The financial sector, led by the banks, has always held the whip hand over its human customers. For example, in Virginia and other states, a creditor can insert a clause in a contract allowing it to get a judgment against the debtor from a court clerk, without bothering a judge with the need for a hearing. And when clever people fight their way past some provision, state legislators can be counted on to clear the way for the banks. Just look at the way the supposedly independent experts at the National Conference of Commissioners on Uniform State Laws fixed the rules on perfecting a security interest in personal property for banks, or the way the Tennessee legislature fixed the rules about deeds to help incompetent bankers. In re Akins, 87 S.W.3d 488, 492 (Tenn. 2002). Congress allows the rich and corporations to cram down their mortgages in bankruptcy, but even in the aftermath of the Great Crash and its horrific impact on millions of Americans, the parties united to deny regular people the right to do the same thing.

At the national level, we have the National Mortgage Settlement, which establishes the amount of foreclosure fraud banks can inflict on human beings in the form of the National Mortgage Settlement, as Dave Dayen shows here. President Obama allows his captured regulators to ignore national crimes committed by banks, like money laundering for drug cartels and terrorist states, manipulating LIBOR at enormous cost to millions, stealing from supposedly segregated customer funds at commodity brokerages, failure to file Suspicious Activity Reports on Ponzi Schemes like Bernie Madoff, and fraudulent sales of various forms of real estate mortgage-backed securities to pension plans, municipalities and small banks around the globe. Then, to cover the banks’ losses on these phony securities, federal and state governments rally to whip the debtors into submission and penury.

Next up, we have the overt sadists, @FixTheDebt and the entire panorama of austerity freaks, who believe that a good beating applied to the serfs will encourage them to get a job, or at least shut up about their loss of jobs, homes, pensions, 401(K)s, IRAs, job security, and their membership in the middle class. Then they tell us how much better things would be if only the rich and their mega-corporations and their off-shore money were not taxed. Congress and President Obama just love this perversion, and add the sequester, so that government workers can take huge pay cuts, kids can lose Head Start, research can go unfunded, and on and on, but heaven forbid airline travelers should be inconvenienced. This, even though there is a consensus among economists that cutting government spending will slow down the economy.

On top of that, Obama’s solution to the fake debt problem is to cut Social Security, Medicare and Medicaid. He longs to whip those old people and people who hope to get old for the benefit of the job creators, who really need tax cuts. Maybe people will die early from malnutrition or inability to obtain medical services, which will really cut those costs. That’s going to happen to those people who can’t get cancer treatments because of the sequester. Hey, if rich people can’t have their tax cuts, we need to balance that out by lashing out at the old and sick.

It isn’t only the rich and their politician servants who enjoy these sadistic perversions. Take a look at the comment section on any article about the national debt. It’s full of people ready to take a beating for their sake of their betters. Just look at the auto-tweets of the masochists who support @FixTheDebt; people apparently unable to see the connection between the plans of that astro-turf operation and their own lives.

In his excellent book, Taking It Big, Stanley Aronowitz describes the work of Wilhelm Reich in the 1930s on why people are receptive to authoritarianism:

If humans have no inner life, they can be manipulated at will by powerful external forces. Whether by design or by intuition, the fascists were extremely sensitive to those sections of the population that had already developed a sado-masochistic character but were largely apolitical, and for this reason, were prone to respond affirmatively to their reactionary appeals. P. 154.

There are way too many sadists in positions of unimaginable wealth and power holding the whip hand, too many enablers in Congress and the Obama Administration, and way too many financial masochists rushing to the front of the line for financial beatings. It’s past time for all of them to grow out of their creepy fantasies of domination and submission.

The Obama Budget Document includes 11 mentions of Chained CPI. Here are the first four:

In the interest of achieving a bipartisan deficit reduction agreement, beginning in 2015 the Budget would change the measure of inflation used by the Federal Government for most programs and for the Internal Revenue Code from the standard Consumer Price Index (CPI) to the alternative, more accurate chained CPI, which grows slightly more slowly. Unlike the standard CPI, the chained CPI fully accounts for a consumer’s ability to substitute between goods in response to changes in relative prices and also adjusts for small sample bias. Most economists agree that the chained CPI provides a more accurate measure of the average change in the cost of living than the standard CPI. P. 46

The first bold section tells us that Obama believes there is a bipartisan consensus that we have to cut Social Security and raise taxes on the middle class. I’m not seeing that in any segment of the political world except vicious jerks like the Club for Growth. I can’t wait to see the Hastert Rule operate in the House, forcing Speaker Boehner to admit that a majority of House Republicans thinks hiking taxes on the middle class and slashing Social Security is a terrible idea.

