Tag Archive | "Wall Street"

How Washington does the bidding of Wall Street

Everybody knows the worst kept secret in Washington is that many, if not most, politicians work more at the behest of the interests of Wall Street than the interests of the American people.

It’s not just hyperbole. It’s not a conspiracy. It’s simply business as usual.

This is the third installment of my series on the Occupy Wall Street movement, the protest movement that has grown around the country and the world expressing dissatisfaction with the status quo and the way Wall Street operates.

I promised last time to explore the collusion between Washington and Wall Street and to try to explain how politicians paved the way for the financial crisis with their mantra of deregulation.

Wall Street lobbying

According to Wall Street Watch, a non-partisan consumer advocacy group, the financial services industry spent over $5 billion to peddle its lobbying influence in Washington from 1998 to 2008, 55 percent of which went to Republicans and 45 percent went to Democrats.

In 2007, the year before the financial crisis, there were approximately 3,000 officially-registered Wall Street lobbyists who influence policy makers in Washington — that’s five lobbyists for every one member of Congress.

Wall Street is also the lead contributor to presidential campaigns. In 2008, Wall Street firms made up the top contribution slots of both the Obama and McCain campaigns.

Goldman Sachs was the largest private contributor to Obama’s campaign and the second largest contributor overall, while JPMorgan Chase, Citigroup, Morgan Stanley and UBS AG all made Obama’s top 20.

The top contributor to the McCain campaign was Merrill Lynch with JPMorgan Chase, Citigroup, Morgan Stanley, and Goldman Sachs taking the next top slots, and Bank of America, Wachovia, UBS AG and Lehman Brothers all made the top 20.

Through the revolving door

There’s also an endless revolving door between Wall Street and Washington.

President Clinton’s Treasury Secretary Robert Rubin had once worked at Goldman Sachs and after leaving office, went to work for Citigroup, even serving as the chairman of the company from 2007 to 2009.

Larry Summers, who succeeded Rubin as Treasury Secretary, later worked as managing director for the hedge fund D. E. Shaw and, in 2008, was paid $2.7 million in speaking fees by Wall Street firms such as JP Morgan Chase, Citigroup, Goldman Sachs, Lehman Brothers and Merrill Lynch.

Henry Paulson, who served as Treasury Secretary under President George W. Bush, had worked at Goldman Sachs since 1974 before taking office, even serving as the company’s chairman and CEO from 1998 to 2006.

Current Treasury Secretary Timothy Geithner worked as the head of the New York Federal Reserve before taking office. And who took Geithner’s place at the New York Fed? That would be William C. Dudley, the chief economist for Goldman Sachs from 1984 to 2007.

Geithner’s current Chief of Staff is Mark Patterson, who before taking office worked as a lobbyist for Goldman Sachs.

How about Gary Gensler, the current chairman of the Commodity Futures Trading Commission, the federal regulatory agency tasked with regulating futures and options markets?

Gensler spent 18 years of his life working for — yep, you guessed it — Goldman Sachs.

Is it really any wonder why these Wall Street firms got the largest government bailout in history following the financial crisis of 2008? And the Obama administration has surrounded itself with the very same architects of said bail-out.

Now let’s look at some of the ways Washington has done the bidding of Wall Street.

Repeal of Glass-Steagall

In 1998, the banking giant Citicorp merged with the insurance giant Travelers Group to create Citigroup. At the time, this merger was illegal under the Glass-Steagall Act of 1933.

Congress passed the Glass-Steagall Act after the Great Depression, in part, to create firewalls between commercial banks, investment banks and insurance companies.

Part of the idea of this act was to prevent conflicts of interest that could arise from lending institutions using their customers’ credit to make risky investments. It also hoped to prevent the consolidation of these industries into megalithic investment companies.

But in 1999 Congress passed the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act, which repealed key provisions of the Glass-Steagall Act.

Congress drafted and passed this legislation, in part, to retroactively make the Citigroup merger a legal consolidation. It also paved the way for endless Wall Street mergers and acquisitions to come.

In the wake of the financial crisis of 2008, many have cited the repeal of the Glass-Steagall Act as the catalyst that created the legal framework for investment banks becoming “too big to fail.”

Leverage ratios

In 1975, the Securities and Exchange Commission, the federal regulatory agency tasked with enforcing securities laws, instituted what was known as the “net capital rule,” a financial regulation that, among other things, dictated the leverage ratio of lending institutions.

