Anton Valukas is Chairman of the Jenner & Block law firm. A former United States Attorney specializing in civil and white collar criminal litigation, he was selected as the Lehman Brothers (OTC:LEHMQ) bankruptcy trustee. He just released his 2,200 page report (he is, after all, a lawyer, and gets paid by the page) on how Lehman dug itself into the hole it could not climb out of.
Among his conclusions? Lehman Brothers used "materially misleading" accounting (that’s a lawyer term for “lied”) to hide $50 billion in what were supposed to be assets during the second quarter of 2008. During the third quarter, you’ll recall, Lehman collapsed, triggering the waterfall-effect crisis in US banking. Mr. Valukas reports that Lehman used repo swaps (“you say you’re buying them from me and I’ll record them as gone, but really we’ll have a separate agreement that I have to buy them back from you when you tell me to”) to temporarily remove $50 billion of toxic waste from its balance sheet, hiding these time bombs from both investors and the credit rating agencies.
Wall Street bankers and brokerages are already trying to soft-pedal this unethical, disgusting, and criminal act. One of Lehman’s former chief financial officers called these lies-designed-to-defraud "shenanigans." Shenanigans? Makes it sound like some sort of April Fool’s joke or college prank, doesn’t it? This was no shenanigan, it was the same kind of dishonesty and arrogance that led to the Crash of 1929, when banks with bad loans were found to have been hiding them in subsidiaries. Lehman was pretending to sell noxious junk but then buying it back in what what were designed and executed as sham transactions.
Valukas adds that Lehman's CEO, Richard Fuld, either knew or was "grossly negligent." Something of an understatement, that. It was exactly the same as Nixon’s Dilemma when Watergate burst on the scene. Either the President knew about it and was a liar, or he didn’t know in which case he was “merely” incompetent and unaware that his most trusted lieutenants had effectively taken the reins of the Presidency from him. He knew. (Fuld, that is…)
Valukas also calls Ernst & Young on to the carpet – as well he should. As the accounting firm that audited Lehman's books, Ernst & Young either falsified their public affirmation that Lehman was following appropriate accounting standards or they are incompetent. Not a lot of middle ground here, is there? Public accountants exist to protect the public, yet they receive their compensation from company management. No conflict there…
Of course, the real takeaway for you and me in all this is never stated in the trustee’s report. That is: How many other banks and brokerages are doing the same thing today?
Has that conflict of interest between public accountants’ responsibilities and how they are compensated been resolved? No.
Is there now greater transparency in terms of “off-book” agreements for repos and reverse repos between mega-firms declaring all these great profits in 2009? No.
Have we seen a commitment on the part of the Fed, the Treasury, or the Office of the Attorney General to upset the big-banker applecart by delving into these transactions? No.
Were these smarmy manipulations restricted to Lehman, or were / are they still common, if not public, practice today? Do we really know how much counter-party liability Citigroup (NYSE:C) has to other banks and brokers? How many mortgage-related derivatives Wells Fargo (NYSE:WFC) has or how many more credit default swaps AIG (NYSE:AIG) has underwritten? Nobody knows, or at least nobody who has divulged it to us mere mortals. Instead, the Fed has used taxpayers’ money to “assist” the banks to unload those assets onto the Fed’s own balance sheet.
I don’t have the answers. This may be a tempest in a teapot and everything is just as hunky-dory as Ben and Tim tell us it is. But, you know, I only have a finite amount of money. (Just like the US government, although no one there seems to get that…) Just as the airlines used to say back when it was true, “We know you have a choice of airlines…,” I have a choice of many sectors in which I can invest. I have decided that I’ll fly a few other sectors but I will not expose myself or our clients to the risks of the large financials nowadays. They’re already priced for perfection and this situation isn’t exactly screaming “perfection.”
Not every article should end with a buy or sell recommendation. This one does. We have now sold 100% of our large banks and are considering a pilot purchase of the ProShares Short Financials (SEF.) If you are long money-center and other large financials, maybe you should take a close look at what you see, and add a little Kentucky windage for what they may not be letting you see…
Author's Disclosure: We and our clients have no more long positions in US financials. For some clients and ourselves, we will consider purchase of SEF.
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but will not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”!
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