Commentaries

Lehman the tax scofflaw

Wow, Lehman Brothers really didn’t like paying taxes.

Back in June, New York City’s tax department filed a $626 million claim for back taxes against the bankrupt investment bank. And now comes New York State with an even bigger $1.2 billion tax claim.

Most of Lehman’s unpaid taxes to the state stem from last year, not surprising given what happened to the firm. But the state lists Lehman as having a $223 million outstanding corporate tax liability from 1999.

The unpaid liability from 1999 is so old that the interest owed to the Empire State actually exceeds the amount in unpaid taxes.

It makes you wonder is other Wall Street are equally as stingy when it comes to paying the taxman.

UBS’ days of wine and CDOs

Expensive wines and toxic assets are rarely mentioned in the same breath.

But that was the talk at UBS during the summer of 2007, when the Swiss banking giant sold some $35 million in soon-to-be rotten collateralized debt obligations to Pursuit Partners, a Connecticut hedge fund, which is now suing the bank.

Last week, a Connecticut judge ruled that Pursuit had presented sufficient evidence that UBS sold the CDOs even though the bank had confidential information that Moody’s Investors Service was planning to slash its credit ratings on those subprime-backed securities.

The judge, in issuing a preliminary ruling against UBS, cited an internal UBS email that has received a fair amount of attention because a trader boasted: “Sold some more crap to Pursuit.”

But it’s the email exchange leading up to that trader’s comment, which wasn’t included in the judge’s decision but was obtained by Reuters, that may be just as revealing.

Much of the discussion between trader Evan Malik and a colleague concerns the amount of money they’d each spent on a 2000 vintage bottle of wine. The sale of the “crap” CDOs almost seems an afterthought in the email thread titled: “95pts Wine Spec. Best Tignanello since 1997.”

On the anniversary of the implosion of Lehman Brothers, it’s important to remember that the financial crisis really began a full year earlier — in July 2007 — with the collapse of two Bear Stearns hedge funds that had loaded up on CDOs.

Obama urging Wall Street to do the right thing

In his speech, Obama emphasizes that big banks should take it upon themselves to give back to the community after the tax payer has done so much to put them on them on the road to recovery. While I agree with the point in theory, I’m not sure Wall Street is built to think about the moral imperative of creating a better society when it’s primary goal is to make money.

Wall Street, and I use this term broadly, has already demonstrated that when it’s presented with a  choice, it chooses the money. While many bristle at the thought of more regulation, especially when it means it could undermine financial innovation – God forbid – one of the important take aways from the crisis should be there needs to be a counterweight to greed. The industry cannot regulate itself.

From the speech, which you can see in all its glory on Felix’s blog.

The fact is, many of the firms that are now returning to prosperity owe a debt to the American people. Though they were not the cause of the crisis, American taxpayers through their government took extraordinary action to stabilize the financial industry. They shouldered the burden of the bailout and they are still bearing the burden of the fallout – in lost jobs, lost homes and lost opportunities. It is neither right nor responsible after you’ve recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system, and a more broadly shared prosperity.

So I want to urge you to demonstrate that you take this obligation to heart. To put greater effort into helping families who need their mortgages modified under my administration’s homeownership plan. To help small business owners who desperately need loans and who are bearing the brunt of the decline in available credit. To help communities that would benefit from the financing you could provide, or the community development institutions you could support. To come up with creative approaches to improve financial education and to bring banking to those who live and work entirely outside the banking system. And, of course, to embrace serious financial reform, not fight it.

Has the moment passed for bank reform?

A year on from the collapse of Lehman Brothers and there is plenty being written and broadcast about the lessons, the winners and losers and where we go from here.

Amidst all the noise, a relatively short (765 word) commentary from Barbara Ridpath who is head of the International Centre for Financial Regulation (ICFR) — a think tank set up to shape regulatory cooperation and best practice – makes some worthwhile points:

The sector’s problems are not yet behind us. Loan losses, which lag other indicators, will continue to build and cost banks in provisions for some foreseeable time to come. Nonetheless, some in the financial sector are choosing to think the worst is behind them. They hope that systemic change is not longer necessary because they have begun to make money again in such a low interest rate environment.

Legislators are working to implement G20 proposals either domestically or regionally with mixed results. It is remarkable how much easier it was to act in a concerted fashion when the world was in genuine crisis mode. Now that we appear to have stepped back from the brink, political unity has gone by the wayside. Political expediency, partisanship, and the settling of old scores have come to the fore. This is a shame.

It appears that banks have also returned to ‘business as usual.’ Big bonus payments and hefty pay packages for star teams are back in the news and those banks that can afford to are hiring talent again. Governance reforms are mooted, but most teams are still compensated on revenues, not risk-adjusted returns. Most departments within banks continue to see each other as competitors, instead of having a unified sense of identity, teamwork and strategy for their institutions. Shareholder activism on governance issues has not actually increased.

