Here is an excerpt from some of my work on the never ending financial crisis, caused by fraud and corruption...
The fraud, corruption,
and weaponization of financial instruments at the heart of the crisis have
continued years after the recession was declared over. Two brief examples
illustrate the power of the financial industry to acquire billions using
essentially no collateral, the degree of systemic risk of the entire system,
and the extent to which fraud operates throughout the system.
The
MF Global scandal is significant in two ways. First, it is significant because
it demonstrated the lack of regard held for customer collateral accounts by the
financial industry. Second, it illustrates how a process known as
“re-hypothetication” has enabled multiple financial institutions to use the
same pot of money as collateral. In January of 2012, the Wall Street Journal
concluded that $1.2 billion in customer funds held in collateral accounts had
“vaporized” due to “chaotic trading” (Funds From MF
Global Feared Gone" A1). As collateral accounts, these funds were supposed
to remain untouched. Christopher Elias, in his article "MF
Global and the great Wall St re-hypothecation scandal" explains that
customer accounts were essentially re-hypothecated, or used as collateral for
borrowing billions of dollars in a complex repurchasing (i.e., “repo”)
agreement:
Re-hypothecation occurs when a bank or
broker re-uses collateral posted by clients, such as hedge funds, to back the
broker’s own trades and borrowings. The practice of re-hypothecation runs into
the trillions of dollars and is perfectly legal. It is justified by brokers on
the basis that it is a capital efficient way of financing their operations much
to the chagrin of hedge funds.
What is particularly of
note is that the agent that lent billions to MF Global may have used the
re-hypothecated customer funds as its own collateral for further trading. This
is described as “churn:
In fact, by 2007, re-hypothecation had
grown so large that it accounted for half of the activity of the shadow banking
system. Prior to Lehman Brothers collapse, the International Monetary Fund (IMF) calculated that U.S. banks were
receiving $4 trillion worth of funding by re-hypothecation, much of which was
sourced from the UK.
With assets being re-hypothecated many
times over (known as “churn”), the original collateral being used may have been
as little as $1 trillion – a quarter of the financial footprint created through
re-hypothecation.
Essentially,
the “churning” of re-hypothecated funds allows many different financial players
to use the same collateral base. That means if any player defaults, they all
are in danger of default because the re-hypothecated funds would be vaporized.
The MF Global disaster illustrates both vacuous capital accumulation has become
and how vulnerable the entire system is to shocks.
The
second major scandal is the Libor scandal. This scandal demonstrates the degree
to which the market system is rigged by the powerful players. The scandal
concerns the London interbank offered rate, which according to The Wall
Street Journal is "the benchmark for interest rates on trillions of
dollars of loans to individuals and businesses around the world" (Enrich
& Munoz, A1). 15 big banks submit records of the inter-bank interest rates
they pay and the Libor rate is supposed to be averaged from these records from
the 15 biggest banks. However, the banks colluded in emails to submit falsified
records in order to manipulate the Libor rate, and to profit from that
manipulation. In June of 2008, Timothy Geithner, as Secretary of the New York
Federal Reserve Bank, wrote a private letter to Bank of England Governor Mervyn
King requesting six changes that would improve the authenticity of the Libor
rate (Paletta and Hilsenrath, 2012). His letter included a request to "eliminate incentive to
misreport" by banks. Geithner should have contacted the FBI
because he apparently knew that fraud was impacting the rate.[i]
The Wall Street Journal notes, “The latest disclosure makes clear that Fed
officials were aware of irregularities in the Libor interest-rate market. What
is less clear is how far Mr. Geithner and other officials went to address the
problem” (cited in Paletta and Hilsenrath). It is clear that the Bank of
England refused to take action because, as described in The Wall Street Journal, “they didn’t act more aggressively partly
because they were unaware bankers were trying to manipulate the rate…”
(Cimilluca, D., & Enrich, C1).
The
British Bank, Barclays PLC was caught red handed and agreed to pay $453 million
"to settle US and British authorities' allegations that the British bank
tried to manipulate the London interbank offered rate..." (Enrich &
Munoz, A1). The scandal widened when documents revealed that the British Labor
Government may have condoned the conspiracy and fraud involved in manipulating
rates (see Taibbi "Libor Banking"). This scandal to rig the Libor
rate has profound implications because it is the benchmark upon which trillions
of dollars of interest rate linked derivatives are based.
