Crisis probe lacks Pecora edge


By Julian Delasantellis
Asia Times
Jan 21, 2010


During the darkest days of the Great Depression of the 1930s, businessmen knew that they had to go the extra mile to separate customers from their money. For the movie-theater owner, this frequently involved presenting substantially more entertainment and information than just the feature film attraction.

One of these might be what came to be known as the "cliffhanger", basically, a 10-20 minute segment of an adventure/science fiction film, one that began with a resolution of the protagonist's crisis from the previous week, and ended with him getting into another one (as in, hanging off a cliff) that would hold the audience's attention and interest until the following week.

But in 1934, competitive programming arose to challenge the presence in the theaters of buccaneering pirates or dashing heroes with rocket backpacks. These were filmed excerpts of a subcommittee of the United States Senate's committee on banking and currency charged with investigating the financial skullduggery that led to the Great Crash of 1929 and subsequent world Great Depression. Leading the questioning of many of the captains of Wall Street banking and finance was the committee's chief counsel, former New York assistant district attorney, Ferdinand J Pecora, giving the effort the name it has carried through time, the Pecora Commission.

There was wild public interest in the hearings; back then, people actually seemed to be looking for solutions to their dire economic circumstances rather than just scapegoats. Both of the two relatively new technological communications mediums, radio and sound cinema, covered the hearings extensively; radio through live broadcasts of the hearings; cinema through newsreels shown in place of the cliffhangers. Many historians credit the public outrage generated by Pecora as critical in the passage of the market regulation and stabilization regulations such as the Glass-Steagall Act that protected the financial markets for the next 50 years.

Now, in response to many demands for an investigation into America's current economic travails, a new Pecora-type investigative effort has been formed, the Financial Crisis Investigative Committee, chaired by former California state treasurer, Philip Angelides. Also, much like the 1930s, the hearings of the commission, which began last week, were readily available through a new communications medium, the Internet. In a telling point as to the chances of this committee spurring real reform, not even the three cable business networks, CNBC, Fox Business or Bloomberg, carried the full hearings to their conclusion.

As for the general public, well, for them, the hearings never even approached the attention status of the shadow of an ephemeral blip on a radar screen. If there had been a "Rocketeer" type offering of a man setting his pants on fire with his rocket pack, its ratings would have bested the commission's by huge numbers - as proof of that, look at all the coverage and attendant ratings garnered by coverage of the man whose pants were on fire, Tiger Woods.

The committee's first hearings were last week, from Wednesday to Friday, with the big hitters of the financial industry up first - Lloyd Blankfein, chief executive officer of Goldman Sachs, Jamie Dimon of JPMorgan Chase, John J Mack of Morgan Stanley and Brian T Moynihan of Bank of America.

Power breeds arrogance, which breeds hubris, which was most obvious in the case of the de facto ruling inner party elite of Oceania and Eurasia - Goldman Sachs. For Blankfein, you could almost taste the bile rising in the throat of the master, for that day he was forced into a groveling public obeisance to his slaves, the representatives of the people forever to be held in his 29.99% credit card interest rate bondage.

Blankfein: Goldman Sachs is a financial holding company whose principal businesses are investment banking, market making and investment management. We provide services to a diverse and significant client base, which is largely institutional and includes corporations, financial institutions, governments and high net-worth individuals. Our activities are divided into three general areas: Our investment banking business provides strategic corporate services, matching the resources of the firm to specific client needs. This frequently means combining advisory, financing and co-investment capabilities. We help clients access equity and debt capital markets in order to grow their businesses, restructure their balance sheets to improve or to solidify their financial strength and to manage their assets and liabilities. We also assess and facilitate strategic options for M&A [mergers and acquisition], divestitures and corporate defense activities. Through our merchant banking activities, we create and manage investment funds consisting of both our own and our clients' money in order to invest in growing businesses. Our market making or securities sales and trading business facilitates customer transactions for corporations, financial institutions, governments and individuals through market making and trading of fixed income, equities, currencies, commodities and derivatives products. As a market maker, we provide the necessary liquidity to help ensure that buyers and sellers can complete their transactions and markets can function efficiently. In dislocated markets, we are often required to commit capital to hold client positions over a longer term while a transaction is completed. Our asset management and securities services businesses help public and private pension funds, corporations, non-profit organizations and high net-worth individuals plan, manage and invest their financial assets for the long-term. We also provide these entities as well as mutual funds and hedge funds with prime brokerage, securities lending and financing services. You have asked about our business model, major sources of income (or losses) and any changes made. Before the crisis and since, we have remained focused on providing advice, allocating capital, making markets, managing money and investing with and for our clients. We have all witnessed the consequences of having too narrow a business model. At the same time, we have resisted becoming a financial supermarket - concerned that being too big or dispersed would detract from our focus and expertise.

