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No More Deceit — Strictly Regulate Wall Street

8:38 am in Business, Financial Crisis, Legislature by Leo W. Gerard

Recent stories about Wall Street contain a recurring theme: deceit.

For example, this week the CEO of the late Lehman Brothers, Richard S. Fuld Jr., with a completely straight face swore to Congress that he’d been utterly out to lunch on the issue of “Repo 105,” a sleight-of-hand accounting procedure auditors found Lehman used to conceal its debts.

Last week, the Securities and Exchange Commission filed a civil lawsuit charging Goldman Sachs with securities fraud and describing a scheme in which Goldman defrauded clients by selling them a mortgage investment to bet on after secretly permitting selection of its component securities by a hedge fund manager who Goldman knew planned to bet against it.

Also last week, the Senate conducted hearings on failed Washington Mutual following a report by a Senate subcommittee that found the bank’s lending operations rife with fraud, including fabricated loan documents.

This deceit illustrates that America’s largest financial institutions can’t be trusted to refrain from crashing the world economy again. In fact, when the big banks announced their first quarter earnings recently — Citigroup $4.4 billion; Bank of America, $4.2 billion; Goldman Sachs $3.46 billion, and JPMorgan $3.3 billion; Morgan Stanley $1.8 billion – it turned out that much of that money was made by their trading divisions – the very ones that dragged them – and the U.S. economy – down during the crisis in 2008. These are the same risky trading practices that cost taxpayers a $700 billion bank bailout, their savings, their jobs, their businesses.

Clearly, these bankers can’t control themselves. And the “free market” has failed to moderate their behavior. Strict regulation is essential, including re-instituting the Glass-Steagall Act and other rules that will prevent financial firms from growing too big to fail; forcing the banks themselves to pay for liquidation of big financial institutions; placing on open markets trades of those secretive derivatives that brought down AIG and that the SEC says Goldman used fraudulently; and creating an independent consumer financial protection agency to stop practices like predatory lending, usurious interest rates and hidden fees.

Congress lifted bank regulations over the past three decades, including the Glass-Steagall Act passed after the 1929 stock market crash to reduce speculation and conflicts of interest and to prevent “too-big-to-fail” financial institutions by forbidding the combination of investment and commercial banks. Like gullible investors in subprime mortgage bonds, the politicians who reversed those rules bought the argument that the free market would regulate itself. This is the same argument 1,500 Wall Street lobbyists are using, along with millions of dollars, right now in attempts to persuade lawmakers to stop worrying their little heads about seriously regulating Wall Street.

Main Street, where foreclosures continue at a record pace and unemployment remains painfully near 10 percent, desperately needs its own 1,500 lobbyists and millions in influence dollars. It will have the power of thousands of voices at a “Make Wall Street Pay” rally April 29 in the heart of New York City’s financial district, one of several protests across the country organized by the AFL-CIO.

On Main Street the need to forcefully re-regulate to prevent another Great Recession is clear; it’s not in Washington, D.C. In fact, weakening the already-too-soft financial regulation bill proposed by Sen. Chris Dodd is a crusade for Senate Minority leader Mitch McConnell, whose campaign coffers have received more money from security and investment firms than from any other category — $1.3 million. Like a Wall Street banker, McConnell is using deception. For example, he harped all last week that an “orderly liquidation fund” in the Dodd bill was a “bailout fund.”

It’s not. It would be created with fees on banks – not taxpayers. And it’s not for bailouts that preserve banks. It is for bank liquidation. It would pay for the orderly closing of too-big-to-fail banks. Ezra Klein of the Washington Post ridiculed McConnell’s claims, and Katrina vanden Heuvel, editor of the Nation, described McConnell’s attacks on the bill as fraudulent.

All of the sudden on Monday, McConnell changed his mind about Dodd’s bill. Coincidentally, that was three days after the SEC filed the fraud suit against Goldman Sachs, making railing against financial reform appear not quite so politically wise to Republicans anymore. It’s all about the politics in Washington, D.C.

McConnell said he had new optimism that Wall Street reform would pass because Democrats had resumed bipartisan talks and, he said:

“I’m convinced now there is a new element of seriousness attached to this, rather than just trying to score political points.”

