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Home“Lehman Sued Over Conflict in Auction-Rate Securities”
Posted by Larry Doyle on June 10th, 2009 8:02 AM |
Why does a $190 million lawsuit receive scant coverage? Why does a $100 billion plus financial fraud pass below the radar screen? With the exception of Bloomberg News, the scandal surrounding Auction Rate Securities receives very limited serious coverage.
Well, with figures the magnitude of those mentioned above, Sense on Cents is highly energized to publicize the scandal and the embedded conflicts in this fraud.
Bloomberg reports, Lehman Sued Over Conflict in Auction-Rate Securities:
June 9 (Bloomberg) — Lehman Brothers Holdings Inc. was sued by two companies seeking more than $190 million over claims the bankrupt investment bank misrepresented the risk of auction- rate securities and had a conflict of interest in their sale.
The complaints against Lehman Brothers, which filed the biggest bankruptcy in U.S. history last September, were filed in federal bankruptcy court in Manhattan. Ceradyne Inc. and Western Digital Corp. claim Lehman had a conflict of interest serving as underwriter and seller of the securities.
Lehman Brothers wrongly asserted that interest rates on the securities were set through a well-established market, and that they were tradable, liquid, short-term investments, according to the complaint.
“The reality, well known to Lehman Brothers Holdings Inc. but undisclosed to Western Digital Corp., was that, in fact, auction rate securities was not supported by a broad, fully- functioning market and therefore could be subject to failed auctions and illiquidity,” according to the complaint.
The $330 billion auction-rate market collapsed in February, 2008, sparking a series of regulatory probes into how brokerages marketed the long-term securities. One year later investors were stuck with as much as $176 billion of the securities even after regulators have forced banks to buy back more than $50 billion of auction-rate debt that was marketed as safe, cash-like instruments.
Justice Department Probe
Last month, the Wall Street Journal, citing unnamed sources, reported that former Lehman executives have been questioned by U.S. Justice Department officials in an investigation of the company’s auction-rate securities sales.
Ceradyne is a Costa Mesa, California-based maker of ceramic body armor for U.S. soldiers, and Western Digital Corp., based in Lake Forest, California, manufactures hard-disk drives.
Lehman spokeswoman Kimberly Macleod didn’t immediately return a call seeking comment after business hours.
The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).
The key phrase in this story from my perspective is “conflict of interest.” The claimants are asserting that Lehman should have known and revealed the embedded risks in ARS and that they did not because they were benefitting both as issuer and underwriter.
Having written extensively about the ARS scandal here at Sense on Cents (newer readers can access all posts by writing Auction Rate Securities in the search window in the upper right hand corner of the home page), I would STRONGLY encourage Ceradyne Inc. and Western Digital Corp. to engage Finra in their suit. How so and why?
Would Finra need to be subpoenaed or merely interviewed? I am no lawyer so I will defer on that point. That said, if Lehman were conflicted, I believe every ARS investor would benefit from knowing if Finra also had a conflict of interest in the ARS market.
Recall that Finra’s mission is to protect investors. Finra was an ARS investor itself, and liquidated $647 million in Auction Rate Securities in Spring 2007. Finra did not publicly apprise investors of the ARS meltdown until the market had totally frozen in February 2008. Shortly thereafter, Finra posted a warning on its website. Thanks for very little!!
From my ARS archives, please check out: U.S. Attorney and SEC Investigating Lehman’s Auction Rate Securities Sale; They Should Also Investigate Finra’s.
$190 million lawsuit. $176 billion of ARS. That is “real” money and it spells one enormous conflict!!
LD
Interview on The Rude Awakening, 104.3 FM Tampa Bay
Posted by Larry Doyle on June 9th, 2009 6:15 PM |
I will be interviewed tomorrow morning (Wednesday) on The Rude Awakening, WIFL 104.3 FM, Tampa Bay. Show runs from 8-9am. You can listen to the show live via the internet. Details right here . . .
LD
Where Will TARP Money Go? Let’s Start in Hartford
Posted by Larry Doyle on June 9th, 2009 3:03 PM |
Secretary Geithner and President Obama today hailed the repayment of $68 billion in TARP funds as a clear indication of the success of the overall financial recovery programs implemented by the administration. Well, as those familiar with the “shell game” know, in order to keep the game going it is critically important to display some winners on a regular basis.
