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Fraud Didn’t End With Goldman Sachs

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Hats off to ProPublica for their phenomenal follow-ups to the SEC case against Goldman Sachs, and for revealing that what might have been a genuine move against corruption now merely seems like a politically motivated slap on the wrist, a show-trial, essentially, where big bad Goldman Sachs gets forced to pay a pittance of a fine and the rest of their compatriots who indulged in the exact same practices go off scot-free. Let’s not forget that they paid only 1% of their 2009 profits in taxes, so whatever restitution the SEC squeezes out of them won’t begin to cover their debt to the US Government.

For those of you who haven’t been following the byzantine hearings regarding the Goldman case, with their alphabet soup of acronyms and stern avocations from our media that these are “complex financial instruments” we’re dealing with – well, who can blame you? But the gist of the case is relatively easy to follow, and while Goldman may have been a particularly egregious offender, almost every investment bank bigger than a mom-and-pop outfit traded in Collateralized Debt Obligations (CDOs), the “complex instruments” that lie at the center of this case. Earlier this month ProPublica ran an extensive look at Magnetar, a hedge fund that traded exclusively in CDOs, and just a few days ago it revealed that Merril Lynch engaged in identical practices to the ones that got Goldman Sachs sued by the Securities and Exchange Commission.

CDOs are basically a bet that a given asset will perform well or perform poorly. In the Goldman Sachs case, Goldman put together securities (assets) that it knew would fail (the SEC hopes to show that a Goldman trader specifically picked the components of the securities for their especial toxicity), sold those securities to gullible investors, then secretly took out a collateralized debt obligation against that same security, betting, in essence, that its value would go to zero, which of course they knew would happen because they picked it specifically to do so. When, sure enough, the security did become worthless, Goldman hit paydirt.

This is called fraud, and it’s a pretty grievous sin in the world of finance (at least it was, once upon a time). So on one hand, it’s absolutely just for Goldman Sachs to come under the SEC’s gun, get its reputation tarnished a bit, and, with luck, get a few of its executives fired, where they can live the rest of their days in their Park Avenue penthouses, counting their ill-gotten gains. But on the other hand, what is the use of this symbolic prosecution if it doesn’t engender a shift in practices from the financial community?

The case of John Paulson and Goldman Sachs identified in the SEC indictment was neither the biggest nor the most blatant case of securities fraud during the run-up to the crisis. For the SEC to suddenly regain its regulatory muscle, and for them to focus on this one case to the exclusion of all else stinks of politics. President Obama’s approval ratings are dropping fast, and prior to this there had been no prosecutions of financial fraud at all. I could easily see President Obama instructing the SEC to move forward on the Goldman case so he could have something to show by November, especially since Goldman is the most visible and most reviled of all the Wall Street slimeball firms.

Finally, this case brings to light just how important the financial reform being discussed in the Senate is to prevent future such fraud. Currently most of the discussion seems to center around the politically popular “consumer protection”, but while overdraft fees and adjustable rate mortgages were pernicious side effects of the crisis, the real engine behind the financial meltdown was the widespread sale of over-the-counter (unregulated) derivatives like the CDOs mentioned in this case.

“Financial Reform” means nothing if not the outright ban of derivatives trading – or failing that, the erection of a structured derivatives exchange where fraudulent trades like the Goldman Sachs deal would be visible to the public and to investors. Without that, we’re literally back where we started.

Written by pavanvan

April 23, 2010 at 2:54 pm

Fraud and Washington Mutual

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The recent WaMU collapse hearings have brought out some juicy revelations, all of which detail practices widespread among all mortgage lenders. I highly recommend Zach Carter’s Huffington Post piece for its explanatory power:

There are two types of financial outrages: acts that are outrageously illegal, and acts that are, outrageously, legal. Yesterday’s Senate hearing on the rise and fall of Washington Mutual was a rare examination of the former outrage, documenting the pervasive practice of fraud at every level of the now-defunct bank’s business.