Listening to McConnell is like hearing Lehman’s Fuld, who got a $22 million bonus six months before his financial firm filed for bankruptcy, swear to Congress he knew nothing about the “Repo” accounting procedure Lehman used to conceal $50 billion in debts. Following his testimony, Anton R. Valukas, the examiner in the Lehman bankruptcy, told Congress that his investigators found a person who had discussed Repo with then-CEO Fuld and e-mails to Fuld describing it.

The problem with McConnell and his new-found eagerness to pass “bipartisan” legislation is that the Dodd bill needs to be strengthened, not weakened with compromises thrown to Senate Republicans, all 41 of whom signed a letter last week saying they’d vote against it.

Before compromises remove from this bill the power to effectively regulate, Congress needs to review what Goldman is accused of doing. Ezra Klein of the Post described it best:

“Goldman Sachs let hedge-fund manager John Paulson select the subprime-mortgage bonds that he thought likeliest to explode and put them into a package called Abacus 2007-AC1. Paulson, who guessed early that the market was heading for a crash, wanted to bet against these bonds. But he needed someone on the other side of the bet. So Goldman went out and found him some suckers, or, as Goldman called them, “counterparties.” . . .But here’s the rub: Goldman didn’t tell the counterparties that Paulson had picked the bonds. ‘Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party,’ said Robert Khuzami, the director of the SEC’s division of enforcement.”

Khuzami’s description makes Goldman’s behavior sound a lot like lying.

The real economy in this country – the one that manufactures, builds and produces tangible products – can’t afford a Wild West financial economy. The real economy depends on banks to finance business expansion and everyday transactions. All of that froze in the Fall of 2008 because of Wall Street’s reckless, inadequately-regulated gambling.

In a speech in New York City on Thursday, President Obama reinforced that some bankers "forgot that behind every dollar traded or leveraged, there is family looking to buy a house, and pay for an education, open a business, save for retirement."

Obama also referenced the issue of dishonesty when he said this in New York:

"A free market was never meant to be a free license to take whatever you can get, however you can get it."

If McConnell-style deceit about the financial reform bill continues in the Senate, serious regulatory reform won’t happen. Half measures won’t work. Only robust financial reform will end Wall Street’s freedom to deceive.

Financial reform: It’s the Derivatives, Stupid.

5:39 pm in Business, Financial Crisis by Leo W. Gerard

Tricky auto loans didn’t cause the financial meltdown on Wall Street. Unscrupulous payday lenders didn’t cost taxpayers a $700 billion “troubled asset” bailout.

So fussing about whether U.S. Sen. Chris Dodd’s financial reform legislation contains an independent Consumer Financial Protection Agency is like worrying about whether you’ll lose your tool shed as a conflagration consumes your home.

Sure, shielding consumer borrowers would be nice. But safeguarding the entire economy from another collapse is essential.

Preserving the economy requires limiting, regulating and exposing derivative trading. That’s because derivatives – those credit default swaps – took down Wall Street.

Neither the House of Representatives’ version of financial reform nor Dodd’s proposal adequately deals with derivatives. In fact, the language for derivative regulation isn’t even complete in Dodd’s bill. That is to say, it’s unfinished two years after Bear Stearns toppled onto Wall Street, triggering domino disasters at Lehman Brothers, Merrill Lynch and AIG, and warnings from regulators and politicians of a financial doomsday if taxpayers didn’t hand over their hard-earned cash to save financial institutions accustomed to bonus payments in the billions.

In the Alice-in-Wonderland world of Wall Street, derivatives were designed to make investing safer. Instead, in the hands of speculators, they became a form of betting that nearly destroyed the financial world.

Conservatives have repeatedly tried to blame the financial collapse on homeowners defaulting on mortgages. That’s ridiculous. That’s blaming the victim of a crime. Wall Street committed the crime. It went like this: Financial wizards on Wall Street created “securities” out of mortgages. They bought a bunch of mortgages, then sold what were supposed to be high yield bonds based on the future income from the mortgage payments. These were called Mortgage Backed Securities. That worked fine as long as the mortgages were solid – in the sense that the homeowner had income and assets sufficient to make the monthly mortgage payments. In the good old days, when banks didn’t sell off mortgages to Wall Street, they had a vested interest in accurately determining whether the applicant really could pay. So they required proof of income and assets.