Leverage is the ratio of a bank’s debt or assets to a bank’s equity, basically meaning how much cash they keep on hand in accordance with how much cash they borrow.

The SEC used to cap the leverage ratio at 12-1. But in 2004, the SEC succumbed to pressure from the financial services industry’s campaign, led by Goldman Sachs, to authorize investment banks to develop their own capital requirements.

In the run-up to the financial crisis, some of the largest investment banks were operating with a leverage ratio of 40-1, meaning for every $40 in assets, there would only be $1 to cover potential losses.

The Financial Crisis Inquiry Commission’s report noted that “less than a 3 percent drop in asset values could wipe out a firm.”

The FCIC report characterized the situation as such using the investment bank Bear Stearns as an example: “Bear Stearns had $11.8 billion in equity and $383.6 billion in liabilities and was borrowing as much as $70 billion in the overnight market. It was the equivalent of a small business with $50,000 in equity borrowing $1.6 million, with $296,750 of that due each and every day.”

It was another egregious example of government regulators failing to do their job and, instead, surrendering to pressure from the financial services industry and their lobbyists.

Deregulating derivatives

As I explained in the last installment, it was Wall Street’s investment in the derivatives market that perhaps contributed to the financial crisis more than anything else.

Also recall that in 2002, Warren Buffett referred to derivatives as “financial weapons of mass destruction,” and as “time bombs” that could be “potentially lethal.”

But even before Buffett’s dire warning,  in 1998, Brooksley Born, who was the then-head of the Commodity Futures Trading Commission, pleaded with Congress to allow the CFTC to regulate the derivatives market.

Born warned Congress about the risk derivatives “might pose to the U.S. economy and to financial stability around the world.”

But Born was rebuffed in her efforts by none other than Alan Greenspan (who has been wrong about nearly every prediction he ever made), then-chairman of the Federal Reserve, who told Congress, “the degree of supervision of regulation of the over-the-counter derivatives market is quite adequate to maintain a degree of stability in the system.”

Greenspan was joined by then-Treasury Secretary Robert Rubin to applaud the stability of derivatives and fight against regulation. Of course, they would prove to be disastrously wrong and Born would prove to be presciently correct.

However, Congress didn’t listen to Born, and in 2000, it passed the Commodities Futures Modernization Act, which ensured the deregulated of the derivatives market, and laid the groundwork for the creation of the complex, unregulated financial derivatives instruments such as collateralized debt obligations and credit default swaps that were so instrumental in the financial collapse of 2008.

When it comes to Wall Street, Washington should act as watchdogs with government oversight to protect the American people against these financial schemes and machinations instead of kowtowing to its corporate sponsors.

It may be business as usual, but this business model has become dangerously unsustainable. And this is part of what the Occupy Wall Street movement is about, to begin to untangle the stranglehold Wall Street has on our democratic process and return Washington to the people.

W. Paul Smith
Opinions Editor

Occupy Wall Street Series:  Part 1   Part 2   Part 3   Part 4   Part 5

 

Cartoon courtesy of Andy Marlette/amarlette@pnj.com

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How Wall Street swindled the American people

This is the second installment of my series on the Occupy Wall Street movement. I promised in the first installment to try and better explain just how the Wall Street schemes worked.

The full story of the economic collapse of 2008 is far too complicated to tell here, but I will do my best to provide a Cliff’s Notes version of the Wall Street con job.

Everyone needs to understand that what Wall Street perpetrated on the American people and the world was perhaps the biggest heist in the history of civilization.

While it is impossible to quantify the exact amount of capital lost, there is no question that trillions of dollars evaporated in this country and across the globe because of these schemes.

As I stated in the first installment, investments in extremely volatile and risky mortgages were at the heart of the collapse.

Much of the financial crisis finds its origins in a mortgage-investment process known as securitization, whereby many different mortgages were lent out by banks and then pooled together and repackaged into investment instruments known as “mortgage-backed securities,” which were then sold off to large investment banks to be resold to their customers.

A mortgage-backed security in and of itself is not necessarily a bad thing. And in the past, there were times when such an investment was not considered incredibly risky.

However, what lead to the financial crisis were investments in “subprime” mortgages.

The subprime mortgage crisis

A subprime mortgage simply refers to a loan made to someone who may have difficulties making payments and are often the result of a low credit score.

Some people have characterized the financial crisis as resulting from the government wanting to put low-income people into homes they couldn’t afford.

