Almost five years after the financial crisis, Congress confirmed Richard Cordray, former Attorney General of Ohio, as the head of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) established Consumer Financial Protection Bureau (CFPB).

As Ohio’s AG, Cordray took JPMorgan Chase, Bank of America and Citigroup to court over their mortgage servicing practices, robo-signing, forclosure fraud, and losses to state pension funds.

He asserted banks were “operating on a business model built on fraud” and “defrauded our courts” by presenting false evidence manufactured in boiler rooms. He wanted banks to halt foreclosures in every case where they presented the courts with false evidence. He also publicly criticized Bank of America and GMAC; and said Wells Fargo had a serious problem on its hands. Richard Cordray wasn’t reelected, but he became the director of enforcement for the CFPB.

(See also: “Why POTUS Allowed Bailouts Without Indictments“)

Banks’ Boiler Rooms Are Back

Ryan Chittum at the Columbia Journalism Review highlighted the investigative journalism of the L.A. Times’s E. Scott Reckard who with Mike Hudson exposed mortgage lending boiler rooms in the last decade and the falsification of documents by mortgage lenders.

Reckard wrote a recent article on unsound practices at Wells Fargo where branch employees are pushing unnecessary fee generating products on customers:

To meet quotas, employees have opened unneeded accounts for customers, ordered credit cards without customers’ permission and forged client signatures on paperwork. Some employees begged family members to open ghost accounts.

The Consumer Financial Protection Bureau’s mission is to protect consumers from this sort of predatory behavior. The mission focuses on mortgage loans, credit cards and consumer financial products. This helps on the individual level, but it isn’t clear how consumers will be protected from predation on pension funds. Rather, prosecutions would be a deterrent.

Banks Used Structured Finance to Saddle Consumers and Institutional Investors with Losers

Banks and investment banks were large direct and indirect subprime lenders. I’ve written extensively how desperate banks accelerated sales of  fraud-riddled residential mortgage backed securities and collateralized debt obligations as the market unraveled. In addition, variable-rate auction securities (also known as auction-rate securities or ARS), backed by municipal bonds, student loans, subprime mortgages, and/or subprime backed collateralized debt obligations, comprised a $330 billion market. By the end of 2007, municipal bond insurers, including MBIA and Ambac, that credit wrapped the ARS were in trouble after writing credit default protection on toxic collateralized debt obligations with banks. The same banks that blew up the monoline bond insurers dumped doomed ARS on investors.

Banks sold long-dated auction rate securities as if they were money market instruments. They told customers that if there were no buyers at the regular short-term interval auctions at which the ARS coupons reset, the banks would buy back the securities. Retail investors and condominium associations were told these were a prudent substitute for T-Bills, just before the market fell apart. To be clear, banks lied to unsophisticated buyers to foist losses on them.

Regulators’ Potemkin Village of Meaningless Settlements

Investors from large corporations to individual retail investors found their money frozen. After years of looking the other way, regulators built a Potemkin village of financial settlements that were much too late to be viable, while eschewing criminal prosecutions. The settlements occurred just as banks imploded, and the financial system required a taxpayer funded bailout.

On August 7, 2008, just a month before the global financial meltdown, Citigroup reached a multibillion dollar settlement with regulators, at least in principle. There were no criminal prosecutions. Instead, Citi agreed to pay a $100 million fine and buy back $7.3 billion in auction rate securities sold to retail clients. Citi was under no obligation to repurchase $12 billion it had sold to institutional investors; the settlement merely required the bank to address investors’ liquidity concerns. But Citigroup wasn’t in a position to honor the financial terms of the settlement, because this was far from the only area in which financial malfeasance had damaged Citigroup’s balance sheet.

Begging for Bailouts, Including Money to Pay Present and Future Regulatory Settlements

The running joke was that Citi’s plan was to address its own settlement concerns by begging the U.S. Treasury for money. The following month, then Treasury Secretary Hank Paulson was in Congress literally down on one knee begging for bailout money for the global financial system. Of all the banks, Citigroup took the most taxpayer bailout money: $476.2 billion in cash and guarantees.

