Author Archives: A. Tewary

The Need for Criminal Prosecutions to Redress the Bank Excesses of the LIBOR Scandal

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Enforcement of Regulations with the Resources to Seek Criminal Penalties
  • Regulators must seek jail time to deter future criminal activity, especially after such egregious fraud as misquoting the reference lending rate for $800 Trillion of contracts
Occupy the SEC (http://www.occupythesec.org) is pleased to see that the CFTC has acted upon Barclays’ extensive and long-term practice of fraudulent pricing of LIBOR and EURIBOR.  The CFTC’s $200 million dollar settlement with Barclays, the Department of Justice’s penalty of $160 million and the United Kingdom’s FSA settlement of £59.5 million are significant enforcement achievements.  Barclays’ mispricing of reference rates has affected entire economies throughout the globe, given that businesses of all sizes routinely borrow on reference rates tied to LIBOR and Euribor.  This arbitrary and self-serving rate settings affected corporate customers, floating rate lenders, derivative counterparties and ultimately any entity or person doing business with companies borrowing at LIBOR.  There is a strong argument to be made that while $452 million of total settlements that Barclays agreed to is not an insignificant amount, it pales in comparison to the damages caused by incorrect pricing on HUNDREDS of TRILLIONS of dollars of financial contracts.  More recent developments have made clear that criminal manipulation of LIBOR has extended well beyond just Barclays.
Many of the banks involved in LIBOR and Euribor pricing were borrowing at prices typically significantly higher than their LIBOR and Euribor quotes during the period in question, and we have strong reason to believe that mispricing of these reference rates was rampant throughout the industry.  Accordingly, we hope the CFTC and other bank regulators do not limit their investigations to Barclays, and instead scrutinize the activities of all of the banks that participated in the setting of these reference rates.
Further, Occupy the SEC expects the regulators to pursue criminal prosecution of the individuals that participated in this fraud.  The CFTC’s press release makes clear that it knows the exact identities of the principal actors behind this criminal activity.  Occupy the SEC believes the U.S. has historically had been viewed as the strongest, fairest and most transparent financial market in the world.  The entire U.S. economy benefits from this leading position.  Yet if our regulators do not prosecute perpetrators, financial institutions will continue to act fraudulently.  Regulatory fines will be disregarded as the mere cost of doing business, and will lose their deterrent value.  When regulators fail to prosecute, individual perpetrators often walk away scot-free, free to collect their bonuses and continue engaging in similar activities at the same or another institution.
We encourage the regulators, particularly the SEC, to continue to use all the investigative and prosecutorial powers at their disposal to pursue the various securities law violations that have become apparent on an unprecedented scale during the current financial crisis.  We are particularly distressed that the SEC has not taken action to prosecute any major CFOs or CEOs for Sarbanes-Oxley violations, and look forward to the day that the SEC takes an active role in enforcing that critical piece of investor protection legislation.
Criminal traders and bankers tarnish the reputation of 99+% of financial institution employees who act according to the laws of the U.S.  If fraudulent activities are not punished with criminal convictions, opportunists will continue to abuse vulnerable institutions.  For the sake of honest bankers and the integrity of our financial markets, regulators need to set an example, remove anyone acting fraudulently and hold executives accountable where appropriate.  Otherwise, the entire industry’s reputation will be damaged and our markets will become less desirable in a highly competitive global marketplace.  Considering the importance of the financial markets to the U.S. economy from the perspectives of employment, growth and tax revenue, we believe that continuing to let criminals off the hook is an intolerable situation that must end.
Occupy the SEC is a group of concerned citizens, activists, and financial professionals with decades of collective experience working at many of the largest financial firms in the industry. Occupy the SEC filed a 325-page comment letter on the Volcker Rule NPR, which is available at http://occupythesec.org.

Member Perspective: End This Depression: Replace Geithner With Krugman

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Whose base is more energized? That will be a critical question for Obama and Romney come November.

This Occupier fears that there is a ton of energy behind the side chanting “we are all in this alone!” and holding up signs reading “Keep Government Out of Our Medicare” and holding meetings focused on the implementation of “The Hunger Games.” If this side is victorious, I fear that it will truly be the bane of the existence of anything positive in the name of America and the corporation will truly be King.

Obama has not shown nearly enough deference to those who got him there. There are more than enough articles out there to support this point and I will not waste your time nor mine reiterating those points here. What I will argue, instead, is that Obama must do something radical to show the ninety-nine-percent that he is with them. If he wants to get volunteers on the phones, find people willing to do the tough work of door-to-door canvassing, have people leafleting in front of grocery stores, and donating the few extra pennies they have, Obama has got to show us that he understands that “a new world is possible” in which we are all truly our brother’s keeper!

