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Securities Fraud at JP Morgan

11/7/2014

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Matt Taibbi @ Rolling Stone 
Back in 2006, as a deal manager at the gigantic bank, Fleischmann first witnessed, then tried to stop, what she describes as "massive criminal securities fraud" in the bank's mortgage operations.

Thanks to a confidentiality agreement, she's kept her mouth shut since then. "My closest family and friends don't know what I've been living with," she says. "Even my brother will only find out for the first time when he sees this interview." 

Six years after the crisis that cratered the global economy, it's not exactly news that the country's biggest banks stole on a grand scale. That's why the more important part of Fleischmann's story is in the pains Chase and the Justice Department took to silence her.

She was blocked at every turn: by asleep-on-the-job regulators like the Securities and Exchange Commission, by a court system that allowed Chase to use its billions to bury her evidence, and, finally, by officials like outgoing Attorney General Eric Holder, the chief architect of the crazily elaborate government policy of surrender, secrecy and cover-up. "Every time I had a chance to talk, something always got in the way," Fleischmann says.




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Two Finance Posts from Carola Binder

4/18/2013

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Leverage in the Banking System,  Distrust of Financiers
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Ray Dalio talks about the value of induction or experience

2/3/2013

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Council of Foreign Relations interview with Maria B.His views on debt, spending, aggregate demand seems to match up with Steven Keen. He says we are in a "beautiful deleveraging". Nominal growth rate of GDP must exceed nominal interest rate (This is a vote in favour of the Fed policy so far - since this is what they have achieved). "The natural move is toward deflation right now -then there is the response of the central banks."
His views seem to be that we are muddling through the crisis, but we could all die if we hit an "air pocket". Depends on the "appropriate" mix of monetary and fiscal policy. And of course political responses that shape both.  More details on his views can be found here. 
Dalio seems more pessimistic about prospects at the Deadbook conference.
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Iceland defies economic orthodxy and grows

1/27/2013

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They let their banks fail, they said no to austerity, they enacted programs to induce inequailty. The President of Iceland believes this would work for financial center countries like the UK and the US. (Note: I have previously argued on these pages that the US should of let their banks fail-that htis would of led to a much healthier economy by now). For example .....
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Charles Ferguson on Glenn Hubbard

11/3/2012

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Hubbard's behaviour falls into the realm of evaluation for  positive economics not normative economics. He and others like him should be disavowed en masse for their lack of professional integrity and the call is not  even close. And we need to get to a point in society where we stop giving people  a pass for unethical behaviour just because it is legal. We are seriously undermining the case for democracy when we allow elites to fix the rules and  dance around their edges.

For the record - I have only voted against the conservative party once in my eighteen years of voting eligibility. But everything conservatism stood for when I was young - pro family pro small business- is being undermined by current catering to oligarchy elites by the right. 
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They will be rewriting textbooks after the "Great Recession" on ....

7/13/2012

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Shadowbanking and its importance in money creation. This is the first in a series of posts I will do on the topic.
After the "buck was broken" money maekt funds are still trying to prevent regulation.

From the NY Times.

"Currently, money market funds — unlike all other mutual funds — try to appear to be risk-free. The funds have net asset values per share of exactly $1, and  “breaking the buck” is widely feared. The S.E.C. rules allow the funds to maintain that dollar value so long as the real value is at least 99.5  cents". 

 
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Fed and SEC involved in cover up of Lehman Brothers Fraud

4/23/2012

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CBS' s 60 Minutes talks to the lawyer who headed the investigation into Lehman Brothers. He says there is clear evidence of fraud and a cover up by Lehman and Ernst and Young, their accounting firm. A whistle-blower is interviewed. Report suggests that one reason (perhaps the main reason given the strong evidence) no charges have been laid is that the FED and SEC had an office inside Lehman where they oversaw daily transactions for at least the last six months before the collapse. They therefore were aware of the accounting tricks, such as repo #105, used to falsely suggest Lehman had an extra $50 Billion in capital. 
 
Add corruption to the list of things I hate about the US policy response to the crisis. Oh yeah, the whistle blower who refused to sign off on the false accounting statements -he got "downsized" prior to Lehman’s collapse and remains unemployed. Dick Fuld, the x- Lehman president is back working as a consultant (presumably he has a lot to offer FIs on how to deal with regulators).

The narrative sounds like it has been taken directly from HBO’s “The Wire”.

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Financial Crisis 2008, The Wire, Market Design, Why Change is so difficult

1/18/2012

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The  award – winning HBO television series ‘The Wire’ opens with a bleak view of an inner city neighborhood. At first glance a viewer might be mistaken in thinking the location is war torn Sarajevo; however it is soon revealed to be drug infested, dilapidated west Baltimore. Detective, James McNulty, interviews a youth about a shooting homicide. The witness confides that the victim,  player at the weekly dice game, would regularly attempt to abscond with mone being wagered. When the detective asks why the victim was allowed to continue his participation despite continual attempts to rob the game, the witness responds “Got to. This (is) America, man.”  This scene is a metaphor for one of the program’s recurring themes – that despite repeated examples of rampant abuses and systematic gaming, institutions seem resistant to meaningful change.  

“The  Wire” is a poignant meditation on “the game” of life and how the rules of the game influence behavior in institutions. It dramatizes the manner in which weaknesses in market design, individuals chasing statistics for personal gain, and game playing within institutions often lead to tragedy and a tremendous waste of resources. The evolution of the global financial crisis is replete with examples of individuals and corporations gaming the financial regulator framework.

