Greenspan Right 70% of the Time?

Last week Wednesday, former Fed chair Alan Greenspan testified in front of the Financial Crisis Inquiry Commission. The most notable quote of Greenspan’s testimony was when he claimed that during his tenure as Fed Chief he was “right 70% of the time,” meaning of course that he was wrong 30% of the time and admitted to significant errors during his tenure. Once considered the Oracle of the financial markets, Greenspan now comes across as a pilot who crashed a plane but now seeks rhythm because he flew the plane well while it was in the air.

One main criticism of Greenspan is that as fed chair he failed to see or protect against the asset bubble in the housing market the bursting of which contributed to the failure of mortgage backed securities that were a primary cause of the financial crisis. Perhaps out of contrition, in his testimony Greenspan moved away from his laissez faire philosophy and promoted regulation of “too big to fail banks” because “the productive employment of the nation’s scarce saving is being threatened by financial firms at the edge of failure, supported with taxpayer funds, designated as systemically important institutions.” Nonetheless, to have Greenspan, who along with Robert Rubin was one of the foremost proponents of deregulation in the late 1990s, recognize that reform is needed is further evidence of the necessity for substantive financial reform.

Further, as predicted, the Senate began debate on financial reform Thursday after several filibuster hiccups on Monday and Tuesday. With Senator Chris Dodd promising a bipartisan bill, it remains to be seen whether new financial sector reform will have any serious bite.

Walmart’s Diversity Doublespeak

In her well-done post last Tuesday, Lydie Pierre-Louis revealed her surprise that the class action brought by women employees against Walmart alleging sex discrimination had not been settled. She noted that Walmart had been recognized for its efforts to protect the environment and wondered about the incongruity of Walmart’s good citizenship in this regard at the same time it denied accusations about pervasive mistreatment from over a million female employees.

Even more incongruous is Wal-Mart’s articulated position on diversity. The company says all the right things about women and “minority” employees and suppliers. Its supplier diversity program seeks to ensure that the company does business with women and people of color. Wal-Mart even requires diversity at the law firms it retains.

Walmart’s public discourse about diversity is similar to the statements many other companies make. “Diversity is a way of life at Walmart. And our commitment to diversity is not just something we talk about, it’s who we are.” But it’s hard to reconcile this kind of diversity cheerleading with the company’s stubborn denial of the allegations of millions of women about the company’s discrimination in hiring, promotion and pay. It seems to me that a true commitment to diversity would require Walmart to avoid blanket denials about anything amiss with its women employees – now and in the past. A real commitment to diversity would inspire Walmart’s managers to conduct a serious investigation into the accusations, make changes where appropriate, and settle the class action.

Walmart’s denials do not ring true because sexism, sexual harassment and discrimination are still prevalent in U.S. workplaces. Discrimination within a U.S. company that employees millions is inevitable. And, the disparities between the pay and promotion rates of male and female employees at Walmart would inspire a company that is truly interested in diversity to undertake a serious investigation of the plaintiffs’ allegations.

Walmart’s “diversity-is-a-way-of-life” rhetoric is what I call “diversity doublespeak”. I wrote about this phenomenon in an article entitled “’We Are An Equal Opportunity Employer’: Diversity Doublespeak”. Diversity doublespeak allows companies to avoid responsibility for enduring discrimination within a firm. Too often there is a gaping disparity between what companies say – “diversity is a way of life” – and what they do.

Ninth Circuit Certifies Wal-Mart Gender Discrimination Class-Action Law Suit

In a divided 6 to 5 ruling, the Ninth Circuit Court of Appeals has certified a gender discrimination class-action lawsuit against Wal-Mart to proceed to trial. Wal-Mart is the world’s largest retailer. The gender discrimination lawsuit includes over 1 million women, and is the biggest employment discrimination case in U.S. history. Brad Seligman, a lawyer for the plaintiffs and executive director of the Impact Fund, a public-interest litigation organization that funds complex litigation, stated that “Wal-Mart tries to project an improved image as a good corporate citizen. No amount of P.R. is going to work until it addresses the claims of its female employees.”




The class-action lawsuit was originally filed against Wal-Mart in June 2001 by six female Wal-Mart employees who had worked in 13 Wal-Mart stores. The lawsuit alleged that Wal-Mart engaged in a pattern and practice of discriminating against women in promotions, pay, training and job assignments. Since the filing of the lawsuit, Wal-Mart has fiercely defended itself and its outside counsel, Theodore Boutrous, a partner Gibson Dunn & Crutcher LLP, has successfully managed to delay the case for nine long years including obtaining a stay of discovery during the pendency of several appeals. It is not surprising that Wal-Mart's general counsel, Jeff Gearhart, stated that "…Wal-Mart is considering options, including seeking review from the Supreme Court... We do not believe the claims alleged by the six individuals who brought this suit are representative of the experiences of our female associates." Appeals have delayed the lawsuit from moving to trial thus far, Wal-Mart has nothing to lose by appealing the decision to the Supreme Court, other than time.



Many experts believe the court’s class certification ruling provides a major incentive for the parties to reach a settlement before the case goes to trial, because juries are so unpredictable—sometimes awarding plaintiffs big sums and sometimes awarding the plaintiffs nothing. If the case does proceed to trial, approximately 1.4 million female plaintiffs could be awarded billions in actual damages and an even more substantial amount in punitive damages. The Ninth Circuit left the issue of punitive damages to the trial judge to decide whether the plaintiffs can seek punitive damages on class-wide basis or whether they must they pursue punitive damages individually. Seligman stated that he would be "happy to talk settlement." However, Boutrous believes that [Wal-Mart] is focused on a Supreme Court appeal rather than on a settlement. Boutrous stated that "[W]e feel the majority's ruling conflicts with not only Supreme Court precedent, but the law of several other circuits…talks of settlement were premature."




