Monday, December 09, 2013 - Corrupt Practices

Corrupt Practices

by Sinclair Noe

DOW + 5 = 16,025
SPX + 3 = 1808
NAS + 6 = 4068
10 YR YLD + .01 = 2.75%
OIL - .41 = 97.24
GOLD + 9.70 = 1241.40
SILV + .30 = 19.94

Next week the Fed FOMC will meet to determine policy. Today, three Fed big wigs gave speeches. We start with James Bullard, president of the St. Louis Federal Reserve Bank; Bullard says: “A small taper might recognize labor market improvement while still providing the [Fed] the opportunity to carefully monitor inflation during the first half of 2014,” and if inflation doesn't return to something approaching a target of 2%, well the Fed could pause the taper.

In separate remarks, Richmond Fed President Jeffrey Lacker said that the central bankers would discuss pulling back the pace of its asset purchase program but gave no indication of how the discussion could go.

 Dallas Fed President Richard Fisher said the central bank should begin to scale back its bond-buying “at the earliest opportunity,” because, “Money is cheap and liquidity is abundant. Indeed, it is coursing over the gunwales of the ship of our economy, placing us at risk of being submerged in financial shenanigans rather than in conducting business based on fundamentals.”

The taper talk spooked Wall Street traders but it's unlikely the Fed will taper at the December meeting. There is little harm in postponing the decision till the new year, particularly compared to the risks of pulling back too soon.

Meanwhile, the Federal Reserve reports that US net worth, a measure of household wealth, rose 2.6% to $77.3 trillion from July through September. Net worth reflects the value of homes, stocks, bank accounts and other assets minus mortgages, credit cards and other debts.

Net worth peaked at $69.1 trillion in Q3 2007, then dropped to $55.7 trillion in Q1 2009, for a loss of more than $13 trillion, and now it is up $21.6 trillion to $77.3 trillion. Adjusted for inflation, net worth is still about 1 percent below its pre-crisis peak, but both the stock market and home prices have continued to increase in the current October-December quarter.  Rising stock prices boosted Americans’ net worth $917 billion. Higher home values added another $428 billion.

The gains haven’t been equally distributed. The wealthiest 10 percent of households own about 80 percent of stocks. And home ownership has declined since the recession, particularly among lower-income Americans.

Total mortgage debt rose 0.9 percent from the previous quarter. Americans are also holding more consumer debt outside of mortgages, in the form of student loans, auto loans and credit cards. Consumer debt rose 6 percent from the previous quarter.

The flow of funds data from the Fed would indicate that QE has had an effect on the economy, it's still accurate to say it has been an unequal redistribution of wealth; with most of the gains going to Wall Street and little to none making it to Main Street. And then there is a question of the sustainability of the gains.

The other day, I talked about the fines in the JPMorgan $13 billion settlement and I raised the question of how the fines were calculated. Well it turns out they weren't really calculated as much as they were negotiated. It looks like the settlement agreement does not quantify the losses that form the basis for the civil penalty, or even provide an indication of how many violations the government determined occurred in connection with the issuance of the mortgage securities; according to the government, JPMorgan bankers regularly included loans in deals that did not meet the bank's underwriting guidelines and were "not otherwise appropriate for securitization." We just don't know the quantity and the actual losses associated with these toxic mortgages.

The breakdown of the $13 billion settlement with JPMorgan includes a $2 billion fine to prosecutors in Sacramento and $4 billion in relief to struggling homeowners in hard-hit areas like Detroit and certain neighborhoods in New York. The government earmarked the other $7 billion as compensation to federal agencies and state attorneys general across the country. In some settlements, the beneficiary of the fines is often the United States Treasury.

But the 8^th Amendment prohibits excessive fines; something the Supreme Court has defined as fines that would be grossly disproportional to the gravity of the offense. The government can look beyond the actual amount involved in the case and also consider the harm done to others, the need for deterrence, and such other matters as justice may require. And since the settlement was negotiated, JPMorgan could hardly argue now that the fines are excessive.