The second explains that this is good because when prices go up, or incomes drop, consumers can just buy some cheaper thing than the thing they really like. You can read a paper from the Bureau of Labor Statistics explaining this in detail here. The plain fact is that this is an outright admission of the utter failure of the consumption society.

The example you get is that if beef gets more expensive, you can substitute pork, without in any way affecting your life. In other words, the selections among beef, pork, chicken and catfood you currently make are assumed to give you a certain level of pleasure, but now you can’t have that level of pleasure. Either you eat less of something you like, or you just don’t get to eat it, and have to eat something you don’t like as much.

Suppose you lose your nice watch. If the price of your ideal watch has gone up for whatever reason, you get a cheaper watch, or no watch and use your phone. That nice watch you used to be able to have is now out of the picture, but that doesn’t matter because you can still tell time. That’s the magic of substitution.

There is an unspoken connection here: that your income is constant across all these time periods. That isn’t true either. People are losing their jobs and taking lower paid jobs. If you are still getting raises, they come in tiny increments every year. If you are retired, you get nothing on your savings, and little on any equities you might hold. To maintain your standard of living, you have to eat your savings or go into debt. Most likely, you can’t have nice things, so you get to substitute less nice things. No natural fibers for you, too expensive. So what? Just substitute something you don’t like as well, or do without.

There is one other key point: this analysis ignores the effect of substitution in oligopolistic markets. What is the free market for cell phone services or cable services? They are oligopolies. Your choices have nothing to do with the amount produced.Prices are not set based on the underlying cost of service, but upon whatever these people can get away with. They raise prices to maintain their profits. Your only substitution is to buy less service, in a downward spiral. Your life gets worse.

Of course, all this is irrelevant to the feral rich. Their income goes up as they suck out the money from you for your cell phone and your cable service and every other thing you buy. They don’t substitute for anything.

The real point of the Chained CPI is that you don’t get to live nicely. You can expect a declining standard of living. That is the message of your President and the oligarchy he serves.

The fifth mention of Chained CPI in the Budget explains that the switch to chained CPI will decrease the deficit by at least $230 billion over the next 10 years. This is the number in tables S-2 and S-3. P. 184, 186. Table S-5, p. 189, gives the number for Social Security: we are cutting payments to the elderly by $130 billion. Table S-6, p. 191, tells us that over 10 years the average savings is .1% of annual projected GDP. Table S-7, p. 193, gives the annual savings adjusted for population growth and some kind of inflation accounting. In those terms the total savings drop to $107 billion.

The last mention is in Table S-9. There is a line item labeled “Chained CPI: Adjust indexing and protect vulnerable populations”, which according to the footnote includes revenue effects. The ten year total is $230 billion, which includes Social Security cuts and $100 billion in new taxes that slug the middle class resulting from adoption of Chained CPI. That’s another chunk of not having nice things: you have to pay higher taxes, so forget that chicken, and buy a fifty-fifty mix of pink slime and hamburger.

Unless, of course you are in whatever the “vulnerable population” turns out to be. But don’t worry, even if you aren’t now, as inflation eats your savings and the Chained CPI cuts your Social Security, soon enough you’ll enter the vulnerable population. That’s already happening. This study says that 46% of Americans die with less than $10,000 in assets.

The President and the oligarchy are introducing the masses to their Brave New World of not-so-nice things. Or nothing at all. Read the rest of this entry →

The Business Roundtable is an association of the CEOs of America’s biggest companies. Their total revenues are more than $7.3 trillion, and they employ nearly 16 million people somewhere in the world. Their big priority, supported by millions from their corporate treasuries, is to cut corporate taxation from 35% to 25%, which is hilarious when you realize that most of their members don’t pay anywhere near either rate. Among the members are GE, Tenet Healthcare, PG&E Corporation, and a host of other tax dodging companies. And lest you think that matters, Carter Wood, Senior Communications Advisor at Business Roundtable, will be happy to tell you that whatever they pay is way too much, and they are all moving off-shore.

Taxes are the price we pay to live in a civilized society, you know, a society that respects the legal and property rights of GE, Tenet Healthcare, PG&E and the rest of the tax haters. A society that builds ports and roads so people and goods can move in commerce or across the ocean. If someone weren’t paying taxes corporations like Carnival Cruise line wouldn’t be able to operate at all. According to David Leonhart in the New York Times, Carnival has paid only 1.1% of its cumulative 5 year earnings in taxes of any kind. Its big benefit is that it is a Panama corporation, not an American company, (ignore that corporate headquarters in Florida) so under 26 USC § 883(a)(1) it doesn’t owe taxes. That provision was inserted by the Tax Reform Act of 1986, one of many spineless caves by the Democrats to Ronald Reagan’s tax cutting mania.

