The FCIC Report: Yet Another Whitewash


Well, it’s out.

The “long-awaited” FCIC report has been published, and counts 662 pages.

Our task was first to determine what happened and how it happened so that we could understand why it happened. Here we present our conclusions.

And here the FCIC fails.  But we’ll get to that.

• We conclude this financial crisis was avoidable. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public.

No.  The financial crisis was avoidable, but it was not about the ignoring of warnings by captains of finance.  One does not sell “protection” in the form of a credit default swap (CDS) without any capital behind it by accident.  That is done with intent – the intent to collect a premium and never pay.

The buyer of such a CDS has one of two purposes.  He either intends to conceal a loss that he would otherwise have to mark on his books, or he intends to hold up the taxpayer at a later date when the seller cannot pay.  His action is not undertaken due to “inattention” either.

Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs.

The crisis was not only mathematically certain to occur it was foreseen and known to be occurring by the very firms that nearly collapsed.  This is now a matter of public record in the form of testimony under oath by Citibank’s former Chief Underwriter.  Lehman’s insolvency was known by Citibank and others weeks before it occurred, as has been disclosed by the bankruptcy investigation.  Both industry and government regulators intentionally concealed these facts from the public.  It is no longer speculation that “they knew”, it is now a documented fact.

The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not.

The Federal Reserve, by its own publications, knew that the economy was adding 10, 20, even 30% of GDP in debt on a annual basis.  This is not “unsustainable”, it is fraud and an abuse of the currency power granted by The Constitution to Congress.

But Congress knew this too.  This publication is not secret.  Congress has the power – then and now – to put a stop to it.  But Congress decided not to.  Not then, not now.

This crisis was not a couple of years in the making.  The roots of it go back to the 1980s, when Continental Illinois was bailed out.  At that time the FDIC did an unlawful thing – it decided to bail out bondholders, which it has no statutory authority to do.  The deposit insurance fund exists to bail out depositors.  But having exceeded its authority and gotten away with it, the standard was set for The FDIC to make sure that no large institution would be allowed to actually lead to loss by its bondholders. 

The record of our examination is replete with evidence of other failures: financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective;

Those are not failures, they’re fraudulent activities.  The institutions that made, bought and sold those securities represented to buyers and writers of swaps against them that they had specific qualities. 

They LIED, as is now being shown and documented in the myriad lawsuits, along with FCIC testimony.

They took on enormous exposures in acquiring and supporting subprime lenders and creating, packaging, repackaging, and selling trillions of dollars in mortgage-related securities, including synthetic financial products. Like Icarus, they never feared flying ever closer to the sun.

Unsecured lending beyond your capital is a naked short on the currency.  Since no bank has the authority to issue currency, such an action is an act of counterfeiting.

Writing a swap you have no ability to pay on, as happened at AIG, is the writing of paper worth nothing in exchange for money.  If the party you sell it to actually expects to collect, you defrauded him. If he does not really intend to collect and used the paper he bought at under-market rates as a ruse, he defrauded whoever is relying on his assertion that his position is protected.  Either way, someone committed a crime. 

Where are the cops?

Our examination revealed stunning instances of governance breakdowns and irresponsibility. You will read, among other things, about AIG senior management’s ignorance of the terms and risks of the company’s $79 billion derivatives exposure to mortgage-related securities;

Who cares what their exposure was?  The real scandal is that they had $79 billion in exposure with effectively zero capital behind that position.  That is, they sold $79 billion in exposure with no ability to pay.  Yes, the government was complicit in allowing this by exempting these transactions from insurance regulations through the CFMA.  But that doesn’t change the essential element of the deception – if the buyer knew the swaps were worthless, he committed fraud.  If he didn’t know they were worthless and truly believed AIG had the capital to pay when it did not, then AIG committed fraud. 

You cannot sell something you have no ability to deliver and not have someone who committed fraud somewhere in that transaction.

Either the transaction was a sham or the buyer was scammed.  Pick one.

In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed to the hilt, leaving them vulnerable to financial distress or ruin if the value of their investments declined even modestly.

So when are we going to force this bad debt out of the system?

Oh that’s never, right?  There’s nothing – literally nothing – in this report that demand that occur.

The reason is that doing so bankrupts all the institutions that were responsible.  Yet without defaulting this debt and clearing it there is no way to get out of the crisis, only to pile more fraud upon the existing fraud.

Housing values have fallen by $7 trillion, if you believe the reported numbers from various sources.  How much does the Z1 claim housing mortgage debt has fallen by, systemically?  $504 billion.

Where’s the other $6.5 trillion? 

Sure, some of it was “equity” that is now gone.  But not all of it.  The rest – most of it – is unbacked credit and constitutes a continuing naked short on the currency of The United States.  It also constitutes massive systemic risk, in that should it be forced into the open (and it will eventually be so-forced by the market) it exceeds the total capitalization of the ten largest financial institutions in the United States by several times over.

The crisis is not over and the leverage has not come out.  At all.

The fraud that led to this has not been exposed and referred for prosecution.  At all.

The FCIC not only failed to do what it was charged to do, it did so with intent.  The word “fraud” is peppered through the report, appearing dozens of times.  Yet nowhere do we see recommendations for prosecution.

Fraud is a crime.

We cannot resolve what’s broken in the economy without forcing the bad and un-payable debt into the open.  I’m well-aware that doing so will cause a major sell-off in the markets and reduction in GDP.

But this outcome cannot be avoided.  We can only choose to take the damage now, or have it continue to compound.