Via:Naked Capitalism/Yves Smith

Sleaze Watch: NY Fed Official Responsible for AIG Loans Joins AIG Shortly Before AIG Pitches Sweetheart Repurchase to NY Fed Posted: 22 Mar 2011 03:16 AM PDT The corruption in high places is getting more and more brazen with every passing day. The only thing that separates the US from conventional banana republic status is that no one leaves keys to new luxury cars on the desks of officials to secure their cooperation. It’s just not enough of an inducement to get anyone to take action. Masaccio at FireDogLake was suitably outraged at this spectacle of a regulator getting a job with the biggest lobbying group in the industry he regulates…..and staying in his current oversight role: The Washington Post reports that David H. Stevens will be taking over as head of the Mortgage Bankers Association. Stevens currently serves as Assistant Secretary for Housing in the Department of Housing and Urban Development, and as the Commissioner of the Federal Housing Administration. He has a conflict of interest so deep that he should be fired at once… Allowing Stevens to stay on the job, and saying that it comports with ethics rules, is proof that the term “ethics” has lost all meaning. He is working on a settlement that in some news stories calls for a penalty of $20 billion, which only banksters think bears any relationship to the horrifying damage caused by these sharks, through jacked-up fees, fraudulent court filings, dual-track loan modifications and other sleazy tricks played on suffering homeowners. He comes from the industry, and is heading to the group that put out slimy reports condemning any steps that might aid homeowners, including judicial modification of mortgages in bankruptcy. Why is he not immediately fired for cause? President Obama can’t even use his standard excuse, that we should look forward, not at the past. I’m looking forward, and I see a totally compromised person negotiating the future of millions of Americans. Now we have another example of unseemly revolving door behavior, this with an even more direct connection between a former official’s old purview and his current role, this time involving AIG and its biggest sugar daddy, the New York Fed. We were probably remiss in not commenting on the peculiar announcement of AIG’s offer to buy back the bonds in the New York Fed’s Maiden Lane II portfolio for $15.7 billion. The stated reason, that the purchase would “reduce its obligation” to the government is nonsense; it’s astonishing that the press is parroting it. As this Cleveland Fed summary indicates, the latest of a series of restructurings converted the remaining debt payable by AIG to equity; it has paid down all its loan balances. the New York Fed loan to Maiden Lane II is payable by that entity, not by AIG (AIG does have an “equity” position in that portfolio). AIG can buy plenty of bonds in the marketplace; the only reason for it to offer to buy these bonds in particular is if it believes it can obtain them at a discount, which means that this is yet again another pretty blatant subsidy to the giant insurer. (The only other rationale we could fathom at the time of the announcement of this offer was to justify the government’s continued insistence that all these bailout programs were really great deals. Yes, if you have the Federal Reserve engaging in QE, you can play a three card monte game that makes your older portfolio buys look amazingly astute. But as we discuss below, the evidence has now fallen out conclusively on the side of this move being yet another subsidy to AIG). Note that if the NY Fed were serious about selling these bonds and maximizing value to the public, the last way you’d do it would be as a single massive portfolio. Big portfolio sales do result in discounts due to the lack of competing bids (think of selling all the artwork in an estate, which included a lot of painting, sculptures, collectable ceramics, and rugs, as a block versus selling the items individually in an auction). The way to fetch a decent price would be to break the portfolio up, in some cases down even to the single bond level, or at least into much smaller homogeneous lots, and work the orders through multiple dealers over time. Admittedly, AIG made its brazen offer back in December and the officialdom failed to respond. Providing support for our first theory is the offer by Barclay’s today to bid on the portfolio. From the Financial Times: Barclays is among a group of investors weighing a rival bid for a portfolio of mortgage-backed securities that has already drawn a $15.7bn offer from AIG, people familiar with the matter said. The securities are owned by the Federal Reserve Bank of New York and housed within Maiden Lane II, one of the special-purpose vehicles created as part of the insurer’s $180bn rescue during the financial crisis…. People familiar with matter said the Treasury had sought to help broker a deal between the insurer and the New York Fed, reasoning that management’s knowledge of the some 800 securities might help squeeze more profits out of them and maximise taxpayers’ returns on their AIG investment. Fed officials remain concerned how a quick deal with AIG might appear to the public, the people said. How do you read that statement: “management’s knowledge of the some 800 securities might help squeeze more