President Obama Took Care of Wall Street below a Public Persona of Reform

In April, 2010, President Obama gave a speech in New York City to counter what he called “the furious efforts of industry lobbyists” geared to weakening or stopping the new financial regulations that Obama claimed would be needed to stave off a second Great Depression.[1]  It is telling that the banks that had contributed to the financial crisis of 2008 were trying to diminish or block any new regulation. The very legitimacy of industry calls for deregulation in the wake of a market failure caused in part by the industry flies in the face of the rationale for regulation. In short, the rationale for government regulation has to do with market failures, which includes fraud and over-zealous profit-taking at the expense of the public good. The root of the rationale is the difference between the interests of an organization and society (i.e., the public good). 

The full essay is at "Obama Took Care of Wall Street."

1. Peter Baker, "Obama Issues Sharp Call for Reforms on Wall Street," The New York Times, April 22, 2010.

Morgan Stanley: Systemic Mistrust or Bad Financials after the Financial Crisis?

"Morgan Stanley by any measure is a safe and solid investment bank. Except for one: The amount of trust people have in the whole financial and political system. It's just about zero,” according to Jesse Eisinger of The New York Times in October 2011.[1] Even as there is undoubtedly an element of hyperbole in his conclusion—for zero trust in the financial system and governments would occasion far greater problems than the world faced at the time of Eisinger’s report—his broader point that bankers would be held accountable one way or the other for not having learned their lesson on derivatives (and risk more generally) is valid. The subtext is that even though banks like Morgan Stanley were in actuality in solid financial shape, they deserved the negative repercussions from the systemic skepticism that the banks themselves brought about by virtually ignoring risk analysis in preference to a run of profits and (not coincidentally) bonuses.

The full essay is at "Morgan Stanley after the Financial Crisis."

1. Jesse Eisinger, “Between the Lines, Wall St. Banks Face a Deficit of Trust,” The New York Times, October 12, 2011. 

Undermining the Dodd-Frank Act: An Incessant Desire for Profit

In the Dodd-Frank financial reform Act of 2010, financial firms in the U.S. are required to set aside higher reserves to cover losses on trades of securities, including those that “swap” the risk of default of a given security, such as bonds based on subprime mortgages. Almost immediately, the Wall Street bankers set about minimizing the new hindrance.  

The full essay is at "Undermining the Dodd-Frank Act."

Jack Lew at his confirmation hearing for U.S. Treasury Secretary. Lew had been the chief operating officer at units at Citibank.     NPR

An Institutional Conflict of Interest at the New York Federal Reserve

According to The New York Times, even after taxpayers rescued Citigroup, regulators at the New York Federal Reserve failed to monitor the company adequately. The regulators, although adequately staffed and proficient in training, failed to move swiftly as the bank’s financial condition deteriorated from as early as 2005, and were overly optimistic about the bank’s prospects as late as December, 2009. From 2006 to 2007, decisions on poorly underwritten loans were changed from “turned down” to “approved.” As many as 80 percent of the loans that Citigroup sold to Fannie Mae, Ginnie Mae and other investors were defective. “Although the dedicated supervisory team is well-qualified and generally has sound knowledge of the organization, there have been significant weaknesses in the execution of the supervisory program,” according to one excerpt of the 2009 review. Tim Geithner, who as president of the New York Fed from 2003 to 2008 was in charge of overseeing Citigroup, went on to become the US Secretary of the Treasury.

The full essay is at Institutional Conflicts of Interest, available at Amazon.

Public Accountants Betraying Clients: Insider-Trading on Client Information

There are two basic types of conflicts of interest: personal and institutional. In any conflict of interest, two roles conflict in such a way that one role can compromise the other. The role compromised is the more legitimate of the two. In this essay, I distinguish the two types and situate the public accountants involved in insider trading in the personal rather than institutional type. I discuss two specific cases, both of which resulted in the auditors being prosecuted, in order to distinguish that outcome from the failure of society to come to grips with some of the most important ongoing institutional conflicts of interest.