This is all very disturbing. There has been such little media coverage regarding the pending gender discrimination lawsuit that most people, myself included, had forgotten about it. I gather we all assumed that the case had been dismissed or quietly settled. And, Wal-Mart had done such an extraordinary public relations effort of profiling itself as an environmental sustainability superstar over the past six years that our collective focus was misdirected. Professor Jared Diamond’s op-ed piece in the New York Times last December applauded Wal-Mart’s sustainability programs include using renewable energy to power its stores and cleaner transportation to drive its trucking fleet. The new sustainability programs were going to save Wal-Mart’s millions in operating expenses which would have resulted in major savings, that Wal-Mart had announced that it would to pass on to its customers. We were all lovin’ Wal-Mart. However, it makes me wonder whether Wal-Mart’s environmental sustainability efforts were simply smoke and mirrors to create goodwill, and a positive public image to defray attention from Wal-Mart’s mistreatment of its women employees. Perhaps Wal-Mart is committed to environmental sustainability, I certainly hope so, but it all feels pre-calculated and rather icky in light of the gender discrimination lawsuit. As a periodic Wal-Mart customer, is it too much to ask that the world’s largest retailer should help save the environment, and treat its women employees decently? We should demand no less.

Reaching the Gatekeepers – Do We Have to Abandon the Issuer Pay Model for Credit Rating Agencies?

Last Friday, Carl Levin, chair of the Senate Permanent Subcommittee On Investigations rang the alarm. Congress has aimed a spotlight on critical issues such as moral hazard engendered by a “too big to fail policy.” The ability of large financial institutions to employ products or strategies that recklessly or intentionally create excessive risk is a national and arguably global concern. Senator Levin warned, however, that effective reform of financial markets will also require addressing the role of secondary actors, like credit rating agencies. (See here.)

Between 2002 and 2007, each of the three largest credit rating agencies earned more than $6 billion a year, double their annual revenues for years past. (See here.) The increased revenues came largely from rating complex credit derivative instruments. While testimony continues to emerge from various legislative committees, few contest the need to address the central and critical role that credit rating agencies played in the most recent financial crisis. The creation of collateralized debt obligation (CDO) introduced a nascent industry centered on pooling and packaging home mortgage debt. The CDOs offered rights to receive periodic payments from the cash flows associated with specified bundles of home mortgages. Each CDO received a rating from two nationally recognized credit rating agencies. Investors viewed credit rating agencies as gatekeepers who issued independent, fair and accurate assessments of the value of these instruments. Last Friday’s hearing charged credit rating agencies with recklessly assigning ratings. Some have alleged collaboration with the banks that packaged and sold the bonds.

The current financial reform bills in the House and the Senate do address some of these concerns – requiring credit rating agencies to register with the SEC and to offer greater transparency regarding their rating methodologies. There is also a call to adopt an express private right of action to allow investors to sue credit rating agencies – a path that had been closed by judicial decisions protecting credit ratings under the First Amendment.

Ultimately, however, it seems that the stickiest issue underlying the role of the credit rating agencies in the crisis may be the conflict of interest inherent in the issuer pay model. Bond issuers pay credit rating agencies for the ratings issued on the bonds that the issuers hope to distribute. When dissatisfied with the ratings, issuers may shop for a different opinion.

Failing to address the conflict of interest created by the issuer pay model creates an opportunity for continued market manipulation. Arguing that we cannot adopt legislation unless we can contemporaneously fix every open issue may undermine reform because legislators lack the crystal ball required to predict the antecedents of all future crises. Reform should, however, address identified and correctable issues from a comprehensive perspective, or else we will find ourselves reacting to the next crisis or running to shove our fingers and toes into each new hole in the buckling dam of financial markets regulation.

Wrestling with the gods of Risk – Why Do We Keep Coming up Short?

Many thanks to dré cummings and company for inviting me to guest blog with Corporate Justice. I am delighted to discover a forum like Corporate Justice. During my years as a practicing lawyer in New York, I had the opportunity to support clients who engaged in public and private, domestic and international business transactions including securities offerings, syndicated credit facilities and acquisitions and dispositions of businesses. I had hoped and am enthusiastic to embark upon the marriage of that experience with my dream job – law teaching (hang in there, for those planning to go onto the teaching job market next fall).

My current research focuses on a variety of aspects of financial markets regulation. I teach corporations, securities regulations and a seminar exploring the intersection of federal law and corporate governance. I recently posted to SSRN an article exploring derivative securities and hope to share and receive commentary on certain issues raised in the article.

Risk management has presented itself as one of the most interesting topics underlying my current research. The discussion of risk management is rich and complex. For over a decade, financial institutions and hedge funds have challenged regulation of exotic financial investment products like credit derivatives because these instruments, financial intermediaries argue, offer a valuable risk management tool. Even if instruments like credit default swaps assist some financial services firms by allowing them to hedge against risk, as the recent crisis demonstrates, these investment products engender grave concerns.

In my forthcoming posts, I would like to explore these and other concerns such as the pending legislation in Congress designed to address the recent financial crisis, the SEC’s allegations against Goldman Sachs and Goldman’s role in the use of derivatives to assist Greece in doctoring its national debt levels to facilitate the country’s acceptance into the Eurozone. Hopefully, each will offer an opportunity to explore noteworthy normative issues and cultural assumptions about risk management, financial markets and financial market participants’ innovative creation of products and investment strategies designed to defy the odds of risk.

