One Thousand Names for Fraud

One sometimes hears a repeated exaggeration of the Inuit (inappropriately referred to as Eskimos) language, claiming that they have hundreds of words to describe snow. While the actual number is considerably less, this exurban legend does make its point.

I suspect that centuries from now, historians will remark similarly about 21st century America, stating that they had one thousand names for fraud.

The Blackstone Group: Tax Fraud Incorporated

A year or so ago, it was reported that the private equity firm, the Blackstone Group, was going public. Like many, I gave little thought beyond the fact that they had sought investment from China due to their brittle financial position at that time.

Recently, I came across an excellently written research paper by a law professor at the University of Illinois College of Law, Victor Fleischer, titled Taxing Blackstone.

In this paper, Prof. Fleischer makes the following highly enlightening remarks:

The regulatory finesse of the deal was critical to the structure. Section 7704 of the tax code normally requires that publicly-traded partnerships be taxed as if they were corporations. Congress enacted this code section specifically to block entities that functionally resemble corporations from accessing the public equity markets without paying a corporate-level tax. Through some complex deal engineering, Blackstone wedged itself into the literal language of the “passive-type income” exception in section 7704(c), even though its income is active, not passive, as those words are normally used in the tax code and regulations.

What the professor is describing (my terminology, he is somewhat equivocating on the matter) is tax fraud, clear and simple and most flagrant. Blackstone went, officially speaking, from a private equity firm to a publicly-traded partnership, retaining all the tax advantages of the private equity firm (tax treatment of debt, tax relief of corporate debt, deductibility of debt interest, etc.) while enjoying the new benefits of a publicly-traded partnership (or in their case, really a publicly-traded corporation).

Sounds remarkably similar to that exemption granted Goldman Sachs (and Morgan Stanley also) when they became a bank holding company while retaining those investment house advantages. Remarkably similar!

The “passive-type income” dodge (“exception”) mentioned in the quote could readily be used by those few remaining American-based corporations still actually paying federal taxes. (For a review of this, please see my earlier post, Full Spectrum Inequality.)

This example of the lawlessness existing for the super-rich is yet another example of the major problem facing the American economy and American people today.

Should there be anyone still not familiar with the activities and impacts of private equity firms, I would recommend the brief paragraph below by Ignacio Ramonet from his article in Le Monde Diplomatique, titled Vulture Funds: A New Category in Capitalism.

Concretely, two specialists explain to us, this is how things go: "To acquire a company worth 100, the fund takes 30 out of its pocket (on average) and borrows 70 from banks, taking advantage of the very low interest rates of the moment. During three or four years, it reorganizes the company with the management in place, rationalizes production, develops activities and captures all or part of the profits to pay the interest... on its own debt. After which, it will resell the company for 200, often to another fund that will do the same thing. Once the borrowed 70 is repaid, the firm has 130 left in its pocket for an initial bet of 30, or a return of over 300 percent on a four-year investment. What could be better?"

Also, you may wish to read a previous review of Josh Koshman’s excellent book, The Buyout of America, covering the leveraged buyouts by private equity firms and their financial outcomes and socioeconomic impacts.

Now far be it for me to criticize the co-founder and former CEO of the Blackstone Group, Peter G. Peterson. I certainly don’t wish to discount or gloss over Mr. Peterson’s highly civic-minded activities stemming from the organizations he founded, the Concord Coalition and the Peterson Institute.

These organizations valiantly strive to abolish Social Security, Medicare along with working to privatize the public educational system in America. (Sidebar: To any and all foreign readers, extreme amounts of sarcasm are dripping from every pore of my body.)

Oops! I almost forgot! They also strive to offshore as many American jobs as possible.

The Scam

All of these economic machinations revolve around securitization, whether it is the Blackstone Group’s (and other PE firms) real estate transactions, collateralized fund obligations, collateralized loan obligations, etc., and their structured loans from the top banks.

But some people are actually beginning to catch on as demonstrated by Bill Northlich, over at his blog site at Vitus Capital blog:

Today a friend sent me a ref to an interesting synopsis of a new NBER report, "Questions and Answers about the Financial Crisis". The conclusion of the synopsis is "It means that until the REPO market regains some steam there isn’t going to be much natural progress in getting the world economy to start growing again (take out the government stimulus and we’re screwed)". I semi-agree, but here's the semi.

The main reason why banks aren't "lending" is that they, in the aggregate, haven't lent in 20 years. As the article says "Money market funds and junk bonds in the 1980s took all the profit out of being a traditional bank. So banks began securitizing loans to regain those lost profits." Ergo, everyone starting originating loans, but did not really lend. Said another way, they'd loan out their capital, sell the loan up the securitization chain, get their capital back and make some profit (although, less short term than they would make long term with the original loan, assuming it was a good loan. But - the profit is immediate). Goto 1.

There is no one in a bank, except in Minnewaukan, ND, who remembers how to actually loan money, even if some bank wanted to. So, they try to originate and sell. Since the private securitization market disappeared with the shadow bank/repo panic, the only place to sell loans is to the government. That's why FHA, Fannie, Freddie, have been in the news lately, mostly in articles by idiots yelling about how bad it is that these NGO's will have to ask Treasury for more money. The fact of the matter is that if the NGO"s/Gument stopped buying loans, the housing market would disappear overnight. That is the really scary thing. The only hope is to restart the securitization market, but it's pretty hard - there are no buyers (would you buy a new ford if there were zillions of semi-new fords for sale at half the price?). For this reason, there are no securitizers any more. There's no business there.

