THE BLOG
08/20/2013 07:31 am ET Updated Feb 24, 2014

Bankers' Games: Manipulation and 'Litigation'

Price manipulation is a time-honored tradition in structured finance. There will be abuse anytime there is a price "fixing" or a price set on the basis of a trade.

Instances of abuse are the dragons that "regulators" are supposed to constantly slay. When regulators are too slow, unwilling, or unable to do the job -- and if you haven't been paying attention, regulators have been all three for decades -- market professionals take matters into their own hands.

Price manipulation: Business as Usual

Breathless financial media reports focus on "scandals" as if they are extraordinary or shocking events, instead of business as usual. If you trade metals, any commodity, interest rate swaps, foreign exchange, futures, options, CDOs, credit derivatives, stocks, bonds, or any other financial instrument, expect price manipulation. Within limits, price manipulation is tolerated in every financial market.

If you're a market professional, your job isn't to express shock or outrage at the existence of price manipulation. Your job is to figure out how much is being done, and how it is being done. If it were easy, we wouldn't call it work.

Litigation Is a Game to Market Players

Your outrage is better directed elsewhere. So-called regulators, executives, supervisors, and managers make egregious price manipulation dead easy, instead of slaying these inevitable dragons. Laxity simply enables and encourages manipulation.

William K. Black has supplied a speechless market with the proper vocabulary. In a criminogenic environment, control fraud is an expected outcome. In a control fraud, bonus-seeking employees will manipulate financial markets, even if it damages their own financial institution, the host upon which the parasites feed.

In August 2007, Jamie Dimon, CEO of JPMorgan Chase, told me litigation is a game to him. The only thing that interests him is whether the other side is "good for it." This was in the middle of a discussion about flawed CDOs and growing problems at AIG, thirteen months before it required a massive taxpayer-funded bailout. JPMorgan wasn't a key counterparty of AIG (Goldman Sachs and cronies were), but it was the top U.S. bank in credit derivatives. AIG's woes posed systemic risk to the entire credit derivatives market.

Since then, JPMorgan lost money on a massive coal short, larger than the entire coal market, in the commodities unit headed by Blythe Masters. The bank manipulated this important market while the U.S. is at war. It was reported because it was a big loser. You don't hear about the big manipulated winners.

Masters was allegedly a key player in the manipulation of electricity prices according to the Federal Energy Regulatory Commission (FERC), and she allegedly committed perjury. It's likely she would have faced criminal charges had JPMorgan not paid FERC a $410 million penalty. Other banks are fighting FERC's fines, but their officers weren't accused of lying.

Dan Fitzpatrick and Devlin Barrett at the Wall Street Journal report that U.S. Attorney Preet Bharara is now investigating JPMorgan for some of the issues raised by FERC, but at this time it isn't known whether a potential indictment, if any, would be civil or criminal.

JPMorgan's "London Whale" losses show that CEO Jamie Dimon is willing to downplay a potential $1 billion loss and call it a "tempest in a teapot." He also didn't disclose that at the time of his comment, losses had a reasonable chance of ballooning by multiples, and they subsequently did. Many finance pros and bloggers called Dimon out in real time on this nonsense, but regulators act as if it wasn't Dimon's responsibility to know better than to make public misleading statements.

Meanwhile, JPMorgan's problematic CIO unit was a poster child for risk management worst practices --contrary to JPMorgan's signed financial filings--and credit derivatives prices were actively manipulated.
LIBOR fixing involved several banks. Main stream financial media reports this as a news flash. Yet this is no surprise to anyone who has been in the interest rate markets for more than a month. Banks colluded on prices of mortgage loans, credit derivatives indexes, synthetic collateralized debt obligations, CDO-squared and more, and the price fixing was even more blatant.

By the time Congress holds a hearing to wag a finger in an executive's face (right after lauding him), by the time a fringe-dwelling show-trial is launched by the SEC and DOJ, by the time a junior scapegoat is indicted, the damage to investment portfolios will be fully realized. The lesson here is that you are on your own.

This commentary is excerpted and adapted from a longer article that originally appeared at The Financial Report under the title "Structured Finance: Price Manipulation includes Silver and Gold (Part One)."