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Guest post submitted by Cheyenne, writer and producer of the soon to be released documentary, Bailout. Watch a trailer for Bailout here.
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What is the SEC hiding?
Part One
William Cohan of Bloomberg wrote a curious story last week, "Why does the SEC protect banks’ dirty secrets?"
It's a really good question.
Standing alone, however, Cohan's article is just another electric tile in a giant mosaic that flashes intermittently in a news cycle, briefly illuminating another piston or grommet in the Wall Street-Washington corruption machine before fading without impact.
But when coupled with other evidence, Cohan's piece, concerning the S.E.C.'s wholesale expungement of information from Citigroup documents in response to a Freedom of Inforation Act (FOIA) request, leads to what looks very much like a criminal conspiracy by Citigroup executives, up to and including Robert Rubin, to defraud the company's investor-clients on a scale that is nothing short of colossal.
In this light, the S.E.C.'s concealment effort on behalf of Citigroup--not its first, as we shall see--poses issues about the exact nature of the S.E.C.'s role with respect to financial crime, because neither "regulator" nor "crime fighter" applies under any reasonable interpretation of the evidence.
The questions raised here are both fair and viable. They’re fair because the S.E.C. elected to make a mockery of both the law it's supposed to follow and the public it's supposed to serve by redacting in their totality documents sought under the FOIA, leaving the inference of criminality to waft plume-like through its own stench. They’re viable because while the statute of limitations for criminal fraud may have run, the statute of limitations for conspiracy to commit fraud—a crime whose very essence, secrecy, precludes the statute from running in the first place—presents no such legal obstacle.
Part One examines the available evidence, which includes Cohan's article, the congressional testimony of former Citigroup risk officer Richard Bowen, and a lawsuit against Citigroup that the S.E.C. filed and immediately tried to settle--unsuccessfully--a year ago. Along the way, we'll see just how pernicious bailouts are to a functioning democracy.
Part Two will explore the potential ramifications of the S.E.C.'s failure to sweep its suit against Citigroup under the rug. The S.E.C.'s failure was due, almost laughably, to the random assignment of its case to Judge Jed Rakoff, a jurist whose revulsion at the S.E.C.'s corruption, already legendary, may well carry everyone involved into unchartered territory.
Cohan's Article About The S.E.C.'s Response to FOIA Requests Involving Citigroup Mortgages
Cohan’s particular focus was on documents that the S.E.C. produced relating to congressional testimony given by Richard Bowen. Bowen is the former Citi risk officer who told the Financial Crisis Inquiry Commission, among other things, that Citi sold MBS products despite knowing—based on information that Bowen provided to the top ranks of the company, including ex-CEO Robert Rubin himself—that huge swaths of mortgages owned by Citi were defective to the tune of between 60 and 80%.
To pursue Bowen’s revelations further, another Bloomberg reporter, Bob Ivry, filed FOIA requests with the S.E.C. seeking documents related to Bowen’s potent disclosures.
What Ivry likely hoped to discover was additional documentary evidence (beyond Bowen’s email to Rubin included with his testimony) that Citigroup officers, including Rubin, had defrauded purchasers of Citi’s MBS products by intentionally selling investments that Citi executives knew to be dogshit. (The term “dogshit” is used in accordance with Citigroup technical parameters for its investment products, which we’ll come to in a minute.)
What Ivry received in response, after a bit of wrangling, was a pile of documents notable only for their extensive redactions, i.e., blacked out content. The S.E.C. contends that the information that it’s concealing on Citi’s behalf qualifies as trade secrets.
The rub here isn’t whether or not the information satisfies the legal criteria for trade secret status. A bit of it probably does while the heft undoubtedly does not. What carries the trade secret assertion into the theater of absurd moral hazard isn't the nature of the information itself, but rather the fact that Citi is able to make the claim at all.
How Bailouts Cover Up Ineptitude and Potential Crime
Citigroup is the most pathetic TBTF bank in business, no mean feat among a herd of behemoths that is deathly ill. Citi exceeds its peers in just about every category you can think of associating with “broke bank” since the crisis began in 2008:
- Citigroup received the most TARP money, $45 billion, tying it with Bank of America as Wall Street's top welfare recipient known at the time
- Citigroup was alone among its peers in having its toxic assets, $306 billion of them, ring-fenced at taxpayers’ expense
- Citigroup received more secret loans from the Federal Reserve--$2.5 trillion—than any other bank, $500 billion more than Morgan Stanley, which Neil Barofsky informs us (via Ben Bernanke) in Bailout (the book, not the film) would have been the next domino to topple in the Fall of 2008
- Citigroup is the only bank that resorted to a reverse stock split, at 1-to-10, to put its share price back over $5, the low watermark for purchase eligibility among many institutional funds
When the crisis hit in 2008, Citigroup should have followed Lehman Brothers—or perhaps led it—into the morgue of corporate obesity. Citigroup posted losses that year of $27.7 billion, more than four times Lehman’s losses before it collapsed into dust during the third quarter, and yet Citi paid out $32.4 billion in compensation—the bulk of it in bonusesafter receiving the $45 billion welfare check.
