I sense fear, anger and a deep feeling of injustice reminiscent of the climate on the eve of the French revolution

TO BE NOTED: From the FT:

"What the French revolution can teach America

By Dominique Moïsi

Published: April 2 2009 18:13 | Last updated: April 2 2009 18:13

“Eat the wealthy.” The ferocity of the words used by some demonstrators in London on the eve of the Group of 20 summit evokes the worst excesses of the French revolution. Anti-capitalist anger in the west is not confined to Europe. Alexis de Tocqueville’s The Ancien Régime and the Revolution is as relevant to understanding today’s America as his deep and eye-opening thoughts on the young American republic in his Democracy in America.

Of course, America in 2009 is not France in 1788, the year before the fall of the Bastille (the prison that embodied the oppressive nature of the monarchical regime) and the symbolic beginning of the French revolution. The fall of Lehman Brothers in September 2008 has nothing to do with the fall of the Bastille; symbols of wealth should not be confused with symbols of oppression. There is no guillotine around the corner and it would take a lot of imagination to compare President Barack Obama to Louis XVI, or Michelle Obama to Marie-Antoinette.

Yet as a European living in America – watching news on television every night, talking to friends, colleagues or my students – I sense fear, anger and a deep feeling of injustice reminiscent of the climate on the eve of the French revolution. Just replace bread shortages with foreclosures, aristocrats with bankers, and privileges such as the right not to pay tax with stock options. Add to that support for the king but rejection of many of his ministers, and the comparison looks less far-fetched.

The explosion of populist rage that has accompanied the AIG scandal, amplified by an opportunistic Congress and by media that play to the tune of their audiences when not reinforcing their passions, reflects the depth of suffering in the US. Main Street, like much of France at the end of the 18th century, is outraged. Fear for its own present and future is combined with anger at those it considers responsible, and who are much less affected than they. Are not senior bankers today like the aristocrats of yesterday, their privileges no longer justified by their social functions – to serve the king with their swords or to contribute to the creation and dissemination of wealth?

The problem with the economic team of the new president is that, like the court of the king of France in pre-revolutionary times, it has inherited all the bad reflexes of the ancien régime, mixing excessive sympathy for the outdated logic of the world of finance, which it helped to create, with insensitivity to the emotions of the ordinary people, which it tends to ignore. This sympathy is perceived to contrast with the harsh treatment of carmakers.

Bankers and financiers have to reinvent not only their trade but also their way of life and, above all, their value system. In the Madoff scandal, just as shocking as the crime of an individual was the behaviour of many of his rich customers, who combined greed with a lack of financial common sense.

An interesting incident was reported by CNN last week. A group of protesters – very few, to be honest – rented a bus in Connecticut and stopped in front of the mansions of AIG executives to express support for those who had returned their bonuses and outrage against those who had not and were still living in grand style, in contrast with the many more who had lost nearly everything.

The greed of some was tolerated as long as most of society continued to progress. But today’s combination of fear and humiliation with a deep sense of injustice leads to anger that is potentially irrepressible. The strength of the American republic has been bolstered by the popularity of its new president. This capital should not be squandered on reliance on a media-savvy communication culture. As can be seen so often in history, less is more. The president of the US simply speaks too much.

Revolution is not around the corner; at least, not in America. But there are lessons Mr Obama can learn from the French king’s failure to manage dissent. He must not fall prey to populism. His goal is to save the economy, not punish the bankers. At the same time, he must not be seen to have too much sympathy for the world of finance and its excesses or to cut himself off from the suffering of his people. If he fails, the corporate laws of today will face the same fate as the ancien régime rights of yesterday.

World leaders’ agreements, substantive or superficial, will not suffice. It is the trust of their respective citizens, translated into hope and confidence, that will make the difference.

The writer is a visiting professor at Harvard University and author of the forthcoming The Geopolitics of Emotion"

AIG was insuring mark-to-market risk rather than default risk which is where they went wrong.

TO BE NOTED: From A Credit Trader:

"Soros: Kill, kill, kill the CDS

In his latest WSJ post, Soros outlines why he thinks “naked shorting” i.e. buying of CDS without a bond position should be banned.

My commentary to his points are in italics below:

• AIG failed because it sold large amounts of credit default swaps (CDS) without properly offsetting or covering their positions. Perhaps I’m reading in too much into this sentence but to expect AIG to somehow have hedged or offset its CDS trades is akin to an insurance company kidnapping sick people who have bought life insurance and sticking them in incubators to prolong their life. AIG sold protection because it viewed selling CDS as an insurance business. The oft-uttered phrase that AIG was a hedge fund are missing the point that these trades were buy-and-hold; AIG was not in the business, unlike a hedge fund, of dynamically trading in the market.
• What we must take away from this is that CDS are toxic instruments whose use ought to be strictly regulated. I like when the conclusion is stated upfront without any salient points.
• It [heavily regulating CDS] would also save the U.S. Treasury a lot of money by reducing the loss on AIG’s outstanding positions without abrogating any contracts. In fact, the US Treasury had three options in dealing with AIG’s trades: 1) take over AIG and have AIG’s counterparties face the government, 2) post enough cash to cover AIG’s collateral calls, 3) unwind AIG’s trades. It chose 3 which I think is the worst option as a) it locks in massive losses, b) it does so at the absolute wides of the market (spreads naturally blew out as soon as the market realized AIG was in big trouble), c) it commits the most amount of cash upfront.
• Since they [CDS] are tradable instruments, they became bear-market warrants for speculating on deteriorating conditions in a company or country. CDS can be used as easily to go long risk as short risk. In fact, for each nefarious speculator betting on the demise of the poor company by buying protection, there is an avenging angel who is sitting on the other side of the trade and is a seller of protection. While, it is true that there can be heavy one-way flow in CDS on the back of strong protection buying or selling which will drive the market in one direction, the dealers obviously adjust the CDS levels up or down based on this flow at which they are happy to take the other side of the trade.
• Thus, we must understand financial markets through a new paradigm which recognizes that they always provide a biased view of the future, and that the distortion of prices in financial markets may affect the underlying reality that those prices are supposed to reflect. “Reflexivity” strikes again. I don’t think it has ever been news that the prices of assets affect investor psychology which will, in turn, have an effect on the prices of financial assets. This is certainly true of all other assets including CDS.
• Going short on bonds by buying a CDS contract carries limited risk but almost unlimited profit potential. By contrast, selling CDS offers limited profits but practically unlimited risks. This asymmetry encourages speculating on the short side, which in turn exerts a downward pressure on the underlying bonds. If the CDS product payoff profile is so skewed in favor of buyers of protection, why did credit spreads rally for many years until 2008. Also, if the average price of a high yield bond is in the 50s vs. an average historic recovery (yes recoveries in this cycle will be lower) of 40 – that suggests that the payoff profile is in favor of protection sellers, not buyers. Finally, gamma is on the side of protection sellers as well as duration increases as spreads rally – in other words, a protection buyer makes less marginal dollars for each basis point of widening in spreads since risky duration goes down. This can be seen via the Merton debt/equity model as well. Also, for distressed names, protection tends to be priced upfront which means that buying protection in expectation of a quick default is actually quite expensive.
• People buy them not because they expect an eventual default, but because they expect the CDS to appreciate in response to adverse developments. I don’t understand what is wrong with this. If the risk of default increases, protection should be more expensive. That’s called a fair market.
• AIG thought it was selling insurance on bonds, and as such, they considered CDS outrageously overpriced. In fact, it was selling bear-market warrants and it severely underestimated the risk. AIG was insuring mark-to-market risk rather than default risk which is where they went wrong.
• A decline in their share and bond prices can increase their financing costs. That means that bear raids on financial institutions can be self-validating. Lehman went bust largely because it could not raise short-term funding, not because of any CDS pressure. A rating downgrade caused the stock price to fall, making it difficult for Lehman to raise enough cash by issuing equity which caused rating agencies to downgrade it further, leading…. Also, Morgan Stanley CDS traded wider than Bear or Lehman and yet it miraculously survived. I guess reflexivity is only invoked when it works, kind of like those technical indicators.
• I believe that they [CDS] are toxic and should only be allowed to be used by those who own the bonds, not by others who want to speculate against countries or companies. What is wrong with speculation as such? Should we ban short-selling in stocks forever and ever? Metalgesellschaft lost a lot of money on commodities and Orange county on moves in interest rates. Let’s ban those as well. Also, reading this sentence suggests that CDS can only be by those who hold bonds. So, will sellers of protection be required to hold bonds as well. I’m sure this is not what Soros meant, just thought I’d be cheeky."

let's not forget that the FSA deserves a hefty share of the blame as well.