It is true that Fannie Mae and Freddie Mac, government-sponsored enterprises that helped create and invested in mortgage-backed securities, contributed significantly to the problem. But this is only one tiny sliver of the story.

It’s one thing to fault someone for taking out a loan on a house he or she might not be able to afford, but it’s an entirely different matter when the lending institutions are actually giving these shady loans out in the first place.

And the reason they were giving out these questionable loans was not because of some altruistic desire to put poor people in houses, but, rather, in the desire to make oodles of money because of the manner in which Wall Street invested in such subprime loans.

In the years leading up to the financial crisis there was an explosion in subprime mortgages. Because investing in mortgage-backed securities quickly became such a lucrative enterprise, banks began to loosen their lending standards.

The Senate Permanent Subcommittee on Investigations released a report in April of this year stating, “The resulting increased demand for mortgage backed securities, joined with Wall Street’s growing appetite for securitization fees, prompted lenders to issue mortgages not only to well qualified borrowers, but also higher risk borrowers.”

In 1994, subprime lending only accounted for about $35 billion or less than five percent of all mortgage loans made, but by 2006, subprime loans totaled over $600 billion and accounted for over 20 percent of all mortgages.

These increases in subprime mortgages also lead to severe increases in predatory lending and mortgage fraud.

As early as 2004, the FBI even took notice of this, and Assistant FBI Director Chris Swecker warned that the problem could be turn into an “epidemic.”

However, while the main instruments at the heart of the collapse were mortgage-backed securities, it was the instruments Wall Street created and used to invest in such securities that caused the most damage — mainly instruments known as derivatives.

Unregulated derivatives

A derivative is a contract between two parties in which the value of an investment is “derived” from the value of other assets. It is ostensibly a way to spread the risk of an investment.

During the years leading up to the financial crisis, the derivatives market quadrupled in size.

The Bank for International Settlements estimates the global derivatives market to be at $1.2 quadrillion — yes, you read that correctly. This amount is equivalent to 22 times the GDP of the entire world, though technically this figure represents a notional value, while the actual market value is somewhere closer to $20 trillion.

However, this figure shows how much investing takes place using derivatives, and considering they are not traded on any public exchange, much of the derivatives market goes entirely unregulated.

Also, in 2000, Congress, doing Wall Street’s bidding, passed the Commodity Futures Modernization Act that further deregulated the already mostly-unregulated derivatives market.

(In the next installment of this series, I will get into the collusion between Wall Street and Washington and try to explain better how such things became deregulated.)

In 2002, Warren Buffett referred to derivatives as “financial weapons of mass destruction,” and as “time bombs” that could be “potentially lethal.”

Derivatives can include futures, options, forwards and other such financial jargon, but what we need to focus on are types of what are known as “over-the-counter” derivatives instruments called  “collateralized debt obligations” and “credit default swaps.”

Toxic CDOs

Collateralized debt obligations (or CDOs) were one of the main instruments Wall Street used to invest in mortgage-backed securities.

The investment firm Goldman Sachs alone sold $73 billion in “synthetic” CDOs between 2004 and 2007 (synthetic CDOs were CDOs made out of other CDOs… it was some serious Wall Street voodoo shit).

CDOs were instruments that contained these pooled-together mortgage-backed securities (many of which were subprime) along with other assets such as car loans and credit card debt into different levels or “tranches” of investments.

Each tranche offered varying degrees of risk and yields and were given different credit ratings.

A credit rating is a score given to an investment that is supposed to measure the worthiness of the investment and the likelihood of default, with the top rating being “AAA” (indicating a safe investment) and the lowest being a “B” (indicating a junk or toxic investment).

The problem with CDOs was that these tranches were then pooled together and diced up themselves. So, the junk investments were mixed with the safe investments and were then cobbled together into new investments.

This also allowed multiple investments to be made on the same securities. The Financial Crisis Inquiry Commission, a government appointed commission tasked with investigating the causes of the financial crisis, published in their report, “a mortgage on a home in south Florida might become part of dozens of securities owned by hundreds of investors.”

To make matters worse, credit rating agencies such as Moody’s, Standard & Poor’s and Fitch gave ratings to the CDOs, often giving them a score of “AAA.”

This process essentially had the effect of turning junk investments into “AAA” investments.

Ratings fail

A rating of “AAA” is supposed to indicate that there is almost no credit risk to the investor whatsoever and is supposed to have a probability of failure of less than one percent.

Credit ratings are taken very seriously in the financial services industry, and most investors rely on them for determining the validity of an investment. Even the SEC has guidelines for investors to rely on these ratings.