Anyway, as I was saying, 99% of us human Americans are allowed to exist so we can pay the taxes and serve in the Armed Forces that enable Business Roundtable corporations to operate around the world. It’s best if those taxes are paid by poor people, and the two major parties are hell bent on creating as many poor people to pay those taxes as possible. Mammon forbid that any dribble of taxation should fall on the feral rich, their thug corporations or their merely wealthy minions. Taxes are for you and me.

And with the job creators all lined up for reducing the nominal rate, they insist on revenue neutrality, the idea that when we reduce corporate rates, we don’t somehow increase the amount of corporate tax revenue, currently at absurdly low levels. They may be in favor of cutting some tax loopholes, but their good friends in Congress must be vigilant to insure that they don’t increase their share of the burdens of civilization. Problems, problems. Someone in this crowd is going to have to pay more, depending on which loopholes get closed. Maybe Carnival is a good choice, because it has such a crappy image right now. Or maybe we just cut the rates without cutting the loopholes. Leonhart isn’t sure the Business Roundtable supports ending loopholes anyway. They sure haven’t said they do.

So what do they support? Cutting Social Security, Medicare and Medicaid. Gary Loveman, President and CEO of Caesars Entertainment Corp., a gambling company, and Chair of the Business Roundtable Committee on Health and Retirement, published an op-ed in the Wall Street Journal explaining that we, presumably including his own gold-plated butt, can’t afford our government, so we should raise the eligibility ages for Medicare and Social Security, increase private sector involvement in Medicare, and cut Medicare and Social Security for anyone who has a pittance of their own until they are reduced to abject poverty and can’t afford to go to Caesar’s anymore. “We” need to cut Social Security and raise taxes by switching to Chained CPI. That ought to be enough to give Caesars a big tax cut. Oh wait. Caesars doesn’t pay taxes. It’s been losing money for years.

I think Loveman deserves a free trip on Carnival, assuming any of its ships is ever fit to sail again.

Read the rest of this entry →

Fed Chair Ben Bernanke gave a speech recently in which he explained why long-term interest rates are so low. He started by saying that certainly central banks play a role in determining long-term rates, which seems right because the Fed is buying up long term securities Treasuries and mortgage backed securities issued by Fannie, Freddie and Ginnie Mae at a current rate of about $85 billion a month, for a total of about $2.8 trillion. First, he explains basic economic theory on setting rates, then moves to a recap.

Long-term interest rates are the sum of expected inflation, expected real short-term interest rates, and a term premium. Expected inflation has been low and stable, reflecting central bank mandates and credibility as well as considerable resource slack in the major industrial economies. Real interest rates are expected to remain low, reflecting the weakness of the recovery in advanced economies (and possibly some downgrading of longer-term growth prospects as well). This weakness, all else being equal, dictates that monetary policy must remain accommodative if it is to support the recovery and reduce disinflationary risks. Put another way, at the present time the major industrial economies apparently cannot sustain significantly higher real rates of return; in that respect, central banks–so long as they are meeting their price stability mandates–have little choice but to take actions that keep nominal long-term rates relatively low, as suggested by the similarity in the levels of the rates shown in chart 1. Finally, term premiums are low or negative, reflecting a host of factors, including central bank actions in support of economic recovery.

So that’s the reason savers are getting screwed: our fabulous economic system can’t pay decent interest, just like it can’t pay decent wages. The giant corporations that dominate our system, that are sitting on trillions of dollars, that don’t pay taxes, that hide money overseas, that cheat us at every step, that cut the pay of the average worker, that own the media and control public discourse, the poor babies just can’t afford to pay a decent interest rate to the dummies who scrimped and saved for a lifetime so they would be able to retire comfortably.

And there is nothing that the Fed, or any central bank, can do to help. They just sat there and watched the financial sector destroy the real economy. Housing Bubble? No such thing. Stock market froth? No, the market allocates capital wisely and generously. In the wake of the financial crisis, Bernanke has a simple suggestion: Screw you if you don’t want to put your money into the Wall Street casino; no returns for you. And @FixTheDebt adds to that: let’s cut Social Security, Medicare and Medicaid.

