Examiner: Lehman Torpedoed Lehman

A scathing report by a U.S. bankruptcy-court examiner investigating the collapse of Lehman Brothers Holdings Inc. blames senior executives and auditor Ernst & Young for serious lapses that led to the largest bankruptcy in U.S. history and the worst financial crisis since the Great Depression. In the works for more than a year, and costing more than $30 million, the report by court-appointed examiner Anton Valukas paints the most complete picture yet of the free-wheeling culture inside the 158 year-old firm, whose chief executive Richard S. Fuld Jr. prided himself on his ability to manage market risk.

Fuld's arrogance was boundless. He even told a House member to let him finish, when the politician had the temerity to interrupt his testimony before a Congressional committee. Fuld was used to such deference.


The document runs thousands of pages and contains fresh allegations. In particular, it alleges that Lehman executives manipulated its balance sheet, withheld information from the board, and inflated the value of toxic real estate assets. Lehman chose to "disregard or overrule the firm's risk controls on a regular basis,'' even as the credit and real-estate markets were showing signs of strain, the report said.

• Deals: Read the Lehman Examiner's Report
• Details of the 'Hail Mary' to Buffett
• Heard on the Street: Lehman's Racy Repo
• Deals: How Lehman Allegedly Manipulated Its Balance Sheet
• Deals: Lehman Senior VP Warned Auditors About Repo 105
• Deals: Dick Fuld's statement on the report
• MarketBeat: 'Hail Mary' to Warren Buffett
• Probe Yields Windfall for Legal Examiner

Getty Images - Lehman's top executives, including CEO Richard Fuld, were aware of accounting chicanery and failed to disclose it, the report said. Above, Fuld testifies before the House Oversight and Government Reform Committee in October 2008.


Mr. Valukas, chairman of law firm Jenner & Block, devoted more than 300 pages alone to balance-sheet manipulation, accusing Lehman of using accounting methods to move assets off its books.

Coincidentally, the firm is domicilied at 919 Third Avenue.


The examiner said that Lehman—anxious to maintain favorable credit ratings—engaged in an accounting device known within the firm as "Repo 105" to essentially park about $50 billion of assets away from Lehman's balance sheet. The move helped Lehman look like it had less debt on its books.

Seems misleading, to say the least.

In an ordinary repo transaction, Lehman would raise cash by selling assets with a simultaneous obligation to buy them back within days, according to the report. The transactions would be accounted for as financings, and the assets would remain on Lehman's balance sheet. In a Repo 105 transaction, Lehman did the same thing. But because the moved assets represented 105% or more of the cash it received in return, accounting rules allowed the transactions to be treated as "sales" rather than financings. The result: Assets shifted away from Lehman's balance sheet, reducing the amount of debt it showed to investors.

Misleading, and allowed. Nice.


"In this way, unbeknownst to the investing public, rating agencies, Government regulators, and Lehman's Board of Directors, Lehman reverse engineered the firm's net leverage ratio for public consumption," says the report.

Bloomberg News - Erin Callan, Lehman's former financial chief, in an April 2008 interview.

Lehman's own global financial controller, Martin Kelly, told the examiner that "the only purpose or motive for the transactions was reduction in balance sheet" and "there was no substance to the transactions." Mr. Kelly said he warned former Lehman finance chiefs Erin Callan and Ian Lowitt about the maneuver, saying the transactions posed "reputational risk" to Lehman if their use became publicly known.


In a November 2009 interview with the examiner, Mr. Fuld said he had no recollection of Lehman's use of Repo 105 transactions but that if he had known about them he would have been concerned, according to the report.

Plausible deniability?

One party singled out in the report is Lehman's audit firm, Ernst & Young, which allegedly didn't raise concerns with Lehman's board about the frequent use of the repo transactions. E&Y met with Lehman's Board Audit Committee on June 13, one day after Lehman senior vice president Matthew Lee raised questions about the frequent use of the transactions.

In a statement, Mr. Fuld's lawyer, Patricia Hynes, said, "Mr. Fuld did not know what those transactions were—he didn't structure or negotiate them, nor was he aware of their accounting treatment."

Difficult to believe that such a hands-on CEo didn't know a blessed thing about such an important matter. And if true, then he wasn't awatre of a very important matter.

As Lehman began to unravel in mid-2008, investors began to focus their attention on the billions of dollars in commercial real estate and private-equity loans on Lehman's books. The report said that while Lehman was required to report its inventory "at fair value," a price it would receive if the asset were hypothetically sold, Lehman "progressively relied on its judgment to determine the fair value of such assets."

Rift at Fed Over AIG Bailout

A Rift at the Fed Over the Bailout of A.I.G.
By LOUISE STORY and GRETCHEN MORGENSON


New documents submitted to Congressional investigators examining the 2008 rescue of the American International Group show that officials at the Federal Reserve were deeply divided over the structure of the bailout and its long-term implications. At the same time, regulators had to contend with major banks that were A.I.G.’s trading partners and were unwilling to accept a discount from the government when closing out the contracts the banks had struck with the insurance giant.


Ultimately, the government decided to make the banks whole on the contracts, a decision that the documents say was approved by Timothy F. Geithner, the Treasury secretary who, at the time, was president of the Federal Reserve Bank of New York. The Fed’s decision to pay A.I.G.’s trading partners in full on tens of billions of dollars in contracts has been controversial because many analysts say they believe the government could have negotiated a price for a fraction of that amount, reducing taxpayer funds used in the rescue. Similar contracts were being settled at heavy discounts in other deals where the government was not involved.

Not good negotiating, for the most important deals. Such incidents increases one's skepticism of government involvement in anything important.