The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Mr. Goldman Goes to Washington

After watching hours of the US House Government Affairs committee on Investigations’ hearing on Goldman Sachs in 2010,  I concluded--totally contrary to the disavowals by the Goldman managers who testified--that there was indeed a conflict of interest between Goldman’s proprietary and market-making functions.  By proprietary, I mean a bank trading on its own books beyond simply being the counter-party in its market-making transactions. In their testimony, Goldman managers presumed that all of the bank’s proprietary transactions are part of its market-making role. However, I contend that the bank has been both a market-maker and a player in those markets, and furthermore that the latter function has affected the former in ways that are intended to benefit the bank. That is to say, Goldman Sachs’ financial interest has been put before that of its customers. In some cases, Goldman’s employees refused clients’ requests for shorts related to the housing market so Goldman’s own profits in shorting the market  could be preserved. Sen. Susan Collins (R-ME) said, “There is something unseemly about Goldman betting against the housing market as it is selling housing-related products to its customers.” Sen. Conrad, a more conservative Republican, echoed this sentiment.  The fact that Republicans on the subcommittee joined with Democrats rather than joined in Goldman’s paradigm points to a major disconnect between Wall Street “speak” and the discourse of the general public.  In other words, the financial managers and the politicians were largely talking past each other.  Even so, the two “worlds” can be translated into a common language that nonetheless finds Goldman culpable, while acknowledging some of the managers’ points.  In what follows, I discuss a number of the points raised in the hearing to bear out my contentions here.

The full essay is at "Essays on the Financial Crisis," available at Amazon. 

Larry Summers Bowed Out of the Race for Fed Chair: “Advise and Consent” Triumphant

On September 15, 2013, the White House announced that Larry Summers, Barak Obama’s prior chief economic advisor and a Secretary of the U.S. Treasury during the Clinton administration, no longer wanted to be considered to fill the upcoming vacancy as chairman of the Federal Reserve. In the announcement, Obama (or an advisor) wrote, “Larry was a critical member of my team as we faced down the worst economic crisis since the Great Depression, and it was in no small part because of his expertise, wisdom and leadership that we wrestled the economy back to growth and made the kind of progress we are seeing today.”[1] Unfortunately, this statement suffers from a sin of omission, which admittedly had been minimized by the media as well. Accordingly, the Democrats in the U.S. Senate who had just come out against a Summers nomination can be regarded as done the nation a vital service. Moreover, the “check” of the “check-and-balance” feature of the U.S. Senate’s confirmation power worked.

Alan Greenspan, Larry Summers, and Robert Rubin. In the late 1990s, they pressed Congress to keep financial derivatives unregulated. A case of government doing Wall Street's bidding?   Source: pbs.org

The Full Essay is at "Why Summers Bowed Out."

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1.Annie Lowrey and Michael D. Shear, “Summers Pulls Name from Consideration for Fed Chief,” The New York Times, September 15, 2013.

ICE Bought NYSE: Profiting from the Rules?

“Tell me what the rules are, and I’ll make money with them.” This statement, made by Jeffrey Sprecher of Intercontinental Exchange, captures well the attitude that business practitioners should have toward government regulation in a republic. That is to say, businesses should be regulation-takers rather than makers. For the regulatees to make regulation to which they themselves would be subject is an oxymoron, or contradiction in terms. At the very least, it involves a conflict of interest. At the macro level, business as “regulation-maker” effectively turns a democracy into a plutocracy. Accordingly, the strategic use of regulation should pertain to the use side, rather than the regulating side. Crafting regulations—essentially dictating them to legislators or regulators—in order to make money from them takes the strategic use of regulation too far.

 The full essay is at "Profiting from the Rules on Wall Street."

The Financial Crisis of 2008: On the Role of Negligence Breaching Fiduciary Obligation

Roger Lowenstein laments that “New York Times columnist Joe Nocera lamented that ‘Wall Street bigwigs whose firms took unconscionable risks … aren't even on Justice's radar screen.’ A news story in the Times about a mortgage executive who was convicted of criminal fraud observed, ‘The Justice Dept. has yet to bring charges against an executive who ran a major Wall Street firm leading up to the disaster.’ In the same dispassionate tone, National Public Radio's All Things Considered chimed in, ‘Some of the most publicly reviled figures in the mortgage mess won't face any public accounting.’ New York magazine saw fit to print the estimable opinion of Bernie Madoff, who observed that the dearth of criminal convictions is ‘unbelievable.’ Rolling Stone, which has been beating this drum the longest and with the heaviest hand, reductively asked, ‘Why isn't Wall Street in jail?’”