But as these Mortgage Backed Securities became overwhelmingly popular investments, and pressure increased to produce more and more mortgages to create these securities, the standards for investigating mortgage applicants slipped. That’s how no-income, no-asset verification loans – known as a liar’s loans – came to be. It wasn’t necessarily the applicant who was lying. Frequently it was the mortgage broker, who exaggerated income numbers to give loans to unqualified applicants so that the broker could reap a big commission for producing a new mortgage. Brokers and banks didn’t care if the loans were so dicey that applicants weren’t able to make even the first month’s payment because the brokers and banks didn’t keep them. They quickly sold them to those Wall Street wizards who were making “securities” out of them.

Investors could buy what Wall Street calls derivatives — credit default swaps — to “insure” the “securities.” So, for example, if an investor began to feel a little queasy about his “security” paying off because it might be filled with liar loans, then the investor could “insure” it. For an annual premium of a small percent of the face value of the security, the investor got a credit default swap — assurance of payment in full in case of default.

Unlike insurance, however, derivatives like credit default swaps aren’t regulated. So the “insurance company,” like AIG or a bank or a hedge fund needn’t bother keeping collateral on hand to pay its contractual obligations should a tornado of defaults or a hurricane named Bear Stearns occur. Credit default swap issuers are like bookies who collect bets but don’t reserve money to pay winners.

The derivative market differs from the legitimate insurance market in another important way. The derivative market allows speculators to purchase insurance on securities they don’t own. These are called naked credit default swaps. NPR’s Planet Money reporters explained it like this: it’s like buying insurance on your neighbor’s house. The buyer of that policy has a vested interest in your home burning down. And the more “derivative insurance” speculators buy, the greater the interest in your home’s demise.

Many financial analysts believe derivative buyers have used naked credit default swaps in deliberate campaigns of destruction — like, for example, to take down Lehman Brothers or the country of Greece.

If you tried to buy real insurance on your neighbor’s car or house, the broker would turn you away when you couldn’t prove ownership. That’s because states regulate real insurance. And those insurance watchdogs see the inherent problem with speculators placing bets that will pay off if catastrophe befalls the real asset owner. That would, of course, encourage arson.

If derivatives like credit default swaps were traded on public exchanges, investors could at least see orchestrated efforts to take down a firm. But derivatives are traded behind closed doors, in secret deals between speculators and unregulated “insurers” that Wall Street calls “over the counter” but which should really be called “under the table.” AIG provided $440 billion worth of this “insurance” without any regulator knowing, without sufficient collateral to back up those deals, and without anyone questioning why the buyer needed insurance on something he didn’t own.

The secrecy also enabled Goldman Sachs to sell subprime mortgage backed securities to investors with a straight face, and then turn around and buy credit default swaps that bet those securities would fail – and thus pay Goldman big bucks. Greg Gordon of McClatchy Newspapers detailed this duplicitous scheme by Goldman in a story last fall entitled, “How Goldman Sachs secretly bet on the housing crash.”

Goldman made out, as its name says, like gold, in this dealing. Goldman announced record earnings during 2009 and distributed $16 billion in year end bonuses, enough to pay each of its 32,500 workers $498,000. That accomplishment, of course, was aided and abetted by $23 billion in direct and indirect federal aid given to Goldman. It also helped that AIG paid off Goldman bets dollar for dollar – for a total of $12.9 billion from the $180 billion taxpayers gave to rescue AIG.

In the mean time, the individuals and agencies that Goldman sold those crappy mortgage backed securities to, well, they’re not so golden. For example, California’s public employees’ retirement system, called CALPERS, bought $64.4 million in mortgage-backed securities from Goldman on March 1, 2007, Gordon noted in his story for McClatchy. A little more than two years later, Gordon wrote, they were worth $16.6 million – only 25 percent of their original value. Goldman, by contrast, banked on such losses and won big. It earned $13.4 billion last year.

Goldman distributed those big bonuses while Main Street continued to reel from the effects of the Wall Street melt down. The financial collapse reverberated through the economy, causing high unemployment – which meant, of course, that many mortgage holders who had legitimately qualified under old stringent bank rules could no longer make their payments. Now they’re unemployed and homeless – while those wizards at Goldman are sipping champagne on those bonuses. Meanwhile, Gordon showed in his story, Goldman is aggressively seizing the homes of delinquent mortgage holders.

