The Derivative Project

Naked Capitalism and Frontline Debate: Congress, Public Media May Have Outlived its Usefulness

Naked Capitalism and Frontline Debate: Congress, Public Media May Have Outlived its Usefulness

The Derivative Project was shocked with the absolute rewriting of history of the 2008 financial crisis by Frontline, in a PBS investigative report, Money, Power and Wall Street, that purports to tell the “story” of the global financial crisis.  Due to advocacy efforts on retail retirement plan fiduciary standards, time has not permitted a more timely Blog post on this critical topic.  Today is the time.
The mis-use of taxpayer dollars for public media has reached a crescendo.  When our democracy most urgently needs public media to provide unbiased, factual reporting to inform the electorate, it abandons its mission.  The financial crisis has revealed the capture of not only our Executive Branch, but also our Judicial Branch and our Legislative Branch.  Mainstream media failed the American people and now taxpayer supported public media has failed to report the facts.  Our democracy and an informed electorate is in jeopardy, which is indeed weighing on any sound economic recovery.
We commend Yves Smith of the Blog Naked Capitalism, for her in-depth reporting on the “white-wash” that Frontline did to protect Wall Street, Harvard Economists and our Executive Branch by rewriting history of the key facts of the financial crisis.  Here are the debate and well-researched facts by Yves Smith, posted yesterday, More on Frontline’s Astonishing White Wash of the Crisis.
The Derivative Project was alarmed that in the first two episodes, Frontline stated that after the takeover of Bear Stearns on March 16, 2008, “there was no forewarning that AIG had similar issues.  Timothy Geithner and Hank Paulson had no idea there would be more problems, since there was no transparency of derivatives, in particular credit default swaps.”
This is blatantly false. Many counter party credit risk analysts could predict the potential collapse of the financial system as early as Fall, 2007, through analysis of AIG’s quarterly reports.
Here are the facts that we hope Frontline will re-examine in a follow-up investigative piece. Frontline has been given taxpayer dollars to inform our electorate, as without an informed electorate, there is no democracy.  There has never been a more critical time in history for our electorate to understand the regulatory capture of our nation’s watchdogs and the overwhelming influence of Wall Street monied lobbyists in shaping our nation’s economic future.  Further, there are serious issues with the integrity of our most prized academic institutions, such as Harvard and Columbia Business School.
Here are the issues that Frontline must investigate and submit a correction to their first segment. that “no one knew where the risks lurked in counter party risk with credit default swaps, since there was no transparency.”
Issue Number 1

Frontline states Treasury Secretary Paulson and NY Federal Reserve Timothy Geithner did not see the threat by AIG, “since there was no transparency in the size of the derivative exposures.  
No one knew who the counter parties were.”  
AIG’s 2007 Annual Report disclosed the complete picture of their derivative positions and potential losses.   Combine the size of the non-collateralized, speculative derivative positions in credit default swaps and the underlying assets, it was easy to calculate in 2007, the upcoming losses AIG was exposed to given a downward pressure on home prices, which was clearly predicted by Economist Robert Shiller and quoted as fact by AIG Board Member Harvard Economist Martin Feldstein.  
In fact, Martin Feldstein, “as a member of the board of AIG Financial Products, he was one of those who had oversight of the division of the international insurer that contributed to the company’s crisis in September, 2008. On February 6, 2009, Feldstein was announced as one of U.S. President Obama’s advisors on the President’s Economic Recovery Advisory Board.” Why?
Harvard Economist Feldstein predicted in Jackson Hole in 2007 that Mr. Shiller predicted home prices would drop close to 50 percent.  Mr. Feldstein sat on the Board of AIG at this point in time and took no action in Fall 2007 to work with the Bush Administration to manage these trillions of dollars of non-collateralized, speculative positions. Frontline, these are all accessible facts in writing.  
“It is just so complicated” and “no one understood what was going on” is not an acceptable answer when the facts are clear, it was clearly understood.  Many of us tried to get Congress and the media to listen.  They refused.  Why would they ever listen to a “counter party credit analyst” from the Midwest, who had an opinion contrary to a renowned Harvard Economist?  The failure or integrity of our academic institutions is in question, as Charlie Ferguson, Director, Inside Job, so clear depicted.  Why didn’t Frontline continue with those facts  presented by Charlie Ferguson?  Who were they rewriting history for?
Questions for Frontline on Issue Number 1