In other words, if you're looking for the bucking, gunslinging investment banker who took on so much risk as to almost crash the system, look somewhere else - like the other guys at the table, maybe?

Angelides asked Blankfein about one of just the more recent of the Goldman controversies - the reports circulating that the firm had been selling off suspect mortgage-backed securities to investors unprepared to handle the risk. Angelides likened this practice to a shady used-car dealer ( "What's a used car? Blankfein might have wanted to ask an aide. "It's one of those things the servants drive that leave oil stains in their parking spaces.") selling lemons with bad brakes to the little old ladies needing a ride to church, and then having the firm (through credit default swaps) take out a life insurance policy on their deaths from the subsequent car crashes.

Putting down at least a swatch of the cloak of infallibility with which he had covered himself and the firm, Blankfein said that "We did not know at any minute what would happen next ... There were people in the market who thought it was going down and there were others who thought these prices had gone down so much they were going to bounce up again."

Finally, in his interpretation of what were the base causes of the financial crisis, Blankfein said, "Without trying to shed one bit of our industry's accountability, we would also further our collective interests by recognizing other contributing causes to the severity of the crisis"; and with this he shed virtually all of his individual company's accountability by pointing his well-coiffed fingernails further down the witness table and into the halls of the US Congress.

Blankfein: "Factors from both Main Street and Wall Street contributed to today's circumstances. Neither part of our economy acted completely independently of the other. So, any examination of how we got to this point must begin with an understanding of some of the global economic and financial dynamics of the last two decades. Certainly, what started in a localized part of the US mortgage market spread to virtually every corner of the global financial markets. But the genesis of the problem wasn't in sub-prime alone. Instead, the roots of the damage to our financial system are broad and deep. They coalesced over many years to create a sustained period of cheap credit and excess liquidity. The resulting under-pricing of risk led to massive leverage across wide swaths of the economy - from households to the corporate sector to the public sector. I see at least three broad underlying factors: "First, there has been enormous growth in the amount of foreign capital, much of it held in large pools, and a very significant shift in the balance of payments of many emerging markets; Second, and linked to this, nearly 10 years of low long-term interest rates; and Third, the official policy of promoting, supporting and subsidizing homeownership in the United States."

Jamie Dimon, chairman and chief executive of JPMorgan Chase, started by blowing his own horn as well.

Dimon: "Throughout the financial crisis, JPMorgan Chase never posted a quarterly loss, it served as a safe haven for depositors, worked closely with the federal government, and remained an active lender to consumers, small and large businesses, government entities and not-for-profit organizations. As a result of our steadfast focus on risk management and prudent lending, and our disciplined approach to capital and liquidity management, we were able to avoid the worst outcomes experienced by others in the industry. Throughout the crisis, we maintained capital ratios far in excess of 'well capitalized standards'. We began 2008 with a Tier 1 capital ratio of 8.4% and ended it at 8.9% (10.9% including Troubled Asset Relief Program (TARP) funds). At the end of the third quarter of 2009, following our repayment of TARP, our Tier 1 capital ratio stood at 10.2%. Our Tier 1 common ratio at the beginning of 2008 was 7.0% and stood at 8.2% at the end of the third quarter of 2009. In addition to our strong capital ratios, we maintained a high level of liquidity to prepare for unexpected draws and increased our loan loss reserves to account conservatively for anticipated losses."

There were a few raindrops among the sunbeams, like these, that caused the company's stock to fall 72% from September 2007 to March of 2009.

