Experts’ Biggest Fear: New Dodd Bill Won’t Stop Another Meltdown, “Epidemic” of Wall Street Fraud

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(Photo: SEIU
; Edited: Jared
Rodriguez / t r u t h o u t

The political jousting since Sen. Chris Dodd
proposed new
financial reforms
on Monday seems at first to be just another
Washington ideological rift: liberals favoring regulating an industry,
and Big Business and Republicans opposing
. With the Chamber of Commerce willing to spend $3
million to defeat Dodd’s bill
, plus $50 million in a broad-based
campaign targeting dozens of vulnerable Democrats, some liberals
doubtless feel it must surely be a powerful blow against the excesses of
the financial industry.

After all, Senator Dodd proclaimed
the importance of his reform bill: "There hasn’t been a
financial reform on the scale that I’m proposing this afternoon since
the 1930s." In truth, it’s
significantly weaker than the one he introduced last fall
as he’s
fruitlessly sought Republican votes. And, it’s worth noting, FDR’s
original reforms that reined in Wall Street and protected consumers were
not filled with the sort of carve-outs for financial industries and
traders that spent nearly $500 million
in lobbying
last year, money well spent when one considers the
loophole-laden bills
in the House and Senate (with the House bill
having a more independent consumer agency.)

"This bill wouldn’t have prevented the past crisis,
and it won’t prevent a future crisis," says William K. Black, an
economics and law professor at the University of Missouri, Kansas City,
and the former senior financial regulator who cracked down on the
savings and loan industry in the 1980s. In a wide-ranging interview with
Truthout, Black, joining
other critics, raised alarms about assorted obscure bookkeeping ploys
and outright scams that are laying the groundwork for the next meltdown.
Moreover, the ongoing partisan tussling over financial reform and the
independent consumer agency he supports are drawing attention away from
the importance of getting the Obama administration to crack down on
the corporate criminals now.

"Let’s jail the crooks and we don’t have to wait for
new legislation," he said. He argued that there are plenty of laws and
regulations on the books – and more rules that can be written under
regulators’ current authority – allowing for a widespread crackdown,
from civil lawsuits to prosecutions, targeting those who hid the
collapsing value of "toxic" assets and investments they sold and
evaluated. He pointed out, "During the savings and loan debacles, the
Justice Department had 1,000 priority felony convictions – that’s almost
one every three days of the news cycle." He also observed, "At this
stage among the subprime lending specialists, we have zero convictions.
We have zero indictments."

While progressives have been clamoring for Obama and
the Democrats to seize the populist mantle to help pass their agenda and
keep control of Congress, Black is pointing to a straightforward way
for the Obama administration to gain populist cred. On top of that, he
noted, such tough law enforcement and regulatory actions "create the
space and momentum to pass reform legislation." Yet, critics say, the
coziness of Obama’s top economic advisers, along with Fed Chairman Ben
Bernanke and Treasury Secretary Tim Geithner, with their former Wall
Street colleagues makes it highly unlikely we’ll see full-scale reform,
true transparency by Wall Street and federal regulatory agencies, or the
aggressive (and crowd-pleasing) prosecution of wrongdoers.

In looking over the full scope of the proposed Senate
legislation, Black argued, "This is actually going to make it harder
for us to take regulatory steps that are needed to reduce the risk of
financial collapse." That may sound like an extreme claim, but Black
argued that real
enforcement is undermined
by what he calls "window-dressing"
reforms in the Dodd bill – like having a presidentially appointed head
of the all-important New York Fed or, even riskier, having limited
clearinghouses for often overvalued "derivatives,"
thus creating a dangerously false sense of security while free-wheeling
trading with phony pricing continues. Derivatives are bets or
investment vehicles supposedly based on underlying assets, and there’s a
good reason that Warren Buffet has called them "financial
weapons of mass destruction."

Despite the unpopularity of the big banks, Congress
hasn’t been overrun with a populist rage demanding specific financial
reforms, so industry lobbyists have been free to seek out arcane
loopholes as Dodd sought to craft a bill that could gain the 60
to break a Republican filibuster. As Bloomberg News declared
bluntly, "Dodd
Overhaul Bill Dilutes Obama Plan to Seek Support."

