These are a series of old articles by Anton Fekete on the Great Depression, w alternate, non-Keynesian analysis. I find this explanation much more believable.
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By: Antal E. Fekete
Tue, May 7, 2002
Following John Maynard Keynes, mainstream economists hold that the Great Depression was caused by 'contractionist tendencies' of the gold standard. In this revisionist view we shall argue that just the opposite is true: it was the destruction of the gold standard by the government that caused the unprecedented collapse in the world economy. The chain of causation was as follows. Interest rates were cut adrift from their gold moorings by the politicians. Bond speculators were unleashed. Chief among them were the banks. For them the new dispensation was a matter of life or death. The banks were insolvent. They were gambling that they might be able to plug the enormous holes in the balance sheet with capital gains in the bond portfolio, that is, by oushing interest rates down. But there was another factor that made the case for bond speculation compelling. The risks involved, well past the range of prudence of bank portfolio management, were removed by the ban on gold hoarding. This ban has created a captive market for bonds. Previously those individuals who wanted to manage their liquid wealth most conservatively would park it in gold. As this was no longer legally possible, they now had to park it in government bonds. Thus the banks' risk that interest rates would turn against their speculative long position in bonds were removed. This explains the extraordinary virulence of the speculative orgy driving bond prices up or, what is the same to say, driving interest rates down.
Using fundamental principles of accounting we shall prove our main thesis asserting that falling interest rates squeeze the profits of productive enterprise. Worse still, in the 1930's the squeeze was concealed by the accounting code which ill-advised politicians had relaxed at the start of World War I. As a result losses were reported as profits and phantom profits were paid out as dividends to shareholders. There was a hidden destruction of capital across the board. More precisely, capital was clandestinely siphoned off from the balance sheet of the productive sector to show up in the form of capital gains in the balance sheet of the financial sector. The collapse of production was not caused by the collapse of demand as asserted by Keynes. Rather, the collapse of demand was caused by the collapse of production, which could have been avoided by keeping the interest-rate structure stable, as it has always been under the gold standard, shutting out bond speculation. The economists' profession would do well to re-examine its prejudices and prepossessions about the gold standard. The urgency of this task is all the more pressing in view of the unfolding deflationary scenario. Once more, the interest-rate structure appears to be falling inexorably, driven by another tsunami of bull speculation in bonds in which the big American and Japanese banks are calling the shots. Far from being able to control the situation, central banks are helpless. Their financial resources are no match for those of the bond speculators.
The only way to avert another tragedy is to stabilize the interest-rate structure. This the United States government could accomplish overnight, by opening the Mint to gold.
I. SPECULATIVE ORGY IN BONDS
Fly in the Ointment
There are two standard views of the Great Depression of the 1930's. Keynesians maintain that the capitalist system is, by its very nature, prone to overproduction and, in the absence of government intervention, excessive inventories will periodically lead to falling prices and to growing unemployment which will further compound the collapse in demand. They advocate public works financed, if need be, by massive deficit spending. The central bank must be instructed to buy up all the government bonds that the market is unwilling to absorb. According to the Keynesian view in the early 1930's the current economic fetish, the balanced budget, prevented an increase in public spending to boost demand. Thus, then, faulty fiscal policy is to be blamed for the economic collapse that followed. On the other hand Friedmanites maintain that, although the central bank should thrash out new money at a steady rate (something that in the words of Friedman "even a clever horse could be trained to do") the Federal Reserve was unable to learn this simple rule. It has been issuing money erratically, at times too much as in the stock-market frenzy of the 1920's; then again too little as after the stock-market collapse in the 1930's. In the latter episode the economy was squeezed through a shortage of money causing prices to fall. Thus, then, faulty monetary policy is to be blamed for the economic collapse that followed.
For some time it has been increasingly clear that both views fall short of the mark. The Friedmanites ignore the fact that while the central bank has power to issue all the money it wants at any rate of volume it wants through the instrumentality of open market purchases of bonds, yet it is utterly powerless to determine how the new money so created shall be used by market participants. Commodity speculation is not the only use to which newly created money can be put. Another possibility is bond speculation which instead of raising the prices of goods will raise the prices of bonds or, what is the same to say, will lower interest rates. Thus the sorcerer (the central bank) finds itself in competition with its apprentices (the bond speculators) and, of necessity, will lose control to them. On the other hand, the Keynesians ignore the fact that financing public works is a depressant on enterprising exuberance. Entrepreneurs are not prepared to compete unconditionally with the government for funds to finance projects. They want to be convinced that theirs will be profitable. Deficit spending by government brings profitability of the projects of private enterprise very much into question.
Although superficially these two approaches to the problem appear to argue from different angles, they are in fact the same, albeit in different disguise. Both the Keynesians and the Friedmanites advocate the application of the same nostrum: the monetization of government debt, for the same purpose: to suppress the rate of interest for political ends. But there is a fly in the ointment prescribed by quacks of either persuasion, namely, the bond speculator. The so-called fiscal and monetary stimulus to boost demand is a myth. Either stimulus rather than boosting demand for commodities shall only boost speculative demand for bonds. The bond speculator wants to buy first so that he can feed the bonds to the central bank at a hefty price advance when it is ready to enter the open market to buy its quota.
Loading the Dice
Here is the description of the process in more details. As the bond market is destabilized by the expulsion of gold and by the introduction of an extraneous demand for bonds for purposes other than saving (to wit, for political purposes) there will appear an increase in the volatility of bond prices, and a corresponding increase in the volatility of interest rates. Bond speculators, dormant while the interest-rate regime is stable as it is under a gold standard, will come to life with a vengeance as soon as volatility appears. Individual speculators as well as financial institutions will duly note that big money is to be made by trading (as opposed to holding) bonds. There is more. In the new casino (the bond market) the dice are loaded (the odds are stacked in favor of the bulls). Speculators armed with this intelligence can have a free ride to riches. They simply stick to the long side of the market. Since the central bank is a buyer virtually every time it enters the market, the risk inherent in trading bonds has by and large been eliminated. Speculators buy before the central bank does, and sell after. Little wonder that bond speculation has snowballed and become malignant, exceeding even the worst excesses of the earlier stock-market speculation.
Stabilizing or Destabilizing Speculation?
The insight that both the Keynesian and Friedmanite nostrums (allegedly suitable to prevent depressions) are counter-productive in that they aggravate rather than alleviate the crisis, has escaped mainstream economists. They accept the conventional wisdom that speculation tends to dampen volatility in any market. However, this generalization is patently false. One must distinguish between two kinds: stabilizing and destabilizing speculation according as it deals with risks created by nature, or risks created by man. The thesis that speculation will even out fluctuations is true only of the first variety, e.g., speculation in market for agricultural commodities. With regard to the second, speculation in markets dealing with risks created by man (including those created by governments), fluctuations will increase as a result of speculation. For example, in the bond market more speculation means more volatility, not less, as speculators seek to induce and ride price trends, rather than resisting them. They do not act randomly as speculators in the commodity markets do. Bond speculators march in lockstep.
The Rise in the Cost of Liquidating Liabilities
We shall see that bond speculation has a pivotal role in the genesis of depression and deflation. The buying of bonds for speculative purposes depresses interest rates from their true level. The mechanism that transmits the fall in the interest-rate structure to a fall in the commodity price structure is provided by the rising bond price. It makes the present value of total debt rise. As a rule of thumb, the present value of debt gets doubled every time the rate of interest gets halved. (For details, see my two papers Kondratieff Revisited and The Economic Consequences of Mr. Greenspan.) As the present value of debt rises, the cost of liquidating liabilities also rises. Here is the missing link mainstream economists have consistently ignore: the rise in the cost of liquidating liabilities causes an uncontrollable increase in the overall cost of servicing capital already deployed in production. As costs increase, profits fall. Thus the squeeze on profits is not caused by the falling price-structure as asserted by Keynesian orthodoxy. Falling prices are themselves an effect, not a cause. The real cause is the falling interest-rate structure revealing that productive capital has been financed at rates far too high. As a result of the squeeze profits are turned into losses. Many firms fail, taking others down with them in a domino-effect as receivables get harder to collect. Demand collapses, prices fall.
