Editor's NOTE:
This is a fantastic article by Professor Hudson. He has diagnosed the problem in clear and concise language.
Dr. J. P. Hubert
Free money creation to bail out financial speculators, but not Social Security or Medicare
By Michael Hudson
June 17 2011 "Information Clearing House" --Financial crashes were well understood for a hundred years after they became a normal financial phenomenon in the mid-19th century. Much like the buildup of plaque deposits in human veins and arteries, an accumulation of debt gained momentum exponentially until the economy crashed, wiping out bad debts – along with savings on the other side of the balance sheet. Physical property remained intact, although much was transferred from debtors to creditors. But clearing away the debt overhead from the economy’s circulatory system freed it to resume its upswing. That was the positive role of crashes: They minimized the cost of debt service, bringing prices and income back in line with actual “real” costs of production. Debt claims were replaced by equity ownership. Housing prices were lower – and more affordable, being brought back in line with their actual rental value. Goods and services no longer had to incorporate the debt charges that the financial upswing had built into the system.
Financial crashes came suddenly. They often were triggered by a crop failure causing farmers to default, or “the autumnal drain” drew down bank liquidity when funds were needed to move the crops. Crashes often also revealed large financial fraud and “excesses.”
This was not really a “cycle.” It was a scallop-shaped a ratchet pattern: an ascending curve, ending in a vertical plunge. But popular terminology called it a cycle because the pattern was similar again and again, every eleven years or so. When loans by banks and debt claims by other creditors could not be paid, they were wiped out in a convulsion of bankruptcy.
Gradually, as the financial system became more “elastic,” each business recovery started from a larger debt overhead relative to output. The United States emerged from World War II relatively debt free. Downturns occurred, crashes wiped out debts and savings, but each recovery since 1945 has taken place with a higher debt overhead. Bank loans and bonds have replaced stocks, as more stocks have been retired in leveraged buyouts (LBOs) and buyback plans (to keep stock prices high and thus give more munificent rewards to managers via the stock options they give themselves) than are being issued to raise new equity capital.
But after the stock market’s dot.com crash of 2000 and the Federal Reserve flooding the U.S. economy with credit after 9/11, 2001, there was so much “free spending money” that many economists believed that the era of scientific money management had arrived and the financial cycle had ended. Growth could occur smoothly – with no over-optimism as to debt, no inability to pay, no proliferation of over-valuation or fraud. This was the era in which Alan Greenspan was applauded as Maestro for ostensibly creating a risk-free environment by removing government regulators from the financial oversight agencies.
What has made the post-2008 crash most remarkable is not merely the delusion that the way to get rich is by debt leverage (unless you are a banker, that is). Most unique is the crash’s aftermath. This time around the bad debts have not been wiped off the books. There have indeed been the usual bankruptcies – but the bad lenders and speculators are being saved from loss by the government intervening to issue Treasury bonds to pay them off out of future tax revenues or new money creation. The Obama Administration’s Wall Street managers have kept the debt overhead in place – toxic mortgage debt, junk bonds, and most seriously, the novel web of collateralized debt obligations (CDO), credit default swaps (almost monopolized by A.I.G.) and kindred financial derivatives of a basically mathematical character that have developed in the 1990s and early 2000s.
These computerized casino cross-bets among the world’s leading financial institutions are the largest problem. Instead of this network of reciprocal claims being let go, they have been taken onto the government’s own balance sheet. This has occurred not only in the United States but even more disastrously in Ireland, shifting the obligation to pay – on what were basically gambles rather than loans – from the financial institutions that had lost on these bets (or simply held fraudulently inflated loans) onto the government (“taxpayers”). The government took over the mortgage lending guarantors Fannie Mae and Freddie Mac (privatizing the profits, “socializing” the losses) for $5.3 trillion – almost as much as the entire national debt. The Treasury lent $700 billion under the Troubled Asset Relief Plan (TARP) to Wall Street’s largest banks and brokerage houses. The latter re-incorporated themselves as “banks” to get Federal Reserve handouts and access to the Fed’s $2 trillion in “cash for trash” swaps crediting Wall Street with Fed deposits for otherwise “illiquid” loans and securities (the euphemism for toxic, fraudulent or otherwise insolvent and unmarketable debt instruments) – at “cost” based on full mark-to-model fictitious valuations.
Altogether, the post-2008 crash saw some $13 trillion in such obligations transferred onto the government’s balance sheet from high finance, euphemized as “the private sector” as if it were the core economy itself, rather than its calcifying shell. Instead of losing on their bad bets, bad loans, toxic mortgages and outright fraudulent claims, the financial institutions cleaned up, at public expense. They collected enough to create a new century’s power elite to lord it over “taxpayers” in industry, agriculture and commerce who will be charged to pay off this debt.
If there was a silver lining to all this, it has been to demonstrate that if the Treasury and Federal Reserve can create $13 trillion of public obligations – money – electronically on computer keyboards, there really is no Social Security problem at all, no Medicare shortfall, no inability of the American government to rebuild the nation’s infrastructure. The bailout of Wall Street showed how central banks can create money, as Modern Money Theory (MMT) explains. But rather than explaining how this phenomenon worked, the bailout was rammed through Congress under emergency conditions. Bankers threatened economic Armageddon if the government did not create the credit to save them from taking losses.
Even more remarkable is the attempt to convince the population that new money and debt creation to bail out Wall Street – and vest a new century of financial billionaires at public subsidy – cannot be mobilized just as readily to save labor and industry in the “real” economy. The Republicans and Obama administration appointees held over from the Bush and Clinton administration have joined to conjure up scare stories that Social Security and Medicare debts cannot be paid, although the government can quickly and with little debate take responsibility for paying trillions of dollars of bipartisan Finance-Care for the rich and their heirs.
The result is a financial schizophrenia extending across the political spectrum from the Tea Party to Tim Geithner at the Treasury and Ben Bernanke at the Fed. It seems bizarre that the most reasonable understanding of why the 2008 bank crisis did not require a vast public subsidy for Wall Street occurred at Monday’s Republican presidential debate on June 13, by none other than Congressional Tea Party leader Michele Bachmann – who had boasted in a Wall Street Journal interview two days earlier, on Saturday, that she
voted against the Troubled Asset Relief Program (TARP) “both times.” … She complains that no one bothered to ask about the constitutionality of these extraordinary interventions into the financial markets. “During a recent hearing I asked Secretary [Timothy] Geithner three times where the constitution authorized the Treasury’s actions [just [giving] the Treasury a $700 billion blank check], and his response was, ‘Well, Congress passed the law.’ …With TARP, the government blew through the Constitutional stop sign and decided ‘Whatever it takes, that’s what we’re going to do.’”
Clarifying her position regarding her willingness to see the banks fail, she explained:
I would have. People think when you have a, quote, ‘bank failure,’ that that is the end of the bank. And it isn’t necessarily. A normal way that the American free market system has worked is that we have a process of unwinding. It’s called bankruptcy. It doesn’t mean, necessarily, that the industry is eclipsed or that it’s gone. Often times, the phoenix rises out of the ashes.
There were easily enough sound loans and assets in the banks to cover deposits insured by the FDIC – but not enough to pay their counterparties in the “casino capitalist” category of their transactions. This super-computerized financial horseracing is what the bailout was about, not bread-and-butter retail and business banking or insurance.
It all seems reminiscent of the 1968 presidential campaign. The economic discussion back then between Democrat Hubert Humphrey and Republican Richard Nixon was so tepid that it prompted journalist Eric Hoffer to ask why only a southern cracker, third-party candidate Alabama Governor George Wallace, was talking about the real issues. We seem to be in a similar state in preparation for the 2012 campaign, with junk economics on both sides.
Meanwhile, the economy is still suffering from the Obama administration’s failure to alleviate the debt overhead by seriously making banks write down junk mortgages to reflect actual market values and the capacity to pay. Foreclosures are still throwing homes onto the market, pushing real estate further into negative equity territory while wealth concentrates at the top of the economic pyramid. No wonder Republicans are able to shed crocodile tears for debtors and attack President Obama for representing Wall Street (as if this is not equally true of the Republicans). He is simply continuing the Bush Administration’s policies, not leading the change he had promised. So he has left the path open for Congresswoman Bachmann to highlight her opposition to the Bush-McCain-Obama-Paulson-Geithner giveaways.
The missed opportunity
When Lehman Brothers filed for bankruptcy on September 15, 2008, the presidential campaign between Barack Obama and John McCain was peaking toward Election Day on November 4. Voters told pollsters that the economy was their main issue – their debts, soaring housing costs (“wealth creation” to real estate speculators and the banks getting rich off mortgage lending), stagnant wage levels and worsening workplace conditions. And in the wake of Lehman the main issue under popular debate was how much Wall Street’s crash would hurt the “real” economy. If large banks went under, would depositors still be safely insured? What about the course of normal business and employment?
Credit is seen as necessary; but what of credit derivatives, the financial sector’s arcane “small print”? How intrinsic are financial gambles on collateralized debt obligations (CDOs, “weapons of mass financial destruction” in Warren Buffett’s terminology) – not retail banking or even business banking and insurance, but financial bets on the economy’s zigzagging measures. Without casino capitalism, could industrial capitalism survive? Or had the superstructure become rotten and best left to “free markets” to wipe out in mutually offsetting bankruptcy claims?
Mr. Obama ran as the “candidate of change” from the Bush Administration’s war in Iraq and Afghanistan, its deregulatory excesses and giveaways to the pharmaceuticals industry and other monopolies and their Wall Street backers. Today it is clear that his promises for change were no more than campaign rhetoric, not intended to limit a continuation of the policies that most voters hoped to see changed. There even has been continuity of Bush Administration officials committed to promoting financial policies to keep the debts in place, enable banks to “earn their way out of debt” at the expense of consumers and businesses – and some $13 trillion in government bailouts and subsidy.
History is being written to depict the policy of saving the bankers rather than the economy as having been necessary – as if there were no alternative, that the vast giveaways to Wall Street were simply “pragmatic.” Financial beneficiaries claim that matters would be even worse today without these giveaways. It is as if we not only need the banks, we need to save them (and their stockholders) from losses, enabling them to pay and retain their immensely rich talent at the top with even bigger salaries, bonuses and stock options.
It is all junk economics – well-subsidized illogic, quite popular among fundraisers.
From the outset in 2009, the Obama Plan has been to re-inflate the Bubble Economy by providing yet more credit (that is, debt) to bid housing and commercial real estate prices back up to pre-crash levels, not to bring debts down to the economy’s ability to pay. The result is debt deflation for the economy at large and rising unemployment – but enrichment of the wealthiest 1% of the population as economies have become even more financialized.
This smooth continuum from the Bush to the Obama Administration masks the fact that there was a choice, and even a clear disagreement at the time within Congress, if not between the two presidential candidates, who seemed to speak as Siamese Twins as far as their policies to save Wall Street (from losses, not from actually dying) were concerned. Wall Street saw an opportunity to be grabbed, and its spokesmen panicked policy-makers into imagining that there was no alternative. And as President Obama’s chief of staff Emanuel Rahm noted, this crisis is too important an opportunity to let it go to waste. For Washington’s Wall Street constituency, the bold aim was to get the government to save them from having to take a loss on loans gone bad – loans that had made them rich already by collecting fees and interest, and by placing bets as to which way real estate prices, interest rates and exchange rates would move.
After September 2008 they were to get rich on a bailout – euphemized as “saving the economy,” if one believes that Wall Street is the economy’s core, not its wrapping or supposed facilitator, not to say a vampire squid. The largest and most urgent problem was not the inability of poor homebuyers to cope with the interest-rate jumps called for in the small print of their adjustable rate mortgages. The immediate defaulters were at the top of the economic pyramid. Citibank, AIG and other “too big to fail” institutions were unable to pay the winners on the speculative gambles and guarantees they had been writing – as if the economy had become risk-free, not overburdened with debt beyond its ability to pay.
Making the government absorb their losses – instead of recovering the enormous salaries and bonuses their managers had paid themselves for selling these bad bets – required a cover story to make it appear that the economy could not be saved without the Treasury and Federal Reserve underwriting these losing gambles. Like the sheriff in the movie Blazing Saddles threatening to shoot himself if he weren’t freed, the financial sector warned that its losses would destroy the retail banking and insurance systems, not just the upper reaches of computerized derivatives gambling.
How America’s Bailouts Endowed a Financial Elite to rule the 21st Century
The bailout of casino capitalists vested a new ruling class with $13 trillion of public IOUs (including the $5.3 trillion rescue of Fannie Mae and Freddie Mac) added to the national debt. The recipients have paid out much of this gift in salaries and bonuses, and to “make themselves whole” on their bad risks in default to pay off. An alternative would have been to prosecute them and recover what they had paid themselves as commissions for loading the economy with debt.
Although there were two sides within Congress in September 2008, there was no disagreement between the two presidential candidates. John McCain ran back to Washington on the fateful Friday of their September 26 debate to insist that he was suspending his campaign in order to devote all his efforts to persuading Congress to approve the $700 billion bank bailout – and would not debate Mr. Obama until that was settled. But he capitulated and went to the debate. On September 29 the House of Representatives rejected the giveaway, headed by Republicans in opposition.
So Mr. McCain did not even get brownie points for being able to sway politicians on the side of his Wall Street campaign contributors. Until this time he had campaigned as a “maverick.” But his capitulation to high finance reminded voters of his notorious role in the Keating Five, standing up for bank crooks. His standing in the polls plummeted, and the Senate capitulated to a redrafted TARP bill on October 1. President Bush signed it into law two days later, on October 3, euphemized as the Emergency Economic Stabilization Act.
Fast-forward to today. What does it signify when a right-wing cracker makes a more realistic diagnosis of bad bank lending better than Treasury Secretary Geithner, Fed Chairman Bernanke or other Bush-era financial experts retained by the Obama team? Without the bailout the gambling arm of Wall Street would have collapsed, but the “real” economy’s everyday banking and insurance operations could have continued. The bottom 99 percent of the U.S. economy would have recovered with only a speed bump to clean out the congestion at the top, and the government would have ended up in control of the biggest and most reckless banks and AIG – as it did in any case.
The government could have used its equity ownership and control of the banks to write down mortgages to reflect market conditions. It could have left families owning their homes at the same cost they would have had to pay in rent – the economic definition of equilibrium in property prices. The government-owned “too big to fail” banks could have been told to refrain from gambling on derivatives, from lending for currency and commodity speculation, and from making takeover loans and other predatory financial practices. Public ownership would have run the banks like savings banks or post office banks rather than gambling schemes fueling the international carry trade (computer-driven interest rate and currency arbitrage) that has no linkage to the production-and-consumption economy.
The government could have used its equity ownership and control of the banks to provide credit and credit card services as the “public option.” Credit is a form of infrastructure, and such public investment is what enabled the United States to undersell foreign economies in the 19th and 20th centuries despite its high wage levels and social spending programs. As Simon Patten, the first economics professor at the nation’s first business school (the Wharton School) explained, public infrastructure investment is a “fourth factor of production.” It takes its return not in the form of profits, but in the degree to which it lowers the economy’s cost of doing business and living. Public investment does not need to generate profits or pay high salaries, bonuses and stock options, or operate via offshore banking centers.
But this is not the agenda that the Bush-Obama administrations chose. Only Wall Street had a plan in place to unwrap when the crisis opportunity erupted. The plan was predatory, not productive, not lowering the economy’s debt overhead or cost of living and doing business to make it more competitive. So the great opportunity to serve the public interest by taking over banks gone broke was missed. Stockholders were bailed out, counterparties were saved from loss, and managers today are paying themselves bonuses as usual. The “crisis” was turned into an opportunity to panic politicians into helping their Wall Street patrons.
One can only wonder what it means when the only common sense being heard about the separation of bank functions should come from a far-out extremist in the current debate. The social democratic tradition had been erased from the curriculum as it had in political memory.
Tom Fahey: Would you say the bailout program was a success? …
BACHMANN: John, I was in the middle of this debate. I was behind closed doors with Secretary Paulson when he came and made the extraordinary, never-before-made request to Congress: Give us a $700 billion blank check with no strings attached.
And I fought behind closed doors against my own party on TARP. It was a wrong vote then. It’s continued to be a wrong vote since then. Sometimes that’s what you have to do. You have to take principle over your party.
Proclaiming herself a libertarian, Ms. Bachmann opposes raising the federal debt ceiling, Pres. Obama’s Medicare reform and other federal initiatives. So her opposition to the Wall Street bailout turns out to lack an understanding of how governments and their central banks can create money with a stroke of the computer pen, so to speak. But at least she was clear that wiping out bank counterparty gambles made by high rollers at the financial race track could have been wiped out (or left to settle among themselves in Wall Street’s version of mafia-style kneecapping) without destroying the banking system’s key economic functions.
The moral
Contrasting Ms. Bachmann’s remarks to the panicky claims by Mr. Geithner and Hank Paulson in September 2008 confirm a basic axiom of today’s junk economics: When an economic error becomes so widespread that it is adopted as official government policy, there is always a special interest at work to promote it.
In the case of bailing out Wall Street – and thereby the wealthiest 1% of Americans – while saying there is no money for Social Security, Medicare or long-term public social spending and infrastructure investment, the beneficiaries are obvious. So are the losers. High finance means low wages, low employment, low industry and a shrinking economy under conditions where policy planning is centralized in hands of Wall Street (Editor's bold emphasis throughout) and its political nominees rather than in more objective administrators.
Showing posts with label Financial Crisis. Show all posts
Showing posts with label Financial Crisis. Show all posts
Saturday, June 18, 2011
Thursday, June 16, 2011
Stock Prices Have Fallen For Six Weeks In A Row
By: The Economic Collapse Blog
Well, it's official. U.S. stock prices have fallen for six weeks in a row. So will next week make it seven? The last time stocks declined for seven weeks in a row was back in May 2001 when the "dot-com" bubble was bursting. At this point, the Dow has declined by approximately 5 percent since the beginning of June. Things don't look good. So exactly what is going on here? Well, it is undeniable that the recent mini-bubble in stocks has been too good to be true. The S&P 500 had surged nearly 30 percent since last September. Much of this has been fueled by the Federal Reserve's latest round of quantitative easing, but now that is coming to an end in a few weeks and investors are a bit spooked. Meanwhile, wars and revolutions are sweeping the Middle East, Japan is dealing with the damage caused by the tsunami and by Fukushima, Europe is trying to figure out how to bail out Greece again and the U.S. debt crisis is continually getting worse. In addition, wave after wave of bad economic news is certainly not helping the mood on Wall Street. In many ways, a "perfect storm" is developing and many are now extremely concerned about what the rest of 2011 is going to bring for Wall Street.
