Why Do We Need the SEC?

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Why Do We Need the SEC?
by Jim Powell, May 19, 2009

FDR established the Securities & Exchange Commission to protect people in securities markets. Yet there already were plenty of laws against theft and fraud, crimes that are seldom exposed by government regulators.

Consider the succession of big Wall Street scandals since the late 1990s. It’s hard to find a single case that was exposed by the SEC. Typically, Wall Street scandals seem to be exposed by savvy investors, disgruntled employees, financial analysts, internal auditors, or investigative reporters. The SEC tends to arrive on the scene only after a story is out and investors have suffered losses. For example:


In 1998, Cendent disclosed that the income of one of its component companies had been over-stated by $500 million during the previous decade. Presumably the purpose was to inflate the value of the stock of founder Walter Forbes. He denied knowledge of the fraud even though he had been paid $100 million a year as chairman and CEO. In 2007, he was sentenced to 12 years in prison. Where was the SEC?


In May 2000, Xerox announced that it discovered accounting irregularities in its Mexican subsidiary. The company conducted an investigation, fired 13 managers, and announced a $120 million write-off for 2000. Xerox’ assistant treasurer James Bingham insisted this wasn’t the whole story, and he was fired. He subsequently sued the company. The SEC heard about the lawsuit and became involved in the case. Xerox turned out to have over-stated income by $3 billion and earnings by $1.5 billion.


In 1997, Gary Winnick established Global Crossing, a telecommunications company. He raised large sums of money and went on an acquisition spree. By 2000, the stock peaked at $61. But investors became increasingly concerned about all the debt. They began to unload the stock, and it fell to $5. The company filed for bankruptcy in January 2002. Although the SEC conducted an investigation, all they did was levy $100,000 of fines on three top executives. Winnick got off, in part, because of campaign contributions to both Republicans and Democrats.


During the mid-1990s, Houston-based Enron adopted increasingly risky strategies for which it borrowed more and more money. But when their bets backfired, executives tried to hide the losses by cooking the books. Fortune magazine raised serious questions about the company in March 2001. Investors became suspicious, and the stock declined. On August 14, President Jeffrey Skilling resigned mysteriously. A $618 million loss was reported for the third quarter of 2001. The SEC opened an investigation not long before the company collapsed.


Over the course of 15 years, Bernard Ebbers acquired 65 communications companies with $60 billion of borrowed money and made WorldCom a high-flying stock. But he wasn’t very good at integrating all those companies, and he was a reckless spender. The company spun out of control. In March 2002, WorldCom internal auditor Cynthia Cooper began to investigate the company’s accounting practices. Some $11 billion of accounting fraud was discovered. The stock plunged. Ebbers was sentenced to 25 years in prison.


Dennis Kozlowski became Tyco CEO in 1992, and he launched an aggressive acquisition program. By 1999, Tyco’s market value was greater than General Motors and Ford combined. Investors became increasingly uneasy, however, about his free-spending ways. In October, investment manager David W. Tice challenged the accuracy of Tyco’s financial reports. The stock dropped about a third. The SEC investigated but didn’t find anything. Nonetheless, in June 2005 Kozlowski was convicted of looting $150 million from Tyco. The Manhattan judge said: “the heart of the case is basic larceny.”


During the stock market boom of the 1990s, John Rigas and his sons Timothy and Michael launched an aggressive expansion program for Adelphia, their family-held cable TV company. They nearly quadrupled their debt. But they couldn’t manage what they had put together. Many investors became wary. On March 27, 2002, the company disclosed that their debt was $2.2 billion greater than had been previously reported. The stock lost two-thirds of its value. The company filed for bankruptcy. Investigations by the SEC and others revealed fraud.


For nine years, accountant Harry Markopolos sent the SEC evidence suggesting that investment advisor Bernard Madoff might be a fraud. Madoff was socially well-connected to the former chairman of NASDAQ. The SEC didn’t do anything. In 2001, Barron’s ran an article about Madoff’s suspicious secrecy and unusually high returns. The following year, a whistle-blower claimed there were irregularities at Madoff’s firm. The SEC intervened only after December 11, 2008 when Madoff’s sons reported that he had confessed to a Ponzi scheme.

Would we be safer if the SEC had more power? Doubtful, because even in Nazi-controlled Europe, there were plenty of smugglers, document forgers, resistance fighters, black markets, safe houses. and escape networks. The Gestapo couldn’t keep up with them all.

It’s a mistake to imagine that the SEC will protect us. As investors, we must take responsibility for due diligence to protect ourselves. In which case, what do we really need the SEC for?

Jim Powell is policy advisor to the Future of Freedom Foundation and a senior fellow at the Cato Institute. He is the author of FDR’s Folly, Bully Boy, Wilson’s War, Greatest Emancipations, The Triumph of Liberty and other books.

The Strange Death of American Capitalism

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The Strange Death of American Capitalism

May 17, 2009
Source:http://www.crossingwallstreet.com/archives/2009/05/the_strange_dea_1.html

Book Review of Bailout Nation by Barry Ritholtz

In The Strange Death of Liberal England, George Dangerfield famously described how the British Liberal Party—and by extension, England’s once-unshakable faith in liberalism—suddenly and unexpectedly vanished. Despite its outward appearance of solidity, once liberalism was challenged, it crumbled to dust. How could a faith that was so dominant for so long, suddenly disappear; not only die quickly—indeed with a whimper—but do so without putting up any resistance?

These are similar questions future historians will have when they look back at the first decade of twenty-first century America. At the dawn of the new millennium, America’s faith in capitalism was also unshakable. Yet, within a few short weeks in 2008, the entire edifice came crashing down. Even voting didn’t seem to matter. First under a Republican administration and then under a Democratic one, large sectors of the economy received unprecedented amounts of government support. A staggering $15 trillion of taxpayer money has been put on the line.