  1. Why did Martin Feldstein, Hank Paulson, Goldman Sachs and Timothy Geithner wait until the 11th hour to downgrade AIG, call it a crisis, and demand the U.S, taxpayer payout AIG counter parties 100 percent on their positions? It was abundantly clear in Fall 2007, the contracts should have been unwound, since they were entered into by fraudulent misrepresentation by AIG, who knowingly committed to contracts beyond their financial capacity to make good on those contracts.
  2.  Frontline should question Harvard Economist and AIG Board Member’s 2007 Jackson Hole Speech and AIG’s 2007 Annual Report and ask Mr. Feldstein as to why he did not take action on the most obvious collapse of AIG from non- collateralized, speculative credit default positions? Why didn’t he raise alarm with NY Fed President Geithner and Secretary Paulsen as early as Fall 2007?  All the credit default swap positions were fully disclosed to every equity analyst and to the SEC.
  3.  Further, it is now known that  Goldman shorted the market, at that point in time, knowing the real underlying value of the assets.  (Worthless in many cases).  It is now known that Goldman purchased credit default swaps on AIG’s credit risk. Yet, simultaneously, Goldman was fully aware of their $13 billion exposure to AIG.  Why didn’t Goldman go to its former partner, Treasury Secretary Paulson to discuss the impact of these trillions of dollars of non-collateralized speculative positions, whose underlying assets could lose up to 50 percent, and work with the New York Fed President and the Executive Branch for a logical unwinding of these fraudulent positions?
  4. Frontline, re-examine the exact timing of the AIG downgrade and the emergency collateral payments and the “threat” to Congress and President Bush, “that if you do not act now we will not have an economy tomorrow,” with the knowledge the risks of these speculative positions were fully disclosed in Fall 2007 and known by Secretary Geithner and Paulsen.
  5. Frontline, look at The Derivative Project’s emails warning Congressional representatives that this was a “hold-up” of the U.S. taxpayer.  Why were these pleas ignored by Congressional representatives of their constituency?  Wall Street money and Wall Street lobbyists and misrepresentation by our esteemed academic institutions, as to fact, are all that Congr
    ess will listen to.  They now ignore their constituency as to any facts and pleas for  change on Wall Street issues.
  6. Frontline must examine the “incestuous” relationship between Larry Summers and Martin Feldstein as Harvard economists who orchestrated the bailout for AIG and continue to implement policy in the Obama Administration, directly and indirectly.  Frontline has a duty to examine how Harvard Economists and Glenn Hubbard, Dean, Columbia Business School ignored the reality of the collapse of the financial crisis and now refuse to take the necessary steps and a leadership role to prevent it from happening again.
  7. Goldman Sachs had billions of dollars of exposures to AIG through the purchase of AIG credit default swaps with underlying positions.  Goldman is a sophisticated risk manager.  They most surely would have analyzed AIG’s annual report.  Further Goldman shorted the mortgage market in 2007 and were fully cognizant that even a 10 percent drop in the housing market would impair AIG’s ability to fund these credit default swap contracts. Why didn’t Goldman Sachs go to Secretary Paulsen in 2007?  Why did Goldman Sachs wait to downgrade AIG, increasing AIG collateral calls and then simultaneously ask Paulsen and Geithner for a 100 percent payout on their credit default swap contracts with AIG from the U.S. taxpayer?
  8. Geithner testified to Congress that this was all very complicated and “these were new risks, that no one understood.” Non- collateralized counter party credit risk is not a new risk. This is misrepresentation under oath, an offense. Commercial banks, with only 5 major banks representing over 95 percent of the market in over-the-counter derivatives have been managing counter party credit risk with the advent of the OTC market in the early 1980′s.  The major commercial banks all knew in Fall 2007 who had the exposures and how to manage that exposure.  It was in the public record, in every SEC quarterly filing.
Issue Number 2 –  Myth:  Credit default swaps are insurance and they thus escaped regulation by both the banks and the insurance industry.  That was the problem.