QE2 is slated to conclude at the end of June, and many investors are deeply disappointed that it does not appear that we are not going to see QE3 right away. Many fear that the end of quantitative easing will pop the current mini-bubble in stocks and commodities. At the moment, financial markets are more jittery than they have been in a long time.
Frank Davis, director of sales and trading with LEK Securities, says that there is a lot of pessimism on Wall Street right now....
"There's a lot of emotion in this market at the moment, and the conversations among traders are nearly all leaning toward the bear side"
So what are some of the signs that this downturn on Wall Street may turn into a full-blown crash?
Well, according to the Wall Street Journal, junk bonds are being sold off at an alarming rate right now. Does the following quote from the Journal remind anyone of 2008 at least a little bit?....
A steep decline in prices of bonds backed by subprime mortgages has spread through the riskiest segments of the credit markets, ending rallies in high-yield corporate bonds and commercial real-estate debt.
Also, many of the big Wall Street banks are already laying off workers. In a previous article I wrote about the potential for Wall Street to go into "panic mode", I noted that Goldman Sachs, Bank of America, JPMorgan Chase and Morgan Stanley are all laying people off or are considering staff cuts.
The truth is that the big banks on Wall Street are not nearly as stable as most people think that they are. Moody's recently warned that it may downgrade the debt ratings of Bank of America, Citigroup and Wells Fargo.
Another major story on Wall Street right now is oil. OPEC recently announced that oil production levels will not be raised, even though the price of oil has been hovering around $100 a barrel.
World oil supplies are very tight right now. In fact, the globe actually consumed 5 million barrels per day more oil than it produced during 2010. This was possible because the difference was apparently made up by drawing down reserves.
But if oil supplies are this tight already, what is going to happen if a major war (as opposed to all of the minor wars that are already happening) erupts in the Middle East?
The world is sitting on the edge of a financial disaster.
It is important to keep in mind that Europe is also in far worse financial condition than it was just prior to the financial collapse of 2008.
It is being reported that German finance minister Wolfgang Schaeuble is convinced that a "full-blown" financial meltdown by Greece is a very real possibility. The cost of insuring Greek debt has soared to a brand new record high, and officials all over Europe are in panic mode.
But financial problems are not just happening in Greece. The largest bank in France has just cut in half the amount of cash that customers can withdraw from ATMs each week.
Most Americans don't spend much time thinking about the financial condition of Europe, but the truth is that what happens in Europe is going to play a major role in the months and years ahead.
Of course most Americans already know that the U.S. government is a financial mess.
As the "debt ceiling deadline" of August 2nd draws closer, the U.S. government has been raiding retirement funds in order to stay under the debt limit.
Many investors are quite nervous about what may happen if the U.S. government actually does start defaulting on debt on August 2nd.
Others claim that the U.S. government is already in default.
The only Chinese agency that gives credit ratings on sovereign debt says that the U.S. government "has already been defaulting" and the Chinese government has been repeatedly warning that the U.S. needs to get its finances in order.
In any event, this debt ceiling drama will get resolved one way or another.
The bigger question is this....
How is the U.S. government going to respond when the next financial crash happens?
Back in 2008, the Federal Reserve and the U.S. government took unprecedented steps to prop up Wall Street.
But can they really do that again if we see another major crash in 2011 or 2012?
Many believe that things will be totally different this time around. Just check out what Jim Rogers recently told CNBC....
"The debts that are in this country are skyrocketing," he said. "In the last three years the government has spent staggering amounts of money and the Federal Reserve is taking on staggering amounts of debt.
"When the problems arise next time…what are they going to do? They can’t quadruple the debt again. They cannot print that much more money. It’s gonna be worse the next time around."
Jim Rogers is right about that.
The next time we see a collapse on the scale of 2008 it is going to be a much bigger mess.
Global financial markets are extremely vulnerable right now and there are a whole host of potential "tipping points" which could push them over the edge.
The Federal Reserve and the U.S. government more or less used up all of their ammunition on the 2008 crisis.
If we see another collapse in 2011 or 2012 there is not going to be much of a safety net available.
The entire world financial system is simply swamped with way too much debt. The world has never seen anything even remotely close to the gigantic mountains of debt that have been accumulated around the world today.
The current global financial system is not sustainable. More crashes are inevitable. A lot of people are going to get steamrolled.
Hopefully you will not be one of them.
Well, it's official. U.S. stock prices have fallen for six weeks in a row. So will next week make it seven? The last time stocks declined for seven weeks in a row was back in May 2001 when the "dot-com" bubble was bursting. At this point, the Dow has declined by approximately 5 percent since the beginning of June. Things don't look good. So exactly what is going on here? Well, it is undeniable that the recent mini-bubble in stocks has been too good to be true. The S&P 500 had surged nearly 30 percent since last September. Much of this has been fueled by the Federal Reserve's latest round of quantitative easing, but now that is coming to an end in a few weeks and investors are a bit spooked. Meanwhile, wars and revolutions are sweeping the Middle East, Japan is dealing with the damage caused by the tsunami and by Fukushima, Europe is trying to figure out how to bail out Greece again and the U.S. debt crisis is continually getting worse. In addition, wave after wave of bad economic news is certainly not helping the mood on Wall Street. In many ways, a "perfect storm" is developing and many are now extremely concerned about what the rest of 2011 is going to bring for Wall Street.
QE2 is slated to conclude at the end of June, and many investors are deeply disappointed that it does not appear that we are not going to see QE3 right away. Many fear that the end of quantitative easing will pop the current mini-bubble in stocks and commodities. At the moment, financial markets are more jittery than they have been in a long time.
Frank Davis, director of sales and trading with LEK Securities, says that there is a lot of pessimism on Wall Street right now....
"There's a lot of emotion in this market at the moment, and the conversations among traders are nearly all leaning toward the bear side"
So what are some of the signs that this downturn on Wall Street may turn into a full-blown crash?
Well, according to the Wall Street Journal, junk bonds are being sold off at an alarming rate right now. Does the following quote from the Journal remind anyone of 2008 at least a little bit?....
A steep decline in prices of bonds backed by subprime mortgages has spread through the riskiest segments of the credit markets, ending rallies in high-yield corporate bonds and commercial real-estate debt.
Also, many of the big Wall Street banks are already laying off workers. In a previous article I wrote about the potential for Wall Street to go into "panic mode", I noted that Goldman Sachs, Bank of America, JPMorgan Chase and Morgan Stanley are all laying people off or are considering staff cuts.
The truth is that the big banks on Wall Street are not nearly as stable as most people think that they are. Moody's recently warned that it may downgrade the debt ratings of Bank of America, Citigroup and Wells Fargo.
Another major story on Wall Street right now is oil. OPEC recently announced that oil production levels will not be raised, even though the price of oil has been hovering around $100 a barrel.
World oil supplies are very tight right now. In fact, the globe actually consumed 5 million barrels per day more oil than it produced during 2010. This was possible because the difference was apparently made up by drawing down reserves.
But if oil supplies are this tight already, what is going to happen if a major war (as opposed to all of the minor wars that are already happening) erupts in the Middle East?
The world is sitting on the edge of a financial disaster.
It is important to keep in mind that Europe is also in far worse financial condition than it was just prior to the financial collapse of 2008.
It is being reported that German finance minister Wolfgang Schaeuble is convinced that a "full-blown" financial meltdown by Greece is a very real possibility. The cost of insuring Greek debt has soared to a brand new record high, and officials all over Europe are in panic mode.
But financial problems are not just happening in Greece. The largest bank in France has just cut in half the amount of cash that customers can withdraw from ATMs each week.
Most Americans don't spend much time thinking about the financial condition of Europe, but the truth is that what happens in Europe is going to play a major role in the months and years ahead.
Of course most Americans already know that the U.S. government is a financial mess.
As the "debt ceiling deadline" of August 2nd draws closer, the U.S. government has been raiding retirement funds in order to stay under the debt limit.
Many investors are quite nervous about what may happen if the U.S. government actually does start defaulting on debt on August 2nd.
Others claim that the U.S. government is already in default.
The only Chinese agency that gives credit ratings on sovereign debt says that the U.S. government "has already been defaulting" and the Chinese government has been repeatedly warning that the U.S. needs to get its finances in order.
In any event, this debt ceiling drama will get resolved one way or another.
The bigger question is this....
How is the U.S. government going to respond when the next financial crash happens?
Back in 2008, the Federal Reserve and the U.S. government took unprecedented steps to prop up Wall Street.
But can they really do that again if we see another major crash in 2011 or 2012?
Many believe that things will be totally different this time around. Just check out what Jim Rogers recently told CNBC....
"The debts that are in this country are skyrocketing," he said. "In the last three years the government has spent staggering amounts of money and the Federal Reserve is taking on staggering amounts of debt.
"When the problems arise next time…what are they going to do? They can’t quadruple the debt again. They cannot print that much more money. It’s gonna be worse the next time around."
Jim Rogers is right about that.
The next time we see a collapse on the scale of 2008 it is going to be a much bigger mess.
Global financial markets are extremely vulnerable right now and there are a whole host of potential "tipping points" which could push them over the edge.
The Federal Reserve and the U.S. government more or less used up all of their ammunition on the 2008 crisis.
If we see another collapse in 2011 or 2012 there is not going to be much of a safety net available.
The entire world financial system is simply swamped with way too much debt. The world has never seen anything even remotely close to the gigantic mountains of debt that have been accumulated around the world today.
The current global financial system is not sustainable. More crashes are inevitable. A lot of people are going to get steamrolled.
Hopefully you will not be one of them.
12 More Signs That Society Is Collapsing
By Economic Collapse Blog
June 16, 2011 "Economic Collapse Blog" --- What we are now witnessing is the slow motion unraveling of America. Our economy is dying, the American people have lost faith in the government and in almost all of our other major institutions, and our society is collapsing. Most Americans don't understand why all of this is happening, but most of them do realize that something has fundamentally changed. Earlier this year, McDonald's held a "National Hiring Day" and a million Americans showed up to apply for jobs. Only 62,000 of them were hired. That means only 6.2% of the applicants got jobs. So what are we supposed to tell the 93.8% that didn't get hired? Are they supposed to have any hope for the future when they can't even get a minimum wage job at McDonald's? When I was a teenager, I went over to McDonald's one day, filled out an application and was instantly hired. My, how things have changed. Now we have millions upon millions of young people that are staring directly into a very bleak future. The level of frustration in this country is rising to frightening levels and large numbers of people are already showing that they will stoop to anything in order to survive.
In a recent article entitled "18 Signs The Collapse Of Society Is Accelerating" I focused primarily on the chaos that has been erupting in many of our urban areas. But the truth is that, as you will see below, there are signs that society is collapsing coming out of very rural areas as well. This phenomenon cannot just be pinned down to one area of the country or to one group of people. From coast to coast people are already starting to lose it and the economic collapse has only just begun.
The cold, hard reality of the matter is that what we are experiencing right now is rip-roaring prosperity compared to what is coming down the road.
So if people will behave this wildly now, what is our society going to look like someday when there are millions of Americans that have not had anything to eat for several days?
That is something to think about.
History has shown us that when people are really, really hungry they will do just about anything.
But right now we are not even close to that point and yet people all across America are going crazy.
The following are 12 more signs that society is collapsing....
#1 In my previous article, I detailed how the "mob robbery" phenomenon in Chicago is spinning wildly out of control. Well, just this morning, the brother of Billy Corgan (the front man for the Smashing Pumpkins) was mugged and had his iPod stolen by a mob of teens while he was riding a Red Line train in Chicago.
Things have gotten so bad that now even The Wall Street Journal is taking notice of the rash of "mob robberies" that have been happening in Chicago. The following is how a new article in the Journal described one of the recent attacks....
In another incident last Saturday evening, Krzysztof Wilkowski, after shopping on Michigan Avenue, was sitting on his scooter a couple of blocks away checking his phone for a restaurant when he got whacked in the face with a baseball.
At first, he said, he thought it was a prank, but then he looked up and saw 15 to 20 young men approaching. "My first reaction was, 'I'm about to get robbed, what do I do?' " Mr. Wilkowski recalled in an interview.
The 34-year-old insurance company employee from a Chicago suburb grabbed the keys from his ignition and held tight to his phone. A few of the attackers dragged him off his scooter and pulled him onto Chicago Avenue where they punched him, hit him with his helmet and tried to grab his phone.
#2 Sadly, "mob robberies" are not just happening in Chicago. The following is a video of a mob robbery that took place in Stockton, California....
This next video is an Associated Press video report about how police have become extremely concerned about the "flash mobs" that have been plaguing Philadelphia lately.....
This is a very, very disturbing trend. Once these videos go up on YouTube, other groups of young people "copycat" them all over the country.
The next 10 signs are from some of my readers. In response to my previous article that discussed how society is collapsing, a number of people left comments that described what is happening in their particular areas. Sometimes so many dozens of comments get left that some real gems get overlooked. The following is a sampling of what my readers have been sharing about how society is collapsing where they live....
#3 Golden Child (Third Richest County In America):
About a month ago I was robbed in broad daylight walking to the store on a picture perfect 75 degree sunny day at 1 PM by two high school dropout teenagers on the path in my nice suburban town which is located in third richest county in America! A few months before that I was beaten unconscious by random drunk young people on the path near my home that I woke up in the hospital getting stitches in my face. This will be one dangerous summer for places all across America.
#4 Chris (Fargo, North Dakota):
I live in Fargo,ND and we have been having a rash of crime lately. In the past 6 months we have had multiple gas station robberies, bank robberies, and the latest, a shooting at one of our three movie theaters.
#5 Sue (Ogden, Utah):
I am a teacher in Ogden, Utah and this last winter I had a second grade student tell me that if I didn’t tell him how old I was that he was going to “shoot me in the back of my head.” He was suspended from school because that is a threat of violence, but nothing changed. His parents are active gang members.
#6 Heather (Columbus, Ohio):
I live close enough to Columbus, OH to follow the news there. (Thankfully far enough away not to be regularly affected by it.) Every day there is a new report of a violent crime. I believe we are up to 70 or so murders on the year. 10 years ago this wasn’t the case. I could (and did) walk into the worst part of the city and be safe as long as I was vigilant. I wouldn’t try that for the world now. I used to be a bank teller there and there’d be maybe 1 robbery a month throughout the city. It’s at least one a week now, probably more than that. And it’s no longer the downtown banks that are getting robbed–it’s the suburban ones.
#7 The Baroness (Atlanta):
I live in Atlanta Georgia. Everyday there are signs. Today’s headlines are: Babysitter kills toddler, 2 shot outside teen party, Brick thrown from I-75 overpass and several more.
#8 Gas Panic (Unknown):
The first, a 21 year old pizza delivery girl who was held with a knife to her throat while making a delivery. They took all the money she had on her and even took the time to search her car! The second was a 30 year old woman who told me she was walking down the street and was solicited by a pimp telling her she could “make good money”. After she told him to get lost, he stabbed her in the back of the arm. She needed over twenty stitches and showed me the wound.
#9 NS (Fairbanks, Alaska):
Even in Fairbanks, Alaska, there has been similar “mob robbing” going on. Yes, it is spreading everywhere.
#10 Katherine (Unknown):
I’ve also seen a huge increase in theft, vandalism, sexual assault, and violence just in the past couple of years. This is in a city that used to make the list in top places to live in the U.S. year after year.
#11 Doktryn (Richmond, California):
I live in Richmond California aka the city with the 2nd highest murder rate next to New Orleans, aka the city where the probability of you being killed is 5x higher. It is getting very serious out here, and luckily I don’t live in the rough part, however I go to the rough part to try to witness and preach. People are walking zombies. At any point their lives can be taken but the fact is, this is all they know. It is completely hopeless and when you wrote about “American Hellholes” I live in one. Richmond, CA is a post-industrial warzone. I work in the manufacturing industry, and I got here not long ago, but if you just drive through the city, the boarded up homes and abandoned warehouses tell the tale of how a deindustrialized city quickly turns to a battlefield.
#12 I Will Survive (Rural America):
In my area we have been able to sleep well enough and always known our neighbors – up until a few months ago I did not lock my cars or my home most of the time – there was no need. That has changed, neighbors are now siphoning gas out of cars from desperation, and stealing scrap lumber, metal, livestock, produce and anything else they can get their hands on to sell or eat. Over the last year or so the police departments of some areas have started taking these seriously and actually investigated and caught a few. They are sometimes groups of people working together to amass resources to sell. We now keep a vigilant eye on our little flock of chickens and we have a colony of rabbits as well. We no longer “free range” them on our property at all – the risk of theft is too high if others know we have them. We keep any resources away from the road on the back side of our property – we also keep two German Shepherd Dogs for guarding our property. Living in the country is NOT what it used to be.
---------------------------------------------------------
Sadly, this is just the beginning.
This is just the tip of the iceberg.
As the economy collapses, the chaos is going to get a lot worse.
I wish that wasn't true, but this is the world we live in now.
The recent article I did about the "economic hell" that American families are going through right now got a huge response, but honestly what we are experiencing right now is not even worth comparing to how nightmarish things are going to be when our economic system fully collapses.
We have been on the biggest debt binge that the world has ever seen. Our debt-fueled prosperity has enabled us to enjoy an unprecedented standard of living. But the largest debt bubble in the history of the world is going to pop, and when it does the party is going to be over.
You better get ready.
June 16, 2011 "Economic Collapse Blog" --- What we are now witnessing is the slow motion unraveling of America. Our economy is dying, the American people have lost faith in the government and in almost all of our other major institutions, and our society is collapsing. Most Americans don't understand why all of this is happening, but most of them do realize that something has fundamentally changed. Earlier this year, McDonald's held a "National Hiring Day" and a million Americans showed up to apply for jobs. Only 62,000 of them were hired. That means only 6.2% of the applicants got jobs. So what are we supposed to tell the 93.8% that didn't get hired? Are they supposed to have any hope for the future when they can't even get a minimum wage job at McDonald's? When I was a teenager, I went over to McDonald's one day, filled out an application and was instantly hired. My, how things have changed. Now we have millions upon millions of young people that are staring directly into a very bleak future. The level of frustration in this country is rising to frightening levels and large numbers of people are already showing that they will stoop to anything in order to survive.
