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(Publishing Note: Wall Street on Parade blog co-publisher Pam Martens has provided written authorization to the diarist to reproduce her blog's posts in their entirety for the benefit of the Daily Kos community.)


Senate Bombshell Testimony Today:
Citigroup and Bank of America Stock Worthless
Without Implied Government Guarantees

By Pam Martens
Wall Street On Parade
A Citizen Guide to Wall Street
July 31, 2014

Senator Sherrod Brown, Chairman of the Senate Banking Subcommittee on Financial Institutions and Consumer Protection, will take testimony at 2 p.m. today on market subsidies enjoyed by implied future government bailouts of the too-big-to-fail status of Wall Street’s bloated and serially malfeasant banks. The hearing is set to coincide with a new report from the Government Accountability Office (GAO).

An early peek at written testimony by three separate professors set to testify guarantees a belated July 4 fireworks display — one that is not likely to enjoy a welcome reception within the Wall Street corridors of power. Expect the phone lines of lobbyists and congressional campaign managers to be lighting up all over the nation’s capitol this afternoon.

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Boston College Professor of Finance Edward J. Kane
Dr. Edward J. Kane

Edward J. Kane, Professor of Finance at Boston College will get things off to a rousing start by telling the Subcommittee that any suggestion that the Dodd-Frank financial reform legislation ended the implied government guarantees “is a dangerous pipe dream.”

A powerful argument made by Kane (see full text of testimony linked below) is that these too-big-to-fail banks enjoy not just a market subsidy on their debt but on their equity as well. Kane writes:

“Being TBTF [too-big-to-fail] lowers both the cost of debt and the cost of equity. This is because TBTF guarantees lower the risk that flows through to the holders of both kinds of contracts. The lower discount rate on TBTF equity means that, period by period, a TBTF institution’s incremental reduction in interest payments on outstanding bonds, deposits, and repos is only part of the subsidy its stockholders enjoy. The other part is the increase in its stock price that comes from having investors discount all of the firm’s current and future cash flows at an artificially low risk-adjusted cost of equity. This intangible benefit generates capital gains for stockholders and shows up in the ratio of TBTF firms’ stock price to book value. Other things equal (including the threat of closure), a TBTF firm’s price-to-book ratio increases with firm size…”

Kane then lands this bombshell: “The warranted rate of return on the stock of deeply undercapitalized firms like Citi and B of A [Bank of America] would have been sky high and their stock would have been declared worthless long ago if market participants were not convinced that authorities are afraid to force them to resolve their weaknesses.”

Kane goes on to say that it is “shameful” for government officials to suggest that bank bailouts were good deals for taxpayers. Kane writes: “On balance, the bailouts transferred wealth and economic opportunity from ordinary taxpayers to much higher-income stakeholders in TBTF firms. Ordinary citizens understand that this is unfair and officials that deny the unfairness undermine confidence in the integrity of economic policymaking going forward.”

Anat Admati, Professor of Finance and Economics at the Graduate School of Business at Stanford University
Dr. Anat Admati

Anat Admati, Professor of Finance and Economics at the Graduate School of Business at Stanford University, who was voted one of Time Magazine’s top 100 influential people in April of this year, writes in her testimony that “The Fed has the responsibility and the ability to protect the public, yet as a regulator, it has failed the public.”

Admati’s testimony places the blame of the 2007-2009 Wall Street collapse squarely at the feet of regulators, writing in her testimony:

“Financial crises are sometimes portrayed as if they were unpreventable natural disasters, implying that bailouts are similar to emergency aid after an earthquake. This narrative is misleading. The crisis of 2007-2009 was an implosion of a system that had become too fragile, reckless, and distorted. Regulatory failures, including flawed and ineffectively enforced regulations, must take much of the blame for the excessive fragility and the buildup of risk.”

Admati says today’s banking system “is disturbingly similar to allowing heavy trucks with dangerous cargo to drive recklessly at 95 miles per hour in residential neighborhoods. If drivers get a bonus for reaching the destination quickly, and face little risk of injury or death even in an explosion (imagine that they have a special protective mechanism), they will drive recklessly and endanger innocent citizens…”

Admati writes further:

“Encouraging and subsidizing banks to fund themselves with as much debt as is currently allowed (up to 95% for the large bank holding companies) is as perverse as encouraging and subsidizing reckless speed for trucks or rewarding the captains of large oil tankers to go ever closer to the coast. More equity would force banks to stand more on their own when they take risk, rather than shift some of the risk and cost of bearing it to others. Shareholders who benefit from the upside, and not creditors or taxpayers, should be the ones to bear the downside.”

Deniz Anginer, Assistant Professor at the Pamplin Business School at Virginia Tech, also gives Dodd-Frank a thumbs down in terms of ending too-big-to-fail, writing:

“…we find that Dodd-Frank did not significantly alter investors’ expectations that the government will bail out TBTF financial institutions should they falter.  Despite its no-bailout pledge, Dodd-Frank leaves open many avenues for future TBTF rescues. For instance, the Federal Reserve can offer a broad-based lending facility to a group of financial institutions in order to provide a disguised bailout to the industry or a single firm…”

The full list of witnesses set for the hearing appears below.