From The Economics Of Contempt:

"The FSA Deserves Some Blame for Lehman Too

ECB official Lorenzo Bini Smaghi responded to Paul Krugman's recent contention that Europe's response to the financial crisis has been inadequate. One of Smaghi's arguments, though, unfairly places all the blame for allowing Lehman to fail on the US:

[Krugman's argument] doesn’t explain how the most fateful decision of all – the decision to allow a systemically important bank to fail in the midst of a financial crisis – was taken by a single decision-maker, while the 16 euro area governments have managed to avoid making such a large mistake.

Whoa, let's remember what actually happened. The Fed and the Treasury successfully brokered a private-sector rescue for Lehman, in which Barclays would buy all of Lehman except for $40 billion of commercial real estate assets, which would be acquired by a consortium of major banks. Since Barclays is a British bank, the deal required approval from the UK's Financial Services Authority (FSA). On Sunday morning, though, the FSA unexpectedly rejected the deal. As William Cohan recounted:

The Barclays deal required the blessing of the Financial Services Authority, in London - the UK equivalent of the SEC. So Paulson spoke with his UK counterpart, Alistair Darling, the Chancellor of the Exchequer, and to the FSA. He then summoned McDade, Lehman's president, to the New York Fed and told him at around 9:45 a.m., "Deal's off. The FSA has turned it down." At roughly 10 o'clock, Paulson and Geithner briefed the bankers at the Fed.

So while the Fed and the Treasury undoubtedly made a mistake in letting Lehman fail, let's not forget that the FSA deserves a hefty share of the blame as well.

Posted by Economics of Contempt"

Me:

Don said...

Here's a little more on that from Bloomberg on Nov. 10th:

http://www.bloomberg.com/apps/news?pid=20601109&sid=aMQJV3iJ5M8c&refer=home

"Barclays Deal

One of the attendees, Merrill CEO John A. Thain, 53, took stock of his own company's best interests and initiated merger talks with Bank of America. Lewis had concluded on Friday that he couldn't do a deal with Lehman without government backing, which he thought would be forthcoming. After Paulson made it clear to Lewis that a government role wasn't in the cards, the Bank of America CEO pulled his team out of the Lehman talks.

That left only Barclays, since Nomura told Lehman it was unable to move fast enough. Fuld, who rarely left his office that weekend -- working the phones, fielding calls from deputies, talking to Barclays executives -- thought he had a deal Saturday night. Barclays was willing to buy Lehman for about $5 a share if it could leave behind the most troublesome assets, the ones Lehman had proposed spinning off into a separate company as well as some others Barclays didn't want.

Sunday morning brought a false dawn. Geithner and Paulson had talked a syndicate of banks into backstopping the creation of a new entity that would take over $55 billion to $60 billion of Lehman's problem assets, according to people with knowledge of the negotiations.

No Lifeline

Everyone was basking in what seemed a done deal until word came at 11:30 a.m. in New York that the U.K.'s FSA, which regulates that country's banks, refused to waive normal shareholder-approval requirements or to allow Barclays to guarantee Lehman's debts until obtaining that approval. The reason, people familiar with the decision say, was that Barclays lacked sufficient capital to absorb Lehman.

``The only reason it didn't happen,'' Leigh Bruce, a Barclays spokesman said today, ``is that there was no guarantee from the U.S. government, and a technical stock-exchange rule required prior shareholder approval for us to make a similar guarantee ourselves. We didn't have that approval, so it wasn't possible for us to do the deal. No U.K. bank could have done it. It was a technical rule that could not be overcome.''

Don the libertarian Democrat

March 20, 2009 8:38 PM

I've been rude about Gary Matsumoto's conspiracy theories in the past, and now he has a doozy of a new one

TO BE NOTED: From Felix Salmon:

"Naked Shorting: An IM Exchange

I've been rude about Gary Matsumoto's conspiracy theories in the past, and now he has a doozy of a new one: the bankruptcy of Lehman Brothers had very little to do with its management or its insolvency, and everything to do with naked shorting. Gary Weiss is one journalist who's convinced that naked shorting is not a problem: I had this IM interview with him this morning.

Felix Salmon: So Gary Matsumoto is out with 2,685 words of conspiracy-mongering on the subject of naked shorting and Lehman Brothers
Which I know is a subject dear to your heart

Gary Weiss: Yes, following stock market conspiracy theories is one of my favorite hobbies.

Felix Salmon: So, in a nutshell, what's the problem with this one?

Gary Weiss: Well, let's start with the lead paragraph. It says, "The biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts."
My reaction was, "Is he serious?"

Felix Salmon: Well, is he?

Gary Weiss: Yes, that is what I find remarkable. He provides not a shred of evidence for his hypothesis, except for some warmed-over "fails" trade data that proves nothing, a quote from a former SEC chairman who has a vested interest in the subject, and he ignores little things like what Lehman Brothers did to cause its own demise.

Felix Salmon: Why does the failed-trade data prove nothing?

Gary Weiss: Fails to deliver can be caused by any number of factors, of which naked short selling is just one.

Felix Salmon: As for Lehman Brothers causing its own demise, well, yes, obvs. But if short-sellers hadn't driven Lehman stock down to the level at which the bank had to declare bankruptcy over the course of a fraught weekend, might not the authorities in the US and UK have managed to cobble together some kind of rescue package allowing Lehman to be sold to Barclays or Nomura or both?

Gary Weiss: You're talking about ordinary short selling driving down the price of Lehman stock. What he is talking about is fails to deliver, which is another issue entirely.
I agree that the unwise abolition of the uptick rule left open the possibility that shorting could drive down stocks.

Felix Salmon: Is there any real empirical data on what proportion of fails are due to naked shorting?

Gary Weiss: There is absolutely none. In fact, as the SEC enforcement division just pointed out, there are no studies indicating that naked shorting has any impact on the market whatsoever.

Felix Salmon: In that case, is there any evidence that the kind of things which cause fails (and aren't naked shorting) spiked around the time of the Lehman bankruptcy?
Matsumoto has one theory on the spike in fails: that it's due to naked shorting. Do you have an alternative explanation?

Gary Weiss: The problem with fails data is that you can't comb out fails that are unrelated to naked shorting. Since most fails are caused by things that aren't naked shorting, and since SEC Chairman Christopher Cox said that there was no significant naked shorting of bank stocks, including Lehman, I'd suggest that factors other than naked shorting were at work in causing the fails.
Actually Cox's exact words were that there has been no "unbridled" naked shorting of financial issues.

Felix Salmon: Matsumoto nods to this:
"The Federal Reserve Bank of New York lists several reasons for fails-to-deliver in securities trading besides naked shorting. They include misunderstandings between traders over details of transactions; computer glitches; and chain reactions, in which one failure to settle prevents delivery in a second trade."
Still, it seems like it's more than just coincidence that spikes in fails have coincided exactly with periods when the stock in question fell dramatically.

Gary Weiss: Then I guess Cox was lying. Seriously. I am no fan of the man, but if there was no "unbridled naked shorting" of financial issues, and if there actually was significant naked shorting of financial issues, than he should be strung up from the nearest lamp post.
I would suggest that he was not lying and that, as has been the pattern over the years when naked shorting is raised, it is a red herring.

Felix Salmon: But how would he know? And why can't we see the same evidence that he's seeing?

Gary Weiss: I would love to see the SEC release all the evidence that it has on naked shorting. As a matter of fact, I think they should drop everything else that they are doing, stop investing actual stock frauds and Ponzi schemes, and devote themselves entirely to disproving a conspiracy theory.
He would know, by the way, because all trades leave a paper trail, and if a fail to deliver is caused by naked shorting I would think it would be fairly easy to ascertain if that were happening.
And if it were happening, I am sure, given the pressure whipped up over this, that he would have been more than happy to say it was happening.