So why would the credit ratings agency give “AAA” ratings to investments that were incredibly risky and perhaps even toxic? That’s easy: profit.

Credit ratings agencies are paid fees for providing such ratings, and during the years leading up to the financial crisis, their profits more than quadrupled.

The Senate Permanent Subcommittee on Investigations stated in their report, “ratings agencies weakened their standards as each competed to provide the most favorable rating to win business and greater market share,” … so much for the idea that the industry can be self-regulating.

There is a mountain of evidence to suggest the credit ratings agencies were aware such investments were risky and not worthy of the “AAA” score, but what’s worse is that many on Wall Street were also aware of the risk.

The FCIC report stated, “major financial institutions ineffectively sampled loans they were purchasing to package and sell to investors. They knew a significant percentage of the sampled loans did not meet their own underwriting standards or those of the originators.”

So aware was Wall Street of the risk, in fact, that many began betting against the very CDOs in which they were encouraging others to invest.

Betting against the house

This is where the credit default swaps came into play. A credit default swap basically works similar to an  insurance policy that guarantees the credit worthiness of an investment.

However, unlike a traditional insurance policy, unlimited swaps could be taken out on the same investments — and even on investments the swap purchaser didn’t own.

Investment firms such as Goldman Sachs bought billions of dollars in credit default swaps from AIG, a multinational financial insurance corporation, to bet against the same CDOs they were selling to their customers.

This way, when the CDOs failed, Goldman Sachs hoped to still make money.

But because of the unregulated nature of the derivatives market, AIG was not required to set aside the capital to cover such guarantees — and as it turns out, AIG simply didn’t have the funds.

The FCIC report found that credit default swaps “were sold by firms that failed to put up any reserves or initial collateral or to hedge their exposure.”

These practices exponentially magnified the risk for potential financial collapse.

And then, inevitably, the CDOs began to fail.

The bubble bursts

When the people who had originally been given subprime mortgages began to default on their payments, the entire house of cards began to tumble.

People stopped making their mortgage payments, and the market for CDOs simply collapsed.

The rug had suddenly been pulled out from under Wall Street — the bubble had burst, and one by one the largest investment firms in the country began to fall.

In March of 2008, the investment bank Bear Stearns that had sold billions in CDOs to investors was the first to go, being acquired by JPMorgan Chase.

And like a viral contagion, when the collapsing mortgage-backed securities and CDO market took down Bear Stearns, the infection spread across the entirety of Wall Street.

The dominoes finally began to fall.

Fannie Mae and Freddie Mac were the next to crumble, followed by Lehman Brothers, Merrill Lynch and AIG.

The bait-and-switch shell game that Wall Street had built layer upon dizzying layer of deception and fraud went bust… And they mostly got away with it.

In the end, trillions of dollars were lost, the federal government spent billions bailing out the crooks, millions of homes were foreclosed or lost their value, and millions of Americans were unemployed or saw their wages decrease — all in Wall Street’s pursuit of the quick buck in a con game.

There is plenty of blame to be spread around, and every actor played some role in the collapse. But make no mistake about it, Wall Street helped engineer the heist and drove the getaway car, leaving the American people in near-economic ruin to clean up the mess.

But the mess hasn’t been cleaned up, and unless something changes, the new Wall Street swindle is only a matter of time.

W. Paul Smith
Opinions Editor

Occupy Wall Street Series:  Part 1   Part 2   Part 3   Part 4   Part 5


Cartoon courtesy of Andy Marlette/amarlette@pnj.com

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Wall Street should be indicted, not just occupied

The Occupy Wall Street protests that started in New York just a few short weeks ago have now ballooned across the country into a full-fledged movement, with events happening so far in approximately 400 cities in 48 states and a local group even springing up in Pensacola and at UWF.

The thrust of the protests is aimed at corporate greed and shady Wall Street practices.

A protest movement begins

Granted, all protests movements will have elements that begin to look like a circus, and those movements that start on the left tend to feel somewhat like music festivals such as Burning Man or Bonnaroo at times.

However, while these protests occasionally feel a bit disjointed and clunky, I think they can be seen as a shot across the bow to the “banksters” and white-collar criminals that caused the worst financial crisis in history, bringing the world’s economy to the brink.

So, in solidarity with this movement, I have decided to write a series on the issues highlighted by the Occupy Wall Street movement, specifically examining the criminality and unethicality that has become so pervasive on Wall Street, the nexus of collusion between Wall Street and Washington, and where the American people stand after decades of such shady policies and practices.

