Is the Fed Helping the Big Banks to Cook Their Books?
by Mike Whitney
counterpunch.org (April 12 2010)
On Friday, the Wall Street Journal revealed details of a cover up by the
nation's largest banks that have been engaged in potentially-criminal
accounting activities to conceal the amount of debt on their balance
sheets. The SEC has been notified of the allegations and has launched a
probe to determine whether further action is needed. Among the banks
implicated, are Goldman Sachs, JP Morgan, Bank of America, and Citigroup.
According to the Wall Street Journal:
"Major banks have masked their risk levels in the past five quarters by
temporarily lowering their debt just before reporting it to the public,
according to data from the Federal Reserve Bank of New York. A group of
eighteen banks ... understated the debt levels used to fund securities
trades by lowering them an average of 42 per cent at the end of each of
the past five quarterly periods, the data show. The banks, which publicly
release debt data each quarter, then boosted the debt levels in the middle
of successive quarters." {1}
The article has set off alarm bells on Wall Street because of the
similarity between Lehman Brothers. "repo 105" transactions and these new
signs of obfuscation by other large banks. "Repo 105" is an accounting
device that Lehman used to hide $50 billion in debt off its balance sheet
in an attempt to mislead investors about the true state of its financial
health. The Wall Street Journal story suggests that the practice may be
more widespread than originally thought. The "repo 105" scandal is further
complicated by suspicions that Lehman was assisted in its effort by the
Federal Reserve Bank of New York which, at the time, was headed by the
present Secretary of the Treasury, Timothy Geithner. Here is a short recap
of what transpired between the Geithner's New York Fed and Lehman
according to ex-regulator William Black and former New York governor Eliot
Spitzer from an article on Huffington Post:
"The Federal Reserve Bank of New York [that is, New York Fed] knew that
Lehman was engaged in smoke and mirrors designed to overstate its
liquidity and, therefore, was unwilling to lend as much money to Lehman.
The Federal Reserve Bank of New York did not, however, inform the SEC, the
public, or the Office of Thrift Supervision (which regulated an S&L that
Lehman owned) of what should have been viewed by all as ongoing
misrepresentations.
"The Fed's behavior made it clear that officials didn't believe they
needed to do more with this information. The Federal Reserve Bank of New
York remained willing to lend to an institution with misleading accounting
and neither remedied the accounting nor notified other regulators who may
have had the opportunity to do so ... We now know from Valukas and from
former Treasury Secretary Paulson that the Treasury and the Fed knew that
Lehman was massively overstating its on-book asset values." {2}
So the question is whether the New York Fed helped other banks conceal
important financial information from investors, too. And - if that's the
case - then how can the public be confident that the biggest banks in the
country are truly solvent?
According to the Wall Street Journal: "An official at the Federal Reserve
Board noted that the Fed continuously monitors asset levels at the large
bank-holding companies, but the financing activities captured in the New
York Fed's data fall under the purview of the Securities and Exchange
Commission, which regulates brokerage firms".
The Fed's explanation is a tacit denial of its responsibility to regulate
or report suspicious accounting practices to the appropriate agencies. The
response is not just "buck passing", but also suggests collusion. So far,
there's no clear link between the Fed and the shady bookeeping at the
banks. But many now believe that - in the case of Lehman - the Fed acted
as an "enabler", either by serving as a counterparty in repo 105 deals or
by looking the other way while the transactions were executed. Either
way, the situation demands an independent investigation.
To put the Wall Street Journal article in context, it helps to review the
details of the Lehman case. Here's an excerpt from an article by Eric Dash
in the New York Times:
"Newly released report on the collapse of Lehman Brothers ... sheds
surprising new light on Lehman's dealings with the New York Fed. Lehman
engaged in a series of transactions with the New York Fed that were
similar to the ones that drew criticism from the bankruptcy court examiner
who investigated its collapse ...
"The report by Mr Valukas nonetheless raises fresh questions about the
role of the New York Fed in supporting Lehman during the frantic months
leading up to its collapse. It suggests that Lehman executives believed
the Fed would be able to help the bank avert disaster and provide it with
a business opportunity ...
"Lehman, desperate for financing, seized its chance. It packaged billions
of dollars of troubled corporate loans into an investment called Freedom
CLO. Then, in a series of transactions, it shifted Freedom back and forth
to the New York Fed, in exchange for cash. Those moves helped make Lehman
look healthier.
