(As of today's news cycle, will Main Street move beyond the tipping point with regard to the sheer volume of reports relating to ongoing Wall Street fraud and shameless greed? IMHO, I believe this may about do it. Regulatory reform fail, bailout travesties, Greece, Europe, derivatives, pyramid schemes, AIG, Goldman, and now this...)
Over the past few hours, we're just learning about the details of a planned AFL-CIO-led, 200-city protest against Goldman Sachs. Concurrently, we're watching the media downright exploding this morning in a rather contorted business lede which (page one of today's NYT, double-deck on Bloomberg's home page, etc.), for all intents and purposes, cites findings from a Wall Street "coroner's report," by former federal prosecutor and Chicago lawyer Anton Valukas, which dissects the causes and the events leading up to the late-Summer 2008 collapse of Lehman Brothers.
Depending upon what/whom you're reading, Valukas' 2200-page report, issued late Thursday, along with reports covering its release and the related story, tells us...
--"accounting improprieties" and "colorable actions" (read: fraudulent misrepresentations of questionable legality relating to Lehman Bros' financial stability) were the root causes relating to Lehman Brothers' collapse in the late Summer of 2008;
-- at the height of the off-balance-sheet cover-up relating to the now-exposed Lehman Brothers' pyramid scheme, roughly $50 billion was being loaned by the Fed to Lehman on a short-term basis; and then Lehman was using the money to pay down other liabilities while not booking the Fed "repo" loans (overnight and/or short-term, collateralized loans provided by the Fed at its "Discount Window" to major Wall Street firms to enable their day-to-day trading liquidity) as liabilities, but as "sales," instead;
-- most of Lehman Bros' senior management (along with their accounting firm, Ernst & Young) was fully aware of the extent of the scam, as well as being materially involved in the effort to develop it;
-- prior to Lehman's September '08 collapse, in late 2007 and throughout the first eight months of 2008--again, depending upon which report of the story one reads--we're told that Lehman Brothers' claimed it had provided (and/or did not provide) disclosure of its actions to the FDIC, the Securities and Exchange Commission (SEC), and then to the Federal Reserve/NY Federal Reserve Branch; and guidance was provided (and/or not provided at all) by those organizations to Lehman Brothers to "clean it up";
-- as a direct byproduct of the allegations stated in the item immediately above this, it follows that now-Treasury Secretary Tim Geithner was fully aware (or, in the dark, depending upon which report you read) of the accounting problems at Lehman long before he acknowledged it, and was either directly or indirectly involved, or not involved at all, or just negligent with regard to resolving the accounting scams at Lehman--again, depending upon which report of the story that you read;
-- much like reports covering Goldman Sachs' behavior, in 2007-2008, regarding their efforts to collect on AIG credit default swaps' debt, thus stripping much-needed cash from the coffers of that insurance behemoth and creating a perfect creditor's storm which led to its default and subsequent downfall, JPMorgan and Citigroup were doing the same with Lehman Brothers in the days/weeks leading up to its demise;
-- regardless of which version of the story you read, the entire set of reports rightfully brings to the fore the basic question: How many other Wall Street firms are involved in similar coverups of their financial realities, today, and is this issue institutionalized throughout the industry at this point? (I would speculate that the answer to this is a resounding "yes!")
-- as I indicated, above, MSM, Wall Street pundit, and business media coverage of this is quite disparate in its focus this morning, at least in terms of what actually qualifies as the story's lede and/or more salient points; here are some links, with their respective headlines indicating just how different the various outlets' perspectives are with regard to what constitutes the focal point of the story:
New York Times:
"Report Details How Lehman Hid Its Woes as It Collapsed," by Michael J. de la Merced and Andrew Ross Sorkin
Bloomberg:
"JPMorgan, Citigroup Helped Cause Lehman Collapse, Report Says," by Linda Sandler, Bob Van Voris and Don Jeffrey
Bloomberg:
"Lehman's Fuld `Negligent' as Firm Hid Leverage, Examiner Says," by David Scheer and Joshua Gallu
Naked Capitalism:
"NY Fed Under Geithner Implicated in Lehman Accounting Fraud Allegation," Yves Smith
Market Ticker:
"EXPLOSIVE! Lehman Where Are The Cops?" by Karl Denninger
Huffington Post:
"Lehman Bankruptcy Report: Top Officials Manipulated Balance Sheets, JPMorgan And Citi Contributed To Collapse," by Shahien Nasiripour
Zero Hedge:
"The 'Repo 105' Scam: How Lehman Fooled Everyone (Including Allegedly Dick Fuld) And How Other Banks Are Likely Doing This Right Now," by Tyler Durden
Zero Hedge:
"And The Lehman Disclosure Hits Just Keep On Coming; If Fuld Has Not Yet Left The Country, Doing So ASAP May Be A Very Good Idea," by Tyler Durden
Kossack and candidate for US Senate from NY, Jonathan Tasini, posted a diary on some of this a little earlier, during the overnight:
"Indict Lehman Brothers Executives (Geithner?): They Lied BREAKING (UPDATE)."