Now it’s only fair to point out that this means that those rancid corporations don’t get much in the way of a real return on their Treasuries. In fact, after inflation, they may be losing money. Maybe the point of low interest is to encourage them to invest. But that’s pushing on a string: with widespread underutilization of existing capital stock, why buy more capacity? And with the ability to screw workers, why pay more? It isn’t like the shareholders need the money; most of the stock is owned by the rich. It’s no different from blind support of banks in the hope they will increase lending.

Savers are toast in this brutal version of capitalism, but savers, like the unemployed, the foreclosed upon, people with underwater homes, government employees, corporate workers and just about everyone, except the feral rich, aren’t ever going to be helped by the captured Obama Administration, the vicious Republicans or the spineless Democrats. We’re all on our own. Read the rest of this entry →

As this financial disaster grinds through its fifth year, US economists haven’t seemed to change much about their analysis or explanations. The people who got it wrong continue to push their false theories, insisting that if we clap louder their reputations will be saved. It’s working for the hyper-rich. We’ve all seen the figures:

The numbers, produced by Emmanuel Saez, an economist at the University of California, Berkeley, show overall income growing by just 1.7 percent over the period. But there was a wide gap between the top 1 percent, whose earnings rose by 11.2 percent, and the other 99 percent, whose earnings declined by 0.4 percent.
…
Median household income, which was $50,054 in 2011, is about 9 percent lower than it was in 1999, after accounting for inflation.

Economists comfortable with progressive ideas offer the same solutions they always do: infrastructure repair paid for with borrowed money, hikes in the minimum wage, tax cuts for the workers who still have jobs, and so on. Perhaps they are familiar with some of the thinking that offers a better way forward. But let’s be realistic. There is little point in trying to teach any new ideas to Democrats in the legislature. They absolutely refuse to deviate from the standard American view: Chicago School Capitalism Good, Everything Else Bad. Heaven forbid anyone accuse them of being a liberal on economic matters.

Fortunately, some economists in the rest of the world saw that the economic theories they learned in college aren’t working, and are saying so in public. Lord Adair Turner is the Executive Chairman of the Financial Services Authority, presently the top banking and securities regulator in England. He recently gave a lecture entitled Debt, Money and Mephistopheles: How do we get out of this mess? Martin Wolf discussed it in this article.

In normal times, says Turner, monetary policy should work. The central bank lowers interest rates and that leads to an increase in bank lending. That isn’t working now, Turner says, because this is a balance sheet recession. People are paying down their debt, not taking out new loans. It doesn’t matter how low the interest rate goes, they don’t want to borrow, they want to get out of debt. Turner calls it pushing on a string. Turner points to long-term problems created by continuing on this feeble course. Japan is the primary school for this kind of failure.

Turner then addresses fiscal policy, deficit spending to provide tax cuts or infrastructure repairs. This tool has been ridiculed by economists for the last 30 years for several reasons the validity of which was unquestioned by any serious economist. Turner discusses a recent paper by Brad DeLong and Larry Summers arguing that those reasons aren’t applicable in the current crisis. He also points out that even so, they may have long term problems. That is because all deficits are financed using borrowed money. Deficit spending means the issuance of debt, and at some point that will be a serious problem, even if it isn’t right now.

But, of course, it is a huge problem right now, a problem not acknowledged by Turner, or by DeLong and Summers. The deficit hawks are insisting that the existing deficit is going to kill us and our children and their children, and it has to be stopped now, by suffocating cuts to Social Security, Medicare and Medicaid, and tax cuts for their corporate sponsors like @FixTheDebt.

Turner then opens the door to another idea that he calls Overt Money Finance. In the US, it would work like this. The Treasury has an account at the Fed. Congress appropriates money to pay for a program, say, purchase of new building in Pittsburg. Right now, that would be financed by issuing new Treasury bills. With Overt Money Finance, the Fed would simply credit the account of the Treasury with the amount appropriated. There would be no new debt, but the Treasury would have the money to pay for the building. You will note the similarity to the idea of the Trillion Dollar Coin. You will also notice the similarity to the way the Fed lends money to banks.

Overt Money Finance isn’t really a new idea. The most famous proponent was Milton Friedman in a 1948 paper, but it has been studiously ignored by all right-thinking people as much too dangerous. Turner explains that economists think that if politicians realized that they could just issue fiat money, they would destroy the currency by issuing more and more until we had hyperinflation. To prevent that bad outcome, we hobble ourselves with all sorts of laws and institutional rules about debt. One of those is the rule that the Fed can’t just lend money directly to the government. It finances the government by buying and selling Treasury debt in the open market. I suppose the theory is that the Fed is independent, so it won’t destroy the currency. Maybe, but let me point out that the Fed could easily have popped the last two bubbles, and didn’t, so its record on protecting the economy doesn’t give me much hope.