Yet, Congress has failed to act. This is at the same time that European Union officials are considering restricting the trade of derivatives linked to government debt – like those believed to have worsened the economic crisis in Greece.

Wall Streeters who get millions in bonuses to know better are still trading in derivatives. Nothing is preventing another financial collapse, another day when Wall Street comes crying to Washington for a new $700 billion troubled asset bailout.

Q&A with Manufacturing Business Expert Richard McCormack

9:53 am in Business by Leo W. Gerard


Leo W. Gerard:
Richard, when you appeared recently at Youngstown State University as a guest of the Center for Working-Class Lecture Series, you talked about how essential manufacturing is to the U.S. economy and how politicians seem clueless about that. In fact, you said, “Politicians don’t get it.” When did that happen because clearly politicians in the 1950s understood that a solid economy rests on manufacturing products of real value?

Richard McCormack: It happened imperceptibly over the past three decades, but perhaps the defining (though little observed) event was when Wal-Mart overtook General Motors as the country’s largest employer. When that happened, the retail industry became one of the most powerful political entities in the country, replacing the manufacturing industry.

The crossover from GM to Wal-Mart is important because retail started setting the terms of the debate not only with politicians, but also with manufacturers. Retailers are driven by increasing profits by pennies on the dollar by paying workers low wages with no benefits and buying cheap imports.

The loss of the manufacturing sector’s political influence also occurred with the rise of the finance sector, which became the dominant force in political gift-giving. The Wall Street financial sector does not give one-half hoot about American jobs.

The loss of America’s industrial capability also coincided with the persistent selling of economic ideology to the American public and its politicians that the country would be a lot more prosperous getting rid of crappy manufacturing jobs and creating jobs in the service and “knowledge” sectors. That grand experiment in creating a “post-industrial economy” just suffered a monumental collapse.

Americans have allowed the big corporate multinational companies and their agents to take control of their political system. It remains to this day a system that is stacked against American workers and American taxpayers. Americans have not entered the fight to save American jobs. I wonder if the middle class is drugged up on Britney Spears, Michael Jackson and Tiger Woods; addicted to sugar, salt and fat; fake “news” shows on television; and Prozac to deal with depression and lull them into thinking that their condition is beyond control. Something is stopping Americans from getting off their couches and demanding a voice in America’s economic future. Americans have lost their country to a few people who make a lot of money off outsourcing, off-shoring and importing everything Americans used to make and continue to buy. Americans must take their country back before it is too late.

Gerard: You have written about this problem in the book, “Manufacturing A Better Future for America,” and elsewhere. How do we make politicians understand how vital manufacturing is?

McCormack: Politicians need to be hit over their heads with a baseball bat as forcefully as is possible, with Americans insisting that they at least acknowledge that a country that doesn’t make what is consumes is going to fail. It is a simple concept. There are many historical precedents of countries and empires failingafter having lost their productive capacity. It is an ancient concept: a country that does not have industry cannot support an army.

The United States has just gone through a period of unprecedented loss of wealth. Its citizens have taken a collective economic step down. Yet politicians are sitting smug in the belief that they can borrow more money. They work in Washington, D.C., where I live. This place is humming. Most of them have no idea what the country looks like. Have they been to Detroit, Saginaw, Youngstown – America’s heartland? America’s heartland is dead. That means its heart has stopped beating. What happens to a person when their heart stops beating?

The financial meltdown wasn’t caused by the housing bubble or the financial bubble or the dot-com bubble, although all of those things contributed. It was caused by the simple fact that American consumers have sent all of their wealth to China, Korea, Japan, Germany and Mexico buying all of the things they once made. Tell that to the politicians. They don’t get it. They don’t get it and they don’t get it, which means they have to be hit over the head and be hit over the head and be hit over the head as hard as is possible to hit them with the simple message, over and again: the country cannot survive if it sends all of its wealth offshore. The country has to produce what it consumes. Our politicians do not understand this basic FACT. Have they looked at why China is becoming a superpower? It’s not because China exports its sports heroes and pop culture. It’s because China has embraced manufacturing as THE means to economic superiority. It is the same path the United States took to reach global dominance. Inexplicably, the United States abandoned that path.