The central bank is desperately trying to apply damage-control by putting more money into circulation. However, the new money is just oil on the fire. It is not flowing to the commodity markets as expected. It flows to the bond market where the action is. Bidding for bonds in competition with speculators the central bank puts even more pressure on the rate of interest. The vicious circle is closed. The squeeze on profits is increased and more productive enterprise fails. Once Keynesian fiscal policy and/or Friedmanite monetary policy have become official, bond speculators face virtually no risk. Central bank intervention will provide a nice tail-wind to make their sails bulge.
Clandestine Wealth-Transfer
It is not hard to identify the chief culprit of bond speculation. It is the banking fraternity trying to rebuild bank capital that has been devastated during the preceding boom. The banks suffered huge losses in their bond portfolio thanks to the relentless rise in interest rates. Even greater losses were sustained in the investment portfolio due to the proliferation of non-performing loans, as their clients have become over-extended in the face of rising interest rates. Now the rate of interest is falling, and the banks once more have the upper hand. They are determined to make most of it.
The point is that the wealth of failing productive enterprise does not go up in smoke during the depression as suggested disingenuously by the Keynesians and the Friedmanites. It is being siphoned off and will show up as capital gains in the banks' bond portfolio. In this revisionist view the Great Depression appears to have been caused by a massive clandestine wealth-transfer from the productive sector to the financial sector, denuding the former of its capital. The wealth-transfer has been made possible in the first place by the destabilization of the interest-rate structure. For this the responsibility lies squarely with mistaken government policies caving in to anti-gold propaganda and agitation for unlimited deficit-spending.
Why Swissair has fallen out of the sky?
As an example of the clandestine wealth-transfer we may wish to scrutinize the example of the downfall of Swissair. It has been the envy of the airlines industry for half a century. It was well-capitalized and well-managed, with an increasing market-share and with an excellent record of paying dividends. No one could predict that it would be the first to fall out of the sky after September 11. How did it happen?
Swissair was a victim of the clandestine wealth-transfer plaguing the productive sector as a result of the falling interest-rate structure caused by bond speculation. The airlines industry is one of the most capital-intensive industries, which is especially vulnerable to concealed capital consumption through paying out phantom profits. The invisible erosion of the capital base of Swissair finally reached the point that it could no longer pay its bills after the contraction of the market and it folded. The shareholders' equity in the balance sheet of Swissair did not go up in smoke. It ended up in the balance sheet of the bond speculators as a capital gain.
This should be a warning to all firms engaged in productive enterprise. The same could also happen to them, regardless how well-managed or well-capitalized they may appear at the moment.
There is no protection against the vacuum-cleaner effect of bond speculation on their balance sheet if the interest-rate structure keeps falling.
Collapse of Demand or Collapse of Production?
In the second part of this essay we shall put the patience of the reader to test by a detour to discuss some fundamental book-keeping principles. This will be necessary for a full understanding of the stealthy wealth-transfer from the productive to the financial sector. The transfer would have never been possible had the balance sheets of individual firms in the productive sector shown the true financial picture at all times, and had the accounting profession raised the alarm about the ongoing capital consumption. But due to a relaxation of accounting standards to accommodate war-finances in 1914, the balance sheet ignored the huge increases in the cost of liquidating liabilities in the falling interest-rate environment. The accounting profession was in the dark and could not detect the ongoing destruction of capital. Worse still, phantom profits were being paid out that further ate into capital, ultimately leading to the downfall of the productive sector of the economy.
In the third part, out of these elements we construct the revisionist theory of the Great Depression and warn of the consequences of the present falling interest-rate environment in which the same forces are at work once more. We conclude that the causes of the Great Depression are found in the combination of three factors: (1) the fatally relaxed accounting standards, (2) the creation of the Federal Reserve banks in 1913, making the monetization of debt possible, and (3) the destruction of the gold standard in 1933. These three factors interacted to cause wholesale capital destruction in the productive sector. It was not the collapse in demand that caused the collapse of production, as asserted by the currently fashionable Keynesian and Friedmanite orthodoxy. It was the exact opposite: the collapse in production causing the collapse of demand. The collapse in production occurred in response to the invisible destruction of capital due to the falling interest-rate structure which, in turn, was engineered by the bond speculators, chief among them the banking fraternity.
Thursday, April 21, 2011
Monday, April 18, 2011
Watershed Event for US
The federal deficit this year is a record $1.6 trillion -- a number that requires the government to borrow 43 cents out of every dollar it spends. The US government's total debt will mushroom from $14.2 trillion now to almost $21 trillion by 2016.
Obama's projected $1.6 trillion deficit for the current year would be the highest dollar amount ever. It represents 10.8 percent of the total economy, the highest level since 1945 when the deficit was 21.5 percent of GDP and reflected heavy borrowing to fight the Second World War.
more
Obama's projected $1.6 trillion deficit for the current year would be the highest dollar amount ever. It represents 10.8 percent of the total economy, the highest level since 1945 when the deficit was 21.5 percent of GDP and reflected heavy borrowing to fight the Second World War.
more
Inflation Destroys Real Wages
By: Michael Pento
Mon, Apr 18, 2011
In the same vein as medieval physicians believed bloodletting would cure illness, modern snake-oil economists still perilously cling to their claim that rising wages and salaries are the cause of inflation. With my recent debates with these mainstream economists, I've heard the following: "without rising wages, where does the money come from to push prices higher?" I was tempted to respond, "where do the employers get the money to pay those higher wages?" But economists tend to get a little nasty when you make them feel stupid.
It is actually the predominant belief that wages and salaries rise before aggregate price levels in the economy and thus during periods of rising inflation, real wages are always increasing. However, economic history has proven over and over again that real wages actually decrease during periods of rising inflation. Nominal incomes do increase, but this is merely a response to the inflation that has already been created.
The essence of this folly is that modern economists don't have a firm grasp on the mechanics of inflation. At the most basic level, inflation comes from too much money chasing too few goods. The battle against rapidly rising inflation always has its genesis from a central bank that prints money in order to monetize the nation's debt.
And because the central bank typically only gives this new money to the nation's creditors--half of which aren't Americans--the money created is never evenly distributed into the wages and salaries of the people. It goes first into the hands of those bondholders who receive interest and principal payments. In addition, the rapid expansion of the money supply causes the currency to lose value against hard assets and foreign currencies. Nominal wages and salaries eventually respond to soaring commodity prices and a crumbling currency, but always with a lag that causes their purchasing power to fall relative to other asset classes. Have you ever tried to ask your boss for a raise simply because living expenses cost 10% more than a year prior? As you are laughed out of the office, you can see the wage lag in action.
Recent economic data provides clear proof that the "wage-price spiral" alleged by Keynesian economists is plainly wrong.
The Consumer Price Index (CPI) has now increased for nine consecutive months. It increased by 0.5% in March from February and is up 2.7% year-over-year. The YOY increase in the prior month was 2.1%. It appears the increase in consumer prices is accelerating-and quickly. Meanwhile, in the last 12 months, the US Dollar Index has lost 8% of its value against a basket of our 6 largest trading partners. The dollar has also lost 29% of its value since April 2010 when measured against the 19 commodities contained in the CRB Index. If you needed more evidence of the dollar devaluation, producer prices are up 5.8% and import prices surged 9.7% YOY.
So there's your inflation. But was it caused by rising wages and full employment? The unemployment rate has dropped a bit from 10.1% to 8.8% - but this is mostly due to discouraged workers dropping out of the labor force altogether. However, even if the decrease came from legitimate employment gains, it would be hard to argue that an 8.8% unemployment rate would put upward pressure on wages. And, in fact, it hasn't. Real average hourly earnings dropped 0.6% in March, the most since June 2009, after falling 0.5% the prior month. Over the past 12 months they were down 1%, the biggest annual drop since September 2008!
The conclusion is clear: rising wages cannot be the cause of inflation.