Last Thursday, Thomas C. Baxter Jr., the New York Fed’s general counsel, told Congressional investigators of his frustration with the banks, according to committee staff notes obtained by The New York Times. “We asked for concessions, and they said no,” he said, according to the notes. “I wonder why we even bothered.” Mr. Baxter also said that Mr. Geithner verbally approved the decision to pay full price to the banks. A spokesman for the Treasury Department noted that Mr. Geithner’s decision to give the banks 100 cents on the dollar in the A.I.G. bailout was previously discussed in a report that the Treasury’s inspector general released last fall.

Why bother? Why not push the banks to accept?

According to a 13-page slide show prepared by the asset management firm BlackRock that was submitted to the committee, Merrill Lynch and a French bank, Société Générale, were “resistant to deep concessions” on their A.I.G. contracts. Goldman Sachs, another major trading partner, was willing to accept only “a small concession” on its contracts. The slide show is among more than 250,000 pages of documents provided to the House Committee on Oversight and Government Reform in preparation for a hearing next week on the Fed’s role in the A.I.G. bailout. The committee, which is led by Edolphus Towns, Democrat of New York, has been interviewing some of the people who will testify, including Mr. Baxter.

In October 2008, one month after the A.I.G. rescue was initiated, the New York Fed encountered heavy objections to its plans for structuring the bailout from its overseers at the Federal Reserve Board in Washington. The New York Fed had recommended creating two vehicles — known as Maiden Lane 2 and Maiden Lane 3 — to house securities taken in as part of the A.I.G. rescue. A similar vehicle had been created to hold the assets guaranteed by the government in the Bear Stearns collapse.


In an Oct. 15 e-mail message to Mr. Geithner, Sarah Dahlgren, the New York Fed official leading the A.I.G. effort, wrote, “Board staff again reiterated that they didn’t think that the Governors (unnamed) would go for ML2 or ML3.” Later in the same e-mail message, Ms. Dahlgren noted, “The Governors have cited the Bear Stearns deal as a one-off deal that was done on the understanding it wouldn’t be done again (so ML2 and ML3 aren’t well-received...)”


The e-mail message also summarized the board’s questions about the bailout. Atop the list: “What does any of this buy us?” Plenty, said the Treasury Department in a statement on Friday evening. “Those investments have turned out to be very sensible, and the fund at the center of the controversy is on track to return every dollar to taxpayers, and may well yield a profit,” said Andrew Williams, a Treasury spokesman.


The Fed was advised that the banks had valued the contracts in question at severely depressed levels. The contracts were tied to bundles of mortgage bonds known as collateralized debt obligations, or C.D.O.’s. A senior New York Fed official wrote in an Oct. 22 e-mail message to Mr. Geithner that there was a “discrepancy” between “what our advisers are saying these C.D.O.’s are worth and where the firms have them marked.”


Some of the banks seemed to recognize that the mortgage bundles might wind up being worth more than they were claiming at the time. According to BlackRock’s slide show, Goldman and Société Générale were willing to tear up some of the contracts with A.I.G. if they were allowed to keep the underlying C.D.O.’s, indicating that both banks may have thought they could increase in value. The Fed instead decided to take those C.D.O.’s onto its own books and pay the banks to extinguish the contracts.

Curbing size of bog firms

President Franklin D. Roosevelt signed the Glass-Steagall Act, passed in 1933, separating commercial and investment banking.

And Bill Clinton signed the bill that repealed the Act.

A new bubble?

Saw this story on last night's broadcast.

The Business of Life Insurance: Betting on Your Own Mortality

Wall Street Wants to Securitize Life Insurance and Some See Another Debacle in the Offing

by Bill Weir

Oct. 5, 2009—

After Dr. Eddie Powell lost both his legs to a hospital infection, he desperately needed financial help to support his practice and three children in medical school. So the 61-year-old did what more and more cash-strapped Baby Boomers are doing these days: He sold his life insurance. "For close to a million dollars of insurance, I got a hundred and some thousand dollars," Powell said.

Coventry, a life settlement company, took Powell's policies, bundled them with others and sold them to banks or hedge funds as investments. Since they pay the premium every month, the sooner he dies the more money they will make. And now, Wall Street wants in on the action and the life settlement industry welcomes the potential spike in business.

"The 'ick' factor is there and we're certainly aware of it," said Russell Dorsett, president of the Life Insurance Settlement Association. "The secondary market simply lets individuals bet on their own mortality. So, say that I am going to live longer than you think I am. I will take the money now rather than having to wait to die in order to get it. It's no different than the life insurance business itself. Basically mortality, morbidity is a multitrillion dollar market."

For critics, the move to securitize the life insurance industry harkens back to the early days of the subprime mortgage boom. That crisis began when banks gave loans to people who couldn't afford them, but it got much worse when Wall Street used exotic forms of investments (called collateralized debt obligations) to bet that those loans would go bad.

With Wall Street's trillions in play, banks had more incentive to issue more subprime loans. When those loans went bad, the investors got rich but the housing market -- and the entire economy -- nearly collapsed.

If Wall Street is allowed to bet on the early death of seniors or the terminally ill, some worry it could not only strain the insurance industry, but also create a market for shady brokers to prey on the sick and elderly while adversely affecting the health policy of the nation.

"People who have bets on early death will find themselves lobbying against effective health care," said Michael Greenberger, a University of Maryland law professor and former director with the Commodity Futures Trading Commission. "There's no two ways about it, this is an accident waiting to happen in terms of investment&. It's setting up the same wild financial infrastructure that turns out to be nothing more than a casino, unrelated to the underlying transaction."