Gerard: In Youngstown, you quoted Ralph E. Gomory, the retired IBM senior vice president for Science and Technology and a winner of the Heinz Award for Technology, the Economy and Employment, as saying the interests of American corporations have diverged from the interests of America, yet politicians act as if they’re still the same. Can you explain what that means both in terms of the economy and employment?

McCormack: Ralph Gomory has made one of the most profound and important observations on the current global economic situation. He says that outsourcing is not free trade. Yet the federal government still represents the interests of the powerful companies that are firing millions of American workers and shifting those jobs offshore.

Domestic manufacturers have told me repeatedly that the greatest protectionists in our country are the corporate and financial companies that are doing everything in their power to protect their assets in China. To influence policy in their favor, the multinationals, retailers, importers and foreign producers fund think tanks, trade associations, lobbyists, lawyers and public relations firms. These are the real protectionists, not American businessmen who want to save American jobs and the American middle class.

The U.S. government continues to craft policies that are beneficial for companies that outsource jobs. For instance, the U.S. government refuses to confront China over its currency manipulation because the companies that benefit most from China’s undervalued currency are the American companies that have shifted their production there. Who does the U.S. government represent? The tens of millions of American workers who get the ax due to China’s blatant cheating, or the few CEOs at multinational companies and the financial class who make more and more money?

It was no coincidence that the stock market had its best year ever in 2009 – the same year millions of Americans were losing their jobs. The dynamic still hasn’t changed, despite the financial sector’s meltdown: Every time a company announces American worker layoffs, its stock price goes up. Yet policymakers equate the stock market with a healthy economy. They are as wrong on that as they are on the belief that the world is flat.

Gerard: You have also said that politicians’ decision to implement the concept of free trade – which is not fair trade – has largely contributed to the nation’s problems. Would you talk about how something as positive-sounding as free trade devastated American industry?

McCormack: A friend of mine works at the Commerce Department. He says that free trade is a farce. The United States has tariffs of 2 percent or 3 percent on incoming products. Yet the United States trades with countries with tariffs that are 10 times higher. Is that free trade? He has a simple solution to the U.S. trade crisis: hold up a mirror to any nation trading with the United States. Whatever their tariffs are on U.S. products entering their country, that is what the U.S. tariff should be on their products entering America.

How can U.S. producers compete when they must pay for all of the costs that foreign producers don’t have to add to the price of their product? These costs include things like scrubbers and baghouses on coal plants. Not requiring the generation of clean power is a Chinese subsidy offered to all manufacturers setting up shop in China. It is an unfair subsidy that U.S. companies cannot counter without the U.S. government saying that it is unfair. Even worse, 75 percent of the mercury pollution in the United States can be attributed to Asian coal-fired plants that do not have emissions controls. The majority of these plants are located in China. China is poisoning America. If it was happening in the United States, the federal government would take the American utility or industrial company to court and impose fines of millions of dollars. What does the U.S. government do about China’s toxic emissions drifting over U.S. airspace? Nothing.

U.S. manufacturers have to abide by a thousand EPA rules and OSHA standards. Not so in China. That is a huge advantage. The United States government lets American companies that have set up shop in China get away with not having to abide by American standards – even though their products are being sold in the United States.

It is morally wrong.

Any foreign product sold in the United States should be required to be produced under the same conditions as is required for producers of the same product in the United States. If these requirements are not going to be enforced on overseas competitors, as they are here so vigorously by our federal government, then those cost advantages should be calculated and tacked onto the price of the product entering the United States.

Foreign producers should NOT have this unfair advantage. It is an outrage that the United States has allowed this to occur.

It is time for the country to stop listening to importers, their agents in Washington, including foreign governments, retailers and the financial industry. The U.S. government has to start representing the interest of American manufacturers, workers and business owners. It does not now. This is not a conspiracy theory. This is reality.

Gerard: In the chapter you wrote for the book, “Manufacturing A Better Future for America,” you said something that every American should find frightening. You said that when Congress cuts the taxes of individuals or gives them tax rebates in an attempt to stimulate the economy, the actual effect is to create jobs in foreign countries. Can you explain that?

