Tonight, according to a breaking story in Friday's Wall Street Journal, the Federal Reserve Bank of New York has issued a report which acknowledges that rampant and highly institutionalized obfuscation of bank/investment house debt has been the norm among our nation's top 18 finance firms for the past five consecutive quarters, since the beginning of 2009.
As I've reported over the past few days (SEE: "'Enronomics' Is Just Another Word For Nothing Left To Lose"), coverage of the release of tonight's FRBNY report comes with a tacit acknowledgement in the WSJ that major Wall Street firms have been sporadically engaged in similar accounting games going back for at least a decade.
The report, issued at least in part in response to a Securities and Exchange Commission (SEC) letter sent out to top Wall Street firms, on March 30th, requesting accounting data from numerous leading banks and investment houses as part of the SEC's ongoing investigation into the collapse of Lehman Brothers in September 2008, is almost certain to cause a major uproar, at least throughout the blogosphere (if nowhere else), by sunrise.
Big Banks Mask Risk Levels
Quarter-End Loan Figures Sit 42% Below Peak, Then Rise as New Period Progresses; SEC Review
Wall Street Journal
April 9, 2010
By KATE KELLY, TOM MCGINTY and DAN FITZPATRICK
Major banks have masked their risk levels in the past five quarters by temporarily lowering their debt just before reporting it to the public, according to data from the Federal Reserve Bank of New York.
Click HERE for the FRBNY report.
A group of 18 banks--which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.--understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters.
--SNIP--
According to the data, the banks' outstanding net repo borrowings at the end of each of the past five quarters were on average 42% below their peak in net borrowings in the same quarters...
--SNIP--
The SEC now is seeking detailed information from nearly two dozen large financial firms about repos, signaling that the agency is looking for accounting techniques that could hide a firm's risk-taking. The SEC's inquiry follows recent disclosures that Lehman used repos to mask some $50 billion in debt before it collapsed in 2008.
The practice of reducing quarter-end repo borrowings has occurred periodically for years, according to the data, which go back to 2001, but never as consistently as in 2009...
What is truly almost beyond the pale of this morning's story, itself, IMHO, is the way this story is being "managed" by the FRBNY in the WSJ:
That practice, while legal, can give investors a skewed impression of the level of risk that financial firms are taking the vast majority of the time.
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From yours truly, just three days ago...
"Enronomics" Is Just Another Word For Nothing Left To Lose
by bobswern
Tue Apr 06, 2010 at 04:11:10 AM EDT
(Title h/t's to Kris Kristofferson and Janis Joplin)
The rumors of the death of "Enronomics," in 2001, have been greatly exaggerated. The fact is, it never died. We now know, based upon press revelations over the past three weeks, that the financial culture of Enron has been alive and well and pervasive throughout Wall Street for the past decade. In fact, it may now be said that virtually the exact same playbook that Enron used in the late 1990's was redeployed on Wall Street -- at firms such as Bear Stearns, Lehman Brothers and Bank of America, and perhaps others -- immediately after the repeal of the Glass-Steagall Act, in 1999. And, Wall Street--enabled by a culture of corruption, deceptively branded as "financial innovation," which extended from lower Manhattan to Washington, D.C., and to the boardrooms of major banks throughout the U.S.--hasn't looked back since...
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But, Yves Smith, one of my true heroes in the blogosphere, while giving us more than ample background on the entire matter, nine days ago in her Naked Capitalism post, tells it like it is and calls it all: FRAUD.
(The following post is reprinted, in its entirety, with permission from Naked Capitalism Publisher Yves Smith.)
SEC Launches Repo 105 Investigation
Yves Smith
Naked Capitalism
Tuesday, March 30, 2010
The Financial Times reports that the SEC has launched a probe into whether other financial firms used repos to engage in what amounted to financial fraud (as in fraudulent financial reporting), although perilous few are using the "F" word.
From the Financial Times:
US regulators on Monday asked more than 20 financial groups whether they engaged in transactions along the lines of "Repo 105" - an accounting device that helped Lehman Brothers conceal its high leverage ratio during the financial crisis.
The corporate finance division of the Securities and Exchange Commission wrote to chief financial officers of "close to two dozen" large foreign and domestic banks and insurers, demanding details of repurchase agreement deals.
The SEC probe includes whether companies booked repos as asset sales for accounting purposes over the past three years, and whether these deals were concentrated with certain counterparties or certain countries. Regulators also asked companies to quantify the amount of repos that were disclosed as asset sales and to explain the "business reasons" for use of these structures.