Felix Salmon: It is worth pointing out (a) that Cox's statement about unbridled naked shorting came in July, before Lehman collapsed. But also (b) the SEC has given no indication that it thinks there was a problem with naked shorts in Lehman's collapse.

Gary Weiss: Yeah, that too. Getting back to the Bloomberg story, that was omitted entirely from the article.
(Unless it was buried somewhere after the quote from the superb former SEC chairman Harvey Pitt.)

Felix Salmon: The article did quote Susanna Trimbath as saying this:
"Failed trades correlate with drops in share value -- enough to account for 30 to 70 percent of the declines in Bear Stearns, Lehman and other stocks last year, Trimbath said."

Gary Weiss: It may also correlate with the tides and the phases of the moon. The question is, where is the evidence of naked shorting actually taking place? The conspiracists' case depends entirely on statistical data related to a phenomenon ("failed" trades) that is almost always not naked shorting.
Where are the SEC enforcement actions?
Why did Cox say it wasn't a factor?

Felix Salmon: So what would constitute evidence of naked shorting actually taking place? Are we wholly reliant on the SEC to be able to see it and prosecute it?

Gary Weiss: We know that statistical evidence of "fails" data is meaningless, so yes, we have to rely on actual enforcement actions by the SEC and SROs. Heaven knows, they are motivated to find such things happening.

Felix Salmon: But the only evidence we have that fails spikes are meaningless is that there's no correlation between fails spikes and subsequent SEC actions
I mean, I'm sympathetic to what you're saying, but it is 100% reliant on the SEC.

Gary Weiss: And the SROs. Here's an analogous situation:
Occasionally there is statistical evidence of pre-announcement runups in volume and share prices before takeovers.
That is indicative of insider trading and, sure enough there are prosecutions and enforcement actions. It is something actually happening.
Here we have "spikes on charts" and consultants to parties engaged in litigation against alleged named shorters (Ms. Trimbath) finding "correlations" and we have absolutely no regulatory actions whatsoever.
Either the SEC and the SROs are corrupted, as the conspiracists suggest, or it ain't happening.

Felix Salmon: Still, if your argument that naked shorting isn't a problem is entirely reliant on (lack of) SEC activity on this front, then it seems hard for you to attack the SEC itself for releasing a report taking the issue seriously. Aren't they, by your lights, the exact institution which has to take such allegations seriously?

Gary Weiss: Absolutely not. If organized pressure groups and astroturf organizations are demanding disproportionate, unnecessary deployment of scarce SEC resources, the SEC has an obligation to reject those demands, and not pander to them.

Felix Salmon: What's more, we're in a bear market, and it can at times be hard to find a borrow (see eg Citigroup right now) and the temptation to engage in naked shorting must be high. You'd think that at the very least the SEC would have found some small-scale idiots who gave it a try.

Gary Weiss: As happens in all bear markets, there is historically enormous public and political pressure to target people profiting from share price declines.
That happened during the Great Depression, and it is happening now. That results in some good regulatory initiatives, such as the uptick rule, and it results in wastes of time, such as pandering to the naked shorting conspiracy theorists.
Remember: the SEC is often incompetent. I wrote a book in which that was one of the main themes. However, when it is reacting to a public problem, the SEC has the capacity to actually find things happening.
Here we have a campaign that has gone on for some years, backed by "statistical data" to "prove" that a problem called "naked shorting" exists. And the result: zip. Nothing.
My question is: when is the SEC going to have the guts to say, "Enough. It is not happening. We are not going to waste any more time on this."

Felix Salmon: So maybe we can agree about this:
The best-case scenario here is that the SEC should come out and say definitively that in the Bear and Lehman cases, there was no naked shorting going on.
It should make the data public, and explain how it came to that conclusion.
And if that's convincing, then I think allegations of naked shorting elsewhere will dry up.

Gary Weiss: Yes. In my last Portfolio piece on Madoff, I took the idea one step further and suggested that a 9/11 style commission should investigate the entire financial crisis. That should include naked shorting. The only way to combat conspiracy theories of any kind is with facts--not that it matters to the conspiracists, who will always be with us.

Felix Salmon: But maybe they won't get the opportunity to write long articles for Bloomberg.

Gary Weiss: There will always be conspiracists and there will always be bad journalism."

“You can see it a mile off. Subpoena e-mails. Find out who spread false rumors and also shorted the stock and you’ve got your manipulators.”

TO BE NOTED: From Bloomberg:

"Naked Short Sales Hint Fraud in Bringing Down Lehman (Update1)

Share | Email | Print | A A A

By Gary Matsumoto

March 19 (Bloomberg) -- The biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts.

As Lehman Brothers Holdings Inc. struggled to survive last year, as many as 32.8 million shares in the company were sold and not delivered to buyers on time as of Sept. 11, according to data compiled by the Securities and Exchange Commission and Bloomberg. That was a more than 57-fold increase over the prior year’s peak of 567,518 failed trades on July 30.

The SEC has linked such so-called fails-to-deliver to naked short selling, a strategy that can be used to manipulate markets. A fail-to-deliver is a trade that doesn’t settle within three days.

“We had another word for this in Brooklyn,” said Harvey Pitt, a former SEC chairman. “The word was ‘fraud.’”

While the commission’s Enforcement Complaint Center received about 5,000 complaints about naked short-selling from January 2007 to June 2008, none led to enforcement actions, according to a report filed yesterday by David Kotz, the agency’s inspector general.

The way the SEC processes complaints hinders its ability to respond, the report said.

Twice last year, hundreds of thousands of failed trades coincided with widespread rumors about Lehman Brothers. Speculation that the company was being acquired at a discount and later that it was losing two trading partners both proved untrue.

After the 158-year-old investment bank collapsed in bankruptcy on Sept. 15, listing $613 billion in debt, former Chief Executive Officer Richard Fuld told a congressional panel on Oct. 6 that naked short sellers had midwifed his firm’s demise.

Gasoline on Fire

Members of the House Committee on Government Oversight and Reform weren’t buying that explanation.

“If you haven’t discovered your role, you’re the villain today,” U.S. Representative John Mica, a Florida Republican, told Fuld.

Yet the trading pattern that emerges from 2008 SEC data shows naked shorts contributed to the fall of both Lehman Brothers and Bear Stearns Cos., which was acquired by JPMorgan Chase & Co. in May.

“Abusive short selling amounts to gasoline on the fire for distressed stocks and distressed markets,” said U.S. Senator Ted Kaufman, a Delaware Democrat and one of the sponsors of a bill that would make the SEC restore the uptick rule. The regulation required traders to wait for a price increase in the stock they wanted to bet against; it prevented so-called bear raids, in which successive short sales forced prices down.

Driving Down Prices

Reinstating the rule would end the pattern of fails-to- deliver revealed in the SEC data, Kaufman said.

“These stories are deeply disturbing and make a compelling case that the SEC must act now to end abusive short selling -- which is exactly what our bill, if enacted, would do,” the senator said in an e-mailed statement.

Short sellers arrange to borrow shares, then dispose of them in anticipation that they will fall. They later buy shares to replace those they borrowed, profiting if the price has dropped. Naked short sellers don’t borrow before trading -- a practice that becomes evident once the stock isn’t delivered. Such trades can generate unlimited sell orders, overwhelming buyers and driving down prices, said Susanne Trimbath, a trade- settlement expert and president of STP Advisory Services, an Omaha, Nebraska-based consulting firm.

The SEC last year started a probe into what it called “possible market manipulation” and banned short sales in financial stocks as the number of fails-to-deliver climbed.

‘Unsubstantiated Rumors’

The daily average value of fails-to-deliver surged to $7.4 billion in 2007 from $838.5 million in 1995, according to a study by Trimbath, who examined data from the annual reports of the National Securities Clearing Corp., a subsidiary of the Depository Trust & Clearing Corp.