This guy really gets it although, and I mean no criticism by this, just espousing my beliefs from reading thousands of documents and books on this subject, Mr. Northlich still falls into the trap of many, suggesting that there are still benefits to be had from securitization, it was just the irresponsible usage and application of CDOs in the meltdown. (I strongly urge everyone to visit his site and read his full remarks.)

The same is often heard with regard to credit default swaps (and various other types of securitized financial instruments, be they credit derivatives, college student loans and fees, auto loans, infrastructure projects (public-private partnerships, etc.), toll roads and so on.

Sorry folks, but the rise in securitizations follows the rise in tax avoidance by corporations. Utilizing those funds not paid out in federal taxes, said funds could be redirected to the bond interest or dividend payouts to keep up the pretense that the securitization, or securitized financial instruments, or layers of securitizations, were actually paying out money.

As the number of securitizations and quantity of securitized financial instruments (CDOs, CFOs, CBOs, CLOs, CMOs, CPDOs, CDSes, etc.) increased, so too did the number of non-tax paying corporations based in America (and other countries as well).

The only way to de-industrialize America over the past forty or so years, and not immediately collapse the economy, but to dismantle it gradually while profiting a select few (those debt-financed billionaires) and squeezing the many, was to create a financialization bubble to co-exist in its place (FIRE: Finance, Insurance and Real Estate).

With the exponential, and global, expansion of securitizations, any and every asset or debt has been, or will be, securitized.

Adventures in Problem Resolution

Of course, there is any easy enough way to prove me wrong in this matter: simply send in the bank examiners, forensic accountants and certified fraud examiners to audit all those “too big to jail” banksters, private equity firms, hedge funds and oil companies. (And while they’re at it, they might wish to check out all those questionable – and speculative – exchanges.)

The Prediction

Over the past thirty-some years I have plodded through thousands of pages of legislation, from the Fair Credit Reporting Act of 1970 (granting exemption from defamation laws to the credit bureaus and thus allowing for personal identity destruction), the Private Securities Litigation Reform Act of 1995 (curtailing people’s ability to sue for recovery of damages from securities fraud or manipulation), the Gramm-Leach-Bliley Act of 1999 (which rolled back the Glass-Steagall Act and allowed for the creation of ultra-financial monopolies while reaffirming the McCarran-Ferguson Act preventing the federal regulation of insurance), and the Commodity Futures Modernization Act of 2000, which allowed ultra-leveraging by those ultra-monopolies (it removed anti-fraud and anti-manipulation authority from OTC derivatives markets and electronic exchange-traded futures and options).

The preponderance of data strongly suggests that some form of “healthcare non-reform” reform legislation will be passed, containing verbiage for taxpayer-funded exchanges at the national and/or state levels.

These exchanges are crucial to the continuing funding of present and future debt-financed billionaires, as around 2014 to 2016 a number of securitizations will have ended. (Whatever legislation is passed is slated to go in effect four to six years from now.)

The next round of securitizations will then be ready to be comingled with those private insurance choices on those exchanges: mortality derivatives, mortality-linked securities, q-Forwards, and so on, further adding more descriptions to those one thousand names for fraud.

From a SIFMA report extolling the re-securitization of the securitizations we have this wonderful graph below.

Please click to enlarge


Dodd, Randall. "Primer: Key Regulatory Events, and Key Regulatory Institutions, in the United States."Financial Policy Forum.

Fleischer, Victor. Illinois Law and Economics Research Papers Series Research Paper No. LE07-036. “Taxing Blackstone.” 2007. University of Illinois College of Law.

Kosman, Josh (2009). The Buyout of America. New York: Portfolio. ISBN 978-1-591-84285-9

Ludovic, Phalippou and Zollo, Maurizio. The Performance of Private Equity Funds. September 2005

Ramonet, Ignacio. “Vulture Funds: A New Category in Capitalism.” Abridged from Le Monde Diplomatique. Translated by Leslie Thatcher. August 2008.

Securities Industry and Financial Markets Association. “Restoring Confidence in the Securitization Markets.” December 3, 2008. [p. 35 – graph]


21 words for snow

snow job, snowed, snowed under, John Snow, avalanche, lobbyist white paper, "Comprehensive" anything, amendment, loophole, SEC, the Federal Reserve, Committee Chair, 60 votes, capital gains tax rate, Cayman Islands, Treasury, tax break, tax incentive, free flow of capital, snowed in.

That classification of 15% for hedge funds claiming it's just "capital gains", is an outrage. They are living like little feudal lords, running their own little sovereign countries because of this.

Glad to see you here James! I thought we lost you which would have been a crime!

I love your opening analogy, from a writing aspect, very nice.

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The Provenance Of Fools

And we know, of course, who it is that makes tax gaming such as this possible, don't we: The same whore politicians that kill kids with drones in Afghanistan, who arm those who carry out ethnic cleansing on the West Bank, and who countenance the torture and assassination of adversaries worldwide. These problems are moral and political long before they are ever economic. Nothing, absolutely nothing, will ever be achieved in the way of the remediation of these crimes until every last one of these bacteria is purged from "public service". That, in turn, will require an authentic "peoples moment" from which cleaner lines of governance will emerge, democracy will be restored, and the incarceration, interrogation and public trial of these filth will be made possible. Let there be no mistake about it, there will be no addressing these questions through existing parliamentary means. Reform and talk of recourse to the franchise are the provenance of fools.

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Andrei Vyshinsky

Please consider registering for an account. You can even use the contact email on the front page and I will set one up for you. The reason is you are commenting every day now and if you get an account, you bypass the CAPTCHA and have a comment tracker, where you can see who replied to you, see other users, it's way easier to have a conversation that way. Trust me, it's better. The register button is on the upper right hand column.

You're adding great insight and comments.

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