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Lehman Brothers Sham -- Liveblogging the Hearing

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4:40

Black just said Repo 105 was not just fruad, but a felony. It was a deliberate misrepresentation of the company's financial condition that was "material" to investors.

This kind of deception happened all over Wall Street at firms that did not file for bankruptcy. In the savings and loan crisis nearly 1,100 people went to jail. That was a much smaller crisis than what we've been living through since 2007. There is no justification for not making arrests.

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4:30

Brad Miller just pointed out that every published account of Dick Fuld's negotiations toward the end of Lehman's legal life involve Fuld expecting a government bailout. So Miller wants to know what the government has to do to convince decision-makers in the banking industry that the government will not bailout megabanks.

Fuld and Cruikshank are dodging the question.

Here's the answer: Nothing. So long as the failure of a bank could threaten the economy, they will be bailed out, whether the government has a resolution authority or not. We saw that happen in the past crisis. The FDIC has generally used its resolution authority for smaller commercial banks responsibly, but when Wachovia went down in late Septemeber, the Treasury and the Fed (Tim Geithner was a key player here) stepped in to keep the FDIC from deploying it. Wachovia was acquired by Wells Fargo for $7 a share with government assistance, and the Treasury then kicked $25 billion in TARP funds to Wells Fargo a few weeks later.

That will happen again if JPMorgan Chase or Goldman Sachs or Bank of America find themselves on the brink of collapse in the future, whether we have a resolution authority or not. The only solution is to break up the big banks into smaller firms that are not too big to fail.

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4:20

Reps. Jeb Hensarling (R-TX) and Dennis Moore (D-KS) are hammering Fuld on his assertion that he knew nothing about Repo 105. Hensarling notes that Lehman's President and COO called the plan "a drug" for Lehman, and Fuld refused to express an opinion about that comment.

Fuld is also saying that Lehman did $50 billion to $100 billion in "highly liquid" trades a day, and insists that this pesky $50 billion con job wouldn't interest him. All he was worried about were "less liquid assets."

Sorry, that's absurd. Lehman was a $700 billion bank that just happened to move $50 billion off its balance sheet just before it filed its quarterly statements. People inside Lehman referred to this as "sham transactions." If you're engaged in $50 billion in sham transactions, it is totally irrelevant whether those transactions involve Treasury bills or subprime CDOs. It's a $50 billion con being committed in your bank. If you're the CEO, you need to know about it.

Lest anyone forget, Dick Fuld made a lot of money for shouldering this responsibility.

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4:10

Barney Frank is pointing out that the Fed has been unfairly criticized for failing to deflate the housing bubble by using interest rates. The tool they should have used was regulation, but Greenspan didn't believe in regulation.

Bill Black actually talked to me about exactly this issue in an article I wrote for AlterNet in March. From that article:

You should target bubbles, as we did in the savings and loan crisis with commercial real estate in the Southwest—we deliberately popped that bubble. But you should pop it by taking out the folks that are feeding the bubble, not by using huge macroeconomic policies like interest rates. Under that model, you have 8 percent unemployment when times are good. It's a bit like going in and fighting cancer with finely targeted radiation, versus just standing a person in front of a huge radiation source.

Nobody at this hearing will back abolishing central banking or monetary policy altogether. Everybody believes having some sort of macroeconomic policy agency is important. The point is that regulatory policy is just as important, but it is viewed by many members of this Committee as "big government" interfering in the "free market." That is self-imposed helplessness, and there is no excuse for it.

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4:00

Bill Black. "This pushed the financial system to the brink of collapse. I don't follow business as normal as a regulator when that happens." The Fed had lots of leverage, with both carrots and sticks to do something about Lehman, and didn't do it.

And in fact, the Fed didn't follow business as usual. AIG was a clear example of them using very creative legal justifications to step in and stop a disaster. They could have stepped in far earlier as regulators to prevent a failure that necessitated a bailout. Instead, the Fed waited for things to blow up, and then threw the taxpayer in front of the train to stop it.

