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Congressional Testimony of William K. Black regarding the 2008 Lehman Brothers failure.  It’s fraud.  It’s all fraud and Congress has been advised.  They should no longer be allowed the plausible deniability of ignorance.

Coming in October, 2011.  While they don’t come right out and say it, this is the story of the collapse of Lehman Brothers.  A must-see for anyone who wants to further understand the massive and immense amount of fraud that took place in our financial industry over the past decade (and is still taking place today).

Read more at IMDb.

Litigation may be slowly doing the job missed or only partially completed by various governmental investigations into the financial crisis. The Valukas report on the Lehman bankruptcy was revealing, and numerous foreclosure defense attorneys have opened cans of worms that the powers that be would rather pretend simply don’t exist.

The New York Times reports tonight that a case filed last year was unsealed last week. It plumbs a continuing sore point with the public, namely the generous terms of the AIG bailout, both to the company (which defied the government and insisted on remaining largely intact when the plan had been to sell its various units to repay the government funding) and to its credit default swap counterparties. The litigation has the potential to be revealing, particularly if it goes into discovery (various depositions are likely to become public in pre-trial jousting, um, motions). The Times gives an overview:

The lawsuit, filed by a pair of veteran political activists from the La Jolla area of San Diego, asserts that A.I.G. and two large banks engaged in a variety of fraudulent and speculative transactions, running up losses well into the billions of dollars. Then the three institutions persuaded the Federal Reserve Bank of New York to bail them out by giving A.I.G. two rescue loans, which were used to unwind hundreds of failed trades.

The loans were improper, the lawsuit says, because the Fed made them without getting a pledge of high-quality collateral from A.I.G., as required by law.

“To cover losses of those engaged in fraudulent financial transactions is an authority not yet given to the Fed board,” said the plaintiffs, Derek and Nancy Casady, in their complaint, filed in Federal District Court for the Southern District of California.

The lawsuit names A.I.G., Goldman Sachs and Deutsche Bank as defendants, but not the Fed.

The lawsuit itself names other defendants, including Merrill and its successor Bank of America, SocGen, and “Does 1 through 100.”

White shoe types will likely look down their noses at the filing. It makes rather eccentric use of graphics (for instance, including company logos) and includes charts, some of which are very helpful (tables with tabulations and timelines), while others are visual representations of arguments made in the text and hence would be deemed by style snobs to be redundant. It also is somewhat sensationalistic, even heated at points in tone (which does make for more lively reading) and does not unpack its arguments as much as appears to be typical in court filings.

Nevertheless, despite the rough style, there’s some intriguing reading, and the case does a clever job of juxtaposing e-mails and Congressional testimony by AIG executives with various disclosures of the AIG bailout process and the terms of the loan facilities.

To my non-expert eye, the case appears to hinge on the argument that begins on p. 43, that the Fed loans were in violation of the Fed’s authority under the widely-cited “unusual and exigent circumstances” clause. I had taken the reading of former central banker, now Citigroup economist Willem Buiter on this, that it gave the Fed the authority to lend against a dead dog if it chose to.

That appears to be inaccurate, and I wonder if the focus upon this section will embolden the Audit the Fed crowd to have another go at the central bank.

Specifically, the “unusual and exigent” language includes other restrictions, which I read as all being operative:

1. The central bank can lend against “notes, bills, and other drafts of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal reserve bank

2. The “notes, bills, and other drafts of exchange” must be discounted

3. The Federal reserve bank making the loan must obtain evidence that the non-bank party seeking the loan can’t get credit from other banks

4. “….five or more members of the Board of Governors must affirmatively vote to authorize the discount prior to the extension of credit.”

The case focuses on allegedly fraudulent representations made by AIG and the various major dealers in the course of obtaining the financing. But the part I find interesting is the Fed’s evident non-compliance with the requirements of this section, particularly the fact that the central bank lent 100% against the face value of the AIG CDOs, between taking out the CDS and then lending the bailout vehicle Maiden Lane III the funds to buy the CDOs. Interestingly, the SIGTARP investigation missed this issue. If this was at all considered, the argument may have been that the AIG equity in MLIII was tantamount to a discount, but the lawsuit argues that notion is bogus. Since AIG was broke, any money for the AIG equity came from the outside (in fairness, it’s a bit more complex, thanks to reserves set aside over the collateral dispute).

