Tag Archives: William K. Black

Bill Black: Jobs Now, Stop The Foreclosures, Jail The Banksters

Boots on the Ground

Does Obama’s Housing Plan Miss the Mark

William K. Black’s appearance on the Dylan Ratigan Show for Tuesday, October 25th.  For those interested in cutting straight to the chase, Bill comes in around 2:30 min.

http://www.msnbc.msn.com/id/32545640

Bill Black: What I’d Demand of the Fed

Bill Black on The Real News with Paul Jay:

Wanted

http://www.scribd.com/embeds/70145902/content?start_page=1&view_mode=slideshow&access_key=key-261dk8wqm16h3m5c9h28(function() { var scribd = document.createElement(“script”); scribd.type = “text/javascript”; scribd.async = true; scribd.src = “http://www.scribd.com/javascripts/embed_code/inject.js”; var s = document.getElementsByTagName(“script”)[0]; s.parentNode.insertBefore(scribd, s); })();

Greece: the ECB’s Daily Floggings will Continue until the Greek Economy Recovers


The European “troika” that has been driving Greece into adeepening depression has just completed an analysis documenting the failure ofits policies.  The analysis hasleaked.  Here are its introductoryparagraphs.

Greece:Debt Sustainability Analysis
October21, 2011

“Since the fourthreview, the situation in Greece has taken a turn for the worse, with the economyincreasingly adjusting through recession and related wage-price channels,rather than through structural reform driven increases in productivity. Theauthorities have also struggled to meet their policy commitments against theseheadwinds. For the purpose of the debt sustainability assessment, a revisedbaseline has been specified, which takes into account the implications of thesedevelopments for future growth and for likely policy outcomes. It has beenextended through 2030 to fully capture long term growth dynamics, and possiblefinancing implications.
The assessment showsthat debt will remain high for the entire forecast horizon. While it woulddecline at a slow rate given heavy official support at low interest rates(through the EFSF [European Financial Stability Facility] asagreed at the July 21 Summit), this trajectory is not robust to a range ofshocks.  Making debt sustainable willrequire an ambitious combination of official support and private sectorinvolvement (PSI). Even with much stronger PSI, large official sector support wouldbe needed for an extended period. In this sense, ultimately sustainabilitydepends on the strength of the official sector commitment to Greece.”