What’s the radical step I am promoting?! Replacing the Wall Street whipping boy Tim Geithner with the Pulitzer-Prize winning economist Paul Krugman! Mind you, only people like Jamie Dimon would find this to be a radical idea!! I guess one could argue that Geithner served a purpose in that he was able to stabilize the banking industry and make people like Jamie Dimon feel secure. And lo and behold, the banks are back to making sizable profits. So Geithner served his purpose.

However, beyond the international playing field, America is still a mess! Why are we still in such a state of stagnation? Read Krugman’s book, “End This Depression Now!” and you will understand that we are in a credit crunch! Essentially, there is plenty of capital out there, but it is stuck under the mattresses of large banks and large corporations who are too wrought with uncertainty about the direction of our economy to spend their capital and thereby put the car in DRIVE! The key element keeping us in PARK is a lack of demand. Thus, we need to have our government spend money to get the gears going again. For more of an understanding about why we must put our jobs crisis above any concerns regarding debt read Krugman’s book.

The point I am getting at is that when you car is stuck in PARK and you want it to be in DRIVE you seek out a mechanic whom you know has the understanding to fix what is broken and the integrity to not rip you off in the process. As you read, “End This Depression Now,” you will not be able to escape the feeling that Krugman cares! Yes, he is a Pulitzer-Prize winner. But, he’s also got heart. He rails against those who would complicate matters in order to benefit the one-percent. He takes Bloomberg to task for arguing that the housing crisis was the fault of Congress for encouraging minority home-ownership and that the bankers were mere innocents. Krugman responds by stating that, “In fact, during most of the housing bubble Fannie and Freddie were rapidly losing market share, because private lenders would take on borrowers the government-sponsored agencies wouldn’t. Freddie Mac did start buying subprime mortgages from loan originators late in the game, but it was clearly a follower, not a leader.” Take that Doomberg!!

In essence, what we need right now is an economic expert who cares deeply about the ninety-nine percent to take the reigns of the economy and steer it in the direction of more jobs! If Obama made this move now, he would fire up his base and get them working for his campaign. He might be afraid to lose independents who are concerned about the debt. But they wouldn’t have voted for him in any case.

Those are just my two cents (which is actually a lot these days).

-Josh Douglass
Joshdouglass2003@yahoo.com

Member Perspective: Bring Back Glass-Steagall

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The recent brouhaha over the trading losses at JP Morgan’s Chief Investment Office (CIO) has revitalized support for the old Glass-Steagall Act, which created a regulatory wall between investment banking and commercial banking for almost seven decades, until the Act’s repeal in 1999. Under Glass-Steagall, a bank could take your deposits, or take your company public, but not both. Our country needs to rebuild that wall.

The circumstances surrounding JP Morgan’s CIO desk illuminate a fundamental problem in the financial system: greed. The CIO office was ostensibly charged with reducing the bank’s overall risk through safe hedging. In reality, the CIO office did the opposite, taking on as much Value-at-Risk as the entire investment banking division of the behemoth JP Morgan. Those “hedges” have not performed as expected, and now the bank stands to lose over $3 billion and counting. How could this happen?

The SEC, CFTC, the FBI and other enforcement officials are looking closely into this question. But the answer is rather straight-forward. In Oliver Stone’s Wall Street, the flawed protagonist Gordon Gekko brazenly proclaimed that “Greed is Good.” Wall Street has taken this message to heart. Forgetting that Gekko was supposed to a cautionary figure, many Wall Street bankers and traders aspire not just to Gekko’s wealth but also to his tactics, reveling in high-stakes profiteering that often earns them 7, 8 and 9 figure incomes.

It is industry practice to borrow as much as possible (known as “leveraging”), in order to maximize gains. Unfortunately, leveraging can turn minor adverse price movements into gargantuan conflagrations. When banks start to sink, the specter of Too Big to Fail horrifies us into re-floating them with taxpayer funds (e.g., TARP) or through the Federal Reserve’s inflationary money-printing press (e.g., Quantitative Easing). The current banking model involves privatized gains, and socialized losses — a win-win deal for the banks.

No wonder that Senate hopeful Elizabeth Warren and many others have called for the reinstatement of Glass-Steagall. Glass-Steagall would have required banks that enjoy government subsidies (like the Fed’s “discount window”) to focus on conventional loan-making, thereby limiting the banks’ ability to gamble with those subsidies. That sort of restriction makes sense. The last thing you want to do is give a gambling addict an unfettered supply of cash, but that is exactly what the Federal Reserve’s current monetary policy does for bank holding companies.

The observant reader might protest, what about the Volcker Rule? Wouldn’t it have stopped the CIO office from disguising speculation as hedging? Unfortunately, no.