How do we know the TARP funds were utilized properly and everybody won on this government investment? We don’t, despite what Barack says. Money is fungible. The system was saved, with no small thanks to the FASB’s relaxation of the mark-to-market. These TARP recipients are designated as the winners. Meanwhile, the system still has upwards of $500 billion – 1.25 trillion in embedded losses, depending on whose projection you would like to use.
In my opinion, I believe Barack and team would have preferred to keep the TARP funds within these financial institutions. That said, there are other factors at work here. What are they?
1. when the TARP legislation was passed last Fall during the Bush administration, it set specific ground rules necessary for repayment. Barack, Tim, and team would have run the risk of flouting that legislation if they did not allow some firms to repay.
2. the administration will still be able to wield significant influence over these firms via a number of other Fed backstops already in place.
3. not being widely publicized but of very real significance, the administration will need these funds in other firms. What firms? Let’s drive on over to Hartford.
As the WSJ recently revealed, Hartford Chief Expects TARP Funds Soon:
It is expected in the next few weeks to get as much as $3.4 billion in funds under the Treasury’s Capital Purchase Program.
Hartford’s stock was down today as it is being downgraded by equity analysts at Citigroup due to management issues.
Recall that Hartford was one of 6 insurance companies that received thrift status by acquiring a controlling stake in a small institution. As such, these firms became eligible for TARP funds. In my opinion, once the TARP dam is broken with one insurance company, the stigma is lessened for others to acquiesce in accepting these funds.
What might be the next stop after Hartford? Perhaps Newark (Prudential Insurance) or Philadelphia (Lincoln Financial). Sense on Cents will monitor where the TARP train moves next.
LD
As California Goes, Part II: Other People’s Money
Posted by Larry Doyle on June 9th, 2009 11:41 AM |
A few weeks back, I wrote As California’s Economy Goes, So Goes the Country to address the financial precipice of the largest state in our country. As California faces financial armageddon, the state finds itself challenged with the prospects of massive budget cuts, significant tax increases, or a combination of the two.
Are we witnessing the prequel for what our entire country faces? I believe we are. Let’s navigate.
“Governator” Schwarzenegger is adamant about not raising taxes. The prospect of significant spending cuts is causing a firestorm with rank and file union members. Democratic pols find themselves between the proverbial rock and a hard place. The Los Angeles Times writes, State’s Budget Crisis Opens Rift Between Unions and Democrats:
The Capitol’s usual political alliances are being tested by the state’s severe financial problems as interest groups scramble to hold onto as much as possible of the state’s shrinking coffers.
The relationship between Democratic leaders and some of their labor benefactors has turned particularly frosty: Many of the programs union members rely on for paychecks — and the unions rely on for dues — have been slated for deep cuts.
In a period of massive fiscal deficits, obviously no stones are left unturned, everybody must contribute, and pain is felt by all parties. Really? If that were the case, then what good is politics and winning elections?
We may want to think that our political process achieves the greatest common good. In my opinion, though, the political game has become a function of “get as much as you can for as long as you can.” In the process, the politicians have become wedded to their constituencies and incestuous relationships have developed deep roots.
To this end, it is no surprise to see the large unions in California enraged at their political cronies for not “taking care of them.” The LA Times provides insights on this angle:
The friction started when the Democrat-dominated Legislature produced a budget in February that raised taxes but also cut programs and included a GOP-driven plan to put the brakes on state spending. A handful of labor groups then spent millions to help defeat the May ballot measures that the budget spawned.
“Many public employee unions, teacher unions [are] thinking that they were thrown under the bus in the last budget,” said Assemblyman Charles Calderon (D-Montebello). “So now they’re asking themselves: If these Democrats are not going to stand up for us, then what good is it to have them there?”
Why are the California unions so enraged? Well, all we really need to do is review what has occurred on the national level. Why is it that the Supreme Court is reviewing the sale of Chrysler to Fiat? Very simply, Obama overran standard bankruptcy procedures in delivering for the UAW. He justified his “means” because he viewed his “ends” as best for the economy. He ran the same play in the GM bankruptcy.
California union members want a bite from the same apple. Why aren’t they getting it? The great equalizer in our country and economy!! What’s that? The fear of failure. That is, Democratic politicians in California know the pulse of the overall electorate as reflected by the energy embedded in the April 15th “Tea Parties.”
The Times again provides interesting color,
But even some of the most liberal Democrats say some union leaders are ignoring the reality of an angry public, a sour economy and a state government approaching insolvency. Moreover, more taxes would require Republican support in the Legislature, and the minority party has made clear that there will be none.