The leakedmemo helps explain why the Troika always lets the periphery twist slowly in thewind even though doing so hurts everyone – if this memo is representative theTroika must be choking to death on its jargon, theoclassical economics dogma,and its propaganda.  In plain English,the memo concludes:
1.  Greece’seconomy is crashing
2.  Ourclaim that the “reforms” we were imposing would cause productivity improvementsthat would drive a robust recovery has proven false
3.  Ourprediction that the Greek economy would improve and allow Greece to repay itsdebts is inoperative
4.  Ournew prediction is that Greek debt will remain dangerously high for the lengthof our prediction (through 2030)
5.   If anything nasty happens to the economyduring the next 20 years Greece will be unable to repay its debt
6.  Onlylong-term bail outs and requiring Greece’s creditors to take substantial lossescan make it possible for Greece to avoid collapse
Those admissions, while striking, are notthe Troika’s most important admission.  Notethat the Troika’s first paragraph contains the remarkable phrase that Greece is“adjusting through recession.”  Apparently,Greece is adjusting to a recession “through recession.”  One assumes that under this framing Greece“adjusted” to World War II through its troops and civilians dying.  What the Troika appears to be trying to sayis that Greek wages are falling as the Greek economy collapses, which causesthe collapse to accelerate.  Thememorandum claimed that the Troika’s initial model was based on experience inother nations that were forced to adopt austerity during a severe recession andexperienced remarkable recoveries, but admits that the model has failed inGreece.  (The reality is that it failedin the other nations as well, but the Troika is having enough trouble admittingthe truth about Greece.) 
The Troika’s new, more pessimisticforecast is that Greece’s recession is mild by the start of 2012 and is over bythe end of 2012.  That is an extremelyoptimistic assumption, not a pessimistic one. The odds are strong that the Troika’s austerity program will causeGreece to descend into a severe recession. If it does, the Troika’s plan blows up immediately.  But the Troika recognizes that it does notrequire a recession to blow up their projections.  Stresstests to this revised baseline illuminate further the problem with sustainability,revealing that the downward debt trajectory would not be robust to shocks.”  If almost anything material goes wrong – overthe next twenty years – the Troika project that the Greek economy would descendinto a debt and deficit death spiral.  The odds that nothing relevant to the Greekeconomy and government will go wrong over the next two decades are tiny.  The Troika is basing its new plan onassumptions that are so rosy that they could populate a large flower garden.
The Troika assumes that Greece will run avery large “primary surplus” in its budget – and maintain it for decades.  The Troika recognizes that this “requiressustained and unwavering commitment to fiscal prudence by the Greek authorities.”  There are two problems with thisassumption.  It is imprudent to run abudgetary surplus during a collapse of private sector demand that is causing asevere recession.  Doing so will make theexisting recession far worse and trying to do so for decades will cause orexacerbate future recessions.  The Troikaassumes the opposite:  “[S]trong growth willbe very hard to achieve unless Greece’s high debt overhang is decisively tackled.Overall, the scenario emphasizes the crucial importance of frontloadinggrowth-enhancing structural reforms for debt sustainability.”  The Troika concedes that it is critical thatGreece promptly achieve substantial growth. The Troika, however, is insisting on austerity – budget surpluses –during a severe recession.  That is apro-cyclical policy that makes the recession worse.  The Troika is counting on magic –“growth-enhancing structural reforms” to overcome the self-destructive natureof their austerity program and produce a prompt, robust recovery from thereception.    
The second problem is that if the Troikabelieves that the Greek government will display a “unwavering commitment” fordecades to actions that are (deservedly) extremely unpopular among theelectorate then it must have been meeting in a an Amsterdam hash house when itwrote this sentence.
Adopting these new myths about Greece’sprompt recovery from recession and maintenance of very large surpluses fordecades allowed the Troika to abandon two prior myths.  The memorandum shows that the Troika hasdropped the fantasy that Greece will soon be able to borrow funds from themarkets without any guarantees from the European Central Bank (ECB).  The new estimate is that it will take adecade before Greece can borrow and that it will not be able to borrowsubstantial funds “until late [in] the second decade.”  Similarly, the Troika finally admits that aGreek default on its existing debt is certain. “Greece’s debt peaks at very high levels and would decline at a very slowrate pointing to the need for further debt relief to ensure sustainability.” 
The Troika has not given up one of theircentral myths even though it is one of the most pernicious myths in the last 80years.  It is one that Keynes (andreality) disproved long ago.  The Troikabelieves that if Greece fell into a deeper recession it would recover more quickly because of the recession.  The “logic” is that severe recessions lead tosharp drops in working class wages, which makes the nation far morecompetitive, which expands its exports, which accelerates Greece’s recovery under the Troika’s new model.    
“Tomodel this it is assumed that through much deeper recession and deflation thecompetitiveness gap is unwound by 2017, instead of during the next decade. The headwindsfrom the deeper recession are assumed to delay the achievement of fiscal andprivatization policy targets by three years.
Asthe economy rapidly shrinks, debt would reach extremely high levels in theshort run at 208 percent of GDP. If Greece could weather the shock toconfidence this could create, the eventual more rapid recovery of the economywould help bring debt back down towards the revised baseline path….”
This passage “explains” the Troika’s useof the phrase “adjusting through recession.” We can now see what a chilling phrase it is and how little empathy theTroika has for human beings who are suffering. “The competitiveness gap” assumes that the Greek working class isseriously overpaid and that as the recession deepens and causes ever greaterunemployment it will cause Greek wages to fall sharply until it reaches thepoint that the Greeks are competitive with places like Portugal.  The Troika propounds the myth that recessionsare self-correcting and that the more severe the recession the “more rapid[the] recovery.” 
Greece is already a nation beset bysevere income inequality and unemployment, and the Troika claims thatincreasing the income inequality and unemployment dramatically is one of thekeys to recovery.  Slashing working classwages and employment in a Great Recession, however, causes private sectordemand to fall sharply.  The underemployedcut their consumption for obvious reasons, but many workers will cutconsumption because they fear that they will lose their jobs.  The result of the Troika’s austerity policiesin Greece has not been a recovery, but a deepening depression, as the Troika’smemorandum admits.  Greece is notrecovering under the Troika’s self-defeating austerity mandates.  The Troika’s policies are analogous todoctors bleeding their patients centuries ago under the delusion that itimproved their health. 
In the same quoted passage, the Troikapresents an additional myth – “deflation” causes nations in severe recessionsto recover.  Deflation does the opposite,for several reasons.  I will explainbriefly only one of these reasons.  Whenprices are falling on major goods for which it is often possible to deferpurchases (e.g., buying a new automobile or refrigerator), consumers may defertheir purchases because deflation means that they can buy those goods at alower price in the future.  One of thefundamental characteristics of severe recessions is grossly inadequate privatesector demand, so deflation exacerbates recessions by reducing private sectordemand.
The Troika’s memorandum has a revealingaside about what the ECB cares about. The context is the presentation of the necessity of Greece’s creditorsagreeing to large reductions in Greece’s debts.
“DeeperPSI,which is now being contemplated, also has a vital role in establishing thesustainability of Greece’s debt.”
That sentence ends with the followingfootnote.
1“The ECB does not agree with the inclusion of these illustrative scenariosconcerning a deeper PSI in this
report.”
The ECB has no statutory mission toprotect the interests of Greece’s creditors. Its decision to side with the interests of Greece’s creditors(overwhelmingly European banks, particularly German banks) against theinterests of a member nation makes clear why the ECB poses an enormous dangerto Europe.  The ECB is dominated bytheoclassical economists who glory in their “independence” from democraticinstitutions but are slavish servants of the systemically dangerousinstitutions (SDIs) – the misnamed “too big to fail” banks.