The American economy reached its humiliating nadir at Davos earlier this year when our fiscal profligacy was criticized by the Wen Jiabao, the premier of what was once-called Red China. Worst of all, he was right.

What Happened?
In Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy, Barry Ritholtz takes on that question with gusto and the result is a wonderfully engaging book. Bailout Nation describes not only what happened and what went wrong, but also why. Don’t worry, you don’t need an advanced degree in economics to follow the story. Bailout Nation manages to be both comprehensive and easy to read.

Ritholtz is already known to countless investors through his invaluable blog, The Big Picture. (Full disclose: He’s been a supporter of CWS from its earliest days.) I have to confess to having some initial reservations about Ritholtz’s book. What makes him a great blogger, I feared, might not transfer well to a 300-page sustained argument. Let’s just say that Ritholtz isn’t exactly a “shades of gray” kind of guy. When a rapier is needed, Ritholtz is fully willing to use a cluster bomb. If you don’t think it’s possible to get a true sense of moral outrage over, say, the latest BLS report, well...you haven’t read The Big Picture.

Fortunately, my fears were unfounded. Ritholtz does very well in book form. His editor, Aaron Task, served him well; the prose is compact and well-organized, though I’m fairly certain of the sentences where Ritholtz shook off all editorial changes. Where Ritholtz truly shines is in drawing connections between seemingly dispirit events; the fall of Bear Stearns, oleaginous mortgage brokers, the repeal of Glass-Steagall, the growth of credit default swaps, even the effects of reforming the Consumer Price Index, all play a role in this complex mess of unintended consequences, vicious cycles, ideological blindness and abject stupidity. I can't remember that last time I had so much fun reading about the Apocalypse

There are, however, a few minor errors. The Jefferson quote, “Banking establishments are more dangerous than standing armies” (page 15) is probably bogus. Also, on page 96, Ritholtz writes, “the psychological impact that feeling financially flush has on spending cannot be underestimated.” He surely means overestimated. These errors are minor of course, and it may be a reflection of covering events in real time.

Even before its release, Bailout Nation itself became a news story. In February, McGraw-Hill, the originally publisher, announced that it was ditching the project. Ritholtz claimed it was due to his criticisms of the Wall Street ratings agencies (McGraw-Hill owns Standard & Poor’s). McGraw-Hill denied this although curiously, the editor Ritholtz had been working with, resigned one week later. Fortunately, John Willey & Sons picked up the project and brought it to life (or, if you prefer, bailed it out).

Lockheed Was the Original Sin
So how did we end up were we are? Ritholtz persuasively makes the case that we didn’t suddenly abandon our capitalist faith. Instead, he argues that our fondness for bailouts isn’t new. Ritholtz pinpoints our original sin in the 1971 bailout of Lockheed. By today’s standard, that bailout was laughably small—just $250 million.

The important point is that a new standard had been established, and the government and Corporate America responded accordingly. Soon, bailouts became like a narcotic. Our fixes could only be satiated by steadily larger rescues. Soon Penn Central received a bailout, followed by Chrysler a few years later, then Continental Illinois (which ironically found itself in the hands of Bank of America).

Ritholtz agues that the bailouts, even when successful in the short-term, do considerable long-term damage. After the Chrysler bailout, for example, the already somnolent auto industry grew even more complacent. Ritholtz considers an alternative history: What if Chrysler had been allowed to fail? Might Detroit have reformed itself? We’ll never know because as the public became slowly inured to these bailouts, they were free to grow larger.

Ritholtz expands his argument by adding the machinations of the Federal Reserve to the growing bailout trend. This is a crucial point because too few observers see the motives behind the central bank. Any good story needs a top-notch villain and in Bailout Nation, it’s a certain Randian jazz musician named Alan Greenspan.

The Mess That Greenspan Made
Ritholtz doesn’t suffer fools gladly and Greenspan gets a well-deserved skewering.
Ritholtz tracks how Greenspan purposely and quite clearly altered the Fed’s mandate to include supporting asset prices. The facts Ritholtz presents are strong. The Fed-orchestrated bailout of LTCM had a profound effect on Wall Street’s risk-taking mentality. Whenever the market tumbled, Greenspan jumped in to cut rates. Bubbles, however, in tech stocks and later in housing were allowed to grow unchecked.

According to Ritholtz, it was Dr. Greenpan’s tonic of absurdly low interest rates that led to an historic housing bubble and all the unpleasantness that followed. The effect was far more damaging than easy money.

Ritholtz stresses that the Fed’s policies changed the rules of the game. For example, the bond market was now forced into a reckless “scramble for yields.” This in turn fed the practice of securitization which, in turned, fueled the disgraceful behavior of the ratings agencies. When yields were low, mischievous behavior flourished. At each juncture, the dots connect back to Greenspan who even disregarded his fellow members of the Federal Open Market Committee.

Incidentally, the section on ratings agencies (pages 111 to 113) is hardly controversial. Ritholtz simply states what’s widely known, that the ratings practiced a form of payola. There’s no other way to say it—the agencies abandoned their professional and moral obligations.

Real Capitalists Nationalize
As for the debt crisis, Ritholtz writes, “From 1 million B.C. up until the present day, the ability to repay the debt has always been the dominant factor—except, however, for a brief five-year period starting around 2002.” It’s sadly true. One strawberry picker in California got a $720,000 loan despite his annual income of $14,000. The system morphed into capitalism without capital.

Technically, the bubble wasn’t in housing, it was in credit. The numbers are staggering. At one point, close to half of all the new jobs created were tied to real estate. Between 2003 and 2006, 75% of GDP growth was solely due to mortgage equity withdrawals. From December 2006 to December 2007, the notional amounts outstanding of credit fault swaps more than quadrupled from $14 trillion to $58 trillion.