•    Mr. Lawrance L. Evans view testimony
Director, Financial Markets and Community Investment
U.S. Government Accountability Office

•    Dr. Deniz Anginer view testimony
Assistant Professor of Finance
Pamplin School of Business, Virginia Tech

•    Dr. Edward Kane view testimony
Professor of Finance
Boston College

•    Dr. Anat Admati view testimony
George G.C. Parker Professor of Finance and Economics
Graduate School of Business, Stanford University

•    Mr. Douglas Holtz-Eakin view testimony
President
American Action Forum

© 2014 Wall Street On Parade. Wall Street On Parade® is registered in the U.S. Patent and Trademark Office.

WallStreetOnParade.com is a public interest web site operated by Russ and Pam Martens to help the investing public better understand systemic corruption on Wall Street. Ms. Martens is a former Wall Street veteran with a background in journalism. Mr. Martens' career spanned four decades in printing and publishing management.


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There have been a slew of Wall Street travesties that have gained little notice in the MSM over the past 10 days. Here's a sampling of excerpts on just a few of them from Wall Street on Parade...


Another Wall Street Inside Job?: Stock Buybacks Carried Out in Dark Pools

By Pam Martens
Wall Street On Parade
A Citizen Guide to Wall Street
July 21, 2014

The U.S. stock market looks more and more like that box of pasta on the grocer’s shelf. There’s less of it but it costs more.

According to data from Birinyi Associates, for calendar years 2006 through 2013, corporations authorized $4.14 trillion in buybacks of their own publicly traded stock in the U.S.

That should be good, right? Earnings are boosted on a per share basis because of fewer shares, making corporate prospects look brighter. Unfortunately, according to Standard and Poor’s, net equity issuance (the difference between buybacks, leveraged buyouts, etc. and Initial Public Offerings or secondary offerings) has been shrinking as corporate debt has been rising to fund those stock buybacks.

In 2013 alone, corporations authorized $754.8 billion in stock buybacks while simultaneously borrowing $782.5 billion from credit markets. Jeffrey Kleintop, Chief Market Strategist for LPL Financial reports that corporations are now the single largest buying source for all U.S. stocks and the swift pace of buybacks has continued into this year with Standard and Poor’s 500 companies buying back approximately $160 billion in the first quarter.

In addition to concerns over taking on corporate debt for reasons other than growing the franchise, investing in innovation, upgrading technology, etc. – there are also growing concerns over the use of dark pools to conduct these gargantuan share buybacks.

A dark pool is a private, unregulated trading venue that functions like a stock exchange by matching buyers with sellers – but it does so in the dark, without showing its bids and offers on stocks to the public. That has the potential for a great deal of price manipulation…

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Senate: Renaissance Hedge Fund Avoided $6 Billion in Taxes in Bogus Scheme With Banks

By Pam Martens
Wall Street On Parade
A Citizen Guide to Wall Street
 July 22, 2014

Only one word comes to mind to describe the testimony taking place before the U.S. Senate’s Permanent Subcommittee on Investigations this morning: Machiavellian.

The criminal minds on Wall Street have twisted banking and securities laws into such a pretzel of hubris that neither Congress, Federal Regulators or even the General Accountability Office can say with any confidence if the U.S. financial system is an over-leveraged house of cards. They just don’t know.

According to a copious report released last evening, here’s what hedge funds have been doing for more than a decade with the intimate involvement of global banks: the hedge fund makes a deposit of cash into an account at the bank which has been established so that the hedge fund can engage in high frequency trading of stocks. The account is not in the hedge fund’s name but in the bank’s name. The bank then deposits $9 for every one dollar the hedge fund deposits into the same account. Some times, the leverage reaches as high as 20 to 1.

The hedge fund proceeds to trade the hell out of the account, generating tens of thousands of trades a day using their own high frequency trading program and algorithms. Many of the trades last no more than minutes. The bank charges the hedge fund fees for the trade executions and interest on the money loaned.

Based on a written side agreement, preposterously called a “basket option,” the hedge fund will collect all the profits made in the account in the bank’s name after a year or longer and then characterize millions of trades which were held for less than a year, many for just minutes, as long-term capital gains (which by law require a holding period of a year or longer). Long term capital gains are taxed at almost half the tax rate of the top rate on short term gains.

There are so many banking crimes embedded in this story that it’s hard to know where to begin. Let’s start with the one most dangerous to the safety and soundness of banks: extension of margin credit…

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Lawsuit Stunner: Half of Futures Trades in Chicago Are Illegal Wash Trades

By Pam Martens
Wall Street On Parade
A Citizen Guide to Wall Street
July 24, 2014

Since March 30 of this year when bestselling author, Michael Lewis, appeared on 60 Minutes to explain the findings of his latest book, Flash Boys, as “stock market’s rigged,” America has been learning some very uncomfortable truths about the tilted playing field against the public stock investor.