Alas, there is a predictable path for newly created money as it snakes its way through an economy. It is always reflected first in the falling purchasing power of a currency and in the rising prices of hard assets. That's because debt holders move their newly minted proceeds into commodities to protect against the general rise in price levels and as an alternate store of wealth. Food and energy prices have a higher negative correlation to the falling dollar than the items that exist in the core rate. They are the first warning bell in an inflationary period, which may be exactly why they are left out of the headline measure.
Nominal wages and salaries eventually rise but always slower than the rate of inflation, causing real wages to fall. If rising wages increased faster than aggregate prices, inflation would always lead to a rise in living standards. Is that what we've seen in Peron's Argentina or Weimar Germany? The reason why the unemployment rate soars and the economy falls into a depression is precisely because the middle class has their discretionary purchasing power stolen from them.
Mark my words: if the Fed and Obama Administration place their faith in stagnant incomes to contain inflation, they will sit idly by while the country collapses in front of their eyes. Because of their medieval understanding of economics, these central planners are going to bring us right back to the Dark Ages.
Mon, Apr 18, 2011
In the same vein as medieval physicians believed bloodletting would cure illness, modern snake-oil economists still perilously cling to their claim that rising wages and salaries are the cause of inflation. With my recent debates with these mainstream economists, I've heard the following: "without rising wages, where does the money come from to push prices higher?" I was tempted to respond, "where do the employers get the money to pay those higher wages?" But economists tend to get a little nasty when you make them feel stupid.
It is actually the predominant belief that wages and salaries rise before aggregate price levels in the economy and thus during periods of rising inflation, real wages are always increasing. However, economic history has proven over and over again that real wages actually decrease during periods of rising inflation. Nominal incomes do increase, but this is merely a response to the inflation that has already been created.
The essence of this folly is that modern economists don't have a firm grasp on the mechanics of inflation. At the most basic level, inflation comes from too much money chasing too few goods. The battle against rapidly rising inflation always has its genesis from a central bank that prints money in order to monetize the nation's debt.
And because the central bank typically only gives this new money to the nation's creditors--half of which aren't Americans--the money created is never evenly distributed into the wages and salaries of the people. It goes first into the hands of those bondholders who receive interest and principal payments. In addition, the rapid expansion of the money supply causes the currency to lose value against hard assets and foreign currencies. Nominal wages and salaries eventually respond to soaring commodity prices and a crumbling currency, but always with a lag that causes their purchasing power to fall relative to other asset classes. Have you ever tried to ask your boss for a raise simply because living expenses cost 10% more than a year prior? As you are laughed out of the office, you can see the wage lag in action.
Recent economic data provides clear proof that the "wage-price spiral" alleged by Keynesian economists is plainly wrong.
The Consumer Price Index (CPI) has now increased for nine consecutive months. It increased by 0.5% in March from February and is up 2.7% year-over-year. The YOY increase in the prior month was 2.1%. It appears the increase in consumer prices is accelerating-and quickly. Meanwhile, in the last 12 months, the US Dollar Index has lost 8% of its value against a basket of our 6 largest trading partners. The dollar has also lost 29% of its value since April 2010 when measured against the 19 commodities contained in the CRB Index. If you needed more evidence of the dollar devaluation, producer prices are up 5.8% and import prices surged 9.7% YOY.
So there's your inflation. But was it caused by rising wages and full employment? The unemployment rate has dropped a bit from 10.1% to 8.8% - but this is mostly due to discouraged workers dropping out of the labor force altogether. However, even if the decrease came from legitimate employment gains, it would be hard to argue that an 8.8% unemployment rate would put upward pressure on wages. And, in fact, it hasn't. Real average hourly earnings dropped 0.6% in March, the most since June 2009, after falling 0.5% the prior month. Over the past 12 months they were down 1%, the biggest annual drop since September 2008!
The conclusion is clear: rising wages cannot be the cause of inflation.
Alas, there is a predictable path for newly created money as it snakes its way through an economy. It is always reflected first in the falling purchasing power of a currency and in the rising prices of hard assets. That's because debt holders move their newly minted proceeds into commodities to protect against the general rise in price levels and as an alternate store of wealth. Food and energy prices have a higher negative correlation to the falling dollar than the items that exist in the core rate. They are the first warning bell in an inflationary period, which may be exactly why they are left out of the headline measure.
Nominal wages and salaries eventually rise but always slower than the rate of inflation, causing real wages to fall. If rising wages increased faster than aggregate prices, inflation would always lead to a rise in living standards. Is that what we've seen in Peron's Argentina or Weimar Germany? The reason why the unemployment rate soars and the economy falls into a depression is precisely because the middle class has their discretionary purchasing power stolen from them.
Mark my words: if the Fed and Obama Administration place their faith in stagnant incomes to contain inflation, they will sit idly by while the country collapses in front of their eyes. Because of their medieval understanding of economics, these central planners are going to bring us right back to the Dark Ages.
Friday, April 15, 2011
Goldman Sachs Chief Blankfein Could Face Criminal Prosecution For Role In Financial Crisis
WASHINGTON -- Goldman Sachs executives deceived clients in order to profit off the brewing financial crisis and then misled Congress when asked to explain their actions, concluded a top lawmaker who led a two-year investigation into Wall Street's role in the meltdown.
William Alden
Alden@huffingtonpost.com
Carl Levin, chair of the Senate Permanent Subcommittee on Investigations, will recommend that Goldman executives who testified before his panel, including chairman and chief executive Lloyd Blankfein, be referred to the Justice Department for possible criminal prosecution, the Michigan Democrat announced Wednesday. Members of the subcommittee will now deliberate Levin's proposal.
A Goldman spokesman said its executives were truthful in their testimony, adding that the firm disagreed with many of the panel's conclusions.
Two and a half years after a historic crisis that has yielded not a single criminal conviction of anyone who played a leading role in causing it, the prosecution of such a high-profile Wall Street executive may satisfy the public's desire to see culprits brought to justice. Last year, the Securities and Exchange Commission settled a lawsuit it had brought against Goldman.
But the firm was just one target of a sweeping, 639-page report by the Senate panel into the causes of the crisis. Hardly a fluke occurrence, the meltdown was the product of a deeply corrupt financial system, one fueled by profit-hungry banks that deceived their clients, and overseen by lax regulators who were complicit in the firms' chronic abuse of the most fundamental rules of the game, the report concludes.
The investigation found a "financial snake pit rife with greed, conflicts of interest, and wrongdoing," Levin said.
More than any other government report produced in the wake of the crisis, this account names names, blaming specific people and institutions: Goldman Sachs, Washington Mutual, Moody's Investors Service, Standard & Poor's, the Office of Thrift Supervision and others. It targets four types of institutions, all of which it says played key roles in causing the crisis: mortgage lenders that offered prospective homeowners booby-trapped loans; regulators that were paid by the institutions they were regulating and cooperated in widespread deception; rating agencies that gave seals of approval to products they knew to be especially risky, all in the pursuit of market share; and Wall Street banks that duped investors into buying securities that only the insiders knew were destined to go bad.
"Blame for this mess lies everywhere from federal regulators who cast a blind eye, Wall Street bankers who let greed run wild, and members of Congress who failed to provide oversight," said the panel's ranking member, Sen. Tom Coburn, an Oklahoma Republican.
Eventually, as the falling housing market helped drag the broader economy into the most punishing recession since the 1930s, this parasitic apparatus began to crumble. At that point, the key players had already pocketed their profits and were poised to pocket more, while legions of investors and homeowners had been set up for ruin.
The forces behind the economic collapse were multiple, with some causes likely originating decades before the crash. But this report exposes the people who, it says, most immediately caused the crisis -- whose behavior, motivated by profit above seemingly anything else, trashed the financial system, and magnified the devastation from which the real economy has yet to recover.
Wall Street banks magnified the crisis and its fallout. The Senate subcommittee singled out Goldman as a particularly representative case.
Investigators pored over millions of pages of internal Goldman documents and correspondence. They found evidence of traders boasting about how they sold their clients "shitty" deals, and discovered documents that detailed how the storied investment bank -- which has long maintained it didn't make a firm-wide bet against American homeowners -- reversed course over a three-month period in late 2006 through 2007, shedding bets that the value of subprime mortgage-linked investments would rise.