SEC Doing What?

The Securities and Exchange Commission has had a rough decade. Once viewed as the brightest star in the U.S. government agency constellation, the SEC has been its own worst enemy as news keeps spilling out that causes pause. The luster has certainly dimmed. Against the backdrop of egregious misses on Bernie Madoff and Allen Stanford, enormous ponzi schemers, news yesterday indicates that SEC employees were "distracted" at work in recent years. Apparently, viewing pornography while on the clock and using government computer equipment to do so is a routine practice by some at the SEC. The Agency is tasked with protecting investors and ensuring the integrity of the U.S. capital markets.

How surfing porn fits into these objectives is difficult to imagine.

Potential Senate Debate on Financial Reform

As Cheryl Wade noted yesterday, President Obama delivered his financial regulation reform speech near Wall Street touting a bill that just one week ago appeared stalled. The bill appears poised to move ahead on Monday as it was filed for cloture to begin debate on Capitol Hill. Just seven days ago, 41 Republican Senators sent a letter to Democratic Majority Leader Harry Reid promising to filibuster the proposed financial regulation. Today, many see financial reform as inevitable and happening quickly. The reason? External political pressure. The primary argument forwarded by the Republican Senators was that passing the bill would lead to “perpetual bailouts.” This particular talking point, purportedly taken explicitly from a “Words that Work” memo by Republican consultant Frank Luntz written before Senate financial reform was proposed, was too transparent and ridiculed throughout the media. Still, the cloture vote is a political risk as Senator Reid appears to be attempting to call the bluff of the 41 Senators who signed the filibuster letter.

However, it appears that members of Congress are willing to work together towards a deal. Senator Blanche Lincoln, a conservative Democrat introduced tough derivative reform language. Republican Senator Bob Corker has signaled his willingness to deal and has said that he expects financial reform to receive 70 votes, rhetoric that is far more positive toward new regulation than that in the past. Senator Olympia Snowe, one of the few Republicans to vote for President Obama’s stimulus bill, has signaled that she would be willing to be the sole Republican to break a filibuster in favor of reform. The real reason behind this sudden change? Most likely the realization that standing for reform is more politically favorable than standing with Wall Street and its lobbyists.

What’s Missing From Financial Reform: Compliance, Ethics, Due Diligence

Earlier today, President Obama made a much-anticipated speech about reforming financial regulation. Financial reform is not a new item on the President’s agenda. He has advocated for this reform for about two years. And, as we all know, the recent calls for reform were ignited by the 2008/2009 economic meltdown that put our nation into a deep recession. The reform the President called for today responds to some of what is wrong with corporate governance in general, and Wall Street in particular.

But we’ve been through this before – recently. Remember the Sarbanes-Oxley Act? After a string of corporate bankruptcies and governance failures at companies like Enron, WorldCom, Adelphia, Tyco in 2001 and 2002, Congress enacted Sarbanes-Oxley in an attempt to address the managerial misconduct and accounting fraud that plagued these companies. Legislators, regulators, politicians, academics, lawyers and members of the business community argued about whether the Act was necessary, and whether it would prevent future wrongdoing.

The Sarbanes-Oxley Act attempted to close several troubling gaps in corporate governance and compliance, but legislation and regulatory reform cannot address the root causes of what went wrong at Enron at the beginning of the last decade. Legislation and regulatory reform cannot deal with what went wrong at the financial institutions and car manufacturers that were bailed out by the American taxpayers. Legislative and regulatory reform cannot prevent excessive risk taking and poor corporate governance.

Policymakers and reformers must initiate a discussion among business leaders about corporate culture itself. The discussion should include broad concepts relating to compliance, ethics, due diligence and fiduciary duty. For example, public companies should establish corporate cultures that take compliance and ethics programs seriously. Compliance and ethics officers should report directly to corporate boards in order to avoid the marginalization that frequently occurs with respect to this work. Another example - when mortgages are pooled, securitized and sold to investors, the financial institutions involved in the process must perform due diligence in order to understand what they have purchased.

Some say that the details of the reform that President Obama seeks fail to address the problems that led to the economic downturn. We, however, must not get mired in the details. Business leaders must go back to the basics of good corporate governance. And, as a nation, we must expect more from business leaders.

Guest Blogger - Kristin Johnson

The Corporate Justice Blog is pleased to announce that Professor Kristin N. Johnson will be blogging in this space in coming weeks and months as a guest blogger. Professor Johnson currently teaches Securities Regulation and Business Associations at Seton Hall University School of Law. Prior to teaching at Seton Hall, Professor Johnson worked as Assistant General Counsel and Vice president at JPMorgan. Before joining the investment bank, she practiced law as a corporate associate at Simpson, Thatcher and Bartlett LLP in New York, where she represented issuers and underwriters in domestic and international debt and equity offerings, lenders and borrowers in banking and credit matters and private equity firms and publicly traded companies in mergers and acquisitions. Before law school, Professor Johnson was an analyst at Goldman Sachs & Co.

Professor Johnson received her B.A., from Georgetown University, and her J.D., from the University of Michigan Law School.

We look forward to Professor Kristin Johnson's contributions to the Corporate Justice Blog.