In a recent article entitled "18 Signs The Collapse Of Society Is Accelerating" I focused primarily on the chaos that has been erupting in many of our urban areas. But the truth is that, as you will see below, there are signs that society is collapsing coming out of very rural areas as well. This phenomenon cannot just be pinned down to one area of the country or to one group of people. From coast to coast people are already starting to lose it and the economic collapse has only just begun.
The cold, hard reality of the matter is that what we are experiencing right now is rip-roaring prosperity compared to what is coming down the road.
So if people will behave this wildly now, what is our society going to look like someday when there are millions of Americans that have not had anything to eat for several days?
That is something to think about.
History has shown us that when people are really, really hungry they will do just about anything.
But right now we are not even close to that point and yet people all across America are going crazy.
The following are 12 more signs that society is collapsing....
#1 In my previous article, I detailed how the "mob robbery" phenomenon in Chicago is spinning wildly out of control. Well, just this morning, the brother of Billy Corgan (the front man for the Smashing Pumpkins) was mugged and had his iPod stolen by a mob of teens while he was riding a Red Line train in Chicago.
Things have gotten so bad that now even The Wall Street Journal is taking notice of the rash of "mob robberies" that have been happening in Chicago. The following is how a new article in the Journal described one of the recent attacks....
In another incident last Saturday evening, Krzysztof Wilkowski, after shopping on Michigan Avenue, was sitting on his scooter a couple of blocks away checking his phone for a restaurant when he got whacked in the face with a baseball.
At first, he said, he thought it was a prank, but then he looked up and saw 15 to 20 young men approaching. "My first reaction was, 'I'm about to get robbed, what do I do?' " Mr. Wilkowski recalled in an interview.
The 34-year-old insurance company employee from a Chicago suburb grabbed the keys from his ignition and held tight to his phone. A few of the attackers dragged him off his scooter and pulled him onto Chicago Avenue where they punched him, hit him with his helmet and tried to grab his phone.
#2 Sadly, "mob robberies" are not just happening in Chicago. The following is a video of a mob robbery that took place in Stockton, California....
This next video is an Associated Press video report about how police have become extremely concerned about the "flash mobs" that have been plaguing Philadelphia lately.....
This is a very, very disturbing trend. Once these videos go up on YouTube, other groups of young people "copycat" them all over the country.
The next 10 signs are from some of my readers. In response to my previous article that discussed how society is collapsing, a number of people left comments that described what is happening in their particular areas. Sometimes so many dozens of comments get left that some real gems get overlooked. The following is a sampling of what my readers have been sharing about how society is collapsing where they live....
#3 Golden Child (Third Richest County In America):
About a month ago I was robbed in broad daylight walking to the store on a picture perfect 75 degree sunny day at 1 PM by two high school dropout teenagers on the path in my nice suburban town which is located in third richest county in America! A few months before that I was beaten unconscious by random drunk young people on the path near my home that I woke up in the hospital getting stitches in my face. This will be one dangerous summer for places all across America.
#4 Chris (Fargo, North Dakota):
I live in Fargo,ND and we have been having a rash of crime lately. In the past 6 months we have had multiple gas station robberies, bank robberies, and the latest, a shooting at one of our three movie theaters.
#5 Sue (Ogden, Utah):
I am a teacher in Ogden, Utah and this last winter I had a second grade student tell me that if I didn’t tell him how old I was that he was going to “shoot me in the back of my head.” He was suspended from school because that is a threat of violence, but nothing changed. His parents are active gang members.
#6 Heather (Columbus, Ohio):
I live close enough to Columbus, OH to follow the news there. (Thankfully far enough away not to be regularly affected by it.) Every day there is a new report of a violent crime. I believe we are up to 70 or so murders on the year. 10 years ago this wasn’t the case. I could (and did) walk into the worst part of the city and be safe as long as I was vigilant. I wouldn’t try that for the world now. I used to be a bank teller there and there’d be maybe 1 robbery a month throughout the city. It’s at least one a week now, probably more than that. And it’s no longer the downtown banks that are getting robbed–it’s the suburban ones.
#7 The Baroness (Atlanta):
I live in Atlanta Georgia. Everyday there are signs. Today’s headlines are: Babysitter kills toddler, 2 shot outside teen party, Brick thrown from I-75 overpass and several more.
#8 Gas Panic (Unknown):
The first, a 21 year old pizza delivery girl who was held with a knife to her throat while making a delivery. They took all the money she had on her and even took the time to search her car! The second was a 30 year old woman who told me she was walking down the street and was solicited by a pimp telling her she could “make good money”. After she told him to get lost, he stabbed her in the back of the arm. She needed over twenty stitches and showed me the wound.
#9 NS (Fairbanks, Alaska):
Even in Fairbanks, Alaska, there has been similar “mob robbing” going on. Yes, it is spreading everywhere.
#10 Katherine (Unknown):
I’ve also seen a huge increase in theft, vandalism, sexual assault, and violence just in the past couple of years. This is in a city that used to make the list in top places to live in the U.S. year after year.
#11 Doktryn (Richmond, California):
I live in Richmond California aka the city with the 2nd highest murder rate next to New Orleans, aka the city where the probability of you being killed is 5x higher. It is getting very serious out here, and luckily I don’t live in the rough part, however I go to the rough part to try to witness and preach. People are walking zombies. At any point their lives can be taken but the fact is, this is all they know. It is completely hopeless and when you wrote about “American Hellholes” I live in one. Richmond, CA is a post-industrial warzone. I work in the manufacturing industry, and I got here not long ago, but if you just drive through the city, the boarded up homes and abandoned warehouses tell the tale of how a deindustrialized city quickly turns to a battlefield.
#12 I Will Survive (Rural America):
In my area we have been able to sleep well enough and always known our neighbors – up until a few months ago I did not lock my cars or my home most of the time – there was no need. That has changed, neighbors are now siphoning gas out of cars from desperation, and stealing scrap lumber, metal, livestock, produce and anything else they can get their hands on to sell or eat. Over the last year or so the police departments of some areas have started taking these seriously and actually investigated and caught a few. They are sometimes groups of people working together to amass resources to sell. We now keep a vigilant eye on our little flock of chickens and we have a colony of rabbits as well. We no longer “free range” them on our property at all – the risk of theft is too high if others know we have them. We keep any resources away from the road on the back side of our property – we also keep two German Shepherd Dogs for guarding our property. Living in the country is NOT what it used to be.
---------------------------------------------------------
Sadly, this is just the beginning.
This is just the tip of the iceberg.
As the economy collapses, the chaos is going to get a lot worse.
I wish that wasn't true, but this is the world we live in now.
The recent article I did about the "economic hell" that American families are going through right now got a huge response, but honestly what we are experiencing right now is not even worth comparing to how nightmarish things are going to be when our economic system fully collapses.
We have been on the biggest debt binge that the world has ever seen. Our debt-fueled prosperity has enabled us to enjoy an unprecedented standard of living. But the largest debt bubble in the history of the world is going to pop, and when it does the party is going to be over.
You better get ready.
Sunday, February 20, 2011
Why Isn't Wall Street in Jail?
Financial crooks brought down the world's economy — but the feds are doing more to protect them than to prosecute them
By Matt Taibbi
February 17, 2011 "Rolling Stone" -- Over drinks at a bar on a dreary, snowy night in Washington this past month, a former Senate investigator laughed as he polished off his beer.
"Everything's fucked up, and nobody goes to jail," he said. "That's your whole story right there. Hell, you don't even have to write the rest of it. Just write that."
I put down my notebook. "Just that?"
"That's right," he said, signaling to the waitress for the check. "Everything's fucked up, and nobody goes to jail. You can end the piece right there."
Nobody goes to jail. This is the mantra of the financial-crisis era, one that saw virtually every major bank and financial company on Wall Street embroiled in obscene criminal scandals that impoverished millions and collectively destroyed hundreds of billions, in fact, trillions of dollars of the world's wealth — and nobody went to jail. Nobody, that is, except Bernie Madoff, a flamboyant and pathological celebrity con artist, whose victims happened to be other rich and famous people.
The rest of them, all of them, got off. Not a single executive who ran the companies that cooked up and cashed in on the phony financial boom — an industrywide scam that involved the mass sale of mismarked, fraudulent mortgage-backed securities — has ever been convicted. Their names by now are familiar to even the most casual Middle American news consumer: companies like AIG, Goldman Sachs, Lehman Brothers, JP Morgan Chase, Bank of America and Morgan Stanley. Most of these firms were directly involved in elaborate fraud and theft. Lehman Brothers hid billions in loans from its investors. Bank of America lied about billions in bonuses.
Goldman Sachs failed to tell clients how it put together the born-to-lose toxic mortgage deals it was selling. What's more, many of these companies had corporate chieftains whose actions cost investors billions — from AIG derivatives chief Joe Cassano, who assured investors they would not lose even "one dollar" just months before his unit imploded, to the $263 million in compensation that former Lehman chief Dick "The Gorilla" Fuld conveniently failed to disclose. Yet not one of them has faced time behind bars.
Instead, federal regulators and prosecutors have let the banks and finance companies that tried to burn the world economy to the ground get off with carefully orchestrated settlements — whitewash jobs that involve the firms paying pathetically small fines without even being required to admit wrongdoing. To add insult to injury, the people who actually committed the crimes almost never pay the fines themselves; banks caught defrauding their shareholders often use shareholder money to foot the tab of justice. "If the allegations in these settlements are true," says Jed Rakoff, a federal judge in the Southern District of New York, "it's management buying its way off cheap, from the pockets of their victims."
To understand the significance of this, one has to think carefully about the efficacy of fines as a punishment for a defendant pool that includes the richest people on earth — people who simply get their companies to pay their fines for them. Conversely, one has to consider the powerful deterrent to further wrongdoing that the state is missing by not introducing this particular class of people to the experience of incarceration. "You put Lloyd Blankfein in pound-me-in-the-ass prison for one six-month term, and all this bullshit would stop, all over Wall Street," says a former congressional aide. "That's all it would take. Just once."
But that hasn't happened. Because the entire system set up to monitor and regulate Wall Street is fucked up.
Just ask the people who tried to do the right thing.
Here's how regulation of Wall Street is supposed to work. To begin with, there's a semigigantic list of public and quasi-public agencies ostensibly keeping their eyes on the economy, a dense alphabet soup of banking, insurance, S&L, securities and commodities regulators like the Federal Reserve, the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency (OCC) and the Commodity Futures Trading Commission (CFTC), as well as supposedly "self-regulating organizations" like the New York Stock Exchange. All of these outfits, by law, can at least begin the process of catching and investigating financial criminals, though none of them has prosecutorial power.
The major federal agency on the Wall Street beat is the Securities and Exchange Commission. The SEC watches for violations like insider trading, and also deals with so-called "disclosure violations" — i.e., making sure that all the financial information that publicly traded companies are required to make public actually jibes with reality.
But the SEC doesn't have prosecutorial power either, so in practice, when it looks like someone needs to go to jail, they refer the case to the Justice Department. And since the vast majority of crimes in the financial services industry take place in Lower Manhattan, cases referred by the SEC often end up in the U.S. Attorney's Office for the Southern District of New York. Thus, the two top cops on Wall Street are generally considered to be that U.S. attorney — a job that has been held by thunderous prosecutorial personae like Robert Morgenthau and Rudy Giuliani — and the SEC's director of enforcement.
The relationship between the SEC and the DOJ is necessarily close, even symbiotic. Since financial crime-fighting requires a high degree of financial expertise — and since the typical drug-and-terrorism-obsessed FBI agent can't balance his own checkbook, let alone tell a synthetic CDO from a credit default swap — the Justice Department ends up leaning heavily on the SEC's army of 1,100 number-crunching investigators to make their cases. In theory, it's a well-oiled, tag-team affair: Billionaire Wall Street Asshole commits fraud, the NYSE catches on and tips off the SEC, the SEC works the case and delivers it to Justice, and Justice perp-walks the Asshole out of Nobu, into a Crown Victoria and off to 36 months of push-ups, license-plate making and Salisbury steak.
That's the way it's supposed to work. But a veritable mountain of evidence indicates that when it comes to Wall Street, the justice system not only sucks at punishing financial criminals, it has actually evolved into a highly effective mechanism for protecting financial criminals. This institutional reality has absolutely nothing to do with politics or ideology — it takes place no matter who's in office or which party's in power. To understand how the machinery functions, you have to start back at least a decade ago, as case after case of financial malfeasance was pursued too slowly or not at all, fumbled by a government bureaucracy that too often is on a first-name basis with its targets.
Indeed, the shocking pattern of nonenforcement with regard to Wall Street is so deeply ingrained in Washington that it raises a profound and difficult question about the very nature of our society: whether we have created a class of people whose misdeeds are no longer perceived as crimes, almost no matter what those misdeeds are. The SEC and the Justice Department have evolved into a bizarre species of social surgeon serving this nonjailable class, expert not at administering punishment and justice, but at finding and removing criminal responsibility from the bodies of the accused.
The systematic lack of regulation has left even the country's top regulators frustrated. Lynn Turner, a former chief accountant for the SEC, laughs darkly at the idea that the criminal justice system is broken when it comes to Wall Street. "I think you've got a wrong assumption — that we even have a law-enforcement agency when it comes to Wall Street," he says.
In the hierarchy of the SEC, the chief accountant plays a major role in working to pursue misleading and phony financial disclosures. Turner held the post a decade ago, when one of the most significant cases was swallowed up by the SEC bureaucracy. In the late 1990s, the agency had an open-and-shut case against the Rite Aid drugstore chain, which was using diabolical accounting tricks to cook their books. But instead of moving swiftly to crack down on such scams, the SEC shoved the case into the "deal with it later" file. "The Philadelphia office literally did nothing with the case for a year," Turner recalls. "Very much like the New York office with Madoff."
The Rite Aid case dragged on for years — and by the time it was finished, similar accounting fiascoes at Enron and WorldCom had exploded into a full-blown financial crisis. The same was true for another SEC case that presaged the Enron disaster. The agency knew that appliance-maker Sunbeam was using the same kind of accounting scams to systematically hide losses from its investors. But in the end, the SEC's punishment for Sunbeam's CEO, Al "Chainsaw" Dunlap — widely regarded as one of the biggest assholes in the history of American finance — was a fine of $500,000. Dunlap's net worth at the time was an estimated $100 million. The SEC also barred Dunlap from ever running a public company again — forcing him to retire with a mere $99.5 million. Dunlap passed the time collecting royalties from his self-congratulatory memoir. Its title: Mean Business.
The pattern of inaction toward shady deals on Wall Street grew worse and worse after Turner left, with one slam-dunk case after another either languishing for years or disappearing altogether. Perhaps the most notorious example involved Gary Aguirre, an SEC investigator who was literally fired after he questioned the agency's failure to pursue an insider-trading case against John Mack, now the chairman of Morgan Stanley and one of America's most powerful bankers.
Aguirre joined the SEC in September 2004. Two days into his career as a financial investigator, he was asked to look into an insider-trading complaint against a hedge-fund megastar named Art Samberg. One day, with no advance research or discussion, Samberg had suddenly started buying up huge quantities of shares in a firm called Heller Financial. "It was as if Art Samberg woke up one morning and a voice from the heavens told him to start buying Heller," Aguirre recalls. "And he wasn't just buying shares — there were some days when he was trying to buy three times as many shares as were being traded that day." A few weeks later, Heller was bought by General Electric — and Samberg pocketed $18 million.
After some digging, Aguirre found himself focusing on one suspect as the likely source who had tipped Samberg off: John Mack, a close friend of Samberg's who had just stepped down as president of Morgan Stanley. At the time, Mack had been on Samberg's case to cut him into a deal involving a spinoff of the tech company Lucent — an investment that stood to make Mack a lot of money. "Mack is busting my chops" to give him a piece of the action, Samberg told an employee in an e-mail.
A week later, Mack flew to Switzerland to interview for a top job at Credit Suisse First Boston. Among the investment bank's clients, as it happened, was a firm called Heller Financial. We don't know for sure what Mack learned on his Swiss trip; years later, Mack would claim that he had thrown away his notes about the meetings. But we do know that as soon as Mack returned from the trip, on a Friday, he called up his buddy Samberg. The very next morning, Mack was cut into the Lucent deal — a favor that netted him more than $10 million. And as soon as the market reopened after the weekend, Samberg started buying every Heller share in sight, right before it was snapped up by GE — a suspiciously timed move that earned him the equivalent of Derek Jeter's annual salary for just a few minutes of work.
The deal looked like a classic case of insider trading. But in the summer of 2005, when Aguirre told his boss he planned to interview Mack, things started getting weird. His boss told him the case wasn't likely to fly, explaining that Mack had "powerful political connections." (The investment banker had been a fundraising "Ranger" for George Bush in 2004, and would go on to be a key backer of Hillary Clinton in 2008.)
Aguirre also started to feel pressure from Morgan Stanley, which was in the process of trying to rehire Mack as CEO. At first, Aguirre was contacted by the bank's regulatory liaison, Eric Dinallo, a former top aide to Eliot Spitzer. But it didn't take long for Morgan Stanley to work its way up the SEC chain of command. Within three days, another of the firm's lawyers, Mary Jo White, was on the phone with the SEC's director of enforcement. In a shocking move that was later singled out by Senate investigators, the director actually appeared to reassure White, dismissing the case against Mack as "smoke" rather than "fire." White, incidentally, was herself the former U.S. attorney of the Southern District of New York — one of the top cops on Wall Street.
Pause for a minute to take this in. Aguirre, an SEC foot soldier, is trying to interview a major Wall Street executive — not handcuff the guy or impound his yacht, mind you, just talk to him. In the course of doing so, he finds out that his target's firm is being represented not only by Eliot Spitzer's former top aide, but by the former U.S. attorney overseeing Wall Street, who is going four levels over his head to speak directly to the chief of the SEC's enforcement division — not Aguirre's boss, but his boss's boss's boss's boss. Mack himself, meanwhile, was being represented by Gary Lynch, a former SEC director of enforcement.