While a life settlement spokesman acknowledges that around $40 billion worth of policies have been sold in the past five years, he says that number is a small percentage of the multi-trillion dollar industry and could never pose a risk to the system. "We estimate that maybe 1 or 2 percent of policies might qualify for a life settlement at some point," said Dorsett. "While that number will grow due to demographics it's still relatively small compared to the economy as a whole."

As for Dr. Powell, he says he regrets his decision to sell his life insurance for pennies on the dollar. "I made a stupid mistake," he said. Every few months, a representative from Coventry calls to see if he is still breathing. He plans to keep answering for a long time. "My grandma lived to be 115&you've got a long time before Eddie Powell dies," he said.

But if Coventry gets its way, there will soon be plenty of investors on Wall Street hoping, and betting, he is wrong.

Copyright © 2009 ABC News Internet Ventures

Chance to reform the Street is fading

From left, Representative Barney Frank; Mayor Michael R. Bloomberg; former Federal Reserve Chairman Paul Volcker; Christina D. Romer, the chairwoman of the Council of Economic Advisers; and Treasury Secretary Timothy F. Geithner listened to President Obama's speech at Federal Hall.

A crisis has been wasted. Reform is near impossible now. Whatever does get done will be incremental and minuscule.


President Obama on Monday sternly admonished the financial industry and lawmakers to accept his proposals to reshape financial regulation to protect the nation from a repeat of the excesses that drove Lehman Brothers into bankruptcy and wreaked havoc on the global economy last year.

Not one CEO was at the speech; that pretty much tells what they think about it.

But with the markets slowly healing, Mr. Obama’s plan to revamp financial rules faces a diminishing political imperative. Disenchantment by many Americans with big government, along with growing obstacles from financial industry lobbyists pressing Congress not to do anything drastic, have also helped to stall his proposals.

Financial firms oppose a proposed consumer protection agency. That makes their attitude quite clear.

Video
Obama Urges Stronger Finance Rules

Obama Speech on Finance Rules, Part 2

Related

U.S. Is Finding Its Role in Business Hard to Unwind (September 14, 2009)
City Room: Obama and Bill Clinton Have Lunch in the VillageText of Obama’s Speech on Financial Reform

What do I think?

This is a perfect definition of a self-fulfilling prophecy: on page 1 of the Wall Street Journal today, this item appeared: "Stocks started September with a selloff led by financial issues, as investors worried that the summer rally could give way to a correction."

Well, yes: by selling, investors created a correction.

Inside The Great American Bubble Machine

An article from Rolling Stone magazine investigating and reporting on the power of Goldman Sachs,

Fortress on Both Sides of Talks

A specialty of Wall Street:

Multipronged Fortress

The Issue: Fortress is both an equity investor in and lender to real-estate
and railroads firm Florida East Coast Industries Inc.

The Conflict: The company is trying to restructure a $1.5 billion loan,
pitting the interests of Fortress clients against one another.

The Future: Private-equity firms are facing new conflicts as they buy up
the debt of companies they own.

This forms invests in and lends to

Futures Climb on Goldman Results

The best on the Street seems to be back.

Goldman Sachs shares were hovering around the flat line on Tuesday. The bank's profit smashed through analyst estimates after its fixed income, currency and commodities unit posted record quarterly revenue. Goldman posted income of $3.44 billion, or $4.93 a share, up from $2.09 billion, or $4.58 a share, a year earlier. The latest results included a $426 million dividend related to the company's paying back its TARP funds. Excluding that, earnings were $5.71 a share, which beat analyst estimates by more than $2 a share. Net revenue jumped 46% to $13.76 billion.

Read: The latest results included a $426 million dividend related to the company's paying back its TARP funds. So the Treasury made money on its investment: $426 million on $10 billion. On June 19 a story confirmed that GS was one of the institutions that had repaid the Treasury (on 17 June). So perhaps GS had TARP funds for six months; the Treasury made about 8.5% in such a case. Not bad.

But many in the market had expected Goldman to post a strong quarter, and in fact stock futures moved off their best levels of the day after the bank's results.

Investors Circle Ailing Banks, Fed Sets Limits

Don Ipock for The New York Times - First National, with its boarded-up second story and $17 million in assets, is worth about a third of what its owner, a New York investor, paid for an Upper East Side town house in 2006. It is an unlikely launching pad for a new American banking empire.










No one seems to want to own a business in this dusty, windswept corner of rural America, population 370, with its crumbling sidewalks and boarded-up storefronts.

Except, that is, for J. Christopher Flowers, a media-shy New York billionaire who last year bought the First National Bank of Cainesville, one of the United States’ smallest national banks. Mr. Flowers, a private equity manager, has no particular love for rural Missouri; in fact, he has never set foot in Cainsville. Rather, he wants to use the national bank charter he picked up in this farm town to go on a nationwide buying spree.

Vultures do serve a purpose. He is going in where no one else wants to go, because there are opportunities to make money, without question.

With that charter in hand, Mr. Flowers plans to take over a handful of large struggling banks, casualties of the economic crisis. In some cases, he hopes, the federal government will help.

Yet he is counting on the government's help, not exactly the swashbuckling entrepreneur going in alone, taking risks, betting on his own savvy.

But Mr. Flowers, whose investments in banks overseas have made him one of the richest men in America, has run into a major obstacle in the United States: the Federal Reserve, and its very notion of what a bank should be.

Good question.

How to Understand the Disaster

Robert M. Solow, Institute Professor Emeritus of Economics at MIT, won the 1987 Nobel Prize in economics. His most recent book is Work and Welfare. (May 2009)

The plainspokenness I mentioned is what makes this book an event. There is no doubt that Posner has been an independent thinker, never a passive follower of a party line. Neither is there any doubt that his independent thoughts have usually led him to a position well to the right of the political economy spectrum. The Seventh Circuit is based in Chicago, and Posner has taught at the University of Chicago. Much of his thought exhibits an affinity to Chicago school economics: libertarian, monetarist, sensitive to even small matters of economic efficiency, dismissive of large matters of equity, and therefore protective of property rights even at the expense of larger and softer "human" rights.

