losses by big Wall Street firms, now topping those of the Great
Depression in relative terms, have yet to be adequately explained.
Wall Street power players are obfuscating and Congress is too
embarrassed or frightened to ask, preferring to just throw money
at the problem and hope it goes away.
But as job losses and foreclosures mount and pensions and 401(k)s
shrink, public policy measures to address the economic stresses
require a full set of unembellished facts.
that Wall Street is giving mainstream media a stage-managed version
of what went wrong begins with a strange revelation by Gary Crittenden,
CFO of Citigroup, on the November 5, 2007 conference call where
he discusses what have now become the largest losses in the firm's
196-year history. Mr. Crittenden is asked by an analyst why the
firm didn't hedge its risk. Here's his response:
I think it is a very fair question... we are the largest player
in this [collateralized debt obligation; CDO] business and given
that we are the largest player in the business, reducing the book
by half and then putting on what at the time was three times more
hedges than we had ever had at least in our recent history, seemed
to be very aggressive actions given that we were a major manufacturer
of this product... once this [decline in values] process started...
the size was simply not there. The market is simply not there
to do it in size in any way and it would have been uneconomic
to do it."
Crittenden really seems to be saying is that Wall Street, with
Citigroup leading the pack, built a vast market of complex securities
but neglected to put in place a liquid and efficient marketplace
for hedging this risk. Say, for example, big, liquid, exchange
traded indices and futures contracts that are routinely used to
hedge everything from stocks to soy beans to crude oil by as diverse
a group as Iowa farmers to Saudi princes.
private company that would become Wall Street's ticker tape
for pricing exotic credit instruments (derivatives on subprime
mortgages and credit default swaps) started out as Mark-it
Partners in 2001, the brain child of Lance Uggla while he
was working for a division of Toronto Dominion Bank, TD
fact, the unabridged story is breathtaking in its callous disregard
for the economic well being of this nation and its people. Exchange
traded products did not emerge to hedge this risk because, behind
the scenes, Citigroup, along with 12 other big banks and securities
firms were funding a private company to gobble up all the necessary
components to keep this burgeoning cash cow to themselves in the
opaque, unregulated, over-the-counter (OTC) market, despite the
fact that they knew it was dysfunctional.
private company that would become Wall Street's ticker tape for
pricing exotic credit instruments (derivatives on subprime mortgages
and credit default swaps) started out as Mark-it Partners in 2001,
the brain child of Lance Uggla while he was working for a division
of Toronto Dominion Bank, TD Securities.
story goes like this: Mark-it Partners needed big broker dealers
to submit daily price data. As an incentive, it offered 13 large
security dealers options to buy shares in the company providing
they would be regular providers of pricing data: ABN AMRO, Bank
of America, Citigroup, Credit Suisse, Deutsche Bank, Dresdner
Kleinwort Wasserstein, Goldman Sachs, JPMorgan, Lehman Brothers,
Merrill Lynch, Morgan Stanley, TD Securities and UBS.
By 2004, according to an archived company press release, all of
the companies had kicked in capital. The Financial Times would
later report that these banks and brokerage firms held a majority
interest of approximately 67 per cent, hedge funds owned 13 per
cent, and employees 20 per cent. The firm's web site currently
says it has 16 banks as shareholders, without naming the banks.
Bank, Goldman Sachs and JPMorgan were reportedly the first three
firms to take an equity stake in Mark-it on or around August 29,
2003 when the three firms sold a proprietary database of credit
derivative information to Mark-it. Since Mark-it is a private
firm, financial terms have not been disclosed.
August 2003, regulators with a fetish for orderly paper
trails had stumbled upon the fact that there was a growing
backlog of credit derivative trades that were never officially
confirmed between the parties, reaching a peak of 153,860
unconfirmed trades by September 2005.
would have been the incentive for three big Wall Street players
to build a proprietary database and then, in a magnanimous gesture
completely uncharacteristic of Wall Street greed, hand it over
to be shared with their largest competitors?
answer is that around this time regulators with a fetish for orderly
paper trails (but myopic to the rapidly escalating financial hazard
of this unregulated market) had stumbled upon the fact that there
was a growing backlog of credit derivative trades that were never
officially confirmed between the parties, reaching a peak of 153,860
unconfirmed trades by September 2005.
Of this, 97,650 trades were more than 30 days overdue; 63,322
trades were a stunning 90 days past due according to a Government
Accountability Office (GAO) report. (Although regulators knew
about this spiraling trading nightmare as earlier as 2003, the
GAO report did not come out until we were deep into the credit
crisis in June 2007.)
It was during this time that regulators got an agreement from
the major dealers that Mark-it Partners would begin collecting
and aggregating the data on unconfirmed trades, keeping individual
dealer data confidential from other dealers and preparing a monthly
report of aggregated data for regulators.
the banks and brokerage houses responsible for this unmitigated
mess? With only a few exceptions, the exact same firms with a
majority ownership in Mark-it Partners.
the magnitude of this wild west world of trading, one needs to
understand that we are not talking about a market of a few billion
dollars. According to the International Swaps and Derivatives
Association, the credit derivatives market has grown from an estimated
total notional amount of nearly US$1 trillion outstanding at year-end
2001 to over $34 trillion at year-end 2006.
to the US Office of the Comptroller of the Currency (OCC), JPMorgan,
Citigroup and Bank of America handled about 90 per cent of this
trading among US commercial banks in the fourth quarter of 2006.