Aguirre didn't stand a chance. A month after he complained to his supervisors that he was being blocked from interviewing Mack, he was summarily fired, without notice. The case against Mack was immediately dropped: all depositions canceled, no further subpoenas issued. "It all happened so fast, I needed a seat belt," recalls Aguirre, who had just received a stellar performance review from his bosses. The SEC eventually paid Aguirre a settlement of $755,000 for wrongful dismissal.
Rather than going after Mack, the SEC started looking for someone else to blame for tipping off Samberg. (It was, Aguirre quips, "O.J.'s search for the real killers.") It wasn't until a year later that the agency finally got around to interviewing Mack, who denied any wrongdoing. The four-hour deposition took place on August 1st, 2006 — just days after the five-year statute of limitations on insider trading had expired in the case.
"At best, the picture shows extraordinarily lax enforcement by the SEC," Senate investigators would later conclude. "At worse, the picture is colored with overtones of a possible cover-up."
Episodes like this help explain why so many Wall Street executives felt emboldened to push the regulatory envelope during the mid-2000s. Over and over, even the most obvious cases of fraud and insider dealing got gummed up in the works, and high-ranking executives were almost never prosecuted for their crimes. In 2003, Freddie Mac coughed up $125 million after it was caught misreporting its earnings by $5 billion; nobody went to jail. In 2006, Fannie Mae was fined $400 million, but executives who had overseen phony accounting techniques to jack up their bonuses faced no criminal charges. That same year, AIG paid $1.6 billion after it was caught in a major accounting scandal that would indirectly lead to its collapse two years later, but no executives at the insurance giant were prosecuted.
All of this behavior set the stage for the crash of 2008, when Wall Street exploded in a raging Dresden of fraud and criminality. Yet the SEC and the Justice Department have shown almost no inclination to prosecute those most responsible for the catastrophe — even though they had insiders from the two firms whose implosions triggered the crisis, Lehman Brothers and AIG, who were more than willing to supply evidence against top executives.
In the case of Lehman Brothers, the SEC had a chance six months before the crash to move against Dick Fuld, a man recently named the worst CEO of all time by Portfolio magazine. A decade before the crash, a Lehman lawyer named Oliver Budde was going through the bank's proxy statements and noticed that it was using a loophole involving Restricted Stock Units to hide tens of millions of dollars of Fuld's compensation. Budde told his bosses that Lehman's use of RSUs was dicey at best, but they blew him off. "We're sorry about your concerns," they told him, "but we're doing it." Disturbed by such shady practices, the lawyer quit the firm in 2006.
Then, only a few months after Budde left Lehman, the SEC changed its rules to force companies to disclose exactly how much compensation in RSUs executives had coming to them. "The SEC was basically like, 'We're sick and tired of you people fucking around — we want a picture of what you're holding,'" Budde says. But instead of coming clean about eight separate RSUs that Fuld had hidden from investors, Lehman filed a proxy statement that was a masterpiece of cynical lawyering. On one page, a chart indicated that Fuld had been awarded $146 million in RSUs. But two pages later, a note in the fine print essentially stated that the chart did not contain the real number — which, it failed to mention, was actually $263 million more than the chart indicated. "They fucked around even more than they did before," Budde says. (The law firm that helped craft the fine print, Simpson Thacher & Bartlett, would later receive a lucrative federal contract to serve as legal adviser to the TARP bailout.)
Budde decided to come forward. In April 2008, he wrote a detailed memo to the SEC about Lehman's history of hidden stocks. Shortly thereafter, he got a letter back that began, "Dear Sir or Madam." It was an automated e-response.
"They blew me off," Budde says.
Over the course of that summer, Budde tried to contact the SEC several more times, and was ignored each time. Finally, in the fateful week of September 15th, 2008, when Lehman Brothers cracked under the weight of its reckless bets on the subprime market and went into its final death spiral, Budde became seriously concerned. If the government tried to arrange for Lehman to be pawned off on another Wall Street firm, as it had done with Bear Stearns, the U.S. taxpayer might wind up footing the bill for a company with hundreds of millions of dollars in concealed compensation. So Budde again called the SEC, right in the middle of the crisis. "Look," he told regulators. "I gave you huge stuff. You really want to take a look at this."
But the feds once again blew him off. A young staff attorney contacted Budde, who once more provided the SEC with copies of all his memos. He never heard from the agency again.
"This was like a mini-Madoff," Budde says. "They had six solid months of warnings. They could have done something."
Three weeks later, Budde was shocked to see Fuld testifying before the House Government Oversight Committee and whining about how poor he was. "I got no severance, no golden parachute," Fuld moaned. When Rep. Henry Waxman, the committee's chairman, mentioned that he thought Fuld had earned more than $480 million, Fuld corrected him and said he believed it was only $310 million.
The true number, Budde calculated, was $529 million. He contacted a Senate investigator to talk about how Fuld had misled Congress, but he never got any response. Meanwhile, in a demonstration of the government's priorities, the Justice Department is proceeding full force with a prosecution of retired baseball player Roger Clemens for lying to Congress about getting a shot of steroids in his ass. "At least Roger didn't screw over the world," Budde says, shaking his head.
Fuld has denied any wrongdoing, but his hidden compensation was only a ripple in Lehman's raging tsunami of misdeeds. The investment bank used an absurd accounting trick called "Repo 105" transactions to conceal $50 billion in loans on the firm's balance sheet. (That's $50 billion, not million.) But more than a year after the use of the Repo 105s came to light, there have still been no indictments in the affair. While it's possible that charges may yet be filed, there are now rumors that the SEC and the Justice Department may take no action against Lehman. If that's true, and there's no prosecution in a case where there's such overwhelming evidence — and where the company is already dead, meaning it can't dump further losses on investors or taxpayers — then it might be time to assume the game is up. Failing to prosecute Fuld and Lehman would be tantamount to the state marching into Wall Street and waving the green flag on a new stealing season.
The most amazing noncase in the entire crash — the one that truly defies the most basic notion of justice when it comes to Wall Street supervillains — is the one involving AIG and Joe Cassano, the nebbishy Patient Zero of the financial crisis. As chief of AIGFP, the firm's financial products subsidiary, Cassano repeatedly made public statements in 2007 claiming that his portfolio of mortgage derivatives would suffer "no dollar of loss" — an almost comically obvious misrepresentation. "God couldn't manage a $60 billion real estate portfolio without a single dollar of loss," says Turner, the agency's former chief accountant. "If the SEC can't make a disclosure case against AIG, then they might as well close up shop."
As in the Lehman case, federal prosecutors not only had plenty of evidence against AIG — they also had an eyewitness to Cassano's actions who was prepared to tell all. As an accountant at AIGFP, Joseph St. Denis had a number of run-ins with Cassano during the summer of 2007. At the time, Cassano had already made nearly $500 billion worth of derivative bets that would ultimately blow up, destroy the world's largest insurance company, and trigger the largest government bailout of a single company in U.S. history. He made many fatal mistakes, but chief among them was engaging in contracts that required AIG to post billions of dollars in collateral if there was any downgrade to its credit rating.
St. Denis didn't know about those clauses in Cassano's contracts, since they had been written before he joined the firm. What he did know was that Cassano freaked out when St. Denis spoke with an accountant at the parent company, which was only just finding out about the time bomb Cassano had set. After St. Denis finished a conference call with the executive, Cassano suddenly burst into the room and began screaming at him for talking to the New York office. He then announced that St. Denis had been "deliberately excluded" from any valuations of the most toxic elements of the derivatives portfolio — thus preventing the accountant from doing his job. What St. Denis represented was transparency — and the last thing Cassano needed was transparency.
Another clue that something was amiss with AIGFP's portfolio came when Goldman Sachs demanded that the firm pay billions in collateral, per the terms of Cassano's deadly contracts. Such "collateral calls" happen all the time on Wall Street, but seldom against a seemingly solvent and friendly business partner like AIG. And when they do happen, they are rarely paid without a fight. So St. Denis was shocked when AIGFP agreed to fork over gobs of money to Goldman Sachs, even while it was still contesting the payments — an indication that something was seriously wrong at AIG. "When I found out about the collateral call, I literally had to sit down," St. Denis recalls. "I had to go home for the day."
After Cassano barred him from valuating the derivative deals, St. Denis had no choice but to resign. He got another job, and thought he was done with AIG. But a few months later, he learned that Cassano had held a conference call with investors in December 2007. During the call, AIGFP failed to disclose that it had posted $2 billion to Goldman Sachs following the collateral calls.
"Investors therefore did not know," the Financial Crisis Inquiry Commission would later conclude, "that AIG's earnings were overstated by $3.6 billion."
"I remember thinking, 'Wow, they're just not telling people,'" St. Denis says. "I knew. I had been there. I knew they'd posted collateral."
A year later, after the crash, St. Denis wrote a letter about his experiences to the House Government Oversight Committee, which was looking into the AIG collapse. He also met with investigators for the government, which was preparing a criminal case against Cassano. But the case never went to court. Last May, the Justice Department confirmed that it would not file charges against executives at AIGFP. Cassano, who has denied any wrongdoing, was reportedly told he was no longer a target.
Shortly after that, Cassano strolled into Washington to testify before the Financial Crisis Inquiry Commission. It was his first public appearance since the crash. He has not had to pay back a single cent out of the hundreds of millions of dollars he earned selling his insane pseudo-insurance policies on subprime mortgage deals. Now, out from under prosecution, he appeared before the FCIC and had the enormous balls to compliment his own business acumen, saying his atom-bomb swaps portfolio was, in retrospect, not that badly constructed. "I think the portfolios are withstanding the test of time," he said.
"They offered him an excellent opportunity to redeem himself," St. Denis jokes.
In the end, of course, it wasn't just the executives of Lehman and AIGFP who got passes. Virtually every one of the major players on Wall Street was similarly embroiled in scandal, yet their executives skated off into the sunset, uncharged and unfined. Goldman Sachs paid $550 million last year when it was caught defrauding investors with crappy mortgages, but no executive has been fined or jailed — not even Fabrice "Fabulous Fab" Tourre, Goldman's outrageous Euro-douche who gleefully e-mailed a pal about the "surreal" transactions in the middle of a meeting with the firm's victims. In a similar case, a sales executive at the German powerhouse Deutsche Bank got off on charges of insider trading; its general counsel at the time of the questionable deals, Robert Khuzami, now serves as director of enforcement for the SEC.
Another major firm, Bank of America, was caught hiding $5.8 billion in bonuses from shareholders as part of its takeover of Merrill Lynch. The SEC tried to let the bank off with a settlement of only $33 million, but Judge Jed Rakoff rejected the action as a "facade of enforcement." So the SEC quintupled the settlement — but it didn't require either Merrill or Bank of America to admit to wrongdoing. Unlike criminal trials, in which the facts of the crime are put on record for all to see, these Wall Street settlements almost never require the banks to make any factual disclosures, effectively burying the stories forever. "All this is done at the expense not only of the shareholders, but also of the truth," says Rakoff. Goldman, Deutsche, Merrill, Lehman, Bank of America ... who did we leave out? Oh, there's Citigroup, nailed for hiding some $40 billion in liabilities from investors. Last July, the SEC settled with Citi for $75 million. In a rare move, it also fined two Citi executives, former CFO Gary Crittenden and investor-relations chief Arthur Tildesley Jr. Their penalties, combined, came to a whopping $180,000.
Throughout the entire crisis, in fact, the government has taken exactly one serious swing of the bat against executives from a major bank, charging two guys from Bear Stearns with criminal fraud over a pair of toxic subprime hedge funds that blew up in 2007, destroying the company and robbing investors of $1.6 billion. Jurors had an e-mail between the defendants admitting that "there is simply no way for us to make money — ever" just three days before assuring investors that "there's no basis for thinking this is one big disaster." Yet the case still somehow ended in acquittal — and the Justice Department hasn't taken any of the big banks to court since.
All of which raises an obvious question: Why the hell not?
Gary Aguirre, the SEC investigator who lost his job when he drew the ire of Morgan Stanley, thinks he knows the answer.
Last year, Aguirre noticed that a conference on financial law enforcement was scheduled to be held at the Hilton in New York on November 12th. The list of attendees included 1,500 or so of the country's leading lawyers who represent Wall Street, as well as some of the government's top cops from both the SEC and the Justice Department.
Criminal justice, as it pertains to the Goldmans and Morgan Stanleys of the world, is not adversarial combat, with cops and crooks duking it out in interrogation rooms and courthouses. Instead, it's a cocktail party between friends and colleagues who from month to month and year to year are constantly switching sides and trading hats. At the Hilton conference, regulators and banker-lawyers rubbed elbows during a series of speeches and panel discussions, away from the rabble. "They were chummier in that environment," says Aguirre, who plunked down $2,200 to attend the conference.
Aguirre saw a lot of familiar faces at the conference, for a simple reason: Many of the SEC regulators he had worked with during his failed attempt to investigate John Mack had made a million-dollar pass through the Revolving Door, going to work for the very same firms they used to police. Aguirre didn't see Paul Berger, an associate director of enforcement who had rebuffed his attempts to interview Mack — maybe because Berger was tied up at his lucrative new job at Debevoise & Plimpton, the same law firm that Morgan Stanley employed to intervene in the Mack case. But he did see Mary Jo White, the former U.S. attorney, who was still at Debevoise & Plimpton. He also saw Linda Thomsen, the former SEC director of enforcement who had been so helpful to White. Thomsen had gone on to represent Wall Street as a partner at the prestigious firm of Davis Polk & Wardwell.
Two of the government's top cops were there as well: Preet Bharara, the U.S. attorney for the Southern District of New York, and Robert Khuzami, the SEC's current director of enforcement. Bharara had been recommended for his post by Chuck Schumer, Wall Street's favorite senator. And both he and Khuzami had served with Mary Jo White at the U.S. attorney's office, before Mary Jo went on to become a partner at Debevoise. What's more, when Khuzami had served as general counsel for Deutsche Bank, he had been hired by none other than Dick Walker, who had been enforcement director at the SEC when it slow-rolled the pivotal fraud case against Rite Aid.
"It wasn't just one rotation of the revolving door," says Aguirre. "It just kept spinning. Every single person had rotated in and out of government and private service."
The Revolving Door isn't just a footnote in financial law enforcement; over the past decade, more than a dozen high-ranking SEC officials have gone on to lucrative jobs at Wall Street banks or white-shoe law firms, where partnerships are worth millions. That makes SEC officials like Paul Berger and Linda Thomsen the equivalent of college basketball stars waiting for their first NBA contract. Are you really going to give up a shot at the Knicks or the Lakers just to find out whether a Wall Street big shot like John Mack was guilty of insider trading? "You take one of these jobs," says Turner, the former chief accountant for the SEC, "and you're fit for life."
Fit — and happy. The banter between the speakers at the New York conference says everything you need to know about the level of chumminess and mutual admiration that exists between these supposed adversaries of the justice system. At one point in the conference, Mary Jo White introduced Bharara, her old pal from the U.S. attorney's office.
"I want to first say how pleased I am to be here," Bharara responded. Then, addressing White, he added, "You've spawned all of us. It's almost 11 years ago to the day that Mary Jo White called me and asked me if I would become an assistant U.S. attorney. So thank you, Dr. Frankenstein."
Next, addressing the crowd of high-priced lawyers from Wall Street, Bharara made an interesting joke. "I also want to take a moment to applaud the entire staff of the SEC for the really amazing things they have done over the past year," he said. "They've done a real service to the country, to the financial community, and not to mention a lot of your law practices."
Haw! The line drew snickers from the conference of millionaire lawyers. But the real fireworks came when Khuzami, the SEC's director of enforcement, talked about a new "cooperation initiative" the agency had recently unveiled, in which executives are being offered incentives to report fraud they have witnessed or committed. From now on, Khuzami said, when corporate lawyers like the ones he was addressing want to know if their Wall Street clients are going to be charged by the Justice Department before deciding whether to come forward, all they have to do is ask the SEC.
"We are going to try to get those individuals answers," Khuzami announced, as to "whether or not there is criminal interest in the case — so that defense counsel can have as much information as possible in deciding whether or not to choose to sign up their client."
Aguirre, listening in the crowd, couldn't believe Khuzami's brazenness. The SEC's enforcement director was saying, in essence, that firms like Goldman Sachs and AIG and Lehman Brothers will henceforth be able to get the SEC to act as a middleman between them and the Justice Department, negotiating fines as a way out of jail time. Khuzami was basically outlining a four-step system for banks and their executives to buy their way out of prison. "First, the SEC and Wall Street player make an agreement on a fine that the player will pay to the SEC," Aguirre says. "Then the Justice Department commits itself to pass, so that the player knows he's 'safe.' Third, the player pays the SEC — and fourth, the player gets a pass from the Justice Department."
When I ask a former federal prosecutor about the propriety of a sitting SEC director of enforcement talking out loud about helping corporate defendants "get answers" regarding the status of their criminal cases, he initially doesn't believe it. Then I send him a transcript of the comment. "I am very, very surprised by Khuzami's statement, which does seem to me to be contrary to past practice — and not a good thing," the former prosecutor says.
Earlier this month, when Sen. Chuck Grassley found out about Khuzami's comments, he sent the SEC a letter noting that the agency's own enforcement manual not only prohibits such "answer getting," it even bars the SEC from giving defendants the Justice Department's phone number. "Should counsel or the individual ask which criminal authorities they should contact," the manual reads, "staff should decline to answer, unless authorized by the relevant criminal authorities." Both the SEC and the Justice Department deny there is anything improper in their new policy of cooperation. "We collaborate with the SEC, but they do not consult with us when they resolve their cases," Assistant Attorney General Lanny Breuer assured Congress in January. "They do that independently."
Around the same time that Breuer was testifying, however, a story broke that prior to the pathetically small settlement of $75 million that the SEC had arranged with Citigroup, Khuzami had ordered his staff to pursue lighter charges against the megabank's executives. According to a letter that was sent to Sen. Grassley's office, Khuzami had a "secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend" of his and "who was counsel for the company." The unsigned letter, which appears to have come from an SEC investigator on the case, prompted the inspector general to launch an investigation into the charge.
