (to AIG) with “diversified consumer loans”
“we’ll do that too.” (said AIG)
GS went to AIG with subprimes too. “Yep.”
Burry dealt with GS, Deuche Bank, Morgan Stanley, Bank of America, Merrill Lynch too. Wall Street firms were on the other side of the bets. For the most part they had sold the bets on and AIG was on the other side.
Charley Ledley and Jamie Mai
Cornwall Capital
Started with $100,000 in a Schwab Account.
“Wall Street underestimated the likelihood of unlikely events.” (they felt)
They bought options on extreme things happening. Each bet cost them very little. Wrong most of the time but right enough…
Stumble into the subprime mortgage mkt
For paying 2%/yr on dicey subprime mort loans
They knew nothing re bond mkt but they pieced together a picture
They go to SEC; NYTimes, WSJ “there’s fraud in the system.” Nobody understands or pays attention.
They ended up betting against financial instutions themselves – Bear Stearns, etc.
“Who’s taking all this risk?” they asked. Figured out that the WS firms themselves were the dumbest guys at the table. Afraid that BS couldn’t honor their contracts. So bought credit default swaps CDS’s on Bear Stearns too.
Turned $100,000 into $100 million.
None of these guys are natural short sellers. They wanted to be investing in the stock markets but they saw that these markets would be killed by what was going on in the bond (CDS, etc. market).
Personally, although they were making a fortune they had panic attacks; stressed (being right); a bet against an entire financial system; their insight that the system had become rigged; Charlie worried about riots
They were by nature ordinary stock investors; the world forced them into this position.
Herein, on April 2, 2010, I add the following from this, my blog, which indicates that one person,
Joseph Cassano
http://natgagu.blogspot.com/2009/03/joseph-cassano.html
was the cause of the meltdown. Read the whole interview above plus the link to Joseph Cassano, and you can see that we had a financial terrorist in our midst, one who started with Michael Milken.
And the NYT Article of April 1, 2010 adds to the list of names who make billions per year:
http://www.nytimes.com/2010/04/01/business/01hedge.html?scp=2&sq=soros&st=cse
And this review in the WSJ which served as the research for Lewis's book:
http://blogs.wsj.com/deals/2010/03/15/michael-lewiss-the-big-short-read-the-harvard-thesis-instead/tab/article/
But this reviewer says Michael Lewis has it all wrong:
http://www.huffingtonpost.com/yves-smith/debunking-michael-lewis-t_b_512542.html
April 2, 2010
"How'd they do it? The answer is clearly spelled out in the footnotes to AIG's (nyse: AIG - news - people ) 2007 consolidated financial statement. "In most cases AIGFP (American International Group Financial Products) does not hedge its exposures related to credit default swaps it has written."
My notes from listening to the NPR interview of Michael Lewis by Terry Gross with Michael Lewis about 13 days ago:
The Big Short
[verbatim as much as possible]
So much written and reported about the collapse is through the eyes of the people "who had no idea" -- the Treasury Secretary, the Chairman of the Federal Reserve, the heads of the investment banks -- as the crisis was gathering force.
[Lewis got to "Ground Zero" and, in his own words, found that a handful of people were not clueless and were themselves the cause of the crash, after (supposedly--ed note) they tried to warn Wall Street and the NYT and the WSJ.]
"Everybody was working with same set of facts."
The vast majority of people in the markets painted a “very pleasant” picture from the set of facts.
"We 'see' what we want to see."
Michael Burry
Had been studying to be a doctor, was a resident on his way to being one.
Instead went full-time into investing. Formed a hedge fund. Began studying the bond mkt.
Had/has asberger’s syndrome. Didn’t know it at the time.
Having asberger's he studied the prospectuses of mortgage companies.
2003-2004, early 2005
saw the phenomenal growth of interest-only mortgages and negatively amortizing mortgages
“the lending couldn’t get any worse”
he saw the "end of the madness" coming and wanted to bet against it, but didn't know how.
he begins to bet against the subprime mortgage market
the bond mkt is "the wild west;" it's much less regulated and for the investor it's much easier to get ripped off; he’s aware of that. In corporate bond mkt there were a credit default swaps and had been for 10 years. He felt that Wall Street was "bound" to invent them on subprime mortgage bonds.
Michael Burry pesters Wall Street to create credit default swaps for subprime mortgage bonds
He is Ground Zero; "Patient No 1;" March to May 2005
Makes the "bet" (with GS) in March; gets a written contract in May.
GS – why willing? GS had persuaded AIG to sell GS
AIG had unlimited appetite. In a few months $20 billion, at very low prices; close to free,
GS took some on as a bet. Turned around and multiplied price by 10 and sold to Michael Burry.
All of sudden a big institution in the picture.
GS was already thinking along these lines. In other words it wasn't just Michael Berry.
AIG had been insuring corporate bonds for almost a decade.
In 2004 and 2005 GS comes (to AIG) with “diversified consumer loans”
“we’ll do that too.” (said AIG)
GS went to AIG with subprimes too. “Yep.”
Burry dealt with GS, Deuche Bank, Morgan Stanley, Bank of America, Merrill Lynch too. Wall Street firms were on the other side of the bets. For the most part they had sold the bets on and AIG was on the other side.
Charley Ledley and Jamie Mai
Cornwall Capital
Started with $100,000 in a Schwab Account.
“Wall Street underestimated the likelihood of unlikely events.” (they felt)
They bought options on extreme things happening. Each bet cost them very little. Wrong most of the time but right enough…
Stumble into the subprime mortgage mkt
For paying 2%/yr on dicey subprime mort loans
They knew nothing re bond mkt but they pieced together a picture
They go to SEC; NYTimes, WSJ “there’s fraud in the system.” Nobody understands or pays attention.
They ended up betting against financial instutions themselves – Bear Stearns, etc.
“Who’s taking all this risk?” they asked. Figured out that the WS firms themselves were the dumbest guys at the table. Afraid that BS couldn’t honor their contracts. So bought credit default swaps CDS’s on Bear Stearns too.
Turned $100,000 into $100 million.
None of these guys are natural short sellers. They wanted to be investing in the stock markets but they saw that these markets would be killed by what was going on in the bond (CDS, etc. market).
Personally, although they were making a fortune they had panic attacks; stressed (being right); a bet against an entire financial system; their insight that the system had become rigged; Charlie worried about riots
They were by nature ordinary stock investors; the world forced them into this position.
Herein, on April 2, 2010, I add the following from this, my blog, which indicates that one person,
Joseph Cassano
http://natgagu.blogspot.com/2009/03/joseph-cassano.html
was the cause of the meltdown. Read the whole interview above plus the link to Joseph Cassano, and you can see that we had a financial terrorist in our midst, one who started with Michael Milken.
And the NYT Article of April 1, 2010 adds to the list of names who make billions per year:
http://www.nytimes.com/2010/04/01/business/01hedge.html?scp=2&sq=soros&st=cse
And this review in the WSJ which served as the research for Lewis's book:
http://blogs.wsj.com/deals/2010/03/15/michael-lewiss-the-big-short-read-the-harvard-thesis-instead/tab/article/
But this reviewer says Michael Lewis has it all wrong:
http://www.huffingtonpost.com/yves-smith/debunking-michael-lewis-t_b_512542.html
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