But not this time, at least not at one central point, the main point of this book. Here is one of several statements he makes:

Some conservatives believe that the depression is the result of unwise government policies. I believe it is a market failure. The government's myopia, passivity, and blunders played a critical role in allowing the recession to balloon into a depression, and so have several fortuitous factors. But without any government regulation of the financial industry, the economy would still, in all likelihood, be in a depression; what we have learned from the depression has shown that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails. The movement to deregulate the financial industry went too far by exaggerating the resilience—the self-healing powers—of laissez-faire capitalism.

If I had written that, it would not be news. From Richard Posner, it is.

Modern capitalism, it is argued, needs only a little government intervention, to function properly and effectively.

It is easy to be lulled into the comfortable belief that the system can take care of itself if only do-gooders will leave it alone.

The Wall Street Journal crowd so argue. Republicans do, also. But there are imperfections that, left unchecked, do reverberate throughout the system, and, as is the case now, take it to the edge of cataclysmic collapse.

That same financial system, states Solow, has intrinsic characteristics that can make it self-destructively unstable when it meets a large shock. One such characteristic is asymmetric information.

Asymmetric information is that some people have more information than others. Other such characteristics are market imperfections (diverging prices for same security) and the ability of financial giants to raise large sums of credit, in amounts and ways that can affect the whole system, without anyone taking account of, or feeling responsible for, the systemwide effects.

Discussing leverage, Solow illustrates 10-1 and 29-1 scenarios, including making and losing money.

Why did I do such a risky and, as it turned out, stupid thing? Well, it had worked in the past, and made a lot of money for many people. If I had backed off, others would probably have continued to make money for a while. I would have looked like a fool, and very likely an unemployed fool.

... it is leverage that turns large banks and financial institutions into ninepins that cannot fall without knocking down others that cannot fall without knocking down still others. That seems to be the key to the potential instability of an unregulated financial system. It happens without any of the private actors violating the canons of self-interested rationality. Those canons would have been different if the SEC, the Fed, and other institutions charged with regulation had insisted both that all transactions be made public and that there be some limits on leverage.

The regulators, Greenspan, Cox, Donaldson, and Bernanke, too, kept hands off, letting the market self-regulate, following the Reagan mantra, that proved disastrous.

It is a noteworthy intellectual event that Posner has come to this understanding and expressed it forcefully and fearlessly. This same understanding must then also be the key to designing regulations that can reduce the frequency of financial crises like the current one, and limit the collateral damage to the real economy that they entail. Regulation should require that the uses and amounts of leverage, still largely hidden, be made public and that limits be set on the amounts of leverage that financial institutions can bring into play.

But the Wall Street Jounral crowd and the GOP still clamor for a self-regulating market and abhor the socialism they charge the President with instituting.

REP. JOHN BOEHNER, R-Ohio, House minority leader: What we see before us is a budget resolution that is nothing short of the most audacious move to a big, socialist government in Washington, D.C., than anything I could have ever dreamed about before I ran for Congress or, for that matter, any time over the last 18 years that I've been here.

Suntan John opines, and said so on the House floor.

Solow discusses the merits of Posner's use of the word depression, versus his use of the word recession. He goes on from there. Solow discusses the Fed's normal response to the recession of 2001, and cites Posner's discussion of the easy money period beginning then and lasting until the middle of 2004. Liquidity, a housing boom, and

certainly a further spurt. About 1.2 million private housing units were started in 1990, 1.6 million in 2000, and 2.1 million in 2005. Posner emphasizes the corresponding run-up in house prices, and he is right to do so. But the housing boom was not just a financial fact. By 2005 the country had clearly built many more houses, maybe two or three million more, than it could afford to occupy and finance. There would have been a housing slump in any case. We have had housing booms and slumps before, with consequences no worse than an interval of slow growth or a brief downturn, met with normal monetary policy and automatic fiscal stabilizers such as changes in tax rates or in public spending.

Kept a Tight Focus on Customers

An interesting obituary about a businessman who resisted the trends of modern Wall Street, keeping his St. Louis-based brokerage house focused: he "nurtured the firm's reputation for personal service even while increasing the number of branches to nearly 700 from fewer than 50 in 1967, when he became president."

Mr. Edwards took pride in his perch in what he called "the valley between the coasts" and said that his firm served "John Doe American." The firm burnished its reputation as a retail broker with a tight focus on customers. Mr. Edwards answered his own phone, held monthly conference calls with the whole company and spent weeks each year visiting the branch offices. For a decade, A.G. Edwards was ranked in Fortune's annual list of 100 Best Companies to Work for in America.

Imagine many other executives answering their own phones? No, they're too busy.

Yet some considered the firm a bit sleepy for its aversion to Internet trading and the diverse offerings of the large-scale "financial supermarkets" that were starting to take off. When Mr. Edwards retired in 2001, revenues were off in a soft market and speculation was that A.G. Edwards was ripe for a takeover.

The prime financial supermarket was Citigroup, the behemoth that Sandy Weill put together, which is teetering on complete collapse, and would have already failed but for billions of federal bailout funds.

Following Mr. Edwards's retirement, Robert L. Bagby was made chairman and CEO, the first time in the firm's history that it was run by a nonfamily member. Within months, the first layoffs in the firm's history were announced. Aligning A.G. Edwards with industry norms, executive pay went up and broker commissions were cut back.

And where did it all wind up? In disaster.