All of this paints a disturbing picture of a closed and corrupt system, a timeless circle of friends that virtually guarantees a collegial approach to the policing of high finance. Even before the corruption starts, the state is crippled by economic reality: Since law enforcement on Wall Street requires serious intellectual firepower, the banks seize a huge advantage from the start by hiring away the top talent. Budde, the former Lehman lawyer, says it's well known that all the best legal minds go to the big corporate law firms, while the "bottom 20 percent go to the SEC." Which makes it tough for the agency to track devious legal machinations, like the scheme to hide $263 million of Dick Fuld's compensation.
"It's such a mismatch, it's not even funny," Budde says.
But even beyond that, the system is skewed by the irrepressible pull of riches and power. If talent rises in the SEC or the Justice Department, it sooner or later jumps ship for those fat NBA contracts. Or, conversely, graduates of the big corporate firms take sabbaticals from their rich lifestyles to slum it in government service for a year or two. Many of those appointments are inevitably hand-picked by lifelong stooges for Wall Street like Chuck Schumer, who has accepted $14.6 million in campaign contributions from Goldman Sachs, Morgan Stanley and other major players in the finance industry, along with their corporate lawyers.
As for President Obama, what is there to be said? Goldman Sachs was his number-one private campaign contributor. He put a Citigroup executive in charge of his economic transition team, and he just named an executive of JP Morgan Chase, the proud owner of $7.7 million in Chase stock, his new chief of staff. "The betrayal that this represents by Obama to everybody is just — we're not ready to believe it," says Budde, a classmate of the president from their Columbia days. "He's really fucking us over like that? Really? That's really a JP Morgan guy, really?"
Which is not to say that the Obama era has meant an end to law enforcement. On the contrary: In the past few years, the administration has allocated massive amounts of federal resources to catching wrongdoers — of a certain type. Last year, the government deported 393,000 people, at a cost of $5 billion. Since 2007, felony immigration prosecutions along the Mexican border have surged 77 percent; nonfelony prosecutions by 259 percent. In Ohio last month, a single mother was caught lying about where she lived to put her kids into a better school district; the judge in the case tried to sentence her to 10 days in jail for fraud, declaring that letting her go free would "demean the seriousness" of the offenses.
So there you have it. Illegal immigrants: 393,000. Lying moms: one. Bankers: zero. The math makes sense only because the politics are so obvious. You want to win elections, you bang on the jailable class. You build prisons and fill them with people for selling dime bags and stealing CD players. But for stealing a billion dollars? For fraud that puts a million people into foreclosure? Pass. It's not a crime. Prison is too harsh. Get them to say they're sorry, and move on. Oh, wait — let's not even make them say they're sorry. That's too mean; let's just give them a piece of paper with a government stamp on it, officially clearing them of the need to apologize, and make them pay a fine instead. But don't make them pay it out of their own pockets, and don't ask them to give back the money they stole. In fact, let them profit from their collective crimes, to the tune of a record $135 billion in pay and benefits last year. What's next? Taxpayer-funded massages for every Wall Street executive guilty of fraud?
The mental stumbling block, for most Americans, is that financial crimes don't feel real; you don't see the culprits waving guns in liquor stores or dragging coeds into bushes. But these frauds are worse than common robberies. They're crimes of intellectual choice, made by people who are already rich and who have every conceivable social advantage, acting on a simple, cynical calculation: Let's steal whatever we can, then dare the victims to find the juice to reclaim their money through a captive bureaucracy. They're attacking the very definition of property — which, after all, depends in part on a legal system that defends everyone's claims of ownership equally. When that definition becomes tenuous or conditional — when the state simply gives up on the notion of justice — this whole American Dream thing recedes even further from reality.
This article appears in the March 3, 2011 issue of Rolling Stone. The issue is available now on newsstands and will appear in the online archive February 18.
By Matt Taibbi
February 17, 2011 "Rolling Stone" -- Over drinks at a bar on a dreary, snowy night in Washington this past month, a former Senate investigator laughed as he polished off his beer.
"Everything's fucked up, and nobody goes to jail," he said. "That's your whole story right there. Hell, you don't even have to write the rest of it. Just write that."
I put down my notebook. "Just that?"
"That's right," he said, signaling to the waitress for the check. "Everything's fucked up, and nobody goes to jail. You can end the piece right there."
Nobody goes to jail. This is the mantra of the financial-crisis era, one that saw virtually every major bank and financial company on Wall Street embroiled in obscene criminal scandals that impoverished millions and collectively destroyed hundreds of billions, in fact, trillions of dollars of the world's wealth — and nobody went to jail. Nobody, that is, except Bernie Madoff, a flamboyant and pathological celebrity con artist, whose victims happened to be other rich and famous people.
The rest of them, all of them, got off. Not a single executive who ran the companies that cooked up and cashed in on the phony financial boom — an industrywide scam that involved the mass sale of mismarked, fraudulent mortgage-backed securities — has ever been convicted. Their names by now are familiar to even the most casual Middle American news consumer: companies like AIG, Goldman Sachs, Lehman Brothers, JP Morgan Chase, Bank of America and Morgan Stanley. Most of these firms were directly involved in elaborate fraud and theft. Lehman Brothers hid billions in loans from its investors. Bank of America lied about billions in bonuses.
Goldman Sachs failed to tell clients how it put together the born-to-lose toxic mortgage deals it was selling. What's more, many of these companies had corporate chieftains whose actions cost investors billions — from AIG derivatives chief Joe Cassano, who assured investors they would not lose even "one dollar" just months before his unit imploded, to the $263 million in compensation that former Lehman chief Dick "The Gorilla" Fuld conveniently failed to disclose. Yet not one of them has faced time behind bars.
Instead, federal regulators and prosecutors have let the banks and finance companies that tried to burn the world economy to the ground get off with carefully orchestrated settlements — whitewash jobs that involve the firms paying pathetically small fines without even being required to admit wrongdoing. To add insult to injury, the people who actually committed the crimes almost never pay the fines themselves; banks caught defrauding their shareholders often use shareholder money to foot the tab of justice. "If the allegations in these settlements are true," says Jed Rakoff, a federal judge in the Southern District of New York, "it's management buying its way off cheap, from the pockets of their victims."
To understand the significance of this, one has to think carefully about the efficacy of fines as a punishment for a defendant pool that includes the richest people on earth — people who simply get their companies to pay their fines for them. Conversely, one has to consider the powerful deterrent to further wrongdoing that the state is missing by not introducing this particular class of people to the experience of incarceration. "You put Lloyd Blankfein in pound-me-in-the-ass prison for one six-month term, and all this bullshit would stop, all over Wall Street," says a former congressional aide. "That's all it would take. Just once."
But that hasn't happened. Because the entire system set up to monitor and regulate Wall Street is fucked up.
Just ask the people who tried to do the right thing.
Here's how regulation of Wall Street is supposed to work. To begin with, there's a semigigantic list of public and quasi-public agencies ostensibly keeping their eyes on the economy, a dense alphabet soup of banking, insurance, S&L, securities and commodities regulators like the Federal Reserve, the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency (OCC) and the Commodity Futures Trading Commission (CFTC), as well as supposedly "self-regulating organizations" like the New York Stock Exchange. All of these outfits, by law, can at least begin the process of catching and investigating financial criminals, though none of them has prosecutorial power.
The major federal agency on the Wall Street beat is the Securities and Exchange Commission. The SEC watches for violations like insider trading, and also deals with so-called "disclosure violations" — i.e., making sure that all the financial information that publicly traded companies are required to make public actually jibes with reality.
But the SEC doesn't have prosecutorial power either, so in practice, when it looks like someone needs to go to jail, they refer the case to the Justice Department. And since the vast majority of crimes in the financial services industry take place in Lower Manhattan, cases referred by the SEC often end up in the U.S. Attorney's Office for the Southern District of New York. Thus, the two top cops on Wall Street are generally considered to be that U.S. attorney — a job that has been held by thunderous prosecutorial personae like Robert Morgenthau and Rudy Giuliani — and the SEC's director of enforcement.
The relationship between the SEC and the DOJ is necessarily close, even symbiotic. Since financial crime-fighting requires a high degree of financial expertise — and since the typical drug-and-terrorism-obsessed FBI agent can't balance his own checkbook, let alone tell a synthetic CDO from a credit default swap — the Justice Department ends up leaning heavily on the SEC's army of 1,100 number-crunching investigators to make their cases. In theory, it's a well-oiled, tag-team affair: Billionaire Wall Street Asshole commits fraud, the NYSE catches on and tips off the SEC, the SEC works the case and delivers it to Justice, and Justice perp-walks the Asshole out of Nobu, into a Crown Victoria and off to 36 months of push-ups, license-plate making and Salisbury steak.
That's the way it's supposed to work. But a veritable mountain of evidence indicates that when it comes to Wall Street, the justice system not only sucks at punishing financial criminals, it has actually evolved into a highly effective mechanism for protecting financial criminals. This institutional reality has absolutely nothing to do with politics or ideology — it takes place no matter who's in office or which party's in power. To understand how the machinery functions, you have to start back at least a decade ago, as case after case of financial malfeasance was pursued too slowly or not at all, fumbled by a government bureaucracy that too often is on a first-name basis with its targets.
Indeed, the shocking pattern of nonenforcement with regard to Wall Street is so deeply ingrained in Washington that it raises a profound and difficult question about the very nature of our society: whether we have created a class of people whose misdeeds are no longer perceived as crimes, almost no matter what those misdeeds are. The SEC and the Justice Department have evolved into a bizarre species of social surgeon serving this nonjailable class, expert not at administering punishment and justice, but at finding and removing criminal responsibility from the bodies of the accused.
The systematic lack of regulation has left even the country's top regulators frustrated. Lynn Turner, a former chief accountant for the SEC, laughs darkly at the idea that the criminal justice system is broken when it comes to Wall Street. "I think you've got a wrong assumption — that we even have a law-enforcement agency when it comes to Wall Street," he says.
In the hierarchy of the SEC, the chief accountant plays a major role in working to pursue misleading and phony financial disclosures. Turner held the post a decade ago, when one of the most significant cases was swallowed up by the SEC bureaucracy. In the late 1990s, the agency had an open-and-shut case against the Rite Aid drugstore chain, which was using diabolical accounting tricks to cook their books. But instead of moving swiftly to crack down on such scams, the SEC shoved the case into the "deal with it later" file. "The Philadelphia office literally did nothing with the case for a year," Turner recalls. "Very much like the New York office with Madoff."
The Rite Aid case dragged on for years — and by the time it was finished, similar accounting fiascoes at Enron and WorldCom had exploded into a full-blown financial crisis. The same was true for another SEC case that presaged the Enron disaster. The agency knew that appliance-maker Sunbeam was using the same kind of accounting scams to systematically hide losses from its investors. But in the end, the SEC's punishment for Sunbeam's CEO, Al "Chainsaw" Dunlap — widely regarded as one of the biggest assholes in the history of American finance — was a fine of $500,000. Dunlap's net worth at the time was an estimated $100 million. The SEC also barred Dunlap from ever running a public company again — forcing him to retire with a mere $99.5 million. Dunlap passed the time collecting royalties from his self-congratulatory memoir. Its title: Mean Business.
The pattern of inaction toward shady deals on Wall Street grew worse and worse after Turner left, with one slam-dunk case after another either languishing for years or disappearing altogether. Perhaps the most notorious example involved Gary Aguirre, an SEC investigator who was literally fired after he questioned the agency's failure to pursue an insider-trading case against John Mack, now the chairman of Morgan Stanley and one of America's most powerful bankers.
Aguirre joined the SEC in September 2004. Two days into his career as a financial investigator, he was asked to look into an insider-trading complaint against a hedge-fund megastar named Art Samberg. One day, with no advance research or discussion, Samberg had suddenly started buying up huge quantities of shares in a firm called Heller Financial. "It was as if Art Samberg woke up one morning and a voice from the heavens told him to start buying Heller," Aguirre recalls. "And he wasn't just buying shares — there were some days when he was trying to buy three times as many shares as were being traded that day." A few weeks later, Heller was bought by General Electric — and Samberg pocketed $18 million.
After some digging, Aguirre found himself focusing on one suspect as the likely source who had tipped Samberg off: John Mack, a close friend of Samberg's who had just stepped down as president of Morgan Stanley. At the time, Mack had been on Samberg's case to cut him into a deal involving a spinoff of the tech company Lucent — an investment that stood to make Mack a lot of money. "Mack is busting my chops" to give him a piece of the action, Samberg told an employee in an e-mail.
A week later, Mack flew to Switzerland to interview for a top job at Credit Suisse First Boston. Among the investment bank's clients, as it happened, was a firm called Heller Financial. We don't know for sure what Mack learned on his Swiss trip; years later, Mack would claim that he had thrown away his notes about the meetings. But we do know that as soon as Mack returned from the trip, on a Friday, he called up his buddy Samberg. The very next morning, Mack was cut into the Lucent deal — a favor that netted him more than $10 million. And as soon as the market reopened after the weekend, Samberg started buying every Heller share in sight, right before it was snapped up by GE — a suspiciously timed move that earned him the equivalent of Derek Jeter's annual salary for just a few minutes of work.
The deal looked like a classic case of insider trading. But in the summer of 2005, when Aguirre told his boss he planned to interview Mack, things started getting weird. His boss told him the case wasn't likely to fly, explaining that Mack had "powerful political connections." (The investment banker had been a fundraising "Ranger" for George Bush in 2004, and would go on to be a key backer of Hillary Clinton in 2008.)
Aguirre also started to feel pressure from Morgan Stanley, which was in the process of trying to rehire Mack as CEO. At first, Aguirre was contacted by the bank's regulatory liaison, Eric Dinallo, a former top aide to Eliot Spitzer. But it didn't take long for Morgan Stanley to work its way up the SEC chain of command. Within three days, another of the firm's lawyers, Mary Jo White, was on the phone with the SEC's director of enforcement. In a shocking move that was later singled out by Senate investigators, the director actually appeared to reassure White, dismissing the case against Mack as "smoke" rather than "fire." White, incidentally, was herself the former U.S. attorney of the Southern District of New York — one of the top cops on Wall Street.
Pause for a minute to take this in. Aguirre, an SEC foot soldier, is trying to interview a major Wall Street executive — not handcuff the guy or impound his yacht, mind you, just talk to him. In the course of doing so, he finds out that his target's firm is being represented not only by Eliot Spitzer's former top aide, but by the former U.S. attorney overseeing Wall Street, who is going four levels over his head to speak directly to the chief of the SEC's enforcement division — not Aguirre's boss, but his boss's boss's boss's boss. Mack himself, meanwhile, was being represented by Gary Lynch, a former SEC director of enforcement.
Aguirre didn't stand a chance. A month after he complained to his supervisors that he was being blocked from interviewing Mack, he was summarily fired, without notice. The case against Mack was immediately dropped: all depositions canceled, no further subpoenas issued. "It all happened so fast, I needed a seat belt," recalls Aguirre, who had just received a stellar performance review from his bosses. The SEC eventually paid Aguirre a settlement of $755,000 for wrongful dismissal.
Rather than going after Mack, the SEC started looking for someone else to blame for tipping off Samberg. (It was, Aguirre quips, "O.J.'s search for the real killers.") It wasn't until a year later that the agency finally got around to interviewing Mack, who denied any wrongdoing. The four-hour deposition took place on August 1st, 2006 — just days after the five-year statute of limitations on insider trading had expired in the case.
"At best, the picture shows extraordinarily lax enforcement by the SEC," Senate investigators would later conclude. "At worse, the picture is colored with overtones of a possible cover-up."
Episodes like this help explain why so many Wall Street executives felt emboldened to push the regulatory envelope during the mid-2000s. Over and over, even the most obvious cases of fraud and insider dealing got gummed up in the works, and high-ranking executives were almost never prosecuted for their crimes. In 2003, Freddie Mac coughed up $125 million after it was caught misreporting its earnings by $5 billion; nobody went to jail. In 2006, Fannie Mae was fined $400 million, but executives who had overseen phony accounting techniques to jack up their bonuses faced no criminal charges. That same year, AIG paid $1.6 billion after it was caught in a major accounting scandal that would indirectly lead to its collapse two years later, but no executives at the insurance giant were prosecuted.
All of this behavior set the stage for the crash of 2008, when Wall Street exploded in a raging Dresden of fraud and criminality. Yet the SEC and the Justice Department have shown almost no inclination to prosecute those most responsible for the catastrophe — even though they had insiders from the two firms whose implosions triggered the crisis, Lehman Brothers and AIG, who were more than willing to supply evidence against top executives.
In the case of Lehman Brothers, the SEC had a chance six months before the crash to move against Dick Fuld, a man recently named the worst CEO of all time by Portfolio magazine. A decade before the crash, a Lehman lawyer named Oliver Budde was going through the bank's proxy statements and noticed that it was using a loophole involving Restricted Stock Units to hide tens of millions of dollars of Fuld's compensation. Budde told his bosses that Lehman's use of RSUs was dicey at best, but they blew him off. "We're sorry about your concerns," they told him, "but we're doing it." Disturbed by such shady practices, the lawyer quit the firm in 2006.
Then, only a few months after Budde left Lehman, the SEC changed its rules to force companies to disclose exactly how much compensation in RSUs executives had coming to them. "The SEC was basically like, 'We're sick and tired of you people fucking around — we want a picture of what you're holding,'" Budde says. But instead of coming clean about eight separate RSUs that Fuld had hidden from investors, Lehman filed a proxy statement that was a masterpiece of cynical lawyering. On one page, a chart indicated that Fuld had been awarded $146 million in RSUs. But two pages later, a note in the fine print essentially stated that the chart did not contain the real number — which, it failed to mention, was actually $263 million more than the chart indicated. "They fucked around even more than they did before," Budde says. (The law firm that helped craft the fine print, Simpson Thacher & Bartlett, would later receive a lucrative federal contract to serve as legal adviser to the TARP bailout.)
Budde decided to come forward. In April 2008, he wrote a detailed memo to the SEC about Lehman's history of hidden stocks. Shortly thereafter, he got a letter back that began, "Dear Sir or Madam." It was an automated e-response.
"They blew me off," Budde says.
Over the course of that summer, Budde tried to contact the SEC several more times, and was ignored each time. Finally, in the fateful week of September 15th, 2008, when Lehman Brothers cracked under the weight of its reckless bets on the subprime market and went into its final death spiral, Budde became seriously concerned. If the government tried to arrange for Lehman to be pawned off on another Wall Street firm, as it had done with Bear Stearns, the U.S. taxpayer might wind up footing the bill for a company with hundreds of millions of dollars in concealed compensation. So Budde again called the SEC, right in the middle of the crisis. "Look," he told regulators. "I gave you huge stuff. You really want to take a look at this."