The suit argues that the initial loan was made under false premises, since the loan was secured by all assets of AIG, when the assets were already pledged (all the regulated subs have prior claims on them, both to creditors and policy-holders). The understanding, as depicted in various less-than-official accounts, like the Andrew Ross Sorkin Too Big Too Fail, is that the loans were secured by the equity of the subs. Fine in theory, but in practice, that isn’t what the loan document says, and as important (although not argued in the case) is the amount of the loan was based on what AIG needed to stay afloat, not on any effort to find a market value of the assets pledged and discount that.

In addition, the notion that it was acceptable to lend against stock appears to be based on the discount schedule that the Fed posts and revises from time to time as to the types of collateral that are accepted for lending and the various discount rates established for them. But note that schedule is for depositary institutions. The Fed acted as if it could simply lend against the same assets held by non-depositaries, but the language of the germane section does not appear to support that idea.

The various disclosures of how the Fed lent against pretty much anything the banks could round up, including defaulted securities, is troubling. Defenders of the central bank argue no harm was done since the securities have recovered from crisis lows (well save the ones that went to zero). The problem is that the logic is circular. In many cases, the value of the securities now depends on the fact that the Fed is willing to lend at super low interest rates. So the “market” values are fictive and dependent upon Fed intervention, which is coming at the expense of savers. The interdependence between the Fed’s rescue facilities and its continued interventions is given a free pass, but those of us who are not at the top of the food chain are continuing to pay the cost.

Naked Capitalism

Seriously, there’s a difference between being rather foolish and outright bullcrap.

Culture of Deceit: Why Dick Fuld So Needlessly and Recklessly Perjured Himself Before Congress

“Truth is not only violated by falsehood; it may be equally outraged by silence.”

Henri-Frederic Amiel

Yet another whistle blower who has been completely ignored by the SEC just stepped forward to finally be acknowledged by the media.

A Bloomberg analyst reported around noon NY time that they had verified Mr. Budde’s story, and that indeed Dick Fuld easily had received cash in excess of $500 million in compensation for the period in question, higher than even Henry Waxman had asserted in his charts during Dick Fuld’s testimony.

Mr. Budde, a former counsel who was frustrated and plain fed up with the culture of personal greed and deceit among the Lehman executives stepped forward again to tell his story after being completely ignored by the SEC and the Lehman Board of Directors.

Now, I have some sympathy for Dick Fuld. I mean, when you are making the big bucks owed to a master of the universe, and you eat widows and orphans for breakfast, what does it really matter if it is $300 million, or $550 million, or even the one billion that some estimate was the true total compensation? What is a few hundred millions when you can afford to wipe your derrière with Cohiba cigars, and gargle with Cristal Brut 1990? (Oh yeah, that’s class, real class. I must finally be somebody, and not just some schmuck from the Bronx. I’ll show them, show them all.)

I know I have trouble keeping track of what I have exactly in my own wallet at times, especially after paying the kids a couple of quid to walk the dog. And $200 million is hardly a significant sum anymore in the rapidly expanding compensation universe change on Wall Street. There is the locus of Bernanke’s inflation, the FIRE sector, where the liquidity has been channeled, for years.

But what interests me most is why did Dick Fuld perjure himself over something to obviously verifiable, and largely irrelevant? Doesn’t he file tax returns? Did he mess up using Turbo Tax like other board members of the NY Fed are said to have done? Or was he just a little bit ashamed of taking huge sums from a company that he ran into the ground in a Ponzi scheme? On the other hand Goldman execs celebrate their bonuses and just love to roll in their own irrational greed. Perhaps it was just a slip, a bad habit, a automatic reflex.

Fuld was widely disliked on the Street, and when those sharks and sociopaths, who would sell their own mothers for an eighth, don’t like you there just have to be some serious personality issues involved.

But Dick is likely to be just another scapegoat, like Martha Stewart, in an escalating program to feed the relative small fry to the mob and the show trials, while the great bulk of the crime continues to be concealed.