Bailout Nation is quick-paced and Ritholtz sprinkles the test with illuminating charts and eye-catching statistics (i.e., Bear Stearns’ liquidity pool dropped by 90% in three days). He wryly notes that it you want to play the bailout game, make sure you do it first and do it big. Ritholtz also has a novel theory for the explosion in executive compensation on Wall Street, but I won’t spoil it for you here.

Characteristicly, Ritholtz isn’t shy about naming names. In Chapter 19, he lists the folks most at fault for the credit mess. It won’t surprise you that Greenspan tops the list. Personally, I think the "savings glut" deserves more attention. Chapter 20 is an interesting take-down of the phony causes of our troubles, like naked shorting and the Community Reinvestment Act.

I should add that Ritholtz is an equal opportunity critic. Many liberals won’t be pleased by his criticisms of bailouts and his dismal of systemic risk (or more accurately, the threat of systemic risk). Parts of the book could have been written by Milton Friedman. Ritholtz even repeats Friedman’s famous mantra, “there is no free lunch.” Plus, any book with a chapter titled, “The Virtues of Foreclosure,” isn’t about to win a Bleeding Heart of the Year award.

Conservative will certainly take issue with Ritholtz’s criticisms of financial deregulation and his call for therapeutic nationalization. What I find most disturbing is how much of the government’s behavior was simply arbitrary. Ritholtz makes it clear: They were just making it up as they went along.

Ritholtz favors temporarily nationalizing insolvent banks. Mind you, this ain’t exactly Pol Pot. Ritholtz merely wants bad banks taken out, cleaned up and restored to health. He believes it’s the solution that will cause the least damage (“real capitalists nationalize”). I think he’s on sound footing here. It’s odd that we can watch Citigroup fall from $57 to 97 cents, yet bringing it that last bit to $0 is somehow unacceptable. Ritholtz concludes, "Real capitalists nationalize; faux capitalists look for the free lunch."

At the beginning of The Strange Death of Liberal England, Dangerfield wrote of the Liberal’s final triumph, “From that victory they never recovered.” Let’s hope American capitalism doesn’t share their fate.

Posted by edelfenbein at May 17, 2009 2:54 PM

Who’s to Blame for the Collapse of the Financial Markets?

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Who’s to Blame for the Collapse of the Financial Markets?

By editor|May 17, 2009|10:27 PM
Source:http://wallstreetpit.com/4350-whos-to-blame-for-the-collapse-of-the-financial-markets

British newspaper Sunday Times has published a very interesting article on the international insurer AIG. The piece elaborates extensively about the firm’s underwriting methods and creation of the multi-sector CDS portfolio - which seem to have had no correlation between fees paid and the risk assumed. According to Christopher Whalen, managing director of Institutional Risk Analytics, “AIG’s foray into CDS was really the grand finale….Towards the end, it looked much like a Ponzi scheme, yet the Obama administration still thinks of AIG as a real company that simply took excessive risks. In other words, there was never a chance AIG would honor its contracts: its income was nowhere near enough to cover the payouts.”

The article also touches on the firm’s furore over bonuses - calling it “a convenient distraction from the real causes of the crisis.”

The article also argues that while until now the economic crisis has been seen as a giant intellectual errors, the dishonesty in the collapse of the global economy and the financial markets is on a scale that is almost too vast to comprehend.”There are conflicts of interest in American finance and politics that make our own, dear House of Lords look like beginners” the article said. “There are frauds so large, and so long-standing, that it can be hard to see them for what they are. And all these things were allowed to thrive in an intellectual atmosphere that tolerated no dissent.”

From Sunday Times: “Why did no-one see it coming?” asked Queen [Elisabeth] last November, on a visit to the London School of Economics. Well, they did, ma’am. Charles Bowsher, head of the US government’s General Accounting Office, testified as long ago as 1994 that “the sudden failure or abrupt withdrawal from trading” of large dealers in derivatives “could cause liquidity problems in the markets and could also pose risks to others, including… the financial system as a whole”. It took another 13 years, but that is exactly what happened.

One regulator tried to act on Bowsher’s warning, but she was silenced. Brooksley Born, who monitored the futures markets, tried to extend her remit to unregulated derivatives. Alan Greenspan and Robert Rubin, the then Treasury secretary, persuaded Congress to freeze her already limited power, forcing her departure. Rubin had come into government from Goldman Sachs; when he left he went back to banking, and pushed for Citigroup to step up its trading of risky, mortgage-related investments. For his advice, he earned over $126m (£84m) and then, as Citigroup collapsed, became an adviser to Barack Obama. After Greenspan stepped down from the US central bank in 2006, he became a consultant to Pimco, the world’s biggest bond fund, where his insights have been praised by his boss. “He’s made and saved billions of dollars for Pimco already,” said Bill Gross last year. Greenspan is also an adviser to Paulson & Co, a hedge-fund group that has made billions from the collapse in American housing.

The lightness of touch reached a level that defies belief. America has an Office of Risk Assessment, set up in 2004 to co-ordinate risk management for the main regulator, the Securities and Exchange Commission (SEC). Jonathan Sokobin, its director, says it is charged with “understanding how financial markets are changing, to identify potential and existing risks at regulated and unregulated entities”…. By early 2008, this office was reduced to a staff of one…We had gotten down to just one person at the SEC responsible for identifying the risk at all the institutions. The $596-trillion market in unregulated derivatives, including $58 trillion in credit-default swaps, was being watched by one person. That’s when he wasn’t looking at the rest of the corporate world, of course.
…
“From 1973 to 1985,” says Simon Johnson, a former chief economist at the IMF, “the financial sector never earned more than 16% of [US] corporate profits. In the 1990s, it oscillated between 21% and 30%, higher than it had ever been in the post-war period. This decade, it reached 41%.” The whole point of financial companies is to allocate your savings to those who can use the money best. If they are taking 41% of the profit in an economy, something is out of balance. These figures reveal an enormous transfer of wealth.