Credit default swaps were executed as “derivatives” on International Swap Dealer Association (ISDA) financial contracts.  I agree with Yves Smith, credit default swaps are not true derivative contracts, which are risk-transfer agreements that are derived from an underlying asset, such as a currency or a commodity.  
However, AIG did entered into valid financial contracts that were regulated by the 30-year established protocol in the interbank market for trading derivative contracts, that began with the advent of floating exchange rates and grew and matured.  In the interbank market there has always been the understanding it was the honor system, between counter parties, who would analyze and manage the credit of their counter party and the financial institutions would self-police in a market based on a hand shake.
Congress and the CFTC have authorized this “inter bank” OTC derivatives market to continue, based on an honor system and self-policing.  Full disclosure may still not be necessary until one approaches a “swaps dealer” status, now defined as $8 billion.  The issue is the “end-user” exception for hedging bona fide commercial transactions and the will to allow limited collateral for end users to not increased operating costs for end users.  The banks and the counter parties to these end users would continue to self-police based on the financial statements of each end user and they would have the freedom to determine the amount of collateral necessary.
It just happened that AIG was an insurance company.  It could have been any end user. Thus, with AIG’s trillions of dollars of speculative, non- collateralized credit default swap financial contracts, the risks were known and understood by each and every counter party to AIG.  It was not the “wild west” with no regulation that Frontline presented. It was a well-established system for managing counter party credit risk, that was completely overseen by the Office of the Comptroller of the Currency.  Goldman Sachs was not a commercial bank at this point, but as a “sophisticated risk manager” certainly understood the financial position of AIG, but refused to deal with the potential calamity in a responsible fashion for the American economy. 
Under contract law, if a party to a financial contract executes a financial contract with knowledge that they do not have the funds to make good on that financial contract, that is deemed fraudulent misrepresentation and is a criminal offense.  We all know if an individual misleads a bank as to their income sources to secure and repay a loan, that is fraud and most individuals are thrown in jail for doing so, if they fail to meet their financial contract terms.
Questions for Frontline on Issue Number 2