Trade failures rose for Bear Stearns as well last year. They peaked at 1.2 million shares on March 17, the day after JPMorgan announced it would buy the investment bank for $2 a share. That was more than triple the prior-year peak of 364,171 on Sept. 25.

Fuld said naked short selling -- coupled with “unsubstantiated rumors” -- played a role in the demise of both his bank and Bear Stearns.

“The naked shorts and rumor mongers succeeded in bringing down Bear Stearns,” Fuld said in prepared testimony to Congress in October. “And I believe that unsubstantiated rumors in the marketplace caused significant harm to Lehman Brothers.”

Devaluing Stock

Failed trades correlate with drops in share value -- enough to account for 30 to 70 percent of the declines in Bear Stearns, Lehman and other stocks last year, Trimbath said.

While the correlation doesn’t prove that naked shorting caused the lower prices, it’s “a good first indicator of a statistical relationship between two variables,” she said.

Failing to deliver is like “issuing new stock in a company without its permission,” Trimbath said. “You increase the number of shares circulating in the market, and that devalues a stock. The same thing happens to a currency when a government prints more of it.”

Trimbath attributes the almost ninefold growth in the value of failed trades from 1995 to 2007 to a rise in naked short sales.

“You can’t have millions of shares fail to deliver and say, ‘Oops, my dog ate my certificates,’” she said.

Explanation Required

On its Web site, the Federal Reserve Bank of New York lists several reasons for fails-to-deliver in securities trading besides naked shorting. They include misunderstandings between traders over details of transactions; computer glitches; and chain reactions, in which one failure to settle prevents delivery in a second trade.

Failed trades in stocks that were easy to borrow, such as Lehman Brothers, constitute a “red flag,” said Richard H. Baker, the president and CEO of the Washington-based Managed Funds Association, the hedge fund industry’s biggest lobbying group.

“Suffice it to say that in a readily available stock that is traded frequently, there has to be an explanation to the appropriate regulator as to the circumstances surrounding the fail-to-deliver,” said Baker, who served in the U.S. House of Representatives as a Republican from Louisiana from 1986 to February 2008.

“If it’s a pattern and a practice, there are laws and regulations to deal with it,” he said.

Fines and Penalties

Lehman Brothers had 687.5 million shares in its float, the amount available for public trading. In float size, the investment bank ranked 131 out of 6,873 public companies -- or in the top 1.9 percent, according to data compiled by Bloomberg.

While naked short sales resulting from errors aren’t illegal, using them to boost profits or manipulate share prices breaks exchange and SEC rules and violators are subject to penalties. If investigators determine that traders engaged in the practice to try to influence markets, the Department of Justice can file criminal charges.

Market makers, who serve as go-betweens for buyers and sellers, are allowed to short stock without borrowing it first to maintain a constant flow of trading.

Since July 2006, the regulatory arm of the New York Stock Exchange has fined at least four exchange members for naked shorting and violating other securities regulations. J.P. Morgan Securities Inc. paid the highest penalty, $400,000, as part of an agreement in which the firm neither admitted nor denied guilt, according to NYSE Regulation Inc.

Enforcement ‘Reluctant’

In July 2007, the former American Stock Exchange, now NYSE Alternext, fined members Scott and Brian Arenstein and their companies $3.6 million and $1.2 million, respectively, for naked short selling. Amex ordered them to disgorge a combined $3.2 million in trading profits and suspended both from the exchange for five years. The brothers agreed to the fines and the suspension without admitting or denying liability, according a release from the exchange.

Of about 5,000 e-mailed tips related to naked short-selling received by the SEC from January 2007 to June 2008, 123 were forwarded for further investigation, according to the report released yesterday by Kotz, the agency’s internal watchdog. None led to enforcement actions, the report said.

Kotz, the commission’s inspector general, said the enforcement division “is reluctant to expend additional resources to investigate” complaints. He recommended in his report yesterday that the division step up analysis of tips, designating an office or person to provide oversight of complaints.

Schapiro’s Plans

“Our audit disclosed that despite the tremendous amount of attention the practice of naked short selling has generated in recent years, Enforcement has brought very few enforcement actions based on conduct involving abusive or manipulative naked short selling,” the report said.

The enforcement division, in a response included in the report, said “a large number of the complaints provide no support for the allegations” and concurred with only one of the inspector general’s 11 recommendations.

SEC Chairman Mary Schapiro, who took office in January, has vowed to reinvigorate the enforcement unit after it drew fire from lawmakers and investors for failing to follow up on tips that New York money manager Bernard Madoff’s business was a Ponzi scheme. She has “initiated a process that will help us more effectively identify valuable leads for potential enforcement action,” John Nester, a commission spokesman, said in response to the Kotz report.

Last September, the agency instituted the temporary ban on short sales of financial stock. It also has announced an investigation into “possible market manipulation in the securities of certain financial institutions.”

No Effective Action

Christopher Cox, who was SEC chairman last year; Erik Sirri, the commission’s director for market regulation; and James Brigagliano, its deputy director for trading and markets, didn’t respond to requests for interviews. John Heine, a spokesman, said the commission declined to comment for this story.

“It has always puzzled me that the SEC didn’t take effective action to eliminate naked shorting and the fails-to- deliver associated with it,” Pitt, who chaired the commission from August 2001 to February 2003, said in an e-mail. The agency began collecting data on failed trades that exceed 10,000 shares a day in 2004.

“All the SEC need do is state that at the time of the short sale, the short seller must have (and must maintain through settlement) a legally enforceable right to deliver the stock at settlement,” Pitt wrote. He is now the CEO of Kalorama Partners LLC, a Washington-based consulting firm. In August, he and some partners started RegSHO.com, a Web-based service that locates stock to help sellers comply with short-selling rules.

Postponed ‘Indefinitely’

Pitt began his legal career as an SEC staff attorney in 1968, and eventually became the commission’s general counsel. In 1978, he joined Fried Frank Harris Shriver & Jacobson LLP, where as a senior corporate partner he represented such clients as Bear Stearns and the New York Stock Exchange. President George W. Bush appointed him SEC chairman in 2001.

The flip side of an uncompleted transaction resulting from undelivered stock is called a “fail-to-receive.” SEC regulations state that brokers who haven’t received stock 13 days after purchase can execute a so-called buy-in. The broker on the selling side of the transaction must buy an equivalent number of shares and deliver them on behalf of the customer who didn’t.

A 1986 study done by Irving Pollack, the SEC’s first director of enforcement in the 1970s, found the buy-in rules ineffective with regard to Nasdaq securities. The rules permit brokers to postpone deliveries “indefinitely,” the study found.

The effect on the market can be extreme, according to Cox, who left office on Jan. 20. He warned about it in a July article posted on the commission’s Web site.

Turbocharged Distortion

When coupled with the propagation of rumors about the targeted company, selling shares without borrowing “can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions,” he said in the article.

“‘Naked’ short selling can turbocharge these ‘distort-and- short’ schemes,” Cox wrote.

“When traders spread false rumors and then take advantage of those rumors by short selling, there’s no question that it’s fraud,” Pollack said in an interview. “It doesn’t matter whether the short sales are legal.”

On at least two occasions in 2008, fails-to-deliver for Lehman Brothers shares spiked just before speculation about the bank began circulating among traders, according to SEC data that Bloomberg analyzed.

On June 30, someone started a rumor that Barclays Plc was ready to buy Lehman for 25 percent less than the day’s share price. The purchase didn’t materialize.

‘Green Cheese’

On the previous trading day, June 27, the number of shares sold without delivery jumped to 705,103 from 30,690 on June 26, a 23-fold increase. The day of the rumor, the amount reached 814,870 -- more than four times the daily average for 2008 to that point. The stock slumped 11 percent and, by the close of trading, was down 70 percent for the calendar year.

“This rumor ranks up there with the moon is made of green cheese in terms of its validity,” Richard Bove, who was then a Ladenburg Thalmann & Co. analyst, said in a July 1 report.

Bove, now vice president and equity research analyst with Rochdale Securities in Lutz, Florida, said in an interview this month that the speculation reflected “an unrealistic view of Lehman’s portfolio value.” The company’s assets had value, he said.

