Lehman Died as Regulators Lied (?)

Is it fair to say "regulators lied?"  We find that soundbite to be too harsh.  True, maybe, but too harsh. Two recent news/opinion articles (New Light on Regulators and Fed Fretted ... Demise of Lehman) push the ideas that:

(1) Paulson, Bernanke, Geithner, and other regulators didn't know what they were doing in 2008;

(2) Some or all of these celebrity regulators were less than candid, shall we say, in their public remarks; and

(3) The U.S. gov't should have bailed out Lehman.


We say "YES" to (1), "YES" to (2) - but understandable given (1), and "NO" to (3).


Instead of a deep-dive analysis, we'll content ourselves here with a few pithy observations:

*    As Treasury Secretary, Paulson had no right - in our opinion - to dictate an initial equity bid of $2 per share to Bear Stearns in March 2008.  Where did he get the idea that was legal?!

*    JP Morgan messed up the "Bear Stearns debt guarantee" in March-April 2008.  This same issue arguably killed the Barclays rescue of Lehman in September of that year.  Nobody seems to understand this point - and it still matters!

*    The New York Fed bent (broke?) the law in its participation in the Bear Stearns bail-out.  To make this dubious deal work, the Fed encouraged and condoned the mis-marking of "Maiden Lane" collateral.

*    In the bail-out of AIG, Bernanke didn't understand AIG insurance entities were not at risk from the failure of AIG Financial Products (the part of AIG with all the losses).

As references for the observations, see:

   House of Cards by William Cohan - the excellent book (not the movie!)

   In Fed We Trust by David Wessel

   Too Big to Fail by Andrew Ross-Sorkin

   Lehman Chapter 11 Proceedings Examiner Report

Rather than dwell on what is fast becoming ancient history, our goal is to make a simpler point.  The financial markets are complicated!!  Regulators don't know how it all works.  Neither do the people who run the banks.  Let's not be surprised when we learn 5 years after the fact that the Fed and the government didn't see failures at Lehman, Fannie, Freddie, AIG FP, and WaMu until the very end.  The executives of all these firms were just as surprised!

Advisors Beware: Investors Can Sue Third Parties for Aiding Fraud

WSJ reports on a recent 7-2 Supreme Court decision allows investors of R. Allen Stanford's Ponzi Scheme to sue advisors for allegedly aiding and abetting the fraudulent scheme. This is an important decision that will give investors additional pockets for recovering their losses. 

ICAP to lose role of ISDAfix Benchmark Administrator

Bloomberg reports that ISDA is "seeking offers from companies wanting to become the benchmark administrator for ISDAfix, a measure used in the $426 trillion swaps market."  I can imagine what the job qualifications should probably say: applicant must not have any positions in the swaps market; must not have employees who are friendly with banks' swaps traders; must be immune to all types of material and spiritual temptations. NOTE: we don't know if there have been any past wrongdoings and we're not saying that there has been. But, just changing the administrator is insufficient to prevent potential future wrongdoing. ISDA needs to make sure the administrator is a party that has no trading interests that could be impacted by the ISDAfix.  

NYT DealBook: Facebook Stock Not So Different Than Bitcoin

The title of Rob Cox's post says it all, except perhaps for the money laundering angle.  Easier to launder money using Bitcoin or put it differently, I'm not aware of any federal criminal cases where prosecutors are alleging money laundering through the use of Facebook stock. 

UBS Said to Cooperate in FX Investigations in a Bid for Immunity

Bloomberg today reports that people familiar with the investigations say that UBS is cooperating with regulators in the US and the EU into the benchmark FX allegations and will disclose any wrongdoings.  As we have reported in prior posts, there is a huge incentive for all banks to consider this course of action, and we would be surprised if other banks are not doing/planning to do so.  The biggest benefits go the first movers and so there should be a rush to the investigators, as many banks have mounted internal investigations to uncover wrongdoing.  In addition, it has been previously reported that LIBOR settlements require many of the banks to cooperate in any benchmark rate investigations.

EURIBOR Benchmark Reforms

The EURIBOR European Banking Federation (EURIBOR-EBF) manages short term interbank interest rate benchmarks within the EU.  The European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) released a report reviewing changes made by the EURIBOR-EBF, noting the progress made in "raising the transparency of the benchmark setting process, enhancing the governance and control mechanisms of the benchmark, thereby improving the quality and reliability of the resulting index".