"Essentially, Lehman was able to temporarily warehouse illiquid
investments that were worrying its investors at the New York Fed in return
for cash. The Fed created this facility immediately after the near
collapse of Bear Stearns. Some suspect that other banks engaged in similar
maneuvers." {3}
So why did "Lehman executives believe the Fed would be able to help the
bank avert disaster and provide it with a business opportunity"? Most
likely, because that had been standard operating procedure. The Fed was
merely acting as it had before. Lehman used the repo market to amplify
leverage to maximize profits (the same as the other banks), and when they
couldn't find a counterparty to accept their garbage collateral, the Fed
would step in and provide short-term loans and "warehouse" their toxic
assets. In essence, the Fed was helping to defraud investors who
believed the banks reports were accurate. Here's Yves Smith at Naked
Capitalism who sums it up perfectly:
"The New York Fed, and thus Timothy Geithner, were at a minimum massively
derelict in the performance of their duties, and may well be culpable in
aiding and abetting Lehman in accounting fraud and Sarbox violations ...
at a minimum, the New York Fed helped perpetuate a fraud on investors and
counterparties. This pattern further suggests the Fed, which by its
charter is tasked to promote the safety and soundness of the banking
system, instead, via its collusion with Lehman management, operated to
protect particular actors to the detriment of the public at large. And
most important, it says that the New York Fed, and likely Geithner
himself, undermined, perhaps even violated, laws designed to protect
investors and markets." {4}
So if the New York Fed had no moral qualms about its "repo 105" dealings
with Lehman, than why would it hesitate to do the same thing for the other
banks? Tyler Durden at Zero Hedge answers the question like this:
"We contend that Repo 105 type book-cooking and quarter end balance sheet
window dressing was a prevalent phenomenon among all the banks. The fact
that over the past two and a half years this resulted in a differential
from the peak quarterly assets of over $65 billion is unbelievable, and
the fact that this had slipped through the regulators' fingers is
inexcusable ...
"We are confident that armed with this data, the SEC will be able to
provide a prompt and logical response to why the primary dealers have such
a peculiar pattern in downshifting their assets toward quarter end, and
much more relevantly, who the counterparties are that would consistently
take the other side of these quarter end window-dressing trades." {5}
Durden's logic looks good. If Lehman was being aided in its "book cooking"
by the New York Fed, then the other banks were probably being helped, as
well. It looks like Geithner left his fingerprints everywhere.
If we add these new developments to the fact that the Financial Accounting
Standards Board's (FASB) "mark to market" rule has been suspended
(allowing banks to arbitrarily assign whatever value they choose to the
own illiquid assets) and, the fact that the Federal Reserve still refuses
to allow an independent audit of the dodgy collateral it accepted from the
banks in exchange for Treasuries and other loans; then it still looks like
the banking system is either teetering or insolvent.
And don't expect the Securities and Exchange Commission to get to the
bottom of this either. SEC chairman Mary Schapiro is a proven financial
industry loyalist who has no intention of upsetting her Wall Street
overlords by digging too deep or issuing subpoenas. If she pursues the
investigation at all, it will only be to placate the public and to apply
liberal amounts of whitewash to the whole matter.
Notes:
{1} "Big Banks Mask Risk Levels" by Kate Kelly, Tom McGinty and Dan
Fitzpatrick, Wall Street Journal
http://online.wsj.com/article/SB10001424052702304830104575172280848939898.html
{2} "Time for the Truth" by William Black and Eliot Spitzer, Huffington
Post
http://www.huffingtonpost.com/eliot-spitzer/time-for-truth-three-card_b_500867.html
{3} "Fed Helped Bank Raise Cash Quickly" by Eric Dash, New York Times
http://www.nytimes.com/2010/03/13/business/13freedom.html
{4}
http://www.nakedcapitalism.com/2010/03/ny-fed-under-geithner-implicated-in-lehman-accounting-fraud.html
{5} "Evidence That Primary Dealers Have Collectively Engaged In Repo 105
And Qtr-End Book Cooking Type Schemes For Years", zero hedge, April 09
2010
http://www.zerohedge.com/article/evidence-primary-dealers-have-collectively-engaged-repo-105-and-qtr-end-book-cooking-type-sc
_____
Mike Whitney lives in Washington state. He can be reached at
[email protected]
http://www.counterpunch.org/whitney04122010.html
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