‘Obscene’ Leverage

During the first six days following the Barclays hearsay, the level of failed trades averaged 1.4 million. Then, on July 10, came rumors that SAC Capital Advisors LLC, a Stamford, Connecticut-based hedge fund, and Pacific Investment Management Co. of Newport Beach, California, had stopped trading with Lehman Brothers.

Pimco and SAC denied the speculation. The bank’s share price dropped 27 percent over July 10-11.

Banks and insurers wrote down $969.3 billion last year -- and that gave legitimate traders plenty of reason to short their stocks, said William Fleckenstein, founder and president of Seattle-based Fleckenstein Capital, a short-only hedge fund. He closed the fund in December, saying he would open a new one that would buy equities too.

“Financial stocks imploded because of the drunkenness with which executives buying questionable securities levered-up in obscene fashion,” said Fleckenstein, who said his firm has always borrowed stock before selling it short. “Short sellers didn’t do this. The banks were reckless and they held bad assets. That’s the story.”

‘Market Distress’

On May 21, David Einhorn, a hedge fund manager and chairman of New York-based Greenlight Capital Inc., announced he was shorting stock in Lehman Brothers and said he had “good reason to question the bank’s fair value calculations” for its mortgage securities and other rarely traded assets.

Einhorn declined to comment for this story. Monica Everett, a spokeswoman who works for the Abernathy Macgregor Group, said Greenlight properly borrows shares before shorting them.

Even when they’re legitimate, short sales can depress share values in times of market crisis -- in effect turning the traders’ negative bets into self-fulfilling prophecies, says Pollack, the former SEC enforcement chief who is now a securities litigator with Fulbright & Jaworski in Washington.

The SEC has been concerned about the issue since at least 1963, when Pollack and others at the commission wrote a study for Congress that recommended the “temporary banning of short selling, in all stocks or in a particular stock” during “times of general market distress.”

Airport Runway

On Sept. 17, two days after Lehman Brothers filed for Chapter 11 bankruptcy, the number of failed trades climbed to 49.7 million, 23 percent of overall volume in the stock.

The next day, the SEC announced its ban on shorting financial companies in 2008. The number of protected stocks ultimately grew to about 1,000. On Sept. 19, the commission announced “a sweeping expansion” of its investigation into possible market manipulation.

The ban, which lasted through Oct. 17, didn’t eliminate shorting, according to data from the SEC, the NYSE Arca exchange and Bloomberg. Throughout the period, short sales averaged 24.7 percent of the overall trading in Morgan Stanley, Merrill Lynch & Co. and Goldman Sachs Group Inc. on NYSE Arca. In 2008, short sales averaged 37.5 percent of the overall trading on the exchange in the three companies.

To date, the commission hasn’t announced any findings of its investigation.

Pollack, the former SEC regulator, wonders why.

“This isn’t a trail of breadcrumbs; this audit trail is lit up like an airport runway,” he said. “You can see it a mile off. Subpoena e-mails. Find out who spread false rumors and also shorted the stock and you’ve got your manipulators.”

alleged that they had been misled to believe the minibonds were as safe as bonds

TO BE NOTED: From the FT:

"HSBC and BNY Mellon sued over ‘minibonds’

By Justine Lau

Published: March 13 2009 18:44 | Last updated: March 13 2009 18:44

A group of investors has sued HSBC and Bank of New York Mellon, alleging that the banks failed to protect Hong Kong buyers that bought into complex derivative instruments known as “minibonds” linked to the now defunct Lehman Brothers.

The class-action lawsuit filed in New York calls for $1.6bn of collateral held by HSBC and BNY Mellon to be released to investors. Minibonds have lost most of their value since the collapse of Lehman.

According to the complaint, HSBC is the issuer, trustee and custodian of the minibonds, while BNY Mellon is custodian of some assets held by the products.

The complaint named Lehman as one of the defendants. The class action was filed by the US law firm Coughlin Stoia, which also represented a group of Enron investors.

“The trustee failed to protect the collateral backing the minibonds. The issuer failed to execute the terms of the deal so that the promised high-quality collateral would be purchased and safeguarded, and also failed to give notice of negative information about the derivatives underlying the minibonds,” according to the complaint.

HSBC said it was the trustee of the minibonds, but not the issuer. The bank said it did not know whether it was a custodian.

“Any suggestion that we were involved with the design or selling of the minibonds is wrong. We were the trustee and we provided services on that basis,” HSBC said.

BNY Mellon declined to comment.

About 34,000 investors in Hong Kong bought HK$13.9bn (US$1.79bn) worth of the Lehman minibonds from 23 local banks and brokers.

The products were sold for at least five years before the US bank filed for Chapter 11 bankruptcy protection last year.

The minibonds were also sold in Singapore, although this class action focuses on Hong Kong.

Controversy surrounding the minibonds has sparked an outcry in Hong Kong, as angry investors, mostly retirees and pensioners, alleged that they had been misled to believe the minibonds were as safe as bonds.

“Although these minibonds were marketed as low-risk, safe and secure, in reality they were backed by numerous credit default swaps and synthetic collateralised debt obligations – the kinds of toxic financial instruments that are at the heart of the current financial crisis,” the complaint said.

Peter Chan, chairman of the Allied Victims of Lehman Products in Hong Kong, said the lawsuit was a “milestone”, adding: “We have suffered a lot in the last few months. I hope this would bring us closer to an end.”

Some minibond holders in Hong Kong have filed court cases against individual banks in the territory, which does not have a class action suit system.

Hong Kong’s legislative council has formed a special committee to investigate the issue and any mis-selling, while the Securities and Futures Commission, the market regulator, is also looking into it.

In January, Sun Hung Kai Investment Services, a local broker, agreed to refund HK$85m to more than 300 buyers in full for their losses on the minibonds."

But I think they could not fathom that the Federal Reserve would permit this to happen

TO BE NOTED: From Spiegel Online:

'The Global Banking Community Had a Heart Attack'

Bryan Marsal, head of Wall Street restructuring firm Alvarez & Marsal, has been liquidating assets for Lehman Brothers, the investment bank that collapsed last fall. He talked to SPIEGEL ONLINE about the reasons for the collapse, mistakes made by US leaders and the lessons of the financial crisis.

SPIEGEL ONLINE: Lehman filed for bankruptcy on September 15th, 2008. How did you take over?

Marsal: I was watching a football game when I received a call from the board of directors of Lehman Brothers. This was at 10:30 at night on September 14th, and they asked me: Would I take on responsibility for the wind-down of Lehman?

AFP

Leman Brothers headquarters, New York, in better times.

SPIEGEL ONLINE: How did you react?

Marsal: I said yes. And my question to them was: How much planning has gone into this bankruptcy? Their response was: This phone call is the first planning we have done.

SPIEGEL ONLINE: This must have been quite a shock.

Marsal: Well, when you figure the assets of this entity were $651 billion (€509 billion), you would have expected there would be a lot of planning going into it.

SPIEGEL ONLINE: They were apparently convinced they couldn't die.

Marsal: We weren't there. But I think they could not fathom that the Federal Reserve would permit this to happen -- because of the complexity, the interdependency and the fragile nature of the global banking system. I think that the Federal Reserve, under a lot of pressure, made the decision to not support Lehman the way they had supported Bear Stearns....

SPIEGEL ONLINE: ... the big New York investment bank that almost went bankrupt in March and was bought by JP Morgan after the US government and the Federal Reserve came to the rescue. Why didn't they help Lehman?

Marsal: You would have to ask the Fed that question. But this action indicated to the rest of the financial community that you don't get a free ride, and the government should not be expected to bail you out. At the same time, AIG was on the brink of disaster and a decision on what to do had to be made. Unfortunately, when the decision was made to let Lehman file for bankruptcy, the global banking community had a heart attack. So, the Federal Reserve jumped in to rescue AIG, and then helped Bank of America with Merrill Lynch, then Wachovia, and on and on and on.

SPIEGEL ONLINE: This means it was a political decision to let Lehman fail?

Marsal: I am not a politician so I won't speculate. If you're too greedy and lose sight of risk, there's a chance you can lose your business. I think the Treasury was signaling the need for fear to moderate greed. I think that was the message they were giving.