profits out of them and maximise taxpayers’ returns on their AIG investment” ? That reads as if the Treasury is considering interceding on behalf of AIG to “maximize returns” meaning screw the Fed to allow the garbage barge AIG get a better deal. This is more or less an accounting gimmick among the main actors, but sticking the Fed with a bad deal is not all that visible, while tarting up AIG’s financials will presumably help with the public offering. Thus this, along with every retrade of the AIG deal (I think we are up to five), is yet another covert bailout. Oh, and more evidence that AIG is trying to get a steal: “It’s a very different story with or without these securities,” Robert Benmosche, AIG’s chief executive, told the Financial Times. “We can improve yields by 3-4 per cent.” That, dear readers, means AIG can’t buy this many bonds at a comparable risk/return tradeoff in the market. It can’t be “a different story” unless this portfolio is bought at prices far better than those required for comparable bonds in the market. It’s prima facie evidence that the intent is to get an above market yield, which is tantamount to a discounted price. Now where is the sleazy part in this? Aside from the hidden bailout, is that the NY Fed official who was responsible for overseeing Fed loans to TARP recipients, including the AIG loan, Brian Peters, joined AIG in late January. See this letter to the Committee on Oversight and Government Reform, based on subpoenaed information from the Fed, p. 8, the e-mail cited in footnote 31, for a sighting of Peters in action. Given the extensive interactions between the Fed and Treasury on the fight with Ken Lewis over his threat to walk from the Merrill purchase (the two were working in tandem here, and pretty much on all the major TARP recipients who got Fed loans), and the continued close cooperation between the Treasury and the NY Fed, it isn’t hard to imagine that Peters has good knowledge of and relationships with the key actors at the Treasury as well as at the NY Fed. So we have a former NY Fed official, deeply involved in the exchanges among the Fed and AIG and almost certainly the Treasury as well, now joining AIG. It isn’t hard to imagine that the reason he was hired was due to his intimate knowledge of how to move things along at the NY Fed and Treasury, and in particular, what Blackrock had told the NY Fed about Maiden Lane II and what the NY Fed’s return and political considerations were. The Treasury is not trying to protect the NY Fed from any information advantage AIG might have regarding the Maiden Lane II assets; Blackrock is certainly up to that task. It’s entirely about appearances of cutting a deal that favors AIG without that looking too bloody obvious. So in this warped world of priorities, where giving financial firms great deals to “preserve the system” and cook the books on the TARP are top priorities, having an former insider grease the wheels is probably seen as really helpful. It’s merely another proof of what Simon Johnson pointed out in May 2009: the government is firmly in the hands of financial oligarchs.

More on the Lack of Criminal Prosecutions: Was the SEC Deterred by a Widely Overlooked Ruling? Posted: 22 Mar 2011 01:14 AM PDT Bloomberg’s Jonathan Weil, who is normally an effective critic of bank chichanery and weak regulatory oversight, may have missed the mark on a key issue in an article last week, “Moral for CEOs Is Choose Your Fraud Carefully“. In it, he criticizes the SEC for failing to attack accounting fraud: It seems the Securities and Exchange Commission won’t be doing anything to challenge that pretense, either, and that this may be by design. The SEC for years has been bending over backward to avoid accusing major financial institutions of cooking their books, even when it’s obvious they did. So much for upholding financial integrity. Weil cites a series of object lessons where the SEC has not gone after financial firms executives for accounting fraud: Fannie Mae’s Donald Mudd, Countrywide’s Angelo Mozilo, and three executives at Indy Mac. Weil charges them with “see no accounting evil”. Let’s be clear: I’m no fan of the SEC’s actions in the wake of the crisis. The regulator has been kept resource starved. Under Arthur Levitt (hardly the most aggressive of SEC chiefs) any effort at enforcement led to threats from Congress of budget cuts (Joe Lieberman was particularly aggressive). Chris Cox was put in charge, as far as I can tell, to make sure the agency did at little as possible. So the SEC only knows how to do insider trading cases, and on any other type of action, it seeks to get a settlement, when a trial in some cases might have more value as a deterrent (plus you don’t get to be good at litigating if you never litigate). Moreover, the SEC also seems to believe it needs to win pretty much all of its cases to be perceived as a threat. That isn’t true either. Look at the Green Bay Packers, who were correctly the favorites to win the Super Bowl despite having a lousy win/loss record prior to the playoffs. But all those losses had been close, in hard-fought, well-played games. In litigation, embarrassing revelations in discovery or on the stand can also have deterrent value, and can serve as building blocks for future cases. Let’s deal with the misconstructions in Weil’s article. He