All of Washington Mutual’s sketchy practices can be traced back to rampant fraud in its mortgage lending offices. The company repeatedly performed internal audits of its lending practices, and discovered multiple times that enormous proportions of the loans it was issuing were based on fraudulent documents. At some offices, the fraud rate was on new mortgages over 70%, and at yesterday’s hearing, the company’s former Chief Risk Officer James Vanasek described its mortgage fraud as “systemic.”

When most people think of mortgage fraud, they think of a clever borrower conning an unwitting banker into extending him a loan he cannot afford. But this isn’t really how fraud usually works in the mortgage business. According to the FBI, 80% of mortgage fraud is committed by the lender, so it shouldn’t be surprising that WaMu’s internal audits concluded that its widespread fraud was being “willfully” perpetrated by its own employees. The company also engaged in textbook predatory lending across all of its mortgage lending activities–issuing loans based on the value of the property, while ignoring the borrower’s ability to repay the loan.

These findings alone are pretty bad stuff in the world of white-collar crime. For several years, WaMu was engaged in fraudulent lending, WaMu managers knew it was engaged in fraudulent lending, and didn’t stop it. The company was setting up thousands, if not millions of borrowers for foreclosure, while booking illusory short-term profits and paying out giant bonuses for its employees and executives. During the housing boom, WaMu Chairman and CEO Kerry Killinger took home between $11 million and $20 million every single year, much of it “earned” on outright fraud.

Written by pavanvan

April 15, 2010 at 8:58 pm

New Desperation from the FDIC

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(c/0 The Daily Digest)

ZeroHedge has a good find today: The FIDC is getting so desperate that it’s literally begging Americans to open savings accounts. Here’s the press release:

FOR IMMEDIATE RELEASE
February 22, 2010     Media Contact:
Greg Hernandez (202) 898-6984
Cell: (202) 340-4922
Email: ghernandez@fdic.gov

The Federal Deposit Insurance Corporation (FDIC) is calling upon consumers across the nation during America Saves Week to  consider establishing a basic savings account or boosting existing savings. FDIC Chairman Sheila Bair said, “One fundamental lesson of the financial crisis is that savings can help families withstand sudden changes in their economic well being. Establishing a savings account in a federally insured institution is a great first step to build wealth and begin a savings habit that will last a lifetime.”

The personal savings rate rose to 4.6 percent in 2009 from 2.7 percent in 2008, according to the U.S. Department of Commerce. “I am pleased to see that people are saving more of their hard-earned money and building wealth. Having personal savings for an emergency fund or saving for a future expenditure, such as a college education, can make a big difference in avoiding other costly alternatives. I’ve always been a big advocate of a back-to-basics approach to financial services; it’s my hope that Americans’ increase in savings is the beginning of a long-term trend,” Bair said.

“Money saved by consumers also provides a stable source of funding for investments in the economy that benefit all Americans,” said Bair. “In fact, a country with robust savings generally has more capital to fund investments and support economic growth over the long-term. As demonstrated recently, it is harmful to an economy when consumers spend beyond their means, financed by debt that they cannot afford to repay.”

Man, things are not looking good. And for those who are interested, here are the number of  FDIC “problem banks” over time, now in convenient chart format!

That’s a lot of liabilities. Oh yeah, and their reserves just went negative, so they’re basically broke. Hooray!

Written by pavanvan

February 24, 2010 at 10:32 pm

Unemployment Still Trending Upward

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Dean Baker makes a catch that nearly every mainstream outlet declines to report: jobless claims are up more than 31,000 from last week. In other news, the Federal Reserve, whose stated job it is to keep unemployment “low” (usually defined as 4.0%) is failing miserably at its job. What’s worse, it seems to consider employment a secondary concern, particularly if this Times article is any indication.

I hasten to remind my readers that by law, the Fed is required to do all it can to keep unemployment as near to 4% or below. Its unseemly focus on “bank stability” and “inflation” are illegal. Maybe someone should inform Mr. Bernanke.

