Archive for May 17th, 2010
The lie is comfortable, an illusion easy to live with, familiar, and safe.
Writing from the ‘disgraced profession’ of economics, James K. Galbraith speaks of the unspoken, the many frauds and deceptions underlying the recent financial crisis centered in the US. Many will read this and shake their heads in agreement, but will be unable to take the next logical step and internalize the implications of the depth and breadth of the dishonesty that enabled it then, and continues to sustain it, even today. Galbraith is asking ‘why’ and framing a further inquiry into the consequences of this unwillingness to reform.
“Some appear to believe that “confidence in the banks” can be rebuilt by a new round of good economic news, by rising stock prices, by the reassurances of high officials – and by not looking too closely at the underlying evidence of fraud, abuse, deception and deceit. As you pursue your investigations, you will undermine, and I believe you may destroy, that illusion.”
It is easier to go with the flow, relax, rationalize, and be diverted and entertained by ‘the show.‘ The truth may set you free, but before that it can make you feel very insecure and uncomfortable, especially when it requires challenging the ‘official story’ and policy decisions. Better to say nothing offensive to the oligarchs, and even occasionally to utter intelligent sounding condemnations of those who dare to question the very things you wonder about, and fear, in order to prove your loyalty and to reassure yourself that you are a right-thinking, practical individual. For the disparity that is unavoidably noticed between what is seen and what is said makes one uneasy, fearful that they are losing their bearings, if not reason. And the vested interests play on those fears. See Techniques of Propaganda
The consequences of ‘extend and pretend’ will be to worsen the final outcome, the day of reckoning.
“The initial deviation from the truth will be multiplied a thousandfold.” Aristotle
The banks must be restrained, the financial and political system reformed, and balance restored to the economy, before there can be any sustained recovery.
Why the ‘Experts’ Failed to See How Financial Fraud Collapsed the Economy
By James K. Galbraith
May 16, 2010
Editor’s Note: The following is the text of a James K. Galbraith’s written statement to members of the Senate Judiciary Committee delivered this May.
Chairman Specter, Ranking Member Graham, Members of the Subcommittee, as a former member of the congressional staff it is a pleasure to submit this statement for your record.
I write to you from a disgraced profession. Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis. Concepts including “rational expectations,” “market discipline,” and the “efficient markets hypothesis” led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on, and that widespread fraud therefore could not occur. Not all economists believed this – but most did.
Thus the study of financial fraud received little attention. Practically no research institutes exist; collaboration between economists and criminologists is rare; in the leading departments there are few specialists and very few students. Economists have soft- pedaled the role of fraud in every crisis they examined, including the Savings & Loan debacle, the Russian transition, the Asian meltdown and the dot.com bubble. They continue to do so now. At a conference sponsored by the Levy Economics Institute in New York on April 17, the closest a former Under Secretary of the Treasury, Peter Fisher, got to this question was to use the word “naughtiness.” This was on the day that the SEC charged Goldman Sachs with fraud.
There are exceptions. A famous 1993 article entitled “Looting: Bankruptcy for Profit,” by George Akerlof and Paul Romer, drew exceptionally on the experience of regulators who understood fraud. The criminologist-economist William K. Black of the University of Missouri-Kansas City is our leading systematic analyst of the relationship between financial crime and financial crisis. Black points out that accounting fraud is a sure thing when you can control the institution engaging in it: “the best way to rob a bank is to own one.” The experience of the Savings and Loan crisis was of businesses taken over for the explicit purpose of stripping them, of bleeding them dry. This was established in court: there were over one thousand felony convictions in the wake of that debacle. Other useful chronicles of modern financial fraud include James Stewart’s Den of Thieves on the Boesky-Milken era and Kurt Eichenwald’s Conspiracy of Fools, on the Enron scandal. Yet a large gap between this history and formal analysis remains.
Formal analysis tells us that control frauds follow certain patterns. They grow rapidly, reporting high profitability, certified by top accounting firms. They pay exceedingly well. At the same time, they radically lower standards, building new businesses in markets previously considered too risky for honest business. In the financial sector, this takes the form of relaxed – no, gutted – underwriting, combined with the capacity to pass the bad penny to the greater fool. In California in the 1980s, Charles Keating realized that an S&L charter was a “license to steal.” In the 2000s, sub-prime mortgage origination was much the same thing. Given a license to steal, thieves get busy. And because their performance seems so good, they quickly come to dominate their markets; the bad players driving out the good.
