We Have to Have Hope

            I was watching “60 Minutes” two weeks ago.  I like “60 Minutes” because I believe it tries to delve into the dirt of our world.  This particular story featured a respected author out of California who has been digging into the roles the big banks played in encouraging our worldwide financial crises.  He talked about how Goldman Sachs allegedly paid the bond rating agencies to give top ratings to mortgage-backed securities that Goldman allegedly knew contained substantial subprime mortgages.  And while Goldman was selling these top-rated, high-yielding mortgage securities to their investors, they were also buying credit default swaps from A.I.G., with the assumption that the home mortgage market could be in trouble.  Credit default swaps are insurance policies that insure against the failure of the entity being insured.  We know about the colossal failure of A.I.G. as a result of their overexposure to these types of higher risk, unregulated policies.

            And now we are getting information on what deceptive practices Lehman Brothers may have been involved in.  According to information provided by Ted Kaufman, Senator from Delaware, the examiner’s report shows that Lehman used accounting ‘tricks’ to hide billions in debt from its investors and the public.  According to the report, beginning in 2001, Lehman Brothers began abusing financial transactions that are called repurchase agreements or “repos.”  They are an exchange of collateral for cash that can be unwound (or terminated) as soon as the next day.

            The problem is not with the usage of the repo, as they are not illegal in and of themselves, the problem comes with how they were being used.  Lehman allegedly used the repos to move assets to make it appear more healthy than it actually was.  And guess when it appears they would do this?  Right around the ends of the reporting quarters.

            Even more unbelievable, the examiners’ report says that Lehman’s management claimed that the firm was decreasing its leverage (its borrowing) so that investors would stay with them (businessinsider.com/theres-deep-fraud-on-wall-street-and-goldmans-behavior-in-greece-is-just-the-tip-2010).

            And now more recently, Senator Kaufman has revealed that Goldman Sachs may have aided Greece in deceiving the European Union.   We know of Greece’s debt problems. Debt problems are frowned upon when attempting to gain membership in the E.U.  So, Greece allegedly became involved in what are called ‘cross-currency swaps’ that exchange cash flows denominated in one currency for cash flows denominated in another.  And these swaps were priced “off-market” meaning that they did not use prevailing market exchange rates.  Instead, according to Senator Kaufman, these very unusual transactions provided Greece with a large upfront payment (and a reduction of debt), which they then paid off over time, with the payment at maturity being the largest.  In other words, Goldman Sachs allegedly provided Greece with a loan that was not identified as a loan (businessinsider.com/theres-deep-fraud-on-wall-street-and-goldmans-behavior-in-greece-is-just-the-tip-2010).

            The problem with white-collar crime is that the criminals are often very intelligent people.  They are often covering up their crimes as they commit them.  (Senator Kaufman refers to it as “plotting their defense.”)  And the problem with trying to prosecute the crimes is that often there are only a few people on the inside who are familiar with the crime.  And they, because they may have gained from the crime, are not likely to come forward with the evidence that could lead to prosecution.

            And incredibly, our government leaders passed a law earlier in this decade, called Sarbanes-Oxley, that gave self-regulatory responsibilities to company CEO’s, accountants, and lawyers.

            I quote Senator Kaufman, “We became enamored of the view that self-regulation was adequate, that “rational” self-interest would motivate counterparties to undertake stronger and better forms of due diligence than any regulator could perform.” (businessinsider.com/theres-deep-fraud-on-wall-street-and-goldmans-behavior-in-greece-is-just-the-tip-2010).

            Obviously, this naïve self-regulatory approach has failed us.  Now, stronger financial legislative reform is being demanded by angry Americans and proposed in Washington.  Senator Chris Dodd of Connecticut, head of the Banking Committee, has come forward with a financial reform bill.  According to Lauren Tara LaCapra, “the Dodd proposal is softer than some consumer advocates would like, but hard enough that it lacks full support from Wall Street banks like Goldman Sachs, Morgan Stanley, as well as those with consumer exposure like Bank of America, JP Morgan Chase, Wells Fargo, and Citigroup.  It’s worth noting that all of the banking titans that would suffer under tighter regulation were also counterparties made whole by the rescue of American International Group (A.I.G.)” (thestreet.com/story/10708174).

            As we, hopefully, move forward, we can hope that new legislation will bring better accountability and transparency on Wall Street.  As Senator Ted Kaufman so eloquently said, “At the end of the day, this is a test of whether we have one justice system in this country or two.  If we don’t treat a Wall Street firm that defrauded investors of millions of dollars the same way we treat someone who stole 500 dollars from a cash register, then how can we expect our citizens to have faith in the rule of law?  For our economy to work for all Americans, investors must have confidence in the honest and open functioning of our financial markets.  Our markets can only flourish when Americans again trust that they are fair, transparent, and accountable to the laws.”

            I can only have hope that they will.

Opinions expressed are solely those of the author and not LPL Financial, and are not intended to provide specific advice or recommendations for any individual.  To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Jim Rigtrup is the owner of and a Wealth Manager with Keystone Wealth Management Group, LLC.  Sandy, UT.  He can be reached at (801) 572-1077 or at jim.rigtrup@lpl.com

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