Dimon: "To be sure, there are a number of things we could have done better: the underwriting standards in our mortgage business, for example, should have been higher, and we wish we had done an even better job in managing our leveraged lending and mortgage-backed securities exposures, all of which I discuss later in my testimony. But our entire team - including the firm's credit officers, risk officers, and legal, finance, audit and compliance teams - worked diligently to address these issues and minimize the cost to our company and our customers. I would like to outline a few of the actions we took leading up to and during the financial crisis."

But when all was said and done, and with more than a little help from the Treasury's TARP program, they were all on the side of good 'ol Mr American Middle Class Taxpayer.

Dimon: "After acceptance of the government's $25 billion preferred stock investment, we continued our lending activities to consumers, businesses and governments. In the fourth quarter of 2008 alone, we extended over $150 billion in new credit to consumers, businesses, municipalities and non-profit organizations. That figure includes over $50 billion in new consumer originations (mortgages, home equity loans, credit cards, student loans, auto loans, etc); over $20 billion in new credit extended to 8,000 small and mid-sized businesses; and $90 billion in new and renewed commitments to our corporate and other clients. We also dramatically increased our presence in the interbank market, lending an average of $50 billion a day to other banks. We did so while maintaining prudent risk management and underwriting standards, mindful of market and credit risks. In early May 2009, we successfully completed an extensive stress testing program for major banking institutions that determined there would be no need for us to raise additional capital even under the most adverse scenario envisioned by regulators. After consultation with our regulators and the Treasury Department, we received approval to pay back TARP funds in June 2009. Along with the $25 billion that we repaid, we paid $806 million in dividends on the preferred stock. In December 2009, the United States Treasury sold for $936 million the JPMorgan Chase warrants it received in connection with its TARP investment. Thus, all told, taxpayers received more than $1.7 billion, or an 11% annualized return on their investment."

As for the mortgage market, the bank continues, at least for publication, to hold fast to the American credo that anything with human-like DNA should be able to live in a house they own - just as long as the Government is subsidizing the risk.

Dimon: "JPMorgan Chase is also at the forefront in doing everything we can to help families meet their mortgage obligations. Even before this current crisis, we undertook comprehensive efforts to help families avoid foreclosure. Our foreclosure prevention efforts include both the loans that we own and those that we service. We believe that it is in the best interests of both the home owner and the mortgage holder to take corrective actions as early as possible. Since 2007, we have helped prevent over 885,000 foreclosures through our own program, as well as through participation in government programs like the US Making Home Affordable initiative. Through November 30, 2009, we have offered almost 570,000 new trial loan modifications to struggling homeowners. Of these, over 112,000 loans have been approved for permanent modification. We are also conducting extensive outreach to borrowers. By March 31, 2010, Chase will have opened 51 mortgage assistance centers across the country where our customers receive direct and personal assistance in reviewing their mortgage loans and documents, and gain a better understanding of their options. We also launched a coordinated program to call a customer 36 times, reach out by mail 15 times and make at least two home visits, if necessary, to obtain the appropriate documents. We attempt to explore every avenue for borrowers in helping them keep their homes."

But the shop-till-you-drop credit card consumerist convulsions of the early part of the previous decade are over, at least until the banks can find some new suckers, err, investors, to once again roll up and buy their securitized credit card receipts.

Dimon: "As I noted earlier, we have also made changes to our credit card business, including raising the credit score threshold for direct mail marketing; increasing the number of applications subject to a more thorough review process; lowering credit lines for the riskiest borrowers while offering extensions to the most creditworthy borrowers; and closing accounts that are inactive, which in our experience, are at increased risk. We are offering payment plans for our borrowers where necessary."

If all those nasty over-leveraged speculators were nowhere to be found at JPMorgan Chase and Goldman, they were there in spades at Morgan Stanley, and, early on in the financial crisis, the bank paid the price, according to John Mack, Morgan Stanley chief executive until late last year,

Mack: "While the firm's residential mortgage-related business was not as large as some of our peers, Morgan Stanley participated in the markets for residential mortgage-backed securities and collateralized debt obligations, and suffered losses as a result of its positions in these markets. Most significantly, during the fourth quarter of 2007, Morgan Stanley had to write down approximately $9.4 billion in losses related to its exposure to mortgage related securities and derivatives. Approximately $7.8 billion of these losses related to a proprietary trading position in one part of the firm; the remainder related largely to our exposure to other mortgage-related products, which also had declined in value amidst the widespread decline in the credit and mortgage markets."