The complexity of the mortgage finance sector before the crisis highlights another characteristic marker of fraud. In the system that developed, the original mortgage documents lay buried – where they remain – in the records of the loan originators, many of them since defunct or taken over. Those records, if examined, would reveal the extent of missing documentation, of abusive practices, and of fraud. So far, we have only very limited evidence on this, notably a 2007 Fitch Ratings study of a very small sample of highly-rated RMBS, which found “fraud, abuse or missing documentation in virtually every file.” An efforts a year ago by Representative Doggett to persuade Secretary Geithner to examine and report thoroughly on the extent of fraud in the underlying mortgage records received an epic run-around.
When sub-prime mortgages were bundled and securitized, the ratings agencies failed to examine the underlying loan quality. Instead they substituted statistical models, in order to generate ratings that would make the resulting RMBS acceptable to investors. When one assumes that prices will always rise, it follows that a loan secured by the asset can always be refinanced; therefore the actual condition of the borrower does not matter. That projection is, of course, only as good as the underlying assumption, but in this perversely-designed marketplace those who paid for ratings had no reason to care about the quality of assumptions. Meanwhile, mortgage originators now had a formula for extending loans to the worst borrowers they could find, secure that in this reverse Lake Wobegon no child would be deemed below average even though they all were. Credit quality collapsed because the system was designed for it to collapse.
A third element in the toxic brew was a simulacrum of “insurance,” provided by the market in credit default swaps. These are doomsday instruments in a precise sense: they generate cash-flow for the issuer until the credit event occurs. If the event is large enough, the issuer then fails, at which point the government faces blackmail: it must either step in or the system will collapse. CDS spread the consequences of a housing-price downturn through the entire financial sector, across the globe. They also provided the means to short the market in residential mortgage-backed securities, so that the largest players could turn tail and bet against the instruments they had previously been selling, just before the house of cards crashed.
Latter-day financial economics is blind to all of this. It necessarily treats stocks, bonds, options, derivatives and so forth as securities whose properties can be accepted largely at face value, and quantified in terms of return and risk. That quantification permits the calculation of price, using standard formulae. But everything in the formulae depends on the instruments being as they are represented to be. For if they are not, then what formula could possibly apply?
An older strand of institutional economics understood that a security is a contract in law. It can only be as good as the legal system that stands behind it. Some fraud is inevitable, but in a functioning system it must be rare. It must be considered – and rightly – a minor problem. If fraud – or even the perception of fraud – comes to dominate the system, then there is no foundation for a market in the securities. They become trash. And more deeply, so do the institutions responsible for creating, rating and selling them. Including, so long as it fails to respond with appropriate force, the legal system itself.
Control frauds always fail in the end. But the failure of the firm does not mean the fraud fails: the perpetrators often walk away rich. At some point, this requires subverting, suborning or defeating the law. This is where crime and politics intersect. At its heart, therefore, the financial crisis was a breakdown in the rule of law in America.
Ask yourselves: is it possible for mortgage originators, ratings agencies, underwriters, insurers and supervising agencies NOT to have known that the system of housing finance had become infested with fraud? Every statistical indicator of fraudulent practice – growth and profitability – suggests otherwise. Every examination of the record so far suggests otherwise. The very language in use: “liars’ loans,” “ninja loans,” “neutron loans,” and “toxic waste,” tells you that people knew. I have also heard the expression, “IBG,YBG;” the meaning of that bit of code was: “I’ll be gone, you’ll be gone.”
If doubt remains, investigation into the internal communications of the firms and agencies in question can clear it up. Emails are revealing. The government already possesses critical documentary trails — those of AIG, Fannie Mae and Freddie Mac, the Treasury Department and the Federal Reserve. Those documents should be investigated, in full, by competent authority and also released, as appropriate, to the public. For instance, did AIG knowingly issue CDS against instruments that Goldman had designed on behalf of Mr. John Paulson to fail? If so, why? Or again: Did Fannie Mae and Freddie Mac appreciate the poor quality of the RMBS they were acquiring? Did they do so under pressure from Mr. Henry Paulson? If so, did Secretary Paulson know? And if he did, why did he act as he did? In a recent paper, Thomas Ferguson and Robert Johnson argue that the “Paulson Put” was intended to delay an inevitable crisis past the election. Does the internal record support this view?