Pay Czar Strikes Back at Excessive Executive Compensation

In June 2009, President Obama appointed Kenneth Feinberg, the Pay Czar, as he is often referred to in the media, after public anger exploded over high executive compensation at companies that received Troubled Asset Relief Program (TARP) bailout funds. Feinberg is well versed in areas of human resources valuation, and consensus building without the need for litigation. Feinberg previously oversaw the distribution of funds for victims of the attacks of Sept. 11, 2001. In August, 2009, revision to the TARP legislation attached executive compensation restrictions to the pay for the top 25 earners of any company that received TARP funds, and compensation totaled more than $500,000 from October 2008 through February 2009, including 2008 end-of-the-year bonus payments. The revisions to the TARP legislation also gave Feinberg “wide authority to attempt to recoup money” paid to employees at companies that received TARP funds.

A few weeks ago in March, Feinberg completed his review of executive compensation at 419 companies that had received bailout funds. Feinberg in his discretion determined whether any payments were contrary to public interest and may request that individual executives return the excess money received. Unfortunately the TARP legislation, despite its “wide authority to attempt to recoup money“ does not specifically provide Feinberg with any enforcement authority, regarding the recoupment of excess executive compensation. As such, Feinberg cannot force executives to return the money. However, this lack of enforcement authority does not seem to concern Feinberg. He believes that the he can be very persuasive. An interview with Feinberg discussing his authority to recoup funds from executives is available here. Executives at several companies fall into this category including JP Morgan Chase, Goldman Sachs, AIG, Citigroup, General Motors, and GMAC. Bank of America repaid $45 billion to the U.S. Treasury, two days before Feinberg’s report was released, and effectively removed itself from Feinberg’s scrutiny.

Feinberg's executive compensation restrictions and recoupment power is regarded by some as a bold expansion of his “review of pay powers,” and may send a signal to Wall Street that it cannot return to big bonus payments without intense public and governmental scrutiny, and ire. Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University, believes that Feinberg's look-back plans are necessary. Hurley stated that “[I]f the notion was to see who had their hand in the cookie jar when the crisis was unfolding, then that should be revealed."


Recently, the New York State Comptroller released a report in February showing that bonuses on Wall Street rose 17 percent in 2009 to $20.3 billion. This figure is a little incredulous to me given that the vast majority of Americans are struggling to save their jobs, homes, retirements, and feed their families. Wall Street's disconnect with human suffering or basic moral compass as to what is appropriate, reminds me of the Army-McCarthy Hearing which was the first federal hearing broadcasted live to the American people in February 1950. Senator Joseph R. McCarthy was chairman of the Senate Committee on Government Operations and its Subcommittee on Investigations. McCarthy demanded preferential treatment for his aide who had been drafted, and was scheduled to be sent abroad. When the U.S. Army refused to extend any preferential treatment on Senator McCarthy’s behalf by deciding not to intercede in the draft process, Senator McCarthy immediately commenced an investigation of the U.S. Army. McCarthy was summoned to appear before Congress to answer questions regarding his motive for commencing an investigation of the U.S. Army. The verbal inter-change between McCarthy and Special Counsel for the U.S. Army, Joseph N. Welch, became very heated. At one point Welch, exasperated with McCarthy’s sarcasm and blatant lack of respect for the U.S. Army, Congress, and anyone who dared to question his actions, lost his usual reserved demeanor, stood up and yelled at McCarthy-- “You have done enough. Have you no sense of decency sir, at long last? Have you left no sense of decency?” Americans were outraged by McCarthy’s lack of respect, decency, and his sense of entitlement to preferential treatment. Americans wasted no time in expressing their outrage to their elected officials. Within a few months of the hearing, the Senate voted to condemn McCarthy.

Public exposure has proven to be a powerful tool, as evidenced by the condemnation of Senator McCarthy, and the slow but largely successful repayment of bonuses that were previously paid to AIG employees. However, some experts are doubtful, “Wall Street might be immune to shame,” said Russell Roberts, an economics professor at George Mason University, and research fellow at Stanford University's Hoover Institution. Roberts stated that, “[I]f the goal is to shame executives, there is not much shame on Wall Street, and I doubt it would have much effect if that is [Feinberg’s] only lever." I would not underestimate Feinberg. He has proven to be very very persuasive, and Americans are outraged. It may prove to be a combustible combination.

Lydie Nadia Cabrera Pierre-Louis

Toyota Still Under Fire As Shareholders File Lawsuits Against The Auto Giant

After recalling more than eight million vehicles worldwide due to sudden unintended acceleration, Toyota Motor Corporation is now facing a host of lawsuits from the company’s shareholders and individuals impacted by the recalls. In at least three class-action lawsuits, shareholders are suing over the dramatic drop in Toyota’s stock price, arguing that company executives gave investors and the public false assurances that the sudden acceleration issue was easily fixable and intentionally misrepresented the depth of the problems. Moreover, shareholders contend, Toyota executives knew for almost a decade that faulty throttle controls caused the cars to swerve out of control, but that the executives breached their duty to disclose truthful information and covered up the defective design through press releases, conference calls, and interviews with stock analysts. This deception resulted in a false reputation of safety and artificially inflated Toyota’s stock price.

As of early March 2010, Toyota’s stock price fell nearly 16 percent, from its price of $90 on January 21, 2010. Although the stock rebounded in mid-March to nearly $80, the price decrease caused shareholders to potentially lose millions of dollars. Additionally, Toyota’s total U.S. market capitalization fell 13 percent to $136 billion after the sticky pedal recall in January 2010.
The lawsuits come as Toyota desperately works to regain public confidence in the wake of one of the nation’s largest auto recalls. If Toyota is found liable, it could face billions of dollars in damages. Toyota does however, have case precedent to argue from. In 2001, Ford Motor Company won its product liability lawsuit against investors who alleged that the company deliberately misled the public about the safety of its Explorer vehicle prior to a massive tire recall. A federal judge held that Ford could not reasonably foresee the impact of the recall when it made the public statements. Toyota shareholders likely face an up hill battle to hold Toyota liable for its disclosures concerning defective cars.