Thus, the firm met the gyrations and market spasms of September, 2008 nearly fatally weakened. Without government help, it probably would have succumbed.

Mack: "In the immediate wake of Lehman's failure on September 15 [2008], Morgan Stanley and similar institutions experienced a classic "run on the bank," as investors lost confidence in financial institutions and the entire investment banking business model came under siege. In the days following Lehman's bankruptcy, Morgan Stanley and many other financial institutions experienced significantly wider credit spreads on their outstanding debt and sharp declines in stock market capitalization, which in turn led clearing banks to request that firms post additional collateral, causing further depletion of cash resources. In an effort to stem the panic, we announced our very strong third quarter earnings a day earlier than planned - on September 16 - but Morgan Stanley's stock price continued to drop. The crisis of confidence in the financial sector fed a chain reaction in the broader economy, as lower prices for financial assets undermined confidence and led to lower prices throughout the rest of the economy.

"This period was marked by rampant - often untrue - rumors and speculation, and the entire Morgan Stanley leadership team worked nonstop over the course of the following week to provide information to clients, the markets, and our employees in order to dispel the false rumors that were spreading through the financial markets and to provide investors with an informed basis to make investment decisions. We also worked closely with our regulators in an effort to keep them informed and achieve the right result for the markets, the economy and the firm.

"Ultimately Morgan Stanley's position began to stabilize on September 22, when the firm announced that Mitsubishi UFJ Financial Group - the world's second largest bank holding company - agreed to enter into a global strategic alliance with the firm as part of a $9 billion investment. This alliance, which closed in October 2008, was fundamental to Morgan Stanley's effort to arrest the panicked downward spiral that was affecting every major institution in the world financial markets in the fall of 2008 ... Morgan Stanley also accepted and pledged to responsibly use the government's investment through the TARP Capital Purchase Program. Morgan Stanley has, as you know, since paid back our TARP funds and repurchased the related warrants at a price that provided US taxpayers a 20% annualized return on their investment. Our firm appreciates the importance of the federal government's financial support, which helped prevent a collapse of the financial system."

And in a rejoinder to those conservatives now desperately trying to once again lower their skirts and reclaim the free-market purity lost in those sultry conference-room debaucheries with government of Autumn 2008, Mack said that those who say that the TARP funds were "forced" onto the banks are only luxuriating in the holiday lands of denial.

Mack: "There's no denying that every firm in the industry - and the broader financial markets as a whole - benefited from this support."

The bank's salvation, was, of course, the general economy's curse - deleveraging, the retrenchment of the bank's lines of credit which acted, and continue to act, to starve the general economy of desperately needed credit.

Mack: "These early losses were a powerful wake-up call for Morgan Stanley, and we began moving aggressively in late 2007 and early 2008 to adapt our business to the rapidly changing environment - reducing leverage, trimming the balance sheet, raising private capital, and further strengthening risk management. For instance, Morgan Stanley brought its leverage down significantly - from 32.6 times at the end of 2007 to 11.4 times at the end of 2008. Similarly, we reduced our balance sheet from more than $1 trillion in 2007 to approximately $650 billion in 2008 as the firm reduced its exposure to legacy assets. At the same time, we also further strengthened our capital and liquidity positions with a total of $24.7 billion in new Tier-1 capital. Due to these actions, Morgan Stanley was in a better position than many of our peers to weather the financial storm that occurred in late 2008."

Of course, the market had its own thoughts on that. Morgan Stanley's stock dropped by over 85% from early August to early October of 2008. Back at the bank, the deleveraging and shying away from risk continued almost to the point of fetishism.

