Sunday March 14, 2010

Friday we linked to reports by the bankruptcy examiner on the Lehman Brothers Fraud. Those transactions are the subject of longer reports in Section 2 of the WSJ Weekend Edition out now. But the most clear explanation we have seen is from Dylan Ratigan.  The video clip runs ten minutes but is a must see for accounting students and anyone else interested in the ongoing financial crisis. 

Ratigan makes it clear that Lehman, using backs as pawn shops, swapped assets for cash which would later be repaid. These are known as repo transactions which stands for reverse purchase. The borrower pawns an asset for cash, the cash will later be repaid along with an interest charge. However, Lehman represented these repos as sales, not as a temporary loan. And CEO Fuld and his three CFOs during the period, note the turnover, knew of the fraud. And Ernst and Young, outside auditors, also knew what was going  on but rendered a clean opinion.  Students will recall that SARBOX requires CEO and CFO sign off on the accuracy of the statements. So, they lied instead to perpetuate the fraud. Oh, and Fuld paid himself a total of $500 M over the years he did this. And, Jeff Skilling of Enron is in jail while Fuld is not. Gee life is not fair.

Observations

As Ratigan says, Wall Street uses complex instruments to perpetuate fraud, recall that Carlo Ponzi used Postal Reply Coupons in the 1920s for the basis of his scheme. We study derivatives in Intermed II, this is, ahem, not a proper use of derivatives.

Now, as humorists Dave Barry and Jeff Foxworthy say, you just can't make this stuff up. In the first appearance I have seen since his resignation as Governor about a year ago, Ratigan has Eliot Spitzer aboard to describe, with suitable outrage, a transaction whose only purpose was to mislead the public. This is surely the height of irony given the subterfuge Spitzer used to cover up his relations with a young lady who was not his wife. 

I will grant that Spitzer is an expert on the Justice Dept having worked there and come under criticism for over zealous prosecution to advance his own agenda. And I suppose it is rather like having Barry Minkow describe a fraud, but then Minkow has recanted and admitted his misdeeds. 

Okay, now what?  Will the Justice Dept pursue Fuld and his auditors, Ernst and Young,  oh by the way, where was the SEC while all this was going on, out to lunch as usual. 

From a socionomic standpoint,  the science of social prediction,  again this is unfolding like the Watergate scandal. The mood has improved reflected in the stock market advance. But let the markets fall again and the public and politicians who are just as complicit will look for a scapegoat. Then I would expect this investigation to really gather steam. 

This is a good example of why I author this blog, there is not time to cover all this in class and well, Foxworthy is right, I can't make this stuff up!

Friday March 12, 2010

This is beginning to remind me of Watergate. I do not mean the facts, that a President's staff member was involved in a break in that was denied and then finally admitted. I mean the way the Bear Lehman Merrill fiasco is slowly unfolding just like Watergate. Most of these things involve some sort of wrongdoing that is denied and then it turns out to be worse than imagined. 

Naked Capitalism blogger Yves Smith reports on the law firm report investigating the Lehman 'lack of oversight.' Turns out the external auditor, well read this excerpt

Quite a few observers, including this blogger, have been stunned and frustrated at the refusal to investigate what was almost certain accounting fraud at Lehman. Despite the bankruptcy administrator’s effort to blame the gaping hole in Lehman’s balance sheet on its disorderly collapse, the idea that the firm, which was by its own accounts solvent, would suddenly spring a roughly $130+ billion hole in its $660 balance sheet, is simply implausible on its face. Indeed, it was such common knowledge in the Lehman flailing about period that Lehman’s accounts were sus that Hank Paulson’s recent book mentions repeatedly that Lehman’s valuations were phony as if it were no big deal.

Well, it is folks, as a newly-released examiner’s report by Anton Valukas in connection with the Lehman bankruptcy makes clear. The unraveling isn’t merely implicating Fuld and his recent succession of CFOs, or its accounting firm, Ernst & Young, as might be expected. It also emerges that the NY Fed, and thus Timothy Geithner, were at a minimum massively derelict in the performance of their duties, and may well be culpable in aiding and abetting Lehman in accounting fraud and Sarbox violations.

So we have Lehman, Ernst and Young, the Fed, and the Secretary of the Secretary of the Treasury, all involved. This as he says at the end of the post reads like a blockbuster novel. 

For our younger readers, President Nixon had been re elected in a landslide in 1972 over George McGovern. Nixon had always been despised by the liberal press.  Nixon raised the ante by creating an actual enemies list. The Dow had risen to its highest point ever, over 1,000 on the re election news. Then slowly in 1972, the story about a break in at the Democrat Party Headquarters at the Watergate building started getting traction. The Viet Nam War was still underway, much to the dismay  of just about everyone. Does this sound eerily familiar with the current situation-a bi polar congress, unpopular legislation, a never ending war?  As the story unraveled, the Democrat controlled Congress held continual hearings until someone inadvertently admitted the break in. The Dow Jones, read confidence index, slumped from 1,000 to a final low of 577 by December 1974, Nixon resigned rather than face impeachment. The problem was not the break in as much as the cover up and denial. 

This time the Democrat party has provided some cover and admittedly this is not a Presidential cover up as it occurred across both Bush and Obama. But…….will there be a Gladwell Tipping Point for this?

Meanwhile Kansas City has closed half its schools… no that is not a typo. See Friday March 12 post at Mish.