“We have an economy which is in intensive care, and another round of tax increases . . . would put that patient in cardiac arrest,” said Assembly GOP leader Sam Blakeslee of San Luis Obispo.
Barack, Nancy, Harry….are you listening?
Insights from our friends on the “left coast” are always appreciated!!
LD
Uncle Sam Economy: Not Exactly a Level Playing Field
Posted by Larry Doyle on June 9th, 2009 8:08 AM |
As we navigate the landscape of the Uncle Sam Economy, we will soon realize that the “playing field” is anything but level. What does this mean? How can we most appropriately manage? Will there be opportunities? Let’s break out our compass and project what is on the horizon.
As Bloomberg reports, U.S. Said to Plan Approval for 10 Banks to Repay TARP:
The Treasury is preparing to announce today it will let 10 banks buy back government shares, people familiar with the matter said, signaling confidence some of the largest U.S. lenders won’t again need a taxpayer rescue.
JPMorgan Chase & Co. is among those cleared to repay Troubled Asset Relief Program funds, a person said on condition of anonymity. Goldman Sachs Group Inc., American Express Co. and State Street Corp. are also among those that have sold shares and debt unguaranteed by the government, demonstrating they can raise funds without federal aid.
Allow me to provide further color:
1. Why are these institutions keen to repay TARP funds, which are widely held to be a cheap source of funding?
As none other than Pimco’s Bill Gross said of Uncle Sam, “don’t turn your back on him.” I would agree. Uncle Sam is not a good business partner. His agenda runs much farther afield than the bottom line focus of these institutions.
Make no mistake, the greatest motivation for these institutions to repay TARP funds is to be freed from the shackles of compensation controls. The major assets of financial institutions ride down the escalator and go out the door every evening. Operating under compensation caps is a surefire way for an institution to achieve “extreme mediocrity” over the long haul. Why?
The strongest employees will gravitate toward more attractive and financially rewarding opportunities.
2. From an investment perspective, how should we think of TARP recipients versus prospective non-TARP recipients?
In my opinion, the non-TARP institutions will be viewed much more as “growth” opportunities. Why? They will be able to more aggressively allocate capital and take risk unencumbered by Uncle Sam and his minions.
The TARP recipients may very well gravitate more toward a utility-type of business in which they provide basic services while simultaneously fulfilling elements of Uncle Sam’s social agenda.
Geithner, Bernanke, Obama and team will discount this reality but I believe it is a strong likelihood within the financial industry, much as it will be within the automotive industry.
3. From a borrower’s perspective, how should we think of TARP recipients versus non-TARP recipients?
Perhaps initially there will not be much disparity in the relative pricing of different products, but I do believe the disparity will grow over time. All we need to do is review the undercutting of prices within the insurance industry by AIG to see the potential for the same within the financial industry. As borrowers, we will likely have more opportunities to comparison shop going forward. It is not inconceivable that certain non-TARP institutions decide to exit select businesses as pricing becomes non-economical.
4. The greatest question remains, will any of these institutions, both TARP and non-TARP alike, ever be allowed to fail?
The fear of failure at one point was the greatest motivator for innovation and real long term success. Having violated this moral hazard by unprecedented margins, the cost to capitalism will only be known far down the road.
As such, the need to prudently and proactively navigate the economic landscape will remain of paramount importance. The need for Sense on Cents will grow ever stronger.
That’s a good thing!!
LD
A Bear Flattener
Posted by Larry Doyle on June 8th, 2009 2:25 PM |
For those actively involved in financial markets, the term “bear flattener” is common knowledge. For those not actively involved in the markets, let’s quickly address this concept, what drives it, and what it may mean for the economy.
Let’s break the “bear flattener” into its component parts.
Bear: short for bearish, this term implies declining valuations or prices for whatever security or market sector is being analyzed.
Flattener: analysis of the U.S Treasury yield curve (or the yield curve for any market sector) is typically referenced in terms of whether the curve is flattening or steepening. Reflect back on Algebra II and the concept of slope. Yield curve analysis is all about the slope of the curve.
A flattening of the slope of the curve implies that rates for short maturities are rising faster than rates on longer maturies. In a rising rate environment, bond prices are declining thus the flattening is a bear flattener. If rates were falling but short maturity rates were not falling as much as long maturities, then the flattening would be considered a “bull” flattener.