(For the record, generally speaking, I'm only going to post Yves' work, in its entirety, about once a week. Of course, I'm sure I'll be including normal-length blockquotes from her other diaries in my "regular" posts (as I have done that for some time), but only in standard DKos formats. However, I'm making an exception tonight, due to the scope and potential implications of this particular, quite important, breaking story.)
# # #
The following Naked Capitalism post and analysis--updated as recently as two hours ago--is provided to the community with the permission of its author and publisher, Yves Smith.
"NY Fed Under Geithner Implicated in Lehman Accounting Fraud Allegation"
Naked Capitalism
Yves Smith
Thursday, March 11, 2010
[Upated through 3AM, Friday, March 12, 2010]
Quite a few observers, including this blogger, have been stunned and frustrated at the refusal to investigate what was almost certain accounting fraud at Lehman. Despite the bankruptcy administrator's effort to blame the gaping hole in Lehman's balance sheet on its disorderly collapse, the idea that the firm, which was by its own accounts solvent, would suddenly spring a roughly $130+ billion hole in its $660 balance sheet, is simply implausible on its face. Indeed, it was such common knowledge in the Lehman flailing about period that Lehman's accounts were sus that Hank Paulson's recent book mentions repeatedly that Lehman's valuations were phony as if it were no big deal.
Well, it is folks, as a newly-released examiner's report by Anton Valukas in connection with the Lehman bankruptcy makes clear. The unraveling isn't merely implicating Fuld and his recent succession of CFOs, or its accounting firm, Ernst & Young, as might be expected. It also emerges that the NY Fed, and thus Timothy Geithner, were at a minimum massively derelict in the performance of their duties, and may well be culpable in aiding and abetting Lehman in accounting fraud and Sarbox violations.
We need to demand an immediate release of the e-mails, phone records, and meeting notes from the NY Fed and key Lehman principals regarding the NY Fed's review of Lehman's solvency. If, as things appear now, Lehman was allowed by the Fed's inaction to remain in business, when the Fed should have insisted on a wind-down (and the failed Barclay's said this was not infeasible: even an orderly bankruptcy would have been preferrable, as Harvey Miller, who handled the Lehman BK filing has made clear; a good bank/bad bank structure, with a Fed backstop of the bad bank, would have been an option if the Fed's justification for inaction was systemic risk), the NY Fed at a minimum helped perpetuate a fraud on investors and counterparties.
This pattern further suggests the Fed, which by its charter is tasked to promote the safety and soundness of the banking system, instead, via its collusion with Lehman management, operated to protect particular actors to the detriment of the public at large.
And most important, it says that the NY Fed, and likely Geithner himself, undermined, perhaps even violated, laws designed to protect investors and markets. If so, he is not fit to be Treasury secretary or hold any office related to financial supervision and should resign immediately.
I am reading the report, and will provide an update later, but here are the key bits (hat tip reader John M). As much as Karl Denninger has done some terrific initial reporting, he does not go far enough as far as the wider implications are concerned.
The key revelation is that Lehman as of late 2007 was routinely using repo transactions at the end of the quarter to mask how levered it truly was:
Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet.2850 Lehman's periodic reports did not disclose the cash borrowing from the Repo 105 transaction - i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt.2851 Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios.