Markets Respond To The SEC's Securities Fraud Lawsuit Against Goldman Sachs

On April 16, 2010, the SEC announced it's civil lawsuit against Goldman Sachs based on securities fraud. Accusing Goldman Sachs of lying to its investors, the SEC alleges that the investment company deliberately failed to disclose that its collateralized debt obligation packages, which relied on the performance of sub-prime residential mortgage-backed securities, had been designed to fail by hedge fund Paulson & Co., which took short positions against the mortgage securities and ultimately generated billions of dollars in profits at investors’ expense. The SEC further asserts that Goldman Sachs’ actions are in direct violation of the company’s business principals, which state that its clients’ interests always come first. The complaint filed by the SEC charges Goldman Sachs with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5.

On Friday, the news of the lawsuit instantly caused Goldman Sachs’ stock to plunge by 13%, to $166.70, destroying over $10 billion of the company’s market value. To make matters worse, Wall Street analysts predict that the SEC, after being sharply criticized for failing to uncover the causes of the financial crisis, is cracking down on companies that have a link to the mortgage crisis. In anticipation of future charges and heavy fines, analysts downgraded Goldman Sachs’ stock. Goldman Sachs issued a statement saying it would vigorously contest the lawsuit and defend the firm’s reputation. Goldman Sachs is concerned about its reputation only to others on Wall Street.

What is particularly troubling about the back dealings of Goldman Sachs is the craps game the industry played with sub-prime residential mortgages. While Goldman Sachs gambled, low-income communities suffered and continue to suffer from the foreclosure consequences of sub-prime mortgage lending. Few of us are surprised by these antics, but it sure gets me “dang” fired up when I am reminded of just how much money Wall Street makes at the misery of our communities. Where is the harm to reputation for disregarding the families facing foreclosure!

GOP Meltdown Continues Apace

Well it looks like the financial reform bill will come to the Senate floor for a vote this week. Further, in what will certainly go down as one of the great political blunders in American history the GOP is poised to filibuster the bill, and they apparently have the votes in line to pull it off.

But the GOP better proceed with caution. Yesterday, I posted a blog at Nuestras Voces Latinas that questioned the political strategy of the GOP in cozying up to the hateful and violent elements of the Tea Party. The risk of alienating blacks, Latinos and other minorities seems likely to guarantee the demise of the GOP.

Today, I want to emphasize the political dead end they are flirting with by threatening to kill financial reform. Here is the issue: they are trying to claim the bill is too friendly to banks. The problem is the banks have lined up with the GOP. As Senator Dodd states: "why are those Wall Street firms taking the Republican side in this bill?” Every consumer group lines up with the Dems and every business group supports the GOP. Bush appointee Sheila Bair also supports the bill and as head of the FDIC has proven herself to be a reliable and professional regulator. Bair claims the bill makes bailouts impossible. The American people will see through the GOP's sophistry. The Dems should force the issue and require the GOP to stall all Senate business by actually filibustering the bill with the full media circus that will entail. If that happens it will be the death knell of the GOP.

If the GOP kills this bill all future financial crashes should be credited to their obstinate refusal to do anything. The financial sector has spent $1 million per congress person to stop this bill; if the GOP gives them a victory the American people will abandon the GOP in November.

A Failure of Capitalism?

In 2008 testimony to the House Committee on Oversight and Government Reform in the days following the failure of Lehman Brothers, former Federal Bank chair Alan Greenspan told Congress, “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.” Law and economics icon Judge Richard Posner wrote in his 2009 book entitled “The Failure of Capitalism” that “we are learning from [the crisis] that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails.”

How did the economy run off the rails in 2008? New revelations have just surfaced that should add additional “shocked disbelief” to Greenspan’s admittedly flawed worldview. Last Wednesday, news from Congressional interrogation shows that Washington Mutual, once the nation’s largest savings and loan association, was deliberately packaging mortgages they knew were delinquent or strongly believed would become delinquent, and securitized them as CDOs to pass the risk of known or sure default on to investors. The bank admittedly and purposefully "used shoddy lending practices . . . to make tens of thousands of high-risk home loans that too often contained excessive risk, fraudulent information or errors” according to the congressional report. The bank, in its reckless pursuit of profits, in the face of competition that had materially minimized its returns resorted to innovative new financial instruments that instead of freeing up capital caused a financial collapse.

In light of this purported failure of capitalism, have Wall Street investment banks and national commercial banks changed their practices—reined in the reckless pursuit of profits at the expense of consumers and shareholders? It appears that the answer is no. Eighteen banks, including Goldman Sachs, JP Morgan and Citigroup, "understated their debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods." The very banks that needed bailout money from the U.S. taxpayers in 2008, have for the past five quarters in 2009 and 2010 manipulated their balance sheets by hiding their true risk exposure directly before required quarterly disclosures are due to investors. While these banks argue that this manipulation of balance sheets falls within GAAP (generally accepted accounting principles), that is also the argument that Lehman Brothers makes in response to its “repo 105” practice that has been slammed in the recent Valukas Report.

The incentives inherent in a deregulated market, the private market discipline mantra of Alan Greenspan and the insatiable greed exhibited by Wall Street bank executives clearly do not promote the public welfare. Un-regulated markets that incentivize failure for profit rather than sustainable growth are not beneficial no matter how “free.”