Lowenstein interprets these sentiments as implying “that the financial crisis was caused by fraud; that people who take big risks should be subject to a criminal investigation; that executives of large financial firms should be criminal suspects after a crash; that public revulsion indicates likely culpability; that it is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy; and that Wall Street bears collective guilt for which a large part of it should be incarcerated.”

Lowenstein argues that “(t)hese assumptions do violence to our system of justice and hinder our understanding of the crisis. The claim that it was ‘caused by financial fraud’ is debatable, but the weight of the evidence is strongly against it. The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors, and regulators were all blind to risk. More broadly, the crash was the result of a tendency in our financial culture, especially after a period of buoyancy, to push leverage and risk-taking to the extreme.”

Lowenstein also ticks off a loose monetary policy (i.e., extremely low interest rates), unaccountability at Fannie Mae and Freddie Mac, weak financial regulation, and an overconfidence in “risk management” methods in arguing that we should not be reductionist in ascribing the crisis to fraud alone or even primarily.  

Analysis at "Negligence in the Financial Crisis of 2008."

On the Strategic Use of Regulation: Financial Reform at the Bequest of Wall Street

According to The New York Times, Wall Street bankers were busy working on how to weaken the regulations or otherwise profit from them before the ink was dry on the financial reform law of 2010 . First, regarding trying to profit from the new regulations, BOA, Wells Fargo and other big banks that were faced with new limits on fees associated with debit cards were imposing fees on checking accounts. Compelled to trade derivatives in the daylight of closely regulated clearinghouses rather than in murky over-the-counter markets, titans like J.P. Morgan Investment Bank and Goldman Sachs were building up their derivatives brokerage operations. Their goal was to make up any lost profits — and perhaps make even more money than before — by becoming matchmakers in the vast market for these instruments. That critics were pointing to them as a principal cause of the financial crisis made no difference to those bankers. Even when it comes to what is perhaps the biggest new rule — barring banks from making bets with their own money — banks found what they thought was a solution: allowing some traders to continue making those wagers as long as they also work with clients.

The full essay is at "Strategic Use of Financial Regulation."

On the Influence of Wall Street in Congress: The Proposal to Distinguish Financial and Commercial Derivatives

In the process whereby financial reform legislation made its way through Congress after the financial crisis of 2008, the U.S. House and Senate had different approaches concerning who would be required to go through a clearing house to buy or sell derivative securities. According to Michael Masters, "The clearing house would stand in the middle of the transaction and guarantee both sides of the trade. If one counterparty to the transaction fails, then the central counterparty absorbs those losses, protecting the system as a whole from collapse."  Masters claims that "Wall Street firms hate this idea because their prodigious profits will dwindle when derivatives are traded in the light of day, letting their counter-parties see the true costs. So Wall Street is pushing hard to exempt as many transactions as possible."  Given the culpability of Wall Street in the financial crisis, they were in no position to "push hard." That they did nonetheless is a telling sign of the underlying character, or lack thereof, "on the street."  Furthermore, that the representatives and senators were listening to them ought to cause the voters some concern.  Yet because of the reality of the banks' muscle on the hill, the power of the banks to exploit any loopholes in the final legislation should have been salient as the legislation made its way through Congress. This can be seen in whether to favor the House or Senate version.

The full essay is at "Wall Street's Influence in Congress."

A Structural Conflict of Interest in Deutche Bank: Beyond Proprietary Holdings

While creating and selling mortgage-based securities to some of its clients, Deutsche Bank AG was not only advising other clients to bet the other way, but also sometimes doing it itself, according to the Wall Street Journal. A trader at the bank would help create an index that made it easy for the bank to bet against housing even as sales people at the bank were selling the securities as if there were no downside to the American housing market. Then some of the tax-payer money was paid by the US Government to AIG to reimburse Deutsche’s hedge-fund clients who had bought the mortgage securities. American regulators looked at whether there were misrepresentations made to the hedge fund managers who bought the mortgage-backed securities even as Deutsche Bank was betting against the housing market.

