Market Manipulation 101 or How to Rob Fort Knox in front of a Congressional Panel

Every day, as the AIG saga unfolds, I have to wonder if there is any vestige of a functional regulatory scheme left in this country. I’ve already decided that there is no shred of decency left in any one whose hand came close to unraveling the insurance giant and its deals. I know this is an area where eyes glaze over, but really, it’s like solving a crime that even Miss. Marple couldn’t fathom. Ladies and Gentlemen, we’ve been robbed.

It may be too complex for most journalists to report about, but the financial blog realm, full of individual investors, academics and pissed off Americans is keeping the story alive. The headline today from the Atlantic is there are $100 Million More in AIG bonuses. Don’t forget, we basically OWN this company so this is OUR money. Most voters are wise enough to know that this alone does not pass the threshold of decency. You don’t have to have a PHd with an emphasis on corporate governance to figure out that something is very wrong when people can bankrupt a company one year, and still collect bonuses the very next.

In the ongoing AIG bonus saga, the troubled insurer will distribute around $100 million in bonuses today, that’s likely much to the dismay of taxpayers who now own the firm. Despite the fact that AIG is technically under compensation restrictions, many so-called “guaranteed bonuses” that were in place before AIG’s collapse still must be honored by law. This is a regrettable situation, and speaks loudly to the messy problem that bailouts pose.

This is the headline today in many of the mainstream papers. This includes the NY Times that reports those bonuses may have been lowered by$20 million to lessen the blow. This is a mere trifling compared to what was pilfered from the dying AIG by Goldman Sachs as it was in the throes of death. Those Revenuers let Goldman Sachs pick clean the dead body of AIG before we got the bill for the funeral.

“A.I.G. has taxpayers over a barrel,” said Senator Charles E. Grassley, an Iowa Republican, in a statement on Tuesday night. “The Obama administration has been outmaneuvered. And the closed-door negotiations just add to the skepticism that the taxpayers will ever get the upper hand.”

A.I.G. first promised the retention bonuses to keep people working at its financial products unit, which traded in the derivatives that imploded in September 2008, leading to the biggest government bailout in history.

The contracts, which were established in December 2007, were intended to keep people from leaving the company and called for the bonuses to be paid in regular installments to more than 400 employees in the unit. The final payment, which was for about $198 million, was due in mid-March, but was accelerated to Wednesday as part of the agreement to reduce its size.

Fearing a firestorm like the one last spring, A.I.G. had been working with the Treasury’s special master for compensation, Kenneth R. Feinberg, on a compromise that would allow it to keep its promise in part, without offending taxpayers.

So, the bonuses plays into the theme of the moment–Populist Outrage–which is driving everything from angry teabots to high ratings for media screamers like Glenn Beck. It hides a bigger problem. What is going on behind the schemes in the books and the deals as we attempt to bailout a group of bad gamblers is far worse. Yves Smith of Naked Capitalism lays out some of the issues on HuffPo as well as a series of thread at her own blog. While we rage at the bonuses, the real crime happened behind the curtains, where you’re not supposed to notice Timothy Geithner, pulling the strings and blowing the steam from the giant talking head of Glenn Beck.

Although the focus of press and public attention has been the decision to pay out “100%”, this issue has not been framed as crisply as it should be. Remember, the underlying transactions were crap CDOs that the banks (or bank customers, a subject we will turn to later) owned, and on which the banks had gotten credit default swaps from AIG. The Fed in fact paid out WELL MORE than 100% on the value of the AIG credit default swaps by virtue of also buying the CDOs.

That is one simple paragraph to describe the scheme behind the bailout of AIG. The facts are nearly beyond belief and as Congressman Dennis Kucinich put it, the testimony provided by Timmy-in-the-Well-again Geithner and among others doesn’t “pass the smell test.” I’m not sure how you miss the smells coming from an open, festering mass grave. But, the majority of Americans, and Congressio Critters, seem to think it could be just a few dead birds in the attic. The evil is the ledger accounts at the New York Fed.