And just so you don’t feel too sorry for the Dickster, on November 10, 2008 Fuld sold his Florida mansion to his wife Kathleen for $100; this may protect the house from potential legal actions and judgements against him. They had bought it only 4 years earlier for $13.56 million.

Still, one can only ask the question, and wonder, what a brave new world, that has such people in it, virtually running the regulators, the Congress, and the government for their own irrational benefit and obsessive greed.

Bloomberg
Fuld Understated Pay More Than $200 Million, Lehman’s Budde Says
By James Sterngold

April 29 (Bloomberg) — Before Lloyd Blankfein of Goldman Sachs Group Inc. took his place, Richard S. Fuld Jr.’s angry face was the universal symbol of Wall Street greed.

On Oct. 6, 2008, three weeks after Lehman Brothers Holdings Inc. filed the largest bankruptcy in U.S. history, Lehman’s former chief executive officer found himself before Representative Henry A. Waxman, the California Democrat who chaired the House Committee on Oversight and Government Reform. Waxman has stared down plenty of CEOs over the years, yet this had to be one of the most intense confrontations of his career.

“Mr. Fuld will do fine,” Waxman said. “He can walk away from Lehman a wealthy man who earned over $500 million. But taxpayers are left with a $700 billion bill to rescue Wall Street and an economy in crisis.”

Fuld said he was a victim, not an architect, of the collapse, blaming a “crisis of confidence” in the markets for dooming his firm. Reckless management had nothing to do with it. “Lehman Brothers,” he said, “was a casualty.”

Fuld and Waxman went on to disagree about just how much money Fuld had taken out of Lehman before it went under, Bloomberg Businessweek reported in its May 3 edition. Fuld, now 64, said his total compensation from 2000 through 2007 was less than $310 million, not the $485 million that appeared on Waxman’s chart. He said 85 percent of his pay was in Lehman stock that had become worthless. “I never sold my shares,” Fuld said at one point. At another, he said he had not sold the “vast majority” of them.

“That just seems to me an incredible amount of money,” Waxman responded.

Under Oath

Among those closely observing Fuld was a 49-year-old former Lehman lawyer named Oliver Budde who was watching the hearing at home on C-Span. Budde (pronounced Boo-da) was certain Waxman’s figures weren’t too high. They were too low, and he could prove it. Fuld, he believed, had understated the amount he was paid during those years by more than $200 million, and now he had done it under oath, for the entire world to see.

For nine years, Budde had served as an associate general counsel at Lehman. Preparing the public filings on executive compensation had been one of his major responsibilities, and he had been infuriated by what he saw as the firm’s intentional under-representation of how much top executives like Fuld were paid. Budde says he argued with his bosses for years over the matter, so much so that he eventually quit the firm. After he left, he couldn’t let the matter rest.

Contacting Regulators

He contacted the Securities and Exchange Commission and the Lehman board of directors and says neither showed interest in meeting him. He was so shocked by Fuld’s testimony in front of Congress that he started thinking about writing a book going public with his story, which is told here for the first time.

“I wasn’t surprised, because these guys don’t surprise me anymore,” Budde says. “But it just struck me — they’re doing it again. I wasn’t going to sit back and watch…”

Geithner and the NY Fed Accused of Willfully Ignoring Fraud and Covering Up Lehman’s Bad Assets by Senior Regulator During the S&L Crisis

Inquiring minds are digging into a 27 page statement made by William Black before the Financial Services committee. Black is an Associate Professor of Economics and Law, at the University of Missouri.

Professor Black’s statements regarding the collapse of Lehman and the role the Fed played in that collapse are refreshingly candid.

Please consider “Public Policy Issues Raised by the Report of the Lehman Bankruptcy Examiner“. Emphasis, highlighting, and subtitles are mine.

I begin with a short description of my background that is relevant to your questions. My primary appointment is in economics. I have a joint appointment in law. I am a white-collar criminologist. My research specialization is financial fraud by elites and financial regulation. I was a senior regulator during the S&L debacle (and had the honor of testifying many times before this Committee).