Yves here. While this is a welcome move, the open question is whether the SEC has sufficient reach to be effective. Repo 105 provides a template for one sort of violation, but how many other balance-sheet flattering games, involving God-knows-what jurisdictions, might have taken place? The SEC regulates broker-dealers, so for commercial banks with broker-dealer operations, its authority extends only to the US broker dealer operations. Even for the former investment banks, the SEC's authority over the holding companies was tenuous. Per an earlier post:
The SEC did not have statutory authority over Lehman's holding company. Its authority was "voluntary", a sort of regulatory default. The lack of statutory authority creates ambiguity as to its basis for action (for instance, it cannot use statutory violations as a basis for action, nor can it threaten to revoke a license, since it does not have licensing authority. The examiner's report is definitive upon this point (p. 1484):
The Gramm-Leach-Bliley Act of 1999 had created a void in the regulation of systemically important large investment bank holding companies. Neither the SEC nor any other agency was given statutory authority to regulate such entities.
In keeping, to induce the US LIBHCs to participate in an toothless regulatory scheme, the SEC weakened net capital requirements, an action that many experts see as having played a direct role in the crisis (as it is allowed investment banks to attain higher levels of leverage). Moreover, note the implicit limits on the SEC's authority. From Report 466-A, published September 25, 2008:
The CSE program is a voluntary program that was created in 2004 by the Commission pursuant to rule amendments under the Securities Exchange Act of 1934. This program allows the Commission to supervise these broker-dealer holding companies on a consolidated basis. In this capacity, Commission supervision extends beyond the registered broker-dealer to the unregulated affiliates of the broker-dealer to the holding company itself. The CSE program was designed to allow the·Commission to monitor for financial or operational weakness in a CSE holding company or its unregulated affiliates that might place United States regulated broker-dealers and other regulated entities at risk.
Yves here. Did you catch that? While the SEC can supervise the holding company and unregulated entities, its scope of action is limited to preserving the health of regulated entities only.
The CSE program focused on liquidity, NOT solvency.
Back to the current post. So for the former investment banks, the SEC presumably has some history in supervising their "unregulated entities" but it can't really force them to comply. Now these firms don't want to appear to be obstructionist, but I would not be surprised to see any queries answered as narrowly as possible.
And how far can the SEC get, say, with a US or foreign bank with US broker dealer operations? It can presumably demand that the US broker dealer explain any suspect looking end of reporting period transactions, but the SEC's ability to demand documents from the entity on the other side of the trade (even if it is another affiliate) would seem to be limited.
That is a long-winded way of saying that it is not a good sign that the SEC appears to be conducting this investigation without the support of other regulators, both in the US and overseas. Perhaps some will throw their weight behind it, but the lack of coordinated action does not bode well for reform.
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Tonight's breaking story in the WSJ is a classic example of the "they-all-were-doing-it" excuse and retort.
And, frankly, it's nothing more than institutionalized bullshit...taking place at the highest level of our society, as is self-evident in the release of this preemptive strike by the FRBNY during the overnight news cycle.
It's the greatest financial ripoff of a society in history. And, one of the most important chapters in it--"the history we didn't know"--is being read aloud to us, tonight, as I post this.
IMHO, it's regulatory capture writ large. And, you know what? If they "all were doing it," as far as I'm concerned, they should all go to jail.
This story's legs just grew massively, tonight, with the release of this lame attempt at managing the carnage.
Friday should be a real interesting day in the financial blogs.
What do you think about it?
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REFERENCE: "REPO LOANS" via Wikipedia
Repurchase agreement (a/k/a Repo Loans)
From Wikipedia, the free encyclopedia
A Repurchase agreement (also known as a repo or Sale and Repurchase Agreement) allows a borrower to use a financial security as collateral for a cash loan at a fixed rate of interest. In a repo, the borrower agrees to sell immediately a security to a lender and also agrees to buy the same security from the lender at a fixed price at some later date. A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is the interest on the loan while the settlement date of the forward contract is the maturity date of the loan.
Structure and terminology
A repo is economically similar to a secured loan, with the buyer (effectively the lender or investor) receiving securities as collateral to protect against default of the seller (effectively the borrower). Almost any security may be employed in a repo, though practically speaking highly liquid securities are preferred because they are more easily disposed of in the event of a default and, more importantly, they can be easily secured in the open market where the buyer has created a short position in the repo security through a reverse repo and market sale; by the same token, illiquid securities are discouraged. Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as "collateral" in a repo transaction. Unlike a secured loan, however, legal title to the securities clearly passes from the seller to the buyer. Coupons (installment payments that are payable to the owner of the securities) which are paid while the repo buyer owns the securities are, in fact, usually passed directly onto the repo seller. This might seem counterintuitive, as the ownership of the collateral technically rests with the buyer during the repo agreement. It is possible to instead pass on the coupon by altering the cash paid at the end of the agreement, though this is more typical of Sell/Buy Backs.
Although the underlying nature of the transaction is that of a loan, the terminology differs from that used when talking of loans because the seller does actually repurchase the legal ownership of the securities from the buyer at the end of the agreement. So, although the actual effect of the whole transaction is identical to a cash loan, in using the "repurchase" terminology, the emphasis is placed upon the current legal ownership of the collateral securities by the respective parties.