Senate Banking Committee Chairman Christopher Dodd’s
plan for the biggest Wall Street regulatory overhaul since the 1930s
drops provisions he sought in November and dilutes others as he seeks
bipartisan support.

The measure shelves a single regulator that would
have stripped the Federal Reserve and Federal Deposit Insurance Corp. of
bank-supervision roles, and a plan to hold brokers to the same
fiduciary standard as investment advisers. Dodd’s plan for an
independent consumer protection agency becomes a unit within the Fed and
the so-called Volcker Rule to limit risky trading by banks would be
introduced only after a period of study.

Critics point to other dangerous
: more exemptions for the risky investment bets known as
derivatives; allowing banks and investment firms to continue to mask
their losses through over-valued
shady accounting tricks
; and muzzling an independent consumer
protection agency by housing it in the pro-banking
, although it would be nominally "independent."

Yet, the Fed’s new in-house consumer bureau could
only regulate the largest banks and mortgage companies, while
everyone from most payday lenders
to small banks to auto dealers
could continue to peddle their dicey loans.

On top of that, the compromised agency’s actions are
subjected to a veto by a "systemic
risk" council
made up of the same federal regulatory agencies that
ignored the bubbles, scams and frauds
that caused the last meltdown. As the advocacy group Consumer
Watchdog’s Washington Director Carmen Balber remarked, "You can’t pull
an agency’s teeth, and let other regulators tie its hands, and still
call it an independent champion for consumers."

Even so, in the world of pragmatic politics on the
Hill, most reformers aren’t nearly as harsh as Black or Balber because
they’re hoping that some reform is better than none at all, while
working in a harsh political climate to strengthen what’s been
introduced. Heather Booth, the executive director of the 200-group,
progressive Americans for Financial Reform, told reporters this week
that she was "concerned" and "troubled" by the limitations on the
consumer agency and other loopholes, but they’re not drawing any lines
in the sand yet over the legislation:

"We are troubled by the provisions that allow
Consumer Financial Protection Agency decisions to be appealed to a
council dominated by institutions that failed consumers in the past, and
by holes in its enforcement authority. Derivatives, and other elements
of the shadow markets must be clearly and effectively regulated, without
exceptions or loopholes that undermine these rules, and we must put
real measures in place to take on the menace of ‘too big too fail’ banks
playing heads they win tails we lose games with our economy….

"It has been well over a year since the Big Banks
bought our economy to the edge of the abyss. It is far past time for

In this case, though, unlike the value of a
compromise health care law, if Democrats settle for what could turn out
to be a fig leaf of reform, it may not provide any political benefit at
all. That’s because of the off-balance
accounting and other tricks to hide losses from regulators
and investors that are still allowed to continue. The result could well
be another financial collapse, abetted by trillions in taxpayer loans,
bailouts and guarantees that make risk-taking so pervasive that "all we
get is moral hazard," Black said, citing the perverse incentives to risk
wrecking the economy for short-term gain.

With his years of studying fraudulent banks, Black
said, "accounting fraud is the ideal weapon." When combined with lavish
executive compensation for short-term profits, our current system –
fundamentally unchanged by the Dodd proposal, he said – creates what he
called a "criminogenic environment" leading to "epidemics of accounting

In the recent report on Lehman Brothers’ failure, for
instance, the court-appointed examiner revealed that Lehman Brothers,
apparently with the acceptance or possible
of then-New York Fed President Geithner (which he
denies), temporarily sold off its often-shaky assets to raise $50
billion in cash to hide its losses. It’s yet another Enron-style move
known as "Repo

Black’s colleague, L. Randall Ray, an economist at
the University of Missouri, Kansas City, contended in the blog Naked
Capitalism that the Lehman Scandal should be called "Timmy-Gate," and
"Did Geithner Hide Lehman Fraud?"
He argued:

Just when you thought that nothing could stink more
than Timothy Geithner’s handling of the AIG bailout, a new report
details how Geithner’s New York Fed allowed Lehman Brothers to use an
accounting gimmick to hide debt. The report, which runs to 2200 pages,
was released by Anton Valukas, the court-appointed examiner. It actually
makes the AIG bailout look tame by comparison. It is now crystal clear
why Geithner’s Treasury as well as Bernanke’s Fed refuse to allow any
light to shine on the massive cover-up underway.

