Wall Street Fraud

Wall Street Fraud (8)

America continues to slog through the same path as our Roman ancestors, as it allows institutional forces from within to destroy what forces from without could not destroy

Fraud takes many forms, oftentimes it is disguised and deeply embedded within the cultural, economic or social systems that most take for granted. Other times, fraud is overt, specific and perpetrated by outside forces. The police, our local and federal governments, private investigators, or internal audits target the obvious, non-institutional frauds, whether personal, financial, social or economic.

Examples of these overt frauds are criminal activity, Medicare fraud, insurance fraud, personal infidelity, or the failure of corporate governance. These types of fraud, though, are relatively easy to detect and spot, and are generally correctable given sufficient remedial activity. Institutional fraud, on the other hand, is pervasive and endemic to our society.

History often repeats itself, and from it America can divine its future, or at least one version of that future. A brief history lesson will highlight the perils of ignoring deep institutional fraud domestically and the risks associated with it. The Roman Empire concerned itself with empire building, marching vast armies for years through conquered territories, but ignored the institutional decay that was ossifying the Roman homeland. Ultimately, it was not merely enemy armies that collapsed the empire, but the collapse of economic, social and moral structures deep within the empire.

Likewise, the United States continues to project formidable military and economic strength abroad, and is perceived as a protector of Western values and cultural institutions. This role protects the oligarchic military industrial complex and the enormous profits derived from these missions, but much like the Romans ignores the enormous costs and social impacts inherent in maintaining this infrastructure. The Chinese, much like the barbarians that faced the Roman armies, threaten to broach our economic and military borders not because of advanced technology or superior skill, but because of sheer brute strength and population size.

Similarly, the German Wehrmacht, the most formidable military machine ever assembled, was overwhelmed by waves of Russian divisions in World War II.  In spite of possessing advanced technology and brilliant military tacticians, the Germans were slaughtered by waves of Russian soldiers, even as Germans killed 20 Russians for every slaughtered German. Both China and Russia currently have a near endless supply of labor, both militarily and economically, with which to rout American interests in the very near future.

Why is this history lesson critically important to us at this juncture? Because, as a nation facing some steep challenges economically, socially and culturally, we have chosen to ignore the deep institutional fraud that is fraying our homeland institutions. Instead, we continue to see risks only abroad, and ignore the destruction of our own homeland. These risks will consume us long before the Chinese or Russians have imposed their will.


Category: Wall Street Fraud
A recent study by three University of North Carolina researchers indicates that market short sellers profit from their enhanced ability to discern publicly available information, not from market manipulation or insider knowledge.

Common wisdom is that short sellers, those market participants attempting to capitalize on the misfortunes of individual stocks, manipulate or shape negative information to their benefit. The study, reviewed here in the New York Times, and published here, reveals that short sellers are merely very astute and perform a very high level of due diligence. These "informed traders" do not merely time the markets and information, and therefore, obtain unfair advantages over other market participants. Rather, short sellers perform effective due diligence and often prognosticate future failure or scams.

The researchers looked for evidence that short sellers' informational advantages were due to timing, and looked for evidence of abnormal short selling ahead of news events in the U.S. over the 2005-2007 period. They found no such patterns, and noted that the "ratio of short sales to total volume is nearly constant around news events." The researchers actually found that "there is a significant increase in short selling AFTER the news event" which indicates that the short sellers are trading on publicly available information.


Category: Wall Street Fraud
Wednesday, 23 December 2009 06:50

Duplicity in our Decade

Frank Rich of the New York Times writes, here, that the narrative of our decade has been defined by how easily we've all been duped by the con-artists in our midst. Collectively, Americans have become inured to the deception that surrounds our social, commercial, cultural and economic relationships.

Our vacuous minds have purposely ignored the fraying of these relationships and the resulting impact on our country because acknowledging this reality would require a painful acceptance of the cancer that is slowly consuming our society.