FDL readers will recognize Overt Money Finance, because we know about Modern Money Theory, thanks to the efforts of letsgetitdone and other diarists and commenters, and an excellent Book Salon with L. Randall Wray. Wray discusses Milton Friedman’s paper in Chapter 6 of his Modern Money Theory, A Primer on Macroeconomics for Sovereign Monetary Systems, and goes on to explain how it would work today and the steps that would be taken to prevent inflation. Turner has some ideas about that too.

Martin Wolf provides some helpful framing in his article in the Financial Times:

…[I]t is impossible to justify the conventional view that fiat money should operate almost exclusively via today’s system of private borrowing and lending. Why should state-created currency be predominantly employed to back the money created by banks as a byproduct of often irresponsible lending? Why is it good to support the leveraging of private property, but not the supply of public infrastructure? I fail to see any moral force to the idea that fiat money should only promote private, not public, spending.

I fail to see any moral force to that idea either. Why should those criminals get any help from government after wrecking the economy and ruining the lives of hundreds of millions of people around the world? Let’s do something nice for ourselves, preferably at the expense of the hyper-rich. Maybe we could fix some of those 70,000 structurally deficient bridges.

Big lawsuits are great opportunities to look at the state of mind of reporters, pundits and bloggers. I have posts on the case focused on the facts, the law and what they say about the Department of Justice. Of course, my biases are obvious: I think the DOJ refused to enforce the laws against fraud by Wall Street executives, that the refusal to investigate and enforce the law was a deliberate policy choice by President Obama, and that policy was intentionally put into practice by Attorney General Eric Holder and the head of the DOJ Criminal Division, Lanny Breuer. Others show their biases as well.

John Tamny, writing for Steve Forbes’ rag, tells us that S&P was a bunch of second raters, and if the big Wall Street players couldn’t see the coming market crash no one should expect the “financial equivalent of the last player picked for a pickup basketball game” to catch it. Funny, yes, accurate, no. Tamny uses John Paulson’s massive bet against the market as proof that the big boys were ignorant. That’s just false. I discussed the SEC suit against Goldman Sachs here. Paulson and Goldman Sachs were not wild-eyed speculators, they were consciously selling garbage to unsuspecting small banks. In fact, Goldman Sachs made $3.7 billion shorting CDOs just before the Great Crash. The S&P complaint says that the big Wall Street players knew the crash was coming, and they were desperate to get the garbage off their books. The complaint says that S&P knew that, and still they continued to use the same rating system instead of one they had that was more accurate. Forbes isn’t going to let the facts get in the way of a good story.

The Wall Street Journal Op-Ed page explains that the S&P suit is a result of failed regulation and revenge. The evil feds regulated the ratings agencies and “ forced investors to rely on them”. That, of course, is nonsense. There is a rule that some financial institutions, including credit unions, can’t invest in securities that receive low ratings. That rule assumes that the ratings agencies are doing their jobs. If they don’t, they can and do cause enormous losses, and they should be sued.

And look, they say, Moody’s wasn’t sued, and they were just as bad. The decision to end the Moody’s investigation, if that happened, was made at the time S&P downgraded the US. And, get this:

… that’s also coincidentally when White House Chief of Staff Jack Lew was aggressively promoting the President’s campaign to prevent entitlement reform. Mr. Lew had worked in the heart of Citigroup’s subprime investment factory, and the President has not only been willing to forgive and forget. He’s even nominated Mr. Lew to become Secretary of the Treasury. But the company that put a shot across the Beltway bow over deficit spending is now the only target of a credit-ratings prosecution.

Those pesky facts again: Obama and the rest of his minions were perfectly willing to slash Social Security, Medicare and Medicaid to achieve his Grand Bargain, and that’s still on the table. The Wall Street Journal: once a valuable source of business reporting, now the print version of Fox News.

One more example from Red State’s Ed Morrisey, who managed to read a story from Bloomberg on the lawsuit. Bloomberg points out that the complaint says that Citibank and Bank of America are both the underwriters and purchasers of some of the overrated securities listed in the complaint. On its face this does seem odd. But recall that the investment banking arms of the company aren’t the same as the commercial banking group. Another Bloomberg writer, Jody Shenn, has an explanation. The suit is brought under FIRREA, the statute passed in the wake of the S&L disaster of the late 1980s in recognition of the fact that insiders at banks used their control to benefit themselves at the expense of shareholders and at the expense of federal insurance programs and taxpayers. The CEO of Citi testified to Congress that he didn’t know that the ratings system was corrupt. I imagine that this is true, and some employees of the bank were dumping the bad deals on the bank to enrich themselves.

