Tuesday, March 16, 2010

Are All the Large Banks Insolvent?

Last Thursday, the Lehman bankruptcy court's examiner report was filed.  It was undertaken by Anton Valukas of Jenner and Block; it took a year, is over 2200 pages, and cost 38 million well spent dollars.  The Baseline Scenario has since posted an excellent, brief synopsis of the more relevant sections.  Yves Smith of naked capitalism was one of the first to respond with emphasis on the collaboration of the New York Fed under Geithner, which allowed a series of lowered criteria stress tests to be performed on Lehman and ignored they failed.

Washington'sblog concentrated on the fraudulent aspects of the cooking of the books and the failure of the Fed and the accounting firm, Ernst & Young to sufficiently act on what they knew.  Karl Denninger of MarketTicker espoused the judgment that this proves all large banks are insolvent as the result of fraudulent accounting and government cover up and he was according liquidating all of his long positional trades as a direct result.

We briefly discussed the above on last Saturday's radio show, but did not have the time we would have liked for this subject, because this report shows serious, deep failures of the financial and regulatory system to curtail blatantly fraudulent activities much less systemically dangerous.  How fraudulent?  Can you say ":Enron"?  With Enron, their independent auditor, Arthur Anderson, went out of business, although it was ultimately found they were not as liable as originally alleged.  Unfortunately, it is not uncommon for auditors, particularly if a very large and prominent or otherwise important client is involved, to not press issues or dig deep enough if the client is adamant in their position and the issue involves a technical call decision on facts which are not black-and-white caught in the spot light.  But Ernst & Young had information from a whistleblower, had questioned the transactions, kicked the issue up their own organizational ladder, and ended up going along with it.

Some people are calling for Fuld as the Lehman CEO and Lehman financial officers to be charged with fraud.  Fuld has already denied any knowledge of how the Repo 105 transactions happened improperly.  Basically, they took a financing transaction which should have been reported on both sides of the balance sheet and recorded it as a sale taking it completely off the balance sheet.  Authorities should not only be looking at former Lehman officers but the Board of Directors also.  If members of the New York Fed knew of these transactions, they are complicit.

The Valukas report also questions if JP Morgan Chase, whose CEO, Jaime Dimon, sits on the Board of the New York Fed, made collateral claims in the days just prior to the Lehman failure which put it in an over collateralized position and may have contributed to the failure.  We already know that Joseph Stiglitz believes the Fed district banks are working conflicts of interest with bankers regulating bankers.  How much did Jaime Dimon know about Lehman from his position as a Director of the New York Fed. and did he use it to protect JP Morgan Chase?

Frank Partnoy has questioned whether Lehman was too complex to do anything but fail, because the Valukas report cites numerous valuation problems.  To Partnoy this implies Lehman did not know how to value its trades, assets, and liabilities.  To me, I find it impossible to believe that the Lehman employees and officers did not understand exactly what they were doing.  It was done extensively and repeatedly to such an extent that the Board of Directors had to know enough, at the very least, to not ask.

We have repeatedly discussed the role of Treasury and the Fed in getting regulatory authorities to allow the banks to fraudulently represent their balance sheets while they rebuild their capitalization with new stock and debt issuances.  They have enjoyed the "legal" deferral of proper accounting of assets and transactions which, if practiced by any other business entity would result in terminal fraud charges.  They have been allowed to carry toxic assets on their books at exaggerated valuation.  Repo 105 transactions are not the only type of financial transaction that could have been utilized by any bank to misrepresent value and hide leverage in any of the gray areas of FASB 140 or other financial transactions and trades utilizing off balance sheet entities or other willing companies desiring to make a few basis points quick profit.

The brush fire which has ensued from the Valukas report has started to encircle Tim Geithner and all of the poisoned apples collected in his financial rescue basket.  What did he know and when did he know it or is he just a dupe of the bankers?  If all the banks are using or have used similar financial chicanery much less been allowed to carry toxic assets at inflated values, are any of the large banks not insolvent?

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