Rich notes that we have witnessed a decade of scam, fraud and misfortune in the likes of Citigroup, Fanny Mae, Ted Haggard, Enron, Madoff, Drier, housing, Stanford, AIG, Barry Bonds and Iraq, to name a few, and that Tiger Wood's fraud is merely the culmination of this era. Tiger's demise is all the more pronounced, writes Rich, because of his "sham beatific image, questioned by almost no one until it collapsed".

Rich emphasizes, though, that it is not Tiger's hypocrisy and our collective disappointment at yet another fallen hero that is remarkable, but the canyon-like gulf between Tiger's public image as a "paragon of businesslike discipline" and his "maniacally reckless life". A worse breach, though, reveals the lie of Tiger's near-obsessive dedication to building trust as the cornerstone of his public image, and also of Tiger as the paragon of corporate resoluteness and self-discipline.

Trust and its destruction have defined these frauds. Tiger purposely cultivated an image of trust and self-discipline, and ultimately became Accenture's standard bearer. Similarly, Enron, AIG, Fanny Mae and Madoff collectively hyped trust and reliability as the cornerstones of their businesses. Rich notes that "We keep being fooled by our leaders in all sectors of American life, over and over" and that after Enron, our financial leaders and government regulators should have been more careful in monitoring our financial landscape and critically analyzing the developing housing bubble.

Category: Wall Street Fraud
Monday, 23 November 2009 22:51

Wall Street's Smarts Exposed

As Wall Street became the destination of choice for MIT and Harvard mathematicians and physicists throughout the last decade, alarm bells should have sounded at our regulatory and policy-making institutions.

An interesting op-ed piece by Calvin Trillin appeared in the New York Times recently, here, that caps a recent trend exposing the so-called genius of Wall Street as a fraud. Other Times writers, including Joe Nocera, here, Dennis Overbye, here, and Steve Lohr, here, have tackled the subject of Wall Street's smarts, but none as succinctly as Mr. Trillin. In the op-ed, Mr. Trillin claims to have met a man in a Manhattan bar who summarized the cause of the financial system's near-collapse: "Because smart guys had started working on Wall Street." This overly simplistic analysis became profoundly interesting as I continued reading, and developed into the following rubric:

  1. Fortune and academic standing on Wall Street are historically inversely correlated, with Wall Street's millionaires graduating in the lower third of their class;
  2. The lower third, who usually made generous livings on Wall Street, became enamored of potentially huge fortunes, and began leveraging their businesses;
  3. Top graduates, who typically became physicists or judges (tip money on Wall Street), instead began calculating arbitrage risks for hedge funds and other investors;
  4. The top graduates, who were very smart, invented credit default swaps and other derivatives, enabling the lower third to become obscenely wealthy;
  5. Wall Street nearly collapsed largely due to derivatives and credit default swaps developed by these very-smart people.
Category: Wall Street Fraud
Monday, 26 October 2009 20:47

Magical Thinking and Denial

Denial is a powerful emotion, especially when coupled with an avalanche of media hype and feel-good sensationalism.

Our economy has just weathered the most severe downturn in 70 years, and it's business as usual for Wall Street and bankers. The increasing disconnect between the pain of Main Street and Wall Street's prosperity is numbing, given the increasingly dour news befalling consumers. The current pain merely illustrates that for average Americans, the last 8 years was a mirage, an episode of magical thinking where debt became income and homes became assets.

Truth be told, though, this illusion has been repeated in every asset bubble of the last thousand years. The resulting collapse, was, sadly, completely predictable. Because humans have such short memories, the past repeats itself in almost eery lock-step, just ask the Dutch about those thousand-dollar tulips.

Category: Wall Street Fraud
Saturday, 17 October 2009 22:49

Revenge of the Nerds

The greatest failure of the last two years is not the collapse of the securitized mortgage markets or the housing collapse that spawned them, but the failure of faulty risk analysis that continues to permeate the financial industry.