Throughout this time, no one has been more adamant than Terrence (Terry) Duffy, the Executive Chairman and President of the CME Group, which operates the largest futures exchange in the world in Chicago, that the charges made by Lewis about the stock market have nothing to do with his market. The futures markets are pristine, according to testimony Duffy gave before the U.S. Senate Agriculture Committee on May 13.

On Tuesday of this week, Duffy’s credibility and the honesty of the futures exchanges he runs came into serious question when lawyers for three traders filed a Second Amended Complaint in Federal Court against Duffy, the Chicago Mercantile Exchange, the Chicago Board of Trade and other individuals involved in leadership roles at the CME Group.

The conduct alleged in the lawsuit, backed by very specific examples, reads more like an organized crime rap sheet than the conduct of what is thought by the public to be a highly regulated futures exchange in the U.S…

…The most stunning allegation in the lawsuit is that an estimated 50 percent of all trading on the Chicago Mercantile Exchange is derived from illegal wash trades…

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Wall Street’s Regulators Sell Out on Illegal Wash Sales

By Pam Martens and Russ Martens
Wall Street On Parade
A Citizen Guide to Wall Street
 July 28, 2014

Wash sales – one of the most virulent forms of stock manipulation that bankrupted banks and corporate conglomerates in the Great Depression and intensified the stock market crash of 1929 to 1932 – has reached scandalous proportions in today’s markets. The response from regulators? Gut the rules that make it a crime.

On March 18 of last year, Bart Chilton, then a Commissioner at the Commodity Futures Trading Commission (CFTC), stunned CNBC viewers with the announcement that wash sales were rampant in the futures markets. Speaking to Squawk Box host, Joe Kernen, Chilton stated:

“Well these wash sales, Joe, people know they’re illegal; they’re not allowed. A wash sale is when somebody trades with themselves. But what we’ve discovered is that they are going on at this large, voluminous level. I mean, to me, a shocking level. And they’re impacting what people see as volume. So this is an area that we’re going to review to ensure that markets are operating efficiently and effectively. Who knows what sort of impact they’re having. And it raises a host of policy questions that we have out there, because this stuff just shouldn’t be allowed.”
Volume is hardly the only problem with wash sales: the age old tactic of a wash sale is to pump a stock’s price so insiders can bail out at the top and transfer the losses of a worthless or inflated security to uninformed investors. This is done by the same party conducting or authorizing simultaneous buying and selling in the stock, typically making sure trades occur at ever rising prices until the operators have unloaded their stock. Without that support, the price crashes.

Laws making it illegal for one party to be on both the buy and sell sides of a stock transaction were implemented during the legislative reforms of Wall Street in the 1930s. They have had legal certainty for the past 80 years until this May 1 when Wall Street’s coddling, captured regulators, the Securities and Exchange Commission and the Financial Industry Regulatory Authority (FINRA), gutted the wash sale rules beyond recognition – even changing the name of the illegal practice from “wash sale” to the benign “self trade.”…

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Wall Street Journal Reporter: “The Entire United States Market Has Become One Vast Dark Pool”

By Pam Martens and Russ Martens
Wall Street On Parade
A Citizen Guide to Wall Street
July 29, 2014

In 2012, Wall Street Journal reporter, Scott Patterson, released his 354-page prescient overview of U.S. market structure titled, Dark Pools: High Speed Traders, A.I. Bandits, and the Threat to the Global Financial System. (For those whose computer prowess is limited to turning on a laptop, like millions of fellow Americans, “A.I.” means artificial intelligence – machines teaching themselves to think like humans, but faster.)

Patterson comes to an epiphany on page 339 of his book, writing in the notes section: “The title of this book doesn’t entirely refer to what is technically known in the financial industry as a ‘dark pool.’ Narrowly defined, dark pool refers to a trading venue that masks buy and sell orders from the public market. Rather, I argue in this book that the entire United States stock market has become one vast dark pool. Orders are hidden in every part of the market. And the complex algorithm AI-based trading systems that control the ebb and flow of the market are cloaked in secrecy. Investors – and our esteemed regulators – are entirely in the dark because the market is dark.” (The italics in this excerpt are as they appear in the hardcover book.)

We totally agree with Patterson that U.S. markets are the darkest they have ever been in history – from their early origins in the bright sunlight under the Buttonwood tree at 68 Wall to today’s secretive, unregulated stock exchanges known as dark pools that trade in private across America – the lights have gone out. And as each light has flickered and dimmed, public confidence has drained from the system, leaving it today as the unsafe battlefield of hedge funds, high frequency traders and dark pool operators.

Wall Street and its sycophants began this journey into darkness with their push to run their own private justice system on Wall Street in the 1980s. Called mandatory arbitration, Wall Street was given a green light by the U.S. Supreme Court in its 1987 decision, Shearson/American Express v. McMahon. Since then, cases filed by both customers and employees against Wall Street firms, which could shed critical light and serve as an early warning system on patterns of fraud and abuses, have been removed from the sunlight of open courtrooms into the dark shadows of a private justice system that claimants believe is rigged against them…

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