Tavakoli Structured Finance LLC

The Financial Report

By Janet Tavakoli

Alan Greenspan Played Daily Show’s Jon Stewart

Alan Greenspan, former chairman of the Federal Reserve board (August 1987 – January 31, 2006), recently appeared on The Daily Show with Jon Stewart. Greenspan said he didn’t see the financial crisis coming; he thought bankers would be better stewards of their capital. That was meant to be an apologia of sorts for the Fed’s bungling oversight of the banking system. According to Greenspan, banks didn’t understand their risks, and neither the Fed nor the banks can forecast well. He added that people on Wall Street are “screwy.” Greenspan says he always thought “screwiness” would wash out, since people “would act rationally in their long term self-interest.”

Stewart’s sound rejoinder was that anyone would be incredulous when looking at a bank balance sheet leveraged 30:1. (Deutsche Bank is currently leveraged more than that.) The former Fed chairman spread a false narrative that dodges the reality that widespread interconnected control fraud was a major contributing factor to the financial crisis. (Video: Jon Stewart interviews Alan Greenspan – October 21, 2013)

Greenspan now recommends bank capital be doubled and also believes banks won’t do it. In other words, the failed regulator is now happy to put forward proposals that he thinks have no chance of implementation. Greenspan played the jester, but Jon Stewart was not amused.

Alan Greenspan, Lincoln Savings, Control Fraud, and “Screwiness”

Alan Greenspan had a front row seat to the Savings & Loan crisis in the late 1980’s. In 1984, Greenspan was part of a private firm and consulted for Charles Keating, the former owner of Lincoln Savings & Loan Association. Among other things, Greenspan was to study Lincoln’s financial condition. He found nothing wrong and in 1985, he wrote a letter advocating that Lincoln receive an exemption for risky direct investments. Greenspan became Fed chairman in 1987. Lincoln was seized by regulators in 1989 and cost U.S. taxpayers an estimated $3 billion. Keating was convicted and imprisoned and the charges were overturned on a technicality; he was never retried for those charges. Keating later pleaded guilty to four other federal fraud counts.

In its decision not to retry Keating on the overturned charges, the Department of Justice stated it would have been “a lengthy and complex trial” and witnesses’ memories “may have faded after more than 10 years.” According to the U.S. Attorney for the Central District of California’s April 6, 1999 press release: “In his plea agreement with the government, Keating specifically admits fraudulently disbursing $250,000 of ACC funds in February 1989, soon after learning the company was facing a huge cash shortfall that would put it more than $100 million in the red in a matter of months. The $250,000 was disbursed as “loans” to Keating’s son and his son-in-law, and the money was transfered [sic] back to Keating on the same day. In March 1989, another $500,000 in “loans” was disbursed to Keating and to his son, and another $225,000 in “loans” was disbursed in April. Two weeks after the last payment was made, ACC declared bankruptcy.”

After his admission of guilt, Keating was sentenced to over four years time already served for his previously overturned conviction on other charges. It seems to me Greenspan would have taken careful note of a control fraud—by someone he knew and from whom he received pay—that resulted in the bankruptcy of an institution Greenspan once evaluated.

Greenspan’s former consulting role haunted him after he became Fed chairman. Critics pointed out he didn’t see the problems coming. In 1989, Greenspan maintained:

”I don’t want to say I am distressed, but the truth is I really am. I am thoroughly surprised by what has happened to Lincoln.”

Greenspan’s descriptions of his “surprise” about the 2008 financial crisis sound remarkably similar to his description of surprise over the Lincoln Savings scandal. As Fed chair, Greenspan had a direct connection with a failed Savings & Loan, surely that would have given him a few clues. Greenspan’s omission of the teachable moments from the S&L era is “screwy.”

William K. Black, an Associate Professor of Economics and Law at the University of Kansas City-Missouri, was a top regulator during the S&L clean-up. Regulators generated thousands of felony indictments and won convictions. He wrote a book about the Savings & Loan scandal: The Best Way to Rob a Bank Is to Own One, and explained that control fraud thrives in a criminogenic environment with no effective punishment for the individual perpetrators. Greenspan might consider reading it (again?) to assist his “faded” memory. Financial institutions suffer as executives pay themselves lavish compensation. The parasites eat the host. A recent example of control fraud is JPMorgan’s London Whale scandal.

Banks, Not Just Investment Banks, Were Top Subprime Lenders

A false narrative around subprime lending and subprime exposure claims that it was a phenomenon outside the U.S. banking system. Top mortgage lenders from 2005 to 2007 included Long Beach ($65 billion in loan volume) then owned by Washington Mutual (now part of JPMorgan Chase); Wells Fargo Financial ($52 billion); Chase Home Finance (part of JPMorgan Chase with $30 billion in loans); CitiFinancial (part of Citigroup with $24 billion); and Wachovia ($17 billion).