But the feds once again blew him off. A young staff attorney contacted Budde, who once more provided the SEC with copies of all his memos. He never heard from the agency again.
"This was like a mini-Madoff," Budde says. "They had six solid months of warnings. They could have done something."
Three weeks later, Budde was shocked to see Fuld testifying before the House Government Oversight Committee and whining about how poor he was. "I got no severance, no golden parachute," Fuld moaned. When Rep. Henry Waxman, the committee's chairman, mentioned that he thought Fuld had earned more than $480 million, Fuld corrected him and said he believed it was only $310 million.
The true number, Budde calculated, was $529 million. He contacted a Senate investigator to talk about how Fuld had misled Congress, but he never got any response. Meanwhile, in a demonstration of the government's priorities, the Justice Department is proceeding full force with a prosecution of retired baseball player Roger Clemens for lying to Congress about getting a shot of steroids in his ass. "At least Roger didn't screw over the world," Budde says, shaking his head.
Fuld has denied any wrongdoing, but his hidden compensation was only a ripple in Lehman's raging tsunami of misdeeds. The investment bank used an absurd accounting trick called "Repo 105" transactions to conceal $50 billion in loans on the firm's balance sheet. (That's $50 billion, not million.) But more than a year after the use of the Repo 105s came to light, there have still been no indictments in the affair. While it's possible that charges may yet be filed, there are now rumors that the SEC and the Justice Department may take no action against Lehman. If that's true, and there's no prosecution in a case where there's such overwhelming evidence — and where the company is already dead, meaning it can't dump further losses on investors or taxpayers — then it might be time to assume the game is up. Failing to prosecute Fuld and Lehman would be tantamount to the state marching into Wall Street and waving the green flag on a new stealing season.
The most amazing noncase in the entire crash — the one that truly defies the most basic notion of justice when it comes to Wall Street supervillains — is the one involving AIG and Joe Cassano, the nebbishy Patient Zero of the financial crisis. As chief of AIGFP, the firm's financial products subsidiary, Cassano repeatedly made public statements in 2007 claiming that his portfolio of mortgage derivatives would suffer "no dollar of loss" — an almost comically obvious misrepresentation. "God couldn't manage a $60 billion real estate portfolio without a single dollar of loss," says Turner, the agency's former chief accountant. "If the SEC can't make a disclosure case against AIG, then they might as well close up shop."
As in the Lehman case, federal prosecutors not only had plenty of evidence against AIG — they also had an eyewitness to Cassano's actions who was prepared to tell all. As an accountant at AIGFP, Joseph St. Denis had a number of run-ins with Cassano during the summer of 2007. At the time, Cassano had already made nearly $500 billion worth of derivative bets that would ultimately blow up, destroy the world's largest insurance company, and trigger the largest government bailout of a single company in U.S. history. He made many fatal mistakes, but chief among them was engaging in contracts that required AIG to post billions of dollars in collateral if there was any downgrade to its credit rating.
St. Denis didn't know about those clauses in Cassano's contracts, since they had been written before he joined the firm. What he did know was that Cassano freaked out when St. Denis spoke with an accountant at the parent company, which was only just finding out about the time bomb Cassano had set. After St. Denis finished a conference call with the executive, Cassano suddenly burst into the room and began screaming at him for talking to the New York office. He then announced that St. Denis had been "deliberately excluded" from any valuations of the most toxic elements of the derivatives portfolio — thus preventing the accountant from doing his job. What St. Denis represented was transparency — and the last thing Cassano needed was transparency.
Another clue that something was amiss with AIGFP's portfolio came when Goldman Sachs demanded that the firm pay billions in collateral, per the terms of Cassano's deadly contracts. Such "collateral calls" happen all the time on Wall Street, but seldom against a seemingly solvent and friendly business partner like AIG. And when they do happen, they are rarely paid without a fight. So St. Denis was shocked when AIGFP agreed to fork over gobs of money to Goldman Sachs, even while it was still contesting the payments — an indication that something was seriously wrong at AIG. "When I found out about the collateral call, I literally had to sit down," St. Denis recalls. "I had to go home for the day."
After Cassano barred him from valuating the derivative deals, St. Denis had no choice but to resign. He got another job, and thought he was done with AIG. But a few months later, he learned that Cassano had held a conference call with investors in December 2007. During the call, AIGFP failed to disclose that it had posted $2 billion to Goldman Sachs following the collateral calls.
"Investors therefore did not know," the Financial Crisis Inquiry Commission would later conclude, "that AIG's earnings were overstated by $3.6 billion."
"I remember thinking, 'Wow, they're just not telling people,'" St. Denis says. "I knew. I had been there. I knew they'd posted collateral."
A year later, after the crash, St. Denis wrote a letter about his experiences to the House Government Oversight Committee, which was looking into the AIG collapse. He also met with investigators for the government, which was preparing a criminal case against Cassano. But the case never went to court. Last May, the Justice Department confirmed that it would not file charges against executives at AIGFP. Cassano, who has denied any wrongdoing, was reportedly told he was no longer a target.
Shortly after that, Cassano strolled into Washington to testify before the Financial Crisis Inquiry Commission. It was his first public appearance since the crash. He has not had to pay back a single cent out of the hundreds of millions of dollars he earned selling his insane pseudo-insurance policies on subprime mortgage deals. Now, out from under prosecution, he appeared before the FCIC and had the enormous balls to compliment his own business acumen, saying his atom-bomb swaps portfolio was, in retrospect, not that badly constructed. "I think the portfolios are withstanding the test of time," he said.
"They offered him an excellent opportunity to redeem himself," St. Denis jokes.
In the end, of course, it wasn't just the executives of Lehman and AIGFP who got passes. Virtually every one of the major players on Wall Street was similarly embroiled in scandal, yet their executives skated off into the sunset, uncharged and unfined. Goldman Sachs paid $550 million last year when it was caught defrauding investors with crappy mortgages, but no executive has been fined or jailed — not even Fabrice "Fabulous Fab" Tourre, Goldman's outrageous Euro-douche who gleefully e-mailed a pal about the "surreal" transactions in the middle of a meeting with the firm's victims. In a similar case, a sales executive at the German powerhouse Deutsche Bank got off on charges of insider trading; its general counsel at the time of the questionable deals, Robert Khuzami, now serves as director of enforcement for the SEC.
Another major firm, Bank of America, was caught hiding $5.8 billion in bonuses from shareholders as part of its takeover of Merrill Lynch. The SEC tried to let the bank off with a settlement of only $33 million, but Judge Jed Rakoff rejected the action as a "facade of enforcement." So the SEC quintupled the settlement — but it didn't require either Merrill or Bank of America to admit to wrongdoing. Unlike criminal trials, in which the facts of the crime are put on record for all to see, these Wall Street settlements almost never require the banks to make any factual disclosures, effectively burying the stories forever. "All this is done at the expense not only of the shareholders, but also of the truth," says Rakoff. Goldman, Deutsche, Merrill, Lehman, Bank of America ... who did we leave out? Oh, there's Citigroup, nailed for hiding some $40 billion in liabilities from investors. Last July, the SEC settled with Citi for $75 million. In a rare move, it also fined two Citi executives, former CFO Gary Crittenden and investor-relations chief Arthur Tildesley Jr. Their penalties, combined, came to a whopping $180,000.
Throughout the entire crisis, in fact, the government has taken exactly one serious swing of the bat against executives from a major bank, charging two guys from Bear Stearns with criminal fraud over a pair of toxic subprime hedge funds that blew up in 2007, destroying the company and robbing investors of $1.6 billion. Jurors had an e-mail between the defendants admitting that "there is simply no way for us to make money — ever" just three days before assuring investors that "there's no basis for thinking this is one big disaster." Yet the case still somehow ended in acquittal — and the Justice Department hasn't taken any of the big banks to court since.
All of which raises an obvious question: Why the hell not?
Gary Aguirre, the SEC investigator who lost his job when he drew the ire of Morgan Stanley, thinks he knows the answer.
Last year, Aguirre noticed that a conference on financial law enforcement was scheduled to be held at the Hilton in New York on November 12th. The list of attendees included 1,500 or so of the country's leading lawyers who represent Wall Street, as well as some of the government's top cops from both the SEC and the Justice Department.
Criminal justice, as it pertains to the Goldmans and Morgan Stanleys of the world, is not adversarial combat, with cops and crooks duking it out in interrogation rooms and courthouses. Instead, it's a cocktail party between friends and colleagues who from month to month and year to year are constantly switching sides and trading hats. At the Hilton conference, regulators and banker-lawyers rubbed elbows during a series of speeches and panel discussions, away from the rabble. "They were chummier in that environment," says Aguirre, who plunked down $2,200 to attend the conference.
Aguirre saw a lot of familiar faces at the conference, for a simple reason: Many of the SEC regulators he had worked with during his failed attempt to investigate John Mack had made a million-dollar pass through the Revolving Door, going to work for the very same firms they used to police. Aguirre didn't see Paul Berger, an associate director of enforcement who had rebuffed his attempts to interview Mack — maybe because Berger was tied up at his lucrative new job at Debevoise & Plimpton, the same law firm that Morgan Stanley employed to intervene in the Mack case. But he did see Mary Jo White, the former U.S. attorney, who was still at Debevoise & Plimpton. He also saw Linda Thomsen, the former SEC director of enforcement who had been so helpful to White. Thomsen had gone on to represent Wall Street as a partner at the prestigious firm of Davis Polk & Wardwell.
Two of the government's top cops were there as well: Preet Bharara, the U.S. attorney for the Southern District of New York, and Robert Khuzami, the SEC's current director of enforcement. Bharara had been recommended for his post by Chuck Schumer, Wall Street's favorite senator. And both he and Khuzami had served with Mary Jo White at the U.S. attorney's office, before Mary Jo went on to become a partner at Debevoise. What's more, when Khuzami had served as general counsel for Deutsche Bank, he had been hired by none other than Dick Walker, who had been enforcement director at the SEC when it slow-rolled the pivotal fraud case against Rite Aid.
"It wasn't just one rotation of the revolving door," says Aguirre. "It just kept spinning. Every single person had rotated in and out of government and private service."
The Revolving Door isn't just a footnote in financial law enforcement; over the past decade, more than a dozen high-ranking SEC officials have gone on to lucrative jobs at Wall Street banks or white-shoe law firms, where partnerships are worth millions. That makes SEC officials like Paul Berger and Linda Thomsen the equivalent of college basketball stars waiting for their first NBA contract. Are you really going to give up a shot at the Knicks or the Lakers just to find out whether a Wall Street big shot like John Mack was guilty of insider trading? "You take one of these jobs," says Turner, the former chief accountant for the SEC, "and you're fit for life."
Fit — and happy. The banter between the speakers at the New York conference says everything you need to know about the level of chumminess and mutual admiration that exists between these supposed adversaries of the justice system. At one point in the conference, Mary Jo White introduced Bharara, her old pal from the U.S. attorney's office.
"I want to first say how pleased I am to be here," Bharara responded. Then, addressing White, he added, "You've spawned all of us. It's almost 11 years ago to the day that Mary Jo White called me and asked me if I would become an assistant U.S. attorney. So thank you, Dr. Frankenstein."
Next, addressing the crowd of high-priced lawyers from Wall Street, Bharara made an interesting joke. "I also want to take a moment to applaud the entire staff of the SEC for the really amazing things they have done over the past year," he said. "They've done a real service to the country, to the financial community, and not to mention a lot of your law practices."
Haw! The line drew snickers from the conference of millionaire lawyers. But the real fireworks came when Khuzami, the SEC's director of enforcement, talked about a new "cooperation initiative" the agency had recently unveiled, in which executives are being offered incentives to report fraud they have witnessed or committed. From now on, Khuzami said, when corporate lawyers like the ones he was addressing want to know if their Wall Street clients are going to be charged by the Justice Department before deciding whether to come forward, all they have to do is ask the SEC.
"We are going to try to get those individuals answers," Khuzami announced, as to "whether or not there is criminal interest in the case — so that defense counsel can have as much information as possible in deciding whether or not to choose to sign up their client."
Aguirre, listening in the crowd, couldn't believe Khuzami's brazenness. The SEC's enforcement director was saying, in essence, that firms like Goldman Sachs and AIG and Lehman Brothers will henceforth be able to get the SEC to act as a middleman between them and the Justice Department, negotiating fines as a way out of jail time. Khuzami was basically outlining a four-step system for banks and their executives to buy their way out of prison. "First, the SEC and Wall Street player make an agreement on a fine that the player will pay to the SEC," Aguirre says. "Then the Justice Department commits itself to pass, so that the player knows he's 'safe.' Third, the player pays the SEC — and fourth, the player gets a pass from the Justice Department."
When I ask a former federal prosecutor about the propriety of a sitting SEC director of enforcement talking out loud about helping corporate defendants "get answers" regarding the status of their criminal cases, he initially doesn't believe it. Then I send him a transcript of the comment. "I am very, very surprised by Khuzami's statement, which does seem to me to be contrary to past practice — and not a good thing," the former prosecutor says.
Earlier this month, when Sen. Chuck Grassley found out about Khuzami's comments, he sent the SEC a letter noting that the agency's own enforcement manual not only prohibits such "answer getting," it even bars the SEC from giving defendants the Justice Department's phone number. "Should counsel or the individual ask which criminal authorities they should contact," the manual reads, "staff should decline to answer, unless authorized by the relevant criminal authorities." Both the SEC and the Justice Department deny there is anything improper in their new policy of cooperation. "We collaborate with the SEC, but they do not consult with us when they resolve their cases," Assistant Attorney General Lanny Breuer assured Congress in January. "They do that independently."
Around the same time that Breuer was testifying, however, a story broke that prior to the pathetically small settlement of $75 million that the SEC had arranged with Citigroup, Khuzami had ordered his staff to pursue lighter charges against the megabank's executives. According to a letter that was sent to Sen. Grassley's office, Khuzami had a "secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend" of his and "who was counsel for the company." The unsigned letter, which appears to have come from an SEC investigator on the case, prompted the inspector general to launch an investigation into the charge.
All of this paints a disturbing picture of a closed and corrupt system, a timeless circle of friends that virtually guarantees a collegial approach to the policing of high finance. Even before the corruption starts, the state is crippled by economic reality: Since law enforcement on Wall Street requires serious intellectual firepower, the banks seize a huge advantage from the start by hiring away the top talent. Budde, the former Lehman lawyer, says it's well known that all the best legal minds go to the big corporate law firms, while the "bottom 20 percent go to the SEC." Which makes it tough for the agency to track devious legal machinations, like the scheme to hide $263 million of Dick Fuld's compensation.
"It's such a mismatch, it's not even funny," Budde says.
But even beyond that, the system is skewed by the irrepressible pull of riches and power. If talent rises in the SEC or the Justice Department, it sooner or later jumps ship for those fat NBA contracts. Or, conversely, graduates of the big corporate firms take sabbaticals from their rich lifestyles to slum it in government service for a year or two. Many of those appointments are inevitably hand-picked by lifelong stooges for Wall Street like Chuck Schumer, who has accepted $14.6 million in campaign contributions from Goldman Sachs, Morgan Stanley and other major players in the finance industry, along with their corporate lawyers.
As for President Obama, what is there to be said? Goldman Sachs was his number-one private campaign contributor. He put a Citigroup executive in charge of his economic transition team, and he just named an executive of JP Morgan Chase, the proud owner of $7.7 million in Chase stock, his new chief of staff. "The betrayal that this represents by Obama to everybody is just — we're not ready to believe it," says Budde, a classmate of the president from their Columbia days. "He's really fucking us over like that? Really? That's really a JP Morgan guy, really?"
Which is not to say that the Obama era has meant an end to law enforcement. On the contrary: In the past few years, the administration has allocated massive amounts of federal resources to catching wrongdoers — of a certain type. Last year, the government deported 393,000 people, at a cost of $5 billion. Since 2007, felony immigration prosecutions along the Mexican border have surged 77 percent; nonfelony prosecutions by 259 percent. In Ohio last month, a single mother was caught lying about where she lived to put her kids into a better school district; the judge in the case tried to sentence her to 10 days in jail for fraud, declaring that letting her go free would "demean the seriousness" of the offenses.
So there you have it. Illegal immigrants: 393,000. Lying moms: one. Bankers: zero. The math makes sense only because the politics are so obvious. You want to win elections, you bang on the jailable class. You build prisons and fill them with people for selling dime bags and stealing CD players. But for stealing a billion dollars? For fraud that puts a million people into foreclosure? Pass. It's not a crime. Prison is too harsh. Get them to say they're sorry, and move on. Oh, wait — let's not even make them say they're sorry. That's too mean; let's just give them a piece of paper with a government stamp on it, officially clearing them of the need to apologize, and make them pay a fine instead. But don't make them pay it out of their own pockets, and don't ask them to give back the money they stole. In fact, let them profit from their collective crimes, to the tune of a record $135 billion in pay and benefits last year. What's next? Taxpayer-funded massages for every Wall Street executive guilty of fraud?
The mental stumbling block, for most Americans, is that financial crimes don't feel real; you don't see the culprits waving guns in liquor stores or dragging coeds into bushes. But these frauds are worse than common robberies. They're crimes of intellectual choice, made by people who are already rich and who have every conceivable social advantage, acting on a simple, cynical calculation: Let's steal whatever we can, then dare the victims to find the juice to reclaim their money through a captive bureaucracy. They're attacking the very definition of property — which, after all, depends in part on a legal system that defends everyone's claims of ownership equally. When that definition becomes tenuous or conditional — when the state simply gives up on the notion of justice — this whole American Dream thing recedes even further from reality.
This article appears in the March 3, 2011 issue of Rolling Stone. The issue is available now on newsstands and will appear in the online archive February 18.
Friday, December 24, 2010
Financial Crisis: Professor Bill Black, "Everywhere you Look you Find Massive Financial Fraud"
Professor Black Says:
--So far, no arrests, no prosecutions, no convictions have occurred in the wake of the Financial Crisis, in contrast to over 1000 convictions in the Savings and Loan debacle of the 1980's.
