Beware of Geeks Bearing Grifts
Risk Professional (Chapter 6 of Dear Mr. Buffett) - December 2009 issue
By Janet Tavakoli

The December 2009 edition of Risk Professional published an excerpt of Chapter 6 of Dear Mr. Buffett (Wiley 2009), “Beware of Geeks Bearing Grifts.”

In a control fraud, the agents, highly paid “professionals” of financial institutions, prosper but shareholders and debt holders suffer losses (debt holders were bailed out in our recent crisis, and they shouldn’t have been).

How did investment banks go through several bonus cycles of packaging bad loans without showing a loss? The answer is CDO hawala. Losses were disguised by stuffing wasting assets into a variety value-destroying securitization vehicles and/or transferring the risk using credit derivatives. Credit derivatives provided both leverage and opacity, and were sometimes used as speculative instruments to profit from the plunge in CDO values.

CDO hawala is similar to the complex, but highly effective, money brokering system used in the Middle East. It makes it virtually impossible to trace cross border money flows. Suspect collateral was traded among mortgage units and structuring firms. This makes it hard for anyone, except someone with the authority or subpoena power to examine your trade tickets, to figure out what you are doing.

The securitization activity of former investment banks and affiliated firms should undergo fraud audits. A fraud audit doesn’t mean you are accusing anyone of fraud, only that the audit will be thorough enough to uncover fraud, if it exists.

In the article I give examples of actual problematic deals, and I give many more real-time examples (naming specific deals and participants) in Dear Mr. Buffett. The largest Ponzi scheme in the history of the capital markets was conducted under the unseeing eye of the Slumbering Esquire's Club, the SEC. Suspect securitization activity should have been shut down and audited in the early stages. Instead it was allowed to form a mushroom-shaped cloud over the global capital markets.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008).

Janet Tavakoli's book on the global financial meltdown is Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley 2009)


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