The financial industry became enomored of quantification modeling as a strict denominator of risk, and it largely collapsed as a result. Wall Street embraced modeling techniques that attempted to quantify risk by placing numeric valuations on the amount of risk they were holding. Wall Street investment banks, and the “quants” that wrote the programs, truly became enamored of the "simplification" of risk analysis that these models offered.

Finally it seemed, there appeared an easily understood evaluation technique that anyone could understand. Just run the “program”, and a daily benchmark would assess the entities’ risk, which was then comparable and quantifiable. These models became the Holy Grail of risk analysis on Wall Street. One such model, the VaR, or Value at Risk model, expresses risk as a number, or dollar valuation to be precise. VaR, and the hundreds of models like it, became a crutch, a lazy method of quantifying risk and compartmentalizing this part of their operation.

It also became a convenient way of transferring blame should the risks materialize. No one could, after all, shoulder blame when their “quant models” incorrectly assessed their exposure. Reliance on these models was intellectually lazy, a function of ignorance and of management's inability to perform critical analysis. It may have been unrealistic to believe that many of these Wall Street analysts, most bred as political science, history, or English majors, could realistically understand the dynamics of corporate risk and perform in-depth analysis of their firms' balance sheets or profit and loss statements.

Category: Wall Street Fraud
Thursday, 20 August 2009 22:46

Manipulating the Markets

In a lengthy expose, Rolling Stone.com columnist Matt Taibbi explores Goldman Sachs’ role and participation in every major economic cyclical expansion and bust throughout the last century.

His thesis is quite simple, that Goldman has managed to position itself to gain from every major speculative bubble this century by manipulating the regulatory structures and regimes, all with the tacit approval of our government and politicians. Goldman has managed to secure this approval by positioning its minions deep inside government and in highly influential private and public positions. The number of senior Goldman executives who occupied high level government positions or have become executives at other financial services firms is staggering: Robert Rubin, Bill Clinton’s former Treasury secretary and former Citibank chairman; John Thain, chief of Merrill Lynch; George Bush’s last Treasury secretary, Henry Paulson, who was Goldman’s CEO; Joshua Bolten, Bush’s chief of staff, and Mark Patterson, the current Treasury chief of staff. This is just the short list, and does not include dozens of other, less senior executives.

Category: Wall Street Fraud
Sunday, 09 August 2009 19:58

Audit Failures and Ratings Agencies

Why is anyone still surprised at the magnitude of the disaster that has befallen our economy? An economic collapse that resulted from the faulty analysis performed by those organizations charged with bestowing ratings on the thousands of securitized and structured finance products.

That anyone is surprised is simply amazing, given the collective failures of auditing firms in the last 20 years, and the collapse of Arthur Andersen due to the Enron audit failure. While audits of financial statements and audits of securitized products are dissimilar in many tangible respects, the rationale behind their failures is remarkably similar.

Complex financial statements and complex securitizations share one common feature: no one really understands them. Financial statements continue to be obtuse rationalizations of highly complex organizations and disparate companies, cobbled together and "consolidated" to appear as if the reporting entity was one, giant, unified company, rather than a series of companies that may or may not have little in common. This "consolidated" financial report purports to "fairly represent" the financial results of the consolidated entities, while providing little in the way of unconsolidated and segregated information on the disparate companies that comprise the whole.

The audits are prepared by rotating bands of auditors who generally leave the "Big 4" after little more than 2-3 years in practice, having grown weary of the numbing nature of audits. These "experts" are charged with engaging senior management in lively discussions regarding the adequacy and materiality of their financial representations, while being tethered by the massive audit fees these engagements generate. Think there's a slight conflict of interest here? Of course there is. Senior managers have a schizophrenic need to "preserve" the client relationship while ensuring the fairness of the financial statements, a tightrope that often fails.

Category: Wall Street Fraud