Coroner’s report on Lehman: Terrifying fraud.

(10 am. – promoted by ek hornbeck)

Dylan Ratigan & Eliot Spitzer plainly explain the fraud that occurred at Lehman.  Ratigan hands Spitzer collateral (a trash can), and Spitzer hands Ratigan cash.  Lehman “pawned” its garbage in exchange for short-term loans to spruce up the quarterly books with “more cash, less trash.”  This is the “repo 105” fraud everyone is talking about since the release of the bankruptcy examiner’s report.  Please watch:

CEO Dick Fuld alone made half a billion bucks off this fraud.  He remains a free man today.  As Spitzer said, the accounting firm Ernst & Young, the Fed, and the Treasury were also involved in this fraud.

Ratigan: “This report comes just short of suggesting this is by no means an accident but instead one of the greatest crimes ever perpetrated by a group of people, and enabled by the US government.”

And Spitzer concludes: “there is no doubt civil cases will be brought. We had a failure of CEO, the CFO, the accountants, and indeed the regulators, the Fed and the Treasury, that were inside these banks, and the question has to be asked: where were they?”

UCSD school of law professor Frank Portnoy says the “repo 105” fraud chapter of the bankruptcy examiner’s report on Lehman is not even the worst revelation; rather that the Valuation of Assets section is “500 pages of utterly terrifying reading.”

But an even more troubling section of the Lehman report is not Volume 3 on Repo 105. It is Volume 2, on Valuation. The Valuation section is 500 pages of utterly terrifying reading. It shows that, even eighteen months after Lehman’s collapse, no one – not the bankruptcy examiner, not Lehman’s internal valuation experts, not Ernst and Young, and certainly not the regulators – could figure out what many of Lehman’s assets and liabilities were worth. It shows Lehman was too complex to do anything but fail.

In short, Lehman’s own in-house “product control team,” i.e., quality control accountants, were not able to put value on Lehman’s assets and liabilities because they couldn’t figure out the math.  Instead, they punted, and used the friggin’ trader’s models to do the valuations on CDOs.  

So much for independent vetting.  Portnoy continues, astonished:

My favorite section describes the valuation of Ceago, Lehman’s largest CDO position. My corporate finance students at the University of San Diego School of Law understand that you should use higher discount rates for riskier projects. But the Valuation section of the report found that with respect to Ceago, Lehman used LOWER discount rates for the riskier tranches than for the safer ones:

The discount rates used by Lehman’s Product Controllers were significantly understated. As stated, swap rates were used for the discount rate on the Ceago subordinate tranches. However, the resulting rates (approximately 3% to 4%) were significantly lower than the approximately 9% discount rate used to value the more senior S tranche. It is inappropriate to use a discount rate on a subordinate tranche that is lower than the rate used on a senior tranche. (page 556)

It’s one thing to have product controllers who aren’t “quants”; it’s quite another to have people in crucial risk management roles who don’t understand present value.

Lehman’s risk management team didn’t understand “risk.”  The bankruptcy examiner found that many of the “asset tranches” were worth one-thirtieth (1/30th) of what Lehman claimed they were worth.  Think about that in the context of Congress forcing mark-to-model rules on FASB, or rather, mark-to-fantasy rules that are in use today at all the bigger, failer institutions.

Portnoy concludes:

The Repo 105 section of the Lehman report shows that Lehman’s balance sheet was fiction. That was bad. The Valuation section shows that Lehman’s approach to valuing assets and liabilities was seriously flawed. That is worse. For a levered trading firm, to not understand your economic position is to sign your own death warrant.

Capitol Hill and the White House have zero appetite for any real financial reform or prosecution of criminal conduct, because it would reveal a horror show.  The Fed and Treasury are up to their necks.  Congress says that swift financial reform is “unrealistic,” what with all that great health care passing, and such.  Don’t expect anything “Dodd-acious” to happen.  

Fear of facing the real horror show of the American Way of Life is the existential crisis in everything we do.  One way or another, the death warrants are signed and sitting in the vaults.

I’ll give Ilargi the last word:

This present bag of Al Capones, except for a few carefully selected scapegoats (Dick Fuld: Tar and Feathers!), will never be brought to justice, because Eliott Ness wouldn’t stand a chance in today’s America, or London, Paris, or Tokyo. We just would like to believe he would, so much so that that very belief is actually aiding and abetting both the crimes and perpetrators. We don’t want real life, we want the hologram. We tell ourselves: “but there’s nothing I can do about it”, and we use that statement as an excuse to let people like Dick Fuld and Tim Geithner walk all over our children’s graves.

There’s times when I think that perhaps the best thing that could happen to us is for our lives and dreams to be thrown off a cliff and see what survives the landing, we can’t seem to wake up in any other way. You know, the sort of thing that sounds good in theory. But I can clearly see the suffering that would come with it, and I don’t like it. Not one bit. Whatever we do, though, we must make sure of one thing. That we find back our moral fiber, and act on it.

Update: While I was writing this diary Bobswern posted a diary on Kos about some brewing Dodd-acious-ness.  Bob does good work, but the US government has been utterly impervious to any real reform, and this attempt at “independence” of the Fed is just a drop in the bucket.

Update 2 good to resist, Greek edition:

A sane society might recognize the conflict of interest between the power-aspirations of a money-lending class and the public welfare — doubtless the inspiration behind Jefferson’s warning that banks are “more dangerous to liberty than standing armies.” It is a very good question why matters of public finance should remain within the private sphere at all, even if this is beyond the scope of any one nation to resolve.