Rather, the firm went "short," the report exhaustively documents. In Wall Street parlance, shorting an investment means betting its value will fall.
Levin said his investigators found 3,400 instances of Goldman officials using the phrase "net short" in the documents they reviewed. He intimated that Goldman likely used the phrase many more times in other documents not reviewed by his panel.
As of December 2006, Goldman had $6 billion in bets that the value of its subprime assets would surge, according to the panel's report. By February of the next year, its mortgage traders had $10 billion in bets that such securities would collapse.
By June, the firm was net short on subprime borrowers to the tune of $13.9 billion, according to the report.
As more borrowers fell behind on their payments and as the value of securities linked to their mortgages slid, Goldman stayed "net short." Other banks suffered. But not this one.
"Tells you what might be happening to people without the big short," Goldman's chief financial officer David Viniar wrote in a July 2007 email to the firm's chief operating officer, Gary Cohn.
Even when these documents came to light last year, Goldman maintained it never took the position that housing-linked securities would decline, particularly considering that it was selling its clients investments that were bullish on homeowners. Goldman, too, suffered losses from housing-related investments, the firm pointed out.
But Levin's investigators don't dispute that Goldman took losses during the financial crisis. His team asserts that while Goldman salesmen were peddling investments linked to bonds backed by subprime mortgages, its traders were betting that those securities -- and others like it -- would fail, and that the two teams were in contact. The assertion raises a crucial question about whether the firm violated securities rules prohibiting double-dealing.
Worse, Levin said, Goldman traders attempted to manipulate the market for derivatives linked to such investments, according to the report.
Internal company documents show that in May 2007, Goldman traders tried to artificially drive down the price of certain bets it wanted to make -- bets that borrowers would default on their home loans.
The plan was for one group of Goldman traders to peddle such securities across Wall Street "at lower and lower prices, in order to drive down the market price [of the securities] to artificially low levels," the report notes. Due to Goldman's size and market power, that would have driven down prices across the Street, forcing holders of such securities to record losses.
The firm wanted "to cause maximum pain," Michael Swenson, a head mortgage trader at Goldman, wrote in a May 25, 2007 email documented in the report.
By that point, many Wall Street players were betting on homeowners to default. The price of placing such bets was rising. Goldman wanted a cheaper way in.
As part of the plan, another Goldman unit was to buy those positions at a lower price, enabling them not only to add to their growing bet that the American homeowner would eventually default, but to do so at a lower price.
Goldman initiated this plan "despite the harm that might be caused to Goldman's clients," according to the report. Indeed, clients began to complain of a "sudden mark-down" of their positions.
A Goldman representative who showed Swenson the complaints of one hedge fund client was met with a terse response: "We are ok with that," Swenson wrote in another documented email. "They do not have much more gun powder."
In other words, Goldman didn't have to worry about the client because the client didn't have the resources -- the "gun powder" -- to compete with Goldman, according to the report.
One of the traders Swenson oversaw, Deeb Salem, laid this all out in a self-evaluation of his performance in 2007 that he sent to Goldman's senior management.
"In May, while we were remain[ing] as negative as ever on the fundamentals in sub-prime, the market was trading VERY SHORT, and susceptible to a squeeze," Salem wrote, emphasizing that traders across Wall Street were shorting the market. "We began to encourage this squeeze, with plans of getting very short again, after the short squeezed cause[d] capitulation of these shorts."
"This strategy seemed do-able and brilliant," he wrote.
Interviewed by investigators in October of last year, Salem denied that he had tried to squeeze the market. Investigators reading his self-evaluation put too much emphasis on "words," according to the report.
Goldman abandoned the plan the next month after a rival investment bank's hedge funds collapsed.
"While we disagree with many of the conclusions of the report, we take seriously the issues explored by the subcommittee," Goldman said in a statement. A Goldman spokesman added that the firm recently overhauled its business standards to improve transparency and disclosure and to strengthen its client relationships.
Levin, who briefly described the strategy during a Senate hearing last December, said Wednesday that it was the type of "disgraceful" behavior emblematic of Goldman's attitude at the time: Goldman first, clients last.
Deutsche Bank, Germany's largest lender and one of the biggest in the world, also came under fire for its crisis-era activities.
The panel caught one of its former traders, Greg Lippmann, referring to such securities over email as "crap" and "pigs," according to the report. Lippmann was made semi-famous by author Michael Lewis for his prescient call to short subprime securities.
His unit sold some of the very securities he criticized.
The banker who oversaw Lippman's unit, Michael Lamont, told a colleague at another firm how Deutsche was rushing to sell these financial instruments "before the market falls off a cliff," according to a February 2007 email Lamont sent.
Meanwhile, buyers of the securities were never told.
At one point, Lippman described the creation and selling of such instruments as a "Ponzi scheme." He also said he would "try to dupe someone" into buying a particularly risky mortgage-linked security he himself was being asked to purchase, according to the report.
He later backed off some of those comments when interviewed by Senate investigators.
Levin said the German bank engaged in "disturbing activities."
During this time, the now head of enforcement at the SEC, Robert Khuzami, served as a top lawyer at Deutsche, overseeing litigation and regulatory investigations.
The panel said it didn't find anything incriminating that would implicate Khuzami in the matters under investigation.
Khuzami is now in charge of pursuing financial wrongdoers. He has pledged to recuse himself from investigations involving the German lender.
Goldman, for its part, sold a collection of questionable securities. Levin's investigators uncovered four securities -- complex financial instruments with names like Hudson and Timberwolf -- that Goldman recommended to customers without fully disclosing key information, or saying whether the firm was betting against them.
For example, in the Hudson deal, Goldman told investors its interests were "aligned" with theirs when in reality the firm held "100 percent of the short side" of that security, according to the report. Goldman was betting on Hudson to fail.
Also, Goldman said the assets in Hudson were "sourced from the Street." But investigators said Goldman selected the assets and priced them itself.
Wednesday's disclosures are similar to a case from last year, in which Goldman Sachs allegedly helped set up a mortgage-linked investment for a favored client, designing it to fail, yet selling it anyway to its other clients, reaping the favored client nearly $1 billion. The deal, named Abacus, was also targeted in the Senate report. Goldman settled the accusations with the SEC last year for $550 million.
"Goldman was sticking it to their own clients," Levin told reporters. "Goldman gained at the expense of their clients, and used abusive practices to do it."
Goldman, though, has rejected such characterizations.
"Much has been said about the supposedly massive short Goldman Sachs had on the U.S. housing market," Goldman chief Blankfein said in testimony before Levin's panel last year. "The fact is, we were not consistently or significantly net-short the market in residential mortgage-related products in 2007 and 2008."
"We didn't have a massive short against the housing market, and we certainly did not bet against our clients," he added. Other Goldman executives made similar claims.
"That is simply not true," Levin said Wednesday. "They clearly misled their clients and they misled the Congress," he added, announcing that he will recommend that his panel refer all of the Goldman executives who testified before the committee for possible criminal prosecution by the Justice Department and for sanctions by the SEC for violations of securities laws.
Goldman disputed Levin's characterizations.
"The testimony we gave was truthful and accurate and this is confirmed by the subcommittee's own report," the firm said. "The report references testimony from Goldman Sachs witnesses who repeatedly and consistently acknowledged that we were intermittently net short during 2007. We did not have a massive net short position because our short positions were largely offset by our long positions, and our financial results clearly demonstrate this point."
The investigative panel must deliberate Levin's recommendations before making any referrals to prosecutors or regulators. Coburn, the Republican, would have to agree with Levin in order for the referrals to be made.
Asked about the general lack of prosecutions of high-powered Wall Street executives, Levin replied: "There is still time."
"Hope springs eternal," he added with a smile.
William Alden
Alden@huffingtonpost.com
Carl Levin, chair of the Senate Permanent Subcommittee on Investigations, will recommend that Goldman executives who testified before his panel, including chairman and chief executive Lloyd Blankfein, be referred to the Justice Department for possible criminal prosecution, the Michigan Democrat announced Wednesday. Members of the subcommittee will now deliberate Levin's proposal.
