In-depth coverage of the crisis, as it is occurring, by a Wall Street veteran.
After years of receiving slaps on the wrists by regulators for helping insolvent companies hide the true state of their finances from investors, Citigroup’s day of reckoning has arrived in the form of “street” justice.
Wall Street colleagues are publicly challenging the adequacy of Citigroup’s capital, its accounting practices, and its own black hole-Cayman Islands debt structures. Some of the oldest Wall Street firms are also refusing to pony up billions for a grand scheme endorsed by the U.S. Treasury, ostensibly to unfreeze debt markets. Wall Street firms see it as a bail out of Citigroup and just one more free ride from the Feds.
The saga of how the top minds in Washington and on Wall Street have dealt with the deepening financial crisis in the U.S. would make a great Hollywood screenplay, except for this: it’s absurdly unbelievable.
Storyline: The largest bank in the United States (by assets), Citigroup, is discovered to have stashed away over $80 Billion of Byzantine securities off its balance sheet in secretive Cayman Islands vehicles with an impenetrable curtain around them. Citigroup calls this black hole a Structured Investment Vehicle or SIV. Wall Street insiders call it a “sieve” that is linked to the breakdown in trading of debt instruments around the globe and the erosion of wealth in assets as diverse as stock prices to home values. Additionally, tens of billions of dollars in short term commercial paper backed by these and similar Alice in Wonderland assets are sitting in mom and pop money market funds at the largest financial institutions in America, with a AAA rating from our renown credit rating agencies.
With each new revelation of multi-billion dollar losses from the largest Wall Street firms, there has been this nagging question as to how these Masters of the Universe got stuck with these massive write-downs. Isn’t Wall Street supposed to execute trades for others; not build huge inventories of toxic, non-trading securities for themselves?
Given that these big Wall Street players now own some of our largest, taxpayer insured, depositor banks (courtesy of a legislative gift from Congress called the Gramm-Leach-Bliley Act) and the Federal Reserve is shoveling tens of billions of our dollars into some very big black holes, common sense might suggest that Congress would be holding public hearings. These hearings might shed light on how Wall Street has, under the cloak of darkness, mutated from a trading venue to manufacturing and warehousing exotic concoctions registered offshore.
The massive losses by big Wall Street firms, now topping those of the Great Depression in relative terms, have yet to be adequately explained. Wall Street power players are obfuscating and Congress is too embarrassed or frightened to ask, preferring to just throw money at the problem and hope it goes away. But as job losses and foreclosures mount and pensions and 401(k)s shrink, public policy measures to address the economic stresses require a full set of unembellished facts.
With Wall Street capital disappearing as fast as foreclosures are climbing, one foreign head of state had an epiphany. French President Nicholas Sarkozy advanced the idea recently that the global financial system is “out of its mind.” To develop this theory further, I’ve reconstructed below some of the mileposts on our journey to this financial loony bin.
Exhibit One: Commit-a-Felony-Get-a-Bonus Contract.
Back in 2002, Mark Belnick, who had previously been one of the legal go-to guys for Wall Street as a rising star at corporate law firm Paul,Weiss, Rifkind, Wharton & Garrison, found himself transplanted as General Counsel at fraud-infested Tyco International. Mr. Belnick inked a retention agreement for himself and it was duly filed without fanfare at the top corporate cop’s web site, the Securities and Exchange Commission (SEC). The agreement guaranteed Mr. Belnick a payment of at least $10.6 million should he commit a felony and be fired before October 2003.
Wall Street is collapsing not because of bad mortgage debt or lack of capital or over-leverage. Those are merely symptoms. Wall Street is collapsing because it deserves to collapse; it needs to collapse in order for America to survive. The economist Joseph Schumpeter called it creative destruction, a system where outdated models collapse to make room for new innovation.
Wall Street of the past decade never really had a business model as much as it had a business creed: greed is good; leveraged greed is even better.
In 1897, when 8-year old Virginia O’Hanlon posed her Santa Claus query to the New York Sun, she received a heart-warming editorial response reassuring her that “Yes, Virginia…He exists as certainly as love and generosity and devotion exist….”
Today, we hand our 8 year olds a $13 trillion national debt while our Congress hands Wall Street banksters the national purse without so much as a hearing to determine the cause of the debt collapse. Worse still, the money is doled out to the very same individuals who leveraged their institutions to casino status.
The parallels with 1932 are breathtaking: billions in bonds defaulting; dysfunctional global credit markets; commodity prices crumbling; stocks in free fall; home foreclosures; rising unemployment; banks teetering; an angry populace; a Republican administration clinging to their discredited trickle down theory; a Democratic contender for President with charismatic oratory skills tapping into the public mood with a message of a New Deal, this time called “change we can believe in.”
Citigroup’s two best known ad campaigns, “Citi Never Sleeps” and “Live Richly,” will hopefully become a cautionary warning for the next generation: don’t take advice from sleep-deprived money managers and live within your means.
As of last Friday’s close, Citigroup had $2 trillion in “assets” and $20.5 billion in stock market value, strongly suggesting the term “assets” is a misnomer on Wall Street. Late last night the U.S. government agreed to dump hundreds of billions more into this black hole without any survival plan required of the company as demanded of the auto makers: apparently if you make those four wheel machines that get us to work you’re suspect; if you manufacture losses in unintelligible derivatives, you’re good to go.
RiskMetrics is acknowledged as the firm that created a highly complex model called Value at Risk, or VaR, which attempts to express how much money a financial institution or trading desk can lose over a set period of time, such as the next 24 hours, week or month. As can be seen by the SEC order against Citigroup officials, if the risk modelers are not aware of an extra $39 billion of risk hiding in an offshore vehicle, the risk model is worse than useless because it’s actually creating a false sense of security…Across Wall Street, human questioning was getting in the way of taking those oversized, insanely leveraged risks that would lead to fat bonuses. So the human brain was turned off and the VaR brain, or a proprietary clone of it, was turned on. According to insiders, those highly complex Collateralized Debt Obligations (CDOs) that consisted of subprime loans stacked in convoluted tranches were plugged into the risk model as a simple AAA bond. Garbage in, garbage out.