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David Trainer
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Follow me on Twitter: @NewConstructs David is CEO of New Constructs (, an independent research firm that leverages proprietary technology to find key insights from the Financial Footnotes of 10Ks and 10Qs. Having analyzed over 70,000 annual reports and their Financial... More
My company:
New Constructs
My blog:
The Diligence Institute
My book:
The Valuation Handbook
  • The Leak on WikiLeaks – Regulators Should’ve Known About CDS Risks That Led to Financial Fallout 0 comments
    Dec 2, 2010 1:26 PM | about stocks: BAC, AIG

    While I can­not pre­dict what Wik­iLeaks will leak about some major banks, I have a hunch that one of the rev­e­la­tions might be from a spe­cial New Con­structs report pro­vided to the Sen­ate Bank­ing Committee’s Sub­com­mit­tee on Secu­ri­ties, Insur­ance, and Invest­ment in late Octo­ber 2009.

    In that report, we revealed that reg­u­la­tors – if they were pay­ing atten­tion – would have seen that many Wall Street firms were engag­ing in alarm­ing lev­els of credit deriv­a­tives (aka credit default swaps or CDS) activ­ity. For exam­ple, the notional value of Bank of America’s (BAC) credit deriv­a­tives con­tracts at the end of 2007 was over $3 tril­lion and 5328% greater than the $57 bil­lion at the end of 2001. For Amer­i­can Inter­na­tional Group (AIG,) the notional value of its credit deriv­a­tives con­tracts at the end of 2007 was $562 bil­lion and 447% greater than the $126 mil­lion at the end of 2001. It is a won­der that Bank of Amer­ica was able to sur­vive the finan­cial cri­sis with­out the same level of bailout/takeover by the US gov­ern­ment expe­ri­enced by AIG given that BAC’s credit deriv­a­tive expo­sure was so much greater. Per­haps, Wik­iLeaks will offer some insight into how that happened?

    The growth in expo­sure to credit deriv­a­tives was so high that any­one pay­ing atten­tion would have noticed. So, either the reg­u­la­tors knew and chose to do noth­ing about it (i.e. Bernie Mad­off) or they sim­ply were not pay­ing atten­tion (i.e. Enron, World­Comm etc).

    The point is not that reg­u­la­tors missed or ignored clear and obvi­ous early warn­ing sig­nals of the impend­ing finan­cial fall­out that occurred years later. The point is that they seem to miss these sig­nals quite often.

    None of this sur­prises me given my expe­ri­ence work­ing with the SEC, Sen­ate Bank­ing Com­mit­tee, FDIC, Sen­a­tor Corker, and the Con­gres­sional Over­sight Panel. My pre­sen­ta­tions to them focused how to improve the integrity of the cap­i­tal mar­kets most effi­ciently by imme­di­ately fill­ing holes in the cor­po­rate finan­cial report­ing sys­tem. I high­lighted sev­eral major breaches of finan­cial dis­clo­sures that had gone unde­tected and remain uncor­rected by the SEC. For exam­ple, over the last 5 years we found 10 com­pa­nies whose income state­ments do not add up cor­rectly and 20 com­pa­nies in the last 11 years whose bal­ance sheets do not bal­ance. For more exam­ples, see the Cor­po­rate Finan­cial Dis­clo­sure Trans­gres­sions report I sub­mit­ted to the SEC and the Sen­ate Bank­ing Com­mit­tee. What you read in that report will surprise you.

    In my hum­ble opin­ion, our reg­u­la­tory frame­work (before and after over­haul) is woe­fully ill-equipped to find, track and address the finan­cial machi­na­tions con­stantly invented on Wall Street and in cor­po­rate America.

    As I stated in Pri­vate Sec­tor to the Res­cue, “Given that our abil­ity to trust polit­i­cal lead­ers is low, we must rely more than ever on pri­vate enter­prise to lead our society.”

    Investors can speak louder than all politi­cians and reg­u­la­tors com­bined with how they allo­cate their research spend­ing and how they make their invest­ment deci­sions. In other words, you must decode Wall Street Pro­pa­ganda and make sure you know the finan­cial ins-and-outs of the stocks you buy and sell. There is no short-cut to suc­cess or the hard work required to ana­lyze Finan­cial State­ments and the Finan­cial Foot­notes to deter­mine the true eco­nomic earn­ings of com­pa­nies. But the ben­e­fits can save your…

    In short, there is no sub­sti­tute for “doing the dili­gence.” Watch your back when invest­ing in this mar­ket because no one else is watch­ing it for you.

    Disclosure: No positions
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