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Lehman Brothers Dies While Getting Away With Murder: Regulatory Capture

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Let's get something straight right off the bat. We all know there is a certain level of fraud sleight of hand in the financial industry. I have called many banks insolvent in the past. Some have pooh-poohed these proclamations, while others have looked in wonder, saying "How the hell did he know that?"

The list above is a small, relevant sampling of at least dozens of similar calls. Trust me, dear reader, what some may see as divine premonition is nothing of the sort. It is definitely not a sign of superior ability, insider info, or heavenly intellect. I would love to consider myself a hyper-intellectual, but alas, it just ain't so and I'm not going to lie to you. The truth of the matter is I sniffed these incongruencies out because  2+2 never did equal 46, and it probably never will either. An objective look at each and every one of these situations shows that none of them added up. In each case, there was someone (or a lot of people) trying to get you to believe that 2=2=46.xxx. They justified it with theses that they alleged were too complicated for the average man to understand (and in business, if that is true, then it is probably just too complicated to work in the long run as well). They pronounced bold new eras, stating "This time is different", "There is a new math" (as if there was something wrong with the old math), etc. and so on and associated bullshit. 

 So, the question remains, why is it that a lowly blogger and small time individual investor with a skeleton staff of analysts can uncover systemic risks, frauds and insolvencies at a level that it appears the SEC hasn't even gleaned as of yet? Two words, "Regulatory Capture". You see, and as I reluctantly admitted, it is not that I am so smart, it is that the regulator's goals are not the same as mine. My efforts are designed to ferret out the truth for enlightenment, profit and gain. Regulators' goals are to serve a myriad constituency that does not necessarily have the individual tax payer at the top of the heirachal pyramid. Before we go on, let me excerpt from a piece that I wrote on the topic at hand so we are all on the same page: How Regulatory Capture Turns Doo Doo Deadly

First off, some definitions:

  • The Doo Doo, as in the Doo Doo 32: A  list of 32 banks that I created on
  • Regulatory capture (adopted from Wikipedia): A term used to refer to situations in which a government regulatory agency created to act in the public interest instead acts in favor of the commercial or special interests that dominate in the industry or sector it is charged with regulating. Regulatory capture is an explicit manifestation of government failure in that it not only encourages, but actively promotes the activities of large firms that produce negative externalities. For public choice theorists, regulatory capture occurs because groups or individuals with a high-stakes interest in the outcome of policy or regulatory decisions can be expected to focus their resources and energies in attempting to gain the policy outcomes they prefer, while members of the public, each with only a tiny individual stake in the outcome, will ignore it altogether. Regulatory capture is when this imbalance of focused resources devoted to a particular policy outcome is successful at "capturing" influence with the staff or commission members of the regulatory agency, so that the preferred policy outcomes of the special interest are implemented. The risk of regulatory capture suggests that regulatory agencies should be protected from outside influence as much as possible, or else not created at all. A captured regulatory agency that serves the interests of its invested patrons with the power of the government behind it is often worse than no regulation whatsoever.

About a year and a half ago, after sounding the alarm on the regionals, I placed strategic bearish positions in the sector which paid off extremely well. The only problem is, it really shouldn't have. Why? Because the problems of these banks were visible a mile away. I started warning friends and family as far back as 2004, I announced it on my blog in 2007, and I even offered a free report in early 2008.

Well, here comes another warning. One of the Doo Doo 32 looks to be ready to collapse some time soon. Most investors and pundits won't realize it because a) they don't read BoomBustblog, and b) due to regulatory capture, the bank has been given the OK by its regulators to hide the fact that it is getting its insides gutted out by CDOs and losses on loans and loan derivative products. Alas, I am getting ahead of myself. Let's take a quick glance at regulatory capture, graphically encapsulated, then move on to look at the recipients of the Doo Doo Award as they stand now...