The full essay is at Institutional Conflicts of Interest, available at Amazon.

Paul Samuelson: The Model 20th Century Economist

Paul A. Samuelson, the first American Nobel laureate in economics and the foremost academic economist of the 20th century, died at the end of 2009 at 94.  Samuelson was credited with changing the academic discipline of economics, according to The New York Times,  ”from one that ruminates about economic issues to one that solves problems, answering questions about cause and effect with mathematical rigor and clarity.”  Essentially, he redefined twentieth century economics. Mathematics had already been employed by social scientists, but Dr. Samuelson brought the discipline into the mainstream of economic thinking. His early work, for example, presented a unified mathematical structure for predicting how businesses and households alike would respond to changes in economic forces, how changes in wage rates would affect employment, and how tax rate changes would affect tax collections.  He developed the rudimentary mathematics of business cycles with a model, called the multiplier-accelerator, that captured the inherent tendency of market economies to fluctuate.  Mathematical formuli that Wall Street analysts use to trade options and other complicated securities (derivatives) have come from his work (FYI: derivatives too complicated for outsiders such as the government to understand/regulate were at the center of the financial crisis in 2008).

The full essay is at "20th Century Economist."

JPMorgan: Fault and Criminal Fraud under the Settlements' Radar?

Resolving just a part of the $13 billion being demanded by the U.S. Government in court, JPMorgan capitulated in October of 2013 to a $5.1 billion settlement to resolve claims by the U.S. Federal Housing Finance Agency that the largest American bank had sold Fannie Mae and Freddie Mac mortgages and mortgage-based (i.e., derivative) securities by knowingly misrepresenting the quality of the loans and the loan-based bonds.[1]  At the time of the $5.1 billion settlement, JPMorgan’s executives were trying to settle “state and federal probes into whether the company misrepresented the quality of mortgage bonds packaged and sold at the height of the U.S. housing boom.”[2] It would seem that the bank was in a vulnerable position in the settlement negotiations, having “capitulated.” I’m not so sure.

The full essay is at "Essays on the Financial Crisis."

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[1] Clea Benson and Dawn Kopecki, “JPMorgan to Pay $5.1 Billion to Settle Mortgage Claims,” Bloomberg, October 25, 2013.

[2] Ibid.

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Return of the Mortgage-Based Bonds: Another Bubble in the Making?

In case it has been a while since you have been entertained by going around in circles while sitting on a painted wooden horse, permit me to re-introduce you to the Merry-Go-Round, a staple at virtually any amusement park.

The world itself might just be such a ride, with us mere earthlings playing out our respective roles while spinning around and around as the world goes by once and then again, and again. Lest it seem monotonous to go around in circles, it is possible—at least in principle—to learn something new on each pass.  Weighing against a learning-curve that might thwart an eternal recurrence of past failures are other, less salubrious proclivities of the mind. These include (but are not limited to) avarice, power, and even the force of habit. More damning still may be the arrogance of pride—the hubris of presumption. 

The full essay is at Another Bubble.

On the Arrogance of Power: Greenspan, Rubin, and Summers in the Clinton Administration

Over two years after the financial crisis of 2008, a commentator on Fox News said that the banks should not stop the foreclosure process because that would not be good for the free market. He said that people who cannot afford their houses should lose them. Another commentator remarked that there was still too much government in the financial sector. This, according to the commentator, is “the problem.” It is particularly striking that Alan Greenspan’s stark admission to a U.S. House committee in 2008 that the deregulated laissez faire market paradigm contains a fundamental flaw was lost on the two commentators. In May 2011, House Speaker Boehner charged that business is over-regulated. This comment too is remarkable given Greenspan’s realization. If a people disowns its own lessons, history is destined to repeat itself.

The full essay is at Essays on the Financial Crisis.