--The FBI and justice department can't be successful at bringing fraud cases unless the regulators do their jobs which they're not doing. They have submitted zero criminal referrals this decade.
--There has been a total coverup in this crisis, a death of regulation including the sham bank stress-tests.
--Everywhere you look you find massive fraud and millions of liars loans.
--There has been a really severe recession in the past 2 years which has reduced demand by almost 6 trillion dollars.
--The actual losses in this financial crisis have never been disclosed. The crooks are all still in place.
--The accounting rules via the Financial Accouting Standards Board (FASB) have been changed to help hide the debt and to allow the continued paying of exhorbitant bonuses to Bank executives.
--Citizens should demand that the government end Systemically Dangerous Institutions (SDI's) also known as too big to fail institutions and insist on accurate accounting standards!
_____________________________________
Professor Michael Hudson on The Faux "Recovery" and the End of Capitalism
Professor Hudson Says:
--The post-industrial economy is nothing more than a return to Neo-Feudalism.
--The Federal Reserve is a sham. There is no reason the government of the United States should have to pay interest to a quasi-private body in order to print more money. The US Treasury should do so directly thereby eliminating the need to pay interest to the Fed which could be abolished or subsumed under the Treasury Department.
--Since the beginning of the Financial Crisis, the national debt has virtually tripled from roughly 5 trillion to 15 trillion dollars. In order to service the new debt, taxes will have to be increased markedly in order to avoid default.
Friday, December 4, 2009
How Free-Market Delusions Destroyed the Economy
By Raj Patel
December 01, 2009 "Information Clearing House" -- If war is God’s way of teaching Americans geography, recession is His way of teaching everyone a little economics. The great unwinding of the financial sector showed that the smartest mathematical minds on the planet, backed by some of the deepest pockets, had not built a sleek engine of permanent prosperity but a clown car of trades, swaps and double dares that, inevitably, fell to bits. The recession has not come from a deficit of economic knowledge, but from too much of a particular kind, a surfeit of the spirit of capitalism. The dazzle of free markets has blinded us to other ways of seeing the world. As Oscar Wilde wrote over a century ago: "Nowadays people know the price of everything and the value of nothing." Prices have revealed themselves as fickle guides: The 2008 financial collapse came in the same year as crises in food and oil, and yet we seem unable to see or value our world except through the faulty prism of markets.
One thing is clear: The thinking that got us into this mess is unlikely to rescue us. It might come as some consolation to know that even some of the most respected minds have been forced to puzzle over their faulty assumptions. Perhaps the most pained admission of ignorance happened in a crowded room in front of the House Committee on Oversight and Government Reform when, on October 23, 2008, Alan Greenspan described the failure of his worldview.
Greenspan was one of the acknowledged legislators of the world’s economy over the past nineteen years in his role as chairman of the Federal Reserve. A card-carrying member of the free market brigade, he used to sit at the feet of Ayn Rand who, although largely unknown outside the United States, remains influential long after her death in 1982. Her 1957 book Atlas Shrugged, in which heroic business moguls fight the scourge of government officials and union organizers, has once again scaled the bestseller lists. Regarding altruism as “moral cannibalism," Rand was the cheerleader for an extreme free market libertarian school of thought, which she called “Objectivism."
Drawn into her circle by this heady philosophy, Greenspan earned himself the nickname “the Undertaker" for his jolly demeanor and dress sense. When Greenspan chose a career in government, it was rather like a hippie joining the marines, a lapse that his former friends could never forgive. Despite this, Greenspan remained largely faithful to Rand's philosophy, continuing to believe that egoism would lead to the best of all possible worlds, and that any form of restraint would result in disaster.
At the end of 2008, Greenspan was summoned to the U.S. Congress to testify about the financial crisis. His tenure at the Fed had been long and lauded, and Congress wanted to know what had gone wrong. As he began to read his testimony, Greenspan looked exhausted, his skin jowly and sagging, as if the vigor that once kept him taut had all been spent. But he came out swinging. In the first round, he took aim at the information he’d been working with. If only the input had been right, the economic models would have worked, and the predictions would have been better. In his words, a Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.
Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.
This is a garbage-in-garbage-out argument: The model worked just fine, but the assumptions about risk and data, based only on the good times past, were faulty and so the output was correspondingly wrong. Greenspan’s nemesis on the panel, Henry Waxman, pushed him to a deeper conclusion, in this remarkable exchange:
Waxman: The question I have for you is, you had an ideology, you had a belief that free, competitive -- and this is your statement -- “I do have an ideology. My judgment is that free, competitive markets are by far the unrivalled way to organize economies. We have tried regulation, none meaningfully worked.” That was your quote. You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. And now our whole economy is paying the price. Do you feel that your ideology pushed you to make decisions that you wish you had not made?
Greenspan: Well, remember, though, what an ideology is. It’s a conceptual framework with [sic] the way people deal with reality. Everyone has one. You have to. To exist, you need an ideology. The question is, whether it is accurate or not. What I am saying to you is, yes, I found the flaw, I don’t know how significant or permanent it is, but I have been very distressed by that fact.
Waxman: You found a flaw?
Greenspan: I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.
Waxman: In other words, you found that your view of the world, your ideology, was not right, it was not working.
Greenspan: Precisely. That is precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.
The flaw, to be clear, wasn’t a minor one of shoddy data. Nor was it the bigger Black Swan problem that writers like Nassim Taleb discuss, a problem of failing to account for highly unlikely events that, should they happen, involve catastrophic consequences. Greenspan’s flaw was more fundamental still. It warped his view about how the world was organized, about the sociology of the market. And Greenspan is not alone. Larry Summers, the president’s senior economic advisor, has had to come to terms with a similar error -- his view that the market was inherently self-stabilizing has been "dealt a fatal blow." Hank Paulson, Bush’s Treasury Secretary, has shrugged his shoulders with similar resignation. Even Jim Cramer from CNBC’s "Mad Money" admitted defeat: "The only guy who really called this right was Karl Marx." One after the other, the celebrants of the free market are finding themselves, to use the language of the market, corrected.
The extent of Greenspan's admission has passed most of us by. If you trawl the oped pages of the financial press, you'll find plenty of analysis that fits Greenspan's first gambit, with pundits offering stories about how risk was incorrectly priced (which it was), how the lack of regulation allowed the panic to feed back into the financial system (which it has), how the incentive structures rewarded traders who were able to push financial risk far into the future (which they did) and how free market ideologues removed the sorts of circuit-breaking policies that might today have helped (and they did that too). But these are all it-could-have-been-fixed-if-we'd-planned-better responses. I am not sure that we're able to comprehend what Greenspan's admission might really mean for us. It would be too big a shock to have the fundamentals of policy in both government and the economy proved wrong, and to have nothing with which to replace them.
It's as if one day, you were to wake up and find yourself transformed into a cockroach. This is the premise of Franz Kafka's novella Metamorphosis. In the first sentence, a young salesman named Gregor Samsa wakes up, after a night of bad dreams, to find that he has turned into an enormous bug. Gregor Samsa's response is revealing, telling us a little bit more about ourselves than we'd like. For what does Samsa do when he discovers he's a bug? He doesn't scuttle from his room screaming, or ponder how this happened, or what his transformation means, and what he might become tomorrow. His response is essentially this: "Poor me! How am I going to keep my job?" Which is almost exactly how we've reacted to this economic crisis. While no one has yet woken up in the body of a bug, we have all found ourselves in a world turned upside down, where everything we were told was to our advantage has turned out to be its opposite. Greenspan's "flaw" has profound repercussions -- to understand it fully would mean a complete reappraisal of the way we conduct our lives. We would need not only a new way of mooring our expectations of our society and our economy, one based on richer assumptions about human nature, but also a different ideology governing the exchange of goods and services.
Prices do some heavy ideological lifting in Greenspan's world. They provide a way to see and know the collective wants and resources of our small planet. This is Friedrich Hayek's economic philosophy, in which prices are the tendrils through which wants and needs are communicated. Science fiction fans will already be familiar with what this looks like. In "The Matrix," liberated humans (and the programs who hunt them) can see the world in its raw form, as a digital rain of symbols and signs. This is the science fiction that governs economic fact. Data pelting down monitors is what the masters of the universe on the global financial exchanges stare at, their eyes darting from screen to screen, trying to see through the world and profit from it. In "The Matrix," the signs were a simulation of the real world, hiding more than they revealed. The trouble is that this unreliable digital ticker tape has now become a central prop in the drama of modern commerce.
Consider the fate of Volkswagen, which at the end of October 2008 managed briefly to become the world's most valuable corporation without having to sell a single vehicle. With the economy still in free fall, traders on stock market floors were taking a dim view of Volkswagen. They looked at their screens and concluded that, just like every other auto manufacturer, Volkswagen was heading for tough times. Imagine you're a trader who feels in your bones that the stock price can only fall. One way to cash your hunch in is to sell Volkswagen stock today, and buy it back when the price falls. Since you don't walk around with Volkswagen stock falling out of your pockets, you'll turn to someone who does, like an institutional investor. You borrow their stock, for a price, and promise to return all of it very soon. The institutional investor is happy because they make money from lending out the stock, which they will get back in one piece. You're happy because you can sell this stock, wait for the price to fall, buy it back and, with the profit, not only pay back the institutional investor, but make the next installment on your yacht in Monaco. This practice is called "shorting."
The trouble was that Volkswagen's rival, Porsche, had started quietly buying Volkswagen stock, aiming to secure 75 percent of the company. When the scale of Porsche's buying spree came to light, it became rapidly clear that there was little of the company left to trade. With Porsche sucking up all the shares, the price for Volkswagen didn't drop. Traders were selling borrowed stock to Porsche, and when Porsche announced its intentions to hold the stock, traders panicked. This led to a "short squeeze," a flocking of investors looking to cover the ill-conceived bets that they'd paid for with stock that they didn't own. They'd wagered that Volkswagen's price, like that of any other car company in a recession, would fall. When it became clear that even if Volkswagen wasn't doing well in the car market, its share price was nonetheless defying gravity, the speculators rushed to buy before the price went any higher.
Their combined purchases drove the price of shares up further. So high did the price rise that Volkswagen entered the DAX 30 index of the largest corporations on the German bourse. This triggered another buying spree, driven not by stock market gamblers, but by their polar opposites -- conservative institutional investors. Pension funds, for instance, invest with an eye to long-term returns; they prefer a slow and certain accumulation of wealth rather than risky bets. One way that they keep their portfolio on an even keel is to buy shares in nothing but blue chip corporations, ones that are guaranteed to be least susceptible to the shocks that stocks are heir to, ones that are in the top, say, thirty corporations traded in the open market. When Volkswagen joined the ranks of the DAX 30, a flock of institutional investors automatically wanted in. So they bought Volkswagen shares at what ever price they could find them. The result? The price per share went from 200 to 1,000 in a week--an increase in company value of 300 billion (244 billion; $386 billion). It made Volkswagen, briefly, bigger than ExxonMobil (with a book value of a mere $343 billion). And for this, the company didn't raise a finger.
In the end, the rules on the DAX were changed, the price settled down and, in 2009, Volkswagen bought Porsche. It is easy enough to tell this story as one where institutional investors got caught with their pants down, where there was imperfect information about the size of the market, where the rules of different short-run and long-run games tangled. But look more closely. Underwriting this version of the story is a conceptual structure that lies beneath every story of excess and crash. The very notion of a bubble relies on the premise that when the bubble pops, things return to a normal state, a situation of price reflecting value more accurately. This is the story told after every boom and bust, from the South Sea Bubble of 1720 to the housing catastrophe of 2008. There's a widely shared opinion that normality will ultimately return to the world economy--but it's a consensus view that rests on a story where bubbles are exceptions to the standard (and successful) procedures of market valuation. If those procedures themselves were flawed, as Greenspan suggests, then our faith in a gentle return to earth is misplaced, for there is and never has been any solid ground beneath our feet.
There is a discrepancy between the price of something and its value, one that economists cannot fix, because it's a problem inherent to the very idea of profit-driven prices. This gap is something about which we've got an uneasy and uncomfortable intuition. The uncertainty about prices is what makes the MasterCard ads amusing. You know how it goes -- green fees: $240; lessons: $50; golf club: $110; having fun: priceless. The deeper joke, though, is this: The price of something doesn't measure its value at all. This prickly intuition has become entertainment. An alien from another planet would find it strange that one of the most popular TV shows in dozens of countries is one that trades on the confusion around what something's worth: "The Price Is Right." In the show, the audience is presented with various consumer durables, and asked to guess the retail price of each. Crucially, you don't win by correctly guessing how useful something is or how much it costs to make -- prices are poor guides to use and true costs of production. You win by developing an intuitive sense of what corporations believe you're willing to pay.
In the world of fund management, the systematic confusion surrounding what something is worth has made some people very rich. Traders' salaries are linked to the returns above expected rates for the risk they take on, the so-called alpha that they contribute to the returns. Think of a bet on a coin flip, with odds of two to one. I bet $1 that I will hit heads, and every time I do, I get $2. In the long run, I'd expect a dollar bet with those odds to return a dollar because I'll come up heads about half the time. But if I'm returning $1.50 on the bet, I'm making magic happen. This magic gets turned back into coins that I get to keep, through bonuses and increased salary. This is a tough trick to pull off because there are only a handful of ways to create added value in fund management -- I can pick undervalued stocks that outperform expectations, I can nurture innovations that change the rules of the game, or I can create new bespoke assets that institutional investors might like.
So we would expect alpha to be rare, and it is, but driven by the desire to cash in, there were many who created fake alpha through bets that appeared to produce consistently good returns despite having a small built-in chance of catastrophic loss. If the expected value of this loss were factored in, the alpha would disappear. But the risks were ignored and bonuses flowed. The frat boys who ran the economy, and profited from its poor regulation, made billions. They were paid today for outcomes that they predicted would happen in the future, using a "mark to model" accounting practice that essentially allowed them to book today what they projected they'd earn tomorrow. This practice was justified on the grounds that "markets know best."
That markets should know best is a relatively recent article of faith, and it took a great deal of ideological and political work to make it part of governments' conventional wisdom. The idea that markets are smart found its apotheosis in the Efficient Markets Hypothesis, an idea first formulated by Eugene Fama, a Ph.D. student in the University of Chicago Business School in the 1960s. In the ideological foundations it provided for financiers, it was a mighty force -- think of it as Atlas Shrugged, but with more equations.
The hypothesis states that the price of a financial asset reflects everything that a market knows about its current and future prospects. This is different from saying that the price actually does reflect its future performance -- rather, the price reflects the current state of beliefs about the odds of that performance being good or bad. The price involves a bet. As we now know, the market's eye for odds is dangerously myopic, but the hypothesis explains why economists find the following joke funny:
Q: How many Chicago School economists does it take to change a lightbulb?
A: None. If the lightbulb needed changing, the market would have already done it.
The problem with the Efficient Markets Hypothesis is that it doesn't work. If it were true, then there'd be no incentive to invest in research because the market would, by magic, have beaten you to it. Economists Sanford Grossman and Joseph Stiglitz demonstrated this in 1980, and hundreds of subsequent studies have pointed out quite how unrealistic the hypothesis is, some of the most influential of which were written by Eugene Fama himself. Markets can behave irrationally -- investors can herd behind a stock, pushing its value up in ways entirely unrelated to the stock being traded. Despite ample economic evidence to suggest it was false, the idea of efficient markets ran riot through governments. Alan Greenspan was not the only person to find the hypothesis a convenient untruth.
By pushing regulators to behave as if the hypothesis were true, traders could make their titanic bets. For a while, the money rolled in. In the mid-1990s, the Financial Times felt able to launch a monthly supplement, titled "How to Spend It," to help its more affluent readers unburden themselves. The magic of the past decade's boom also touched the middle class, who were sucked into the bubble through houses that were turned from places of shelter into financial assets, and into grist for the mill of the financial sector. But ordinary homeowners couldn't muster the clout that banks could: Governments enabled the finance sector's binge by promising to be there to pick up the pieces, and they were as good as their word. When the financiers' bets broke the system, the profit that they made from these bad bets remained untouchable: The profit was privatized, but the risk was socialized. Their riches have cost the whole world dear, and yet in 2009 the top hedge fund managers have had their third best year on record. George Soros is, in his own words, "having a very good crisis," and staff at Goldman Sachs can look forward to the largest bonus payouts in the firm's 140-year history.
What this suggests is that the rhetoric of "free markets" camouflages activities that aren't about markets at all. Goldman Sachs employees are doing well because their firm turned some distinctly nonmarket tricks. Rolling Stone journalist Matt Taibbi has recently revealed, with characteristic verve, how Goldman Sachs has bought the U.S. government. In the Obama administration's economic team, Wall Street has a generation of finance-friendly appointees, from Treasury Secretary Tim Geithner, who arranged a historic $29 billion loan to persuade JPMorgan Chase to acquire Bear Stearns during his tenure as chair of the Federal Reserve Bank of New York; to Larry Summers, who earned $5.2 million by working one day a week for a couple of years in a large Wall Street hedge fund. Their new positions in the White House make them the Tarzans of the economic jungle. Wall Street has reason to be pleased. Goldman had invested heavily in AIG, the insurance giant whose financial products division had brought the 90-year-old giant to bankruptcy. With the 2008 AIG rescue, the $13 billion that Goldman invested was repaid at full face value. Investors in Chrysler, by contrast, stand to get 29 cents for every dollar they invested.
Anyone concerned with democracy should be worried that the seam between Wall Street and the government is almost invisible. At the very least, it raises serious reasons to doubt that the institutions that facilitated the crisis can clean up their mess. Nassim Taleb points to the absurdity here: "People who were driving a school bus (blindfolded) and crashed it should never be given a new bus." The problem is that because both our economy and to a larger extent our politicians aren't really subject to democratic control, the bus drivers are always going to be graduates of the same driving school.
Despite the ongoing hijack of government by Wall Street, a word that hasn't been heard in over a generation is being uttered by politicians: "regulation." It's true that Goldman Sachs and others are profiting handsomely from the collapse, but there is nonetheless a growing sense among politicians that the market may have been allowed too free a rein. Naomi Klein's devastating critique The Shock Doctrine demonstrates how disasters were turned into platforms for rabidly free market policies, and it's an analysis that explains the post-World War II era and today's ongoing financial plunder, from California to Wall Street to the City of London, very well. But there is a recognition among the public and some politicians that today's economic crisis is a failure of free market thinking, and not a warrant for more. In response to popular outcry, politicians around the world seem ready to discuss how to regulate and restrain the market. The question is, can they, and, if they can, in whose interests will this regulation work?