This is the kind of performance that scores people jobs at major regulatory agencies, and Black has the experience to justify such an appointment. What's standing in his way? He'd actually hold people accountable, and almost everybody in this hearing room is trying to avoid holding anybody-- public-sector or private-sector-- accountable.

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3:40

Some of Black's testimony is fundamentally depressing. Obama has stuck with both Bernanke and Geithner, who totally screwed up during the crisis. So long as these people are in power, we will never be able to hold anyone in government accountable for their actions, because they'll be able to manipulate their agencies to withhold information. It's just like leaving bad bank CEOs in charge of failed banks. They cover their tracks.

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3:35

Black is ripping the SEC, Treasury and Fed right now. Bernanke said the Fed sent two people to Lehman, but Black notes that regulators send 50 people to the largest savings and loan to collapse in the S&L crisis. True.

"Let's start with the Repos . . . we have known since Enron" that this is a major scam. There was a proposal in 2004 to stop it, the Bush-appointed regulatory heads actively stepped in to block that proposal.

"We have known for a decade that these are frauds, we have known for a decade how to stop them."

If regulators won't take action, Congress has to force their hand.

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3:35

Bill Black is awesome. He's an ex-regulator who actually believes in regulation, and he has no sympathy for bank execs, bad regulators, or bad regulations from Congress.

"Lehman's story . . . is a story of fraud."

"Lehman was the leading purveyor of liar's loans for most of this decade . . . studies of liars loans show incidence of fraud of 90 percent."

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3:30

Lehman director Thomas Cruikshank is emphasizing that what seems obvious today was not obvious back in the wild days of 2008, and that the judgments that lead to the firm's collapse.

I have absolutely no sympathy for this argument. Wall Street directors and officers got paid a tremendous amount of money. They didn't get paid that money to make reasonable errors. They got paid that money to make sure their firms didn't to terribly reckless things and ruin the economy. Then they did those things, and kept the money.

Cruikshank notes that even after Bear Stearns collapsed in March 2008, then-Treasury Secretary Henry Paulson said that the worst was likely behind us. The IMF also told Treasury to prepare contingency plans for the event of another major failure, and Paulson ignored them. This was not unforseeable.

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3:23

There it is. Fuld says he and Lehman have been "unfairly villified" and that he has no recollection of Repo 105. Unbelievable.

Fuld is also stating that Repo 105 didn't move "toxic assets" off its books. But of course, that's not important. Repo 105 was a way for Lehman to temporarily sell assets to other parties, with a commitment to repurchase those assets in the near future. The point was to reduce their total assets, so their leverage ratio (assets vs. equity) looked lower to investors. Whether they were "selling" subprime mortgage CDOs or Treasury bills, isn't relevant. Lehman was using the deals to reduce their leverage and make themselves look healthier from a financial perspective.

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3:20

Finally, more than four hours into the hearing, Dick Fuld takes the stand.

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3:05

Valukas says Lehman CEO Dick Fuld either knew or should have known about Repo 105 transactions. Fuld now says he has "no recollection" of Repo 105.

"I don't remember" is always the best defense against white-collar crime, because you get to deny culpability, and it's very hard to prove that you are perjuring yourself. But if Fuld can't remember how is company was handling $50 billion in assets for months on end, it's just impossible to justify the money he took home as Lehman CEO.

Let me reiterate that-- if Fuld's point is true, then the top execs of top Wall Street firms have no idea what they are doing.

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2:40

Garrett keeps hammering the SEC for not coming down on Lehman, and I think it's pretty clear the SEC could have done a lot more.

It's also pretty clear that giant complex institutions like Lehman Brothers are much more difficult for regulators to decipher than smaller institutions, particularly when Congress has created massive loopholes allowing their derivatives business to be insulated from regulatory oversight. But Garrett isn't interested in fixing either of those problems.

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2:25

Valukas just said Lehman's accounting firm, Ernst & Young, is liable for misconduct associated with Repo 105. There are four major accounting firms. All of them oversee major banks who applied optimistic accounting values to their assets to help them weather the crisis. If the SEC is serious about investigating fraud charges, it will go after the major accountants.