The Volcker Rule, often called Glass-Steagall-lite, restricts bank holding companies from engaging in proprietary trading, or speculating for their own profit. In theory, the Volcker Rule forces banks to focus on customer loans, the way Glass-Steagall required. Unfortunately, the Volcker Rule’s current form, as proposed by banking regulators, contains many loopholes that would permit egregious speculation like that undertaken by JP Morgan’s CIO office. For instance, the Volcker Rule creates broad exemptions for market-making, portfolio hedging and liquidity management. It also creates lucrative carve-outs for the toxic activities that actually caused the recent financial crisis, like securitizations and repurchase agreements.

JP Morgan can easily bear the $3 billion loss from its CIO desk. That’s not the problem. The real issue is that other banks, and possibly other divisions within JP Morgan, may be replete with similarly mischaracterized and under-capitalized trades. Can we as a society rely on banks, which are private, profit-seeking entities, to do what is best for us all?

The banks seem to think so. Their lobbyists have inveighed upon Congress and financial regulators, assuring them that the banks have sufficient capabilities to self-regulate, free from government constraint. After all, all the major banks are full of astrophysicists and mathematicians with PhD’s from places like Harvard and MIT, and the job of these “quants” is to do nothing else but build esoteric financial models to manage risk. However, despite all that brainpower, banks continually and repeatedly sabotage themselves through excessive risk-taking. The Great Recession of 2008, the worst financial crisis since the Great Depression, is testament to that fact. Simply put, no amount of financial engineering can overcome that entirely mundane human foible: greed. JP Morgan’s CIO debacle hammers that point home. As long as banks remain profitable, there will be gross incentives for them to conjure schemes to make money in ways that put the rest of us at risk.

That is exactly why we need hard-and-fast rules, like the Glass-Steagall firewall between investment banking and commercial banking, or the similar Vickers ring-fencing regime that is gaining traction in Europe. In Macbeth, Shakespeare warned of “Vaulting ambition, which o’erleaps itself and falls on the other.” We need a simple wall like Glass-Steagall to serve as a check on bankers’ vaulting ambitions.

Akshat Tewary

The Need for Credit Derivatives Reform

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JP Morgan’s loss shows exactly why we need an effective Volcker rule or a return of Glass Steagall, along with transparency in all derivatives, especially credit derivatives.  While the markets are somewhat volatile now, we certainly are not in a 2008 freefall.  Yet JP Morgan managed to lose at least $2 billion and counting.  Under extreme conditions, could this derivative position have lost 10x that? 20x given there is practically zero liquidity during a crisis?

While a $40 billion loss still would not leave JP Morgan insolvent, it would most likely put it below regulatory capital minimums, especially considering a fair amount of JP Morgan’s other assets would have lost value too.  This in turn could lead to a liquidity squeeze, (an ability to obtain funds needed in the near-term, typically from short-term markets), which could leave JP Morgan unable to meet its obligations.  In that case, JP Morgan would essentially be bankrupt and a bailout, to protect depositor assets would most likely be necessary.

There is also a concern whether a similar bailout would even be possible.  Consider that the total amount of the bank and corporate bailouts was $16 trillion across all Fed and Treasury programs (source: CBO, July 2011).  While the bailouts were mostly low or no-cost loans, they cost the government at least 2% – 3% per annum, borrowing long term and lending short term.  Can the country afford something like this again?

Worse, this is not even the largest threat.  Everyone in the financial world is worried about the level of borrowing both in the US and globally.  The leverage is extremely high when one considers the sum total of government, corporate and personal borrowing.  Yet the amounts discussed do not even consider the $80 trillion to $300 trillion credit derivative market (depending on your source).

Derivatives add leverage to an economy.  An investor in credit derivatives agrees to an obligation to pay based upon a reference asset, but only puts up a small portion of the notional amount as collateral.  So a $1 billion credit derivative may only have $100 million or more likely closer to $10 million as collateral.  What this implies is $900 million or $990 million of assumed risk without collateral.  That is essentially added leverage to the system.  Multiply this type of leverage by the credit derivative market size and we have a catastrophe waiting to happen.

Further, unlike cash obligations, derivatives are promises to pay and therefore include counterparty risk.  Unlike Goldman Sachs selling a bond to AIG, if the bond defaults, the only loss is to AIG’s account.  If a credit derivative, at 50x the notional size of a bond trade, goes bad for one counterparty, it may be so bad that the other counterparty would now suffer losses as well.  Indeed this is what happened with AIG and led to $182 billion of taxpayer funded bailouts and guaranties.