Cross-posted on the SALT Law Blog.

Lehman's Alter Ego: Hudson Castle and the Collapse of Lehman Brothers

A few weeks ago I discussed the Lehman Brothers collapse on this blog. Well, as we found out recently, the saga continues. In a April 12, 2010 New York Times story entitled "Lehman Channeled Risks Through 'Alter Ego' Firm " written by Louise Story and Eric Dash, Lehman's use of a small company named Hudson Castle as an "alter ego" was exposed.

Essentially, according to Lehman documents and interviews with former Lehman employees, the NY Times reporters highlighted the critical role Hudson Castle played in keeping a number of transactions off Lehman's balance sheet prior to the Lehman collapse in Septemeber 2008. On the surface Hudson Castle possessed all of the appearances and attributes of a stand-alone corporation. However, as noted, Hudson Castle was entwined and interconnected with Lehman Brothers in ways no one could imagine. For example, for a number of years Lehman owned 1/4 of Hudson Castle equity, controlled the Hudson Board of Directors, and stocked Hudson's ranks with former Lehman employees. Despite this entanglement Lehman did not disclose these facts to shareholders or regulators.

Lehman, and a host of other large banks, use corporations like Hudson Castle to exchange investments for cash--thereby making their cash position and finances look better to the outside world. Often, "off-balance sheet" transactions like the transactions that Lehman and Hudson Castle engaged in are mentioned in occasional financial statement footnotes, and at worst are never mentioned at all. Indeed, in the case of the relationship between Lehman and Hudson Castle, Lehman failed to inform their shareholders about the relationship and arrangement. Additionally, credit rating agency Moody's decided not to mention the Lehman and Hudson Castle relationship in credit ratings reports covering Hudson Castle vehicles.

Sadly, arrangements like the one between Lehman and Hudson Castle are legal. Federal securities disclosure laws require that publicly traded corporations like Lehman, are only obligated to disclose material investments or purchases of public companies. Unfortunately, Lehman's relationship with Hudson Castle did not meet either of these requirements.

In my last post on Lehman Brothers, I discussed Lehman's "Repo 105" program. Apparently, Hudson Castle was at the forefront of the Repo 105 program. Allegedly, "Hudson Castle created at least four separate legal entities to borrow money in the markets by issuing short-term i.o.u.'s to investors. It then used that money to make loans to Lehman and other financial companies, often via repurchase agreements, or repos." Under these repurchase or repo agreements, banks sell assets and promise to buy them back at a set price in the future. The transactions are made to look like arms-length transactions to shift "toxic" or "risky" assets off-balance sheet. The idea is to prevent these off-balance sheet risks from appearing as "headline risk" in the event of their failure or collapse on-balance sheet.

We are finding out more and more about the collapse of Lehman Brothers. I'm interested to find out what other skeletons we end up uncovering. What do you think about Hudson Castle? Are more regulations and tougher disclosure requirements necessary?

SEC Hits Back At Goldman Sachs

Today, the Securities and Exchange Commission filed fraud charges against Goldman Sachs accusing the Wall Street giant of defrauding investors by failing to disclose that it was packaging toxic Collateralized Debt Obligations for some clients while betting against those same investments for their own interests and on behalf of other clients.

According to Bloomberg:

"The SEC alleged that Goldman Sachs structured and marketed CDOs that hinged on the performance of subprime mortgage-backed securities and failed to disclose to investors that hedge fund Paulson & Co. was betting against the CDOs, known as Abacus, and influenced the selection of securities for the portfolio, the SEC said. Paulson wasn’t accused of wrongdoing."

Goldman Sachs responded to the SEC civil complaint as “completely unfounded in law and fact” and Goldman promises that it will “vigorously contest them and defend the firm and its reputation.”

The scheme as identified in the SEC complaint was the initiation of Abacus 2007-AC1 at the request of a prominent hedge fund manager John Paulson (who earned close to $3.7 billion in 2007 correctly wagering against the housing bubble). Goldman allegedly allowed its client Paulson to select the actual mortgage bonds that he wanted to bet against, those most likely to fail, and then packaged and securitized those subprime mortgages for Paulson into Abacus 2007-AC1, an investment vehicle that Goldman then peddled to investor clients including foreign banks, pension funds, hedge funds and insurance companies without disclosing the true nature of the investment (built to fail). The client and Goldman, then bet that this instrument would fail through purchasing credit default swaps against failure and then shorting it.

This allegation sounds very similar to the admissions made by Washington Mutual executives earlier this week, where the bank admitted knowingly securitizing instruments of its worst loans, those that would undoubtedly fail, and then selling the dreck to investors sans disclosure.

That the SEC has decided to take on global financial titan Goldman Sachs is a signal to the broader market that it is intent on stripping the subprime market crisis down and exposing the greed and avarice that overwhelmed Wall Street during the subprime housing bubble.

Financial Sector Regulation Takes Center Stage

As financial sector reform takes center stage in Washington, D.C., stories and investigative reports pour out from all mediums and news centers. Many of the stories expose Wall Street and commercial bank fraud, while others implicate lender fraud and borrower irresponsibility in the days, months and years leading up to the market collapse of 2008. Congress is beginning its expected posturing and inane line drawing despite significant national support for thoughtful regulation.

Below are some of the more interesting stories and reports as the debates heat up.

Wall Street banks continue to mask their risk levels by using the “repurchase” or “repo” market to intentionally drop risk level reporting directly prior to quarterly financial disclosures.