SPIEGEL ONLINE: The problem is, markets worldwide went into panic after Lehman filed for bankruptcy.

Marsal: Lehman was just too big to fail. The interdependency among the banks did not permit the government to simply walk away from these institutions. Maybe there is a lesson to be learned here. Maybe financial institutions should not be allowed to get that big.

SPIEGEL ONLINE: What's the alternative?

Marsal: If instead of having five banks, you had 15 banks, and the banks were one-third the size that they are, then you probably could handle of one of them going under.

SPIEGEL ONLINE: But did Lehman have a real chance to survive? Or wasn't it doomed anyway?

Marsal: I'm not suggesting that Lehman should have survived. That I don't know. But if Lehman was going to be wound down, it needed to be wound down as it was done with Bear Stearns. When Bear Stearns was transferred to JP Morgan, all their derivatives were transferred to JP Morgan, and the Federal Reserve provided a multi-billion dollar emergency loan. This way, JP Morgan was able to liquidate Bear Stearns under its wing. That's what the Fed did with Merrill Lynch and Bank of America as well. For whatever reason, they decided to not do it with Barclays, the British bank that wanted to buy Lehman.

SPIEGEL ONLINE: Nine hundred thousand derivative contracts with financial institutions all over the world were open at the time of Lehman's bankruptcy filing. Contracts with trading partners all over the world were defaulted on. What went wrong?

Marsal: Lehman derivative contracts should have been transferred to a new, creditworthy party. The good assets of Lehman and the derivative contracts should have been transferred to a creditworthy acquirer, with help from the Fed. The bad assets, the toxic assets, should have been left with holdings, and then a bankruptcy filing should have occurred. The failure to do so cost creditors approximately $50 to 75 billion.

SPIEGEL ONLINE: Is Lehman different from your customers in other industries, or is there no difference when a company fails?

Marsal: Financial services are different. Money has a faster and more direct impact on people. The deterioration of Lehman happened in a blink. Financial services companies can go bad very very quickly and crises of confidence ensue; and not because the equity has run out, but because the liquidity has run out.

SPIEGEL ONLINE: In other words, we wouldn't be in such a bad worldwide crisis, had Lehman been saved?

Marsal: Let's look at the outcome of what happened with Bear Stearns, where the markets breathed a sigh of relief. This was handled in a rational way. Much like what the British did, or what the Germans did. Consistency of leadership and decision-making is key. I think we would be better off today if they had agreed to let Barclays take over Lehman and provide Barclays the protection that they gave JP Morgan when they took over Bear Stearns.

SPIEGEL ONLINE: Is it true that you're still working with Richard Fuld, Lehman's former CEO?

Marsal: He is no longer receiving any salary or bonus or benefits. He has graciously agreed in exchange for an office, but no compensation, to be available to answer any questions about some of the assets that we have that he would be familiar with. For example, some of the hedge fund investments, or private equity investments, or real estate investments.

SPIEGEL ONLINE: How much money does Lehman owe its creditors?

Marsal: We have roughly $200 billion (€156 billion) worth of claims.

SPIEGEL ONLINE: How are you going to satisfy them?

Marsal: We have liquid and illiquid assets. Illiquid assets are much more difficult to convert to cash. The private equity portfolio in the US was about $12 billion, and the real estate portfolio was over $40 billion.

SPIEGEL ONLINE: You won't get so much for them these days.

Marsal: Lehman has approximately $9 billion in cash today. So we don't have a liquidity or cash crisis. We are not compelled to sell anything under pressure. Our attitude is to sell at a fair price or to hold until we get a fair price.

Interview conducted by Frank Hornig

URL:

• http://www.spiegel.de/international/business/0,1518,613196,00.html

A customer can prove in court either that his bank gave him erroneous advice, or that his advisor concealed hidden commissions.

TO BE NOTED: From Spiegel Online:

'O FOR OLD, D FOR DUMB'

How German Seniors Lost Nest Eggs in Lehman Collapse

By Hauke Goos

Bankers called them "OD customers" -- "old and dumb" investors who let their advisors talk them into buying Lehman Brothers securities last year. They lost their savings in the financial storm, but now the injured parties are fighting back, with help from an experienced fighter.

They arrive like a flock of birds, a few minutes ahead of schedule. They laugh and hug each other, presumably pleased not to have to deal with their anger alone anymore. They wear stocking caps to ward off cold and carry signs to protest the indifference of society. The signs include slogans like "Phony Advice -- Total Loss" or "No More Money -- No More Confidence." They've come together to hold a vigil in downtown Frankfurt, and for many it's the first time they have ever demonstrated.

Housewives, retirees, teachers and plumbers have gathered on this cold February afternoon in the city's Bornheim neighborhood. They include small investors, ordinary savers, women who watch the popular "Tagesschau" TV news program. They are not speculators. They wanted their money managed conservatively. They didn't want to have to worry about their savings. They just wanted to watch their assets grow.

As conservative investors, they bought securities their bank advisors had recommended -- supposedly safe proucts with relatively low yields, issued by US investment bank Lehman Brothers. But last September, far away in New York, Lehman declared bankruptcy and suddenly these German investors were part of the crisis. The certificates their banks had sold them were nothing but gambles.

Some people lost only a few thousand euros, perhaps money they had set aside for their funerals. Others lost anywhere from €10,000 ($12,800) to €50,000 ($64,000) on these speculative investments. Many of the protesters in Frankfurt are between 65 and 75 years old. A relatively young man is standing in the cold on behalf of his 89-year-old mother. She lost her savings because her investment advisor had placed her into "Risk Group 4," which is defined as "speculative."

Some bought the securities in late 2007, some in February or March 2008, and some in June, when many Lehman employees had a hunch that the bank would not survive 2008 as an independent firm. Did the German investors know the securities were certificates, and that they were subject to issuer risk? No.

Did they know what a certificate was? No.

Did they know they could lose their money? No, they say, outraged. "If I had known," says one of the protestors, "I would never have done this." Three banks have branches on this square in Frankfurt-Bornheim: Citibank, Dresdner Bank and Frankfurter Sparkasse, the three institutions that were especially zealous about selling Lehman securities in Germany. Frankfurter Sparkasse has admitted that it sold Lehman securities to 5,000 of its customers, for a total of about €75 million ($96 million) -- securities it touted as "absolutely safe," which are absolutely worthless today.

The people picketing on this Frankfurt square know that Lehman is now being run by a bankruptcy administrator. They have read that deposits with Lehman's German subsidiary are covered by the deposit guarantee fund of the Association of German Banks (BdB), but they also know that this makes no difference in their cases, because Lehman only had institutional investors in Germany. Those investors will get their money back, but small investors will not, because the certificates they purchased were issued by the parent company in the United States.

"I went to my investment advisor," says an old man. "I'd invested €50,000 ($64,000). It was everything I had. The advisor looked at his screen and said, 'Your account has been set to zero.'"

In one case a bank advisor in the northern port city of Bremerhaven sold his customer a Lehman certificate for about €93,000 ($119,000) as late as Aug. 21. According to a flyer the advisor brought to the meeting, Lehman was rated A+. But by then Standard & Poor's had downgraded Lehman to an A rating, "outlook negative."

When I'm 64

One of the Lehman casualties in Frankfurt holds a sign that reads, "A safe capital investment??? Never again!" Another sign reads, "Advised and sold by bank experts." Yet another, "Investors in the tank, robbers in the bank."

That evening about 60 investors who lost their money as a result of the Lehman bankruptcy convene in Sachsenhausen, another part of Frankfurt. They've invited an attorney, Matthias Schröder, of the law firm Leonhardt Spänle Schröder, experts in investment fraud. They ask Schröder how to get their money back. He is a tall, slim, matter-of-fact man. During a bank traineeship he once worked for a few months as a customer advisor; the program included a stint in the legal department at Commerzbank, where he learned how to ward off claims for damages. Schröder understands banks.

The Lehman bankruptcy has brought him hundreds of new clients. He's established himself as one of the clean-up men in this mess. His job is to examine the wreckage and make sure small investors are not lost in the fray.