Valukas Report Documents Three Major Deficiencies In Lehman Governance

The [Valukas] Report documents at least three major deficiencies in Lehman’s corporate governance that need to be addressed globally. First, it points out that Lehman, and many other Delaware corporations, have eliminated the fiduciary duty of “care.”

… Alan Greenspan has admitted that he had a similar view and that events have falsified this naïve account. It is insane to withdraw accountability for negligence. Doing so encourages negligence. Congress should mandate that corporate officers and directors be subject to the fiduciary duties of care and loyalty. They will still, of course, have the very substantial protection of the business judgment rule.

Second, the same individual should not serve as the CEO and Chair of the Board of Directors of a large corporation. The imperial CEO is a consistent problem in this and prior crises.

Third, Lehman ignored its stated risk “limits” and simply increased its limits retroactively to accommodate its violations of its risk limits. In plain English, that means it had no meaningful limits. ….

I have a different view than Mr. Valukas about the overall state of Lehman’s corporate governance. First, Lehman’s nominal corporate governance structure was a sham. Lehman was deliberately out of control with regard to “risk” in its dominant operation – making “liar’s loans.” Lehman did not “manage” the risk of making liar’s loans. It engaged in massive, fraudulent transactions that were “sure things”.

The Valukas Report bears witness to the consequences of these transactions. The Report provides further evidence of the accuracy of Akerlof’s and Romer’s famous article – “Looting: Bankruptcy for Profit.”

Lehman’s principal source of (fictional) income and real losses was making (and selling) what the trade accurately called “liar’s loans” through its subsidiary, Aurora. (The bland euphemism for liar’s loans was “Alt-A.”) Liar’s loans are “criminogenic” (they create epidemics of mortgage fraud) because they create strong incentives to provide false information on loan applications.

The FBI began warning publicly about the epidemic of mortgage fraud in 2004 (CNN). Liar’s loans also produce intense “adverse selection” – even the borrowers who are not fraudulent will tend to be the least creditworthy. The combination of these two perverse incentives means that liar’s loans, in economics jargon, have a deeply “negative expected value” to the lender. In English, that means that the average dollar lent on a liar’s loan creates a loss ranging from 50 – 85 cents.

That loss, however, may not be recognized for many years – particularly if the liar’s loans become so large that they help hyper-inflate a financial bubble. In the near-term, making massive amounts of liar’s losses loans creates a mathematical guarantee of producing record (albeit fictional) accounting income. (As long as the bubble inflates, the liar’s loans can be refinanced – creating additional fictional income and delaying (but increasing) the eventual loss. The industry saying for this during the S&L debacle was: “a rolling loan gathers no loss.”

Lehman Hid Its Insolvency

Lehman’s underlying problem that doomed it was that it was insolvent because it made so many bad loans and investments. It hid its insolvency through the traditional means – it refused to recognize its losses honestly. It could not resolve its liquidity crisis because it was insolvent and its primary source of fictional accounting income collapsed with the collapse of the secondary market in nonprime loans. If Lehman sold its assets to get cash it would have to recognize these massive losses and report that it was insolvent. Investors knew that Lehman was grossly inflating its asset values, so they were generally unwilling buy stock in Lehman or acquire it.

There is no way to “manage” the “risk” of making massive amounts of liar’s loans. Lehman was the world leader in making liar’s loans. As the name makes clear, Lehman’s top managers knew that their principal source of income was making fraudulent loans. It was necessary, therefore, that Lehman not document that its liar’s loans were frequently fraudulent. Lehman, instead, classified its massively fraudulent liar’s loans as “prime” loans. Its disclosures did not identify how many of the “prime” loans it held were actually liar’s loans. As I will discuss in more detail in response to your final question, Lehman personnel that pointed out the fraudulent liar’s loans were attacked, even fired, by Lehman’s management. Honest managers, of course, would be delighted if employees identified frauds.

That same pattern of conscious managerial indifference to pervasive mortgage and accounting fraud was the norm at other nonprime mortgage participants that have been investigated. I refer to it as the financial “don’t ask; don’t tell” policy.

