William K. Black said over a year ago, that the government’s entire strategy is to cover up how bad things are.
Paul Krugman and others point out that Geithner has been trying to artificially prop up asset prices, but that such a strategy cannot succeed. The stress tests were a total sham, with a pre-ordained passing grade for the banks. The government has allowed the giant banks to hide their liabilities and maintain dizzying amounts of leverage by using clever accounting gimmicks.
The Bank for International Settlements (BIS) slammed “the use of gimmicks and palliatives”, and said that anything other than letting asset prices fall to their true market value, increasing savings rates, and forcing companies to write off bad debts “will only make things worse”.
This is what Marc Faber and many other economists have said for years. But Bernanke and the other central bankers ignored BIS’ advice in 2007 and 2008, and they are still ignoring it today.
Instead, we are doing everything possible to prop up asset prices by trying to stimulate a new bubble by handing out trillions to the banks and allowing giant toxic debts to remain hidden on their books.
Fraudulent Accounting At Lehman
Recent court documents released online have detailed fraudulent accounting practices in the days prior to the collapse of Lehman Brothers. The documents also implicate the US Federal Reserve bank for possibly knowingly allowing these practices to go on.
Geithner and Bernanke have been busted for allowing Lehman to cook its books to try and hide its problems.
The New York Times notes:
The examiner, Anton R. Valukas, for the first time, laid out what the report characterized as “materially misleading” accounting gimmicks that Lehman used to mask the perilous state of its finances.
Lehman executives engaged in “actionable balance sheet manipulation” A large portion of the examiner’s report centers on the accounting maneuvers, known inside Lehman as “Repo 105.”
First used in 2001, long before the crisis struck, Repo 105 involved transactions that secretly moved billions of dollars off Lehman’s books at a time when the bank was under heavy scrutiny.
Huffington Post explains:
Senior officials failed to disclose key practices, opening them up to legal claims. The report concludes that the firm’s auditor, Ernst & Young, failed to meet “professional standards.”
The examiner also found that parties have claims to pursue against JPMorgan Chase and Citibank in connection with their behavior regarding the modification of agreements with Lehman and their increasing collateral demands in Lehman’s final days. These demands had a “direct impact” on Lehman’s diminishing liquidity — its cash on hand — which was a prime reason behind the firm’s demise.
There are colorable claims against Lehman’s external auditor Ernst & Young for, among other things, its failure to question and challenge improper or inadequate disclosures in those financial statements.
The examiner also notes that the issue giving rise to these potential claims was Lehman’s creative use of repurchase agreements, otherwise known as repo. These are agreements between financial firms that essentially act as loans for cash — one firm pledges collateral to another in exchange for cash with a promise that they’ll buy back that collateral.
The examiner said the sole function of Lehman’s use of repo was “balance sheet manipulation,” according to the report:
Although Repo 105 transactions may not have been inherently improper, there is a colorable claim that their sole function as employed by Lehman was balance sheet manipulation. Lehman’s own accounting personnel described Repo 105 transactions as an “accounting gimmick” and a “lazy way of managing the balance sheet as opposed to legitimately meeting balance sheet targets at quarter end.”
The reason for that, the report notes, was to lower Lehman’s leverage — a critical component of the firm’s credit rating.
In 2007-2008, Lehman knew that net leverage numbers were critical to the rating agencies and to counterparty confidence. Its ability to deleverage by selling assets was severely limited by the illiquidity and depressed prices of the assets it had accumulated.
Against this backdrop, Lehman turned to Repo 105 transactions to temporarily remove $50 billion of bad assets from its balance sheet at first and second quarter ends in 2008 so that it could report significantly lower net leverage numbers than in reality.
Lehman did so despite its understanding that none of its peers used similar accounting at that time to arrive at their leverage numbers, to which Lehman would be compared.
Lehman’s failure to disclose the use of an accounting device to significantly and temporarily lower leverage, at the same time that it affirmatively represented those “low” leverage numbers to investors as positive news, created a misleading portrayal of Lehman’s true financial health.
Colorable claims exist against the senior officers who were responsible for balance sheet management and financial disclosure, who signed and certified Lehman’s financial statements and who failed to disclose Lehman’s use and extent of Repo 105 transactions to manage its balance sheet.
In May 2008, a Lehman Senior Vice President, Matthew Lee, wrote a letter to management alleging accounting improprieties; in the course of investigating the allegations, Ernst & Young was advised by Lee on June 12, 2008 that Lehman had used $50 billion of Repo 105 transactions to temporarily move assets off balance sheet at quarter end.
The next day – on June 13, 2008 ‐ Ernst & Young met with the Lehman Board Audit Committee but did not advise it about Lee’s assertions, despite an express direction from the Committee to advise on all allegations raised by Lee.