When the world steps out of a sixty-year old referential framework

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GEAB N°35 is available! Global systemic crisis: June 2009 - When the world steps out of a sixty-year old referential framework


- Public announcement GEAB N°35 (May 16, 2009) -
Source:http://www.leap2020.eu/GEAB-N-35-



The financial surrealism which has been at the heart of stock market trends, financial indicators and political commentaries in the past two months, is in fact the swan song of the referential framework within which the world has lived since 1945.

Just as in January 2007, the 11th edition of the GEAB described that the turn of the year 2006/07 was wrapped in a « statistical fog » typical of an entry into recession and designed to raise doubts among passengers that the Titanic was really sinking (1), our team today believes that the end of Spring 2009is characterized by the world’s final stepping out of the referential framework used for sixty years by global economic, financial and political players in making their decisions, in particular of its “simplified” version massively used since the fall of the communist bloc in 1989 (when the referential framework became exclusively US-centric). In practical terms, this means that the indicators that everyone is accustomed to use for investment decisions, profitability, location, partnership, etc ... have become obsolete and that it is now necessary to find new relevant indicators to avoid making disastrous decisions.

This process of obsolescence has increased dramatically over the past few months under pressure from two trends:

. first, the desperate attempts to rescue the global financial system, particularly the American and British systems, have de facto "broken navigational instruments" as a result of all the manipulation exerted by financial institutions themselves and by concerned governments and central banks. Among those panic-stricken and panic-striking indicators, stock markets are a perfect case as we shall see in further detail in this issue of the GEAB. Meanwhile, the two charts below brilliantly illustrate how these desperate efforts failed to prevent the world’s bank ranking from experiencing a major seism (it is mostly in 2007 that the end of the American-British domination in this ranking was triggered).

. secondly, astronomical amounts of liquidity injected in one year into the global financial system, particularly in the U.S. financial system, led all financial and political players to a total loss of touch with reality. Indeed, at this stage, they all seem to suffer from a syndrome of diver’s nitrogen narcosis – impairing those affected and leading them to dive deeper instead of surfacing. Financial nitrogen narcosis has the same effects than its aquatic counterpart.

Destroyed or perverted sensors, loss of orientation among political and financial leaders, these are the two key factors that accelerate the international system’s stepping out of the referential framework of the past few decades.

Of course, it is a feature of any systemic crisis and easy to establish that, in the international system we are used to, a growing number of events or trends have started popping out of this century-old framework, demonstrating how this crisis is of a kind unique in modern history. The only way to measure the magnitude of the changes under way is to step back several centuries. Examining statistical data gathered over the last few decades only enables one to see the details of this global systemic crisis; not the overall view.

Here are three examples showing that we live in a time of change that occurs only once every two or three centuries:

1. In 2009, the Bank of England official interest rate has reached its lowest level (0.5 percent) since the creation of this venerable institution, i.e. since 1694 (in 315 years).



Bank of England official interest rate since its creation in 1694 - Source: Bank of England, 05/2009
2. In 2008, the Caisse des Dépôts et Consignations, the French government’s financial arm since 1816 under all France’s successive regimes (kingdom, empire, republic…), experienced its first yearly loss ever (in 193 years) (2).

3. In April 2009, China became Brazil’s leading trade partner, an event which has always announced major changes in global leadership. This is only the second time that this has happened since the UK put an end to three centuries of Portuguese hegemony two hundred years ago. The US then supplanted UK as Brazil’s leading trade partner at the beginning of the 1930s (3).

It is not worth reviewing the many specifically US trends popping out of the national referential framework compared to the past century (there is no relevant referential framework older than that in the US): loss in value of the Dollar, public deficits, cumulated public debt, cumulated trade deficits, real estate market collapse, losses of financial institutions… (4)

But of course, in the country at the heart of the global systemic crisis, examples of this kind are numerous and they have already been widely discussed in the various issues of the GEAB since 2006. In fact, it is the number of countries and areas concerned, which is symptomatic of the world’s stepping out of the current referential framework. If there was only one country or one sector affected, it would simply indicate that this country/sector is going through an unusual time; but today, many countries, at the heart of the international system, and a multitude of economic and financial sectors are being simultaneously affected by this move away from a “century-old road”.



Stock market trends – adjusted for inflation – during the last four major economic crises (grey: 1929, red: 1973, green: 2000, and blue: current crisis) - Source: Dshort/Commerzbank, 17/04/2009
Thus, to conclude this historical perspective, we want to emphasize that the stepping out of the century-old reference system is graphically visible in the form of a curve simply popping out of the frame which allowed ongoing trends and values to be represented for centuries. This popping out of traditional referential frameworks is speeding up, affecting increasing numbers of sectors and countries, enhancing the loss of meaning of indicators used daily or monthly by stock markets, governments, or official sources of statistics, and accelerating the widespread awareness that "the usual indicators" can no longer give any insight, or even represent the current world developments. The world will thus reach summer 2009 without any reliable references available.

Of course, everyone is free to think that a few points’ monthly variation of a particular economic or financial indicator, itself largely affected by the multiple interventions of public authorities and banks, carries much more value on the evolution of the current crisis than those stepping out of century-old referential frameworks. Everyone is also free to believe that those who anticipated neither the crisis nor its intensity are now in a position to know the precise date when it will end.

Our team advises them to go see (or see again) the movie Matrix (5) and to think about the consequences of manipulating the sensors and indicators of one’s perception of given environment. Indeed, as we will examine in detail in our special summer 2009 GEAB (N°36), the coming months could be entitled « Crisis Reloaded » (6).

In this 35th issue of the GEAB, we also express our advice on which indicators, in this period of transition between two referential frameworks, are able to provide dependable information on the evolution of the crisis and the economic and financial environment.