Making liar’s loans is not risky – it is suicidal. That is why every significant lender specializing in liar’s loans failed. The pervasive fraud cannot be admitted – for Lehman’s entire business model was premised on massive sales of liar’s loans to others.

Lehman’s senior managers consciously chose to take the unethical path because they viewed it as extraordinarily profitable. ….

Black Accuses Geithner and the NY Fed of Willfully Ignoring Fraud

It was a painful, as a former regulator, to read the Valukas report’s discussion of the FRBNY staff’s open disdain for working cooperatively with the SEC to protect the public. The Valukas report exposes the sick relationship between the country’s main regulatory bodies and the systemically dangerous institutions (SDIs) they are supposed to be policing. The FRBNY, led by President Geithner, had a clear statutory mission — promote the safety and soundness of the banking system and compliance with the law – stood by while Lehman deceived the public through a scheme that FRBNY officials likened to a “three card monte routine”. …

Translation: The FRBNY knew that Lehman was engaged in fraud designed to overstate its liquidity and, therefore, was unwilling to loan as much money to Lehman. The FRBNY did not, however, inform the SEC, the public, or the OTS (which regulated an S&L that Lehman owned) of the fraud.

The Fed official doesn’t even make a pretense that the Fed believes it is supposed to protect the public. The FRBNY remained willing to lend to a fraudulent systemically dangerous institution (SDI). This is an egregious violation of the public trust, and the regulatory perpetrators must be held accountable. ….

The FRBNY acted shamefully in covering up Lehman’s inflated asset values and liquidity. It constructed three, progressively weaker, stress tests – Lehman failed even the weakest test. The FRBNY then allowed Lehman to administer its own stress test. Surprise, it passed.

The Fed’s defense of its disgraceful refusal to protect the public is meritless. It argues that it was not there in its regulatory capacity and that it sent only a few staffers that laced the capacity or the leverage to accomplish any supervisory goals. This is either a deliberate obfuscation or a confession of a core failure.

Structural Problems at the Fed

The Fed has inherent problems even in safety & soundness regulation due to its structure. First, the regional FRBs have boards of directors dominated by the industry. Congress already made the policy decision, in removing all regulatory functions from the FHLBs in the 1989 FIRREA legislation, that this is an unacceptable conflict of interest.

Second, supervision is, at best, a tertiary activity at the Fed and regional banks. Monetary policy gets all the emphasis, the credit windows come second, and economic research and safety & soundness regulation vie for a distant third place. (Consumer regulation is a bastard step child at the Fed and most agencies.)

Third, the Fed is far too close to the systemically dangerous institutions. The SDIs are in an ideal position to exploit opportunities for regulatory “capture.”

Fourth, the Fed is dominated by neo-classical economists that have no theory of, experience with, or interest in the complex financial frauds that are the dominant cause of our recurring, intensifying financial crises. Bernanke appointed an economist, Patrick Parkinson, with no examination or supervision experience to head all Fed examination and supervision.

Fifth, the Fed is addicted to opaqueness and its senior ranks believe the bankers when they claim that the people must never be allowed to learn the truth about asset losses. One of the conflicts of interest that a banking regulator must never succumb to is the temptation to encourage or allow the regulated entity to lie about its financial condition for the purported purpose of preventing a run on the bank. Geithner, unfortunately, embraced that temptation and stated it openly to the Bankruptcy Examiner.

It is very easy, psychologically, to believe that you are letting a bank lie to the public for a noble reason – protecting the public. The bankers always tell the regulators that the world will end if the banks tell the truth – but that is a lie. Regulators’ greatest asset is their integrity.

The relevant issue was never: can Lehman be saved? The relevant issue, one that the SEC and the Fed appear never to have even asked, was: how can we stop Lehman from serving as a vector spreading the epidemic of liar’s loans? They should have asked themselves that question — and acted — no later than 2001.

That is a very damning appraisal of the competence of Ben Bernanke and the entire Fed.

It is also grounds for indictment of Tim Geithner and the board of directors at Lehman. Assuming Bernanke was a willing conspirator in the ongoing coverup of Lehman, he should be indicted for criminal fraud as well.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
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