Just as interest rate benchmark process changes have been and continue to be made, changes in FX benchmarks are on the way as well.  We reported earlier this week that Singapore has stopped publishing FX benchmarks for certain SE Asian currencies used for non-deliverable forwards (Singapore Ends FX Benchmark for Indonesian Currency).  It is unlikely that WM Reuters or other benchmark setters will wait for the results of investigations before changing their processes as press reports have raised market concerns which will need to be addressed as soon as practical.

EURIBOR-EBF

How Soon They Forget!! (Or Did They Never Learn?)

Hard to believe - we learned today that the EU is troubled by new Fed rules for foreign banks operating in the U.S.

Michel Barnier, one of those innumerable European commissioners nobody really keeps track of, is worried.  He's fretting about the potential impact on the global level playing field since we must always ensure competition on an equal footing.

Where's the substance??!!

Why isn't M. Barnier making the strongest case he possibly can that European banks have plenty of capital now?!  Prove - or at least argue - that the banks on his side of the Atlantic are highly immune to insolvency risk and that they no longer have assets much longer in maturity than their liabilities.  In other words, make the argument that your banks are strong and NOT just that you want regulation to be "fair!"

These concepts of "fairness" and "level playing field" are not new!  Putting such amorphous and non-essential concerns ahead of true substantive analysis of banking risk is one of the many enablers of the disarray of the past 7 years.

See here the text of a conference presentation we made in Sydney in 2001.  Here's an excerpt:

"Why are the BIS rules so bad?  Well, the portfolio credit risk puzzle is quite difficult.  More importantly, BIS regulation is unavoidably a political process.  That means the end result must be simple and comprehensible to all, everybody - worldwide! - must agree, and all banks and countries must be treated “fairly” (where “fairness” is generally in the eye of the allegedly offended).  That can’t work.  We end up with rules that are wrong but for which there is universal agreement."

(If we had it to do over again, we'd certainly leave out the idea that rating agencies could do a better job than the BIS.  Live and learn!)

FX Benchmark Investigations to Drag into 2015

An article in FX Week regarding the FCA investigation into the FX benchmark allegations quotes a defense attorney as saying that the findings would become public when the investigation nears its final stages, not before early 2015.  In the event of any disciplinary action, it is at this point that warning notices would be publicly issued.

The investigation complexity is driven by the large number of banks alleged to be involved, the wide ranging and voluminous documents expected to be handed over, and as well, the large number of people who will be interviewed.

There are investigations by several national and supranational regulators.  It is safe to assume that they will cooperate with each other and that none will be in a position to announce results in the near future.

WSJ reports new LIBOR charges open new front in probe

The WSJ reports that British prosecutors have charged three former Barclays traders with LIBOR manipulation. What's more interesting in the article is the preference that UK based defendants and potential defendants have in being charged in the UK than the US due to harsher penalties in the US.  We've heard of forum selection but this takes it to a new level.  Anecdotally, is anyone keeping a tally of the number of individuals charged with respect to LIBOR compared to the housing crisis? 

FX Benchmarks for Indonesia's Currency Changing to Rectify Deficiencies found by MAS

Another aspect of the widening of the FX probes - Reuters reports that Singapore banks will no longer set the benchmark rates for the Indonesian rupiah. This follows last years's investigation by the Monetary Authority of Singapore which censured traders for attempts to manipulate both interest rates and currency rates, including ones used in the pricing of Southeast Asian non-deliverable forward FX contracts.  

News stories have spread from the original London close benchmark rate to other FX benchmarks and also include reports of collusion, traders trading for their personal accounts, sharing client orders with certain clients and trades against client interests relating to option levels.  Investigations by regulators around the world continue.

Public in the dark re: FX manipulation

Just when it seemed like you couldn't have any more regulators piling on to the FX investigations, various media sources now reporting that the G20's Financial Stability Board will review the FX markets in light of the investigations into alleged manipulations and as banks continue to place FX traders on leave or outright fire them.  While there has been much noise, there is very little data or information made available to the public.  What do the regulators know? 