Joseph Cassano, CFO of AIG’s financial products unit, that wrote speculative, non- collateralized credit default swaps in the trillions, knew full well if the markets moved say 10 percent against them, they could not make good on their speculative financial contract liabilities.  This is fraud.
Joseph Cassano traded interest rate swaps before he traded credit default swaps,  He knew the interbank rules and ISDA rules for large derivative positions. He simply wrote contracts beyond AIG’s ability to honor these contracts.  This is fraud under U.S. contract law.
Frontline, needs to reopen the investigation.  The Derivative Project asked the Department of Justice why AIG had not committed contractual fraud.  The DOJ responded AIG did not understand what they were doing.  The Department of Justice let AIG off the hook, gave them an $182 billion taxpayer dollar mistake under the “stupidity defense.” A sense of lawless is beginning to pervade our judicial system, whether they be in the role of FINRA, restricting retirement investors to their day in court  and now proposed self-regulatory organizations to administer justice for every ‘investment adviser”, to a $180 billion taking of taxpayer dollars based on the “stupidity defense.”
There is a legal system to prosecute AIG’s financial contract malfeasance.  Frontline needs to determine why AIG is not being prosecuted when there were laws to protect taxpayers.  Was it the $300,000 that AIG gave to President Elect Obama?  Was it Treasury Secretary Paulsen’s relationship with Goldman Sachs to ensure Goldman would get $13 billion taxpayer dollars on Goldman’s AIG exposures, without having to have that money at risk in the bankruptcy courts. Farmers’ segregated funds are now tied up in bankruptcy court with the MF Global bankruptcy. These farmers would have loved treatment that Goldman Sachs and other AIG counter parties received, escalating payouts by taxpayers to avoid their claims to languish in bankruptcy courts for years.
Was it an incestuous relationship between Martin Feldstein, Larry Summers, Hank Paulsen and other “highly trained Ivy League Harvard Economists” who have allowed an unconscionable taking of $182 billion dollars from the U.S. taxpayer and who sat idly by while the economy drifted into crisis, without taking swift action to prevent it, despite financial statements clearly laying out the most obvious course to a financial crisis?
It is imperative that Frontline dispel the myth that there was not a system to monitor these OTC exposures for any and every counter party.  It is a most obvious myth that is AIG collapsed because its credit default swaps were not regulated as an insurance product. “This is just something that fell through the cracks.” That is a false statemen
t that can be backed up by real facts.  One needed the honesty of the commercial banks and the requisite diligence of every equity analyst to read AIG’s annual report and ask the most basic questions and take the responsible actions to protect the American people from economic calamity.
Issue Number 3 – The Derivative Project Alerted Institutional Money Managers to the Threat Posed by AIG’s Trilions of Dollars of Speculative Credit Default Swap Contracts 
In October 2007, The Derivative Project alerted Charles Schwab Institutional Money Managers (Liz Ann Sonders) that the equity markets were quite likely to collapse due to trillions of dollars of speculative, non- collateralized credit default swaps on the part of AIG as one major counter party.  The Derivative Project urged Charles Schwab Institutional and Retail Money Managers again in March 2008 to move retiree’s funds and for those close to retirement to cash, FDIC insured CD’s and Bonds to weather the storm.  Schwab placed their profit motives over that of every retiree client’s life savings.
Money managers had a duty beginning in early 2008 to prepare their Clients portfolios for a financial crisis and a most obvious major setback in the future of economic growth, perhaps for decades to come.  Money managers have the tools to hedge retiree’s IRA assets, $4.7 trillion, now larger than the 401K market.  Money managers left their clients hanging, yet took in their fee income without lifting a pencil, and ruined the lives of many retirees, who lost their life savings and who could have locked in decent bond returns in Spring 2008.
In Spring 2008, FDIC insured CD’s were yielding close to 5 percent, which could have been locked in to see retiree’s through the financial crisis period, which could be years to come.  The most common sense portfolio with long-end bonds, TIPS and FDIC insured CD’s all purchased in 2008, combined with the purchase of Apple Stock (185 per share in Spring 2008) was created and is now up over 30 percent year to date. Frontline must examine the abject failure of money managers in protecting American’s retirement savings and putting their profit motives over their fiduciary duty to IRAs and 401k’s.  There were easy options to avoid trillions of dollars of losses.
There is major legislation pending that directly affects our economy and American’s retirement savings that a real understanding of the causes of the financial crisis could be invaluable for our Congressional representatives in shaping effective regulation going forward. Frontline could take a major role in getting the word out to our electorate, in plain English, of this most critical legislation to their futures.
It is the Wall Street lobbyists that are dictating the future of our economy both to the SEC (and FINRA) and to Congress and the Executive Branch.  It is Frontline’s duty to expose this regulatory capture and the influence of Wall Street money on shaping Congressional legislation that is harming our economic system overall.
The point is common sense and an understanding of over-the-counter derivatives in 2008, without a conflicted position, but a true fiduciary position, could have protected retiree assets and help to prevent a $2 trillion loss in retirement assets.
The point is banks and investment banks role in trading speculative, non-collateralized OTC derivatives was perhaps one of the most lucrative trades for those taking these positions in the history of the OTC derivative markets. It was not stupidity, it was greed.  Until the real facts are exposed, there will be no economic recovery, as the regulatory capture will continue, the fraud will continue. 
Questions for Frontline on Issue Number 3
Why did The Derivative Project understand, as early as late 2007, the risks posed by trillions of dollars of non- collateralized counter party credit risk and its substantial threat to the financial system and Secretary Geithner, Goldman Sachs, Treasury Secretary Paulson supposedly did not? Of course they understood.  The question is why did they allow the situation to turn into a major crisis?  Cronyism? Greed? Paybacks?
Was Secretary Paulson conflicted due to his relationship with Goldman? 
Why did Charles Schwab, despite repeated oral and written warnings, not investigate and take action to protect their client’s savings from unnecessary losses?  They took no action due to their conflicted status and such action would have reduced their profits.  All the major Wall Street firms are currently lobbying Congress and the SEC against a strict fiduciary standard that is in the best interest of every American’s retirement savings.
Why is the Department of Justice saying AIG did not know they were going to cause over $182 billion dollars in taxpayer support, but an individual mortgage holder who did not understand the financial contract and what he committed to is still on the hook?  Prosecutions for fraud are the only way to stop fraud.  If this prosecution happens at the individual level, it must also happen at the corporate level.
We sincerely hope that Frontline will work with both Naked Capitalism and The Derivative Project experts in both the mortgage industry and commercial banking/ counter party credit risk, to prevent a more balance perspective and present the real facts to help shape every American’s future.
If Frontline fails to take this proposed mission seriously, it is the death knell for public media. The electorate will be forced to move to Blogs, such as Naked Capitalism and The Derivative Project for the sole provider of un biased facts and for their understanding of how to vote come November 2012.
Mike Wiser and Martin Smith, we thank you for your initiative in getting the debate out there on the causes of the financial crisis. We certainly hope we can work together on the sequel to Money, Power and Wall Street that will present a more balanced, main street perspective, with real facts.  It is so critical for shaping the future of our economy.  Time is of the essence with the 2012 election.  A well-informed electorate and the mission of public media have never been more important to every American’s economic future.
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