Rating Moody’s and S & P: A Structural Conflict of Interest

For years, banks and other issuers have paid rating agencies to rate their securities. This is a bit like restaurants paying food critics to write on their food.  In the wake of the SEC’s charge that  people at Goldman Sachs built the Abacus investment to fall apart so a hedge fund manager, John A. Paulson, could bet against it, the Senate’s Permanent Subcommittee on Investigations questioned representatives from Moody’s and Standard & Poor’s about how they rate risky securities. Carl M. Levin, the Michigan Democrat who heads the Senate panel, said in a statement: “A conveyor belt of high-risk securities, backed by toxic mortgages, got AAA ratings that turned out not to be worth the paper they were printed on.” Throughout the testimony, the institutional conflict of interest was salient whereby credit-rating agencies put market-share considerations foremost in rating securities presented by the banks that are paying the agencies.

The full essay is at Institutional Conflicts of Interest, available at Amazon. 

On the Differential Impact of Pro-Business Cultural Values on Financial Regulation in the EU and US

On May 18, 2010, the German state legislature banned naked short-selling of certain euro-debt and credit-default swaps, as well as some financial stocks because it was believed that “excessive price movements” could endanger the stability of the financial system. In an interview with Frankfurter Allgemeine Sonntagszeitung, Wolfgang Schauble, the Finance Minister at the time, said that the “financial market is only concerned with itself, instead of fulfilling its purpose and financing sensible, sustainable economic growth.” The legislation runs counter to a race to the bottom in which governments relax financial regulation to entice the banking sector. At the same time, however, the American state governments and that of their union seemed like apologists for the industry they are supposed to be regulating.  In fact, Tim Geithner, the U.S. Treasury Secretary, did not waste any time in criticizing the E.U. state for the legislation. While doing so, he dismissed the German Chancellor's proposal for a global financial transactions tax (the proceeds of which would go into an emergency fund to divert a collapse of the financial system). To be sure, while the European proposals were a healthy sign of government not enslaved by the money and power of big business, the problem of banks too big to fail still existing was not tackled. Furthermore, whereas Americans may be too insular, the Europeans may be unrealistic in their visions for global regulation. Indeed, many tend to conflate their own union with an international organization.

The full essay is at "Essays on Two Federal Empires."

Fraud as Fair: Lehman as Beneficiary of Society's Pro-Business Cultural Values

In April, 2010, Richard Fuld, the former CEO of Lehman Brothers, told a congressional committee that he had "absolutely no recollection whatsoever of hearing anything" about Repo 105 at the time of the transactions. Lehman's demise, he claimed, was caused by "uncontrollable market forces" and the U.S. government's unwillingness to rescue the firm. Of course, Henry Paulson, the U.S. Treasury Secretary in 2008, had tried in vain to get Fuld to accept a buyer offering a reasonable price; Fuld had been holding out for more in spite of the financial condition of Lehman. It is stunning that a man who had been allowed to reach such a pristine and lofty office in the business world would not even permit himself to acknowledge any contributory role in the downfall of the organization he had run. Such an attitude alone seems worthy of a prison sentence (and the return of his salary and bonuses); how he and his "team" had manipulated the books to make the bank look wealthier than it was would seem to make such a sentence inevitable.

The full essay is at "Essays on the Financial Crisis."

TARP and Foreclosures: A Matter of Misplaced Priorities

Neil Kashkari wrote up the U.S. Treasury department’s Break the Glass Bank Recapitalization Plan in April, 2008—months before the financial crisis—as a “just in case.” It was essentially the TARP program.  Karshkari states in his plan that governmental purchases of toxic mortgage-based assets would do “nothing to help homeowners without [there being] a complimentary program.” He notes that should there be a crisis, “there would be enormous political pressure” for relief going to homeowners in trouble.  Considering the noted downside to his plan, he may have viewed any such pressure from “the masses” as a problem to be ignored rather than even assuaged.  He also admits in his plan that it would provide “no guarantee banks [would] resume lending.”  It is odd that his was made explicit yet not dealt with.  He does gloss an alternative option (C) that would involve refinancing the troubled mortgages, though he assumes a (needlessly cumbersome) case by case basis and that the servicers would determine which loans to put into the program.  The culprits could opt out to insist on the higher payments. In other words, Kashkari was assuming that the government shouldn’t or couldn’t force the banks to take write-downs.  As a former Goldman Sachs man himself (like his boss at the time, Henry Paulson), Kashkari probably didn’t want to propose anything that the bankers wouldn’t view as being in their interest.

The full essay is at "Essays on the Financial Crisis."