LIBOR Settlements may Ease the Investigations into Potential FX Benchmark Manipulation

This Financial Times article highlights the weak position in which the money center banks find themselves vis-a-vis the regulators' investigations into potential manipulation of FX benchmark fixes.  In addition to the potential for large fines and a wave of civil litigation, as reported to the FT by the US DOJ, the LIBOR settlements for several banks included pledges for the banks to co-operate with investigations into all benchmark manipulations.

Thus in addition to banks co-operating to uncover any wrongdoing by their employees, or to seek a first mover advantage in securing possible leniency or immunity, these prior agreements may be part of the reason for the reports of numerous investigations and quick turning over of findings by banks.

Single-Family Rental: A Crowded Trade for Would-Be Mega Landlords

Single-Family Rental (SFR) is an idea born several years ago in the U.S. with the premise that large investors can buy many houses across the country at depressed prices.  The investors will then become landlords to rent the houses until that glorious future year when the investors sell the houses at large profits in that great housing rebound that must eventually arrive (knock on wood).

The marquis investor is Blackstone and today's Bloomberg article reminded us of the scheme.

As a natural contrarian, we find flaws in the logic.  Our instinct is that one cannot rely on the house flip.  If the business works as a true long-term buy-and-rent model, then push the business down that path.  But we doubt the rental business works.  Landlords are like bankers - you never get the benefit of the doubt in a dispute with your customer.

Further, there is this nice-sounding philosophy that "many Americans should be renters rather than buyers, so the SFR business helps this trend."  Well, maybe, but there's a reason the landlord business is tough - both as reputational quicksand and finding black ink on the bottom line.  The renters are tenants - they don't have owners' incentive to maintain the property.  A successful mega landlord business will need an ingenious and cost-efficient network of property managers.  It's never been done for single-family houses to our knowledge.

Is anybody making money or breaking even yet?  Our guess is "no" - but we could be wrong.  The Bloomberg article highlights American Homes 4 Rent (AMH).  But this young company hasn't hit break-even (see 10-Q).

Yes, it's far too early to say profits will never appear or that ROE will always be anemic.  But the Landlords should not assume they'll win as Flippers.

Law Firm to Lead FX Litigation Appointed

Reuters reports U.S. District Judge Lorna Schofield of SDNY has appointed the law firm of Scott + Scott LLP as interim lead counsel in a consolidated class action against the FX banks alleging manipulation. This matter appears to be proceeding rather quickly considering that news of the alleged manipulation broke not so long ago. 

At Least 10 Suits Filed to Date Alleging WM Reuters FX Fix Manipulations

There have been at least 10 lawsuits filed regarding the WM Reuters fix allegations.  Below is a list of suits, which began November of last year.  Although the banks accused in each case are not exactly the same, looking at a list of the 10 largest banks in FX gives a good indication.  The cases have been filed in the Second Circuit New York District Court.  The allegations of collusion among the banks has antitrust violations as the most typical cause of action.

November 1 - A Haverhill Retirement System
November 8 - Simmtech Co., Ltd.
December 23 - Oklahoma Firefighters Pension and Retirement System
December 26 - Employees' Retirement System of the Government of theVirgin Islands
December 31 - Prudent Forex Fund I LLC
January 17 - United Food and Commercial Workers Union and Participating Food Industry
                    Employers Tri-State Pension Fund    
January 24 - Boston Retirement System
January 27 - Five Star Forex, L.P.
February 5 - Newport News Employees #39 Retirement Fund, Value Recovery Fund LLC, and
                    Augustus International Master Fund LP

The 10th and most recent suit is filed by the City of Philadelphia Board of Pensions and Retirement goes a bit further in trying to prove it's case, as described in this article in the Financial Times . Its evidence purports to show that there was much greater volatility at the WM Reuters fix times before Bloomberg News published a story on the fix allegations, then afterwards.

Bad Test for Phony Data ?

Just over a year ago came the news that researchers applied "Benford's Law" to show that GDP data from China is likely fraudulent.  That's a huge finding!

                            BUT WE FIND THIS TEST TO BE UNRELIABLE

See above a graph that demonstrates BOTH the USA and China fail "Benford's Law" for GDP data from 1961 through 2012.  A conventional "Chi Square" test shows that both the USA and China data fail to obey Benford's Law at a confidence level higher than 95%.