Regulate Me, Please

April 16, 2009 - Op-Ed Contributor

Regulate Me, Please

By Tom Wilson

THERE are plenty of people singling out causes for the collapse of the financial markets, and conveniently, the source of the problem is usually someone else. But accountability lies with all of us — the insurance industry, regulators, banks and credit rating agencies. The insurance companies that wrote credit default swaps were happy not to be regulated. Insurance regulators didn’t expand their oversight to ensure the solvency of these companies. Banking regulators, banks and credit rating agencies did not properly assess the strength of issuers and readily accepted these complex derivatives.

My company, Allstate, serves more than 17 million American households. While we played only a small role in unregulated insurance markets, we have a duty to help stabilize the financial system. It was, after all, an insurance product that contributed to the risk that almost brought down the global economy.

Insurance is defined as coverage by contract in which one party agrees to indemnify or reimburse another for loss. The credit default swaps written by American International Group are clearly insurance since they are a contractual obligation by A.I.G. to pay should there be a default on a security. It should be no surprise that a big insurer like A.I.G. would be a major issuer of credit default swaps. What is surprising is the claim that insurance did not contribute to the recent market failures, and therefore insurers don’t need to consider how to prevent them from happening again.

Unlike banks or investment houses, insurance companies are not regulated by the federal government. Instead, they are regulated by individual states, which lack the expertise to properly oversee rapid innovation or systemic risks. Business leaders must work with the government to create a new regulatory structure. All companies that create risk for the financial markets need to be in “the pool” of federal regulation, including companies like Allstate. A good start would be for Congress to eliminate the hodgepodge of state regulatory systems by establishing a federal regulator for national insurance companies.

Such a sophisticated federal insurance regulator would oversee the financial stability of large companies. We should also consider expanding private insurance to protect personal savings from systemic risks. And we need to establish a federal agency that would be empowered to deal with any large failing financial institutions, outside of bankruptcy. We must all accept responsibility for our current situation, and work together to broaden the scope of federal regulation to protect both consumers and financial markets.

Business and government leaders must avoid the trap of diminished expectations and continue to demand the best of ourselves and our fellow Americans. Millions of hard-working families are counting on us to get this right.

Tom Wilson is the chief executive of Allstate.

Cerberus Tries to Get Chrysler Out of a Ditch

A giant stumbles, loses money, and gets a financial bloody nose.

For Stephen A. Feinberg, the long road back from the most disastrous investment of his career — Chrysler L.L.C. — began last week around a polished wood table inside the Treasury Department. It was not the road he had envisioned when his private investment firm, Cerberus Capital Management, bought Chrysler in the summer of 2007.

O, yes, in 2007 things looked good. Really good. As it turns out, that was the very top of the stock market's ride.

Back then, Mr. Feinberg was hailed as a hero — the Wall Street financier who just might save the American car industry. Instead, he lost billions for his investors and co-investors. And last week it became clear that he would lose Chrysler’s auto operations, as well.

Cerberus is one of the big financial players.

So as the Obama administration prepared to assert control over Chrysler and General Motors, Mr. Feinberg flew to Washington to try to salvage what he could. In a midweek meeting with Treasury officials, Mr. Feinberg agreed to give up the 80.1 percent stake in Chrysler held by Cerberus and its co-investors, according to a person briefed on the negotiations. He first offered to do this last year.

Billions of investment dollars gone poof!

But Mr. Feinberg did not go quietly. He also discussed additional federal money to help his other wayward investments in Detroit: GMAC and Chrysler Financial. Cerberus is now pushing the government to help orchestrate a merger of the two auto financing companies — a move that might eventually yield a profit for Cerberus.

GMAC is now a bank. Imagine that: Chrysler Bank.

Whether the Obama administration will oblige is unclear. But this much is certain: Cerberus, long considered one of the most formidable investment firms on Wall Street and in Washington, stumbled badly in Detroit. It is now struggling to rescue not only what it can of its investments — about $3 billion in Chrysler and the two finance companies — but also its reputation. Cerberus persuaded others on Wall Street to invest billions more.

But the loss is bigger, wider than that.

Cerberus, many agree, was like so many private equity firms that overreached during the late boom in corporate buyouts. But the firm also seems to have miscalculated in Washington. Mr. Feinberg employs a Who’s Who of Washington insiders, among them John W. Snow, the former Treasury secretary, and Dan Quayle, a former vice president. Cerberus has lobbied aggressively in recent months to shape the government’s rescue of the auto industry, to little avail.

I wonder how many people Dan Quayle (or is that Quayl? — get it?) lobbies, and how many don't laugh.

But Cerberus, like many private equity firms, loaded its new ward with what turned out to be crippling amounts of debt. Cerberus piled about $20 billion of debt onto Chrysler, Mr. Gabbert said. As car sales plunged across the industry — and, in particular, at Chrysler — the carmaker began to buckle under its load.

That is a huge debt load.

Cerberus began losing its control over its Detroit investments when the government stepped in to rescue the automakers last year. In the case of GMAC, the government invested money in December and required that most of Cerberus’s operations team be removed. But some co-investors said that made sense because at that time, the government became the majority owner of GMAC.

Cerberus’s investors in the Chrysler deal include pension funds for public employees in Indiana and for public school employees in Pennsylvania, according to PitchBook.

Battles Over Reform Plan Lie Ahead

“Our system failed in fundamental ways,” Mr. Geithner told the House Financial Services Committee. “To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game.”



March 27, 2009
Battles Over Reform Plan Lie Ahead
By EDMUND L. ANDREWS

WASHINGTON — Outlining a far-reaching proposal on Thursday to rebuild the nation’s broken system of financial regulation, the Treasury secretary, Timothy F. Geithner, fired the opening salvo in what is likely to be a marathon battle.