What does a bear flattener portend for the economy? Typically a bear flattener is an indication of an economic contraction. Why? The rise in rates is usually a function of an increase in rates by the Federal Reserve. Why would the Fed raise rates? To slow the economy, the pace of inflation/expected inflation, or a combination of the two.
Let’s quickly review today’s price action across the U.S. Treasury yield curve. For purposes of measuring the slope of the curve, market analysts typically look at the relative performance and changes in rates on the 2yr Treasury note and the 10yr Treasury note. In today’s price action:
2yr Treasury note has increased by 8 basis points to 1.38%
10yr Treasury note has increased by 3 basis points to 3.86
The 2/10 slope thus equates to 2.48% or 248 basis points. The curve has flattened by 5 basis points today.
Be mindful that although the curve has flattened today as well as the last week (the slope peaked at approximately 275 basis points), the curve started the year at a rather flat level of 1.52% (152 basis points).
A steepening curve is beneficial to financial companies and typically, though not always, indicates an improving economy. A steepening curve can also be a harbinger of inflation as the increase in long term rates is a sign that inflation is likely to increase.
A flattening curve is typically an indication of a slowing economy and is definitely not beneficial to financial companies as funding costs increase.
As evidenced in my initial post this morning, Bernanke Conundrum, the market will often adjust interest rates and bond prices well before the Fed actually changes interest rates and Fed policy.
Thus, despite what market analysts or government officials may say, the slope of the yield curve speaks volumes.
Why don’t you engage your better half this evening with, “Did you see that bear flattener today?” Who knows, it may take your relationship into an entirely new realm as you navigate the economic landscape!!
LD
Where Is Finra’s 2008 Annual Report?
Posted by Larry Doyle on June 8th, 2009 10:33 AM |
Finra released its 2007 Annual Report in mid-April 2008. Here it is June 8, 2009 and Finra has yet to release its 2008 Annual Report. What is going on? Aside from speculating, I called Finra this morning to inquire.
A source from within Finra’s Media Source division informed me to call back in a month. I questioned how and why in a period of economic and market dislocation, and with a heightened sensitivity on increased regulatory transparency, that Finra is being less transparent. I received a healthy dose of red tape and little direction. I have a call into Finra spokesman Herb Perone. That said, June 8, 2009 and no Annual Report. “Call back in a month.”
Why do I want to review Finra’s 2008 Annual Report? I know that fines and sanctions collected by Finra diminished by approximately 30% over the last year. The WSJ highlighted that information and I expounded upon it in writing, How Courageous is Mary Schapiro? My specific area of interest is a review of Finra’s investments within their own internal portfolio.
Recall that from their investment portfolio, Finra sold $647 million (position as of year end 2006) of Auction Rate Securities in Spring 2007. What did Finra do with their investments in hedge funds, fund of funds, private equity, common equities, and fixed income? Would Finra be so forthcoming as to provide insight as to why they needed to raise all that cash from the Auction Rate Securities liquidation?
Our markets and economy are screaming for increased transparency and regulation in an attempt to reinstill a measure of investor confidence.
Finra is prominently situated as a Wall Street regulatory body. Finra is currently being less transparent than a year ago. Why? Ms. Schapiro at the SEC and Richard Ketchum, new head of Finra, can TALK all they want about increased transparency and stiffer regulations. Talk is cheap. Information is everything.
“Call back in a month…” does NOT get it done.
LD
Bernanke Conundrum
Posted by Larry Doyle on June 8th, 2009 7:27 AM |
Overnight markets indicate that Treasury prices are lower and interest rates subsequently higher (remember the inverse relationship between bond prices and interest rates). 2yr Treasury notes are trading at 1.33% and 10yr Treasury notes are trading at 3.85% (both are .03% higher from Friday’s close).
If interest rates are higher, clearly that move must be an indication that economic activity is improving and equity markets should be higher overnight, correct? In “normal” economic times, perhaps that line of reasoning would hold water, but in the Uncle Sam economy, we need to go deeper.
Equity futures indicate our stock markets will open lower by approximately 1%. What’s going on? Welcome to the Bernanke conundrum! What is the riddle wrapped inside our economic enigma? How can Fed chair Ben Bernanke nurse our economy back to health while at the same time maintaining the necessary fiscal independence, integrity, and discipline of robust Fed policy?
Big Ben has used aggressive measures to backstop a wide swath of our markets. In the process, he has created a fair amount of stability but with an effective government guarantee “insurance” policy as the cost of stability. Some of these policies have lessened in size as certain sectors have normalized. However, the major Fed programs remain in place. What are these?
