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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.