By Pam Martens: December 7, 2007
Imagine you moved in next door to a mischievous child. Over the years, you watched the parents scold ever so lightly as the deviant behavior grew from stealing loose change to petty larceny to bank robbery. You knew for sure the child would eventually get caught and end up in prison; but you didn’t count on one thing: the parents used their political clout with each ratcheting up of the crimes to avoid prosecution, effectively turning the overseers of the public interest into criminal enablers. As the enablers “fixed” the outcome of each crime, they also sealed the records from public view and historical perspective.
That scenario typifies how criminal behavior has exploded on Wall Street and why President Bush, Congress and the regulators are stumbling around in the dark looking for cures for a financial crisis that they can neither understand nor contain: they’re enablers in denial.
Nothing more dramatically illustrates the criminal contagion than the fact that for the second time in 13 years, Orange County, California has found Wall Street toxic sludge threatening its public funds.
Here’s what happened the first time around: a Merrill Lynch stockbroker, Michael Stamenson, sold billions of dollars of complex securities to Orange County, which ran a pooled investment fund for close to 200 cities and school districts in the county. The county lost $1.7 billion when the highly leveraged fund imploded, the county filed bankruptcy, resulting in serious job losses and cutbacks in social services to the poor. In all, Merrill made approximately $100 million in fees with Stamenson collecting $4.3 million in just the two-year period of ’93 and ’94.
Stamenson was immortalized in evidence produced in court as the star of a Merrill Lynch training tape for rookie brokers where he maps out the road to success on Wall Street: “the tenacity of a rattlesnake, the heart of a black widow spider and the hide of an alligator.”
As the evidence against Stamenson and higher ups at Merrill played out in court, Merrill Lynch continued to pay annual compensation of $750,000 to Stamenson and eventually settled the case for $400 million and sealed the documents. It also paid $30 million to the county to settle and abruptly end a grand jury investigation, leading to loud cries of foul play. Once again, the documents and testimony were sealed from public view. This is what consistently happens on settlement when a customer or employee attempts to sue a Wall Street firm and is ushered instead into a Wall Street Star Chamber called mandatory arbitration.
Today, Orange County is hardly an isolated case of banksters gone wild. The same type of sludge sits in public funds for schools, cities and pensions from coast to coast.
A Local Government Investment Pool in Florida recently saw a run on its assets after it was revealed that $1.5 billion of defaulted and downgraded debt, courtesy of Wall Street, was part of this supposedly safe money market fund for hundreds of towns and school districts in Florida.
Even four small Norwegian towns near the Artic Circle have lost $64 million from complex securities created by Citigroup and sold to them by a local broker, Terra Securities. Additionally, billions of dollars of the sludge sit stealthily in Mom and Pop money market funds at some of the largest and most prestigious financial institutions in the U.S.
And if the situation were not dangerous enough, the U.S. Treasury Secretary, Hank Paulson, has misdiagnosed the problem (wittingly or unwittingly). Mr. Paulson would have you believe that if he can help enough people avoid foreclosure on their homes, by changing their teaser mortgage rate to a fixed rate on their subprime loan, he will have taken a big step forward in alleviating the financial crisis. While any constructive step to keep people in their homes is to be applauded, what is blowing up all over the globe is not just subprime mortgages. The real problem arises from Structured Investment Vehicles (SIVs) and Special Purpose Entities (SPEs) which, just like Enron, hide enormous amounts of debt from public scrutiny, making companies appear more profitable and solvent than they really are.
Mainstream media has also been implanting the idea that it’s all about homeowners and mortgage loans instead of banksters hiding bad debt. On December 5, 2007, the Associated Press, which is syndicated to newspapers across the country, carried this inaccurate statement: “SIVs are investment funds created by banks like Citigroup Inc. or HSBC Holdings PLC and sold to investors. The funds borrow short-term money and use it to buy mortgage debt, profiting off the difference between what they collect on the mortgage debt and what they pay to borrow.” [Italicized emphasis added.]
Mortgage debt? According to Citigroup, the largest purveyor of the black hole SIVs with over $83 billion in seven SIVs as of September 30, 2007, 58% of its SIV holdings is financial institution debt, with 32% mortgage related, 5% student loans, 4% credit cards and 1% other. It goes on to say that just $70 million of this $83 billion has indirect exposure to U.S. subprime assets. On November 30, 2007, Moody’s put on review for possible downgrade (as well as actual downgrades on some securities) debt totaling $64.9 billion that was issued by six Citigroup SIVs. [1]
In other words, financial institution debt, together with imploding mortgages, off balance sheet mountains of debt and the worst transparency we’ve had since 1929, are the full set of problems.