1. quantitative easing: commitment to buy $1.3 trillion in total of Treasury and mortgage-backed securities in an attempt to keep these rates down. Then why are rates rising? More on this in a second.
2. commitment to provide necessary liquidity as needed to support the “wards of the state” including Freddie Mac, Fannie Mae, GM, AIG, Citigroup.
These programs in conjunction with the massive deficit spending programs undertaken by the Obama administration have ballooned our expected funding needs in calendar 2009 to upwards of $3 trillion, a fourfold increase over prior years.
In my opinion, interest rates are moving up much less on any real signs of economic improvement than on these funding needs and very real signs of a monetary printing press malfunction. What’s that? With the Fed Funds rate at 0-.25%, the Fed is literally flooding the economy with cash. Where is that cash going? Is it flowing through to the economy? Not really.
The cash is pouring into the banking system to cushion and support financial institutions from the ongoing losses connected to rising defaults on credit cards, residential mortgages, commercial real estate, and corporate loans.
The market is now very clearly sending a signal to Bernanke, Geithner, Obama and team that if they want to continue their programs as designed (and they do and will), the price, that is the rate of interest, is going up. Why?
The market is very concerned that the flood of liquidity will lead to inflation if not rampant inflation and potentially hyperinflation. How does Bernanke head that off?
Withdraw the very liquidity that he has found so necessary to pour into the financial system. How does he do that?Two ways.
1. increase the Fed Funds rate: that is, make borrowing more expensive.
2. reverse the quantitative easing program so that the Fed actually sells Treasury and mortgage-backed securities into the market and takes liquidity out in the process. What are the impacts of both those maneuvers? Higher interest rates.
In fact, interest rates are moving higher already in anticipation of Bernanke being forced to make these moves. Can Bernanke “thread this needle?” What will happen if interest rates move higher?
Slow the economy, especially housing given higher mortgage rates, and lower earnings especially for financial institutions. To wit, our equity markets are lower overnight.
Nobody said this was going to be easy.
LD
Krugman Turns Bullish; Ginsburg Delays Chrysler Sale
Posted by Larry Doyle on June 8th, 2009 4:41 PM |
Nobel prize-winning Princeton economist Paul Krugman commented today that he believes our economy will emerge from recession in the 3rd quarter of 2009. In response to those comments, our equity markets rallied back to unchanged levels on the day after having previously been down by 1%.
Krugman, as with any economist, is entitled to his opinion as well as to changing his opinion. To this point Krugman has been openly critical of many of the Obama administration policies.
I am disappointed that such a substantial, market-moving comment by a high profile economist is not supported with more thorough analysis. I have scanned all of the major news outlets and see nothing of substance. Against that backdrop, I will pose questions myself that I hope Krugman will address:
1. What prompted the change?
2. Are you still openly critical of the programs intended to repair bank balance sheets?
3. Are you still in the camp concerned more by deflation than inflation?
If Krugman believes our economy is emerging from the recession while still battling deflation, he may be all by his lonesome on that front.
While the equity markets did rally back to close unchanged, the bond market continued to sell off led by the front end of the yield curve. The 2yr Treasury is now trading at a 1.43% (+13 basis points on the day) while the 10yr Treasury is now trading at a 3.91% (+8 basis points on the day). Price action of that sort is not indicative of a potentially deflationary environment.
Mr. Krugman, the ball remains in your court. Any Nobel prize-winning economist in good standing will address the full spectrum of questions when leading with such a bold statement as you did earlier today.
LD
Also of note: Supreme Court Justice Ruth Bader Ginsburg has ruled that the sale of Chrysler to Fiat is subject to further review by the court. An Indiana pension fund, which is a Chrysler creditor and holds a very small percentage (approximately .5%) of Chrysler’s outstanding debt, requested a ruling on the Chrysler sale by the court. Any sort of extended delay and review may very well imperil the sale of Chrysler to Fiat. In so doing, Chrysler may be forced into liquidation.
Please recall that many creditors shared the feelings of the Indiana pension fund but were “strongly encouraged, if not intimidated,” by the Obama administration to accede to the administration’s directives.
I tip my hat to Ginsburg for her juris prudence and her respect for attempting to separate the judicial and executive branches of our government.
Tags: Justice Ginsburg stays Chrysler sale, Krugman on recession, Krugman predicts end of recession, Paul Krugman, Paul Krugman comments on economy
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