What we call Benford's Law states that the first digits of a collection of numerical data will follow a known and non-intuitive pattern UNDER THE RIGHT CIRCUMSTANCES.  (See this link for a good discussion.)

But GDP % Change over time is not a data collection that typically satisfies criteria for Benford's Law to be relevant.  In fact, Benford's Law is often mis-used.

LINK TO WORLD BANK DATA SOURCE

What Happens When the Investigators Investigate Themselves?

No, the title of this post is not a Zen meditation question.  News comes that the BOE has hired outside counsel to investigate whether its own staff condoned practices at the heart of the FX manipulation controversy.  This disclosure shows an uncomfortable repeat of the accusations in the press that the Federal Reserve knew about the alleged LIBOR manipulation before it was disclosed to the public.  Of course this also brings to mind criticisms from Democratic legislators, most notably Senator Warren, about the close relationships between regulators and banks. Assuming that the conversations between the banks and the BOE regarding FX trading did occur as reported by the media, there's a reasonable argument to be made that banks should be able to rely on whatever approvals the BOE officers gave them. In which case, why did the BOE officers not recognize problematic behavior in the first place?  Or, more troubling, did they acknowledge the questionable behavior but provided cover to the banks anyway? So many questions and so few answers in all of these market manipulation matters. 

Is Puerto Rico the next Jefferson County?

The rating agencies have downgraded Puerto Rico's debt to junk status, latest being Fitch. There has long been talk of PR's financial woes and it really took the agencies a while to catch up to the market chatter, which is not atypical. But there seems to be a split in opinion as to whether Puerto Rico will default, which would heavily impact retail investors.  Any thoughts? 

Fatal Flaw in Bitcoin Programming?

Dealbook reports that Mt. Gox has detected a previously unknown software glitch in Bitcoins requiring it to halt trading. The chief scientist at the Bitcoin Foundation disputes this and said the problem is with Mt. Gox's software.  The Bitcoin market now has to reckon with the possibility that the software may have glitches or worst, that it could be hacked.  Will Satoshi Nakamoto will release a patch? 

NY Fed: The Transformation of Banking: Tying Loan Interest Rates to Borrowers' Credit Default Swap Spreads

A researcher at the New York Federal Reserve has published a study about banks tying the interest rates that borrowers pay to their credit default swap spreads.  It is easy to envision banks, as a next step, tying consumer interest rates to our FICO scores.  

In FX it's Not just the Fix under Investigation; Are Banks Racing to the Regulators?

In addition to the fix and traders trading for their personal accounts, banks are reported to have found instances of traders providing "sensitive information" (which we assume to be customer orders) to other customers and of having traded against their clients' interests by defending or preventing a breach of fx levels that will cause the client to receive an option payout.
WSJ

These allegations are reported to have been uncovered by banks during internal investigations of the fix allegations.  That leads us to this article by Reuters which says that UBS approached investigators last September to provide evidence of misconduct in an effort to get preferential treatment from the regulators when/if punishments are meted out to banks.  We had a prior post regarding the 'first mover advantage" to a bank being the first to provide evidence to regulators (see here May a Bank Tell All to Regulators?)

Forget Bitcoins, Do You Take iPhones?

Courtesy of BusinessWeek, I now know that instead of Bitcoins and Louis Vuitton handbags I can buy iPhones to bartering for services. Apparently Hermes is quite popular too, but I don't really want to carry a USD$10k saddle around with me.

Bloomberg: BOE Staff Said to Have Condoned Currency Traders’ Conduct

Bloomberg reports that the Bank of England staff may have known and possibly "blessed" the sharing of information that appears to be at the heart of the investigations re: fx manipulation.  Could this provide legal cover for the banks?  How much did BOE know?  Are we surprised?  

Doubling Down: Bitcoin Evangelist Won't Back Down

Dealbook reports that Charls Shrem, one of the most visible advocates of Bitcoin, has not backed down from his support of the virtual currency, despite his arrest and accusations of money laundering.     The post mentions Mr. Shrem's dreams of a Bitcoin debit card, different business such as a private charter jet company or a bar taking Bitcoin.  In particular he noted that "Bitcoin really allows you to have such a global life — it allows you to be able to move anywhere within days if you want to."  Let's see, I can travel internationally now at a moment notice, use debit cards, buy drinks and charter a jet (if I had the money).  So what exactly does Bitcoin provide that real currencies cannot? 

