Dec 10

Banking with Criminal Intent

Banking with Criminal Intent

Make no mistake about it, the disaster that is now the U.S. banking industry is the culmination of a decade or more of greed and theft.

However, the ongoing malaise is actually the result of a failure of the smallest (in terms of debt obligations) of the 3 major financial derivative products, which has poisoned world financial markets.

Even with tons of cash pouring in from pension funds and 401k accounts through the early 1990s into the 21st century, Goldman Sachs and companies like them, could not resist borrowing against those funds.

Rather than take those funds and manage towards productive, sound investments in sustainable infrastructure; employee training programs; and/or new product research and development, these same bankers and financiers engaged in asset skimming schemes in order to pocket billions of dollars in fees and loan proceeds, which produced absolutely no value.

All while sticking investors with highly leveraged, and thus, highly devalued, if not worthless, assets.

The three major derivatives out there are

1) mortgage backed – be they called mortgage bonds or mortgage backed securities;

2) credit default swaps (CDS) – which is essentially insurance for an investment ;

and 3) collateralized debt obligations (CDO) – a pool of loan and bond obligations from different originating sources.

First, we heard of mortgage backed securities and how they have led to the demise of Bear Stearns, Morgan Stanley, and weakening of Citigroup and Goldman Sachs, among other banking giants.

Henry Paulson started at Goldman Sachs in 1974. He was COO from 1994-1998 and succeeded John Corzine as CEO and Chairman in 1998, prior to joining Bush as Treasury Secretary in 2006.

One of his top performers at Goldman, John Thain (who later went on to head NYSE and is now head of Merrill Lynch, and currently seeking a $10 million bonus for 2008 performance even though he has worked there a little over a year, and Merrill has also tanked!) had a 25-year career at Goldman Sachs, climbing the ranks as a mortgage bond trader to become president of the biggest U.S. securities firm by market value at the time. His career was based largely on the leveraging of mostly consumer mortgages, which themselves were already leveraged investments.

So, where is the crime, and was it intentional?

If you consider mortgage bonds have been fraudulently rated and priced as if they were guaranteed annuities from a blue chip company, capable of paying for the life of the bond, then perhaps there is a crime.

Pricing and marketing them as ‘safe investments’ garnered inappropriate interest from pension funds, hedge funds and 401k funds, which led to the generation of enormous “fees” that directly enriched Thain, Paulson, and Goldman Sachs executives and employees for decades.

But, was the pricing and rating of these bonds fraudulent?

Well, if you know anything about Moody’s or Fitch ratings services, a consumer, call him Joe Mainstreet, cannot issue a AAA rated bond out on his mortgaged house, ever.

But alas, with the help of deregulation and a little fraud, Goldman can change the name of the bond issuer from Joe Mainstreet to Goldman Sachs, and voila, a AAA rated bond is born!

These mortgage bonds were NOT backed by a blue chip company with a product and revenue stream. They’re backed by ordinary consumers who rely on a job and increasing property values to remain solvent.

And, unlike a corporate bond where revenues based on productivity and sales repay the bond, a mortgage bond does not have a revenue stream because the consumer is not a producer. In other words, there is no economic activity or productivity creating revenue to pay these bonds.

Ultimately, the selling and re-selling of the new debt against existing assets reduced the value of the underlying assets to junk status.

By the late 1990s, mortgage bond traders like Thain were well aware that the actual risk, as well as underlying value of these mortgage bonds, as measured by normal accounting measures, had already slipped well into junk status.

Yet, through false marketing, fraud, and vigorous government lobbying, Thain and company continued to diligently skim any and all increased value created by the real estate price bubble from 2001 to 2006, by selling bonds backed by issuance of 2nd and 3rd mortgages on those same leveraged assets.

Those 2nd and 3rd mortgage loans were bundled, knowingly, into bonds and securities, for yet more grotesquely undeserved fees, on debt that was even more worthless than the first (or second) round issued previously.

The banking and finance industry knowingly ensured that the underlying value of the property, if not already, would eventually become worthless. This was intentional and pre-meditated, since at every opportunity, more leverage was created instead of settling existing outstanding debt. Every penny “earned” by those asset skimming schemes was obtained fraudulently, with intent.

But, don’t expect Paulson, Thain and company to surrender to authorities. Rather, expect them to ask for trillions more to bail themselves, and their criminal friends, out of their cesspool. And believe me, there is still lots more to come!

Mortgage securitized debt (mortgage bonds and mortgage collateralized securities), and leveraging of already leveraged real property loans has led to a wave of loan defaults and property devaluation, ultimately decimating the US economy.

Yet, we still must brace for a bigger wave of wealth-destruction (not wealth-creation) coming. This one will be a veritable tsunami compared to the gentle wave of distress caused by the collapse in the value of mortgage backed derivatives the past 12 months.

Credit Default Swaps (CDS) and Collateralized Debt Obligation (CDO) are leveraging tools that, like mortgage backed derivatives, are “asset skimmers” that attach to purportedly sound investments.

The sale of those derivatives has a sole purpose to borrow, again, against assets and projected earnings that are already leveraged several times over.

For instance, if a stock holder already has claim to future earnings, how can you issue a bond or security on those same earnings? There is a simple name for this. It is called fraud.

CDO values will similarly evaporate in value as their mortgage-backed counterparts have, due in large part to the ongoing and severe recession (depression) causing more and more bankruptcies.

As bankruptcies rise, bond and loan debtors will increasingly default on payments. This, in turn, will create more claims against the credit default swaps (CDS) that were purchased to guard against default.

As companies come to collect on their CDS contracts, the “insurance” for all of these failed investments, companies like AIG and, again, Goldman Sachs, will reel and come screaming for trillions more.

The cycle will continue, until approximately $512 trillion worth of CDS and CDO obligations have been unwound (de-leveraged), wiping out 3 times as much wealth as was just wiped out by the collapse of mortgage-backed securities.

Jeff Hamilton, Technology-Leadership

Technology-Leadership is a leading consultancy company in financial and business management consulting strategies, focusing on issues involving corporate strategy, technology, financing, planning and implementation.

Leave a Reply