Smith says the details show the FED as either captured regulator exhibiting ‘crony behavior’ or the behavior of Geithner was duplicitous and merits legal action. That is even mild. Her Huffpo article lays out the arguments for both scenarios. Either way, Giethner’s NY Fed comes off badly and Paulson and the Bush Treasury come off as co-conspirators to a heist.

Another article which demonstrates palpable anger at both the ineffective Fed and Congress is written in the financial/investment blog Money Morning by Shah Giliani who is a retired Hedge Manager. Again, the lack of knowledgeable staff could be the reason the pieces to the puzzle are being put together outside of the mainstream media. It could be the story is too complex to be glamorous and deemed beyond the reach of the average 5th grade reading level achieved at most major newspapers. It’s even possible no one wants to take on the financial industry. The deal is what happened as outlined in the testimony–had some one on that Congressional Panel actually had a background in something other than professional politics subsidized by the FIRE lobby and a plethora of worthless law degrees and knew finance–should’ve caused outrage around the country and sent subpoenas flying out of the justice department and the SEC. The central players in this are Goldman Sachs and the New York Fed whose people are so entrenched now in the Treasury and the West Wing that you have to wonder if there ever will be enough justice left in this country to counteract what should be the cries of lynch mobs. Following through with the legal obligations to pay out the bonuses–with the smallish $20 million concession–is just the sprinkles on the cake. Perhaps it’s easier to pay them than to have the AIG financiers talk about the details as the FED and Treasury unwound their deals.

The rationale for what is essentially the breaking of so many laws is the rescue of the U.S. and the world from another Great Depression. There are always ignoble deeds, however, done in the name of the most noble causes. This should go down in the press and in history as The Great U.S. Treasury and Financial Market Heist. The last two secretaries of Treasury-Paulson and Geithner–should be hauled before a government tribunal and stuck in Gitmo with the rest of the terrorists and enemies of the state. The dirty details follow the fold.

From Giliani:

The reality is that at the time of the government’s initial $85 billion infusion into AIG on Sept. 16, 2008, for which it received a 79.9% ownership interest, there was no mention of AIG’s endangered insurance subsidiaries. In fact, New York Insurance Superintendent Eric Dinello, who oversaw AIG’s insurance businesses, was confident enough in the subsidiaries to consider transferring $20 billion in excess reserves from the insurance subsidiaries to their AIG parent.

What was really sucking the life out of AIG were collateral demands – in other words, margin calls. A wholly owned, London-based financial-products subsidiary of AIG had written hundreds of billions of dollars of credit-default-swap contracts on exotic collateralized debt obligations (CDOs).

The derivative swaps on the CDOs were insurance policies that would protect the buyers of those CDOs against losses on underlying subprime mortgage pools. As losses on subprime mortgages mounted, the insured parties demanded more collateral from AIG.

AIG ran out of cash to make the collateral calls.

At the time of AIG’s crisis, the Fed and the Treasury Department were terrified that if the “counterparties” to AIG’s credit default swaps weren’t paid, the ripple effect would threaten all counterparties – not to mention the entire financial system.

So here’s what the Fed did. It formed two Delaware-based, limited-liability companies, Maiden Lane II and Maiden Lane III (Maiden Lane I had already been set up and funded by $29 billion of taxpayer money to buy and hold the bad assets from the failure of The Bear Stearns Cos., so that JPMorgan Chase & Co. (NYSE: JPM) could take over whatever remained of Bear’s carcass).

Maiden Lane II borrowed $19.5 billion from the Federal Reserve Bank of New York to buy $39.3 billion of residential mortgage backed securities from AIGs solvent insurance subsidiaries for $20.8 billion, or about 50 cents on the dollar. Maiden Lane III borrowed $24.3 billion from the New York Fed to buy an asset portfolio of CDOs, whose “fair value” was estimated to be $29.6 billion.