Tyler Durden of Zero Hedge slammed the NY Fed saying:
There should be an immediate investigation into how many other banks are currently taking advantage of this artificial scheme to manipulate and misrepresent their cap ratio, and just why the New York Fed can claim it had no idea of this very critical component of the Shadow Economy.
Karl Denninger the Market Tickerguy called for prosectution in a recent blog post.
“Remember, The Feral Reserve is supposed to by the “uber-regulator” and the safety and soundness manager for the entire financial system. They did a great job, right? Well…”
“When the Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.”
However the Examiner said:
Although various Government agencies had information that raised serious questions about Lehman’s reported liquidity and about the sufficiency of its capital and liquidity to withstand stress scenarios, the agencies generally limited their activities to collecting data and monitoring.
Essentially, they looked but didn’t act.
Stress Tests Were A Sham
After March 2008 when the SEC and FRBNY (Federal Reserve Bank of New York) began onsite daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress-testing scenarios to test Lehman’s ability to withstand a run or potential run on the bank.
The FRBNY developed two new stress scenarios: “Bear Stearns” and “Bear Stearns Light.” Lehman failed both tests. The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed.
However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed. It does not appear that any agency required any action of Lehman in response to the results of the stress testing.
They ran two sets of stress tests and the firm failed both. Not satisfied with the results they then designed a third set, which the firm also failed.
Instead of applying any of these three, the FRBNY under command of Mr. Timothy Geithner, now our current Treasury Secretary (who reported directly to Ben Bernanke), took Lehman’s word that all was ok and took no further action.
In the spring of 2009 we were told that all the big banks ran “Stress Tests” of Geithner’s design. But Treasury didn’t actually run them and didn’t actually get and process the data – they told the banks to do so at their own discretion.
Lehman passed its own “internally computed” stress test but failed all three of the externally-computed ones.
The stress tests were a sham. With only one outcome being permissible: that Lehman pass. So after the Fed was unable to come up with an objective-looking stress test that Lehman could satisfy, they permitted Lehman to devise a test with low enough standards to give itself a clean bill of health.
The SEC inspection revealed significant problems at Lehman. The SEC found that Lehman’s Price Valuation Group was understaffed; and it found that Lehman’s asset pricing function was overly “process driven.” But the SEC did not release its findings or formally present them to Lehman prior to Lehman’s demise.
So The SEC knew of problems and they too did nothing.
While Geithner is implicated as being “concerned” about Lehman in the paper, the most-troubling part the narrative is here:
The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in “collateral damage” by demonstrating weakness and exposing “air” in the marks.
The word Air is an apparent admission that FRBNY and Tim Geithner specifically knew that the marks that these banks were taking on their assets were materially and intentionally false.
All of the banks that have failed in 2009 had 25-40% discounts to their claimed balance sheet values when the marks are actually reduced to losses to the deposit fund by the FDIC!
1. Geithner, and presumably everyone under him, knew the marks on these assets were fictions months before Lehman failed, yet they intentionally concealed this fact from the market and took no action (nor did the SEC) to disclose this intentional misdirection.
2. The misdirection and false claims in this regard are almost certainly continuing today, as evidenced by the FDIC seizures literally on an every-week basis.
Who is Responsible?
What about Ben Bernanke? He maintains that primary responsibility lay with the SEC, he said:
“Our concern was about the financial system, and we knew the implications for the greater financial system would be catastrophic, and it was.”
Geithner and Bernanke’s strategies of covering up how bad things are, trying to paper over the severity of the problems of the financial giants by artificially inflating asset prices and allowing accounting tricks are doomed to failure.
Yves Smith of Naked Capitalism points out that Geithner must be fired and that a full audit of the Fed must be conducted:
The key revelation is that Lehman as of late 2007 was routinely using Repo transactions at the end of the quarter to mask how levered it truly was:
Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet. Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt. Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios.
Lehman was engaging in blatant misreporting, treating these “repos”, in which a bank still shows them on its balance sheet as sold but with the obligation to repurchase, as sales. Note that at the time analysts and others kept probing at the seeming miracle of Lehman’s deleveraging in a difficult market.
The Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.
So even though Lehman dressed up its accounts for the great unwashed public, it did not try to fool the authorities. Its games playing was in full view to those charted with protecting investors and the financial system.
The SEC handed assessing Lehman over to the Fed, which under direction of Tim Geitner bent over backwards to give it a clean bill of health.
Lehman type accounting, in other words, is being institutionalized, with the active support from senior government officials.
Geithner must go. He is not fit to serve as Treasury secretary.
And the time is overdue for a full audit of the Fed, and in particular the New York Fed, from the start of the Bear crisis through and including all the retrades of the AIG bailout.
If Geithner is not replaced by someone who will actually try to fix things instead of just covering up for the big banks shenanigans, and if the Fed is not audited so that the air can be cleared, it will almost certainly spell doom for America. Ending up being a crisis much worse than the Great Depression.
Edited by MJ Harris