A picture is worth a thousand words...

fasb_mark_to_market_chart.png

 So, how does this play into today's big headlines in the alternative, grass roots media? Well, on the front page of the Huffington Post and ZeroHedge, we have a damning expose of Lehman Brothers (we told you this in the first quarter of 2008, though), detailing their use of REPO 105 financing to basically lie about their liquidity positions and solvency. The most damning and most interesting tidbit lies within a more obscure ZeroHedge article that details findings from the recently released Lehman papers, though:

 On September 11, JPMorgan executives met to discuss significant valuation problems with securities that Lehman had posted as collateral over the summer. JPMorgan concluded that the collateral was not worth nearly what Lehman had claimed it was worth, and decided to request an additional $5 billion in cash collateral from Lehman that day. The request was communicated in an executive?level phone call, and Lehman posted $5 billion in cash to JPMorgan by the afternoon of Friday, September 12. Around the same time, JPMorgan learned that a security known as Fenway,which Lehman had posted to JPMorgan at a stated value of $3 billion, was actually asset?backed commercial paper credit?enhanced by Lehman (that is, it was Lehman, rather than a third party, that effectively guaranteed principal and interest payments). JPMorgan concluded that Fenway was worth practically nothing as collateral.

Hold up! Lehman was pledging as collateral allegedly "investment grade", "credit enhanced" securities that were enhanced by Lehman, who was insolvent and in need of liquidity, itself. For anybody who is not following me, how much is life insurance on yourself worth if it is backed up by YOU paying out the proceeds after you die bankrupt? Lehman was allowed to get away with such nonsense because it was allowed to value its OWN securities. Think about this for a second. You are in big financial trouble, you have only a $10 bill to your name, but your favorite congressman (whom you have given $10 bills to in the past) has given you the okay to erase that number 10 on the $bills and put whatever number on it you feel is "reasonable". So, when your creditors come a callin' , looking for $20 in collateral, what number would you deem reasonable to put on that $10 bill. 

Ladies and gentlemen, in the short paragraph above, we have just encapsulated the majority of the mark to market argument. Let's delve farther into the ZH article:


By early August 2008, JPMorgan had learned that Lehman had pledged self-priced CDOs as collateral over the course of the summer. By August 9, to meet JPMorgan’s margin requirements, Lehman had pledged $9.7 billion of collateral, $5.8 billion of which were CDOs priced by Lehman, mostly at face value. JPMorgan expressed concern as to the quality of the assets that Lehman had pledged and, consequently, Lehman offered to review its valuations. Although JPMorgan remained concerned that the CDOs were not acceptable collateral, Lehman informed JPMorgan that it had no other collateral to pledge. The fact that Lehman did not have other assets to pledge raised some concerns at JPMorgan about Lehman’s liquidity


Hmmm!!! Three day old fish has a fresher scent, does it not? So where was the SEC, the NY Fed, or anybody the hell else who's supposed to safeguard us against this malfeasance? Even bloggers picked up on this months before it collapsed. The answer, dear readers: REGULATORY CAPTURE!

Again, from ZH:

The SEC was not aware of any significant issues with Lehman’s liquidity pool until September 12, 2008, when officials learned that a large portion of Lehman’s liquidity pool had been allocated to its clearing banks to induce them to continue providing essential clearing services. In a September 12, 2008 e?mail, one SEC analyst wrote: Key point: Lehman’s liquidity pool is almost totally locked up with clearing banks to cover intraday credit ($15bnjpm, $10bn with others like citi and bofa). withThis is a really big problem.


 BoomBustBlog featured several warnings starting January of 2008!

 One would think that after all of this, the problem would have been rectified. To the contrary, it has been made worse. Congress has pressured FASB to institutionalize and make acceptable the lies that Lehman told its investors, counterparties and regulators. That's right, not only will no one get in trouble for this blatant lying, the practice is now actually endorsed by the government - that is until somebody blows up again. At that point there will be a bunch of finger pointing and allegations and claims such as "But who could have seen this coming".  

Do you not believe me, dear reader. Reference About the Politically Malleable FASB, Paid for Politicians, and Mark to Myth Accounting Rules: the nonsense is unfolding and collapsing right now, even as I type this sentence.

The next place to look??? Who knows? Maybe someone should take an An Independent Look into JP Morgan .. or maybe even an unbiased gander at Wells Fargo (see

The Wells Fargo 4th Quarter Review is Available, and Its a
Doozy!
). After all, If
a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear
It?