The Anti-Regulators are the “Job Killers”


The new mantra of the Republican Party is the old mantra –regulation is a “job killer.”  It iscertainly possible to have regulations kill jobs, and when I was a financialregulator I was a leader in cutting away many dumb requirements.   Wehave just experienced the epic ability of the anti-regulators to kill well overten million jobs.  Why then is there nota single word from the new House leadership about investigations to determinehow the anti-regulators did their damage? Why is there no plan to investigate the fields in which inadequateregulation most endangers jobs?  Whilewe’re at it, why not investigate the areas in which inadequate regulationallows firms to maim and kill.  This columnaddresses only financial regulation.

Deregulation, desupervision, and de facto decriminalization (thethree “des”) created the criminogenic environment that drove the modern U.S.financial crises.  The three “des” wereessential to create the epidemics of accounting control fraud thathyper-inflated the bubble that triggered the Great Recession.  “Job killing” is a combination of two factors– increased job losses and decreased job creation.  I’ll focus solely on private sector jobs –but the recession has also been devastating in terms of the loss of state andlocal governmental jobs. 


http://www.bls.gov/web/cewbd/annchrt1_1.gif
From 1996-2000, for example, annual private sector gross jobincreases rose from roughly 14 million to 16 million while annual privatesector gross job losses increased from 12 to 13 million.  The annual net job increases in those years,therefore, rose from two million to three million.  Over that five year period, the net increasein private sector jobs was over 10 million. One common rule of thumb is that the economy needs to produce an annualnet increase of about 1.5 million jobs to employ new entrants to our workforce,so the growth rate in this era was large enough to make the unemployment andpoverty rates fall significantly.

The Great Recession (which officially began in the thirdquarter of 2007) shows why the anti-regulators are the premier job killers inAmerica.  Annual private sector gross joblosses rose from roughly 12.5 to a peak of 16 million and gross private sector jobgains fell from approximately 13 to 10 million. As late as March 2010, afterthe official end of the Great Recession, the annualized net job loss in theprivate sector was approximately three million (that job loss has now turnedaround, but the increases are far too small). Again, we need net gains of roughly 1.5 million jobs to accommodate newworkers, so the total net job losses plus the loss of essential job growth waswell over 10 million during the Great Recession.  These numbers, again, do not include the largejob losses of state and local government workers, the dramatic rise inunderemployment, the sharp rise in far longer-term unemployment, and thesalary/wage (and job satisfaction) losses that many workers had to take to finda new, typically inferior, job after they lost their job.  It also ignores the rise in poverty,particularly the scandalous increase in children living in poverty.