Recall that the New York Fed arranged for AIG to pay
one hundred cents on the dollar on bad debts to its
counterparties-benefiting Goldman Sachs and a handful of other favored
Wall Street firms. The purported reason is that Geithner so feared any
negative repercussions resulting from debt write-downs that he wanted
Uncle Sam to make sure that Wall Street banks could not lose on bad
bets. Now we find that Geithner’s NY Fed supported Lehman’s efforts to
conceal the extent of its problems. Not only did the NY Fed fail to blow
the whistle on flagrant accounting tricks, it also helped to hide
Lehman’s illiquid assets on the Fed’s balance sheet to make its position
look better. Note that the NY Fed had increased its supervision to the
point that it was going over Lehman’s books daily; further, it continued
to take trash off the books of Lehman right up to the bitter end,
helping to perpetuate the fraud that was designed to maintain the
pretense that Lehman was not massively insolvent. 

Indeed, Geithner somehow just couldn’t remember if he
knew about the still-legal accounting scam, according to the court
examiner’s report (via Zero

From 2003 to 2009, Treasury Secretary Timothy
Geithner served as President of the Federal Reserve Bank of New York
("FRBNY"). The Examiner described to Secretary Geithner how Lehman used
Repo 105 transactions to remove approximately $50 billion of liquid
assets from the balance sheet at quarter-end in 2008 and explained that
this practice reduced Lehman’s net leverage. Secretary Geithner "did not
recall being aware of" Lehman’s Repo 105 program, but stated: "If this
had been a bank we were supervising, that [i.e. Lehman’s Repo 105
program] would have been a huge issue for the New York Fed."

The Lehman report, the first truly thorough probe of
any financial institution involved in the crash, illustrates a broader
scandal at work in Wall Street and across the financial industry, Black
believes. Yesterday, he and Eliot Spitzer called in an op-ed for an immediate
Congressional investigation
and potential prosecutions:

The damning 2,200-page report, released last Friday,
examines the reasons behind Lehman’s failure in September 2008. It
reveals on and off balance-sheet accounting practices the firm’s
managers used to deceive the public about Lehman’s true financial
condition. Our investigations have shown for years that accounting is
the "weapon of choice" for financial deception. [Bank examiner Anthony]
Valukas’s findings reveal how Lehman used $50 billion in "repo" loans to
fool investors into thinking that it was on sound financial footing …
Such abusive off-balance accounting was and is endemic. It was a major
cause of the financial crisis, and it will lead to future crises.

According to emails described in the report, CEO
Richard Fuld and other senior Lehman executives were aware of the games
being played and yet signed off on quarterly and annual reports.
Lehman’s auditor Ernst & Young knew and kept quiet.

The Valukas report also exposes the dysfunctional
relationship between the country’s main regulatory bodies and the
systemically dangerous institutions (SDIs) they are supposed to be
policing …

The Federal Reserve Bank of New York (FRBNY) knew
that Lehman was engaged in smoke and mirrors designed to overstate its
liquidity and, therefore, was unwilling to lend as much money to Lehman.
The FRBNY did not, however, inform the SEC, the public, or the Office
of Thrift Supervision (which regulated an S&L that Lehman owned) of
what should have been viewed by all as ongoing misrepresentations…. 

Black, Spitzer and other experts are especially
worried at the continued fakery in pricing and valuation of assets,
along with unchecked accounting fraud, that are all setting us up for
another fall. They point to the little-noticed change when an obscure
federal accounting board was successfully pressured to allow banks to
ignore traditional market-value
for their near-worthless assets. Instead, bank officials
were allowed to value them at nearly the inflated prices they were
bought for at the height of the real estate bubble – thus allowing
banks and Wall Street executives to artificially boost their profits

(and their multi-billion dollar bonuses). As Spitzer and Black warned:

Three years since the collapse of the secondary
market in toxic mortgage product, we have yet to see significant
prosecutions of the kind of fraud exposed in the Valukas report. The
Systematically Dangerous Institutions (SDIs), with Bernanke’s open
support, extorted the accounting standards board (FASB) to change the
rules so that banks no longer need to recognize their losses. This has
made the SDIs appear profitable and allows them to pay their executives
massive, unearned bonuses based on fictional profits.