The Securities and Exchange Commission, after taking a beating for its failures precipitating the financial crisis and the Madoff Ponzi Scheme, is trying to resuscitate its image.

Consensus among independent financial experts builds for breaking up “too big to fail” banks.

Michael Lewis, author of “The Big Short,” expressing a sarcastic and skeptical view toward those that warned of dangerous market conditions and excessive risk prior to the market crash.

Yves Smith challenging Michael Lewis’s “The Big Short” thesis describing the underlying reasons for the market crash.

How one hedge fund managed to maintain the housing bubble and continue to housing market madness.

Will tougher leverage requirements for commercial and investment banks lead to them seeking to transfer off balance sheet?

Secretary Timothy Geithner has written an op-ed in the Washington Post supporting the current financial sector regulation reform.

INET

Last weekend I attended the inaugural conference of the Institute for New Economic Thinking (INET), in Cambridge, at Keynes Hall. That would be John Maynard Keynes Hall.

Ok, let me first be honest--the entire event blew me away and I still do not fully know how I came to be invited. Having said that, it was by far the best conference I have ever attended. Many of the conference speakers can be viewed here: http://ineteconomics.org/


In particular, I recommend that everyone take a few minutes to listen to Baron Adair Turner who is the head of the FSA in the UK. Brilliant!

All in all, I must say the conference was a non-stop parade of brilliance. I was overwhelmed.

The INET is sponsored by a number of individuals and organizations, but the founder is George Soros. In my view, George Soros deserves huge credit for seeking to understand and prevent a repeat of the current crisis. The executive director of INET is Robert A. Johnson. He is a master of conference planning. He also has written some outstanding scholarship regarding the political foundations of the financial crisis. INET will be a powerful voice in coming years regarding financial and economic reform. I encourage everyone to support its efforts.

U.S. Supreme Court Justice John Paul Stevens Announces Retirement: Will The Court's Liberal Wing Be Silenced?

Yesterday, Supreme Court Justice John Paul Stevens announced that he would retire from the Surpeme Court at the end of the Court's current term this summer. Stevens, who will soon turn 90, was appointed by Republican President Gerald Ford. Stevens will step down as the second-oldest justice to ever serve on the Supreme Court, slightly behind Justice Oliver Wendell Holmes, who retired in 1932 at age 90 years, and 10 months. Depending on the date of his actual retirement Justice Stevens quite possibly could end up being the second longest serving justice behind Justice William O. Douglas.

During his tenure on the Supreme Court, Stevens "evolved from a maverick who would often write solitary opinions to a coalition builder and leader of the court's liberal wing." Richard Fallon, a Harvard Law School constitutional law professor made the following observation about Stevens: "There really were two Justice Stevenses...[t]he first Justice Stevens was a somewhat iconoclastic moderate. The second Justice Stevens was the great liberal voice on the Supreme Court for the past two decades." Justice Stevens stance shifted from a moderate stance to a more liberal stance in the early 1990's upon the retirement of liberal Justices William Brennan and Thurgood Marshall. Professor Fallon noted: "It was as if there was a void on the court...[t]here was no longer a great liberal voice, and Justice Stevens moved to fill that void."

Let's examine some of Justice Stevenses notable majority opinions and dissents:

• In 1978 Justice Stevens authored the court's opinion allowing the Federal Communications Commission to punish broadcasters for airing offensive language. Comedian George Carlin's monologue about the seven "filthy words" was at the center of this decision.

• In the 1989 flag burning case, where the court ruled that flag burning was protected free-speech, Justice Stevens dissented arguing that desecration of the flag was not protected speech.

• Justice Stevens wrote the 1997 opinion that allowed Paula Jones to continue her sexual harassment suit against President Bill Clinton.

• In 2000, Justice Stevens dissented in the Supreme Court's decision to halt the ballot recount in Florida, which arguably led to President George W. Bush's election over opponent Al Gore.

• In 2002, Justice Stevens authored the opinion in a 6-3 decision that prohibited the execution of mentally retarded killers.

• In 2005, Justice Stevens joined in a 5-4 decision banning the execution of murderers who were under the age of 18 at the time of commission of their crime.

• In 2004 and 2006, Justice Stevens wrote two (2) opinions bolstering the rights of Guantanamo Bay detainees. The latter ruling barred military tribunals.

Older age did not slow Justice Stevens down. Most recently, in Citizens United v. Federal Election Commission, the recent decision paving the way for corporate spending in elections, Justice Stevens issued a passionate 90-page dissent. This momumental decision was discussed recently on this blog by my colleague Steve Ramirez. Citizens United struck down decades-old precedent banning corporate money from political campaigns. In his dissent, Justice Stevens wrote: "While American democracy is imperfect, few outside the majority of this court would have thought its flaws included a dearth of corporate money in politics..." Additionally, Justice Stevens noted: "The difference between selling a vote and selling access is a matter of degree, not kind...And selling access is not qualitatively different from giving special preference to those who spent money on one's behalf." Only time will tell whether Justice Stevenses admonition that treating corporate speech the same as that of human beings holds validity.

With the announcement of Justice Stevenses retirement, the ball is now squarely in President Obama's court, no basketball pun intended. Justice Stevenses retirement reminds us that presidential elections are extremely important. By selecting Supreme Court Justices, the President can have an impact on society far beyond their years in office. Indeed, the judicial selection process can have generational impact.