A  housing bubble is fueled by short term interest rates that are kept too low for too long in the wake of September 11, 2001. US consumers through home equity refinancing begin to use their homes as ATMs.  Individuals game the system by taking out loans they can not afford.

As the housing boom matures and most good quality borrowers have either bought or refinanced, the market looks for ways to keep the housing boom going. Credit standards weaken.  At a retail  level, mortgage originators fail to verify income. Since mortgage originators do  not keep mortgages on their books but instead sell them to financial institutions they are able to game the system by not having proper lending standards. 

At  the wholesale level, financial institutions buy mortgages from originators and  in turn repackage them as derivatives, mortgage back securities (MBS), and  resell the mortgages in pieces. Rating agencies fail to properly rate MBS products because they depend on the revenue of the financial institutions that issue them. In retrospect, it is not surprising that a MBS issue comprised of  80% subprime mortgages was given the highest possible investment grade rating. Investment banks game the system by shopping for ratings and selling paper that they know is substandard. 

In order to curry favor with Wall Street and voters, Congress and the Federal Reserve promote homeownership and financial innovation at the expense of Financial system stability. Financial institutions successfully lobby to have leverage restrictions relaxed -allowing them to shift from 10-12 times leverage to 30 to 40 times leverage. Products such as subprime mortgages and adjustable rate mortgages allow weaker borrowers to access the mortgage market. Quasi government entities, such as Fannie Mae and Freddie Mac, become some of the largest holders of MBS portfolios. Credit levels in the private US economy balloon to a multiple of 2.5 times average levels. 

The over-the-counter (OTC) derivatives market, with hundreds of billions of dollars of notional exposure, is left completely unregulated and opaque. AIG, the world’s largest insurance company, is allowed to sell tens of billions of dollars of OTC derivatives and credit defaults swaps (CDS) –insurance on MBS, without being required to allocate any capital as a reserve. The individuals within AIG game the system by selling insurance products whose claims they can not pay.

Then, in the fall of 2008, in the space of a few weeks, the entire global financial system unravels. A system wide bailout, the Troubled Asset Relief Program (TARP), is implemented. Financial institutions and individuals that took enormous risk, issued “toxic waste” products, and profited from gaming the system in good times, are now allowed to socialize their losses.
  
 In response to the crisis Congress passed the Frank-Dodd financial reform bill that is seen by many market observers and participants as not being a substantive modification of the regulatory framework.  David  Einhorn, president of Greenlight Capital, a hedge fund with $7 billion dollars in assets under management, recently talked about the reforms on Charlie Rose.
He characterized the measures as Washington letting Wall Street off the hook with the understanding that Wall Street would let Washingtonoff the hook. “And so I think that the reform -- it doesn’t go after any of the obvious issues  that were identified in the crisis.” Among other changes, Einhorn believes credit rating agencies should  be abolished and reserve capital requirements need to be imposed on CDS.  

The lack of regulation of OTC derivatives market is a case of “déjà vu  all over again”. In the mid nineties, Brooksley Born, a Clinton appointee to chair the Commodity Futures Trading Commission, attempted to regulate the opaque market. The financial sector lobbied strongly against regulation. Robert Rubin the Secretar of Treasury, Arthur Levitt chairman of the Securities and Exchange Commission, Deputy Secretary of the Treasury Larry Summers, and Alan Greenspan chairman of the Federal Reserve, went to congress and successfully lobbied to remove her statutory ability to regulate the market. Shortly thereafter Born resigned her post. Even after the financial crisis, provoked by Long term Capital Management  in 1999, the OTC market was left unregulated. 
 
The Brooksley Born saga is reminiscent of a scene in “The Wire” where police  officers gather on both ends of a desk and attempt to move it through a door. They struggle mightily to no avail finally giving up - convinced that the desk just doesn’t fit. A moment later it becomes evident that they had been trying to push the desk in opposite directions. Born’s experience is representative of another major theme of “The Wire”. Institutional champions trying to affect  meaningful change often find themselves thwarted by those who benefit from  maintaining the status quo.     

The  recent global financial crisis is an example of life imitating art. The lack o fappropriate OTC regulatory response, despite two financial crises in the space of a decade, places us in the shoes of The Wire’s Detective McNulty. We are left to ask “why do we let the financial institutions play the same game, an unregulated OTC market, if it repeatedly leads to financial crises?” 
 
Several  lessons emerge. Markets are not self regulating. If the “market” is not correctly designed, individual and institutional optimization will be to the detriment and even collapse of the system as a whole. Absent proper changes to market design, market failures will follow a predicable repeating pattern. 
 
The  regulatory response to the financial crisis transferred a lot of private debt to  public balance sheets. It has sown the seed for the most likely next global crisis – sovereign debt. Furthermore, absent meaningful reform, it is only a matter of time before we will have another crisis sparked by the opaque unregulated OTC derivatives market. 

It  was not by accident that the Canadian financial system weathered the global financial crisis better than almost any other developed nation. Canadian  consumers or bankers are not intrinsically more ethical or risk adverse than their American counterparts. Also, one need only look to the case of  Icelandto see that being a small  country does not guarantee that markets will be more appropriately designed and  regulations more easily implemented. We were spared not by intrinsically superior virtues, but rather by the markets we designed and manner in which we regulated them.

In  the words of Omar, one of ‘The Wire’s’ most memorable characters: “I'll do what I can to help y'all. But, the game's out there, and it's play or get played. That simple.” 



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