argues: There’s a pattern here. When the SEC in 2009 accused former Countrywide Financial Corp. CEO Angelo Mozilo of securities fraud, it claimed the lender’s management foresaw as early as 2004 that the company would suffer massive credit losses on the home loans it was making. The SEC’s complaint accused Mozilo of “disclosure fraud” for hiding such information from investors. Later he points out Yet if the SEC’s allegation were true, it would mean Countrywide had been overstating its earnings for years, by delaying the recognition of losses long past the point when management knew they were probable. That would be an accounting violation. The SEC never made that connection in its complaint, though, and clearly had made a decision not to. Mozilo later paid $67.5 million to settle the suit, without admitting or denying the regulator’s claims. But this is flat out wrong, that they missed the connection and that they made a decision not to prosecute. As a result he, and just about everyone else, misses a key story. The SEC did make the connection, clearly and explicitly in the complaint. Most Countrywide coverage focused on the fact that the agreement settled securities fraud and insider trading charges. What’s missing from the reporting is that the original complaint, which was ready to go to trial, contained three elements, securities fraud, insider trading AND violations by the CEO and CFO of the key element of Sarbanex Oxley law (Section 302). Yet the settlement is silent on the Sarbox charges. The SEC apparently chose not to wade into the ‘accounting violation’ bog in the Sarbox portion, and instead complained of false of disclosures of the risks in the portfolio. That was a defensible tactical decision if the objective is to go after top executives. Look at Anton Valkas’ detailed discussion of where the thinks “colorable claims” lie in Volume 3 of the Lehman report. Note, for instance, that while CFO Erin Callan was aware of and uncomfortable with Repo 105, Valkas argues that she is liable for breach of duty of care and failure to notify the board of directors; the accounting liability sits with Ernst & Young, for professional malpractice. As law professor Franks Partnoy stressed in his book Infectious Greed, executives can use complicit accounting and law firms as liability shields. Now Weil can argue the the SEC should pursue them in addition to key decision-makers at failed financial firms, but the compliant about accounting seems a little wide of the mark in piece focused on cases against top executives. There’s no need to go after the consequential accounting violations (which would drag external audit and regulatory forbearance into the mix) when it’s much easier to explain the equally egregious risk disclosures to a jury. The Sarbox penalties are the same, since the violations are equivalent. The obvious strategy would be to choose the risk disclosure violations. The SEC complaint against Mozilo builds a compelling case that Countrywide was guilty failure to disclose portfolio risks, and that they were non trivial disclosure violations. Weil observation that that the disclosure violations would result in accounting violations is correct but irrelevant to the SEC’s strategy. So, the question is what went wrong? It’s bad enough that the SEC settled for such a trivial amount but with Mozilo why did the SEC also drop the Sarbox question from the settlement? A Sarbox victory in Countrywide would have opened the door to Sarbox prosecutions for everyone else. I doubt that was lost on anyone involved in the litigation. Indeed, he IndyMac case looks very similar to Countrywide. The glaring difference is that the IndyMac complaint does not include Sarbox violations. The Freddie litigation is at a much earlier stage; Wells notices have been sent ,so we can’t compare complaints yet, but it’s a safe beet they’ll look more like the IndyMac than the Countrywide complaints This appears to be the missed smoking gun: the order denying summary judgment: Order Denying Summary Judgment in S.E.C. v. Mozilo The germane section: D. Violation of Rule 13a-14 of the Exchange Act In the Fourth Claim for Relief, the SEC alleges that Mozilo and Sieracki violated Rule 13a- 14 of the Exchange Act, requiring them to certify that Countrywide’s 2005, 2006, and 2007 Forms 10-K did not contain any material misstatements or omissions.See 17 C.F.R. § 240.13a-14. Mozilo and Sieracki move for summary judgment, arguing that a violation of Rule 13a-14 of the Exchange Act cannot be pled as an independent claim for relief. The Court agrees with the reasoning of SEC v. Black, 2008 WL 4394981, at *16-17 (N.D. Ill. Sept. 24, 2008), and concludes that a false Sarbanes-Oxley certification does not state an independent violation of the securities laws. Accordingly, the Court GRANTS Mozilo and Sieracki’s Motions for Summary Judgment as to the SEC’s Fourth Claim for Relief The Fourth Claim for Relief was the Sarbox violation. Unfortunately, this leaves us in the dark since because the SEC v. Black decision was unreported. Here is portion of the SEC’s brief where they argued that Mozilo’s motion for summary judgment on this issue should not be granted: H. Violation of Rule 13a-14(b) Is A Stand Alone Cause Of Action In This Circuit Mozilo and Sieracki argue that they are entitled to summary judgment