Written by pavanvan

February 21, 2010 at 10:09 am

China Ready to Dump US Securities

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(c/o ZeroHedge)

This is serious. The Asia Times reports today that China is ready to start selling off its US Treasury Notes, ostensibly as a “punishment” for the recent US sales of arms to Taiwan. I and others previously warned about what would happen if China decided to let go of its dollar holdings – the gist is that China is the only thing standing between the US and catastrophic inflation. Previously these fears were pooh-poohed by establishment figures with the familiar arguments: “China needs us more than we need them”, “Who will China sell its surpluses to?” I even heard someone say, “Without us, the Chinese will be cavemen”. Well, it looks like China might have found itself a new trading partner, if this Asia Times article is any indication:

Dollar-denominated risk assets, including asset-backed securities and corporates, are no longer wanted at the State Administration of Foreign Exchange (SAFE), nor at China’s large commercial banks. The Chinese government has ordered its reserve managers to divest itself of riskier securities and hold only Treasuries and US agency debt with an implicit or explicit government guarantee. This already has been communicated to American securities dealers, according to market participants with direct knowledge of the events.

It is not clear whether China’s motive is simple risk aversion in the wake of a sharp widening of corporate and mortgage spreads during the past two weeks, or whether there also is a political dimension. With the expected termination of the Federal Reserve’s special facility to purchase mortgage-backed securities next month, some asset-backed spreads already have blown out, and the Chinese institutions may simply be trying to get out of the way of a widening. There is some speculation that China’s action has to do with the recent deterioration of US-Chinese relations over arm sales to Taiwan and other issues. That would be an unusual action for the Chinese to take–Beijing does not mix investment and strategic policy–and would be hard to substantiate in any event.

Where do you think we’re getting the money to prosecute these $5,000 per second conflicts in the Middle East? Where did the money for our $2,500,000,000,000 (and counting) bank bailouts come from? China. They make our money real. Without their manufacturing powerhouse backing us up, our dollars are worthless. What, you think the world is going to value our “service economy” at $13,000,000,000,000 per annum if that money weren’t backed by Chinese promises? Not likely. And now those promises are now increasingly under threat.

Be afraid.

Written by pavanvan

February 12, 2010 at 3:25 pm

Stimulus Fraud

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Propublica continues its fantastic coverage of the Obama stimulus bill by drawing attention to a true face-palm moment:

The Kentucky transportation department has awarded $24 million in stimulus contracts to companies associated with a road contractor who is accused of bribing the previous state transportation secretary, according to an audit by the federal Department of Transportation [1] (PDF).The DOT’s internal watchdog used the case to highlight the significant delays in the time it takes for the Federal Highway Administration to suspend or bar someone from receiving government contracts. Though the agency is supposed to make such a decision within 45 days, federal highway officials waited 10 months after the indictment to put the men accused of bribery onto the list of banned contractors.

I think this happy little episode displays pretty succinctly the vast and systemic corruption with which the Government has dispensed this stimulus.

The shadowy underworld of government contract awards is mysterious indeed:

In the Kentucky case, at trial this week, prosecutors have alleged that longtime road contractor Leonard Lawson paid state employees for confidential engineering estimates that helped him get a leg up on bidding for contracts.

Paul KrugmanMatt Yglesias, Ezra Klein, and the rest of the “progressive” blogosphere have each chastised Mr. Obama for not providing a “big enough” stimulus, and while there may be theoretical reasons for thinking such, it seems clear that even the biggest “stimulus” will fail to stimulate if it’s handled with fraud and deceit.

Eye on the Stimulus

We’re tracking the stimulus from bill to building, and we’re organizing citizens nationwide to watchdog local stimulus projects. Our team includes editor Tom Detzel, lead reporter Michael Grabell, Jennifer LaFleur, Amanda Michel, Eric Umansky and Christopher Flavelle.