Let us suppose that the investigation that you are about to begin confirms the existence of pervasive fraud, involving millions of mortgages, thousands of appraisers, underwriters, analysts, and the executives of the companies in which they worked, as well as public officials who assisted by turning a Nelson’s Eye. What is the appropriate response?
Some appear to believe that “confidence in the banks” can be rebuilt by a new round of good economic news, by rising stock prices, by the reassurances of high officials – and by not looking too closely at the underlying evidence of fraud, abuse, deception and deceit. As you pursue your investigations, you will undermine, and I believe you may destroy, that illusion.
But you have to act. The true alternative is a failure extending over time from the economic to the political system. Just as too few predicted the financial crisis, it may be that too few are today speaking frankly about where a failure to deal with the aftermath may lead.
In this situation, let me suggest, the country faces an existential threat. Either the legal system must do its work. Or the market system cannot be restored. There must be a thorough, transparent, effective, radical cleaning of the financial sector and also of those public officials who failed the public trust. The financiers must be made to feel, in their bones, the power of the law. And the public, which lives by the law, must see very clearly and unambiguously that this is the case. Thank you.
James K. Galbraith is the author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too, and of a new preface to The Great Crash, 1929, by John Kenneth Galbraith. He teaches at The University of Texas at Austin.
Fascism: Arose during the 1920s and ’30s partly out of fear of the rising power of the working classes; it differed from contemporary communism (as practiced under Joseph Stalin) by its protection of business and landowning elites and its preservation of class systems. — Encyclopaedia Britannica
America’s Ten Most Corrupt Capitalists (Fascists)
The financial crisis has unveiled a new set of public villains—corrupt corporate capitalists who leveraged their connections in government for their own personal profit. During the Clinton and Bush administrations, many of these schemers were worshiped as geniuses, heroes or icons of American progress. But today we know these opportunists for what they are: Deregulatory hacks hellbent on making a profit at any cost. Without further ado, here are the 10 most corrupt capitalists in the U.S. economy.
1. Robert Rubin
Where to start with a man like Robert Rubin? A Goldman Sachs chairman who wormed his way into the Treasury Secretary post under President Bill Clinton, Rubin presided over one of the most radical deregulatory eras in the history of finance. Rubin’s influence within the Democratic Party marked the final stage in the Democrats’ transformation from the concerned citizens who fought Wall Street and won during the 1930s to a coalition of Republican-lite financial elites.
Rubin’s most stunning deregulatory accomplishment in office was also his greatest act of corruption. Rubin helped repeal Glass-Steagall, the Depression-era law that banned economically essential banks from gambling with taxpayer money in the securities markets. In 1998, Citibank inked a merger with the Travelers Insurance group. The deal was illegal under Glass-Steagall, but with Rubin’s help, the law was repealed in 1999, and the Citi-Travelers merger approved, creating too-big-to-fail behemoth Citigroup.
That same year, Rubin left the government to work for Citi, where he made $120 million as the company piled up risk after crazy risk. In 2008, the company collapsed spectacularly, necessitating a $45 billion direct government bailout, and hundreds of billions more in other government guarantees. Rubin is now attempting to rebuild his disgraced public image by warning about the dangers of government spending and Social Security. Bob, if you’re worried about the deficit, the problem isn’t old people trying to get by, it’s corrupt bankers running amok.
2. Alan Greenspan
The officially apolitical, independent Federal Reserve chairman backed all of Rubin’s favorite deregulatory plans, and helped crush an effort by Brooksley Born to regulate derivatives in 1998, after the hedge fund Long-Term Capital Management went bust. By the time Greenspan left office in 2006, the derivatives market had ballooned into a multi-trillion dollar casino, and Greenspan wanted his cut. He took a job with bond kings PIMCO and then with the hedge fund Paulson & Co.—yeah, that Paulson and Co., the one that colluded with Goldman Sachs to sabotage the company’s own clients with unregulated derivatives.
Incidentally, this isn’t the first time Greenspan has been a close associate of alleged fraudsters. Back in the 1980s, Greenspan went to bat for politically connected Savings & Loan titan Charles Keating, urging regulators to exempt his bank from a key rule. Keating later went to jail for fraud, after, among other things, putting out a hit on regulator William Black. (“Get Black – kill him dead.”) Nice friends you’ve got, Alan.