U.S. banks also extended credit lines to the most culpable subprime lenders. To offer just three examples using the top three subprime lenders for the period 2005-2007: Countrywide ($97 billion in loan volume and now part of Bank of America) had lines from Bank of America, JPMorgan Chase, and Citibank. Ameriquest Mortgage (more than $80 billion in loan volume) had credit lines from JPMorgan, Citibank and Bank of America (Merrill Lynch is now part of Bank of America). New Century, a bankrupt subprime mortgage lender ($76 billion loan volume) had credit lines from Bank of America and Citibank. Moreover, many had credit lines from investment banks that became bank holding companies after the financial crisis. U.S. banks also bought credit default protection on suspect synthetic collateralized debt obligations from bond insurers. AIG took a government bailout, and monoline insurers saw their credit ratings crash.

An Example: Greenspan and Citigroup

Citigroup has had a history of bad lending problems. In Greenspan’s time, it was one of the banks in trouble due to unwise loans to Latin American countries. Citi took partial belated write-offs, but it also benefited from the Fed sanctioned cosmetic accounting cover-up known as Brady Bonds. During Greenspan’s time at the Fed, Citigroup ramped up risky activities. The SEC alleged Citi subsequently deceived investors about $13 billion of exposure to subprime risk: “Between July and mid-October 2007, Citigroup represented that subprime exposure in its investment banking unit was $13 billion or less, when in fact it was more than $50 billion.” [Quote added Oct 31, 2013.]

Moreover, that was far from Citi’s only problem. The Congressional Oversight Panel’s final report revealed that Citigroup received the most bailout money of any U.S. bank. Between TARP, the FDIC, and the Federal Reserve, Citigroup got a total of $476.2 billion in cash and guarantees. The panel noted:

“Very large financial institutions may now rationally decide to take inflated risks because they expect that, if their gamble fails, taxpayers will bear the loss…Ironically, these inflated risks may create even greater systemic risk and increase the likelihood of future crises and bailouts.”

Citi stock prices pre-crisis and presentIn 2011, Citibank did a reverse 1:10 stock split, because it looked awful to have one of our too-big-to-fail banks trading in the low single digits. (In 2009, Citi traded under $1 per share.) Today Citibank trades at around $50 per share, or $5 expressed in pre-reverse split pricing.

Fed Apologists Enable Criminal Incentives

The University of Chicago Crime Lab published its study on gun violence showing that when an individual perpetrator receives a direct penalty for committing a crime, it is an effective deterrent. When they don’t receive a punishment, guess what happens? They tend to escalate.

The UofC study supports stiffer sentences for firearms violations. Those convicted of gun possession charges and who received probation—rather than jail time—were four times more likely to be rearrested for murders and nine times more likely to be jailed for non-fatal shootings.

One of the problems in the financial system is that perpetrators are rarely held responsible. Shareholders pay fines, and the DOJ rarely files criminal charges. Individuals get off even better than scot-free. They are handsomely rewarded for crime. They net millions, sometimes tens of millions of dollars and subsequently land prestigious jobs.

Failed regulators like Alan Greenspan express surprise at serial escalating failure, while claiming they’ve studied incentives and human nature. Greenspan may have missed the University of Chicago Crime Lab study. But is it even possible he missed the body of work done by other regulators during the front page S&L scandals?

Today, bankers with malicious mischief on their minds have no effective deterrents. Instead, they have compelling monetary incentives for engaging in control fraud. Thanks to the muddled thinking of failed regulators like Alan Greenspan, these distorted incentives remain in place.

Jon Stewart Is More Effective than the Financial Times

If you subscribe to the Financial Times, you may have read Gillian Tett’s disappointing interview with Alan Greenspan. I’ve met Gillian a couple of times. She has interviewed me for some of her articles, and she was kind enough to mention me in the acknowledgements of her book on the origins of credit derivatives, Fool’s Gold. It appears Gillian didn’t arrive well prepared for the Greenspan interview. I wrote her a brief note and copied Lionel Barber, the FT‘s editor. The interview’s omission of Greenspan’s consulting role at Lincoln Savings—and the subsequent S&L crisis—seems an egregious omission of relevant context.

Access Journalists and Undisclosed Payments to Academics

There seem to be too many “access journalists” and too few investigative journalists. The Nation gave a great example of investigative journalism when it exposed academics receiving undisclosed payments from Wall Street. These academics fight financial reform and push false narratives to the financial press. So-called journalists lacking critical thinking skills parrot these academics.

The Nation targeted Todd Zywicki, Hal Scott, J.W. Verret, Darrell Duffie, and Craig Pirrong  along with the National Economic Research Associates, Oliver Wyman, Charles River Associates, Cornerstone Research and the Global Economics Group. The article is titled: “The Scholars Who Shill for Wall Street.” So many journalists and academics seem to be eager to shill, that I’m surprised the oversupply hasn’t resulted in Wall Street payments of a dime a dozen.

I’d like to give the Financial Times the benefit of the doubt. Perhaps it will do a follow-up to justify its claim that the subscription price goes towards high quality global journalism.

Endnote: Gillian Tett did first-rate work before the financial crisis in a series of articles that exposed manipulation of models and more. I was quoted in several of them, and here’a s link to one of them at the end of my commentary: “Volcker Blames Models, Dimon Blames Policymakers.”

Update April 24, 2014: Last night, at a dinner honoring Jean-Claude Triceht, I sat next to a fund manager. The first thing we read every morning is the Financial Times. We both feel the FT did a better job in the run up to the financial crisis, particularly when it came to bonds, and the FT is still our first choice.

Share This Post