According to Schröder, the average Lehman casualty is 64. Schröder will be 40 in June. The people who come to see him in his office are old enough to be his parents. They feel betrayed and ashamed, and they want to show the banks that they are not about to take this sort of treatment lying down.

Of the roughly 300 clients he now has, no more than 15 are still working, says Schröder. The overwhelming majority are retirees who spent their lives saving for old age. Most were customers of the same bank for decades. They knew and trusted their advisors, which made them attractive targets for the banks' sales strategists. Two received calls from their advisors in a retirement home, says Schröder. One thought Schröder, who visited him later, was from his bank, "because you too are such a nice man."

Schröder's oldest client will celebrate his 100th birthday in May. He "survived both world wars and the Turnip Winter (1916-17, when a frost destroyed harvests)," he told Schröder, "and now Frankfurter Sparkasse is burning up the last of my money."

Investment advisors referred to agreeable elderly customers as "flexible Lehman grandmas." These were people they would call when it was time to show sales results and fulfill quotas, or when they were short on time. Bankers called them "OD customers" -- O for old, D for dumb (or "AD" in German, for alt und doof). "These were conditions you would normally expect only in a gray market," says Schröder.

He says there are two ways to win a lawsuit against Frankfurter Sparkasse, Dresdner Bank or Citibank. A customer can prove in court either that his bank gave him erroneous advice, or that his advisor concealed hidden commissions.

Schröder has brought a file containing documents from bank employees he knows in Frankfurt. Some are confidential, marked "for internal use only," and some are evidence. He produces an email written by a bank advisor three months before the Lehman collapse. In the message, the advisor promises "hedging of the invested capital with 100 percent protection of capital on the maturity date." The prospects for winning this particular case are good, says Schröder.

Most of the customers were unaware that certificates, unlike investment funds, carry an issuer risk. If the issuer goes under, a certificate automatically becomes worthless. There is no such thing as "100 percent protection of capital," as the Lehman investors have since learned.

Schröder holds up the folder and tells his audience that every issuer is required to file a detailed prospectus with the German Federal Financial Services Authority, or BaFin.

"The bonds are not subject to any capital protection," is written in bold lettering on page 1 of the prospectus. "A partial or total loss of invested capital is possible." Further back, the prospectus notes that buyers of certificates should have experience with derivatives, options and warrants, and that before buying these instruments investors should "consult with their own legal and tax advisors, accountants or other advisors." A murmuring sound passes through the room.

The flyer handed to some of the Lehman casualties by their advisors makes no mention of risks.

For Schröder, the methods used by banks to unload these Lehman securities on long-standing customers were nothing short of "perverse" and "unscrupulous." The sole purpose of certificates, he explains, is to let a bank make a killing without its customers noticing. "These are standard gaga products," says Schröder. "As an investor, you simply cannot make money with them, because you are betting against top professionals." His goal is to prove "that the sale of certificates in Germany was a huge scam," Schröder says in his Frankfurt office. "And I am not the least bit concerned that we will not succeed."

Translated from the German by Christopher Sultan

URL:

• http://www.spiegel.de/international/germany/0,1518,613102,00.html

“it would have been the end of our economic system and our political system as we know it,” is another matter."

From Alphaville:

"The Kanjorski meme and the end of the world, redux Posted by Sam Jones on Feb 16 11:36.

It looked on Wednesday last week like Felix Salmon had had the last word on what he earlier dubbed the Kanjorski meme - a little piece of web flotsam alighted upon by a number of blogs, among them FT Alphaville - the gist of which went something like this:

Within 24 hours the world economy would have collapsed.

More specifically, the Kanjorski meme referred to this C-Span clip - dug up by Zero Hedge - of Dem representative Paul Kanjorski in which the congressman recounted a fateful day in September:

On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that they could not stem the tide.Felix, sceptical from the off, appeared to have put things to bed:

…there never was a $500 billion outflow from any asset class in the space of a couple of hours or even weeks, and the Fed never shut down or froze any money-market accounts.

In fact, writes Salmon, notwithstanding the dramatic withdrawal requests from the Reserve Primary fund (which broke the buck on September 15, when Lehman failed), money market funds, though roiled, were not completely collapsing.

The news from The Reserve was gruesome, and total withdrawals from money-market funds reached $104 billion that day, according to Crane Data. Another data provider, ICI, says that as of the close of business on the 17th, money-market funds had a total of $3,549.3 billion, which was a fall of just $30.3 billion from their level a week previously.

The following day, September 18, was bad but not quite as bad, with withdrawals of $57 billion, according to Crane Data. By the 24th, according to ICI, the total was $3,456.2 billion — a drop of another $93.1 billion from the 17th.

Now firstly, there’s a problem with looking at the MM fund market as a whole. There are three types of MM fund - those that invest in corporate commercial paper, those that invest in US Treasuries and those that invest in other government bonds. The really dramatic problem in the money markets - the one which, as Kanjorski intones was tantamount to “an electronic run on the banks” - was the shift within the money market fund universe, specifically, the massive redemptions from bank commercial paper-investing funds (called “prime funds) and an almost consummate increase in deposits at Treasury and Government funds. It’s nicely illustrated by this Bank of America graph, which like Felix, uses Crane data:

Looking at the fall in size of the money market fund universe in aggregate is something of a canard. It certainly doesn’t show the crisis quite for what it was - a total collapse in prime funds - and with that, an acute liquidity crisis for any corporate institution with a sizeable CP facility.

Secondly, there’s the figure at the heart of the Kanjorski meme: the $550bn of withdrawals from money market funds on Thursday September 18th. Salmon suggests that the number originated in no less reputable a place than the New York Post, which on September 21 wrote:

According to traders, who spoke on the condition of anonymity, money market funds were inundated with $500 billion in sell orders prior to the opening [on Thursday]. The total money-market capitalization was roughly $4 trillion that morning.

But David Merkel at the Aleph blog may, in fact, have something which corroborates the provenance of the Kanjorski meme; and most notably, that some of the numbers in it came from Hank Paulson. The below is an extract from a research report (authored by Congressman Jim Saxton) to the Joint Economic Committee of Congress (emphasis ours):

Irrational runs on money market mutual funds began. For the week ending on Wednesday September 17, 2008, investors redeemed $145 billion from their money market mutual funds. On Thursday September 18, 2008, institutional money managers sought to redeem another $500 billion, but Secretary Paulson intervened directly with these managers to dissuade them from demanding redemptions. Nevertheless, investors still redeemed another $105 billion. If the federal government were not to act decisively to check this incipient panic, the results for the entire U.S. economy would be disastrous.

In other words, institutional clients tried to pull around $500bn, but were dissuaded by the Treasury Secretary - who must then have also been hectically working on the money market fund insurance programme, announced only the following day.

Such a subtle correction to the Kanjorski meme answers a lot of questions.There were requests for $500bn of redemptions, but not actually $500bn of redemptions. And it feels right too. FT Alphaville is aware of very similar circumstances back in September 2007 when secretary Paulson rang around various money market funds to dissuade them themselves from pulling money from a number of ailing bank SIVs (which were dependent on CP for daily financing). Rating agencies got similar calls.

And, anyway, zooming out slightly, is $500bn really such a big number in context? Reserve Primary breaking the buck was a phase transition - it completely altered the market and the psychology of it. Put yourself in the position of a huge institution with billions stashed in a money market fund - the equivalent of a personal bank account, as far as such institutions are concerned - you have no insurance and there’s a very very significant risk you’ll lose money if you keep it where it is while everyone else is redeeming. It’s a bit of a no-brainer. Considering prime funds had around $1.9 trillion in them before Lehman’s collapse, $500bn isn’t that much.

Now whether you follow through with Kanjorski on the conclusion that “within 24 hours the world economy would have collapsed,” and that “it would have been the end of our economic system and our political system as we know it,” is another matter.

Related links:
A systemic risk counterfactual - FT Alphaville
Revenge of the dull plodding nerds - FT Alphaville

This entry was posted by Sam Jones on Monday, February 16th, 2009 at 11:36 and is filed under Capital markets, People. Tagged with Bailout, breaking the buck, hank paulson, kanjorski meme, lehman, Money market funds, paul kanjorski, Reserve Primary, TARP, TARP 2."