The two other major themes addressed in this May 2009 issue of the GEAB are, first, the programmed failure of the two major economic stimulus plans: namely the Chinese and American plans, and, secondly, the United Kingdom’s appeal to the IMF for financial assistance by the end of summer 2009.

In terms of recommendations, in this issue, our team anticipates the evolution of the worlds’ largest real estate and treasuries markets.


-----------
Notes:

(1) At that time, our team added « Just like always when change occurs, the passage by zero is characterized by a «fog of statistics» where indicators point in opposite directions and measurements provide contradictory results, with margins of error sometimes wider than the measurement itself. Regarding our planet in 2007, the on-going wreck is that of the US, that LEAP/E2020 has decided to call the « Very Great Depression », firstly because the « Great Depression » already refers to the 1929 crisis and the years after; and secondly because, according to our researchers, the nature and scope of the upcoming events are very different ». Source: GEAB N°11, 01/15/2007

(2) Source: France24, 04/16/2009

(3) Source: TheLatinAmericanist, 05/06/2009

(4) Political leaders and experts insist on comparing the current crisis to the 1929 crisis, as if the latter were a binding reference. However, in the US in particular, current trends in many fields have moved beyond the events which characterized the « Great Depression ». LEAP/E2020 already reminded in GEAB N°31 that relevant references were to be found in the 1873-1896 global crisis, i.e. more than a century back.

(5) In the Matrix series of movies, reality perceived by humans is created by computers. They think they live a comfortable life when in fact they live in squalor, but all their senses (sight, hearing, taste, touch, smell) are manipulated.

(6)The title of the second in this series of movies: « Matrix reloaded ».

OTHER VOICES: Wall Street greed brought down Detroit

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8:00 pm, May 17, 2009


OTHER VOICES: Wall Street greed brought down Detroit

Source:http://www.crainsdetroit.com/article/20090517/FREE/305179964/1079


By John Mogk

Detroit has been vanquished by Wall Street greed. The auto companies might have better designed models for market needs, but cars are not selling principally because credit has been frozen, consumer wealth has been obliterated and a large number of jobs were lost nationwide after the banking industry collapse.

The crisis was caused by faulty unregulated financial schemes concocted by a few greedy Wall Street financial houses.

After Sept. 11, the U.S. Treasury flooded the economy with federal funds to dramatically increase national spending to avoid a recession. Enormous sums became available to finance home purchases. Banks lowered credit standards to bring tens of thousands of new subprime buyers into the housing market. These actions greatly increased nationwide housing demand, elevated prices to unsustainable levels and eventually caused the collapse of the housing market, the banking industry, Detroit's auto industry and its local economy.

The working poor were aggressively solicited to buy homes with little or nothing down. Lenders salivated over the fees and interest subprime buyers were required to pay because they were poor credit risks. Those fees often left the subprime buyer little or no equity at closing.

The real estate industry sold the view that housing values would continue to increase, allowing borrowers who defaulted to refinance or sell their homes at a profit. Any refinancing would result in even more exorbitant fees.

At first, Wall Street was left out of collecting large subprime mortgage fees, but beginning in 2002, a handful of firms began to sweep up prime and subprime mortgages and bundle them into unregulated mortgage-backed securities, known as “derivatives.” Respected rating agencies gave these risky derivatives their highest rating and they were sold around the world.

Selling derivatives generated large fees for financial firms and injected a large amount of additional capital into the mortgage market. Some derivative investors would purchase them only with protection against potential defaults by mortgage borrowers. So for yet another fee, a select group of financial and insurance firms, like AIG, issued “credit default swaps” that allowed investors to collect on bets that their derivatives would not be repaid.

One purpose of the Sept. 11 attacks was reportedly to destroy the American economy. The cruel irony is that al-Qaeda received unexpected help from a small group of greedy Wall Street leaders and firms.

With trillions of taxpayer dollars bailing out the banking industry, Americans must be assured that never again will Wall Street be allowed to manipulate American capitalism to the destruction of our working-class families.

John Mogk is a professor of law at Wayne State University.

General Motors Leaves U.S. Workers by the Wayside as it Accelerates Operations in China

General Motors Leaves U.S. Workers by the Wayside as it Accelerates Operations in China

By Jason SimpkinsManaging
EditorMoney Morning
Source:http://www.moneymorning.com/2009/05/18/general-motors-china/

For decades, General Motors Corp. (NYSE: GM) was an icon of American industry. But over the past decade its sales in China have steadily increased, while dwindling sales at home have turned the company into a relic.

Now facing bankruptcy, GM has an opportunity to shift its operations to China, its fastest growing and most profitable market. The company is already attempting to move its manufacturing operations to the Asian powerhouse, and that has given rise to speculation that it will move its headquarters as well.

Of course, if GM – which has already received $15.4 in government loans – were to pick up stakes, the political fallout would be epic. What could be more “un-American” than a 101 year-old American automotive company that’s being propped up by taxpayer dollars moving to a communist nation?
But the reality is that American consumers aren’t buying GM vehicles and Chinese consumers are. That means if the company is going to remain viable, China, not America, is GM’s land of opportunity.

GM CEO: Bankruptcy ‘Probable’
GM still has two weeks before the government imposed deadline to demonstrate sustainable viability expires on June 1. But even GM Chief Executive Officer Fritz Henderson has admitted that bankruptcy is “probable” at this point. And in the minds of analysts, it’s almost certain.
“[Bankruptcy] is looking like a real high probability,” Brett D. Hoselton, an analyst with KeyBanc Captial Markets, told the New York Times. “Chrysler is the best indicator at this point of where we’re heading with GM.”