A Goldman spokesman said its executives were truthful in their testimony, adding that the firm disagreed with many of the panel's conclusions.
Two and a half years after a historic crisis that has yielded not a single criminal conviction of anyone who played a leading role in causing it, the prosecution of such a high-profile Wall Street executive may satisfy the public's desire to see culprits brought to justice. Last year, the Securities and Exchange Commission settled a lawsuit it had brought against Goldman.
But the firm was just one target of a sweeping, 639-page report by the Senate panel into the causes of the crisis. Hardly a fluke occurrence, the meltdown was the product of a deeply corrupt financial system, one fueled by profit-hungry banks that deceived their clients, and overseen by lax regulators who were complicit in the firms' chronic abuse of the most fundamental rules of the game, the report concludes.
The investigation found a "financial snake pit rife with greed, conflicts of interest, and wrongdoing," Levin said.
More than any other government report produced in the wake of the crisis, this account names names, blaming specific people and institutions: Goldman Sachs, Washington Mutual, Moody's Investors Service, Standard & Poor's, the Office of Thrift Supervision and others. It targets four types of institutions, all of which it says played key roles in causing the crisis: mortgage lenders that offered prospective homeowners booby-trapped loans; regulators that were paid by the institutions they were regulating and cooperated in widespread deception; rating agencies that gave seals of approval to products they knew to be especially risky, all in the pursuit of market share; and Wall Street banks that duped investors into buying securities that only the insiders knew were destined to go bad.
"Blame for this mess lies everywhere from federal regulators who cast a blind eye, Wall Street bankers who let greed run wild, and members of Congress who failed to provide oversight," said the panel's ranking member, Sen. Tom Coburn, an Oklahoma Republican.
Eventually, as the falling housing market helped drag the broader economy into the most punishing recession since the 1930s, this parasitic apparatus began to crumble. At that point, the key players had already pocketed their profits and were poised to pocket more, while legions of investors and homeowners had been set up for ruin.
The forces behind the economic collapse were multiple, with some causes likely originating decades before the crash. But this report exposes the people who, it says, most immediately caused the crisis -- whose behavior, motivated by profit above seemingly anything else, trashed the financial system, and magnified the devastation from which the real economy has yet to recover.
Wall Street banks magnified the crisis and its fallout. The Senate subcommittee singled out Goldman as a particularly representative case.
Investigators pored over millions of pages of internal Goldman documents and correspondence. They found evidence of traders boasting about how they sold their clients "shitty" deals, and discovered documents that detailed how the storied investment bank -- which has long maintained it didn't make a firm-wide bet against American homeowners -- reversed course over a three-month period in late 2006 through 2007, shedding bets that the value of subprime mortgage-linked investments would rise.
Rather, the firm went "short," the report exhaustively documents. In Wall Street parlance, shorting an investment means betting its value will fall.
Levin said his investigators found 3,400 instances of Goldman officials using the phrase "net short" in the documents they reviewed. He intimated that Goldman likely used the phrase many more times in other documents not reviewed by his panel.
As of December 2006, Goldman had $6 billion in bets that the value of its subprime assets would surge, according to the panel's report. By February of the next year, its mortgage traders had $10 billion in bets that such securities would collapse.
By June, the firm was net short on subprime borrowers to the tune of $13.9 billion, according to the report.
As more borrowers fell behind on their payments and as the value of securities linked to their mortgages slid, Goldman stayed "net short." Other banks suffered. But not this one.
"Tells you what might be happening to people without the big short," Goldman's chief financial officer David Viniar wrote in a July 2007 email to the firm's chief operating officer, Gary Cohn.
Even when these documents came to light last year, Goldman maintained it never took the position that housing-linked securities would decline, particularly considering that it was selling its clients investments that were bullish on homeowners. Goldman, too, suffered losses from housing-related investments, the firm pointed out.
But Levin's investigators don't dispute that Goldman took losses during the financial crisis. His team asserts that while Goldman salesmen were peddling investments linked to bonds backed by subprime mortgages, its traders were betting that those securities -- and others like it -- would fail, and that the two teams were in contact. The assertion raises a crucial question about whether the firm violated securities rules prohibiting double-dealing.
Worse, Levin said, Goldman traders attempted to manipulate the market for derivatives linked to such investments, according to the report.
Internal company documents show that in May 2007, Goldman traders tried to artificially drive down the price of certain bets it wanted to make -- bets that borrowers would default on their home loans.
The plan was for one group of Goldman traders to peddle such securities across Wall Street "at lower and lower prices, in order to drive down the market price [of the securities] to artificially low levels," the report notes. Due to Goldman's size and market power, that would have driven down prices across the Street, forcing holders of such securities to record losses.
The firm wanted "to cause maximum pain," Michael Swenson, a head mortgage trader at Goldman, wrote in a May 25, 2007 email documented in the report.
By that point, many Wall Street players were betting on homeowners to default. The price of placing such bets was rising. Goldman wanted a cheaper way in.
As part of the plan, another Goldman unit was to buy those positions at a lower price, enabling them not only to add to their growing bet that the American homeowner would eventually default, but to do so at a lower price.
Goldman initiated this plan "despite the harm that might be caused to Goldman's clients," according to the report. Indeed, clients began to complain of a "sudden mark-down" of their positions.
A Goldman representative who showed Swenson the complaints of one hedge fund client was met with a terse response: "We are ok with that," Swenson wrote in another documented email. "They do not have much more gun powder."
In other words, Goldman didn't have to worry about the client because the client didn't have the resources -- the "gun powder" -- to compete with Goldman, according to the report.
One of the traders Swenson oversaw, Deeb Salem, laid this all out in a self-evaluation of his performance in 2007 that he sent to Goldman's senior management.
"In May, while we were remain[ing] as negative as ever on the fundamentals in sub-prime, the market was trading VERY SHORT, and susceptible to a squeeze," Salem wrote, emphasizing that traders across Wall Street were shorting the market. "We began to encourage this squeeze, with plans of getting very short again, after the short squeezed cause[d] capitulation of these shorts."
"This strategy seemed do-able and brilliant," he wrote.
Interviewed by investigators in October of last year, Salem denied that he had tried to squeeze the market. Investigators reading his self-evaluation put too much emphasis on "words," according to the report.
Goldman abandoned the plan the next month after a rival investment bank's hedge funds collapsed.
"While we disagree with many of the conclusions of the report, we take seriously the issues explored by the subcommittee," Goldman said in a statement. A Goldman spokesman added that the firm recently overhauled its business standards to improve transparency and disclosure and to strengthen its client relationships.
Levin, who briefly described the strategy during a Senate hearing last December, said Wednesday that it was the type of "disgraceful" behavior emblematic of Goldman's attitude at the time: Goldman first, clients last.
Deutsche Bank, Germany's largest lender and one of the biggest in the world, also came under fire for its crisis-era activities.
The panel caught one of its former traders, Greg Lippmann, referring to such securities over email as "crap" and "pigs," according to the report. Lippmann was made semi-famous by author Michael Lewis for his prescient call to short subprime securities.
His unit sold some of the very securities he criticized.
The banker who oversaw Lippman's unit, Michael Lamont, told a colleague at another firm how Deutsche was rushing to sell these financial instruments "before the market falls off a cliff," according to a February 2007 email Lamont sent.
Meanwhile, buyers of the securities were never told.
At one point, Lippman described the creation and selling of such instruments as a "Ponzi scheme." He also said he would "try to dupe someone" into buying a particularly risky mortgage-linked security he himself was being asked to purchase, according to the report.
He later backed off some of those comments when interviewed by Senate investigators.
Levin said the German bank engaged in "disturbing activities."
During this time, the now head of enforcement at the SEC, Robert Khuzami, served as a top lawyer at Deutsche, overseeing litigation and regulatory investigations.
The panel said it didn't find anything incriminating that would implicate Khuzami in the matters under investigation.
Khuzami is now in charge of pursuing financial wrongdoers. He has pledged to recuse himself from investigations involving the German lender.
Goldman, for its part, sold a collection of questionable securities. Levin's investigators uncovered four securities -- complex financial instruments with names like Hudson and Timberwolf -- that Goldman recommended to customers without fully disclosing key information, or saying whether the firm was betting against them.
