David Trainer's  Instablog

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.