GM reported a first-quarter net loss of $5.98 billion, compared to a loss of $3.3 billion a year earlier. Revenue fell to $22.4 billion, a 47% drop from 2008. The company burned through $10.2 billion in cash in just three months. GM has now lost $88 billion since 2004.
Last year, GM lost its crown as the world’s largest carmaker to Japan’s Toyota Motor Corp. (NYSE ADR: TM). And a company that 40 years ago produced one out of every two vehicles sold in the United States, has seen its U.S. market share slide to just 19%.
On Friday, GM notified 1,100 of its 6,000 U.S. dealerships that it is terminating their contracts, and it plans to cut its network down to 3,600 dealers by next year.

“This company is sick,” Charles Ballard, an economics professor at Michigan State University told Michigan NBC television affiliate WILX 10, “they’re likely going to file for bankruptcy.”
Investors are equally pessimistic. GM stock has plunged 70% since the Obama administration announced it would give the company 60 days to restructure outside of bankruptcy court. GM has lost 94% of its equity value in the past year.
Is China the Right Cure for GM?

So if GM is sick, what then is the medicine? Many analysts believe it’s a healthy dose of China.
While its U.S. sales have plunged, sales in China continue to grow exponentially. In fact, GM sold more vehicles in Asia in the first quarter than it did in the United States. Only 26% of GM’s first-quarter sales came from the U.S., a 36% decline from a year ago.
And while global car sales continue to plunge, auto sales in China are expected to grow between 8% and 9% this year. China actually overtook the United States as the world’s largest auto market for the first time in history in the first quarter.
And unlike the United States, there is actually a strong demand for GM model cars. In China, where the company is neck and neck with Volkswagen for the market-share lead, GM set a monthly sales record of 151,084 vehicles in April. That’s a 50% increase from its April 2008 results.

“Within 10 years, this will be our largest market in the world,” Kevin Wale, president of GM China, told TIME magazine.
GM has been so successful in China it is reportedly negotiating plans with U.S. lawmakers that will send the carmaker’s production overseas, the U.K.’s Telegraph reported.
GM will start shipping cars to the United States from Shanghai in 2011. The company plans to export slightly more than 17,000 vehicles in the first year before ramping up to 50,000 by 2014.
Backlash from GM’s China Plan
While many carmakers import components from China to save on labor costs, GM would be the first company to import whole cars from the Mainland.
Of course the plan doesn’t sit well with unions.

“GM should not be taking taxpayers’ money simply to finance the outsourcing of jobs to other countries,” Alan Reuther, a Washington lobbyist for the United Auto Workers (UAW) union wrote in a letter to U.S. lawmakers.

Indeed, the UAW and others argue that the whole point of bailing out the U.S. auto industry was to save American jobs and help prop up the sagging economy.
Two weeks ago, GM CEO Henderson said his company would cut an additional 21,000 factory jobs, close 13 plants, eliminate about 2,600 dealerships and close its Pontiac division. GM aims to shed 23,000 jobs – 38% of its workforce – by 2011.
But the company expects to open a new factory in mainland China within the next few years and continues to build upon its 21,000 Chinese employees.
“I think that’s wrong,” Keith Pokrefky, a Michigan autoworker, told NBC’s WILX. “I think that’s wrong for America. I think it’s wrong for American jobs. It’s un-American.”
On the other hand, GM argues that it is only logical to produce cars where they’re going to be sold.

“GM’s philosophy has always been to build where we sell, and we continue to believe that is the best strategy for long-term success, both from a product development and business planning standpoint,” GM’s China office said in a written statement to the Associated Press.
Plus, GM already imports cars from other countries, just not China. The Chevrolet Aveo and Pontiac G3 come from South Korea. The Pontiac G8 comes from Australia. The Saturn Astra comes from Belgium, and the Vue from Mexico.

Harvard Business School professor Clayton Christenson – who was also a consultant to Richard Wagoner, the architect of GM’s China strategy – told TIME that inexpensive, Chinese-made Chevys, exported to the United States could be the “disruptive” force the company needs to resuscitate North American sales.
“It’s exactly the right thing for them to do,” Christenson said.
While China keeps its data on labor costs under lock and key, analysts estimate that wages and benefit payments per factory worker are less than a tenth of what they are in North America, TIME reported.

MSU professor Charles Ballard says that while the notion of outsourcing more jobs to China may not be pleasing, it is also in GM’s best interest.
“I think everyone needs to keep in mind that if this company fails, that’s the worst case scenario," Ballard said. "It would be really good for the people of Michigan and for Lansing for GM to become a viable company. Right now, it’s not."

And perhaps that’s the root of the issue. There was a time when what was good for GM was good for America. But somewhere along the line, the interests of the two diverged. Now, they’re too far entangled for there to be an amicable solution to this problem, and the Obama administration is left with a political powder keg.

The government stepped in to fire former GM chief Richard Wagoner, but it doesn’t want to be too heavy-handed in its treatment of the private sector. It has already spent months sidestepping questions about whether or not it would nationalize U.S. banks.
“We didn’t think in America that the President could fire the CEO of a private company,” one Chinese executive told TIME. “For us Chinese it was very confusing.”

But if the Obama administration lets GM move ahead with its plans, it must confront the unpleasant reality that it is subsidizing the outsourcing of U.S. jobs with taxpayer money.
“Production location is a corporate decision, but when it’s on the taxpayer dime, there are different sensitivities, so the notion of billions for a rescue package and offshore production, I think, could be politically combustible," Harley Shaiken, a professor at the University of California at Berkley who specializes in labor issues, told the AP.