The Great Recession was triggered by the collapse of thereal estate bubble epidemic of mortgage fraud by lenders that hyper-inflatedthat bubble.  That epidemic could nothave happened without the appointment of anti-regulators to key leadershippositions.  The epidemic of mortgagefraud was centered in loans that the lending industry (behind closed doors)referred to as “liar’s” loans – so any regulatory leader who was not ananti-regulatory ideologue would (as we did in 1990-1990 during the first waveof liar’s loans in California) have ordered banks not to make these pervasivelyfraudulent loans.  One of the problemswas the existence of a “regulatory black hole” – most of the nonprime loanswere made by lenders not regulated by the federal government.  That black hole, however, conceals two broaderfederal anti-regulatory problems.  Thefederal regulators actively made the black hole more severe by preempting stateefforts to protect the public from predatory and fraudulent loans.  Greenspan and Bernanke are particularlyculpable.  In addition to joining the jihad state regulation, the Fed hadunique federal regulatory authority under HOEPA (enacted in 1994) to fill theblack hole and regulate any housing lender (authority that Bernanke finallyused, after liar’s loans had ended, in response to Congressional criticism).  The Fed also had direct evidence of thefrauds and abuses in nonprime lending because Congress mandated that the Fedhold hearings on predatory lending.   

The S&L debacle, the Enron era frauds, and the currentcrisis were all driven by accounting control fraud.  The three “des” are critical factors increating the criminogenic environments that drive these epidemics of accountingcontrol fraud.  The regulators are the“cops on the beat” when it comes to stopping accounting control fraud.  If they are made ineffective by the three“des” then cheaters gain a competitive advantage over honest firms.  This makes markets perverse and causesrecurrent crises.       

From roughly 1999 to the present, three administrations havedisplayed hostility to vigorous regulation and have appointed regulatoryleaders largely on the basis of their opposition to vigorous regulation.  When these administrations occasionallyblundered and appointed, or inherited, regulatory leaders that believed inregulating the administration attacked the regulators.  In the financial regulatory sphere, recentexamples include Arthur Levitt and William Donaldson (SEC), Brooksley Born(CFTC), and Sheila Bair (FDIC).  Similarly,the bankers used Congress to extort the Financial Accounting Standards Board(FASB) into trashing the accounting rules so that the banks no longer had torecognize their losses.  The twinpurposes of that bit of successful thuggery were to evade the mandate of thePrompt Corrective Action (PCA) law and to allow banks to pretend that they weresolvent and profitable so that they could continue to pay enormous bonuses totheir senior officials based on the fictional “income” and “net worth” producedby the scam accounting.  (Not recognizingone’s losses increases dollar-for-dollar reported, but fictional, net worth andgross income.)  When members of Congress(mostly Democrats) sought to intimidate us into not taking enforcement actionsagainst the fraudulent S&Ls we blew the whistle.  Congress investigated Speaker Wright and the“Keating Five” in response.  I testifiedin both investigations.  Why is the new Houseleadership announcing its intent to give a free pass to the accounting controlfrauds, their political patrons, and the anti-regulators that created thecriminogenic environment that hyper-inflated the financial bubble thattriggered the Great Recession and caused such a loss of integrity?  The anti-regulators subverted the rule of lawand allowed elite frauds to loot with impunity. Why isn’t the new House leadership investigating that disgrace as one oftheir top priorities?  Why is the new Houseleadership so eager to repeat the job killing mistakes of taking the regulatorycops off their beat?              
Bill Black is an Associate Professor of Economics and Law atthe University of Missouri-Kansas City. He is also a white-collar criminologist, a former senior financialregulator, a serial whistleblower, and the author of The Best Way to Rob a Bank is to Own One.  

Prof. Bill Black and #OWS: “This is Not a Red State / Blue State Issue”

Dylan Ratigan speaks with William K. Black, and two Wall Street occupiers in his latest podcast of Radio Free.

http://player.soundcloud.com/player.swf?url=http%3A%2F%2Fapi.soundcloud.com%2Ftracks%2F25908258&Ep 73: Prof. Bill Black and Occupiers Goldi & Calvin by Dylan Ratigan

William K. Black on Democracy Now: 10/19/2011

For those of you who missed the live interview this morning, watch Bill Black on Democracy Now with Amy Goodman:

Not with a Bang, but a Whimper: Bank of America’s Death Rattle

By William K. Black

Bob Ivry, Hugh Son and Christine Harper have written anarticle that needs to be read by everyone interested in the financialcrisis.  The article (available here) is entitled: BofA Said to Split RegulatorsOver Moving Merrill Derivatives to Bank Unit. The thrust of their story is that Bank of America’s holdingcompany, BAC, has directed the transfer of a large number of troubled financialderivatives from its Merrill Lynch subsidiary to the federally insured bank Bank of America (BofA).  The story reports that the FederalReserve supported the transfer and the Federal Deposit Insurance Corporation(FDIC) opposed it.  Yves Smith of Naked Capitalism has written an appropriately blistering attack on this outrageous action, which puts thepublic at substantially increased risk of loss.  