2012 BOE Meeting with Senior FX Traders on Banks Sharing Benchmark Positions

Almost a month ago it had been reported in the press that the Bank of England had met with FX traders in 2012 and discussed the sharing of customer trade data before the WM Reuters fix at the London close.  Now Bloomberg is reporting that they have spoken with three people with knowledge of what was discussed at the meeting, and with a person who has seen a trader's notes that were made immediately after the meeting and subsequently handed over to regulators as part of the investigation.

Bloomberg reports that according to these people,the officials from the BOE FX Joint Standing Committee were told by the bank traders that they shared their positions in order to net their positions ahead of the fix in order to avoid trading during the very volatile time of the fix.  Reportedly the BOE representatives viewed this as a volatility reducing measure and did not bring the issue up to higher levels.  

Of course, the concerns raised in the press relate not to netting of positions, but what allegedly occurred when there were sizable net positions on one side of the market.  The BOE has issued little comment so far on what was discussed at the meeting.  Details of the discussion will hopefully be forthcoming, but it appears to us that what has been released so far does not address whether or not there was misconduct or even whether the BOE was condoning the activities which are alleged in the press. However, in the event that misconduct is ultimately found to have occurred, a question will be whether the BOE acted appropriately.  
BOE Knowledge of FX Position Sharing in 2012

More Answers than Questions - the Hank Paulson Story

If ever there was a man who had "more answers than questions" - as the cliche on a cliche goes - it's Hank Paulson.  But let's give him his due.  He's a hard-working guy.  He rose to high prominence and stayed there.  He's as honest as the day is long (not meant to be a joke that we're writing in winter).  His signature is on the currency we all use.  You can't beat the career credentials.

In today's news, though, he's making a comeback to tell us all that there are still big financial problems.  We know that!  While it's not offensive to state the obvious, we need more content than that.  We need a bigger message with REASONS and proposed ACTIONS.

Well, Paulson does have talking points.  He focuses on Fannie and Freddie and the government's dominance and ownership of residential mortgage lending since the Crisis.  Paulson:

    "It perplexes me that nothing has been done [by Washington politicians to unwind his own takeover of Fannie and Freddie as Treasury Secretary in 2008]."

He's perplexed that Washington wants to retain government control?!  Then Paulson says:

    "Every financial crisis has its roots in flawed government policies that lead to excesses in the markets that build up and build up, and then you get a bubble and it bursts."

In his very next breath, Paulson chides a group that is TRYING to reform Fannie and Freddie with an accusation of "OVERSIMPLIFICATION."  And his explanation above of the bubble burst was ..... WHAT?  Brilliantly deep analysis?!  A problem with these Paulson statements is that he's not saying anything.  There's no content.  It's surface-level thinking and reacting.

We read On the Brink, Paulson's book about the Crisis published in 2010.  The book is valuable as historical record.  (We recommend it.)  What is most striking is the absence of any Paulson thoughts.  The man just does not think deeply about the ways of the financial world.  A recurring theme of Paulson's in the book is (paraphrase) "I didn't have time to explain to House and Senate members why it was necessary to spend $700 billion and bail out the banks.  They just wouldn't have understood.  The financial world is too complicated to explain quickly to non-experts."

OUR QUESTION:  Well, why not tell us in your book, Mr. Paulson?  (In his book, he doesn't like strangers calling him "Hank.")  Every book begins with many blank pages.  Fill them with that long, complicated explanation that Congress couldn't understand.  But there's nothing there.  There's no discussion of whether banks are over-leveraged - for example, why is 20:1 leverage okay?  If it's not okay, what should it be?  Why?  (Leverage is just the first and easiest question!)

Additional Regulator to Investigate FX Benchmark Rates

Today saw the addition of a 12th regulator investigating the allegations of banks colluding in the manipulation of the WM Reuters fix.  The New York State Department of Financial Services regulates banks in NYS including the US operations of many non-US banks.
Bloomberg Article

The increasing stream of suspensions and firings of senior traders at many banks as part of internal investigations, makes it appear increasingly likely that the investigations will find misconduct on the part of at least some of the major banks.

