FedUpUSA

Sarbanes-Oxley was supposed to prevent crap like this:

From the paper:

Lehman employed off-balance sheet devices, known within Lehman as “Repo 105” and “Repo 108” transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm’s financial condition in late 2007 and 2008.2847

Oh yeah, that’s legal?  It’s not supposed to be!

Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet.2850  Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt.2851  Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios.

Isn’t that special?

It gets better, as you might expect.

The Examiner concludes that colorable claims of breach of fiduciary duty exist against Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of professional malpractice exists against Arthur Anderson Ernst & Young.2915  (strikethrough mine, not in the original)

It is stated that Government Regulators (FRBNY and The SEC) had “no knowledge” of these practices.  Perhaps true.  But this calls into question why we’re hearing of this just now, and whether other firms have or are at present doing the same sort of thing.

There also appears to be a colorable claim that Lehman Management was fully-aware of what was going on:

Although interview statements given to the Examiner were inconsistent at times, no reasonable dispute exists that each of Lehman’s Chief Financial Officers from late 2007 to September 2008 possessed some knowledge of and/or involvement with multiple aspects of Lehman’s Repo 105 program, including the existence of firm-wide Repo 105 limits, the volume of Repo 105 activity Lehman engaged in at quarter?end, and Lehman’s efforts to manage its balance sheet using Repo 105 transactions.

Well that’s special.

But we’re just getting warmed up.

Remember, The Feral Reserve is supposed to by the “uber-regulator” and the “safety and soundness” manager for the financial system.

They did a great job, right?  Well…

For example, when

the Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.

True?  Let’s see what the Examiner had to say:

Although various Government agencies had information that raised serious questions about Lehman’s reported liquidity and about the sufficiency of its capital and liquidity to withstand stress scenarios, the agencies generally limited their activities to collecting data and monitoring.

Oh.  They looked but didn’t act.  I see.

Indeed, they looked pretty closely….

After March 2008 when the SEC and FRBNY began onsite daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress?testing scenarios to test Lehman’s ability to withstand a run or potential run on the bank.5753 The FRBNY developed two new stress scenarios: “Bear Stearns” and “Bear Stearns Light.”5754 Lehman failed both tests.5755 The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed.5756 However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed.5757 It does not appear that any agency required any action of Lehman in response to the results of the stress testing.

So let’s see what we got here.  They ran two sets of stress tests and the firm failed both.  Not satisfied with the results they then designed a third set, which the firm also failed (we can reasonably presume the third had less stringent requirements than the other two!)

Instead of applying any of these three, FRBNY, which was run by one MR. TIMOTHY GEITHNER, NOW OUR TREASURY SECRETARY WHO REPORTED TO ONE BEN BERNANKE, instead took Lehman’s word that all was ok and did nothing.

Wait a minute. In the spring of 2009 we were told that all the big banks ran “Stress Tests” of Geithner’s design.  But Treasury didn’t actually run them and didn’t actually get and process the data – they told the banks to do so. 

Uh, that’s exactly what Lehman did, right?  And Lehman passed its own “internally computed” stress test but failed all three of the externally-computed ones.

Do you still accept that all these other banks are solvent?  What about the facts we do know – such as the inconvenient fact that between them the “big banks” have something like $150 billion of Home Equity lines behind an underwater and delinquent first mortgage, which is, by the way, worth zero yet being carried at or near full value……

Nor did it end there.

The SEC inspection revealed significant problems at Lehman. The SEC found that Lehman’s Price Valuation Group was understaffed; and it found that Lehman’s asset pricing function was overly “process driven.”5761 But the SEC did not release its findings or formally present them to Lehman prior to Lehman’s demise.

So The SEC knew, and they too did nothing.

It’s worse.  While Geithner is implicated as being “concerned” about Lehman in the paper, the most-troubling part the narrative is here:

The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in “collateral damage” by demonstrating weakness and exposing “air” in the marks.5823

Air?

Uh, that’s an apparent admission that FRBNY and Tim Geithner specifically knew that the marks that these banks were taking on their assets was materially and intentionally false.

Where have we seen this of late?  Oh yeah – in all those banks that have failed of late, with 25-40% discounts to their claimed balance sheet values when the marks are actually reduced to losses to the deposit fund by the FDIC!

So let’s see here.  We now have:

1. Geithner, and presumably everyone under him, knew the marks on these assets were fictions months before Lehman failed, yet they intentionally concealed this fact from the market and took no action (nor did the SEC) to disclose this intentional misdirection.

2. The misdirection and false claims in this regard are almost certainly continuing today, as evidenced by the FDIC seizures literally on an every-week basis.

How about Bernanke?  While he maintains (as did Geithner) that primary responsibility lay with the SEC, he also said:

Our concern was about the financial system, and we knew the implications for the greater financial system would be catastrophic, and it was.”