Yves here. The stunning bit is these "repos" were actually a conventional type of repo, despite the name, but Lehman was engaging in blatant misreporting, treating these "repos" (in which a bank still shows them on its balance sheet as sold with the obligation to repurchase) as sales. Note that at the time (as the report notes) analysts and others kept probing at the seeming miracle of Lehman's deleveraging in a difficult market. This ruse may also square the circle on a Lehman leak we broke in 2007. A former Lehman MD had reported that most of the deleveraging that had occurred at the end of 2Q 2008 had resulted from the placement of $55 billion of assets with newly-formed entities in which Lehman retained a 45% ownership interest and were operated by former Lehman employees. To put it mildly, these were off balance sheet entities that strained the idea of independence. Bloomberg got hold of the story, and Lehman asserted that only $5 billion of assets had actually been transferred. I am now wondering whether the $55 billion were indeed transferred precisely as the source had said originally (he in turn had been told this by several people at Lehman) but that most of it was via this type of repo, and then re-materialized on Lehman's balance sheet once the quarter end had passed (the Examiner's report notes that the amount that Lehman moves off its balance sheet at the end of 2Q 2008 was $50.38 billion, which tallies with the difference between what the Lehman MD said had been moved off balance sheet versus what they fessed up to when asked by Bloomberg) .
Denninger raises one question: were other banks engaging in this type of accounting chicanery? But there is another question: did some of Lehman's counterparties must have suspected what was going on, given that this took place on a large scale basis at the end of every quarter? How many had an idea that Lehman was engaging in massive window dressing and chose to play along?
But here is the part of the report that discussed how the Fed aided and abetted Lehman misconduct:
the Examiner questioned Lehman executives and other witnesses about Lehman's financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.
Yves here. So get this: even though Lehman dressed up its accounts for the great unwashed public, it did not try to fool the authorities. Its games playing was in full view to those charted with protecting investors and the financial system.
So what transpired? The SEC (which in all fairness, has never had much expertise in credit markets, this is a major regulatory problem) handed assessing Lehman over to the Fed, which bent over backwards to give it a clean bill of health:
After March 2008 when the SEC and FRBNY began onsite daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress-testing scenarios to test Lehman's ability to withstand a run or potential run on the bank.5753 The FRBNY developed two new stress scenarios: "Bear Stearns" and "Bear Stearns Light."5754 Lehman failed both tests.5755 The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed.5756 However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed.5757 It does not appear that any agency required any action of Lehman in response to the results of the stress testing.
Yves here. So get this: the stress tests were a sham. Only one outcome was permissible: that Lehman pass. So after the Fed was unable to come up with an objective-looking stress test that Lehman could satisfy, they permitted Lehman to devise a test with low enough standards to give itself a clean bill of health.
So why should we trust ANY government designed stress test, particularly when the same permissive grader, Timothy Geithner, was the moving force behind the ones dreamed up last year, which have been widely decried by banking experts, including Bill Black, Chris Whalen, and Josh Rosner? We linked to a simple analysis by Mike Konczal that demonstrates that for the biggest four banks alone, merely on their second mortgage portfolios, the stress tests of 2009 were too permissive to the tune of at least $150 billion.
Lehman type accounting, in other words, is being institutionalized, with the active support from senior government officials.
It is time for Geithner to go. He is not fit to serve as Treasury secretary.
And the time is overdue for a full audit of the Fed, and in particular the New York Fed, from the start of the Bear crisis through and including all the retrades of the AIG bailout.
Update 12:00 AM, 3/12/10. Oh, boy, the spin is in in the US. Bloomberg focuses on an interesting revelation in the report, but which strikes me as secondary, that JP Morgan and Citi delivered the fatal blow to Lehman by withholding collateral. That JP Morgan seized $17 billion of collateral has been reported elsewhere; the only new elements are Citi's role and that its and JPM's actions could serve as grounds for legal action:
"There are a limited number of colorable claims for avoidance actions against JPMorgan and Citibank," Valukas said in the report. He defined a colorable claim as sufficient credible evidence to persuade a jury to award damages at trial.
The Times pointed ignores the Fed's lapses, as does the Journal and the major report at the Huffington Post.
Update 3:00 AM. Have now read the germane section a bit (over 300 pages, please do not bust my chops). Every page is stunning (the law firm did a great job, this is one case where big fees are associated with big time value). The nonsense is mile high. Lehman had been doing this sort of thing since 2001. No US law firm would give them cover via an opinion letter for their phony repo accounting, they managed to get the opinion they sought in the UK and accordingly shuffled assets through the UK for the repo 105 transactions. Frankly, if you don't need colorful characters or glam settings, this is as attention-capturing as Too Big To Fail.
# # #