3. Larry Summers
During the 1990s, Larry Summers was a top Treasury official tasked with overseeing the economic rehabilitation of Russia after the fall of the Soviet Union. This project, was, of course, a complete disaster that resulted in decades of horrific poverty. But that didn’t stop top advisers to the program, notably Harvard economist Andrei Shleifer, from getting massively rich by investing his own money in Russian projects while advising both the Treasury and the Russian government. This is called “fraud,” and a federal judge slapped both Shleifer and Harvard itself with hefty fines for their looting of the Russian economy. But somehow, after defrauding two governments while working for Summers, Shleifer managed to keep his job at Harvard, even after courts ruled against him.
That’s because after the Clinton administration, Summers became president of Harvard, where he protected Shleifer. This wasn’t the only crazy thing Summers did at Harvard—he also ran the school like a giant hedge fund, which went very well until markets crashed in 2008. By then, of course, Summers had left Harvard for a real hedge fund, D.E. Shaw, where he raked in $5.2 million working part-time. The next year, he joined the the Obama administration as the president’s top economic adviser. Interestingly, the Wall Street reform bill currently circulating through Congress essentially leaves hedge funds untouched.
4. Phil and Wendy Gramm
Summers, Rubin and Greenspan weren’t the only people who thought it was a good idea to let banks gamble in the derivatives casinos. In 2000, Republican Senator from Texas Phil Gramm pushed through the Commodity Futures Modernization Act, which not only banned federal regulation of these toxic poker chips, it also banned states from enforcing anti-gambling laws against derivatives trading. The bill was lobbied for heavily by energy/finance hybrid Enron, which would later implode under fraudulent derivatives trades. In 2000, when Phil Gramm pushed the bill through, his wife Wendy Gramm was serving on Enron’s board of directors, where she made millions before the company went belly-up.
When Phil Gramm left the Senate, he took a job peddling political influence at Swiss banking giant UBS as vice chairman. Since Gramm’s arrival, UBS has been embroiled in just about every scandal you can think of, from securities fraud to tax fraud to diamond smuggling. Interestingly, both UBS shareholders and their executives have gotten off rather lightly for these acts. The only person jailed thus far has been the tax fraud whistleblower. Looks like Phil’s earning his keep.
5. Jamie Dimon
J.P. Morgan Chase CEO Jamie Dimon has done a lot of scummy things as head of one of the world’s most powerful banks, but his most grotesque act of corruption actually took place at the Federal Reserve. At each of the Fed’s 12 regional offices, the board of directors is staffed by officials from the region’s top banks. So while it’s certainly galling that the CEO of J.P. Morgan would be on the board of the New York Fed, one of J.P. Morgan’s regulators, it’s not all that uncommon.
But it is quite uncommon for a banker to be negotiating a bailout package for his bank with the New York Fed, while simultaneously serving on the New York Fed board. That’s what happened in March 2008, when J.P. Morgan agreed to buy up Bear Stearns, on the condition that the Fed kick in $29 billion to cushion the company from any losses. Dimon– CEO of J.P. Morgan and board member of the New York Fed– was negotiating with Timothy Geithner, who was president of the New York Fed– about how much money the New York Fed was going to give J.P. Morgan. On Wall Street, that’s called being a savvy businessman. Everywhere else, it’s called a conflict of interest.
6. Stephen Friedman
The New York Fed is just full of corruption. Consider the case of Stephen Friedman (expertly presented by Greg Kaufmann for the Nation). As the financial crisis exploded in the fall of 2008, Friedman was serving both as chairman of the New York Fed and on the board of directors at Goldman Sachs. The Fed stepped in to prevent AIG from collapsing in September 2008, and by November, the New York Fed had decided to pay all of AIG’s counterparties 100 cents on the dollar for AIG’s bets—even though these companies would have taken dramatic losses in bankruptcy. The public wouldn’t learn which banks received this money until March 2009, but Friedman bought 52,600 shares of Goldman stock in December 2008 and January 2009, more than doubling his holdings.