For example, in the Hudson deal, Goldman told investors its interests were "aligned" with theirs when in reality the firm held "100 percent of the short side" of that security, according to the report. Goldman was betting on Hudson to fail.
Also, Goldman said the assets in Hudson were "sourced from the Street." But investigators said Goldman selected the assets and priced them itself.
Wednesday's disclosures are similar to a case from last year, in which Goldman Sachs allegedly helped set up a mortgage-linked investment for a favored client, designing it to fail, yet selling it anyway to its other clients, reaping the favored client nearly $1 billion. The deal, named Abacus, was also targeted in the Senate report. Goldman settled the accusations with the SEC last year for $550 million.
"Goldman was sticking it to their own clients," Levin told reporters. "Goldman gained at the expense of their clients, and used abusive practices to do it."
Goldman, though, has rejected such characterizations.
"Much has been said about the supposedly massive short Goldman Sachs had on the U.S. housing market," Goldman chief Blankfein said in testimony before Levin's panel last year. "The fact is, we were not consistently or significantly net-short the market in residential mortgage-related products in 2007 and 2008."
"We didn't have a massive short against the housing market, and we certainly did not bet against our clients," he added. Other Goldman executives made similar claims.
"That is simply not true," Levin said Wednesday. "They clearly misled their clients and they misled the Congress," he added, announcing that he will recommend that his panel refer all of the Goldman executives who testified before the committee for possible criminal prosecution by the Justice Department and for sanctions by the SEC for violations of securities laws.
Goldman disputed Levin's characterizations.
"The testimony we gave was truthful and accurate and this is confirmed by the subcommittee's own report," the firm said. "The report references testimony from Goldman Sachs witnesses who repeatedly and consistently acknowledged that we were intermittently net short during 2007. We did not have a massive net short position because our short positions were largely offset by our long positions, and our financial results clearly demonstrate this point."
The investigative panel must deliberate Levin's recommendations before making any referrals to prosecutors or regulators. Coburn, the Republican, would have to agree with Levin in order for the referrals to be made.
Asked about the general lack of prosecutions of high-powered Wall Street executives, Levin replied: "There is still time."
"Hope springs eternal," he added with a smile.
Deutsche Bank Sold Mortgage-Linked ‘Pigs’ as Market Buckled, Lawmakers Say
By Bob Ivry, Jody Shenn and Michael J. Moore - Apr 13, 2011 Bloomberg Opinion
Deutsche Bank AG (DBK), whose bets against subprime mortgages helped it weather the financial crisis, pressed to sell a $1.1 billion collateralized debt obligation to clients in 2007 as the co-head of its CDO team foresaw a market slump, a U.S. Senate panel found.
“Keep your fingers crossed but I think we will price this just before the market falls off a cliff,” Michael Lamont, the group’s co-head, said in a Feb. 8, 2007, e-mail about Deutsche Bank’s Gemstone CDO VII Ltd., according to a report released yesterday by the Permanent Subcommittee on Investigations. The Frankfurt-based firm sold $700 million of the instruments, which lost most of their value within 17 months.
The bi-partisan panel, led by Michigan Democrat Carl Levin, placed Germany’s biggest bank in a spotlight alongside Goldman Sachs Group Inc. (GS), saying that the firms’ creation and sales of mortgage-backed investments “illustrate a variety of troubling and sometimes abusive practices.” The “case study” also focuses on Greg Lippmann, Deutsche Bank’s then-top CDO trader, who led its bets against subprime home loans and described some Gemstone VII collateral as “pigs” and “crap.”
“The bank sold poor quality assets from its own inventory to the CDO,” according to the report. Then “the bank aggressively marketed the CDO securities to clients despite the negative views of its most senior CDO trader, falling values, and the deteriorating market.”
Internal Disagreements
CDOs package assets such as mortgage bonds and buyout loans into new securities with varying risks.
Lamont, who now works at New York-based hedge fund Seer Capital Management LP, declined to comment. So did Lippmann, 42, who left Deutsche Bank last year to start LibreMax Capital LLC, an investment firm based in New York.
While Lippmann’s trades yielded a $1.5 billion total return, the bank’s other executives long disagreed with his assessments. The firm’s New York-based residential mortgage- backed securities group and one of its London hedge funds amassed home-loan positions that reached a market value of more than $25 billion in 2007, the panel said. The company, led by Chief Executive Officer Josef Ackermann, 63, lost almost $4.5 billion on the mortgage-related investments that year after Lippmann’s gains.
“There were divergent views within the bank about the U.S. housing market,” Michele Allison, a spokeswoman for the company, said in an e-mailed statement. “Moreover, the bank’s views were fully communicated to the market through research reports, industry events, trading-desk commentary and press coverage.”
Biggest Trading Gain
Lippmann, whose bets against the housing market were also described in Michael Lewis’s “The Big Short,” had repeatedly tried to warn co-workers and clients in 2006 and 2007 about the poor quality of the mortgage securities underlying many CDOs, according to the report. The return on his bets against mortgages “was the largest profit obtained from a single position in Deutsche Bank history,” he told the subcommittee.
Disagreements among executives were common in firms across Wall Street as the mortgage market began to unravel, said Edward J. Grebeck, chief executive officer of Tempus Advisors, a debt- consulting firm in Stamford, Connecticut.
“I’m surprised the subcommittee’s report is focused only on Deutsche Bank and Goldman,” he said. “You could investigate any bank that put together structured products and look for conflicts.”
Hearings
Levin and Senator Tom Coburn of Oklahoma, the panel’s top Republican, held public hearings on the financial crisis last year, examining regulatory failures, the collapse of Washington Mutual Inc., the role of credit-rating firms in fueling bets on high-risk debt and the business practices of New York-based Goldman Sachs and rival investment banks.
Deutsche Bank underwrote 47 CDOs with a combined value of $32 billion from 2004 to 2008, according to the subcommittee. It made $4.7 million in fees from Gemstone VII, the report said.
The panel faulted the bank throughout Gemstone VII’s creation and sale. Nearly a third of the mortgages backing the CDOs were originated by three subprime lenders -- New Century Financial Corp., Fremont General Corp. and Washington Mutual Inc.’s Long Beach mortgage unit -- known for the poor performance of their loans, the report said.
While Deutsche Bank had “the right to reject” securities that were slated for Gemstone VII, Lippmann allowed bonds he viewed as toxic to be included, according to the report. He told the panel his responsibility was only to ensure that bonds bought by the CDO were priced accurately based on current market values, and an e-mail from him showed he sought to reduce the valuation of one.
Demand for Debt
About $27 million of the CDO’s assets came from the bank’s own inventory, including one bond that Lippmann referred to by asking another trader in an instant message, “DOESNT THIS DEAL BLOW,” according to the report.
“The way the politicians use these e-mails is to hang them out as evidence that misconduct occurred, but there is in fact a market for low-quality credit paper,” said Roy Smith, a finance professor at New York University’s Stern School of Business in Manhattan. “There has been for years, and the market is very legitimate.”
After assets set aside for Gemstone VII dropped in value, Abhayad Kamat, a member of the CDO group assembling the vehicle, told a Deutsche Bank sales team to use valuations from the CDO manager, Dallas-based HBK Capital Management, rather than from the bank’s traders, the report found. HBK’s values were 1.1 percent higher.
‘Significant Vintage Risk’
When a member of the sales group asked about the decision, Kamat responded in an e-mail that the values “we got from Jordan are too low,” referring to Jordan Milman, then a trader on Lippmann’s team, according to the report. He emphasized that the salespeople should identify HBK as the source of the valuations, the report said.
Kamat didn’t return telephone messages seeking comment.
The Senate panel said that Lamont’s group prepared an internal report listing risks to the bank from the deal that cited the 88 percent concentration of the CDO’s portfolio in 2005 and 2006 residential bonds without highlighting the “significant vintage risk” in disclosures to investors.
