Sunday, April 11, 2010

Big Banks Move to Mask Risk Levels

The Wall Street Journal wrote on Friday, Big Banks Move to Mask Risk Levels.

"Major banks have masked their risk levels in the past five quarters by temporarily lowering their debt just before reporting it to the public, according to data from the Federal Reserve Bank of New York. A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters."

After the news of Lehman's Repo 105 shenanigans this is pretty outrageous. "The SEC now is seeking detailed information from nearly two dozen large financial firms about repos, signaling that the agency is looking for accounting techniques that could hide a firm's risk-taking. The SEC's inquiry follows recent disclosures that Lehman used repos to mask some $50 billion in debt before it collapsed in 2008."

The whole article is short and worth reading. I'm curious how this was found out and what i means for regulation. This is apparently legal though misleading. This was in a New York Fed report because they monitor banks constantly but the regulation (and I guess investigation) of this apparently falls under the SEC. So does the SEC monitor the numbers continuously or just based on quarterly reports? Part of the problem is that the Fed monitors banks and this is a brokerage issue which falls under the SEC. Under Glass-Seagul these were different entities, now, post Lehman, these are merged even-more-mega-firms. This is why I think financial reform should have one regulator that covers everything (and all parts of current and future shadow banking) so that firms can't shop around for the most ineffective regulator of choice.


Anonymous said...

How is the practice of "masking" risk not fraud?

Masking = Deception = Fraud

Here's one of the parts of Securities Law which speaks to such actions. Why are these obviously deceptive practices not prosecuted.

Rule 10b-5: Employment of Manipulative and Deceptive Practices":

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security."

If the laws are not upheld they are meaningless and then we no longer are a nation based on the rule of law.

Regulation means nothing without enforcement. For regulation to have teeth, there must be severe consequences for non-compliance, So far, the Banksters have gotten trillions of dollars in low-interest loans from the federal gov't of the US, and had most, if not all of their bad debt (trillions) bought by the federal reserve.

Last year (2009) the banksters with walked away with some of their biggest bonuses ever thanks to the largesse of the US taxpayer and willful blindness of the congress and president of the United States.

Some punishment.

I for one do not like being played for a sucker.

These cases must be brought before juries immediately!


Howard said...

I'm not a securities lawyer and don't think you are either. I agree it's troubling and am glad the SEC is looking into it. Perhaps it is illegal. I could see that since the trade were real, the reports were truthful. At the end of the month, those were the numbers, they just weren't the numbers in the middle of the month. It does seem clear that if it was illegal, it should be prosecuted, and if it wasn't, the reporting laws need to be changed.

Anonymous said...

You are correct, I am not a securities lawyer, but many who are have been calling for prosecutions on such matters to no avail.

Yes, the trades actually occured. That is not at issue. This would not be a Bernie Madoff type fraud, where trades did not occur.

The question that must be asked is "why did the trades occur?". If the answer turns out to be to hide the real value of toxic assets then that is deceptive. All you need to do is look at the selling and buying patterns.

Using legal tools for the purpose of masking is a deceptive practice and needs to be prosecuted. These laws were written broadly with the foresight to understand that people who intend to defraud do not make their schemes obvious and that the perpetrators would actively look for ways to skirt the law.

This is not mere "window dressing" to use a street term. It is willful and deceptive use of a "legal" tool to hide the actual financial stability of an organization.

I say let's put in in front of a jury and see if reasonable citizens think it was deceptive, or not.