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2:15

Kanjorski is asking Anton Valukas, the Lehman bankruptcy examiner, whether the fact that regulators failed to take action against Lehman puts the onus on Congress to enact strict requirements for regulators to take action in the future.

Geithner opposes placing hard requirements on regulators, because he wants them to have flexibility if financial terrain changes in the future. That's exactly what happened over the past decade, as regulators used that flexibility to stop regulating.

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1:15

Brad Miller is making a good point about derivatives transactions. Derivatives get favorable treatment in bankruptcy. When a bank like Lehman fails, it's much easier for its derivatives counterparties to get their money back than it is for other creditors. That encourages Wall Street to engage in (generally unregulated) derivatives transactions, because there's effectively a safety net for the deals. Even if the company you are trading with goes under, if you have a derivatives trade, you're more likely to get your money back.

That's something that has to be addressed in financial reform, and Geithner is hedging, saying that derivatives can be dealt with by increasing capital and margin requirements. Those are important, but they aren't enough. Derivatives are often just raw gambles-- like Goldman's infamous subprime CDOs-- or sham transactions -- like Lehman's Repo 105. If we want the financial system to do productive work for the economy, we can't favor these kinds of deals over transactions that actually do something useful. This requires Congressional action.

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12:25

And here's Sherman. He says we need to break up the banks, and Congress has to mandate it, not just give regulators the power to do so.

He's also highlighting the fact that the reform bill includes a fund to pay for any costs associated with shutting down a failing bank. Sherman lead the push to make sure that large Wall Street banks have to pay into that fund ahead of time, so that when a big bank does fail, Wall Street pays to make sure the failure doesn't kill the economy, not taxpayers.

Republicans are calling this a taxpayer bailout fund. It's not. It's a fund that forces Wall Street to pay the economic costs of its own excess. Banks fail. That's a fact of life, and not all bank failures can or will be prevented. If we don't have the fund, then when big banks fail, ordinary taxpayers like you and me have to pay for it. It's much, much better to make Wall Street banks pay for it than to make us pay for it.

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12:20

This hearing is no longer about Lehman Brothers. Republicans are just levying ridiculous accusations at Democrats to excuse their votes against reforms, and Democrats are offering rejoinders of varying degrees of effectiveness.

If you're watching, the members of this Committee who actually care about reform are Reps. Brad Sherman (D-CA), Brad Miller (D-NC) and Alan Grayson (D-FL). There are others who vote for reform when it's convenient, but those three will be the attack dogs. Everything else here is partisan jousting.

12:00

Kanjorski just asked why Geithner opposes breaking up the banks. Geithner is dodging.

He just asked Bernanke about breaking up the banks. Bernanke is dodging. He says he likes the authority to break up big banks, but he doesn't say he wants to actually use it.

It's much easier for Democrats to look tough on banks when their top economic policy officials actually support getting tough on the banks (Bernanke is a Greespan-esque Republican, but Obama reappointed him).

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11:55

Both Geithner and Bernanke want more power for the Fed. Bernanke is emphasizing that the Fed began overseeing the Fed by gathering information, but is noting that the Fed had no regulatory power over the firm, because it wasn't a bank holding company. Even though Lehman was a bank, it was primarily an investment bank, rather than a commercial bank that accepts deposits. This is only a rough characterization, as Lehman actually had several billion in consumer deposits. But regardless, it's true that the Fed wasn't Lehman's regulator.

And Bernanke is making a good point here: Repo 105 wouldn't have changed the Fed's view of Lehman's financial condition, nor would it have changed the SEC's view, which were both very negative. Both regulators thought the bank was dying. Treasury and the Fed tried to force Lehman to accept an emergency merger deal, and Lehman CEO Dick Fuld refused to take the deal, holding out for a big taxpayer bailout.

But Bernanke's excuse that the Fed had no power to step in and save Lehman is pretty weak. The Fed found some very creative legal justifications for saving AIG, which was an insurance company, not a bank. If they could rescue AIG, they could have rescued Lehman. That doesn't mean I think the Fed would have handled a Lehman rescue well-- just look at the bonuses they permitted to go through at AIG.