Well, we all have our biases, don’t we, but that doesn’t mean we can’t agree on some things. I too want to know why Moody’s and Fitch weren’t sued. And why no one was indicted for fraud.

Read the rest of this entry →

I discussed here the compelling facts alleged in the complaint against Standard and Poor’s filed by Los Angeles US Atttorney André Birrotte, Jr. Now let’s look the legal claims, and try to explain why there is no criminal prosecution.

Wire Fraud

The suit is grounded in wire fraud. There are three elements to the crime. Shah, Mail and Wire Fraud, 40 Am. Crim. L. Rev. 825 (2003) (available through your public library). The prosecutor must prove the existence of a scheme to defraud, intent to defraud, and use of the internet or the phone in furtherance of the scheme to defraud.

a) Scheme to defraud. The concept of fraud comes to us from the Common Law, and has not been defined by statute. Here is a definition from Black’s Law Dictionary Free On-line:

Fraud consists of some deceitful practice or willful device, resorted to with intent to deprive another of his right, or in some manner to do him an injury.

It is easy to see how S&P’s actions described in the complaint fit this definition. S&P knew that the issuers would only hire it if the issuer was satisfied with the proposed ratings The complaint says that the issuers had input into the software used to calculate the ratings. See, for example, ¶¶ 125 and following, and 171. The goal of the scheme to defraud was to enable S&P to earn those fees. As part of that scheme, S&P defrauded investors about the nature of their ratings. At the same time, S&P was aggressively touting its independence and objectivity. This element doesn’t require that the injury itself results in gain to the perpetrator. It is enough if it injures the victim.

b) Intent to defraud. Lanny Breuer, the soon-to-depart head of the Criminal Division of the Department of Justice, constantly whines about the difficulty of proving intent. It isn’t hard. Shah explains:

The second element the government must prove for a mail fraud conviction is the defendant’s specific intent to defraud. This element is met using circumstantial evidence and “a liberal policy has developed to allow the government to introduce evidence that even peripherally bears on the question of intent.” Similarly, the defendant can also use circumstantial evidence to show that she did not have the requisite intent.

Id. at 835-6. The US Attorney Criminal Resource Manual agrees:

Read the rest of this entry →

The US Attorney for Los Angeles, André Birotte, Jr., sued Standard and Poors for wire fraud against financial institutions earlier this week. Thanks to FT Alphaville, we have a copy of the complaint. This is a fraud case, and the rules require that the circumstances showing fraud be alleged “with particularity”. The complaint is full of particularity, about 110 pages worth. You can get a good idea of the sense of the complaint from the table of contents. Let’s take a look at the alleged facts; I’ll have a separate post on legal stuff.

S&P is a Nationally Recognized Statistical Rating Organization, regulated by the SEC. Some federally regulated financial institutions, such as Credit Unions, are only allowed to hold securities rated as AA- or better by at least one NRSRO. Other regulated financial institutions used ratings as an integral part of their investment decisions. S&P knew this.

Issuers pay S&P for the ratings, and for follow-up monitoring of the performance of their real estate backed mortgage securities (RMBS) and collateralized debt obligations (CDO). S&P knew that if it understated the risks of securities, it would be easier for issuers to sell them, so issuers would use S&P instead of one of its competitors. S&P knew that it would make more money if its ratings were higher than justified by the data. And it knew that if it understated the risks, investors could more easily lose money. The complaint alleges that S&P deliberately understated the risks in order to preserve and increase its sales. At the same time, it constantly and loudly insisted that its ratings were objective and accurate. The complaint says that this constitutes a scheme to defraud investors by S&P.

The complaint puts flesh on these bones. The rating system used by S&P in 1999 to estimate defaults on real estate backed mortgage securities was called LEVELS 5.6. It used a sample of “166,000 almost exclusively first-lien, fixed rate, prime mortgage loans”. ¶ 135. The issuer gave S&P information about the proposed pool of securities. S&P ran the data through LEVELS 5.6 to create the ratings. Over the next few years, S&P used LEVELS 5.6 even as the securities it was rating included more and more risky non-prime loans, including Alt-A and subprime loans.

By 2002, S&P had acquired a sample of 642,000 loans which included many riskier loans. It did not incorporate this into LEVELS 5.6, so actual evaluation was based on the old sample for the next two years.