“Our system failed in fundamental ways,” Mr. Geithner told the House Financial Services Committee. “To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game.”

On the surface, both the lawmakers who listened to the Treasury secretary and the financial industry’s lobbying groups made it sound as if they completely agreed with Mr. Geithner’s call for what he described as “better, smarter tougher regulation.”

But in fact industry groups are already mobilizing to block restrictions they oppose and win new protections they have wanted for years. Even though Mr. Geithner carefully avoided specific details, laying out mostly broad principles for overhauling the system, financial industry groups are identifying issues they plan to pursue and lining up well-connected lobbyists and publicists to help make their cases.

If history is any guide, Mr. Geithner’s proposals will start an equally intense battle among the regulatory agencies themselves — including the alphabet soup of banking regulators, the Securities and Exchange Commission and the Federal Reserve — to stay in business and enhance their authority.

It took years to complete past efforts to overhaul regulation of the financial industry — replacing the Depression-era laws that separated commercial banks from investment banks, for example, and knocking down barriers between the telephone and cable television industries.

And those efforts were in some ways easier than the task confronting President Obama and Congress today. Many of the past overhauls were really about deregulation, knocking down legal barriers that had prevented different segments of an industry from competing with each other.

By contrast, Mr. Geithner’s plan marks the first attempt in decades to drastically tighten the restrictions on industry. It would create a new still-unidentified “systemic risk regulator” that would have the authority to scrutinize and second-guess the operations of bank holding companies like Citigroup or JPMorgan Chase, insurance conglomerates like the American International Group and other financial institutions that are deemed too big to fail.

Hedge funds and private equity funds, which have been almost entirely unregulated, would have to register with the S.E.C. and tell it about their risk-management practices. Many financial derivative instruments, like credit-default swaps, would come under supervision for the first time.

Mr. Geithner’s most specific proposal, which Democratic lawmakers hope to pass in the next few weeks, would allow the federal government to seize control of troubled institutions whose collapse or bankruptcy might jeopardize the broader financial system.

In the months ahead, Mr. Geithner said, he will unveil more detailed proposals to set up a new regime for tighter regulation of most segments of the financial services industry. He has also said the government should more actively regulate executive compensation, not just at companies that are receiving federal bailout money, but at all companies that might be providing incentives for excessive risk-taking.

“The days of light-touch regulation are over,” said Representative Barney Frank of Massachusetts, chairman of the House Financial Services Committee.

Mr. Frank said the financial and economic catastrophes of the last 18 months had created a new political consensus in favor of tighter financial supervision. Mr. Frank said he hoped to pass a bill “very soon” to give the federal government “resolution authority” to seize control, restructure and shut down troubled financial institutions.

And he said he hoped to pass a much broader bill along the lines of Mr. Geithner’s plan by the end of this summer.

But administration officials acknowledged that enacting broad financial reforms would provoke political battles that are almost certain to drag on for months, if not years.

President Obama and his economic team are already trying to navigate between the deep popular anger over reckless financial practices and the pragmatic need to coax support from the financial industry for regulations they almost reflexively oppose.

On Friday, Mr. Obama will meet with executives from the nation’s biggest financial institutions. Bank executives said they expected Mr. Obama to try to sell them on his ideas, and perhaps to encourage them to keep participating in the Treasury Department’s Troubled Asset Relief Program, or TARP. Goldman Sachs has signaled that it wants to return the government’s money that the Treasury loaned it under that program.

On Thursday, most industry lobbying groups held their fire and reacted to Mr. Geithner’s proposals as if they agreed with him entirely.

The Securities Industry and Financial Markets Association said on Thursday that it “has been advocating for many of the same reforms” and that it “looks forward” to developing specific legislation.

The Private Equity Council, which represents firms like Kohlberg Kravis Roberts and the Carlyle Group, praised the Obama administration for its “plan to comprehensively address systemic risk.” The American Insurance Association declared that “we agree with Secretary Geithner” that the new rules should “encourage high standards and a race to the top.”

But industry lobbying groups are pushing their own agenda. Edward L. Yingling, president of the American Bankers Association, said he hoped to use the meeting with Mr. Obama to make the case for relaxing mark-to-market rules, which require financial institutions to value their investment securities at current market prices. Banks have argued that the rules are hurting their financial positions.

Many insurance companies, for their part, are hoping to free themselves from the oversight of 50 separate state insurance regulators. Lobbyists for the retailing and restaurant industry, meanwhile, are hoping to use the banner of financial reform to persuade Congress help reduce the fees that credit card companies charge for processing customer transactions.

Edmund L. Andrews reported from Washington, and Louise Story from New York. David Stout contributed reporting from Washington, and Michael de la Merced and Zachery Kouwe from New York.

Obama’s Real Test

Thomas Friedman weighs in on AIG and Obama.

When you hear a sitting U.S. senator call for bankers to commit suicide, you know that the anger level in the country is reaching a “Bonfire of the Vanities,” get-out-the-pitchforks danger level. It is dangerous for so many reasons, but most of all because this real anger about A.I.G. could overwhelm the still really difficult but critically important things we must do in the next few weeks to defuse this financial crisis.

That's a very good, important point: This is by no means over; there is a lot more heavy lifting to be done yet.

Let me be specific: If you didn’t like reading about A.I.G. brokers getting millions in bonuses after their company — 80 percent of which is owned by U.S. taxpayers — racked up the biggest quarterly loss in the history of the Milky Way Galaxy, you’re really not going to like the bank bailout plan to be rolled out soon by the Obama team. That plan will begin by using up the $250 billion or so left in TARP funds to start removing the toxic assets from the banks. But ultimately, to get the scale of bank repair we need, it will likely require some $750 billion more.