In the event of such a finding the banks will be facing large fines ($6 billion in the LIBOR rigging), additional regulation, the loss of profits from the misconduct, and additional pressure from customers to reduce spreads after the bad publicity.  Benefits for the banks may include trades moving away from fix prices that provide the banks with no spread income as well as, in the long run, greater trust from customers due to a different type of fix / fix trades and the additional regulation.

NYT Dealbook: Senior FX Execs from Goldman and Citi to Step Down

Dealbook reports that senior FX officials from Goldman and Citi are stepping down in part due to fallout from the continuing investigations over alleged FX manipulation. I don't recall so many executives losing their jobs from the LIBOR investigations. Is anyone keeping count? 

Reuters Describes the Path that FX Manipulation Cases will Need to Follow

Based upon the allegations to date (no regulatory investigations have been completed) and the class action antitrust cases filed, the article highlights some of the issues that the plaintiffs will need to prove:
- that there has been anti-competitive collusion and that it rises to the level of antitrust behavior under the Sherman Act
- although there are differences from the LIBOR case, those antitrust claims were dismissed by a New York federal judge
- certifying a class when on any given day any alleged manipulation may help or hurt a particular plaintiff, depending upon the direction of the manipulation and the plaintiff's position.
Reuters

These are valid points relating to the potential difficulty of these antitrust suits. From the banks' perspective, at least as important will be the result of the regulators' investigations. Should these show manipulation to have occurred, even if problems are found with these suits, a subsequent set of lawsuits could reasonably be expected. Thus, regardless of the outcome of these suits, the banks may not be able to remove themselves very easily from another set of legal troubles in the event that the ongoing investigations find misconduct.

WSJ: Deutsche Bank Fires Currency Traders

Wonder what Deutsche found? http://on.wsj.com/1fPE1TY

Financial Conduct Authority says 10 Banks have Provided Evidence on the FX Benchmark Allegations; FCA Warns 2 that they will be Charged with Misconduct regarding LIBOR

The Financial Conduct Authority (FCA) announced today that 10 banks have provided evidence to the British regulator.  The head of the agency said that the investigation is unlikely to be concluded this year, and that the FX benchmark allegations are "as bad as LIBOR".
BusinessWeek

The FCA also warned 2 individuals that they intend to charge them for misconduct related to the LIBOR rate manipulation.  This is the first time that the FCA has issued such a warning since this power was granted to it in 2013.  These unnamed individuals are likely not the same ones who will face criminal charges.
DealBook NY Times

The Long Reach of the Foreign Corrupt Practices Act

Today's WSJ reports on the probe by the DOJ investigating whether financial firms such as Goldman Sachs, Credit Suisse, JPMorgan, Och-Ziff Capital Management and even Blackstone have violated the anti bribery law in their dealings with Libya.

This follows other reported ongoing investigations into other famous firm-country pairs such as Wal-Mart - Mexico and JPMorgan - China.

FCPA investigations are highly fact intensive that can translate into large legal bills.  For example,  Wal-Mart supposed haas spent over $230 million with no end in sight.

The range of the investigations publicized (and I'm only talking about the high profile cases) shows that the government will look at alleged misconduct worldwide, but they won't take every case that's publicized. For example, I wonder whether the SEC or the DOJ is taking any action on the alleged bribery of UK police officers by News Corp. reporters.  

Bitcoin’s Emerging Price "Stability" via TechCrunch

TechCrunch has an interesting piece about Bitcoin's price volatility, or rather, that its price has reached a new stage of stability, looking at the month of January, 2014.  

I think the jury is still out on Bitcoin and to have true statistical value, we need more than 1 month's worth of data to determine whether there is price stability.  That's assuming we agree on what we mean by "stability." 

Be a Bomb-Thrower - Espouse Market Efficiency !

If you enjoy starting heated conversations, tell a Wall Street friend you believe markets are generally efficient.  Then ask your friend's thoughts and stand back.  You'll get a visceral and prolonged reaction.

The topic of market efficiency - especially among experts - provokes a fascinating battle between the right and left sides of the brain.  The left-brain considers the historical data and track records of experts and concurs with efficiency in major markets.  The right-brain screams in derision and indignation.

To keep this post brief, we note that Burton Malkiel is the great source of detail and exposition for this subject.  We also add our layperson explanation as a chapter excerpt from the book Simple Money.