I write toadd some context, point out additional areas of inappropriate actions, and adda regulatory perspective gained from dealing with analogous efforts by holdingcompanies to foist dangerous affiliate transactions on insureddepositories.  I’ll begin by adding somehistorical context to explain how B of A got into this maze of affiliateconflicts.

KenLewis’ “Scorched Earth” Campaign against B of A’s Shareholders

AcquiringCountrywide: the High Cost of CEO Adolescence

During this crisis, Ken Lewis went on a buying spreedesigned to allow him to brag that his was not simply bigger, but thebiggest.  Bank of America’s holdingcompany – BAC – became the acquirer of last resort.  Lewis began his war on BAC’s shareholders byordering an artillery salvo on BAC’s own position.  What better way was there to destroyshareholder value than purchasing the most notorious lender in the world –Countrywide.  Countrywide was in themidst of a death spiral.  The FDIC wouldsoon have been forced to pay an acquirer tens of billions of dollars to induceit to take on Countrywide’s nearly limitless contingent liabilities and toxicassets.  Even an FDIC-assistedacquisition would have been a grave mistake. Acquiring thousands of Countrywide employees whose primary mission wasto make fraudulent and toxic loans was an inelegant form of financialsuicide.  It also revealed the negligiblevalue Lewis placed on ethics and reputation.  
    
But Lewis did not wait to acquire Countrywide with FDICassistance.  He feared that a rival wouldacquire it first and win the CEO bragging contest about who had the biggest,baddest bank.  His acquisition ofCountrywide destroyed hundreds of billions of dollars of shareholder value andled to massive foreclosure fraud by what were now B of A employees. 

But there are two truly scary parts of the story of B of A’sacquisition of Countrywide that have received far too little attention.  B of A claims that it conducted extensive duediligence before acquiring Countrywide and discovered only minor problems.  If that claim is true, then B of A has beendoomed for years regardless of whether it acquired Countrywide.  The proposed acquisition of Countrywide was hugeand exceptionally controversial even within B of A.  Countrywide was notorious for its fraudulentloans.  There were numerous lawsuits andformer employees explaining how these frauds worked. 

B of A is really “Nations Bank” (formerly named NCNB).  When Nations Bank acquired B of A (the SanFrancisco based bank), the North Carolina management took completecontrol.  The North Carolina managementdecided that “Bank of America” was the better brand name, so it adopted thatname.  The key point to understand isthat Nations/NCNB was created through a large series of aggressive mergers, sothe bank had exceptional experience in conducting due diligence of targets foracquisition and it would have sent its top team to investigate Countrywidegiven its size and notoriety.  Theacquisition of Countrywide did not have to be consummated exceptionallyquickly.  Indeed, the deal had an “out”that allowed B of A to back out of the deal if conditions changed in an adversemanner (which they obviously did).  If Bof A employees conducted extensive due diligence of Countrywide and could notdiscover its obvious, endemic frauds, abuses, and subverted systems then theyare incompetent.  Indeed, that word istoo bloodless a term to describe how worthless the due diligence team wouldhave had to have been.  Given the manyacquisitions the due diligence team vetted, B of A would have been doomedbecause it would have routinely been taken to the cleaners in those earlierdeals.

That scenario, the one B of A presents, is not credible.  It is far more likely that B of A’s seniormanagement made it clear to the head of the due diligence review that the dealwas going to be done and that his or her report should support that conclusion.  This alternative explanation fits well with Bof A’s actual decision-making. Countrywide’s (and B of A’s) reportedfinancial condition fell sharply after the deal was signed.  Lewis certainly knew that B of A’s actualfinancial condition was much worse than its reported financial condition andhad every reason to believe that this difference would be even worse atCountrywide given its reputation for making fraudulent loans.  B of A could have exercised its option towithdraw from the deal and saved vast amounts of money.  Lewis, however, refused to do so.  CEOs do not care only about money.  Ego is a powerful driver of conduct, and CEOscan be obsessed with status, hierarchy, and power.  Of course, Lewis knew he could walk awaywealthy after becoming a engine of mass destruction of B of A shareholdervalue, so he could indulge his ego in a manner common to adolescent males.   