Me:

Don the libertarian Democrat Feb 16 19:23

I think that there are two separate takes on this story:
1) "Tthe suggestion that the Fed was able to monitor redemptions AND make calls to forestall such redemptions is just operationally and technologically incorrect."
This is about the specifics of the story. I took this to be the focus at first as well, and, finding that Blodget/Tom Brown clip and looking at contemporary sources which focused on the main point as far as I was concerned, namely, the government actions and guarantees, the story seemed overblown. But, there's also this:
2)"Those two plans/programs saved the MMF industry from collapse - that is without argument. Had the plans not been announced on Friday 9/19 before the open, the outflows would have continued and there would not have been sufficient liquidity to meet redemptions. This could have had multiple funds breaking the buck. Keep in mind a certain investment bank acknowledged that the parent had to commit $26Bn to its MMFs to fund redeptions from the funds (this was before the ABCPFF was implemented)."
In other words, reading comments on blogs, I found that many people didn't seem to be aware of 2. Hence, i started taking 2 as the story readers were focusing on. If you were aware of 2, 1 didn't seem to add much except a kind of dramatic portrayal of what occurred.

This is not unusual. If you remember the tax provisions in TARP that allowed Wells Fargo to horn in on the Wachovia deal, many people weren't aware of them until November, when it became a big story.

Just my take.

“Nomura’s stock is trading with at a price-to-book ratio of 0.6

From Alphaville:

"How the ‘Lehman shoku’ could morph into the ‘Nomura shoku’ Posted by Gwen Robinson on Feb 06 20:05.

Nomura, which is still digesting big chunks of Lehman Brothers’ Asian, European and Middle East operations that it bought last year, would probably be the first to deny it has bitten off more than it can chew. But perhaps even Nomura can see the irony in the “curse of the Lehman acquisition”.

The Lehman deal, although it came with a bargain price tag, has proven far more costly than Nomura envisaged - estimates of $2bn of integration costs are probably on the conservative side - while the timing of its acquisition strategy (to expand beyond its mature home market and compete head-on with Western rivals) has proven unfortunate.

Hence, Japan’s biggest investment bank had to warn on Friday it may raise as much as Y300bn ($3.3bn) selling stock to replenish capital after posting a record quarterly loss of Y342.9bn ($3.8bn) for the three months to December 31.

That is less than two months after Nomura raised about Y410bn ($4.4bn at today’s exchange rates) in debt from local investors.
The latest $3.3bn is equity, which roughly equates to about 25 per cent of Nomura’s market cap. According to Reuters, which quotes sources “with knowledge of the plans”, Nomura wants to issue the equity by the end of March, although it registered to issue the new stock over one year from February 19.

Ostensibly, the reason for this move is to “put the money towards growth opportunities, including the Lehman business” and “invest in its consolidated subsidiaries”, Reuters noted.

The truth probably has a more resounding ring of urgency: the bond sale in December boosted Nomura’s Tier 2 capital by 40 per cent to Y1,000bn, but did not lift its higher-quality Tier 1 capital, which dropped by about 20 per cent to Y1,47obn following the bank’s massive loss in the quarter to December.

And there are other reasons for concern. Nomura’s CEO, Kenichi Watanabe, recently estimated costs of about $2bn to integrate the units bought from bankrupt Lehman Brothers in Asia and Europe, which includes the absorption of about 8,000 Lehman employees, reports Bloomberg. And top executives including Watanabe are forgoing bonuses and taking pay cuts of up to 30 per cent after Nomura’s shares slid 63 per cent in the past 12 months.

Nomura sources told Reuters the bank may limit the issue or cancel it altogether if market conditions are too weak, but if - as it would dearly like to do - Nomura does rush the entire amount of new shares out by March 31, it risks a significant dilution effect. Already, as Reuters noted, “Nomura’s stock is trading with at a price-to-book ratio of 0.6, indicating the market is valuing it at far less than what it theoretically could be liquidated for”.

In Lex’s view, Nomura wants to be the financial services firm that flourishes in the crisis. “But building up an investment bank, even when others are retreating, is a costly business, especially in these markets”:

After its December debt issue, Nomura insists the fresh money in the form of new stock is all about growth – seeding investments in new opportunities – rather than about bolstering its capital base.

If so, investors can only hope that these will subsequently prove better prospects than past investments in Iceland or in Bernard Madoff’s funds, and more tightly-focused than the Lehman acquisition, which has been followed by cost-cutting and job cuts.

This entry was posted by Gwen Robinson on Friday, February 6th, 2009 at 20:05 and is filed under M&A, Capital markets. Tagged with Lehman Brothers, nomura."

Me:

Don the Libertarian Democrat Feb 7 01:40

“Nomura’s stock is trading with at a price-to-book ratio of 0.6, indicating the market is valuing it at far less than what it theoretically could be liquidated for”.

So,it has losses that haven't become apparent yet? Otherwise, wouldn't somebody else buy up this stock? Is there a day that goes by any more without some really odd and inexplicable number turning up? How low would this stock have to go for investors to overcome their fear and aversion to risk concerning it?

When Lehman failed, it did so with clear indications from its regulators that they wouldn't continue with Bear-style bailouts

From Felix Salmon:

"More on Lehman Revisionism

I've been thinking a bit more about the Lehman Brothers revisionism coming from the likes of Bernanke, Paulson, and Geithner: the fact that although they were quite clear about letting Lehman fail at the time, they subsequently have backtracked on that, and said that although they tried very hard to rescue Lehman, they simply weren't allowed to do so.

I still think that's probably bullshit, and that in this crisis, as we've seen, where there's a will, in government, there's a way. Paulson, for one, was not the type of person to let a bunch of Federal Reserve lawyers stop him from doing what he thought needed to be done. But what if he's telling the truth, and rescuing Lehman really was illegal? How can that be squared with contemporaneous statements?

I think the answer might lie in market psychology. When Lehman failed, it did so with clear indications from its regulators that they wouldn't continue with Bear-style bailouts, and that there was no kind of Paulson Put, where failed banks automatically get rescued by Treasury.

If the sun rose the following morning and the world didn't come to an end, that would be an astonishingly strong signal about market resilience in the face of government inaction, and would help boost sentiment a very great deal.

On the other hand, if Lehman's failure really was going to have nasty systemic consequences, then a few statements from Treasury were unlikely to make things substantially worse: an apocalyptic meltdown is an apocalyptic meltdown either way.

So I can see why Paulson and Bernanke said what they did in the immediate wake of Lehman's collapse: there was substantial upside to saying it if markets went up, while if markets went down the downside was so big either way it made very little difference whether they said it or not."

Me:

From the Economics Of Contempt:

http://economicsofcontempt.blogspot.com/2009/01/merrill-and-basis-trade.html

"Any CDS contract with Lehman as counterparty needed to be replaced when Lehman collapsed. Remember the emergency "Risk Reduction Trading Session" the ISDA opened on the Sunday that Lehman was preparing to file for bankruptcy? That was so that the major dealers could start replacing their derivative contracts where Lehman was the counterparty with contracts with other counterparties. The emergency trading session was a disaster (about which more later), but it was especially disastrous for Merrill.

Remember the timing.

The emergency trading session ran from 2 pm to 6 pm on the Sunday that Lehman was preparing to file for bankruptcy. The news that BofA was in advanced talks to buy Merrill didn't break until around 5 pm. Before that announcement, everyone was looking for who would be the next to fall, and the consensus was that Merrill was next in line. So traders turned their guns on Merrill. In a standard CDS, no money is exchanged upfront. But when a firm looking to enter into a CDS contract might default before the contract matures, counterparties start to demand money upfront—known as "points upfront" or "initial margin." Since Merrill was expected to collapse if it couldn't find a buyer, and news of the BofA deal had not yet leaked, counterparties were demanding that Merrill make huge upfront payments in order to enter into a CDS contract. And because Merrill had huge exposure to Lehman as a counterparty, it had a lot of contracts it needed to replace."

Doesn't this show that a Calling Run, Fisher's Debt-Deflation, was a real possibility if Lehman collapsed?