What does all this say about the stability of things now?

Yeah, I know, everyone’s “too big to fail.” 

But what if the truth is that they’re “too big to bail“, for instance, if one of the “big four” was to get in trouble today due to a recognition in the marketplace that not only is this what blew up Bear Stearns and Lehman Brothers, but that the same chicanery with “asset values” is continuing even today, and as such one cannot be reasonably certain that liquidity provided today will be repaid tomorrow?

Why is it that if the implications would be catastrophic (and they were), both the SEC and FRBNY knew that Lehman had insufficient liquidity long before the collapse (and they did) neither the SEC, The Federal Reserve or FRBNY did a damn thing to blow the whistle on this crap and put a stop to it?

This report sets out a damning case against the pseudo-government and government actors, who it is alleged were well-aware of critical weaknesses in Lehman’s risk controls and liquidity months before it collapsed, yet none of them did a damn thing about it until days before the bankruptcy filing.

Why should any of the clown-car riders who clearly knew that this situation existed for literal months before it blew up, yet did nothing, still retain their jobs and, in Geithner’s case, obtain a promotion?  These people are unqualified for supervisory positions involving anything more complicated than handing out towels in the men’s room.

The key question facing the nation this evening is not, however, the past.  It is the future.  We have over 100 literal instances in which banks have been seized by the FDIC since Lehman blew up in which their balance sheet “asset values” have been shown by the FDIC’s own DIF loss projections to be abject fictions, yet none of these institutions have been flagged to investors or the public, no indictments or civil complaints have been brought by the SEC or Department of Justice, and they have remained operating for months with these bogus values exhibited for bank examiners and regulators to see.

IF – and I stress IF – these fictions are also present in our large banking institutions, and there is NO REASON TO BELIEVE THEY ARE NOT, it is simply a matter of time before one or more of them detonates in a similar if not identical fashion.  Since these firms are all much larger than Lehman and neither the FDIC or Treasury has a spare $500 billion laying around for the potential payout to depositors that might be necessary in such an instance, we cannot reasonably assume that the risk of financial Armageddon has in fact passed until we know for a fact that all fictional balance sheets are excised and all off-sheet exposures accounted for.

Well now this is a rather interesting editorial:

Today, we should all be paying attention to a new theme: the simultaneous and significant deterioration in the public finances of many advanced economies. At present this is being viewed primarily – and excessively – through the narrow prism of Greece. Down the road, it will be recognised for what it is: a significant regime shift in advanced economies with consequential and long-lasting effects. To stay ahead of the process, we should keep the following six points in mind.

El-Erian goes on to list six points that make most people’s eyes glaze over.  Indeed, the entire editorial is one of those things that reminds one of Alan Greenspan and his famous “how to write 3,000 words and yet never find two people who agree on what you said.”

The final three paragraphs are worth reading though:

This leads to the sixth and final point. We should expect (rather than be surprised by) damaging recognition lags in both the public and private sectors. Playbooks are not readily available when it comes to new systemic themes. This leads many to revert to backward-looking analytical models, the thrust of which is essentially to assume away the relevance of the new systemic phenomena.

You mean things like taking in 30% of what the government spends via taxes, then dismissing this as “oh we’ll just issue some more T-bills”?

There is a further complication. Timely recognition is necessary but not sufficient. It must be followed by the correct response. Here, history suggests that it is not easy for companies and governments to overcome the tyranny of backward-looking internal commitments.

Uh, did you parse that one folks?

“…..tyranny of backward-looking internal commitments”

That’s code for “entitlements that were promised to people but cannot possibly be provided, no matter how long people howl – or how loudly.”

Where does all this leave us? Our sense is that the importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood. Yet, with time, it will prove to be highly consequential. The sooner this is recognised (sp), the greater the probability of being able to stay ahead of the disruptions rather than be hurt by them.

Forget it.  One need only look to Greece, where telling people they have to actually go to work and produce something in order to earn a public-sector salary produces riots.

If you think we’re “more advanced” in our thinking here in the United States you’re simply insane.

Times like this require a man in the left seat with a big fat church-bell sized set of balls, and the willingness to be unpopular enough to be a one-term wonder.  This is inherently in conflict with the narcissist personality required to run for President in the first place.

Nobody who wants the job and is electable to the office is fit for it at a time like this.  I’d do it if drafted, but I’d never put up with the crap required to get there, nor am I electable – because I refuse to lie in the fashion required to obtain the office.  Stumping for votes while pointing out that promising to pay $100 trillion in Social Security and Medicare that we don’t have and can’t acquire, that if we try to print our way out of debt that “obligation” will go from $100 trillion to $250 trillion (which still can’t be paid), and that the sort of measures required to bring the economy and government back into balance – at both a state and federal level – will result in massive shifts in the economy’s balance and, in the short-term, lead to even more pain, are not popular.  To the contrary – not one person receiving those handouts would vote for me, and since they’re nearly half the population there’s not a snowball’s chance in Hades that I could carry the day at the polls.