Mack: "Morgan Stanley has taken a number of steps during and in the immediate wake of the crisis to strengthen our position and create a solid foundation for well managed growth, including reducing leverage, cutting the balance sheet, and raising capital. In addition to these stabilizing steps, Morgan Stanley also made several important, systemic changes to our business practices, risk management structures, and executive compensation policies, and we remain committed to continuing to improve these policies and practices in the months and years ahead… One of the clearest lessons from the 2008 crisis was that many firms simply carried too much risk. Beginning in 2007, Morgan Stanley moved aggressively to reduce its leverage, bringing it down from 32.6 times at the end of 2007 to 15.7 times at the end of the third quarter of 2009. Today Morgan Stanley remains focused on maintaining prudent levels of leverage by carefully targeting capital to those businesses that offer the most attractive risk adjusted returns.

"Morgan Stanley has devoted significant additional resources over the last two years to further strengthen our risk management policies and procedures. The firm's risk management-related governance structure includes the Firm Risk Committee, the Chief Risk Officer, the Internal Audit Department, independent control groups, and various other risk control managers, committees and groups in and across business segments. The Firm Risk Committee is composed of Morgan Stanley's most senior officers. It oversees the entire risk management structure and has responsibility for risk management principles, procedures and limits, and monitoring of material market, credit, liquidity and funding, legal,operational and franchise risks and the steps management has taken to monitor and manage such risks."

In other words, you can continue to expect this bank to continue tossing around new loans like manhole covers for a long, long time.

Finally, like the lion lying down with the lamb, Morgan Stanley does the unthinkable - it asks for more government oversight.

Mack: "The financial crisis laid bare failures of risk management at individual firms across the industry and around the globe. But, more significantly from a policy perspective, it made clear that regulators simply didn't have the tools or the authority to protect the stability of the financial system as a whole. That's why we need a systemic risk regulator with the ability and responsibility to ensure that excessive risk-taking never again jeopardizes the entire financial system."

Of course, a "systemic risk regulator" is exactly what the financial industry's well-paid courtesans on Capitol Hill are working to see that the banks are never burdened with.

Finally, far away from scandal- and sin-sodden Wall Street, down there in god's country of Charlotte, North Carolina, came Brian T Moynihan of Bank of America, commencing his testimony with this extraordinary confession.

Moynihan: "Over the course of this crisis, we as an industry caused a lot of damage. Never has it been clearer how mistakes made by financial companies can affect Main Street, and we need to learn the lessons of the past few years. "

Moynihan follows with a fairly lucid but standard explanation of how the subprime crisis - involving poor credit borrowers, "liar's loans", adjustable-rate mortgages, low or non-existing down payments and meretricious mortgage brokers - metastasized into the global financial crisis, through securitization, leverage, credit default swaps and speculation. Moynihan goes on to call for a return to sounder banking principles as related to underwriting and leverage, as well as a new emphasis on liquidity of financial products; that is, can they survive a modern day "run on the bank?" Moynihan says the least, almost nothing, actually, about excess bonuses and other forms of executive compensation at his bank, perhaps because his institution has always carried the reputation as one of the most parsimonious in the financial industry.

The last two-and-a-half days of committee hearings featured folk who, instead of just covering their shiny assets, actually had some interesting things to say.

Texas hedge-fund manager Kyle Bass, who had the financial crisis paying off for him like jumbo jackpots on slot machines through his shorting of subprime mortgage securities, called for a reigning in of the over-the-counter (OTC) derivatives market through the creation of a central options clearinghouse, as well as a reversal of the 2004 Securities and Exchange Commission (SEC) ruling that allowed massive expansions of investment bank leverage.

Mark Zandi, chief economist and co-founder of Moody's Economy.com, and a former economic advisor to 2008 Republican Party presidential candidate John McCain, called the 2007 financial system crisis mostly over, with the financial system now generally stabilized under the protection of world governments. However, for the economy as a whole, the picture was not nearly as bright, and would not be for a long time.

Zandi: "The longer-term fallout from the economic crisis is also very substantial. GDP is lower and unemployment will remain higher as a result. It will take years for employment to regain its pre-crisis level."