Other banks also stuffed investors with their ARS: JPMorgan Chase, Deutsche Bank, Credit Suisse, Wachovia Corp (now part of Wells Fargo), UBS, Bank of America; and brokers and funds including (but not limited to)  Merrill Lynch (now part of Bank of America), Goldman Sachs (awarded bank holding company protected status in 2008), Morgan Stanley (awarded bank holding company protected status in 2008), Lehman Brothers (bankrupt in September 2008), Pacific Investment Managemetn Co. (PIMCO), Oppenheimer, and BlackRock Advisors.

Pension funds of states, towns, and cities throughout the United States were among the investors in auction-rate securities.

Both retail investors and institutional investors have been trying to recover funds for years. Many of the regulators’ settlements were “stunningly inept.”

CNBC Irony

In this August 7, 2008 CNBC clip, I explain to Maria Bartiromo that whether stuck investors would ultimately recoup losses depended on what backed the ARS. Many municipalities weren’t in trouble (but some were, and some ARS were backed by student loans and failing structured finance products).

In a moment of financial meltdown high comedy, just after I explained the systemic connections and that other banks had problems…followed by the other guest seemingly downplaying the implications, breaking news revealed Bank of America was just served with subpoenas. I finished with explaining the context of the underlying problems, the systemic problems: mortgage lenders, student loan originators, banks, phony collateralized debt obligations, credit rating downgrades, and damaged bond insurers.

Pension Fund Shortfalls: How Much Is Due to Corruption, Predation, and Mismanagement?

When we talk about underfunded pension funds, the focus is usually on cutting benefits paid to employees. Some of those employees paid up to 8% of their compensation into those funds. We rarely investigate the role that the pension fund administrators and Wall Street had in helping to create massive shortfalls.

For example, in 2008, when former Goldman Sachs CEO Jon Corzine was governor of New Jersey, the New Jersey Division of Investment bought $400 million of Citigroup stock (January 2008), $300 million in Merrill Lynch stock (January 2008), and $180 million in soon-to-be-bankrupt Lehman shares (June 2008).

The afternoon that New Jersey announced its Lehman investment, Corzine reappointed Orin Kramer as the Investment Council Chairman. Both Corzine and Kramer were key fundraisers for President Barack Obama’s election campaigns.

What percentage of New Jersey’s pension fund shortfall is due to factors outside of employees’ control: corruption, predation, and/or mismanagement?

Jon Corzine is also a former New Jersey state Senator and the former CEO of now-bankrupt MFGlobal. He faces civil law suits after $1.2 billion customer money was improperly used to satisfy margin calls for leveraged derivatives trades he engineered. Most of the money was eventually recovered, but during the long delay farmers and other businesses were ruined or damaged. Corzine claims that although he is a detail sort of guy, he has no knowledge of how MFGlobal’s impermissible use of customer funds occurred. He has not been criminally indicted.

Goldman Sachs, one of the top five municipal bond underwriters, recommended that its customers buy credit default protection on New Jersey (short New Jersey’s debt) in December 2008. In other words, while Goldman Sachs sold New Jersey’s bonds, it advised clients to buy credit default protection. I cannot find fault with Goldman’s recommendation given Jon Corzine had already been the state’s chief executive for almost three years.

Many pension funds invested in subprime securities, variable auction rate securities, equities in financial institutions with subprime exposure, and other financial instruments that were damaged by global systemic risk.

Wall Street’s New Get-Rich-Quick Scheme

Now pension funds face a cash flow challenge as years of a low interest rate policy for U.S. treasury bonds has created a stock market bubble, while the global banking system is highly leveraged and houses hidden systemic risks. (See “How Hidden Bank Risks Drive Investors to Productive Assets, U.S. Treasuries, and Gold“). I don’t think pension funds should take comfort in a Wall Street engineered get-rich-quick solution presented to the Chicago Council on Global Affairs: total return swaps that generate high fees for the only guys who will get-rich-quick with this scheme.

Note added January 29, 2014: One enormous east coast pension fund asset manager wanted more fee income and by 2006 “managed” seven collateralized debt obligations of around $800 million and planned to expand. Banks underwrote and distributed the deals, but the pension fund manager, with no one dedicated to this full time and with no viable model, also bought equity in a couple of these deals. They had no clear understanding of the risks, no proper protocols, and apparently no oversight that holds them accountable for proper procedures. They are now the subject of class action litigation from retirees whose checks were delayed. It’s also alleged they improperly kept gains instead of posting them to retirees accounts.

See also: “Gasparino’s Glass Jaw is No Audience Draw“