So what’s required is a paradox.  You need a man or woman who will run for the office saying all the “right things” while lying through their teeth.  Someone who will shed that veneer the instant the election is over, then take the left seat and be a five-alarm bastard once in office, placing a big sign on the door “$ = NO!”

Someone who will take a look at The Constitution and if they can’t find whatever it is being proposed in the four corners of the text, it’s gone.  That is, Social Security and Medicare – gone.  Provide some sort of subsidy to the states with whatever we’ve actually got in the so-called “Trust Fund” (that is, distribute to them the “special Treasuries” in the so-called “box”) and immediately end FICA.  The States are then free to run the programs as they see fit.  This will instantly force accountability and a transition to a privately-owned pair of accounts, or perhaps one account that provides both functions, since people move and won’t accept anything else.

Someone who will align tax revenue with GDP permanently and radically.  This means The Fair Tax, and if Congress won’t enact it, then The President does it by executive order – by abolishing the IRS’ funding and authority!  Issue an executive order barring the DOJ and other Federal Law Enforcement from enforcing anything in The Internal Revenue Code, and suddenly Congress will become far more reasonable since in order to acquire funds they will have to do the right thing.  Radical?  Yes.  Bye-bye 16th Amendment and “K Street.”

Now go find the rest.  Departments of Education and Agriculture, as just two examples: Gone.  All State Mandates from The Federal Government: Gone.

If you can’t find it in The Constitution it goes back to The States and is regulated within their borders.  The ability of the people to freely migrate from one state to another enforces fiscal responsibility – if you behave like a jackass, such as California has done, you will be rapidly de-populated and without a tax base, your policies fail.  End of discussion.  No more Federal Welfare of any sort.  If The States want to provide it and can fund it, goody for them.  More likely what happens is that The States suddenly find that they can provide lots of workfare doing things that need done, provided they outlaw public employee unions first to disarm those thugs.

On monetary policy it’s simple: The Fed either honors its actual written mandate or they’re gone too.  No more BS, no more opacity.  Everything they do is public and published on The Internet. Send up a bill mandating that any gaming of economic statistics or monetary policy is a federal offense garnering you 20-to-life in the can and demand that it pass or you’ll veto every bill that comes to your desk until it does.

On Credit Default Swaps and other instruments: All trade on a public exchange.  All exchanges in the US are public, non-profit organizations.  The Federal Government will run one and The States are welcome to set them up too – but only as public non-profits.  National Best Bid and Offer (NBBO) is guaranteed by law with felony criminal penalties for anyone gaming it – like offering ”Flash Orders.”  Any federally-chartered institution that fails to adhere to One Dollar of Capital is instantaneously closed – without exception.  All firms trading on a public exchange or doing business in The United States across state borders (and therefore under proper federal regulation) is required to produce full, complete and truthful financial statements, without exception.  This means the use of off-balance sheet anything is absolutely prohibited under pain of immediate delisting and felony fraud prosecution.

We adopt a national policy that tariffs are set to provide wage parity.  This will produce howling from the WTO.  Tough.  No longer will we permit wage arbitrage as a reason to offshore jobs.  This is not only Constitutional, it is the premise upon which this nation was founded in terms of how the Federal Government is supposed to acquire its funds!  Combined with The Fair Tax, which will make the United States a corporate tax haven (zero corporate and personal income tax rate) this will result in an instantaneous flood of manufacturing and high-tech jobs back into the United States – all GDP boosters.  The United States GDP would double within a decade.

Refuse to sign any budget that does not run a primary surplus, except in times of declared war.  If Congress or The Administration wants to play International Cop it either funds the entire thing on-budget and pays for it or declares war and has the ability to do so via deficit spending.

Adopt Freedom’s Vision for monetary policy.  No more debt-backed currency.  If The Fed doesn’t like being relegated to a clearing house for payments that’s too damn bad.  Tell the CFTC you’d like them to list a “boiled rope” futures contract just to underline the point.

Radical?  Yes.

The only solution long-term?  Yes.

Will it happen?  Not unless our present Administration grows a set of balls, which it does not at present possess, or someone is willing to both lie themselves into office and then do it anyway.

As a consequence what El-Erian is talking about will happen – an “unexpected” recognition of the reality that what is being done today both is unsustainable and won’t work, but we will do nothing appropriate about any of it until we find ourselves well-off the cliff and furiously pedaling in the air like Wile-E-Coyote – and at that point it will be to late to avoid the ugly consequences.