on the SEC’s Rule 13a-14(b) cause of action because it is not an independent cause of action. Their sole support for this contention is an unreported case from of the Northern District of Illinois, SEC v. Black, 2008 WL 4394891 (N.D. Ill. Sept. 24, 2008). Other courts, including one in this Circuit, have allowed stand alone causes of action for violation of Rule 13a-14(b).SEC v. Sandifur, Fed. Sec. L. Rep. (CCH) P93,728; 2006 U.S. Dist. LEXIS 12243 at *23-25 (W.D. Wash. Mar. 2, 2006) (cause of action for violation of Rule 13a-14(b) pled with sufficient particularity to withstand a motion to dismiss); SEC v. Brady, Fed Sec. L. Rep. (CCH) P93,885; 2006 U.S. Dist. LEXIS 29086 at *17-18 (N.D. Tex. May 12, 2006) (“SEC has adequately pleaded that. . . [defendant] committed a primary violation of Rule 13a-14(b)”). The violation of Rule 13a-14 results from the certification of a periodic report that is false or misleading.SEC v. Kalvex, Inc., 425 F. Supp 310, 316 (S.D.N.Y. 1975) (Section 13(a) embodies the requirement that periodic reports be true and correct, and a failure to comply with such section would result in violations of the securities laws). Mozilo and Sieracki signed Sarbanes-Oxley certifications for each Form 10-Q from Q1 2005 through Q3 2007 and each Form 10-K for the years ended 2005, 2006, and 2007, and signed the Forms 10-K for the years ended 2005, 2006, and 2007. For all of the reasons set forth above, those reports were misleading. Accordingly, Defendants’ motion for summary judgment on this cause of action must be denied. Now as a non-attorney (but my sources agree on this reading) it appears that the judge was saying that if you argue for SEC violations (which this case did) you don’t get to double dip and add a Sarbox charge. That’s far more significant than it appears. As we argued in an earlier post, the language in Section 302 (civil violations) tracks the language in Section 906 (criminal violations). A win on a Section 302 case would thus set up what would appear to be a slam dunk criminal case. The judge’s action is what I call a “BS ruling”. The judge does not explain his reasoning, and this is a ruse when a judge does not want his decision challenged. I’m told lawyers might more politely call it “gutless”. Now does this make Weil wrong and get the SEC off the hook? Hardly. The judge’s negative ruling on a separate Sarbox charge on securities violations does not rule out other types of Sarbox charges, but the SEC incorrectly seems to be reacting this way. Remember, the part of Sarbox that gave a lot of boards fits was that the CEO and the CFO certify the adequacy of internal controls (Section 404). That goes above and beyond traditional SEC representations. As securities lawyer/litigator Bob H argued: It may be important that the Black and Mozilo claims were all about fraudulent disclosure and not failure to maintain an adequate system of internal controls. The latter was not in play in either case. It’s one thing for a court to say that two claims do not arise when it is alleged a Form 10-K includes a fraudulent statement and then say another claim arises because the SarbOx certification (saying there were no fraudulent statements) was wrong. However, I don’t think this logic applies with regard to Section 404 of SarbOx. Here the statement made by the certifiers is that a system of internal controls is in place and is adequate. There are two things in play here and they are different. One, it is alleged the document contained a violation of Rule 10b-5 (contained a false or misleading statement or omission). Two, the company’s system of internal controls was other than represented in the certificate (i.e. it was false). In other words, I don’t believe either court would have dismissed the certification claim on summary judgment if it was about the system of internal controls (as opposed to straight out disclosure). It does not take a lot of imagination to assume that many of the banks that cratered had deficient risk management systems and controls, which in a firm with trading operations is clearly one of the most important control systems. Some readers may believe that putting a case before a jury on risk management deficiencies will simply allow the defense to introduce all sorts of confusing technicalities, and confused juries don’t convict. However, in many cases the risk management systems were obviously, grossly deficient. Lehman was running over 120,000 derivatives positions, on systems that didn’t talk to each other or reconcile nicely; it didn’t even know to within 10,000 how many derivatives positions it was carrying! Similarly, it appears that the banks’ system of internal controls over their mortgage backed positions only went as far as looking at the ratings. In other words, the SEC looks to be quitting far too easily. It isn’t a reasonable expectation to win cases in new areas on maiden efforts. That’s great if it happens but the more likely result is some stubbed toes and partial victories before perfecting how to argue these issues. But the SEC is no doubt enjoying its high profile thanks to the Galleon case, and is too likely to keep pursuing what it knows how to do than go after how a handful of banks blew up the global economy yet got to keep their winnings, which is a matter of much greater consequence for all of us.