‘A Lot Bumpier’
“E-mails reviewed by the subcommittee show that CDO personnel at Deutsche Bank were well aware of the worsening CDO market and were rushing to sell Gemstone 7 before the market collapsed,” the report found. In a message on Feb. 20, 2007, the day before Gemstone VII was priced, Lippmann told Lamont that the CDO market was “going to get a lot bumpier very soon.”
Lamont, in his earlier e-mail that month about keeping “fingers crossed,” suggested turmoil may also present a buying opportunity. A plunge, “as usual will likely find you well- positioned to acquire new risk at a good price,” he wrote in the message to HBK’s collateral manager, who had authority to move assets in and out of the CDO. “We are all focused on pricing as soon as possible.”
Deutsche Bank failed to sell $400 million of the CDO’s slices. Buyers included M&T Bank Corp. (MTB), based in Buffalo, New York, and Charlotte, North Carolina-based Wachovia Corp., Frankfurt-based Commerzbank AG (CBK) and Standard Chartered Plc (STAN), based in London, according to the report. They lost “all or most of their investments,” the subcommittee said. Wachovia is now part of San Francisco-based Wells Fargo & Co. (WFC)
To contact the reporters on this story: Bob Ivry in New York at bivry@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net.
To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; David Scheer at dscheer@bloomberg.net; Gary Putka at +1-617-210-4625 or gputka@bloomberg.net.
Deutsche Bank AG (DBK), whose bets against subprime mortgages helped it weather the financial crisis, pressed to sell a $1.1 billion collateralized debt obligation to clients in 2007 as the co-head of its CDO team foresaw a market slump, a U.S. Senate panel found.
“Keep your fingers crossed but I think we will price this just before the market falls off a cliff,” Michael Lamont, the group’s co-head, said in a Feb. 8, 2007, e-mail about Deutsche Bank’s Gemstone CDO VII Ltd., according to a report released yesterday by the Permanent Subcommittee on Investigations. The Frankfurt-based firm sold $700 million of the instruments, which lost most of their value within 17 months.
The bi-partisan panel, led by Michigan Democrat Carl Levin, placed Germany’s biggest bank in a spotlight alongside Goldman Sachs Group Inc. (GS), saying that the firms’ creation and sales of mortgage-backed investments “illustrate a variety of troubling and sometimes abusive practices.” The “case study” also focuses on Greg Lippmann, Deutsche Bank’s then-top CDO trader, who led its bets against subprime home loans and described some Gemstone VII collateral as “pigs” and “crap.”
“The bank sold poor quality assets from its own inventory to the CDO,” according to the report. Then “the bank aggressively marketed the CDO securities to clients despite the negative views of its most senior CDO trader, falling values, and the deteriorating market.”
Internal Disagreements
CDOs package assets such as mortgage bonds and buyout loans into new securities with varying risks.
Lamont, who now works at New York-based hedge fund Seer Capital Management LP, declined to comment. So did Lippmann, 42, who left Deutsche Bank last year to start LibreMax Capital LLC, an investment firm based in New York.
While Lippmann’s trades yielded a $1.5 billion total return, the bank’s other executives long disagreed with his assessments. The firm’s New York-based residential mortgage- backed securities group and one of its London hedge funds amassed home-loan positions that reached a market value of more than $25 billion in 2007, the panel said. The company, led by Chief Executive Officer Josef Ackermann, 63, lost almost $4.5 billion on the mortgage-related investments that year after Lippmann’s gains.
“There were divergent views within the bank about the U.S. housing market,” Michele Allison, a spokeswoman for the company, said in an e-mailed statement. “Moreover, the bank’s views were fully communicated to the market through research reports, industry events, trading-desk commentary and press coverage.”
Biggest Trading Gain
Lippmann, whose bets against the housing market were also described in Michael Lewis’s “The Big Short,” had repeatedly tried to warn co-workers and clients in 2006 and 2007 about the poor quality of the mortgage securities underlying many CDOs, according to the report. The return on his bets against mortgages “was the largest profit obtained from a single position in Deutsche Bank history,” he told the subcommittee.
Disagreements among executives were common in firms across Wall Street as the mortgage market began to unravel, said Edward J. Grebeck, chief executive officer of Tempus Advisors, a debt- consulting firm in Stamford, Connecticut.
“I’m surprised the subcommittee’s report is focused only on Deutsche Bank and Goldman,” he said. “You could investigate any bank that put together structured products and look for conflicts.”
Hearings
Levin and Senator Tom Coburn of Oklahoma, the panel’s top Republican, held public hearings on the financial crisis last year, examining regulatory failures, the collapse of Washington Mutual Inc., the role of credit-rating firms in fueling bets on high-risk debt and the business practices of New York-based Goldman Sachs and rival investment banks.
Deutsche Bank underwrote 47 CDOs with a combined value of $32 billion from 2004 to 2008, according to the subcommittee. It made $4.7 million in fees from Gemstone VII, the report said.
The panel faulted the bank throughout Gemstone VII’s creation and sale. Nearly a third of the mortgages backing the CDOs were originated by three subprime lenders -- New Century Financial Corp., Fremont General Corp. and Washington Mutual Inc.’s Long Beach mortgage unit -- known for the poor performance of their loans, the report said.
While Deutsche Bank had “the right to reject” securities that were slated for Gemstone VII, Lippmann allowed bonds he viewed as toxic to be included, according to the report. He told the panel his responsibility was only to ensure that bonds bought by the CDO were priced accurately based on current market values, and an e-mail from him showed he sought to reduce the valuation of one.
Demand for Debt
About $27 million of the CDO’s assets came from the bank’s own inventory, including one bond that Lippmann referred to by asking another trader in an instant message, “DOESNT THIS DEAL BLOW,” according to the report.
“The way the politicians use these e-mails is to hang them out as evidence that misconduct occurred, but there is in fact a market for low-quality credit paper,” said Roy Smith, a finance professor at New York University’s Stern School of Business in Manhattan. “There has been for years, and the market is very legitimate.”
After assets set aside for Gemstone VII dropped in value, Abhayad Kamat, a member of the CDO group assembling the vehicle, told a Deutsche Bank sales team to use valuations from the CDO manager, Dallas-based HBK Capital Management, rather than from the bank’s traders, the report found. HBK’s values were 1.1 percent higher.
‘Significant Vintage Risk’
When a member of the sales group asked about the decision, Kamat responded in an e-mail that the values “we got from Jordan are too low,” referring to Jordan Milman, then a trader on Lippmann’s team, according to the report. He emphasized that the salespeople should identify HBK as the source of the valuations, the report said.
Kamat didn’t return telephone messages seeking comment.
The Senate panel said that Lamont’s group prepared an internal report listing risks to the bank from the deal that cited the 88 percent concentration of the CDO’s portfolio in 2005 and 2006 residential bonds without highlighting the “significant vintage risk” in disclosures to investors.
‘A Lot Bumpier’
“E-mails reviewed by the subcommittee show that CDO personnel at Deutsche Bank were well aware of the worsening CDO market and were rushing to sell Gemstone 7 before the market collapsed,” the report found. In a message on Feb. 20, 2007, the day before Gemstone VII was priced, Lippmann told Lamont that the CDO market was “going to get a lot bumpier very soon.”
Lamont, in his earlier e-mail that month about keeping “fingers crossed,” suggested turmoil may also present a buying opportunity. A plunge, “as usual will likely find you well- positioned to acquire new risk at a good price,” he wrote in the message to HBK’s collateral manager, who had authority to move assets in and out of the CDO. “We are all focused on pricing as soon as possible.”
Deutsche Bank failed to sell $400 million of the CDO’s slices. Buyers included M&T Bank Corp. (MTB), based in Buffalo, New York, and Charlotte, North Carolina-based Wachovia Corp., Frankfurt-based Commerzbank AG (CBK) and Standard Chartered Plc (STAN), based in London, according to the report. They lost “all or most of their investments,” the subcommittee said. Wachovia is now part of San Francisco-based Wells Fargo & Co. (WFC)
To contact the reporters on this story: Bob Ivry in New York at bivry@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net.
To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; David Scheer at dscheer@bloomberg.net; Gary Putka at +1-617-210-4625 or gputka@bloomberg.net.
Sunday, April 10, 2011
Teachers' Unions Don't Give a Damn About Kids; Feeling Guilty, But ...