Commentary from the private sector on regulatory reform mean that many proposals are significantly watered down as self-interest once again predominates in every market segment.  The constant threat of moving business elsewhere is used whenever a proposal is mooted that is not in the direct interest of a particular constituency.

Ridpath — who was previously head of ratings for Europe at Standard & Poor’s and has worked as an economist at the Federal Reserve Bank of New York and also at JP Morgan — sums it up neatly when she says:

What happened to the idea that we could never return to anything like where we had been before? The debate on changing the business models and the culture of financial services appears to have fallen by the wayside.

Except for those who have lost their jobs in financial services, their businesses through lack of credit, or their homes through predatory lending practices, there is little sense that any lessons have been learned or that anything fundamental within the culture of financial services needs to change.

Patience is waning. There is a risk that we arrive at a stand-off, where out of frustration politicians respond to the conflict between populism and bankers’ recalcitrance by becoming ever more shrill in their demands, and bankers become ever more threatening in their responses. We shall end with a ‘dialogue of the deaf.’ 

Ridpath isn’t giving us the answers, but she has put her finger clearly on the problems facing those who had hoped for deep-seated reforms.

Securitization survives the fall

A year after the government’s seizure of Fannie Mae, Freddie Mac and AIG , not to mention the bankruptcy of Lehman Brothers that sent the global financial system into a tailspin, very little has changed to prevent debt from being sliced and diced, again and again.

This is a mistake. Although there were many factors contributing to the downfall of the global financial system, the repackaging of toxic debt into esoteric financial products was at the heart of the credit crisis when it erupted in 2007.

It’s easy to forget, particularly when many are focused on anniversary tick-tock accounts of the last days of Lehman Brothers, how nasty CDOs — or worse, CDO squareds — became so incredibly popular in the first place.

Yet, after all the damage, the trillions of dollars lost and the biggest state intervention in financial markets since the Depression, there has been no movement to ban their creation.

Securitization in its broadest form — taking underlying collateral, bundling it together and selling it as tradable debt — is still hailed as an important 20th-century invention that has helped worthy borrowers get the credit they need to buy a home, car, or education that would otherwise be out of their reach.

Policymakers, understandably, are anxious to get it started again after the market snapped shut last year. Wall Street, and investors taking advantage of generous financing from the Federal Reserve, are happy enough to oblige.

And it has worked. As of last week, new bonds backed by consumer debt reached $100.5 billion for the year, according to Barclays Capital. While a fraction of the pre-crisis market, that deal volume represents a healthy revival of a near-dead business. Three-quarters of the new deals are eligible for Fed financing.

‘Living wills’ easier said than done

In the wake of the widespread chaos that accompanied the bankruptcy of Lehman Brothers last September, regulators have sought to find a better way to unwind global financial giants. One approach is that the banks themselves should prepare for their own orderly demise — a kind of “living will”.

That idea has been gathering steam of late. The G20 group of finance ministers and central bankers meeting in London over the weekend agreed to require “systemic firms to develop firm-specific contingency plans.”

The concept has wide appeal. The crisis has convinced politicians and regulators of all colours that even large financial institutions must be allowed to fail without imposing a huge burden on taxpayers. Many bankers see such a regime as a preferable alternative to more intrusive regulation.

However, drawing up a detailed “living will” is easier said than done.

Simon Gleeson of Clifford Chance argues that it is more important for regulators and legislators to establish a cross-border crisis-management and resolution regime than it is for individual firms to prepare for their own demise.

The mandate of the Financial Stability Board (FSB), the international body comprising finance ministries, central banks and financial regulators, was recently expanded to include contingency planning for cross-border crises. It published a series of relevant principles in April. However, as the Institute of International Finance (IIF) noted, it is “clear from the high-level nature of the principles and the aspirational language [that] there remains a lot to be done.”

The IIF is calling for the FSB to develop a convention on crisis management that would include detailed rules, including on early intervention. It also wants the FSB to run cross-border crisis simulations of the sort routinely carried out by domestic regulators.

Banking? Keep it simple stupid

In 1873, Walter Bagehot wrote that “the business of banking ought to be simple; if it is hard it is wrong.” He would have struggled to recognize today’s banking system.

It is not just ever more ornate derivatives that bend the mind. Financial firms themselves have become fabulously complicated. Citigroup lists 2,061 subsidiaries and affiliates while the institutional chart of JPMorgan Chase is 267 pages long.

Complexity — as Bagehot predicted — has become a curse. If nobody can understand financial firms, they will become ever more accident prone.