When it began to test the new sample in 2004 in an update called LEVELS 6.0, it found that the ratings were substantially lower than those given by the old sample. The new data sample recognized that new RMBSs held riskier loans, so issuers would have to increase the number of loans in a pool to insure that the lower rated tranches of the RMBSs would receive investment ratings. That made the RMBS less profitable for the issuers. ¶ 143 A salesperson reported that S&P lost a deal because the new data required 10% more loans than Moody’s, one of S&Ps competitors. S&P did not convert to LEVELS 6.0. Instead, it issued updated versions of LEVELS 5.6 that did not increase the credit support requirements even for the riskier loan pools.

I note that the complaint does not allege what steps, if any, were taken in LEVELS 5.6 to adjust for the different kinds of mortgage loans in the RMBS and the CDOs. However, the complaint says (¶¶ 148-9):

Prior to March 2005, Executive H had suggested to Structured Finance executives that proposed LEVELS 6.0 should be released as soon as possible, because it … was simply a better model. … LEVELS 6.0 would require higher loss coverage levels for subprime loans and … S&P was underpricing risk on RMBS deals by having loss coverage levels that were too low.

The response Executive H received from Structured Finance executives was that if proposed LEVELS 6.0 was not going to result in S&P increasing its market share or gaining more revenue, there was no reason to spend money putting it in place.

The complaint contains similar claims about the rating of Collateralized Debt Obligations. ¶¶ 158 and following. Here is one example. CDOs are pools of debt securities, including tranches of RMBSs, credit default swaps and combinations of the two. CDOs include lower rated tranches of RMBSs that the issuers hadn’t sold. The complaint says that by Spring 2007 S&P knew these tranches would be downgraded, because as part of its services, it monitored their ongoing results. S&P knew that issuers were anxious to get these lower RMBS tranches off their books and into CDOs to help protect their balance sheets. S&P continued to use the original ratings of those lower tranches when they were included in CDOs until public information on the tranches was changed. That meant that the CDOs got higher ratings than would be justified in the face of known upcoming downgrades. ¶¶ 199, 229, 233(b), (i), and (n).

S&P claims that the complaint is without merit. No, really. And they are getting some PR help where you’d expect it, in the pages of Steve Forbes’ rag. I disagree. I think S&P has a problem, and I wonder if Moody’s and Fitch will face similar claims.

PART TWO: The Legal Case Against S&P Read the rest of this entry →

The soon-to-depart Treasury Secretary Timothy Geithner confirmed to Liaquat Ahamed of The National Review that his goal was to protect bankers:

… My own view was that it was going to be very hard, if not impossible to design a financial rescue that was going to be effective in protecting all the innocent victims hit by the crisis and still satisfy the completely understandable public desire for justice and accountability. Those things were in direct and tragic tension, never resolvable at that time.

I always felt that the only preoccupation for people in policy at the time should be to fix the problem as quickly as we could, as effectively as we could, and only after that would other things be possible, including how to figure out not just how to clean up the mess, but reform the financial system.

That’s just silly. There is no tension between protecting the innocent victims and locking up the criminals who caused the Great Crash. None. And his claim that he wanted to do anything for the “innocent victims” is laughable. The truth is what he told Elizabeth Warren and Neil Barofsky: he wanted to foam the runway with the financial corpses of the victims of mortgage and foreclosure fraud so that the banksters and the feral rich would have a soft landing. Geithner thinks us professional leftists who are outraged by the failure to prosecute banks and their criminal employees are short-sighted, if not stupid:

…I think that what really distinguishes countries in crisis are those that are lucky enough to have political leaders who are willing to take the brutal political cost of doing what’s necessary and those countries that waited and let the populist fires burn, or decided they were going to try to teach people a lesson and put populism ahead of other things.

So, it’s fine with him that there were no criminal prosecutions. The only relevant issue was the entire economy, and Geithner thinks he did great there:

I’m biased but I felt that in the basic strategy that the President embraced and that we put into effect, we did something that was incredibly effective for the broad interest of the economy and the financial system.

The results of that effectiveness are obvious, even if Geithner can’t grasp them. Unemployment is outrageously high. The middle class has been crushed by stagnant wages and huge losses in personal wealth, especially home equity. The poor are on the chopping block, with state after state trying to cut the meager assistance they provide and the President bent on cutting Social Security, Medicaid and Medicare. Retirees see their savings dwindle under years of zero to negative real interest rates. The megabanks are bigger and more dangerous than ever.