(These are the same three banks that were backing the scheme last
year with the US Treasury to create a $100 billion bailout fund
for exotic instruments that also had never seen the light of day
of exchange trading. That plan failed when it appeared to be a
thinly disguised artificial pricing mechanism to inflate values
for the worst hit firms on Wall Street: namely, Citigroup.)
grasp the magnitude of this wild west world of trading,
one needs to understand that we are not talking about a
market of a few billion dollars. According to the International
Swaps and Derivatives Association, the credit derivatives
market has grown from an estimated total notional amount
of nearly US$1 trillion outstanding at year-end 2001 to
over $34 trillion at year-end 2006.
to the GAO report, significant progress was achieved for a period
in bringing down these unconfirmed trades but by November 2006,
the numbers had climbed again: there were over 81,000 unconfirmed
trades with around 31,000, or 54 per cent, remaining unconfirmed
for over 30 days.
Raising images of the early 1900s curb market in lower Manhattan
where traders posted securities for sale on lampposts, the report
notes that this vast market is being handled manually to a significant
extent. (Our nation has apparently devolved not only on torture
and constitutional rights and habeas corpus and election integrity
but we now seem to have wiped out 100 years of trading advances.)
solution, a transparent, regulated, automated, exchange traded
model does not seem to have occurred to the Masters of the Universe
or their timid regulators.
It did, however,
occur to four Exchanges: Eurex, the Chicago Mercantile Exchange
(Merc), the Chicago Board of Exchange (CBOE) and the Chicago Board
of Trade (CBOT). In 2007, all four created exchange traded instruments
to hedge the risk of credit defaults. Some traders call the response
from the Wall Street firms a boycott; others call it a cabal that
circled the wagons.
According to a Bloomberg article in April 2007, "Banks and securities
firms are keeping a stranglehold on the market, which has swelled
to cover debt sold by more than 3,000 companies, governments and
industries." A call to the CBOT on January 18, 2008 confirmed
that they are still not seeing any business from the big Wall
Street firms in their credit default product.
for this train wreck was put in place in December 2000 when Congress
passed the Commodity Futures Modernization Act giving a free pass
on regulation to the over-the-counter trading between sophisticated
individuals and institutions.
Brooksley Born, then Chairperson of the regulatory body, the Commodities
Futures Trading Commission (CFTC), literally begged Congress to
slow down the train and carefully consider the future ramifications
of this legislation. Speaking before the House Committee on Banking
and Financial Services on July 24, 1998, Ms. Born said:
or its predecessor agency, the Commodity Exchange Authority, has
regulated derivative instruments for almost three-quarters of
a century. Its authority is contained in the Commodity Exchange
Act ("CEA" or "Act"), which is the primary federal law governing
regulation of derivative transactions. The CEA vests the CFTC
with exclusive jurisdiction over futures and commodity option
transactions whether they occur on an exchange or over the counter.
The Act generally contemplates that, unless exempted, futures
and commodity options are to be sold through Commission-regulated
exchanges which provide the safeguards of open and competitive
trading, a continuous market, price discovery and dissemination,
and protection against counterparty risk."
track for this train wreck was put in place in December
2000 when Congress passed the Commodity Futures Modernization
Act giving a free pass on regulation to the over-the-counter
trading between sophisticated individuals and institutions.
Chair of the Federal Reserve Board at the time, testified before
Congress in favor of this legislation and asked that it be "expedited."
Last week, Mr. Greenspan joined the payroll of the hedge fund,
Paulson & Company, which last year made $15 billion in profits
betting that poor people's homes would be foreclosed on while
using the unregulated over-the-counter contracts that Mr. Greenspan
assisted in making possible.
counter-party risk that Ms. Born highlighted in her testimony
is now set to take center stage in 2008. As it turns out, this
non-exchange based market of darkness totaling $34 trillion has
done business with some parties that are unable to pay up or are
teetering on a death spiral due to looming ratings downgrades.
Last week, Merrill Lynch announced it was writing down over $3
billion as a result of problems with its counter-parties.
As the threat
of some antiseptic sunshine and competition from the exchanges
reached the big Wall Street players late last year, Mark-it Partners,
now known as Markit Group Ltd., had yet another amazing burst
of good fortune. In November 2007, two consortiums owned by essentially
the same group of banks and brokerage firms that were early investors
in Mark-it Partners, who conveniently also owned the major credit
default indices, CDS IndexCo and International Index Co., up and
sold themselves to little Markit Group Ltd.
Included in the deal by CDS IndexCo were the two subprime indices,
ABX and TABX, along with the prominent CDX index which acquired
much of its respectability by previously having the name Dow Jones
in front of its three letters.
ABX and TABX
were the indices Citigroup should have been able to hedge itself
with if this over-the-counter market was liquid, functional and
able to handle pesky details like proof the trade happened. Instead,
401(k) plans, endowments, public pensions and Citigroup employees'
deferred compensation plans, loaded up to their eyeballs in Citigroup's
bizarrely large float of 5 billion shares, have watched the stock
value decline by 53 per cent over the past 12 months as toxic
debt that was never hedged comes home from holiday in the Caymans
to blow up on Citigroup's books.
It was four
years after the crash of 1929 before the major titans of Wall
Street were forced to give testimony under oath to Congress and
the full magnitude of the fraud emerged. That delay may well have
contributed to the depth and duration of the Great Depression.
The modern-day Wall Street corruption hearings in Congress were
cut short by the tragedy of 9/11. They must now resume in earnest
and with sworn testimony if we are to escape a similar fate.
Pam Martens worked on Wall Street for 21 years; she has no securities
position, long or short, in any company mentioned in this article.
She writes on public interest issues from New Hampshire. She can
be reached at [email protected].
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