The crisis that exploded a year ago offered a salutary lesson in the dangers of complexity. Many shareholders and creditors simply did not fully comprehend their investments. Instead they were forced to trust managers and the rating agencies.

Regulators too could be forgiven for scratching their heads.

“Supervisors are at a decided disadvantage in understanding risk-taking and compliance for firms that might involve dozens of jurisdictions, hundreds of legal entities and thousands of contractual relationships,” former Fed official Vincent Reinhart has written.

Indeed Basel II — the international capital code — was an admission of defeat by regulators. The message from the banking accord was that institutions had become so convoluted that only they were able to understand the risks they were taking.

A year on, it’s still a housing story

Around the time Lehman Brothers’ collapse nearly pushed the global banking system off a cliff, Rose Barrett’s own personal financial crisis began.

Recently separated from her husband, the Kissimmee, Florida resident quickly found it hard to keep making her monthly $1,939 mortgage payment on her salary as a night nurse at a local rehabilitation center. She made a hardship application to her lender, the subprime banking arm of Banco Popular seeking relief from her 40-year fixed rate $200,000 mortgage with a hefty 9.45 percent interest rate.

But by the time she asked for help in mid-September, it probably was too late to alter the trajectory of what is an all-too-familiar tale.

As the stories and commentary marking the one-year anniversary of the failure of Lehman mount, it is also worth remembering that housing was a root cause of the financial crisis — and that it had many victims like Barrett.

And even as the banks that are holding mortgages appear to be getting healthier, the tide of foreclosures, which threatens to keep a lid on consumer spending for months to come, shows no signs of abating,

Indeed, Barrett’s story is also about the post-crisis winners like Goldman Sachs, who snatched up opportunities amid the subprime wreckage.

It was an investment subsidiary of Goldman that began a foreclosure proceeding in Polk County Circuit Court on Barrett’s four-bedroom home in December. The Goldman unit last September paid $731 million for Banco Popular’s $1.1 billion subprime mortgage portfolio in the US.

Defoliating JC Flowers

William Cohan has a great takedown of J. Christopher Flowers and his struggling private equity firm in Fortune.

The story sheds light on how Flowers lost a good deal of money for his investors over the past few years and how this has tarnished the reputation he earned years ago at Goldman Sachs.

Cohan also does a great job chronicling the Flowers’ publicity machine, which excels at getting him linked in the business press to numerous potential deals. Even though Flowers’ firm never completes many of the deals he’s said to have interest in.

But the most intriguing part of Cohan’s story is Flowers’ claim that he was one of the people who alerted former Treasury Secretary Hank Paulson to the desperate situation facing American International Group a week before Lehman Brothers collapsed. Flowers says he learned of AIG’s terrible plight in early September when the giant insurer reached out to him as potential savior.

Cohan doesn’t spend much time exploring this conversation between Flowers and Paulson but it’s probably worthy its own investigative story. With the anniversary of Lehman’s collapse fast approaching, this intriguing incident is another reminder of just how clueless our public officials were to the problems that almost sunk the global financial system.

I think Flowers’ account of his talk with Paulson is probably accurate. In the summer of 2008, Paulson was going around the country privately telling news organizations that the financial crisis was nearing an end. What’s particularly shocking is that Paulson was trying to sell this story just a few weeks before the federal government bailed out mortgage giants Fannie and Freddie.

There’s no doubt Paulson didn’t understand just how dire the situation was at AIG. Maybe if he did, he would have done more to avert Lehman’s bankruptcy–an event which nearly turned a very bad credit crunch into the second Great Depression.

Recycle the TARP

The U.S. insurance fund for bank deposits is running out of money. At the same time, some of the big institutions that received federal bailouts last fall have repaid more than $70 billion to the Treasury Department, and more checks to the government may be in the mail soon.

Right hand, meet left hand.

Indeed, one way of dealing with this looming crisis at the Federal Deposit Insurance Corp would be to take all that repaid bailout money and simply inject it into the bank insurance fund. Such a move would instantly bolster the deposit insurance fund, which at the end of June had just $10.4 billion in the kitty.

Transferring the repaid bailout money to the insurance fund would permit bank regulators to move more aggressively in shutting down some of the 416 troubled lenders with $300 billion in assets on the agency’s watch list.

And the sooner the FDIC can dispose of the worst banks, the faster the nation’s financial system will be on the path to a real recovery.

Using money repaid to the Troubled Asset Relief Program would also save President Obama from the embarrassment of having to go to Congress to ask for another bailout if the FDIC exhausts a $100 billion line of credit from Treasury.

It’s far easier for Obama to get Congress to approve the reallocation of bailout money that’s already been appropriated than asking for a new round of government welfare for the nation’s banks.