The CDOs were purchased from AIG’s counterparties. Between the $29.6 billion the counterparties received, and the cash they got from the collateral calls provided by taxpayers when AIG didn’t have the cash to make good on its obligations, those counterparties were made 100% whole on more than $62 billion in par value of toxic-derivative CDOs.

Here’s the rationale behind this egregious maneuver: Government officials believed that the counterparties would sell their toxic junk, and would then cancel their CDS insurance contracts with AIG – which would then end the margin calls.

Alright, let me say just one thing here. THIS is WEIRD in one of those setting off alarm bells sorta way. Again, unfortunately, you can call a Congressional Committee together, but it doesn’t mean any one in the room will know what to do with the testimony. This isn’t the normal way things are done when CDOs are settled at all. Yves Smith nails that in her article at HuffPo.

The Fed could have negotiated a cash settlement (which probably would have amounted to letting the counterparties keep the collateral, with some further adjustments based on the usual arm wrestling. This by the way, could have constituted a 100% payout on the credit default swaps (ie. the decision to pay out in full on the CDS was separate from the decisions to acquire the CDOs), but it would have left the banks with the CDOs. That would have been well short of $62.1 billion; all the dealers felt then that the CDOs had some value (while their marks also said that, dealers have been known to mark paper at unduly high prices to avoid reporting losses; with AIG’s credit-worthiness in doubt, the bankers’ accountants presumably required markdowns on the credit default swap hedges, which might give some banks an incentive to be less aggressive in reducing the value of their CDOs). That implies the credit defaults swaps themselves were worth considerably less than 100 cents on the dollar.

Buying the CDOs was an unnecessary step and increased the amount paid by the Fed, through AIG, to the counterparties. Moreover, the Fed has gone to unusual, even bizarre, lengths to keep matters regarding the CDOs themselves secret (a good bit of the discussion at the House Oversight Committee hearings on Wednesday today revolved around this issue; we’ve discussed previously why the Fed’s arguments for secrecy do not add up; we will return to this subject at later today at Naked Capitalism).

So notice, we not only have what is an irregular settlement procedure, , we appear to have a cover up by the New York Fed.  Timothy Geithner’s dead (la, la, la, la … la… )in the Star Trek alternative universe of lynch mobs and Congress that actually know about what that means.  Back to Gilani to take you to THAT universe.

Here’s the rationale behind this egregious maneuver: Government officials believed that the counterparties would sell their toxic junk, and would then cancel their CDS insurance contracts with AIG – which would then end the margin calls.

In the public hearings, House Committee members focused on why the Fed paid out 100 cents on the dollar to the counterparty banks and why those involved in the payout scheme then tried to hide who got that taxpayer money.

But the real story was unfolding behind the scenes. Congress doesn’t know about it, and the American people don’t know about it. But it will prove to be nightmare of massive proportions.

Although there were many U.S. banks that received inordinate amounts of money in this pay-off scheme, an equally sickening amount was paid to a handful of foreign banks.

But the biggest recipient of the cash siphoned from taxpayers was Goldman Sachs Group Inc. (NYSE: GS).

And you wondered why Blankfein ‘earned’ that $100 million dollar bonus. He got it the old fashioned way. Timothy Geithner helped him rob Fort Knox in a manner that this STUPID congressional committee hasn’t figured out yet. The deal also is that the NY FED is not releasing the TRANSACTIONAL detail that would provide the true post mortem. Now, Fed Chairmans usually don’t get involved in the day to day workings of the the branches. The branches value their in dependency and the Board of Governor’s audits usually are routine and predictable. If Bernanke is worth his salt, he’ll go around that protocol and ask for an complete audit of those books to include the Maiden Lane detail. The deal is that the timing of the deals is really really provocative. Back to Gilani.

Goldman officials had been telling every analyst or journalist who would listen that the investment bank was hedged against any counterparty risk. But what Goldman officials weren’t saying at the time was that the company was also hedged against AIG going bust. How? The company had purchased credit-default-swap insurance on AIG’s demise.