From its inception, the free market has spawned discontent, but rare are the moments when that discontent coalesces across society, when a sufficiently large group of people can trace their unhappiness to free market politics, and demand change. The New Deal in the United States and the postwar European welfare states were partly a result of a consortium of social forces pushing for new limits to markets, and a renegotiation of the relationship between individuals and society. What's new about this crisis is that it's pervasively global, and comes at the last moment at which we might prevent a global climate catastrophe.
December 01, 2009 "Information Clearing House" -- If war is God’s way of teaching Americans geography, recession is His way of teaching everyone a little economics. The great unwinding of the financial sector showed that the smartest mathematical minds on the planet, backed by some of the deepest pockets, had not built a sleek engine of permanent prosperity but a clown car of trades, swaps and double dares that, inevitably, fell to bits. The recession has not come from a deficit of economic knowledge, but from too much of a particular kind, a surfeit of the spirit of capitalism. The dazzle of free markets has blinded us to other ways of seeing the world. As Oscar Wilde wrote over a century ago: "Nowadays people know the price of everything and the value of nothing." Prices have revealed themselves as fickle guides: The 2008 financial collapse came in the same year as crises in food and oil, and yet we seem unable to see or value our world except through the faulty prism of markets.
One thing is clear: The thinking that got us into this mess is unlikely to rescue us. It might come as some consolation to know that even some of the most respected minds have been forced to puzzle over their faulty assumptions. Perhaps the most pained admission of ignorance happened in a crowded room in front of the House Committee on Oversight and Government Reform when, on October 23, 2008, Alan Greenspan described the failure of his worldview.
Greenspan was one of the acknowledged legislators of the world’s economy over the past nineteen years in his role as chairman of the Federal Reserve. A card-carrying member of the free market brigade, he used to sit at the feet of Ayn Rand who, although largely unknown outside the United States, remains influential long after her death in 1982. Her 1957 book Atlas Shrugged, in which heroic business moguls fight the scourge of government officials and union organizers, has once again scaled the bestseller lists. Regarding altruism as “moral cannibalism," Rand was the cheerleader for an extreme free market libertarian school of thought, which she called “Objectivism."
Drawn into her circle by this heady philosophy, Greenspan earned himself the nickname “the Undertaker" for his jolly demeanor and dress sense. When Greenspan chose a career in government, it was rather like a hippie joining the marines, a lapse that his former friends could never forgive. Despite this, Greenspan remained largely faithful to Rand's philosophy, continuing to believe that egoism would lead to the best of all possible worlds, and that any form of restraint would result in disaster.
At the end of 2008, Greenspan was summoned to the U.S. Congress to testify about the financial crisis. His tenure at the Fed had been long and lauded, and Congress wanted to know what had gone wrong. As he began to read his testimony, Greenspan looked exhausted, his skin jowly and sagging, as if the vigor that once kept him taut had all been spent. But he came out swinging. In the first round, he took aim at the information he’d been working with. If only the input had been right, the economic models would have worked, and the predictions would have been better. In his words, a Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria.
Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.
This is a garbage-in-garbage-out argument: The model worked just fine, but the assumptions about risk and data, based only on the good times past, were faulty and so the output was correspondingly wrong. Greenspan’s nemesis on the panel, Henry Waxman, pushed him to a deeper conclusion, in this remarkable exchange:
Waxman: The question I have for you is, you had an ideology, you had a belief that free, competitive -- and this is your statement -- “I do have an ideology. My judgment is that free, competitive markets are by far the unrivalled way to organize economies. We have tried regulation, none meaningfully worked.” That was your quote. You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. And now our whole economy is paying the price. Do you feel that your ideology pushed you to make decisions that you wish you had not made?
Greenspan: Well, remember, though, what an ideology is. It’s a conceptual framework with [sic] the way people deal with reality. Everyone has one. You have to. To exist, you need an ideology. The question is, whether it is accurate or not. What I am saying to you is, yes, I found the flaw, I don’t know how significant or permanent it is, but I have been very distressed by that fact.
Waxman: You found a flaw?
Greenspan: I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.
Waxman: In other words, you found that your view of the world, your ideology, was not right, it was not working.
Greenspan: Precisely. That is precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.
The flaw, to be clear, wasn’t a minor one of shoddy data. Nor was it the bigger Black Swan problem that writers like Nassim Taleb discuss, a problem of failing to account for highly unlikely events that, should they happen, involve catastrophic consequences. Greenspan’s flaw was more fundamental still. It warped his view about how the world was organized, about the sociology of the market. And Greenspan is not alone. Larry Summers, the president’s senior economic advisor, has had to come to terms with a similar error -- his view that the market was inherently self-stabilizing has been "dealt a fatal blow." Hank Paulson, Bush’s Treasury Secretary, has shrugged his shoulders with similar resignation. Even Jim Cramer from CNBC’s "Mad Money" admitted defeat: "The only guy who really called this right was Karl Marx." One after the other, the celebrants of the free market are finding themselves, to use the language of the market, corrected.
The extent of Greenspan's admission has passed most of us by. If you trawl the oped pages of the financial press, you'll find plenty of analysis that fits Greenspan's first gambit, with pundits offering stories about how risk was incorrectly priced (which it was), how the lack of regulation allowed the panic to feed back into the financial system (which it has), how the incentive structures rewarded traders who were able to push financial risk far into the future (which they did) and how free market ideologues removed the sorts of circuit-breaking policies that might today have helped (and they did that too). But these are all it-could-have-been-fixed-if-we'd-planned-better responses. I am not sure that we're able to comprehend what Greenspan's admission might really mean for us. It would be too big a shock to have the fundamentals of policy in both government and the economy proved wrong, and to have nothing with which to replace them.
It's as if one day, you were to wake up and find yourself transformed into a cockroach. This is the premise of Franz Kafka's novella Metamorphosis. In the first sentence, a young salesman named Gregor Samsa wakes up, after a night of bad dreams, to find that he has turned into an enormous bug. Gregor Samsa's response is revealing, telling us a little bit more about ourselves than we'd like. For what does Samsa do when he discovers he's a bug? He doesn't scuttle from his room screaming, or ponder how this happened, or what his transformation means, and what he might become tomorrow. His response is essentially this: "Poor me! How am I going to keep my job?" Which is almost exactly how we've reacted to this economic crisis. While no one has yet woken up in the body of a bug, we have all found ourselves in a world turned upside down, where everything we were told was to our advantage has turned out to be its opposite. Greenspan's "flaw" has profound repercussions -- to understand it fully would mean a complete reappraisal of the way we conduct our lives. We would need not only a new way of mooring our expectations of our society and our economy, one based on richer assumptions about human nature, but also a different ideology governing the exchange of goods and services.
Prices do some heavy ideological lifting in Greenspan's world. They provide a way to see and know the collective wants and resources of our small planet. This is Friedrich Hayek's economic philosophy, in which prices are the tendrils through which wants and needs are communicated. Science fiction fans will already be familiar with what this looks like. In "The Matrix," liberated humans (and the programs who hunt them) can see the world in its raw form, as a digital rain of symbols and signs. This is the science fiction that governs economic fact. Data pelting down monitors is what the masters of the universe on the global financial exchanges stare at, their eyes darting from screen to screen, trying to see through the world and profit from it. In "The Matrix," the signs were a simulation of the real world, hiding more than they revealed. The trouble is that this unreliable digital ticker tape has now become a central prop in the drama of modern commerce.
Consider the fate of Volkswagen, which at the end of October 2008 managed briefly to become the world's most valuable corporation without having to sell a single vehicle. With the economy still in free fall, traders on stock market floors were taking a dim view of Volkswagen. They looked at their screens and concluded that, just like every other auto manufacturer, Volkswagen was heading for tough times. Imagine you're a trader who feels in your bones that the stock price can only fall. One way to cash your hunch in is to sell Volkswagen stock today, and buy it back when the price falls. Since you don't walk around with Volkswagen stock falling out of your pockets, you'll turn to someone who does, like an institutional investor. You borrow their stock, for a price, and promise to return all of it very soon. The institutional investor is happy because they make money from lending out the stock, which they will get back in one piece. You're happy because you can sell this stock, wait for the price to fall, buy it back and, with the profit, not only pay back the institutional investor, but make the next installment on your yacht in Monaco. This practice is called "shorting."
The trouble was that Volkswagen's rival, Porsche, had started quietly buying Volkswagen stock, aiming to secure 75 percent of the company. When the scale of Porsche's buying spree came to light, it became rapidly clear that there was little of the company left to trade. With Porsche sucking up all the shares, the price for Volkswagen didn't drop. Traders were selling borrowed stock to Porsche, and when Porsche announced its intentions to hold the stock, traders panicked. This led to a "short squeeze," a flocking of investors looking to cover the ill-conceived bets that they'd paid for with stock that they didn't own. They'd wagered that Volkswagen's price, like that of any other car company in a recession, would fall. When it became clear that even if Volkswagen wasn't doing well in the car market, its share price was nonetheless defying gravity, the speculators rushed to buy before the price went any higher.
Their combined purchases drove the price of shares up further. So high did the price rise that Volkswagen entered the DAX 30 index of the largest corporations on the German bourse. This triggered another buying spree, driven not by stock market gamblers, but by their polar opposites -- conservative institutional investors. Pension funds, for instance, invest with an eye to long-term returns; they prefer a slow and certain accumulation of wealth rather than risky bets. One way that they keep their portfolio on an even keel is to buy shares in nothing but blue chip corporations, ones that are guaranteed to be least susceptible to the shocks that stocks are heir to, ones that are in the top, say, thirty corporations traded in the open market. When Volkswagen joined the ranks of the DAX 30, a flock of institutional investors automatically wanted in. So they bought Volkswagen shares at what ever price they could find them. The result? The price per share went from 200 to 1,000 in a week--an increase in company value of 300 billion (244 billion; $386 billion). It made Volkswagen, briefly, bigger than ExxonMobil (with a book value of a mere $343 billion). And for this, the company didn't raise a finger.
In the end, the rules on the DAX were changed, the price settled down and, in 2009, Volkswagen bought Porsche. It is easy enough to tell this story as one where institutional investors got caught with their pants down, where there was imperfect information about the size of the market, where the rules of different short-run and long-run games tangled. But look more closely. Underwriting this version of the story is a conceptual structure that lies beneath every story of excess and crash. The very notion of a bubble relies on the premise that when the bubble pops, things return to a normal state, a situation of price reflecting value more accurately. This is the story told after every boom and bust, from the South Sea Bubble of 1720 to the housing catastrophe of 2008. There's a widely shared opinion that normality will ultimately return to the world economy--but it's a consensus view that rests on a story where bubbles are exceptions to the standard (and successful) procedures of market valuation. If those procedures themselves were flawed, as Greenspan suggests, then our faith in a gentle return to earth is misplaced, for there is and never has been any solid ground beneath our feet.
There is a discrepancy between the price of something and its value, one that economists cannot fix, because it's a problem inherent to the very idea of profit-driven prices. This gap is something about which we've got an uneasy and uncomfortable intuition. The uncertainty about prices is what makes the MasterCard ads amusing. You know how it goes -- green fees: $240; lessons: $50; golf club: $110; having fun: priceless. The deeper joke, though, is this: The price of something doesn't measure its value at all. This prickly intuition has become entertainment. An alien from another planet would find it strange that one of the most popular TV shows in dozens of countries is one that trades on the confusion around what something's worth: "The Price Is Right." In the show, the audience is presented with various consumer durables, and asked to guess the retail price of each. Crucially, you don't win by correctly guessing how useful something is or how much it costs to make -- prices are poor guides to use and true costs of production. You win by developing an intuitive sense of what corporations believe you're willing to pay.
In the world of fund management, the systematic confusion surrounding what something is worth has made some people very rich. Traders' salaries are linked to the returns above expected rates for the risk they take on, the so-called alpha that they contribute to the returns. Think of a bet on a coin flip, with odds of two to one. I bet $1 that I will hit heads, and every time I do, I get $2. In the long run, I'd expect a dollar bet with those odds to return a dollar because I'll come up heads about half the time. But if I'm returning $1.50 on the bet, I'm making magic happen. This magic gets turned back into coins that I get to keep, through bonuses and increased salary. This is a tough trick to pull off because there are only a handful of ways to create added value in fund management -- I can pick undervalued stocks that outperform expectations, I can nurture innovations that change the rules of the game, or I can create new bespoke assets that institutional investors might like.
So we would expect alpha to be rare, and it is, but driven by the desire to cash in, there were many who created fake alpha through bets that appeared to produce consistently good returns despite having a small built-in chance of catastrophic loss. If the expected value of this loss were factored in, the alpha would disappear. But the risks were ignored and bonuses flowed. The frat boys who ran the economy, and profited from its poor regulation, made billions. They were paid today for outcomes that they predicted would happen in the future, using a "mark to model" accounting practice that essentially allowed them to book today what they projected they'd earn tomorrow. This practice was justified on the grounds that "markets know best."
That markets should know best is a relatively recent article of faith, and it took a great deal of ideological and political work to make it part of governments' conventional wisdom. The idea that markets are smart found its apotheosis in the Efficient Markets Hypothesis, an idea first formulated by Eugene Fama, a Ph.D. student in the University of Chicago Business School in the 1960s. In the ideological foundations it provided for financiers, it was a mighty force -- think of it as Atlas Shrugged, but with more equations.
The hypothesis states that the price of a financial asset reflects everything that a market knows about its current and future prospects. This is different from saying that the price actually does reflect its future performance -- rather, the price reflects the current state of beliefs about the odds of that performance being good or bad. The price involves a bet. As we now know, the market's eye for odds is dangerously myopic, but the hypothesis explains why economists find the following joke funny:
Q: How many Chicago School economists does it take to change a lightbulb?
A: None. If the lightbulb needed changing, the market would have already done it.
The problem with the Efficient Markets Hypothesis is that it doesn't work. If it were true, then there'd be no incentive to invest in research because the market would, by magic, have beaten you to it. Economists Sanford Grossman and Joseph Stiglitz demonstrated this in 1980, and hundreds of subsequent studies have pointed out quite how unrealistic the hypothesis is, some of the most influential of which were written by Eugene Fama himself. Markets can behave irrationally -- investors can herd behind a stock, pushing its value up in ways entirely unrelated to the stock being traded. Despite ample economic evidence to suggest it was false, the idea of efficient markets ran riot through governments. Alan Greenspan was not the only person to find the hypothesis a convenient untruth.
By pushing regulators to behave as if the hypothesis were true, traders could make their titanic bets. For a while, the money rolled in. In the mid-1990s, the Financial Times felt able to launch a monthly supplement, titled "How to Spend It," to help its more affluent readers unburden themselves. The magic of the past decade's boom also touched the middle class, who were sucked into the bubble through houses that were turned from places of shelter into financial assets, and into grist for the mill of the financial sector. But ordinary homeowners couldn't muster the clout that banks could: Governments enabled the finance sector's binge by promising to be there to pick up the pieces, and they were as good as their word. When the financiers' bets broke the system, the profit that they made from these bad bets remained untouchable: The profit was privatized, but the risk was socialized. Their riches have cost the whole world dear, and yet in 2009 the top hedge fund managers have had their third best year on record. George Soros is, in his own words, "having a very good crisis," and staff at Goldman Sachs can look forward to the largest bonus payouts in the firm's 140-year history.
What this suggests is that the rhetoric of "free markets" camouflages activities that aren't about markets at all. Goldman Sachs employees are doing well because their firm turned some distinctly nonmarket tricks. Rolling Stone journalist Matt Taibbi has recently revealed, with characteristic verve, how Goldman Sachs has bought the U.S. government. In the Obama administration's economic team, Wall Street has a generation of finance-friendly appointees, from Treasury Secretary Tim Geithner, who arranged a historic $29 billion loan to persuade JPMorgan Chase to acquire Bear Stearns during his tenure as chair of the Federal Reserve Bank of New York; to Larry Summers, who earned $5.2 million by working one day a week for a couple of years in a large Wall Street hedge fund. Their new positions in the White House make them the Tarzans of the economic jungle. Wall Street has reason to be pleased. Goldman had invested heavily in AIG, the insurance giant whose financial products division had brought the 90-year-old giant to bankruptcy. With the 2008 AIG rescue, the $13 billion that Goldman invested was repaid at full face value. Investors in Chrysler, by contrast, stand to get 29 cents for every dollar they invested.
Anyone concerned with democracy should be worried that the seam between Wall Street and the government is almost invisible. At the very least, it raises serious reasons to doubt that the institutions that facilitated the crisis can clean up their mess. Nassim Taleb points to the absurdity here: "People who were driving a school bus (blindfolded) and crashed it should never be given a new bus." The problem is that because both our economy and to a larger extent our politicians aren't really subject to democratic control, the bus drivers are always going to be graduates of the same driving school.
Despite the ongoing hijack of government by Wall Street, a word that hasn't been heard in over a generation is being uttered by politicians: "regulation." It's true that Goldman Sachs and others are profiting handsomely from the collapse, but there is nonetheless a growing sense among politicians that the market may have been allowed too free a rein. Naomi Klein's devastating critique The Shock Doctrine demonstrates how disasters were turned into platforms for rabidly free market policies, and it's an analysis that explains the post-World War II era and today's ongoing financial plunder, from California to Wall Street to the City of London, very well. But there is a recognition among the public and some politicians that today's economic crisis is a failure of free market thinking, and not a warrant for more. In response to popular outcry, politicians around the world seem ready to discuss how to regulate and restrain the market. The question is, can they, and, if they can, in whose interests will this regulation work?
From its inception, the free market has spawned discontent, but rare are the moments when that discontent coalesces across society, when a sufficiently large group of people can trace their unhappiness to free market politics, and demand change. The New Deal in the United States and the postwar European welfare states were partly a result of a consortium of social forces pushing for new limits to markets, and a renegotiation of the relationship between individuals and society. What's new about this crisis is that it's pervasively global, and comes at the last moment at which we might prevent a global climate catastrophe.
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