As it turns out, Goldman was the top beneficiary of the AIG bailout, to the tune of $12.9 billion. Friedman made millions on the Goldman stock purchase, and is yet to disclose what he knew about where the AIG money was going, or when he knew it. Either way, it’s pretty bad—if he knew Goldman benefited from the bailout, then he belongs in jail. If he didn’t know, then what exactly was he doing as chairman of the New York Fed, or on Goldman’s board?
7. Robert Steel
Like better-known corruptocrats Robert Rubin and Henry Paulson, Steel joined the Treasury after spending several years as a top executive with Goldman Sachs. Steel joined the Treasury in 2006 as Under Secretary for Domestic Finance, and proceeded to do, well, nothing much until financial markets went into free-fall in 2008. When Wachovia ousted CEO Ken Thompson, the company named Steel as its new CEO. Steel promptly bought one million Wachovia shares to demonstrate his commitment to the firm, but by September, Wachovia was in dire straits. The FDIC wanted to put the company through receivership—shutting it down and wiping out its shareholders.
But Steel’s buddies at Treasury and the Fed intervened, and instead of closing Wachovia, they arranged a merger with Wells Fargo at $7 a share—saving Steel himself $7 million. He now serves on Wells Fargo’s board of directors.
8. Henry Paulson
His time at Goldman Sachs made Henry Paulson one of the richest men in the world. Under Paulson’s leadership, Goldman transformed from a private company ruled by client relationships into a public company operating as a giant global casino. As Treasury Secretary during the height of the financial crisis, Paulson personally approved a direct $10 billion capital injection into his former firm.
But even before that bailout, Paulson had been playing fast and loose with ethics rules. In June 2008, Paulson held a secret meeting in Moscow with Goldman’s board of directors, where they discussed economic prognostications, market conditions and Treasury rescue plans. Not okay, Hank.
9. Warren Buffett
Warren Buffett used to be a reasonable guy, blasting the rich for waging “class warfare” against the rest of us and deriding derivatives as “financial weapons of mass destruction.” These days, he’s just another financier crony, lobbying Congress against Wall Street reform, and demanding a light touch on—get this—derivatives! Buffet even went so far as to buy the support of Sen. Ben Nelson, D-Nebraska, for a filibuster on reform. Buffett has also been an outspoken defender of Goldman Sachs against the recent SEC fraud allegations, allegations that stem from fancy products called “synthetic collateralized debt obligations”—the financial weapons of mass destruction Buffett once criticized.
See, it just so happens that both Buffet’s reputation and his bottom line are tied to an investment he made in Goldman Sachs in 2008, when he put $10 billion of his money into the bank. Buffett has acknowledged that he only made the deal because he believed Goldman would be bailed out by the U.S. government. Which, in fact, turned out to be the case, multiple times. When the government rescued AIG, the $12.9 billion it funneled to Goldman was to cover derivatives bets Goldman had placed with the mega-insurer. Buffett was right about derivatives—they are WMD so far as the real economy is concerned. But they’ve enabled Warren Buffett to get even richer with taxpayer help, and now he’s fighting to make sure we don’t shut down his own casino.
10. Goldman Sachs
No company exemplifies the revolving door between Wall Street and Washington more than Goldman Sachs. The four people on this list are some of the worst offenders, but Goldman’s D.C. army has includes many other top officials in this administration and the last.
Joshua Bolton, chief of staff for George W. Bush, was a Goldman man
Current New York Fed President William Dudley is a Goldman man
Current Commodity Futures Trading Commission Chairman Gary Gensler has been a responsible regulator under Obama, but he was a deregulatory hawk during the Clinton years, and worked at Goldman for nearly two decades before that.
A top aide to Timothy Geithner, Gene Sperling, is a Goldman man
Current Treasury Undersecretary Robert Hormats is a Goldman man
Current Treasury Chief of Staff Mark Patterson is a former Goldman lobbyist
Former SEC Chairman Arthur Levitt is now a Goldman adviser
Neel Kashkari, Henry Paulson’s deputy on TARP, was a Goldman man
COO of the SEC Enforcement Division Adam Storch is a Goldman man
Former Sen. John Corzine, D-N.J., was Goldman’s CEO before Henry Paulson
Rep. Jim Himes, D-Conn., was a Goldman Vice President before he ran for Congress
Former House Minority Leader Dick Gephardt, D-Mo., now lobbies for Goldman
A List of Goldman Sachs People in the Obama Government: Names Attached to the Giant Squid’s Tentacles
and from today’s news: