Investment Banking

Scandal!

New York’s Museum of the Finance, to illustrate the issues surrounding the financial meltdown titled its exhibition of late April ‘Scandal!’ and proceeded to list in chronological order all the great financial scandals concocted in the Big Apple throughout history. And the list is long. The lack of reprisals, however, is surprising.

As if to mock us, on May 10th, the EU and the International Monetary Fund (IMF) announced the huge package of 750 billion euros aimed at stabilizing European markets.

And, ironically, the bankruptcy of US bank Lehman Brothers in September of 2008, one of the erstwhile ‘stars’ of New York, which has hit Europe harder than the US. Is this why US authorities allowed it to fail – changing tactics in the wake of Bear Stearns and Wachovia and Washington Mutual?

Returning to Europe, governments here have wanted to sell the financial package approved in Brussels as sort of “shield against speculation,” when it has been a systematic coordination to impact on prices. If anyone is in doubt, rating agency Moody’s has admitted to coordination practices with ‘hedge funds’, in which speculators drive prices.

That is how the subprime crisis kicked off. Homebuyers – not all with sparking credit –were approved for mortgages and lenders would bundle these and sell them on to investment banks – which in turn would repackage these and sell them to investors. The agencies at the time rated them investment grade and in the process were paid large fees for their involvement. Now they applaud government bailouts and push for more.

The IMF steps in

The IMF, mandated to help developing countries, has been forced into the unthinkable and stepped in to the European crisis following the gluttony of Wall Street and other financial centers. And the cost to Europe and its economic sovereignty will be great.

With the cracks in the $2 trillion subprime market in the US widening in August 2007, global contagion soon followed. Banks such as JP Morgan, for instance, complicit in packaging and distributing sub-prime securities, were betting that they would lose value – a massive conflict of interest. And less than two short years later, European governments were smarting from the crisis, bailing out their financial sector to the tune of billons of euros.

Spitzers' Crusade

Fraud within the investment banking industry of New York is nothing new. Eliot Spitzer, the New York attorney general from January 2007 to March 2008, initiated judicial proceedings against some large names on Wall Street, accusing them of fraudulent and disloyal practices. But his own public image was to suffer a heavy blow when in March 2008 the New York Times published revelations of his involvement as a client in a high-priced prostitution ring. Many on Wall Street must have been relieved; but some NYT shareholders were angered by the investigation into his personal life.
Spitzer had been crusading against financial irregularities for years. In 2002, for instance, after Merryll Lynch settled out of court and was fined for $100 million for recommending shares to investors that it had classified as negative in-house, said: "The payment of the fine is sufficient admission."
But he reiterated that his job was not finished: "We will continue our investigations," he said. Credit Suisse First Boston, Morgan Stanley, Salomon Smith Barney, UBS and Bearn & Sterns all received citations from the DA's office.

Cuomo Continues

In August 2008 Spitzer's successor, Andrew M. Cuomo, reached an extra-judicial agreement in which Citigroup bought back at 100% value some between $7-$14 billion in Auction Rate Securities (ARS), money market instruments, sold as secure investments. And, just like Merrill, Citigroup received a $100 million fine.
In the case of Merill Lynch and Citigroup, the potential for conflict of interest between clients and commercial interests follows the relaxation of regulatory controls instituted in the aftermath of the US's Great Depression of the 1930s.
It was in 1999, when the European single currency came into circulation and Bill Clinton was serving his second term in office, that banking de-regulation picked up speed as parts of the Banking Act of 1933 – or Glass-Steagall – were repealed.
The act, named after its legislative sponsors Carter Glass and Henry B. Steagall, introduced banking reforms which were designed to control speculation and in the spirit of the Franklin D. Roosevelt's New Deal – a series of economic programmes which were instigated in response to the Great Depression; itself sparked by Wall Street's stock market crash of 1929.
Immediately after the revocation of Glass-Steagall in 1999, Citigroup, the first modern financial conglomerate, was forged. Citigroup was a $140bn merger of the banking powerhouse Citicorp and the financial and insurance conglomerate Travelers Group. It boasted businesses as varied as retail and investment banking, credit card lending and insurance. But its size and complexity made it difficult to manage and it was devastated by the financial crisis. It also came under fire for selling Lehman bonds. The bank, which had been one of the world's largest, nearly collapsed and was bailed On the other side of the pond, so to speak, the City of London had morphed into a global financial powerhouse, allowing bankers to shift billions in speculative deals. But the need for financial limits has always existed – though the political will for it began to wane in the 1980s as governments around the world courted the money men.

Data from the European Commission (March 2009) shows total budgetary support from EU countries to the financial sector at a whooping 3.0 billion euros; 2.3 billion in guarantees, 0.3 billion in recapitalization programmes and 0.4 billion in rescuing insolvent organizations.

This has been funded by government debt; overshooting the limits set by the EU’s stability pacts for the euro in all key EU countries – barring Luxembourg and tipping Europe to the edge and pounding the currency.

The number of powerful organizations with their head in the securitization trough has come to light, and with suspicions of financial fraud in some investment banks, hedge funds and rating agencies there must be consequences.

Markets and power

Throughout history society has advanced toward the ideals of democracy and justice. Totalitarian systems of all kinds, from dictatorships to oppressive monarchies were quashed; giving workers the world over optimism and control over their futures. The fall of the Berlin Wall in 1989 put paid to the historic intent of creating a new paradigm. Some called this “the end of history:” and money markets have aimed to take advantage of that vacuum. The masterminds of complex financial deals and those who execute them benefit from huge bounties, they clinch vast sums in a few days with seemingly no risk to themselves. The financial sector, guilty of the greatest crisis in history, has forced governments the world over to concede unlimited facilities in order to carry on its business and with those same funds to speculate against public debt – widening government deficits in a sort of Kafkaesque spiral.

Political accomplices

Politicians have also played a part; instead of looking after our taxes, they have written blank cheques to banks to bail them out and have asked for little in return. Is it not time to forge a new social contract – one which demands guarantees from the public sector in terms of the use of public funds?

Why can’t the European Central Bank, for instance, forge a mechanism to lend directly to member States? Instead, it has been lending to private banks without limits at 1% so that buy government debt, devalued on secondary markets, and thereby force governments to issue new debt at even higher rates. How is it possible that the original lender has to borrow at higher rates than it lends? The incongruous nature of such deals could mean that eventually many people will want to dispense with the banks.

Basic banking, which consists of taking deposits, lending money and organizing a system of collections and payments, is necessary for the development of the economic system and welfare, when it works correctly. But investment banking, the speculative and non-transparent side of banking, needs to be separated from the commercial side. The mammoth returns for its players are linked to a zero-sum speculative e game, where profits for one equal losses for another. How can it be that a business director earns 500 times more than the less well paid worker? It has been reported that Lehman Brothers’ executives received millions of euros during the liquidity crisis.

Is it not necessary to place limits on the bonuses of the financial sector to discourage foul-play and limit salaries so that no one earns 50 times more than the worker at the bottom of the pile? How many million investors should lose their money and how many millions should lose their jobs so that 100 of the so-called golden boys of Wall Street pocket bonuses worth millions each and shareholders pocket vast dividends?

How many lives were ruined as Madoff ran off with $50 billion? And how is it possible that thousands of Lehman Brothers investors have not been paid a cent since September of 2008. Some investment banking practices are unsettling; take May 7th, when a typing error was attributed to a huge – but incorrect – sales order and the Dow Jones index fell 10%.

In Germany, according to a study by the EC in September of 2009, investors lose between 20-30 billion euros a year due to faulty advice from financial companies. Since mid-90s, moreover, lone operators have lost millions of their banks’ and investors’ money.

Take Nick Leeson, author of one of the biggest trading gambles in history – one that brought down Britain’s revered Barings merchant bank in 1995 after it had been operating for 235 years. “If you look back over the last 10 to 12 years, there have been far too many financial scandals and rogue traders to mention,” he says.

Leeson, after a string of jobs with other banks, ended up with Barings and was promoted to the trading floor. He was appointed manager of a new operation in futures markets on the Singapore Monetary Exchange (SIMEX) and soon made millions for the bank, betting on the future direction of the Nikkei Index.

But then the losses hit, he managed to hide them until the company was declared bankrupt with losses of £827 million. It was sold for one pound to ING Bank.

More recently, Societe Generale’s Jérôme Kerviel used his knowledge of back office systems to cover up his huge positions in derivatives. His activity led to over $7 billion in losses for the French bank. And of course, Bernard Lawrence, or Bernie, Madoff a former stock broker who operated the largest Ponzi scheme in history – defrauding thousands of investors of billions of dollars since the early 1990s. On June 29, 2009, he was sentenced to 150 years in prison, the maximum allowed

John Rusnak, former currency trader at Allfirst-AIB Bank, was accused of hiding $750 million in losses at the bank after bad debts accumulated. He served just under six years. Peter Young was another. Young was a fund manger at British bank Morgan Grenfell, subsidiary of Deutsche Bank, and was in 1996 accused of causing losses of over £220 million in unauthorized investments – which he managed to hide by setting up mirror holdings. Young deviated money invested in three large European funds to buy speculative shares. Young was found guilty on all charges, but for reasons of insanity, the judge voided the verdict.

The list could go on, and governments the world over have seemed powerless against such abuses of power and continued to fan the flames by continuing to fund the banks. The facts point to financial markets behaving in uncontrollable ways, posing unacceptable risks and as the financial markets have grown, so has their volatility and lack of wide spread economic usefulness.

Nasdaq, the largest on-screen based equity securities trading market in the US, for instance, has seen unfold the dot com bubble and the bankruptcies of Enron in 2001, of Worldcom in 2002, Parmalat in 2003, of Lehman Brothers in 2008, the bailout of AIG by the US government.

And on Wall Street, life goes on and “greed is good”, the motto coined by Tow Wolfe in his bestselling novel about 1980s Wall Street greed Bonfire of the Vanities, seems to rein supreme. Very supreme. Last November, Goldman Sachs CEO –Lloyd Blankfein said the bank was “doing God’s work.”

But we are in need of serious work now. And consumers should clamor for an International Penal Court to investigate those responsible for the financial crisis and their accomplices.

But governments seem powerless in the face of big money. When Iceland’s volcanic ash cloud hit Europe, flights were grounded. When the economic crisis hit the world, governments threw more money at it. Go figure?