AcquiringMerrill Lynch: the Lure of Liar’s Loans

Merrill Lynch is the quintessential example of why it wascommon for the investment banks to hold in portfolio large amounts ofcollateralized debt obligations (CDOs). Some observers have jumped to the naïve assumption that this indicatesthat the senior managers thought the CDOs were safe investments.  The “recipe” for an investor maximizingreported income differs only slightly from the recipe for lenders.

  1. Grow rapidly by
  2. Holding poor quality assets that provide a premium nominal yield while
  3. Employing extreme leverage, and
  4. Providing only grossly inadequate allowances for future losses on the poor quality assets
Investment banks that followed this recipe (and most largeU.S. investment banks did), were guaranteed to report record (albeit fictional)short-term income.  That income wascertain to produce extreme compensation for the controlling officers.  The strategy was also certain to produceextensive losses in the longer term – unless the investment bank could sell itslosing position to another entity that would then bear the loss. 

The optimal means of committing this form of accountingcontrol fraud was with the AAA-rated top tranche of CDOs.  Investment banks frequently purport to basecompensation on risk-adjusted return.  Ifthey really did so investment bankers would receive far less compensation.  The art, of course, is to vastly understatethe risk one is taking and attribute short-term reported gains to the officer’s brilliance in achievingsupra-normal returns that are not attributable to increased risk(“alpha”).  Some of the authors of Guaranteed to Fail call this processmanufacturing “fake alpha.” 

The authors are largely correct about “fake alpha.”  The phrase and phenomenon are correct, butthe mechanism they hypothesize for manufacturing fake alpha has no basis inreality.  They posit honest gambles on“extreme tail” events likely to occur only in rare circumstances.  They provide no real world examples.  If risk that the top tranche of a CDO wouldsuffer a material loss of market values was, in reality, extremely rare then itwould be impossible to achieve a substantial premium yield.  The strategy would diminish alpha rather thanmaximizing false alpha.  The risk thatthe top tranche of a CDO would suffer a material loss in market value washighly probable.  It was not a tailevent, much less an “extreme tail” event. CDOs were commonly backed by liar’s loans and the incidence of fraud inliar’s loans was in the 90% range.  Thetop tranches of CDOs were virtually certain to suffer severe losses as soon asthe bubble stalled and refinancing was no longer readily available to delay thewave of defaults.  Because liar’s loanswere primarily made to borrowers who were not creditworthy and financiallyunsophisticated, the lenders had the negotiating leverage to charge premiumyields.  The officers controlling therating agencies and the investment banks were complicit in creating a corruptsystem for rating CDOs that maximized their financial interests by routinelyproviding AAA ratings to the top tranche of CDOs “backed” largely by fraudulentloans.  The combination of the fake AAArating and premium yield on the top tranche of fraudulently constructed (andsold) CDOs maximized “fake alpha” and made it the “sure thing” that is one ofthe characteristics of accounting control fraud (see Akerlof & Romer 1993;Black 2005).  This is why many of theinvestment banks (and, eventually, Fannie and Freddie) held substantial amountsof the top tranches of CDOs.  (A similardynamic existed for lower tranches, but investment banks also found it muchmore difficult to sell the lowest tranches.)  

Merrill Lynch was known for the particularly large CDOpositions it retained in portfolio. These CDO positions doomed Merrill Lynch.  B of A knew that Merrill Lynch had tremendouslosses in its derivatives positions when it chose to acquire MerrillLynch. 

Giventhis context, only the Fed, and BAC, could favor the derivatives deal

Lewis and his successor, Brian Moynihan, have destroyednearly one-half trillion dollars in BAC shareholder value.  (See my prior post on the “Divine Right ofBank Profits…”)  BAC continues todeteriorate and the credit rating agencies have been downgrading it because ofits bad assets, particularly its derivatives. BAC’s answer is to “transfer” the bad derivatives to the insured bank – transforming (alaIreland) a private debt into a public debt. 