I can hear the Republicans howling already.

I live in Montgomery County, Md. The schoolteachers here, who make on average $67,000 a year, recently voted to voluntarily give up their 5 percent pay raise that was contractually agreed to for next year, saving our school system $89 million — so programs and teachers would not have to be terminated. If public schoolteachers can take one for schoolchildren and fellow teachers, A.I.G. brokers can take one for the country.

Don't hold your breath, Tom.

Unfortunately, all the money we have already spent on A.I.G. and the banks was just to prevent total system failure. It was just to keep the body alive. That’s why healing the system will likely require the rest of the TARP funds, plus the $750 billion the administration warned Congress in the new budget that it could need.

Another one trillion. That'll go down well on Main Street, huh?

The only person with the clout to sell something this big is President Obama. The bankers and Congress will have to help; every citizen will have to swallow hard. But ultimately, Mr. Obama will have to persuade people that this is the least unfair and most effective solution. It will be his first big leadership test. It is coming soon, and it is coming to a theater — and a bank — near you.

It will be some hell of a fight.

Economic Meltdown No Laughing Matter

Jon Stewart on the "Daily Show" with his guest Jim Cramer who hosts the "Mad Money" show on CNBC. They have been feuding about the economy this week.


Click for video.







It wasn’t a “Brawl Street,” or a thrilla in vanilla. It wasn’t a “Daily Show” friendly feud or even much of a discussion. Mostly, the much-hyped Thursday night showdown between Jon Stewart and Jim Cramer, the mercurial host of “Mad Money” on CNBC, felt like a Senate subcommittee hearing.

Cramer is a buffoon. He has rubber chickens, bells, and makes his show seem a game show. It trivializes what should be fairly serious business. Not that investing needs to be dry and boring, but it is not a game.

Mr. Stewart treated his guest like a C.E.O. subpoenaed to testify before Congress — his point was not to hear Mr. Cramer out, but to act out a cathartic ritual of indignation and castigation.

Well deserved, by CEOS and Cramer.

“Listen, you knew what the banks were doing, yet were touting it for months and months, the entire network was,” the Democratic Senator from Comedy Central said. “For now to pretend that this was some sort of crazy, once-in-a-lifetime tsunami that nobody could have seen coming is disingenuous at best and criminal at worst.”

Exactly.

And while it’s never much fun to watch a comedian lose his sense of humor, in an economic crisis, it’s even sadder to see supposed financial clairvoyants acting like clowns.

Ditto.

Part of his frustration may stem from the fact that while Mr. Stewart clearly won the debate, Mr. Cramer and CNBC stood to profit from the encounter. In today’s television news market, the cable network and its stars are like the financiers they cover — media short-sellers trading shamelessly on publicity, good or bad, so long as it drives up ratings. There isn’t enough regulation on Wall Street, and there’s hardly any accountability on cable news: it’s a 24-hour star system where opinions — and showmanship — matter more than facts.

Fair and Balanced? Gimme-a-break.

The “Daily Show” has shown clip after clip from last year that show Mr. Cramer assuring his “Mad Money” viewers that Bear Stearns was not in trouble — shortly before the heavily leveraged investment firm imploded. He has apologized to his viewers several times since then. (“I have always thought they were honest,” he said on Thursday. “That was my mistake.”)

Oops, sorry.

Once he had Mr. Cramer at his desk, Mr. Stewart showed fresh, and even more embarrassing clips from a 2006 interview with the Web site he founded, TheStreet.com, in which he too candidly explained how hedge fund market manipulation really works.

And the “Daily Show” host pointedly questioned the hyped-up theatricality and dubious claims of CNBC shows like “Mad Money” and “Fast Money.” When Mr. Cramer explained, “There is market for it and you give it to them,” Mr. Stewart stared at him in disbelief, exclaiming. “There’s a market for cocaine and hookers!”

Mr. Stewart kept getting the last word, but Mr. Cramer may yet have the last laugh.

It is all about ratings.

A Lonely Lament From a Whistle-Blower

For Harry Markopolos, the Madoff fallout has brought on sleeping problems and haunting thoughts over the apparent suicide of a French money manager.

Harry Markopolos, the Boston-based investor-turned-investigator who for years warned regulators that Bernard Madoff was running a huge Ponzi scheme, has received pitches to appear on television shows, make movies and write books elaborating on his experience.

Later this month, he is scheduled to appear before Congress to present recommendations to improve the Securities and Exchange Commission.

But rather than enjoy a sense of vindication, Mr. Markopolos says he is miserable. He has trouble sleeping and is haunted by the apparent suicide of Thierry Magon de La Villehuchet, a French money manager found dead shortly after Mr. Madoff's Dec. 11 arrest on fraud allegations.

Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party

To outline his fears about the U.S. economy, Raghuram Rajan picked a tough crowd. It was August 2005, at an annual gathering of high-powered economists at Jackson Hole, Wyo. -- and that year they were honoring Alan Greenspan. Mr. Greenspan, a giant of 20th-century economic policy, was about to retire as Federal Reserve chairman after presiding over a historic period of economic growth.

In 2005 Greenspan was still deified. His record was considered stellar.

Mr. Rajan, a professor at the University of Chicago's Booth Graduate School of Business, chose that moment to deliver a paper called "Has Financial Development Made the World Riskier?"

His answer: Yes.

Mr. Rajan quickly came under attack as an antimarket Luddite, wistful for old days of regulation.

To oppose Greenspan was to defy orthodoxy, an orthodoxy that seemed unassailable because of the track record of an uninterrupted bull market and endless prosperity.