Then, in a commentary his former boss, now facing a serious primary challenge for re-election to his Arizona Senate seat from a candidate called Earl Grey, would not look on with much favor, Zandi points to the absolute centrality of government fiscal support for the economy and the recovery.

Zandi: "The impact on the nation's fiscal situation has been severe. The fiscal outlook was daunting even before the crisis, and now feels overwhelming. It is not that policymakers had a choice. The cost to taxpayers would have been measurably greater if government had not intervened aggressively. The recession would still be in full swing, undermining tax revenues and driving up spending on Medicaid, welfare, and other support programs for distressed families. It is a tragedy that the nation has been forced to spend so much to tame the financial crisis and end the Great Recession. Yet it has been money well spent."

Illinois State Attorney General Lisa Madigan, leading a panel with three other state and local law enforcement officers, noted the efforts of state officials in investigating the questionable mortgage origination and securitization practices that stoked the boom. She also said she could use a hand from the Federal Bureau of Investigation, up unto now mostly silent in prosecution of these offenses.

Madigan: "Even now, there appears to be a lack of will in Washington to fill the regulatory void that led to this crisis. Congress and the federal regulators have yet to put into place strict underwriting standards that apply to all home loans, even though the record shows that such standards are essential to preventing another crisis. Additionally, as seen in the ongoing battle over President Obama's proposed Consumer Financial Protection Agency, the big banks continue to lobby for the ability to operate within state borders without regard to state laws. As my testimony will make clear, the states were far more aggressive than the federal government in our efforts to curb growing abuses in the mortgage lending market from the beginning. The states herefore must be an integral part of any improved regulatory regime that is put into place to prevent a crisis of such catastrophic proportions from happening again."

Finally, SEC chairperson Mary Schapiro and Federal Deposit Insurance Commission chair Sheila Bair took some of the blame onto their own fiefdoms, something that might have been more impressive had the two been actually running these agencies at the time.

Bair: "Not only did market discipline fail to prevent the excesses of the last few years, but the regulatory system also failed in its responsibilities. There were critical shortcomings in our approach that permitted excessive risks to build in the system. Existing authorities were not always used, regulatory gaps within the financial system provided an environment in which regulatory arbitrage became rampant, and the failure to adequately protect consumers created safety-and-soundness problems. Moreover, the lack of an effective resolution process for the large, complex financial institutions limited regulators' ability to manage the crisis. Looking back, it is clear that the regulatory community did not appreciate the magnitude and scope of the potential risks that were building in the financial system."

Both Schapiro and Bair decried the financial industry's use of what is called "regulatory arbitrage", wherein a new financial product is shopped around to different regulatory jurisdictions in order to find the regulator with the lightest touch.

Schapiro: "Regulatory arbitrage possibilities abound when economically equivalent alternatives are subject to different regulatory regimes. An individual market participant may migrate to products subject to lighter regulatory oversight. Accordingly, OTC derivatives should be regulated consistent with their underlying references. This will reduce arbitrage and better ensure market integrity."

Both Schapiro and Bair noted one of the central contradictions of financial regulatory reform - its timing. During the boom years, when risks are being wildly taken and wallets being filled thick and flush, it's hard to fill a hall with a talk on financial market reform; who wants to be the wallflower at the orgy? By the time financial market reform is a critical issue, after the crash, during the subsequent turndown, it's too late to do much about it until the next time.

And then, by the weekend, like the dying echoes of a far away summer thunderstorm, they, the commission and all the witnesses, were gone. Notwithstanding a few interesting exchanges, all the big bankers left Washington exactly as they arrived-with not a glove laid on them. This was quite the contrast to the original Pecora Commission, which led to convictions and jail time. Blankfein, Dimon, and Mack tried to rub some soothing salve on the public's inflamed bruises over all the banking bonuses, but not in the quantity the public would have felt had they actually pledged to curtail the hated practice, which they didn't.

So, by the beginning of the week, the cliffhangers, whether they're about Tiger Woods, Jay Leno, or Conan O'Brian, are free to come back. The Financial Crisis Investigative Commission never really had what it took to be a good cliffhanger. The bad guys kept winning.

Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.

http://www.atimes.com/atimes/Global_Eco ... 1Dj02.html