Banking regulators have known for well over a century aboutthe acute dangers of conflicts of interest. Two related conflicts have generated special rules designed to protectthe bank and the insurance fund.  Onerestricts transactions with senior insiders and the other restrictstransactions with affiliates.  The scamis always the same when it comes to abusive deals with affiliates – theytransfer bad (or overpriced) assets or liabilities to the insured institution.  As S&L regulators, we recurrently facedthis problem.  For example, Ford MotorCompany attempted to structure an affiliate transaction that was harmful to theinsured S&L (First Nationwide).  Thebank, because of federal deposit insurance, typically has a higher creditrating than its affiliate corporations.

BAC’s request to transfer the problem derivatives to B of Awas a no brainer – unfortunately, it was apparently addressed to officials atthe Fed who meet that description.  Anycompetent regulator would have said: “No, Hell NO!”  Indeed, any competent regulator would havedeveloped two related, acute concerns immediately upon receiving therequest.  First, the holding company’scontrolling managers are a severe problem because they are seeking to exploitthe insured institution.  Second, thesenior managers of B of A acceded to the transfer, apparently without protest,even though the transfer poses a severe threat to B of A’s survival.  Their failure to act to prevent the transfercontravenes both their fiduciary duties of loyalty and care and should lead totheir resignations.

Now here’s the really bad news.  First, this transfer is a superb “naturalexperiment” that tests one of the most important questions central to thehealth of our financial system.  Does theFed represent and vigorously protect the interests of the people or thesystemically dangerous institutions (SDIs) – the largest 20 banks?  We have run a real world test.  The sad fact is that very few Americans willbe surprised that the Fed represented the interests of the SDIs even though theywere directly contrary to the interests of the nation.  The Fed’s constant demands for (andcelebration of) “independence” from democratic government, combined withslavish dependence on and service to the CEOs of the SDIs has gone beyondscandal to the point of farce.  I suggestorganized “laugh ins” whenever Fed spokespersons prate about their“independence.”

Second, I would bet large amounts of money that I do nothave that neither B of A’s CEO nor the Fed even thought about whether thetransfer was consistent with the CEO’s fiduciary duties to B of A (v.BAC).  We took depositions during theS&L debacle in which senior officials of Lincoln Savings and its affiliateswere shocked when we asked “whose interests were you representing – the S&Lor the affiliate?”  They had obviouslynever even considered their fiduciary duties or identified their actualclient.  We blocked a transaction thatwould have caused grave injury to the insured S&L by taking the holdingcompany (Pinnnacle West) off the hook for its obligations to the S&L.  That transaction would have passed routinely,but we flew to the board of directors meeting of the S&L and reminded themthat their fiduciary duty was to the S&L, that the transaction was clearlydetrimental to the S&L and to the benefit of the holding company, and thatwe would sue them and take the most vigorous possible enforcement actionsagainst them personally if they violated their fiduciary duties.  That caused them to refuse to approve thetransaction – which resulted in a $450 million payment from the holding companyto the S&L.  (I know, $450 millionsounds quaint now in light of the scale of the ongoing crisis, but back then itpaid for our salaries in perpetuity.) 

Third, reread the Bloomberg column and wrap your mind aroundthe size of Merrill Lynch’s derivatives positions.  Next, consider that Merrill is only one,shrinking player in derivatives. Finally, reread Yves’ column in NakedCapitalism where she explains (correctly) that many derivatives cannot beused safely.  Add to that my point abouthow they can be used to create a “sure thing” of record fictional profits,record compensation, and catastrophic losses. This is particularly true about credit default swaps (CDS) because ofthe grotesque accounting treatment that typically involves no allowances forfuture losses. (FASB:  you must fix thisurgently or you will allow a “perfect crime.”). It is insane that we did not pass a one sentence law repealing theCommodities Futures Modernization Act of 2000. Between the SDIs, the massive, sometimes inherently unsafe and largelyopaque financial derivatives, the appointment, retention, and promotion offailed anti-regulators, and the continuing ability of elite control frauds toloot with impunity we are inviting recurrent, intensifying crises. 

I’ll close with a suggestion and request to reporters.  Please find out who within the Fed approvedthis deal and the exact composition of the assets and liabilities that weretransferred.


To keep up with Bill’s work follow on Twitter @WilliamKBlack and @deficitowl