And Citigroup’s figures that year, as pustulent as they appear, in all likelihood mask even deeper rot within the company. Compare Citigroup's valuations of its MBS holdings with those of another sick TBTF firm at the time, Merrill Lynch.
Merrill matched Citi’s loss with a $27.7 billion loss of its own, and its deteriorating corpus had to be kept alive by Hank “The Hammer” Paulson, who shoved it snugly within a warm Bank of America cavity.
Merrill's troubles reltated in no small part to MBS. In July 2008, Merrill sold $31 billion in mortgage-backed securities at 22 cents on the dollar. A 78% discount, while huge, was not at all unusual as the darkling reality of MBS assets materialized before a market that was sobering up after a very long binge. A few months earlier, Citadel had bought MBS at 27 cents on the dollar. And yet in this very market decline, Citi was marking equivalent investments at the imperial rate of 61 cents.
Of course, when Citi was appraising its MBS assets at nearly 3 times as valuable as those of the soon-to-be-ambulance-bound Merrill, and regulators were looking the other way (often at pornography rather than the raging crisis), no one knew that Richard Bowen would come before Congress and testify that Citigroup mortgages were 60% defective in 2006 and 80% defective in 2007, casting further doubt—this time from within the company itself—on Citi’s 61-cent MBS valuation.
Were Citi's incredibly rich valuations the product of accounting fraud? After all, the congressional repeal of mark-to-market accounting rules wouldn't occur until the following year. Or did Citi have some foresight about that event?
Perversely, we don’t know for one simple reason: Citigroup got bailed out. Citigroup is a confirmed zombie, yes, but a corpse it is not. Unlike Lehman Brothers, Citigroup roams the earth as a going business, complete with armies of lawyers who go around willy-nilly asserting preposterous trade secret protection claims to conceal the truth from the very public that's paying them and their rubber-stamping counterparts in the S.E.C.
Lehman Brothers, of course, is not a going concern and thus faces no threat of competitive harm through the disclosure of internal information, including alleged trade secrets. Consequently, the bankruptcy examiner’s 2200-page report came with 1800 pages of attached documents that were wholly unredacted. Thus we see in all their naked glory information such as internal financial projections made to Lehman’s board of directors.
A second and seldom observed consequence of treating Lehman like a real rather than a crony capitalist was the disclosure of information about regulators, including the S.E.C. We learned, for instance, that the government was in many cases fully aware of Lehman’s scams, to wit:
The Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, [and] a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.
The same governmental complicity, or worse, may be going on within Citigroup, but we don’t know because the government handed Citigroup the ultimate in welfare, a bailout. This opens another can of worms altogether, namely, the motivations behind bailouts. At a minimum they implicate conflicts of interest and may indeed extend to crime. It’s yet another layer in the moral hazard onion, which, as the last four years has demonstrated, is inherently difficult to peel.
This leads us directly back to Cohan’s question: why does the S.E.C. protect Citigroup’s dirty secrets?
Fortunately, we have more to go on than redacted documents that reflect nothing beyond the S.E.C.’s contempt for the law. In particular, there are some extremely suggestive clues in the testimony of Richard Bowen and in the S.E.C.’s own lawsuit against Citigroup.
Bowen’s testimony, taken together with the S.E.C.-Citigroup lawsuit, raises the very grave question of whether Citigroup executives made the conscious decision to defraud investors on a staggering scale, and whether this criminal enterprise has the intentional and ongoing assistance of the S.E.C.
Richard Bowen’s testimony
The parts of Bowen's testimony that are material here are these:
- Bowen was a Senior Vice President and a Chief Underwriter at Citigroup from 2002 through 2005 and was promoted to a Business Chief Underwriter responsible for 220 underwriters doing $90 billion in residential mortgages
- By mid-2006, 60% of Citi’s $50 billion in prime mortgages purchased from 1600 different mortgage companies and sold to Fannie and Freddie and other investors were defective. In 2007, defective prime mortgages rose to 80%
- In 2006, Citi’s residential mortgage volume grew by 40%, and an even bigger increase was expected in 2007
- As part of this expansion, Citi’s Chief Risk Officer (above Bowen) “started changing many of the underwriting decisions from ‘turn down’ to ‘approve'”
- In one $300+ million Merrill Lynch subprime pool, the underwriters turned down 716 mortgages, which the Chief Risk Officer personally changed 260 to approved, and the pool was purchased
- Bowen sent an email to Citigroup CEO Robert Rubin voicing his concerns about the companies’ massive volume of defective mortgages on November 3, 2007
One question that Bowen’s testimony leaves unanswered is this: why did Citigroup, in 2006, start significantly increasing not only the number of mortgages purchased but also the percentage of mortgages that were defective? How could the highest-ranking executives at Citigroup profit from taking on vastly higher volumes of mortgages that they knew were defective?