We know that is true because Stephen Friedman – the former Goldman CEO and onetime New York Fed chairman who was called to testify at the hearing – said so.

Attached to Friedman’s “Factors Affecting Effects to Limit Payments to AIG Counterparties: Prepared Testimony of Stephen Freidman Jan. 27, 2010,” was a “Chronology of Selected Events and Disclosures.”

That chronology included a reference to an Oct. 31, 2008 Wall Street Journal article that Friedman specifically chose to illustrate that it was common knowledge that Goldman was not in need of any government assistance, and wouldn’t be in any danger if AIG were to fail. This Journal excerpt included by Friedman contained the statement: “Goldman hedged its exposure by making a bearish bet on AIG, buying credit-default swaps on AIG’s own debt, according to one person knowledgeable about this move.”

Friedman was called to testify for one very key reason: At the time of the payments to the counterparties, he was chairman of the board of the New York Fed, which authorized those payments. But that’s not all. As a member of the board of directors and a former CEO of Goldman Sachs, Friedman would no doubt have had an excellent idea of the investment bank’s exposure to AIG – as well as what it stood to gain from those payments.

Freidman subsequently resigned from his post at the New York Fed on May 7, 2009, in response to criticism of his December 2008 purchase of $3 million of Goldman stock, which added to his substantial holdings – a purchase made only after he had ushered through Goldman’s approval to become a bank-holding company, enabling the firm to feed at the Fed’s generous liquidity trough.

There are so many red flags here that any one with any knowledge of these transactions is running around the blogosphere with their hair on fire. There are so many questions to be answered in these deals that you just have to hope there is some one in main stream journalism and some one in the Congress that will listen and act. Gilani ends with a list of very good questions. A bad answer to any ONE of them should land Timothy Geithner and a lot of folks in some serious trouble with the SEC.

I’m going to leave you with his list and hope he’s just set your hair on fire. For those of you that read detective fiction, this basically, is like solving a mass murder while the bodies are all still fresh. The Treasury Department (Paulson) and the NY Fed (Giethner) did so many things wrong, that cost us so much money and landed extraordinary profits (followed by the extraordinary bonuses pilfered from investors) that I can’t believe heads aren’t rolling, and again, subpoenas should be flying out of the justice department like bats out of caves at dusk.

  • Why didn’t the Treasury Department make the required margin calls – if they were needed – and stand to get collateral back if the insured CDOs rose in value?
  • Why did the New York Fed buy paper at 50 cents on the dollar and pay banks 100 cents, when they had no idea what the intrinsic value of those securities was at the time?
  • Who really leaned on the New York Fed to not disclose who got our taxpayer money?
  • What did Stephen Friedman know about the payments to Goldman?
  • What records exist of correspondence between Friedman and Timothy Geithner, who was then president of the New York Fed?
  • What records exist of correspondence between Friedman and Henry M. Paulson, Geithner’s predecessor as Treasury secretary and a former Goldman CEO himself.
  • If Goldman was really hedged as Friedman appeared to claim, then why did taxpayers pay the investment bank 100 cents on the dollar?
  • Did Goldman (and others) drive down the value of securities to collect cash, demand to be made whole and at the same time buy credit-default-swap insurance on AIG, which they were helping to sink?
  • Can we see the trade blotters of Goldman’s trading desks to determine what trading strategy those traders employed during this period and later when making record profits?
  • Why are so many Goldman Sachs people in so many powerful government positions?
  • Why has the United States government allowed a cabal of financial interests to hijack America?

One Comment on “Market Manipulation 101 or How to Rob Fort Knox in front of a Congressional Panel”

  1. crisismaven says:

    Thanks for all these links to opinionated articles! Ib case you’re interested: I have just added an Economics Reference List to my economics blog with economic and statistical data series, history, bibliographies etc. for students & researchers, probably the most comprehensive on the Internet. Currently over 200 meta sources, it will soon grow to over a thousand. Check it out and if you miss something, feel free to leave a comment.