Cuomo discusses Wall Street culpability, responsibility

Andrew Cuomo: Culpability and Comeuppance on Wall Street

Maria Bartiromo talks to New York Attorney General Andrew Cuomo

By Maria Bartiromo

05/06/2009

As the global financial crisis drags on, there is increasing talk of culpability. And asking the hard questions about Wall Street accountability and the bailout is New York Attorney General Andrew Cuomo. His office has investigated the bonuses at Merrill Lynch (BAC) that led to the ouster of John Thain. And in a letter to Congress on Apr. 23, Cuomo laid out evidence that Bank of America (BAC) CEO Ken Lewis was pressured by former Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke to complete the purchase of Merrill and didn't fully disclose its condition to BofA shareholders. What that letter revealed was partly behind the ouster of Lewis as chairman on Apr. 29 (he remains CEO). Beyond that, Cuomo's SWAT team is still probing the New York pay-to-play scandal in which middlemen are said to have collected multimillion-dollar fees to steer state pension investments to certain firms. Among the private-equity firms allegedly paying to play were Carlyle Group and Quadrangle Group, where Steve Rattner was a principal before President Obama appointed him car czar. Although Cuomo is a Democrat with deep connections, the AG is aggressively going after members of his own party. In addition, Cuomo has filed civil fraud charges against Ezra Merkin, whose Gabriel Capital controlled hedge funds that allegedly fed into Bernard Madoff's Ponzi scheme. (Merkin's lawyer has said his client will fight those charges.) All of that has raised Cuomo's profile, and there's chatter that he will challenge David Paterson for the Democratic gubernatorial nomination in 2010. I talked with Cuomo on Apr. 29 by phone and e-mail.

MARIA BARTIROMO

What's the most important investigation you're conducting right now?

ANDREW CUOMO

I don't want to characterize any one investigation as most important. I can say that we currently have two main areas that are dominating our agenda: corporate fraud and government corruption. The bulk of my time is being spent on our pension investigations relating to pay-to-play allegations at the New York State common retirement fund and on the Wall Street cases we are pursuing.

Recent stories in the Financial Times and elsewhere suggest that your so-called crusade against Wall Street is in part politically motivated, that it will help you become governor. Are politics involved?
Of course not. Our cases are based on the facts and the law and nothing else. I don't think anyone would argue with the notion that there have been serious abuses on Wall Street. All we are doing is following the facts in our investigations.

Last week you revealed testimony that suggests Paulson and Bernanke pressured Lewis to complete the acquisition of Merrill even though it might not have been in the best interest of shareholders. Why reveal this?
That is an ongoing investigation, so I cannot comment on it at length. As we said in the letter [to Congress and regulators], our investigation involves the conduct of federal agencies and high-ranking federal officials charged with managing the TARP program, and we therefore thought it was important to inform the relevant federal bodies of our findings to date.

The letter also said the SEC was excluded from the talks with BofA. Why was the SEC excluded, and was Tim Geithner, then New York Fed president and now Treasury Secretary, included in those talks? How come no mention of Geithner exerting pressure?
Our letter lays out what we have found thus far.

Some might say that even if Paulson and Bernanke did pressure Lewis, they were taking extraordinary measures to save the financial system at a moment of crisis. What is gained by Monday-morning quarterbacking that move and making it seem nefarious?
We did not make those facts seem nefarious in any way. Certainly we recognize that all parties were operating in unprecedented times and somewhat uncharted waters.

Do you worry that politicians and the media have been fanning the flames of class warfare? The bonuses outrage and "business is bad" theory seem to be obscuring other perhaps more important issues, like fixing the financial system and getting credit moving again.
That is a fair point. People are rightfully upset about Wall Street abuses and excess. And we need to address those issues. But we also need to be very careful and not let that anger become counterproductive and a distraction. I also think Wall Street should be taking a long hard look at the philosophy of incentive compensation. I don't think bonuses are always bad. The question for Wall Street is, can it design incentives that promote the long-term health of the firms as opposed to just hitting short-term numbers?

There are stories saying the pay-to-play scandal may be expanding beyond New York State, and Democrats elsewhere may be involved. Are you feeling any heat from within the Democratic Party to back off?
No. To be clear ... no one is above the law.

One firm mentioned in the scandal is the Carlyle Group. An article in The New York Times last week asked why Carlyle, "one of the biggest and best-performing private equity firms in the world," would need to use a placement agent to pull in investments. Is that a question you have asked?
I cannot comment on Carlyle specifically. I will say that my office is working on a code of conduct that would ban the use of third-party placement agents with respect to state and city pension fund business. Carlyle has agreed to accept such a ban, and that is a positive step in my opinion.

Do you expect to bring criminal charges against Ezra Merkin?
I can't comment on an ongoing investigation.

Will you challenge David Paterson for the Democratic nomination for governor?
I love being Attorney General, and...I am planning to run for reelection as Attorney General next year.

Maria Bartiromo is the anchor of CNBC's Closing Bell.

Reserve Fund founder charged with fraud

Reserve Fund founder charged with fraud

By Aaron Elstein

Published: May 5, 2009 - 3:27 pm

The Securities and Exchange Commission filed fraud charges Tuesday against the father and son team who ran Reserve Management Co., the money-market fund company that rocked the financial world last September when it “broke the buck” on its flagship fund.

The SEC charges represent the latest in a series of heavy blows to Reserve, a Manhattan-based firm that pioneered money-market funds in the early 1970s and invested some $125 billion of clients’ money in low-yielding, ultra-safe assets, such as certificates of deposit or short-term government and corporate debt. Founder and Chairman Bruce Bent, 71, liked to say the point of money-market funds was “to provide safety of principal, liquidity and a reasonable rate of return all the while boring investors into a sound sleep.”

Mr. Bent’s decades of work came undone last September, when his firm revealed that the net asset value of its $62 billion Primary Fund had fallen below the sacrosanct $1 a share, the result of $785 million of investments in Lehman Brothers turning worthless after that investment bank filed for bankruptcy. In other words, Reserve’s Primary Fund “broke the buck”—only the second time such a thing had ever happened to a money-market fund.

As Mr. Bent and his son, Reserve President Bruce Bent II, grasped the depth of disaster they faced, the SEC says they failed to provide key material information to customers, board members and ratings agencies after Lehman collapsed. Reserve and the Bents misrepresented that they would provide the support necessary to protect the $1-per-share asset value of their fund when in fact there was no such intention, the SEC contends. The SEC also charges that Reserve officials significantly understated how many investors were racing to yank their money out after the Lehman bankruptcy hit.