As far as the deterrence factor, the government failed horribly on that front. JPMorgan CEO Jamie Dimon probably had little to no direct involvement in the troubled mortgage deals, even if he did preside over the company and set policies. He did sign off on the annual reports, and under Sarbanes Oxley, he should have had, at the very least, some awareness. Dimon walks scot-free.

But what about the investment bankers who were involved in underwriting and selling the dubious mortgage deals that led to the massive penalty? They appear to be doing just fine as well. Indeed, until last month, three of the top bankers responsible for the deals still worked at JPMorgan. And one of them, the guy in charge of managing risk for the securitization group, is now in charge of the division that monitors risk for the entire bank.

JPMorgan claims that many of the toxic mortgages originated through Bear Stearns and Washington Mutual, the two failed financial institutions that JPMorgan scooped up in the financial crisis. What about the investment bankers who were involved in underwriting and selling the dubious mortgage deals at Bear and WaMu? Well, the head of Bear Stearns' mortgage division (also named in the suit) is now a partner at Goldman Sachs and he's the global head of the bank's mortgage trading division. Another head from Bear's bond business (also named in the suit) is now the head of Deutsche Bank's corporate banking and securities division. Another mortgage chief from Bear ended up as a chief of mortgage products for Bank of America. Other bankers involved in the mortgage scam have retired, but there doesn't seem to be anything in the settlement that would prevent them from continuing in the industry.

So, the bottom line is that there was no individual accountability in the settlement, there was not full disclosure of crimes committed, or any significant attempt to quantify the actual losses, and of course there was no admission of wrongdoing; absent those factors, settlements like these continue to reward and incentivize illegal conduct.

Meanwhile, you'll recall that in August JPMorgan disclosed that the SEC was investigating the bank's hiring practices in China; specifically that the bank favored hiring people from prominent Chinese families in order to win investment banking business. Over the weekend, the New York Times reported that emails uncovered in that investigation appear to clearly indicate that they knew they were crossing the line. In one email, an executive said that hiring sons and daughters of powerful people in China "almost has a linear relationship" with winning assignments. The documents even include spreadsheets that list the bank's "track record" for converting hires into business deals. And the email goes on: “You all know I have always been a big believer of the Sons and Daughters program."

So, the program even had a name, and everybody knew it, except apparently for the upper level executives back in New York, who remarkably remained clueless about the Sons and Daughters program, or the types of trades executed by the London Whale, or the toxicity of the mortgage loans by the mortgage department, or anything else.

Anyway, JPMorgan could be indicted under the Foreign Corrupt Practices Act which prohibits American companies from paying money or offering anything of value to foreign officials for the purpose of "securing any improper advantage."  Under the Act, the gift doesn't have to be linked to any particular benefit to the American firm as long as it's intended to generate an advantage its competitors don't enjoy. Of course, JPMorgan has spreadsheets to prove they got a big bang for their bribery buck. But the point is that the Foreign Corrupt Practices Act is strict.

By comparison, we don't even require that American corporations disclose to their own shareholders the payments they make to American politicians. If a Wall Street bank wants to hire the child of a prominent politician – go ahead. And of course the politicians and the technocrats regularly enjoy the revolving door between Washington DC politics and Wall Street corporate offices.

The list of public officials with past or present ties to Wall Street reads like a government phone book: Treasury Secretary Tim Geithner is now head of Warburg Pincus; budget director Peter Orszag works for Citigroup; Don Regan (Merril Lynch); Robert Rubin (Goldman, Citigroup); Phil Gramm (UBS); Alan Greenspan (Pimco); and that's just a quick sample.

In the Citizens United case, Justice Anthony Kennedy wrote for the majority: “if the First Amendment has any force it prohibits Congress from fining or jailing citizens, or associations of citizens, for simply engaging in political speech.”

Of course, we all know that money talks. JPMorgan has the spreadsheets that prove that money talks in China. And we have to Foreign Corrupt Practices Act to punish bribery. But in the US, we don't have a strict Corrupt Practices Act because the people that write the laws sold us out. Sorry, but you know it's true.