I don't think Bernanke, Paulson or Geithner realized how horrible the Lehman failure was going to be. But the real failure was much earlier. The SEC lifted leverage caps on investment banks like Lehman in 2004 and hasn't cracked down meaningfully since (no regulator with oversight over leverage has). There's a clear need for Congress needs to impose hard leverage caps for financial institutions that regulators can't mess with.

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11:45

Scott Garett (R-NJ) is echoing Bachus. So here's the Republican strategy. Rather than altering incentives at regulatory agencies or trying to fix problems, Republicans are screaming that no regulator can ever be effective ever, and we must rely on the "free market" to save everything. This is preposterous. If the problem is regulatory failures, the free market can't fix it, by definition. "Regulatory failure" just means that the free market is being allowed to perpetrate economic destruction.

And of course, the regulators in charge at the time of all this were Republican regulators. Lots of Democrats don't support meaningful reform. That doesn't excuse Republicans for opposing it.

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11:35

Bachus is at it again. He says, since the Fed dropped the ball on Lehman and other banks, it shouldn't be rewarded with expanded regulatory powers.

I actually agree with Bachus on this. The trouble is, Baucus, his Republican colleagues and many Democrats, refuse to endorse the reasonable alternatives to expanding the Fed's power. If you break up the big banks, there is much less at stake should a regulator drop the ball. But Bachus doesn't want to break up the big banks, because Wall Street will cut back on their campaign contributions to Bachus and other Republicans if he supports break-ups.

The Fed also had comprehensive oversight of consumer protection abuses, and failed to take action. The Fed needs to be stripped of this power, and it needs to be transferred to an independent Consumer Financial Protection Agency (CFPA) with the power to both write and enforce regulations.

But Bachus fought the CFPA tooth-and-nail. In short, he's not interested in reining in bank abuses. Neither are his Republican pals, and neither are many Democratic members of the House Financial Services Committee, because they're all funded by bankers. Members of both parties intentionally pack the FSC with vulnerable members so they can rake in Wall Street money.

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11:25

Rep. Spencer Bachus (R-AL) is suggesting that we don't need any legislation to fix what went wrong at Lehman, arguing that "95% of the failures here" involved regulations on the books that weren't enforced.

This is disingenuous political posturing. The regulators in power had been appointed by Republicans, and didn't believe in regulating. Bachus knows this, and is using the fact that his own party failed to argue that nobody can ever succeed and provide him with political cover for not voting for other reforms.

A Bush appointee, Chris Cox, was head of the SEC when all of this garbage was going down, and Cox was absent throughout the crisis, refusing to leave a birthday party when Bear Stearns was going down.

Not every problem needs new legislation. But it's not at all obvious that Lehman is going to be charged with fraud for doing something outrageous. If there is any hint of uncertainty about whether this kind of behavior is illegal, then Congress needs to take action. That's critical.

Finally, off-balance-sheet transactions are not limited to Lehman Brothers. At the height of the crisis, Citi had roughly $2.2 trillion "official" assets on its balance sheet, and $1.1 trillion "unofficial" assets off its balance sheet. Citi didn't have to tell investors what was going on with one-third of what it owned. That's insane, and if regulators can't or won't take action to stop it, Congress has a responsibility to do so.

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11:05

Rep. Anna Eshoo is laying out the case against Lehman. The company engineered a host of sham transactions to temporarily reduce the company's massive leverage levels. Top-level management knew the transactions were totally meaningless, but engaged in them to make the company look more sound. They allowed Lehman to move about $50 billion in assets off their balance sheet for short periods of time, right before the company filed its quarterly financial statements, to make investors think the company was in much less jeopardy than it actually was.

For the mirage to be effective, Lehman had to conceal the nature of its Repo 105 transactions from the public, and neither the SEC nor the Treasury Department did anything to stop it.

There's some controversy as to whether this act of intentional deception constitutes fraud. But everybody knows it should constitute fraud. This is how Wall Street makes an enormous portion of its profits. Instead of helping some small business get off the ground, or fuel productive economic growth, Wall Street goes to outrageous lengths to simply screw other companies and investors out of their money. That doesn't accomplish anything, and there is no reason to accept a financial system that functions this way.