One
example of how taxpayers have been robbed using the fixed-libor rates can be
found in the interest rate swaps that exist between municipal entities such as
cities, and big banks such as JP Morgan. The big banks help governments at all
levels structure and re-structure their debts (e.g., outstanding bonds),
encouraging governments to push debt repayment far off into the future. In the
US, the big banks often sold interest rate swaps to municipalities when helping
them structure debt (i.e., bonds). An interest rate swap essentially fixed the
interest that the cities/counties would have to pay on their debt by arranging
a swap with the seller. So, for example, X City might pay for a swap with JP
Morgan that would fix their interest rates at 4%. The problem was that these
fixed interest rate swaps were subsequently at rates higher than what the market
rate for the debt would have been. Consequently, X City had to pay more
interest to JP Morgan (hypothetically) than they would have to pay if their
interest on debt floated at market rates. Plus, they had to pay massive fees. Matt
Taibbi wrote a great essay on how this was creating financial havoc for
municipal entities. He describes one county, Jefferson County, whose sewer
bills skyrocketed in the late 1990s when they were between ten and fourteen
dollars a month and recently when they were up to $200 a month, primarily
because of the debt and fees accrued in that country by corrupt officials and
the big banks
Another
major scandal involved in fixing interest rates on municipal debt concerns
fixed auctions. The company, CDR, which helps cities arrange auction for bonds
collaborated with the major buyers of these municipalities to fix the interest
rates the bonds would sell at. Matt Taibbi explains that bid rigging for
municipal debt essentially stole millions. He describes how the auctions were
fixed:
How
did they rig the auctions? Simple: By bribing the auctioneers, those middlemen
brokers hired to ensure the town got the best possible interest rate the market
could offer. Instead of holding honest auctions in which none of the parties
knew the size of one another's bids, the broker would tell the prearranged
"winner" what the other two bids were, allowing the bank to lower its
offer and come in with an interest rate just high enough to "beat"
its supposed competitors. This simple but effective cheat – telling the winner
what its rivals had bid – was called giving them a "last look." The
winning bank would then reward the broker by providing it with kickbacks
disguised as "fees" for swap deals that the brokers weren't even
involved in. (Taibbi “The Scam” 2012).
Taibbi claims that
every major US bank, including Bank of America, Chase, and Wells Fargo City
were involved in this bid rigging.
At the time this chapter was written, state prosecutors
were investigating whether their states incurred losses because of interest rate
manipulation (Eaglesham,
Albergotti, & Corkery, 2012). The Mass. State
treasurer observes that "a significant portion of his office's $9.5
billion cash portfolio is tied directly or indirectly to the performance of
Libor" (Eaglesham,
Albergotti, & Corkery, 2012). However, the Libor
scandal and the fix auction rates for government debt together suggest that the
entire government debt system (outside of the federal government) is ridden
with fraud and corruption. Furthermore, Goldman and other investment banks also
sold synthetic collateralized debt obligations to public entities, which they
subsequently betted against (Duggan 2010, C1, C3). The US government declined
to prosecute those financial agents responsible for the crisis, for betting
against clients, and for profiteering subsequently in rampant foreclosure fraud
(see Tavakoli 2010).
[i] Jim Rickards on the K eiser Report July 19 2012.The Keiser Repor KR316] Keiser Report: Alien Bankers, Leave Earth Alone!
References
Black, William. Holder
& Obama’s Propaganda is “Belied by a Troublesome Little Thing Called
Facts.” New Economic Perspectives (2012, January) http://www.neweconomicperspectives.org/2012/01/holder-obamas-propaganda-is-belied-by.html
Black, William Recurring
Crises Derive From Epidemics of Fraud Stemming from C Suite November 2011.
Speech available: http://www.youtube.com/watch?v=N_AuvLTJNh0&feature=youtu.be See also
http://www.financialsense.com/financial-sense-newshour/guest-expert/2011/09/14/william-k-black-phd/why-nobody-went-to-jail-during-the-credit-crisis
Cimilluca, D., & Enrich, D. Bank of England Rebuffed Tougher Libor Oversight. The Wall Street Journal (2012, July 21-22), B1, B2.
Eaglesham, Jean.
Wall Street Journal May 14, 2012 p. C1, C5
Eaglesham, J., R. Albergotti, & M. Corkery. States Step Into Libor Probe. The Wall Street Journal (2012, July 16) C1, C2.
Elias,
Christopher . "MF Global and the great Wall St re-hypothecation
scandal" Thomas Reuters News and Insight (2011, December), http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/
Enrich, D.,
& Munoz, S. S. (2012, July 5). Rate Scandal Set to Spread. The Wall Street
Journal, p. A1, A5.
"Funds From MF Global Feared Gone." The Wall
Street Journal, Jan 30, 2012 p. A1, A2.
Hart, Keith. Money in an Unequal World. New York: Texere, 2001.
Hutchinson, Martin. Ban Credit Default Swaps? These Corporate Bankruptcies Show We should. Monday Morning (2009, april 23).http://moneymorning.com/2009/04/23/ban-credit-default-swaps/
Lawder, D.,
& Youngla, R. (2010, March 9). Greek CDS overtures fall on deaf ears in
Washington. Reuters [on-line].
Available: http://www.reuters.com/article/idUSTRE62900820100310
Taibbi, M. LIBOR Banking Scandal Deepens; Barclays Releases Damning Email, Implicates British Government. Rolling Stone (2012, July 4),
Read more: http://www.rollingstone.com/politics/blogs/taibblog/libor-banking-scandal-deepens-barclays-releases-damning-email-implicates-british-government-20120704#ixzz1zoUkO4qU
Taibbi, M. The Scam Wall Street Learned
From the Mafia: How America's biggest banks took part in a nationwide
bid-rigging conspiracy - until they were caught on tape. Rolling Stone (2012 ,
June 20), http://www.rollingstone.com/politics/news/the-scam-wall-street-learned-from-the-mafia-20120620?print=true
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