EM08: BACKGROUND

BASIC ELEMENTS

FERDINAND PECORA & THE PECORA COMMISSION
The attorney who, post great depression, prosecuted banks and, in the aftermath, provided the basis for the GLASS-STEAGALL ACT, which separated commercial and investment banking.

Present day publicly traded investment banks have a built in risk compared to the old school model once run as partnerships. The main point here is that the partnerships had to gamble with their own money, they had to have "skin in the game." By going public, personal risk is removed and the economic imperative shifts to fees and risk is minimized since they are gambling with others' money, not their own.

With EM08, the stakes have risen. For example, Goldman helped hedger John Paulson create a hand-picked portfolio derived from Goldman's riskiest mortgages to create junk securities. Goldman then sold those ticking time bombs off to their own customers and bet against their clients without disclosing this information. Is there a better text-book definition of a con?

CREDIT RATING AGENCIES (CRAs)
One of the central linchpins in revealing how corrupt the financial system is, the top CRAs -- Standard & Poors, Moodys and Fitch -- provide their ratings on financial products so that investors can have information upon which to make decisions. Here's the problem: the banks pay the CRAs for their ratings. This is a clear cut conflict of interest.

Imagine you own a widget company, and you pay "American Widget Magazine" a fee to write a review of your latest widget. That's in a nutshell what happened with the banks creating financial products from toxic waste and paying the CRAs to rate them investment grade. (nevermind "traunching," or grading the risk levels as plenty of these WMDs were doled out worldwide ) How this is legal - to this day - is a mystery.

CORPORATE BOARDS
The title "Chairman & CEO" becomes ubiquitous among the too big to fail (tbtf) banks. During the fall of 2008 as EM08 crested with the implosion of Lehman, the top executives of the majority of the tbtf banks -- Dick Fuld (Lehman Brothers), Chuck Prince (Citigroup), Stan O'Neal (Merrill Lynch), John Mack (Morgan Stanley), Lloyd Blankfein (Goldman Sachs),  and Ken Lewis (Band of America) -- all held this dual title (in the cases of O'Neal and Lewis occupying the president position as well.).

The reason this dual title is so fundamental to understanding EM08 and the system of corporate business, is that this is a conflict of interest. Corporate boards are entrusted to check executive management -- there is a clear division between the two. By incorporating both titles in one person, CEOs have undue influence on things as important as executive compensation -- a clear conflict of interest.

Virtually never discussed in the mainstream media (msm), corporate boards are essential to understanding EM08 as they constitute one of the building blocks of the system. John Gillespie (himself a former Wall Street employee) and David Zweig have written a highly recommended book on the inner workings of corporate boards, Money for Nothing: How CEOs and Boards are Bankrupting America. In addition, John Gillespie provides an excellent interview on this subject along with William Cohan (another ex-Wall Street-er) that provides a great overview.

SARBANES--OXLEY ACT ("SOX")

...is a United States federal law that set new or enhanced standards for all U.S. public company boards, management and public accounting firms. It is named after sponsors U.S. Senator Paul Sarbanes (D-MD) and U.S. Representative Michael G. Oxley (R-OH). As a result of SOX, top management must now individually certify the accuracy of financial information. In addition, penalties for fraudulent financial activity are much more severe. Also, SOX increased the independence of the outside auditors who review the accuracy of corporate financial statements, and increased the oversight role of boards of directors.

Pay attention to that last sentence, "increased the oversight role of boards of directors." Now see the above entry for "Corporate Boards" and in particular to John Gillespie's insights.

The most important aspect of SOX is that individuals -- ie, top execs -- must sign off on their company's financials.

First: how does SOX square with the recent court ruling that corporations are people...?

Second:  Penalties are left vague.

No answer for the first, but in light of ZERO criminal indictments -- let alone prosecutions -- nearly (at the time of this writing) 5 years later, it looks like the second point is... ignored?