McCormack: The U.S. government has just spent the past 10 years trying DESPERATELY to stimulate the U.S. economy, with trillion-dollar tax cuts, tax giveaways, low interest rates and even two wars that have lasted for nine years. Then the Democrats took office in 2009 and enacted their own $787 billion “stimulus.” Every time Americans have had a few extra bucks in their pocket (from tax cuts to direct government payments to home equity loans) they have spent that money on products that are now made somewhere else in the world. Is it any wonder why China’s economy was growing by 10 percent per year during the past 10 years, as U.S. consumers shipped more and more of their hard-earned dollars there to buy everything?

Gerard: You have been critical of the second economic stimulus bill – called a jobs bill – that Congress is now talking about. You contend that the proposed bill won’t create new jobs. Here’s what you actually said, “I don’t see any jobs there. I just see more money being spent.” What’s wrong with that bill?

McCormack: It is more of the same. Only a very small percentage of the bill encourages investment in U.S. production. There is not a single program aimed at countering the incentives that foreign countries are providing their companies and U.S. producers to set up operations in their country. The United States has to start competing – to start countering those incentives with its own incentives to manufacturing companies. It doesn’t matter if these companies are American companies or foreign companies. To create lasting, decent jobs, the United States needs global companies to open production in the United States to serve the U.S. market.

Small American companies do not need a $30-billion tax cut to hire workers. They need CUSTOMERS. They won’t hire a soul unless they have a customer to sell them a product. Yet the country continues to lose manufacturing plants to China.

Gerard: If you could actually get Congress to listen to you, what would you tell them is necessary to create good new jobs?

McCormick: Ask the 50 economic development officers from each of the states to form a U.S. Economic Development Council. These people and their offices know what is being planned in terms of company expansions. Give them a war chest, some of the TARP money or funding from the proposed “jobs” bill, and tell them to deploy the same tactics they use in their states to attract industry to America. All of the states are competing against each other to attract industrial investment. They should be working together, especially since supply chains cross state borders.

Gerard: When I go to Washington, what I hear is that we don’t need manufacturing. That’s old and dirty. So many politicians say the U.S. can move to a financial and service economy. You disagree with that. Why?

McCormick: I hear it too, though a little less often, thank goodness. This argument is what has led to the demise of the United States. People are just starting to realize that as manufacturing goes offshore, high-end jobs in design and research and development go with it. When a plant closes, the supply chain disappears. This supply chain includes materials and parts producers, software providers, like CAD (computer-aided design), ERP (enterprise resource planning) and dozens of other high-tech equipment providers, machine tool companies, maintenance, accounting, packaging – the list goes on to include such things as the local restaurants, janitorial services and those dependent on the plant’s tax revenues, like librarians, county clerks, police officers and teachers. These are service jobs, all of which depend on manufacturing. One manufacturing job supports 15 other jobs. No other category of job has such a high multiplier. The United State must do whatever it can to start creating manufacturing jobs.

Gerard: We are losing at the international trade game with imports far exceeding exports and creating a massive trade deficit. Is it over for the U.S., or can Washington actually do something to reverse this situation?

McCormick: The game is not over. Not yet. But the country is perilously close to a period of sustained pain caused by continuing huge trade and budget deficits. The United States is assuming greater and greater debt. The country cannot borrow its way to prosperity. At some point very soon, the United States has to stop accumulating debt and start the process of paying it down. The only way to do this is by producing the products Americans consume – like cellphones, televisions, digital cameras, computers, semiconductors, printed circuit boards, autos, steel, household items, appliances, luggage, clothes – everything – and to start producing a new generation of radical and revolutionary products that the rest of the world needs to buy.

***

Richard McCormack is editor and publisher of Manufacturing & Technology News, a publication he created in 1994. It is read by industry executives, government officials and academics on five continents. McCormack has reported on science and technology, industry and government in Washington, D.C. for 26 years specializing in economic competitiveness and globalization. He has won numerous journalism awards for investigative, analytical and interpretative reporting. He is author of the book, “Lean Machines: Learning from the Leaders of the Next Industrial Revolution.” And he is the editor of the new book, “Manufacturing A Better Future for America,” for which he wrote the first chapter, “The Plight of American Manufacturing.”