One compelling answer comes from the S.E.C. case against Citigroup filed last year: they could package them into shitty deals, short them (via CDS), and then dupe customers into buying them. Such a scheme would have appeared at the time to guarantee Citigroup untold riches at both ends, first in fees and later on the winning bet against its own securities. Back then, the credit default swaps orgy at companies like AIG, which sold $3 trillion in protection before collapsing into Tim Geithner's waiting arms, was raging with Caligulean fury.
The S.E.C. Lawsuit Against Citigroup for Selling "Dogshit" MBS
The S.E.C. lawsuit, which involves mortgage-backed securities, revealed from its outset a significant degree of complicity between the agency and the target of its lawsuit, Citigroup. The S.E.C. tried to settle the case, for $285 million, on the same day it filed the complaint. A lot of judges would have been happy to see a complex securities case like that disappear instantly from their docket. The executive committee of each federal district court is on the lookout for laggards, and keeping tabs on bloated dockets is one way they do it.
But alas, in the Southern District of New York there is both a judge with an eye-opening record of hatred for collusion between litigants at the public's expense and a random case assignment system, and on the day the S.E.C. filed suit against Citigroup, October 19, 2011, Lady Luck frowned on the S.E.C. and Citigroup. There are 47 federal district court judges who could have gotten that case. Rolling snake eyes was a more likely event, and with a far better outcome for the S.E.C. and Citigroup, than drawing Judge Jed Rakoff, which is exactly what happened.
One wonders how much time elapsed--if any--between the time the S.E.C.-Citigroup complaint was stamped "Judge Rakoff" and the S.E.C.'s eager posting of the $285 millionsettlement on its website. In any event, Judge Rakoff was not amused by the parties' patent complicity and turned the proposed settlement into hamburger, which has extended the case by over an entire year beyond its intended 1-day lifespan.
On the merits, the S.E.C.’s lawsuit against Citigroup bears a remarkable resemblance to itsAbacus case against Goldman Sachs: the bank created an investment vehicle specifically designed to fail, shorted it, and then sold it on to unsuspecting investors by concealing both pieces of highly material information.
But here the similarities with Goldman end.
What makes the allegations in the S.E.C.-Citigroup complaint so interesting is how perfectly they gibe with Bowen's testimony, not only in terms of their subject matter (securities backed by bad mortgages) and their timing (early 2007), but with how cleanly they supply a motivation to go behind Bowen's observation that Citi ramped up, in a huge way, its purchases of mortgages known to be defective.
Recall that Bowen supplies the evidentiary linkage to none other than Robert Rubin, which in turn supplies Citigroup's internals with far more gravitas than their equivalents at Goldman, limited as the latter were to half-million-dollar-a-year minions with names like "Fab." The Citigroup allegations are devastating in that the accused bank...
- shorted $500 million of collateralized debt obligations on its mortgages (CDO’s) but concealed this fact from investors
- pocketed $160 million by shorting the CDO’s (via credit default swaps), which defaulted just months later, having already collected $34 million in fees
- had experienced CDO traders privately describing the investment portfolio as “a collection of dogshit” and “possibly the best short EVER!” because “the portfolio is horrible”
- didn’t mention that it had selected the securities itself, telling investors only that selection was “based primarily on structural and credit analysis as well as technical factors which may influence trading levels and pricing"
If the S.E.C. had had any say in the matter, the case would have gone away a long time before regular events in lawsuits, such as document production and depositions, could even be scheduled.
It would be interesting to find out, through such discovery mechanisms, whether the Citi deal at issue in the suit, involving as it did the sale of dogshit mortgages (in perfect accordance with Bowen's testimony), was executed pursuant to a plan by Citgroup executives to profit wildly by systematically defrauding its customers by secretly shorting these "investments."
That would explain Citigroup's suddenly insatiable appetite for mortgages known to be defective. It would also explain Citigroup's zeal to hide just about every scrap of information relating to Bowen's testimony under any label, however ridiculous, including "trade secret."
And last but not least, it would supply the grounds for a case of criminal conspiracy to defraud investors on an uprecedented scale, perpetrated by none other than the highest-ranking executives within Citigroup—exactly what the public has demanded, without satisfaction, for a very long time now.
At the same time, given what we know about the S.E.C.’s treatment of Lehman’s accounting practices, it would raise very serious questions about the agency’s motivation, not only for its over-the-top FOIA redactions, but for its extreme haste in trying the make its case against Citigroup go away.
It would take a planet-sized set of balls and a mountain of luck to set in motion the machinery to see a special prosecutor explore whether the S.E.C. has been systematically betraying the public for years. Strange it is then that out of several hundred federal judges, the one with hands-down the best record of fighting Wall Street-Washington graft is presiding over a case that looks like the tip of an iceberg, and that he's doing so at a time when the two most formidable public enemies of American kleptocrats--Alan Grayson and Elizabeth Warren--will return to Washington, D.C. in just a few short weeks under the titles of "Representative" and "Senator."
Eventually the truth about what happened in 2008, and has been going on ever since, will out, just as it did after 1929. We're just waiting for our Pecora.
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