That “broad interest of the economy” Geithner talks about is to insure that the feral rich pay no price, and are rewarded with ever-increasing personal wealth and income. Geithener and Lanny Breuer are joined at the hip in carrying out the Obama program of wealth protection at any cost, including the rule of law. Read the rest of this entry →

Lanny Breuer is out as head of the Criminal Division of the Department of Justice, according to the Washington Post. After his ratlike performance on Frontline (transcript here) it won’t be long before we find him at some creepy New York or DC law firm defending his best friends, the banks and their sleazy employees. His legacy is simple: too big to fail banks can’t possibly commit crimes, so minor civil fines and false promises of reform are punishment enough. Jamie Dimon couldn’t have put it better.

Breuer tried his best to dodge questions about why he violated his promise to Senator Kaufman that he was actually conducting an investigation of Wall Street fraud. Martin Smith, the interviewer, asks:

We spoke to a couple of sources from within the fraud section of the Criminal Division, and through mid-2010 they reported that when it came to Wall Street, there were no investigations going on; there were no subpoenas, no document reviews, no wiretaps.

Breuer responds: “we looked very hard at the types of matters that you’re talking about.” He doesn’t deny that there were no investigations; no subpoenas, no document reviews, no wiretaps. Instead, he tries to shift the subject to his pointless insider trading cases, his Ponzi cases, the Lee Farkas case (the mortgage firm Taylor, Whitaker and Bean), and a few hapless mortgage originator cases, and even a policeman defrauded by some fraud or other. Smith won’t let that pass. Eventually we get to the heart of the problem to Breuer:

But in those cases where we can’t bring a criminal case — and federal criminal cases are hard to bring — I have to prove that you had the specific intent to defraud. I have to prove that the counterparty, the other side of the transaction, relied on your misrepresentation. If we cannot establish that, then we can’t bring a criminal case.
…
But in reality, in a criminal case, we have to prove beyond a reasonable doubt — not a preponderance, not 51 percent — beyond any reasonable doubt that a crime was committed. And I have to prove not only that you made a false statement but that you intended to commit a crime, and also that the other side of the transaction relied on what you were saying. And frankly, in many of the securitizations and the kinds of transactions we’re talking about, in reality you had very sophisticated counterparties on both sides.

Smith says “You do have plaintiffs who will come forward and say that they relied on the reps and warranties, and they relied on the due diligence claims that were made by the bank.”

Breuer keeps talking, but he can’t worm out of this one. Smith then says:

“We’ve spoken to people inside the Residential Mortgage-Backed Securities Working Group who said that when they began their work in January, February, March of 2012 that they found nothing at the Justice Department in the pipeline, no ongoing cases looking at securitization.”

And lest we forget, Lanny reminds us that these cases have ramifications for the rest of the bank. I don’t know who told Breuer that indicting the investment banking arm of a megabank would destroy the bank, but that’s a piece of idiocy that he claims to believe. This is from a speech he gave last September:

In my conference room, over the years, I have heard sober predictions that a company or bank might fail if we indict, that innocent employees could lose their jobs, that entire industries may be affected, and even that global markets will feel the effects. Sometimes – though, let me stress, not always – these presentations are compelling. In reaching every charging decision, we must take into account the effect of an indictment on innocent employees and shareholders, just as we must take into account the nature of the crimes committed and the pervasiveness of the misconduct. I personally feel that it’s my duty to consider whether individual employees with no responsibility for, or knowledge of, misconduct committed by others in the same company are going to lose their livelihood if we indict the corporation. In large multi-national companies, the jobs of tens of thousands of employees can be at stake. And, in some cases, the health of an industry or the markets are a real factor. Those are the kinds of considerations in white collar crime cases that literally keep me up at night, and which must play a role in responsible enforcement.

This concern is so touching. Too bad he and his team of responsible enforcers never thought about the impact on the families of Aaron Swarz, or any of the countless people serving time for possessing pot, or whistleblowers like John Kirakou and Thomas Drake.

The persistent questioning exposes Breuer’s idea of a hard look: he and his crack prosecutors read the offering documents and let the lawyers for the crooks explain why they make it just fine. They don’t need to issue subpoenas for e-mails that drive the civil cases filed by retirement funds and hedge funds that got screwed by the megabanks. They don’t need to haul the clerks and the functionaries into Grand Juries and find out what they knew and who they told. They don’t need to work up the chain to their bosses and on to the top. They don’t need to identify the lawyers from those white shoe firms that wrote those weasel words into the documents, haul them into the Grand Jury room and find out exactly what they knew and what those words meant. And most important, there is no need to let a jury decide their guilt. Breuer does all that for us.

Breuer is sleazy. But remember, he takes his orders from Attorney General Eric Holder and President Barack Obama. This administration refuses to prosecute. Read the rest of this entry →