Today, however, few are dismissing his ideas. The financial crisis has savaged the reputation of Mr. Greenspan and others now seen as having turned a blind eye toward excessive risk-taking.

And Greenspan can not believe he is being attacked; he calls criticisms unfair, and insists no one could have foreseen the financial tsunami that had caused such calamity.

Rajan got it essentially right: Incentives were horribly skewed in the financial sector, with workers reaping rich rewards for making money, but being only lightly penalized for losses ... which encouraged financial firms to invest in complex products with potentially big payoffs, which could on occasion fail spectacularly.

He pointed to "credit-default swaps," which act as insurance against bond defaults. He said insurers and others were generating big returns selling these swaps with the appearance of taking on little risk, even though the pain could be immense if defaults actually occurred.

Mr. Rajan also argued that because banks were holding a portion of the credit securities they created on their books, if those securities ran into trouble, the banking system itself would be at risk. Banks would lose confidence in one another, he said: "The interbank market could freeze up, and one could well have a full-blown financial crisis."

It all came to pass. What is rather worrisome is how one critic treated Rajan's analysis: Former Treasury Secretary Lawrence Summers, famous among economists for his blistering attacks, told the audience he found "the basic, slightly lead-eyed premise of [Mr. Rajan's] paper to be misguided."

Summers is going to be in charge of the Obama administration's National Economic Council. I can only hope he has learned something from this misguided criticism.

The Jackson Hole contretemps followed by a few months another set of attacks on Mr. Rajan for a study he co-wrote at the IMF that concluded foreign aid didn't help developing countries grow. Mr. Rajan says the twin controversies didn't deter him. At the IMF, he pushed the research department to focus on financial-sector issues, and continued to sound alarm bells about financial-market risks.

By summer 2007, as the crisis began unfolding in earnest, Fed bank presidents Janet Yellen and Gary Stern were citing Mr. Rajan's critiques in their speeches.

Once a pariah, he became an expert others cited. Witness:

Mr. Rajan also urges other safeguards. Along with Chicago colleagues Anil Kashyap and Harvard economist Jeremy Stein, he's come up with a plan to create a form of financial-catastrophe insurance that firms would buy into.

Who would write the insurance? And could that entity withstand a calamity?

When he presented the insurance idea at last year's Jackson Hole confab, the reaction was different than back in 2005. Finnish central-bank governor Erkki Liikanen, recalling the weaknesses Mr. Rajan had spotted in the system back then, said: "I don't dare criticize you. That is all."

Magon de la Villehuchet’s Suicide Leaves Questions

An interesting quote:

“He had a true concept of capitalism,” Bertrand de la Villehuchet, 74, said of his brother. “He felt responsible and he felt guilty. Today, in the financial world, there is no responsibility; no one wants to shoulder the blame.”

How very true. Everyone seems unwilling to accept responsibility, let alone blame, and many still want bonuses. The top dog on this line is Richard Fuld of Lehman Brothers, who put his firm out on a highly leveraged financial limb of risk, saw it collapse, saw other collapsing firms rescued, and could only wonder why Lehman had been allowed to fail.

Mr. de la Villehuchet, a French aristocrat and professional investor who lived in the New York suburbs, had put at least $1.4 billion of his and his clients’ money with Mr. Madoff. He had lost his entire savings. He was overwhelmed and depressed, according to people who had spoken to him. Worse, he felt personally responsible for the money his investors had lost, his brother Bertrand said in a phone interview in Paris this week.

It is not easy to feel bad for an aristocrat, automatically or on reflection, but on further reflection, it is possible.

Suicide is the most intimate of acts, and no one can know exactly what Mr. de la Villehuchet was thinking as he decided to take his own life. But the fraud weighed heavily on him. “It’s a complete nightmare,” he told a longtime client in Paris, less than a day before he died, according to the client.

Thinking of how he must have felt, knowing all the money was gone, is literally impressive: I can imagine the heart ache, the horror, the weight of responsibility.

In a note to his brother written shortly before his death, Mr. de la Villehuchet said that he needed to be held accountable for the losses, his brother said. “If you ruin your friends, your clients, you have to face the consequences,” Bertrand said, explaining what his brother believed.

That is having a sense of honor and of responsibility.

Mr. de la Villehuchet’s attitude appears to be rare. So far, the leading players in Mr. Madoff’s case have maintained a stony silence, studiously avoiding apologies or statements of responsibility.

It is rare. No one accepts any responsibility for the debacle. Hell, even Bernanke is busy fixing the mess he took a pert in creating, or at least in not dealing with much earlier.

Mr. Madoff’s sons have said nothing about how they could have worked at their father’s firm for decades without noticing that the money he supposedly managed did not exist. The accountants and regulators who were supposed to protect investors have not explained their failure to do so. And the hedge funds that invested tens of billions of dollars with Mr. Madoff despite obvious red flags have said the fraud was his fault, not theirs.

The hedge funds can wallow in their own mess. Regulators should be embarrassed and fired. The sons should be punished in some way.

A "feeder fund" advised by Villehuche's firm, Access International Advisors, called Leveraged Options Arbitrage Fund, had $500 million in assets ... and charged investors a management fee of 1 percent of assets annually and 15 percent of any profits the fund generated. Fairly typical, though I've read of funds charging 20% of profits. So this one made $5 million to start with, annually.

A second feeder fund, called LuxAlpha Sicav, had $1.4 billion in assets. It charged a 5 percent upfront fee, a management fee of 0.8 percent annually and a 16 percent performance fee. It is not clear if, or how, the two funds were related.

5% of $1.4 billion is $70 million, charged upfront; 0.8% is $11.22 million, annually.

At the end, it all ended tragically, and sadly. Villehuche is dead, by choice, feeling disgraced; Madoff is alive, the cad.