When Do You Ban a Stimulus Contractor?

by Michael Grabell, ProPublica – January 15, 2010 11:45 am EST
Kentucky highway contractor Leonard Lawson heads to court where he faces charges related to bid-rigging on road construction projects in Lexington, Ky., on Jan. 11, 2010. (James Crisp/AP Photo)
Kentucky highway contractor Leonard Lawson heads to court where he faces charges related to bid-rigging on road construction projects in Lexington, Ky., on Jan. 11, 2010. (James Crisp/AP Photo)

The Kentucky transportation department has awarded $24 million in stimulus contracts to companies associated with a road contractor who is accused of bribing the previous state transportation secretary, according to an audit by the federal Department of Transportation [1] (PDF).The DOT’s internal watchdog used the case to highlight the significant delays in the time it takes for the Federal Highway Administration to suspend or bar someone from receiving government contracts. Though the agency is supposed to make such a decision within 45 days, federal highway officials waited 10 months after the indictment to put the men accused of bribery onto the list of banned contractors.

The combination of lengthy delays in the contractor suspension process and the rapid disbursement of billions of stimulus dollars “creates a ‘perfect storm’ for contractors intent on defrauding the government,” the inspector general audit said.

But the case also highlights a common tension in the contracting world that is now getting more attention with the nearly $800 billion stimulus package: What level of evidence is enough to justify suspending a company from receiving government contracts?

In the Kentucky case, at trial this week, prosecutors have alleged that longtime road contractor Leonard Lawson paid state employees for confidential engineering estimates that helped him get a leg up on bidding for contracts.

Written by pavanvan

January 19, 2010 at 6:33 pm

Reinstate Glass-Stegall!

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I mentioned this before, but I really want to stress that “financial reform” is completely meaningless without reinstating the Glass-Stegall Act. Enacted in 1933 and foolishly repealed in 1999, Glass-Stegall drew a firm line between commercial and investment banks and prohibited the “securitization” that lay at the heart of this crisis. Previously, “commercial” banks – ones in which you deposit your paycheck and which might later loan you money for a house or car – were completely separate entities from “investment” banks – ones that invest your money in whatever way they see fit. Commercial banks were low risk, low rate-of-return, while investment banks carried a higher risk, but with more earning potential. When current Economic Council Director Larry Summers chose to repeal Glass-Stegall back in 1999, he abolished the distinction between commercial and investment banks, allowing erstwhile “safe” organizations to make wildly irresponsible bets and grow so intertwined that they eventually brought the whole system down. Repealing Glass-Stegall created the “Too Big to Fail” banks.

The famous Elizabeth Warren, Paul Vlocker, and even John McCain (whose chief adviser’s name is on the G-S repeal) have come out in favor of reinstating Glass-Stegall. All the “too big to fail” banks are now even bigger, and this is largely because legislation which was traditionally used to keep them from conglomerating was idiotically repealed. This is the biggest one thing Congress can do right now to prevent the need of a future bailout. It would be so easy – they could do it tomorrow! The legislation is already written; all they have to do is sign it.

Sens. John McCain and Maria Cantwell have done a great service by recently proposing a Glass-Stegall reinstatement in the senate last month, but the bill doesn’t seem to have much support. This is totally baffling to me. The only reason I can think why the Senate wouldn’t do this right now is the massive donations they would have to sacrifice. Predictably, all the financial institutions, from Bank of America to Goldman Sachs, are vehemently against Glass-Stegall, as it would require them to break up, and likely diminish their ludicrous profits. Hence in the Bloomberg article you can hear Senators conceding that the bill “makes a lot of sense”, but “[they] don’t know if it’ll ever happen.” Uh…

The toll-free numbers for the Congressional switchboard are: 1-877-851-6437, 1-800-828-0498, or 1-800-614-2803. I think this is one issue where calling your congressman could conceivably sway them. Congress bows to the financial industry only insofar as its money can help them get elected. Public outcry can influence our legislators on legislation as specific as this. Remember, the TARP bailout originally failed in the House because their switchboards lit up with calls from angry voters.