If we are to prevent another, potentially more
devastating financial crisis, we must understand what happened and who
knew what. Many SDIs are hiding debt and losses and presenting deceptive
portraits of their soundness. We must stop the three card monte
accounting practices that create the potential and reality of
fundamental misrepresentation.

Yet, casino-style risky investments
and bogus accounting schemes are still widespread – and not really
addressed in pending legislation and too weakly enforced under current
laws. As Frank Partnoy, a financial journalist, observed in his scathing
article, "The Dodd Wall Street Charade":

"The gaping hole in the bill involves a concept known
as off-balance sheet accounting. The dirty secret of the markets is
that financial statements of major Wall Street banks were, and still
are, a fiction. Until bank balance sheets reflect reality, financial
reform will not work." 

In fact, Partnoy reprints Citigroup’s balance sheet
from 2006 through 2009, with its claim that its assets during the worst
year of the financial crisis, 2008, were $1,938 billion. He observed:

There is not even a hint in these numbers that the
value of Citigroup’s business went from a quarter of a trillion dollars
to nearly zero. There is no indication that Citigroup suffered massive
losses in 2007 and 2008, and then a major post-rescue recovery in 2009.
Instead, the balance sheet suggests that Citigroup’s was steadily and
consistently healthy for all four years. This balance sheet is, in a
word, fiction.

Citigroup is not alone. The balance sheets of every
major Wall Street bank are equally fictitious. They do not reflect
trillions of dollars of swaps. They do not include so-called "Variable
Interest Entities," the subsidiaries banks use to avoid recording risks.
Instead, the banks’ exposure is off-balance sheet. Their financial
statements do not show many of their actual liabilities. 

This mostly legal deception isn’t just another
variation of white collar crime we can hope gets punished someday. It
actually affects the soundness of our economy and the ability to rein in
Wall Street’s most destructive abuses that have already cost American
households $12
trillion in lost wealth
. L. Randall Ray says there will be even
more fallout for yet another underreported accounting scam, the federal
government’s own E-Z "stress tests" for banks, once described by William
Black as "a
complete sham that makes us chumps."
Ray argued:

As our all-time favorite Fed Chairman Alan Greenspan
liked to put it, "history shows" that when financial institutions pass
their own stress tests, they are actually massively insolvent. There is
no reason to believe that this time will be different. Mike Konczal
reports that there is every reason to believe the biggest banks are
hiding huge losses on second liens. These are second mortgages or home
equity loans that amount to about $1 trillion of which almost half are
held by the top four banks…. Since the first principal of a mortgage
is paid first, it is likely that much of the second liens are
worthless…. [if counted accurately] the four largest banks would have
"an extra $150 billion hole in the balance sheet"

What will that mean for the rest of us? Ray’s warning
couldn’t be any more dire:

Of greater importance is the recognition that all
of the big banks are probably insolvent. Another financial crisis is
nearly certain to hit in coming months-probably before summer
. The
belief that together Geithner and Bernanke have resolved the crisis and
that they have put the economy on a path to recovery will be exposed as
wishful thinking. In the bigger scheme of things, this is only 1931.
[Emphasis added.] 

One of the few mainstream journalists to make all
these dangers crystal clear is MSNBC’s loud, but forceful, Dylan
Ratigan, who isn’t buying what he sees as weak reforms that ignore fundamental
in the financial marketplace:

Art Levine, a
contributing editor of The Washington Monthly, has written for Mother
Jones, The American Prospect, The New Republic, The Atlantic,, and numerous other publications. He wrote the October 2007 In
These Times cover story, "Unionbusting Confidential."
is also the co-host of the "
D’Antoni and Levine"
show on BlogTalk Radio, every Thursday at 5:30 p.m. EST. He also blogs
regularly on labor and other reform issues for In These Times and The
Huffington Post.

Consumer Watchdog
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