The Unholy Washington – Wall Street Alliance

Insider Trading

The federal government spent millions prosecuting Martha Stewart for making a few thousand dollars on an insider trading tip, and today, November 5, 2009, announced a large sting with 14 indictments in connection with its insider trading investigation of the Galleon hedge fund.  However, the SEC has ignored the $270 million that was made by a trader who bet $1.7 million on March 11, 2008 that Bear Stearns, then trading just below $63 per share, would lose more than half its value in a 9 day period.  The trader purchased $30 and $25 Puts on Bear which expired on March 20^th.  The day after the purchases, Bear’s stock went into freefall.  If any trade ever deserved an investigation, this one does.  After some Congressional questioning, the SEC issued subpoenas.  Strangely, no mention has ever been made of any findings.

Of critical note, on March 11^th, the same day the mysterious and hugely speculative trades were made, a meeting was held at the Federal Reserve Bank of New York (FRBNY) consisting of Geithner, then FRBNY’s President, Bernanke, and every major Wall Street firm except Bear Stearns.  The meeting was actually secret, only discovered by a Bloomberg reporter by accident, from a mention on Bernanke’s calendar.  Putting the pieces together, one could infer that Bear was the topic of discussion at the March 11^th FRBNY meeting and information was leaked to the trader that same day.  The following questions need answers:  1) Why, more than 18 months after the meeting, and after a period of financial panic, don’t we know the topic of the meeting?  2) If it wasn’t about Bear Stearns, why weren’t they invited?  3) Why won’t the SEC discuss or pursue the source of information used by the trader, or even identify the trader?

Naked Short Selling

One of the tactics used to bring down Bear and later Lehman Brothers was “naked” short selling, an illegal and unethical practice used by (reserved for) the large Wall Street “prime brokers” when they smell blood.  SEC regulations say that to “sell short”, one must “borrow” existing shares.  This regulation is enforced by every broker/dealer for their regular accounts.  That is, you or I cannot “short” without first finding and borrowing the stock.  But, these rules apparently are not enforced on the large Wall Street firms.  In both the Bear and Lehman cases, on the days just prior to their demise, there were more shorts outstanding than there were shares in circulation.  Why isn’t there an investigation of this and a disgorging of the illegal profits as called for under SEC regs?  If you or I had done this, the SEC would want to put us in jail!

What I have said simply here is well chronicled by author Matt Taibbi in the October issue of Rolling Stone.  Not unexpectedly, the article is somewhat irreverent.  What is unexpected is where it was published, Rolling Stone, not a beacon of conservatism.  Why hasn’t the business media, which pursued Martha Stewart with such passion, even made a mention of these “irregularities”?

The AIG Farce

Unfortunately, there is more.  On October 27^th, a Bloomberg story (authors Teitelbaum and Son) appeared regarding the AIG bailout.  It seems that for several weeks prior to the AIG bailout, then CFO, Elias Habeyab,  was trying to persuade banks who had purchased $62 billion (notional value) of AIG’s CDOs to accept 40% discounts on the paper, as AIG didn’t have the wherewithal to pay at par.  On September 16,2008, the FRBNY stepped in with an $85 billion credit line, effectively buying 78% of AIG for the American taxpayers.  Eventually, the rescue plan would amount to $182 billion.  In early November, Geithner (still President of FRBNY), Bernanke, and the Treasury (Paulson) began negotiations with the large Wall Street players about the price at which AIG would pay on its swap obligations.  The price of this stuff on the street was at 40% – 60% discount.  The authors found a term sheet from FRBNY regarding the price.  On the term sheet the discount at which AIG was to redeem this dubious paper was crossed out.  Geithner, Bernanke and Paulson had agreed to repurchase the AIG swaps at par.  The authors calculate that, as a result, the American taxpayers gave the large Wall Street firms a $13 billion gift.  FRBNY placed this paper into an LLC called Maiden Lane III.  As of June 30, 2009, Maiden Lane III was carrying this paper at a $7 billion loss.  Who benefited?  Large Wall Street firms mainly, including Goldman Sachs, JPMorganChase, Morgan Stanley, and Citi.

More Conflicts and Insider Abuse

Clearly, the deal that FRBNY made on behalf of AIG contributed greatly to the profits of Goldman, JPMorganChase, et al.  Some say the deal even saved Goldman (remember, Goldman had to quickly raise capital during this period and even turned to Warren Buffet for a capital injection).   There are several disconcerting facts that need to be aired and investigated: 1) Both Jamie Dimon, head of JPMorganChase, and Stephen Friedman, Chairman of Goldman, sat on the Board of Directors of FRBNY.  Friedman was Chairman of FRBNY at the time.  What role did these two play in the determination of the par price that AIG paid?  If this wasn’t a conflict of interest, it sure has the appearance of one;  2) Friedman purchased 52,600 shares of Goldman stock while it was still under pressure from the market’s belief that AIG would not redeem its CDOs at par.  But, according to the Bloomberg story, those purchases occurred after FRBNY’s decision to pay at par, a decision that Friedman, as FRBNY Chair, certainly had access to, probably had knowledge of, and possibly had input into.  At today’s price for Goldman shares, Friedman’s profits on his Goldman purchases exceed $5 million.  Where is the “insider trading” and conflict of interest investigation?

Control of the Fed

Each of the 12 Federal Reserve Banks are owned by the “members” who contribute capital in proportion to their size.  Because the Fed is privately owned, its ownership list is not publicly available (yet the Fed makes monetary policy on behalf of the public!).  The members, according to their share holdings, elect the Board of Directors.  Thus, the large Wall Street, “Too Big To Fail” institutions, elect and control the Board of Directors.

Winners and Losers

Given the above, it should not be a shock that AIG was given $182 billion and paid its CDO obligations at par (instead of $.60) after it was seized by FRBNY because those in control of FRBNY, Goldman, JPMorganChase, et al, had a huge vested interest and stood to lose significantly, perhaps even to the extent of failure.

In this light, it also isn’t shocking that TARP funds have been given mainly to “Too Big To Fail” institutions that had overleveraged and had lost on their risky bets, while such funds have been withheld from small community institutions that had not overleveraged or placed such risky bets.  Consider this, if the “Too Big To Fail” Wall Street institutions, now all of which are Bank Holding Companies, can get rid of their smaller rivals, there is market share to be gained!

All in all, the whole financial meltdown episode stinks of greed, conflicts of interest, insider manipulation, and government acquiescence to the rich and powerful on Wall Street.  The investigations of “insider trading” now taking place appear to be a smokescreen to convince the public that laws are being enforced, when, in fact, the most egregious acts are ignored because of who committed them.  Unfortunately, there is no one in Washington who is willing or possibly is politically able to stand up to such outrages.  And the business media simply doesn’t want to rock the boat.  Typically, we find such conduct (greed, conflict of interest, unethical and illegal behavior) between the governments and private sector power brokers in third world countries.

Robert Barone, Ph.D.

November 5, 2009