In this first installment I hope to demonstrate that what took place in the lead up to the financial collapse of 2008 was, in fact, criminal.

Crimes were committed

Fraud is fraud, whether it’s committed by a small-time crook or a major Wall Street player. And securities fraud is a crime punishable by a prison sentence.

However, not a single Wall Street criminal has spent a day in jail for the role he or she played during the financial crisis.

When it comes to Wall Street crimes, the U.S. Justice Department has consistently shown it is not interested in throwing the criminals in jail.

Instead, it opts for the Securities and Exchange Commission, the federal regulatory agency tasked with enforcing securities laws, to negotiate fines and settlements to be paid when laws are broken.

Securities laws are extraordinarily complex, as are the schemes and crimes often perpetrated by Wall Street. So without descending into a lawyerly diatribe of the legal minutia, I will focus in this piece on some of the specific settlements Wall Street and its ilk paid out associated with the financial crisis.

The Financial Crisis Inquiry Commission, a government appointed commission tasked with investigating the causes of the financial crisis, said in their 2010 report that the crisis was caused by “systemic breaches in accountability and ethics at all levels.”

Furthermore, it stated, “financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective.”

In the next installment of this series I will attempt to better explain just how some of the Wall Street schemes worked, but suffice it to say for now, extremely volatile and risky mortgages were at the heart of the collapse.

In most cases, banks sold mortgages to people they knew couldn’t afford them and then sold off those mortgages to investment firms which repackaged them into “mortgage-backed securities,” allowing other investors to make boat-loads of quick money on disguised toxic assets while hyper-inflating the financial bubbles.

However, in many of the cases, the investors had no idea their money was going into extremely high-risk toxic deals, and very often these investors were gambling the retirement nest eggs of state workers’ pension funds, such as teachers, police officers, firefighters, etc.

Fines instead of prison

In June of this year, JPMorgan Chase, a multinational banking corporation, paid the SEC a settlement of $151 million on charges that the bank intentionally misled investors in a risky mortgage bond deal.

In 2010, Goldman Sachs, a multinational investment banking and securities firm that had its greedy hands in almost every cookie jar of the financial crisis, reached a $550 million settlement with the SEC for also defrauding investors with toxic mortgage-backed securities.

Though it was the largest single penalty any Wall Street firm had ever paid to the SEC, it still only represented about 4 percent of the profits the company made in 2009.

These are just a smattering of the settlements paid for crimes committed.

But this doesn’t even begin to compare to a settlement deal currently in the works and being finalized by many states’ attorneys general and the Department of Justice, letting all the banks involved with the toxic mortgage frauds off the hook for a measly $20 billion.

The deal would allow all the major banks that engaged in these dirty practices, such as Citigroup, Bank of America, JPMorgan Chase and Wells Fargo, to be essentially granted immunity from criminal prosecution for what collectively amounts to a drop in the ocean of windfall profits they made swindling the American people.

To put this in perspective on just how small this settlement is compared to the crimes committed, the Florida State Board of Administration, which handled investments for state workers’ pensions, lost $62 billion alone in 2008, largely by investing in high-risk mortgage-backed securities.

That’s one pension fund’s investments from one state with losses that total three times what this settlement deal is offering (although it is starting to look like the FSBA was not totally unaware of the risk).

And to put this settlement deal into even broader perspective, the International Monetary Fund estimates losses from the mortgage-backed-securities-fueled financial crisis to be in the trillions.

When the entire cabal of bankster criminals is allowed to get off for only $20 billion, there’s simply no incentive for Wall Street not to continue the status quo and keep orchestrating criminal and unethical financial schemes.

The Department of Justice needs to stop acting like a bunch of feckless cowards and start asking for settlement amounts that actually fit the crimes. And then they need to seek criminal prosecutions that come with jail time.

Mark my words, if we started throwing these Wall Street crooks in prison rather than fining them a pittance, you would see a radical drop in securities fraud and unethical behavior.

It’s time to start indicting these bastards on criminal charges and throwing their asses behind bars.

The Occupy Wall Street movement has succeeded in the very least identifying the targets, and I applaud their efforts to bring these issues to light.

Stay tuned for future installments in this series.

W. Paul Smith
Opinions Editor

Occupy Wall Street Series:  Part 1   Part 2   Part 3   Part 4   Part 5


 

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