By: Mike Shedlock Fri, Apr 8, 2011
As some might expect, I get a fair amount of hate mail from public union workers. However, I actually get more emails from public union workers and government employees who are willing to see the picture the way it is, instead of the way they want it to be.
Please consider this email from Rick, a teacher and a retired US Army Reservist. Rick sent the following email with the title "Feeling Guilty, But..."
I liked his email subject line so I used it as part of the title of this post.
Feeling Guilty, But ...
Rick writes ...
Hi Mish,
I am a teacher and a retired US Army Reservist. I have followed your blog religiously for the past few months and I cannot help but agree with you and support your view of how unions and BIG government are bankrupting we Americans.
When are people going to realize that we cannot kick this debt down the road any more? It's like paying your credit card debt using the 20 year plan. The interest kills you!
The only dilemma that I face is that I feel rather a hypocrite when I condemn my colleagues for believing that they have earned a defined benefit pension by their 30 years of service as a teacher, yet in 8 years I will begin receiving my military retirement pay (plus health care) from the US Government. I feel as though I am feeding at the trough.
I read articles in the news about the Wisconsin teachers "sacrificing" by now agreeing to pay 5-6% toward their pensions and 10-12% for their health care. Whoopee! I currently pay almost 50% of my health care costs out-of-pocket, and and I contribute 10% toward my direct compensation retirement plan. I would gladly contribute toward my pension too if that would help our state (Washington) from red ink.
Thanks for all the broad and informative articles. Keep up the great work.
Rick
Thanks Rick
Your email is deeply appreciated. I do not blame people for taking what comes their way. No one should.
However, I do blame those who feel they are better than everyone else. I also blame people who feel taxpayers owe them enormous benefits that the private sector does not get simply for showing up to work.
Worse yet, many do not even bother showing up for work via various call-in-sick mechanisms that scam taxpayers out of money.
Yesterday I received an email from my friend Tim Wallace. He wrote about the Belvidere New Jersey School District budget.
The issue at had was contract raise of 4.25%. To save teachers jobs, the school district proposed cutting the raise to 2.12%. The union refused, sending a few teachers to unemployment-land. In turn, class sizes will undoubtedly increase or other fees will rise.
Teachers wonder why they are vilified. Unions wonder why they are vilified. The answer is easy. By turning down pay hikes while demanding still more, no one can possibly wonder who is to blame.
Yet public unions pompously ask for property tax hikes "for the kids".
Teachers' Unions Do Not Give a Damn About Kids
Here is the deal, straight up. Teachers unions do not give a damn about the kids.
Please read that carefully. I said "Teachers unions" NOT teachers.
Most teachers do care about the kids. However, teachers are sucked into believing garbage fed by union organizers. That garbage inevitably leads to cannibalization of the lowest on the seniority totem pole, regardless of skills or talent.
Union mentality is also to blame for inability of school districts to get rid of sexual predators and grossly incompetent teachers.
Time For Reflection
This is a time for serious reflection. We all need to think about what government owes us (or doesn't), what taxpayers owe us (or doesn't), and what promises have been made by politicians at taxpayer expense that cannot possibly be met.
We also need to reflect on union rules that make us all slaves. I am going to hammer the slavery point home until it sinks in. If you have not yet done so, please read ....
■Paul Krugman, Stephen Colbert, Bill Maher, others, Ignore Extortion, Bribery, Coercion, and Slavery; No One Should Own You!■Collective Bargaining neither a Privilege nor a Right
Enormous Sense of Entitlement
With very few exceptions, public union members have an enormous sense of entitlement.
Public union members need to put themselves in the the average taxpayer's shoes. Public union members need to figure out how the hell this can possibly be paid for.
I am deeply disturbed by events in this country. We have lost track of what has made this nation great.
Yes, the Fed is part of the mess. So is the "too big to fail" mentality that unjustifiably bailed out the banks. However, at the city and state level, there is no bigger problem than public unions, especially promises regarding wage and pension benefits that cannot possible be met.
Instead of admitting the problem like Rick did, many government workers and public union members attack the messenger and ignore union sponsored slavery because it suits their purpose.
As some might expect, I get a fair amount of hate mail from public union workers. However, I actually get more emails from public union workers and government employees who are willing to see the picture the way it is, instead of the way they want it to be.
Please consider this email from Rick, a teacher and a retired US Army Reservist. Rick sent the following email with the title "Feeling Guilty, But..."
I liked his email subject line so I used it as part of the title of this post.
Feeling Guilty, But ...
Rick writes ...
Hi Mish,
I am a teacher and a retired US Army Reservist. I have followed your blog religiously for the past few months and I cannot help but agree with you and support your view of how unions and BIG government are bankrupting we Americans.
When are people going to realize that we cannot kick this debt down the road any more? It's like paying your credit card debt using the 20 year plan. The interest kills you!
The only dilemma that I face is that I feel rather a hypocrite when I condemn my colleagues for believing that they have earned a defined benefit pension by their 30 years of service as a teacher, yet in 8 years I will begin receiving my military retirement pay (plus health care) from the US Government. I feel as though I am feeding at the trough.
I read articles in the news about the Wisconsin teachers "sacrificing" by now agreeing to pay 5-6% toward their pensions and 10-12% for their health care. Whoopee! I currently pay almost 50% of my health care costs out-of-pocket, and and I contribute 10% toward my direct compensation retirement plan. I would gladly contribute toward my pension too if that would help our state (Washington) from red ink.
Thanks for all the broad and informative articles. Keep up the great work.
Rick
Thanks Rick
Your email is deeply appreciated. I do not blame people for taking what comes their way. No one should.
However, I do blame those who feel they are better than everyone else. I also blame people who feel taxpayers owe them enormous benefits that the private sector does not get simply for showing up to work.
Worse yet, many do not even bother showing up for work via various call-in-sick mechanisms that scam taxpayers out of money.
Yesterday I received an email from my friend Tim Wallace. He wrote about the Belvidere New Jersey School District budget.
The issue at had was contract raise of 4.25%. To save teachers jobs, the school district proposed cutting the raise to 2.12%. The union refused, sending a few teachers to unemployment-land. In turn, class sizes will undoubtedly increase or other fees will rise.
Teachers wonder why they are vilified. Unions wonder why they are vilified. The answer is easy. By turning down pay hikes while demanding still more, no one can possibly wonder who is to blame.
Yet public unions pompously ask for property tax hikes "for the kids".
Teachers' Unions Do Not Give a Damn About Kids
Here is the deal, straight up. Teachers unions do not give a damn about the kids.
Please read that carefully. I said "Teachers unions" NOT teachers.
Most teachers do care about the kids. However, teachers are sucked into believing garbage fed by union organizers. That garbage inevitably leads to cannibalization of the lowest on the seniority totem pole, regardless of skills or talent.
Union mentality is also to blame for inability of school districts to get rid of sexual predators and grossly incompetent teachers.
Time For Reflection
This is a time for serious reflection. We all need to think about what government owes us (or doesn't), what taxpayers owe us (or doesn't), and what promises have been made by politicians at taxpayer expense that cannot possibly be met.
We also need to reflect on union rules that make us all slaves. I am going to hammer the slavery point home until it sinks in. If you have not yet done so, please read ....
■Paul Krugman, Stephen Colbert, Bill Maher, others, Ignore Extortion, Bribery, Coercion, and Slavery; No One Should Own You!■Collective Bargaining neither a Privilege nor a Right
Enormous Sense of Entitlement
With very few exceptions, public union members have an enormous sense of entitlement.
Public union members need to put themselves in the the average taxpayer's shoes. Public union members need to figure out how the hell this can possibly be paid for.
I am deeply disturbed by events in this country. We have lost track of what has made this nation great.
Yes, the Fed is part of the mess. So is the "too big to fail" mentality that unjustifiably bailed out the banks. However, at the city and state level, there is no bigger problem than public unions, especially promises regarding wage and pension benefits that cannot possible be met.
Instead of admitting the problem like Rick did, many government workers and public union members attack the messenger and ignore union sponsored slavery because it suits their purpose.
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