If I could use this blog as my open letter and suggestion to the Obama Administration I would offer up but two (2) meager suggestions. I truly hope that President Obama takes this opportunity to appoint a moderate to liberal leaning associate justice. I think in recent years the Supreme Court majority has moved in a decidedly conservative direction. Often, judicial decisions reflect the overriding needs of society when there is a level of ideological balance and perspective. Hopefully, with balance between conservative, moderate, and liberal viewpoints judges must compromise. Ideally, there is no tyranny of the majority or tyranny of the minority. In order to get things accomplished, judicially and policitally, judges should decide to roll-up their sleeves and work together to reach the best judicial outcomes for society.

As a final matter, I hope that President Obama seeks a measure of diversity in his selection. Let me be clear, when I say diversity, I mean diversity in a broad sense. What one thing do all current Supreme Court Justices hold in common? If you look at the composition of the current Supreme Court, all the current judges are former federal appellate court judges. In the past, Supreme Court justices entered the bench from a diverse number of career paths. Former presidents, senators, politicians, administration officials, distinguished lawyers, law professors, business people, and others populated the bench. Perhaps the time has arrived to broaden the Supreme Court's perspective. As I've grown older, I've keenly come to realize that life is all about the choices that one makes. President Obama I urge you to choose wisely.

I leave you with several questions. Do you think the Supreme Court's liberal wing will be silenced by Justice Stevenses departure? What qualities do you want to see in the next Supreme Court Justice? If you were President Obama, who would you pick? Undoubtedly, it will be very interesting to follow the buzz in the coming weeks and months concerning President Obama's selection.

Momentum Builds For Reform

Momentum has clearly swung toward new financial sector regulation. Some are predicting that new reform will be in place as soon as May. Recent news out of Congress suggests that Republicans in Congress may be more amenable to a deal on financial reform than they seemed only a few weeks ago. Some voices on the right are suggesting that the Republicans should now begin attacking the bill as being too friendly to Wall Street. Other reports indicate that Senator Richard Shelby has proposed exchanging a stronger Consumer Financial Protection Agency for less stringent derivative regulation currently proposed. Unlike health care, debated for decades, Congresspersons are notoriously underinformed about matters of Wall Street and the financial markets. As Congress and staff become more educated about the reckless excesses engaged in by Wall Street leadership in the run-up to the financial market crisis, it is likely that the desire for thoughtful and meaningful reform will increase. President Obama remains heavily involved in shepherding the legislation through Congress.

As is expected, new and careful regulation is being resisted mightily by powerful lobbyists on Wall Street who are incredibly motivated to derail reform. J.P. Morgan Chase alone spent $6.2 million lobbying Congress against new financial reform last year. Despite taking $25 bilion in TARP bailout funds, J.P. Morgan Chase is spending millions to defeat any new regulation of its industry.

Too big to fail should be primary on Congress’s concern list. While difficult to conceptualize much upside to propping up too big to fail financial institutions, the downside of an implicit guarantee to rescue too big to fail institutions is clear and dangerous. Secretary Geithner claims that the current Senate bill solves the problem of too big to fail. Others are less certain. What is certain is that Congress must steel its spine to Wall Street lobbyists and thoughtfully consider, learn about and pass practical solutions to the difficult issues that precipitated the collapse of 2008.

Christian Johnson's Paper on the FED

Christian Johnson just posted a new paper on the Fed: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1584731. I highly recommend this paper to all that have interest in the financial crisis. I do not agree with the paper on every point and/or implication. But, I must say it is the finest exposition of exactly what the Fed what was up to during the crisis I have seen.

I am beginning to think the Fed pursued a contractionary monetary policy based upon this paper, not an expansionary policy. And, they just might have pulled it off.

Views on Financial Regulatory Reform

As Congress, upon return from recess, takes up new financial regulation expect the discourse to heat up again, including intense lobbying from the banking industry and Wall Street. Below are several links worth reading in connection with the upcoming financial regulation debate.

What story does the financial reform bill tell about what went wrong in the financial crisis?

Are capital requirements sufficient to deal with the “too big to fail” problem?

10 questions for those that propose to reform financial services.

Senator Bob Corker (R-TN) agrees that the "shadow banking" system is in need of better regulation.

Is Washington coming to terms with a Consumer Financial Protection Agency becoming law?

Firms are using outside compensation advisers to "approve" executive compensation in order to appease shareholders.

Is regulatory uncertainty the cause of a slow recovery?

Obama Finally Ignores Far Right and Delivers Lethal Blows to GOP

In the past 2 weeks, President Obama has forsworn the far right GOP and scored huge political points while strengthening the economy. First, there was health care. As readers of this blog know the far right (i.e., the entire GOP) has been reduced to incoherent rants and gibberish regarding ridiculous polls they claimed were published in the prestigious New England Journal of Medicine. They just made that up!

Here are the last three table of contents for the NEJM:

http://content.nejm.org/current.dtl

http://content.nejm.org/content/vol362/issue12/

http://content.nejm.org/content/vol362/issue11/

No poll! Only on Fox News does such a poll warrant publication in the NEJM.

Then came historic student loan reform. Who knows what ridiculous points they will raise against eliminating bank subsidies and instead "diverting" money to real students. I can hardly wait to see anonymous comments on that!

But, Obama was not done. Besides strengthening the economy by securing human capital and reforming student loans to eliminate wasteful federal spending, Obama took a page from the GOP and allowed more oil drilling off the coast of the US.

Here's the reality: the GOP is mired in scandal. They are busting apart. The far right has hijacked the GOP and really is behaving in a way that will alienate the middle. Plus, their leaders are spending contributions at strip joints.

Bottom line: Obama is about to open a can of whup ass on the GOP. Look for the Dems to extend their majorities. You heard it here first.

OK, back to the book.