“The fund’s managers turned a blind eye to investors and the reality of the situation at hand,” SEC Chairman Mary Schapiro said in a statement.

A Reserve spokeswoman didn’t immediately respond to a request for comment.

Reserve froze withdrawals after breaking the buck and the fund is now being liquidated. It has set aside $3.5 billion of client money to cover legal expenses anticipated due to suits brought by angry investors.

Reserve began to drift into riskier investments, such as short-term debt issued by Lehman and Merrill Lynch, in 2007, the SEC says. Those investments generated higher returns, helping Reserve attract more customers—and boost its management fees. Unlike other money-market outfits owned by larger institutions, Reserve lacked the resources to shore up its fund when large numbers of investors demanded their money back at once.

The SEC charges are similar to allegations made in January by Massachusetts regulators. According to court documents in the Massachusetts case, Reserve officials sought a federal bailout hours before they disclosed on Sept. 16 that the Primary fund had broken the buck. Mr. Bent II phoned Timothy Geithner, then president of the Federal Reserve Bank of New York, to beg for urgent assistance. The New York Fed declined.

Three days later on Sept. 19, the U.S. Treasury said it would provide $50 billion to offset any losses incurred by investors in money-market funds.

SEC charges money market fund with fraud

Operators of Reserve Primary Fund charged with misleading investors about its vulnerability in wake of Lehman Brothers collapse.

By Tami Luhby, CNNMoney.com senior writer

Last Updated: May 5, 2009: 6:08 PM ET

NEW YORK (CNNMoney.com) -- The Securities and Exchange Commission has filed fraud charges against the operators of the Reserve Primary Fund for failing to provide important information to investors and trustees about the fund's exposure to Lehman Brothers.

By bringing the case, the agency is trying to get the company to release the $3.5 billion it is withholding from shareholders until all lawsuits against the company are resolved.

The money market fund "broke the buck" on Sept. 16, the day after Lehman Brothers filed for bankruptcy, meaning its net asset value fell below $1 a share. Investors seek out money market funds as conservative investments because they are designed to maintain their $1 per share value. Companies also rely on them to purchase short-term corporate debt.

The Primary Fund, however, held $785 million in Lehman-issued securities, which lost most of their worth in the bankruptcy, the SEC said. This dragged down the fund's net asset value.

The agency says that the Reserve Management Company Inc., its chairman Bruce Bent Sr., vice chairman and president Bruce Bent II and Resrv Partners Inc. misled investors and "significantly understated" the volume of redemption requests. They also failed to provide trustees with accurate information about the value of the Lehman securities.

Reserve also said it would provide the money needed to maintain the fund's share value when it "had no such intention," according to regulators.

"Fund managers have serious obligations to keep their trustees and investors informed in both good times and bad, and cannot choose to reveal only favorable facts," said James Clarkson, acting director of the SEC's New York regional office.

The company said in a statement that it intends to defend itself vigorously.

"Since we created the money fund in 1970 we have operated and grown our business by putting our shareholders' interests first," said Bruce Bent Sr. "The Lehman Brothers Bankruptcy filing created an unforeseeable and out-of-control condition for many parties and the results were serious...We remain confident that we acted in the best interest of our shareholders."

There are at least 29 different lawsuits pending against the company, according to the SEC. The agency hopes to bring all claimants together in this case and have it settled together.

The Primary Fund is currently being liquidated. Last month, the company said about $46.1 billion, or approximately 90% of fund assets as of Sept. 15, 2008, has been returned to investors. Approximately $4.5 billion remains in the fund, which once had a value of $60 billion.

The fund's independent trustees, who oversee its operations, said in a statement that they would work with the agency.

"The trustees will continue to fully cooperate with the Securities and Exchange Commission to expedite the distribution of the remaining assets to shareholders and to ensure that all decisions are made in the shareholders' best interest," the trustees said.

The meltdown

The fund's troubles added to the turmoil that roiled Wall Street that week. Not only did Lehman Brothers collapse on Sept. 15, but the federal government stepped in to save AIG (AIG, Fortune 500) with an $85 billion injection and then announced a $700 billion rescue of the American financial industry.

Executives at Reserve, which pioneered the money market fund, hid the fact that Lehman Brother's bankruptcy had pulled the Primary Fund's net asset value below $1 that day, according to the SEC. Already spooked by Wall Street's gyrations, investors rushed to pull out $24.6 billion from the fund, but Reserve only had the money to cover $10.7 billion.

It wasn't until 4 p.m. the next day that the company announced that the fund's value was 97 cents per share.

The Primary Fund's problems led to a run on money market funds in general, forcing the federal government to step in by week's end. The Treasury said it would insure up to $50 billion in money-market fund investments at financial companies that pay a fee to participate in the program. The initiative guarantees that the funds' value does not fall below the standard $1 a share. At the same time, the Fed took steps to stabilize the debt products in which money-market funds invest.

The exodus ended about two weeks later, though investors shifted to more conservative money market funds that invest in government debt, rather than the short-term corporate debt that Primary Fund had in its portfolio. Assets of government money market funds increased in 2008 by more than $700 billion or 90%, while assets of prime funds, which invest in corporate commercial paper, declined by $55 billion or 3%, according to the SEC.

Still, the crisis has led the SEC to reconsider its regulation of the industry.

"In light of the events of last fall, it is essential that the SEC comprehensively re-examine the money market fund regulatory regime, said SEC Chairman Mary Schapiro in a speech to mutual fund directors Monday. "We should do so with a view toward enabling money market funds to afford investors the relatively safe and liquid investment that they expect from an SEC-registered money market fund."

First Published: May 5, 2009: 3:35 PM ET