SANDY WEIL, (mentor to JPMC Chair & CEO JAMIE DIMON)
The godfather of the modern monolithic financial services corporation (tbtf), as the owner of Travelers Insurance, he successfully takes over Citi Bank and thus forms the first mega-bank: Citigroup. Significantly, he performed this coup at a time when such mergers and acquisitions were forbidden, in part because of the fears brought about by the Great Depression and from which came the aforementioned Glass-Steagall Act.

Interestingly, in light of EM08, Weill as of 2012 now says that the tbtf banks should be broken up.

1999 - GRAMM–LEACH–BLILEY ACT
The name here to remember is PHIL GRAMM, lapsed Democrat and arch Republican. Though rarely mentioned in EM08 discussions, if ever there was a key player in the EM08 landscape, Gramm would have to be on the most wanted list.

The Gramm-Leach-Bliley Act effectively did away with Glass-Steagall Act and created the petri dish from which the modern tbtf banks formed.

It's also important to note that the Gramm-Leach-Bliley Act was signed by Bill Clinton. Thus, this provides a clear example of how both Republicans and Democrats laid the groundwork for EM08.

2000 - COMMODITY FUTURES MODERNIZATION ACT
Here's Phil Gramm again, in his second sucker punch right on the heels of the Gramm-Leach-Bliley Act of 1999.

The CFMA basically says that the derivatives market is to be unregulated. For the uninitiated, derivatives in essence (like all investing and insurance), are a gamble, but of a particular nature:

A derivative is a financial instrument which derives its value from the value of underlying entities such as an asset, index, or interest rate—it has no intrinsic value in itself. [Wikipedia; see title link. Emphasis added.]

This is a 100 dollar way to describe betting. Take the toxic mortgages sold by the originators to the banks, who securitized them and further sold them off. The banks, having inside knowledge as to the real quality of the securities, now go to a third party -- let's say AIG for "insurance" (insurance if they are holding the securities). The banks buy this insurance in the form of payments made regularly, just as any other form of insurance.

There are other analysts who go much further in explaining derivatives, but It's important to be clear on this one point and to make no mistake: insurance -- and therefore derivatives (as well as investing) -- is gambling. Example: When you pay an insurer car insurance, you are betting that you won't have an accident.

When the toxic mortgages began to default, it set the wheels in motion for massive calls on derivative bets lost by the insurers and won by the banks and other savvy investors (see EM08 who forecast the housing bubble bursting.

This explains why the largest welfare payouts in history -- billions paid by innocent Americans -- were made when EM08 occurred. What most people don't know is that the lion's share went to an insurer -- AIG -- who turned right around and paid off its bad bets to the banks.

Although not the only one dealing in these WMDs, Joseph Casano is perhaps the poster child ("patient zero" to quote Matt Taibbi's epidemiological application) as he made many of the bets while at AIG. This explains why the lion's share of the initial welfare bailout didn't go to the banks directly - it went to AIG in order to pay off its bad bets to the banks.

ACCOUNTING

In 2007, American sports were rocked in all three major leagues; the roids scandal broke in Major League Baseball (MLB), Michael Vick's  dogfighting scandal and the potentially most damaging, National Basketball Association (NBA) referee Tim Donaghy's conviction because he'd bet on NBA games.

Why is the Donaghy story the most damaging? While players are potentially altering the game by cheating when juicing (using roids) they have a rationale: they are being paid for winning and are therefore inherently biased toward gaining an edge on the competition. But referees are supposed to be impartial; they are supposed to have have no vested interest in the outcome.

When Enron imploded in 2001, one thing above all others stood out: the biggest story of Enron's con wasn't Enron itself, it was that the refs had been fixing the game. And who are the refs in the world of capitalism? The accountants. Who was Enron's accounting firm? Arthur Andersen, one of the former "big five," along with Price Waterhouse Coopers, Deloitte & Touche, KPMG, and Ernst & Young.

You can see where this is going: "The List." Here are the accounting firms for the tbtf  banks:

Deloitte & Touche -- Bear Stearns, the first bank to implode; acquired with welfare money by JPMC .

Ernst & Young -- Lehman Brothers, the largest bankruptcy in history.