So if the market suffers another downturn, how many more crippled institutions will we have that will require a bailout, due to direct exposure on their assets, credit derivative positions or counterparty risk?  What would happen to the economy in the face of such gargantuan losses, even if a bailout could save the market again?  Both are scary questions.

Since credit derivatives are not standardized and not traded on transparent markets, there is no way regulators can adequately check the exposure and market value of financial institutions.  And therefore, our markets are in a precarious position, especially with an overleveraged U.S. Government standing behind the deposits of too big to fail banks.

By: Anonymous OccupytheSEC Member

Member Perspective: Occupy the SEC, JPMorgan-Chase, & the Volcker Rule

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Through its London office, JPMorgan-Chase (JPMC) hedged its overall position and did so with a big enough splash (the Whale) to call attention to itself.  It lost big and is still losing, but that fact is irrelevant.  The only significant question is whether this kind of activity was prohibited by the Volcker rule.  No, says the Comptroller of the Currency (OCC), one of the five federal regulators for the Volcker Rule.  Taking the OCC at its word, there is no story.
Alternatively, there is a story, which is that JPMC did violate the Volcker rule, perhaps not the law’s letter but certainly its intent.  That presumably is the position of the FDIC, which insures deposits at JPMC, and the Fed, which gives JPMC access to its discount window.

If they are correct and the OCC is mistaken, then the Volcker rule comes into question.  It is unlikely to be junked, so it will have to be tightened sufficiently so that the next time JPMC does something like this, the OCC will think there is a story.

That august group called Occupy the SEC (OSEC) aims to work by consensus. On the topic of JP Morgan’s loss, however, it is more like the Supreme Court: producing a majority opinion as well as one or more dissents along the way.   The majority opinion is that the Volcker rule has to be tightened.  The dissenting opinion, at least the one represented by the author of this comment, is that Congress would do better to junk the Volcker rule, start from scratch, and reenact the walls-of-separation familiar to us all from Glass-Steagall.  That minority view will be argued here.

Start with Glass-Steagall itself.  Its hallmark was its separation-of-powers doctrine, which in its case took the form of a separation of commercial banking from investment activities.   Imagine a commercial bank named Chase located on Main Street  and an investment bank named JPM (without the C) located on Wall Street.   Chase makes business loans, JPM makes investments.  JPM authorizes its London Whale to bet big, whether as hedging or not doesn’t matter.  What matters is that the Whale is incurring risks in the names of investors who know what they’re doing and give their consent.
Now what happens if it all goes South, as we like to say, and the investors lose $2 billion, maybe more, because of an investment strategy that was “flawed, complex, poorly executed, poorly vetted and poorly executed,” to use the words of Jamie Dimon at the recent Tampa shareholders‘ meeting.   What do investors do with an agent who says, “I can’t justify what happened” and that “unfortunately these wounds were self-inflicted.”

The answer seems obvious enough: you do what the district attorney would do with a suspect who confesses.   You bring Dimon before a court, present the confession as evidence, get the man convicted and then enjoy the spectacle of his execution as the next best thing to getting your money back.

But the shareholders did nothing of the sort.  They instead confirmed Dimon as CEO and chairman of the board, affirmed his salary at millions of dollars, and gave him a few verbal slaps-on-the-wrist.  The courageous Dimon made Ina Drew the fall-guy, but no one doubts that her severance package will be in the millions.  That Dimon lives to try it all again under a tightened Volcker rule should be sufficiently damning to condemn the rule itself.
So the trouble is with a rule the OCC thinks allowed Jamie Dimon to do what he did.  The trouble is also with a tightened version of that rule, for by the time the regulators get to writing it, Dimon will have gotten beyond his mea culpas and be supporting the new rule while lobbying for exceptions to it.

So what we need is a new two-part rule that allows Dimon to remain in place either at the head of an investment bank called JPMorgan or at the head of a commercial bank called Chase.  If he stays on Wall Street, then the investors will flee or they’ll throw him to the lions if be bets their money and loses it.  Or, under the aegis of a restored Glass-Steagall, Dimon opts to move over to Main Street and goes into the respectable business of dishing out commercial loans, in which case he most likely does not get in trouble.

A resurrection of Glass-Steagall would also allow sinners like Jamie Dimon to become honest people.  If Dimon bet big and lost, he would be able to say, “I bet the house (or houses, in his case) and lost.  It was my money, I knew what I was doing, and I have no regrets.”  Or the last sentence would read: “the money belonged to investors, I didn’t know what I was doing, and I have a lot of regrets because they just sacked me.”  Either way, we could all respect Jamie Dimon.  Right now, under the aegis of the Volcker rule, deep in the realm of legislated hypocrisy, the poor man is forced to lie every time he opens his mouth.

Bob Sullivan