Why would positioning this crisis by the President or U.S. Treasury Secretary as a subprime mortgage problem be preferable to laying out the full scope of the crisis to the American people?
To state the truth would be admitting that the Bush administration and its crony capitalists failed to properly audit the largest banks in America; failed to pay attention as they stashed hundreds of billions of dollars off their balance sheets in a replay of Enronomics; failed to prosecute the banksters when they parked this toxic waste in Mom and Pop money market funds across the country; and failed to jail the banksters before they burned down the bank and became a global threat to financial stability.
Now, these very same banks don’t know what’s hidden off each others balance sheets, how much their largest industrial customers have hidden off balance sheet, courtesy of Citigroup’s propensity to set up SPEs for others; if the bank that is a counterparty to its credit-default swaps is going to be in business when those insurance policies are most needed. Therefore, they say, we’ll just stop doing business with each other since we’re all guilty by association with the same corrupt enablers in Washington.
And while the Securities and Exchange Commission (SEC), Federal Reserve Board (FRB), and Congress bear much blame for the financial crisis, the Office of the Controller of the Currency (OCC) stands out as the quintessential enabler of corruption on Wall Street.
Consider the July 25, 2007 testimony of the Consumer Federation of America on behalf of itself and other leading consumer groups to the Committee on Financial Services in the U.S. House of Representatives:
“Any discussion about the quality of federal financial services regulation must begin by mentioning the ‘elephant in the living room….’ The Supreme Court’s recent ruling in Watters vs. Wachovia Bank, N.A., upheld a regulation by the Department of Treasury’s Office of the Comptroller of the Currency (OCC) that permits operating subsidiaries of national banks to violate state laws with impunity. The court ruled that the bank’s operating subsidiary is subject to OCC superintendence – even if there effectively is none – and not the licensing, reporting and visitorial regimes of the states in which the subsidiary operates…The OCC has even sought to prevent state attorneys general and regulators from enforcing state laws that it concedes are not preempted. The recent court ruling encourages national banks and their subsidiaries to ignore even the most reasonable of state consumer laws.”
To underscore that the overarching problem here is an interbank crisis of confidence over black holes of corruption and crony regulation, rather than the narrowly defined “subprime mortgage mess,” let’s look at the time line of what happened. Beginning this past July, the credit-default swaps of a British bank, Northern Rock, begin to tick higher; by August, they made an additional sharp move upward, signaling a solvency problem. In September, there’s a run on the bank (the first in Britain since 1866). The bank collapses and the Bank of England has to use taxpayer money to bail it out to the tune of approximately 29 billion pounds or close to $60 billion.
What does that have to do with a U.S. financial crisis? As it turns out, this small bank of 6,000 employees has set up Channel Island-based debt structures called Granite, stuffed them with $104 billion of U.K. residential mortgages (which are now showing an increasing propensity to default). Adding further intrigue and local outrage, the offshore trust named a charity for Down’s Syndrome children as part of its funding subterfuge, without the permission or knowledge of the charity. This has sparked a full scale investigation by British authorities.
Terrifying banks on this side of the Atlantic is the knowledge that (1) two of our biggest Wall Street firms, Citigroup and Merrill Lynch, underwrote tens of billions of that Channel Island paper, Granite Master Issuer, and sold it here in the U.S.; (2) Citibank, the commercial banking unit of Citigroup, is the principal paying agent; (3) big chunks of that paper, as of SEC filings on September 30, 2007, is sitting in money markets and fixed income mutual funds in the U.S., raising some serious liability issues for Citigroup and Merrill; and (4) 30 percent of the mortgages have a loan to value (LTV) ratio of 90 to 100 percent while over 50 percent have a LTV of 80 to 100 percent. [2]
It smells Enronesque and Parmalatesque (the bankrupted Italian dairy firm) to a wide swath of the legal and banking community and given that Citigroup will finally face public trials in both of these earlier swindles next year, the timing could not be less propitious for confidence building.
The British Parliament is grilling all the players and regulators for answers to the financial crisis in public hearings while here in the U.S. we prefer to fashion remedies for a financial crisis we’ve yet to investigate or understand.
To recap: there has been the first bank run in 140 years in Britain. We’ve had the first run on a public money market fund in Florida. The U.S. debt markets have been barely functioning for four months. Our largest banks don’t trust each other.
Perhaps one of the presidential candidates could leave the campaign trail long enough to call for emergency hearings in Congress, the venue in which we the people pay them to do the people’s work.
[1] Citigroup’s 3rd Quarter 10Q filing with the SEC discussing its SIV
[2] Granite Master Issuer securitization filing with the SEC:
This article originally appeared at www.CounterPunch.org
