James Lieber in Village Voice is a MUST read

What Cooked the World's Economy? It wasn't your overdue mortgage.

By James Lieber

Lieber asks all the hard questions - you know, the ones the answers to which are really, really embarassing. For example, where exactly has the $7 or $8 trillion from the Fed gone to?

In mid-September, when it was on the ropes, AIG received an astonishing $85 billion emergency line of credit from the Fed. Soon, that was supplemented by another $67 billion. Much of that money, to use the government's euphemism, has already been "drawn down." Shamefully, neither Washington nor AIG will explain where the billions went. But the answer is increasingly clear: It went to counterparties who bought derivatives from Cassano's shop in London.

And what about the chances of prosecuting?

The other key appointment is Attorney General. A century ago, when powerful trusts distorted the market system, we had AGs who relentlessly tracked and busted them. Today's crisis is missing, so far, an advocate as dynamic and energetic as the mortgage bankers, brokers, bundlers, raters, and quants who, in a few short years, littered the world with rotten loans, diseased CDOs, and lethal derivatives. . .  according to William Black, an effective federal litigator and regulator during the 1980s savings-and-loan scandal, by 2004, the FBI perceived an epidemic of fraud. Now a professor of law and finance at the University of Missouri–Kansas City, Black has testified to Congress about the current crisis and paints it as "control fraud" at every level. Such fraud flows from the top tiers of corporations—typically CEOs and CFOs, who control perverse compensation systems that reward cheating and volume rather than quality, and circumvent standard due diligence such as underwriting and accounting. For instance, AIGFP's Cassano reportedly rebuffed AIG's internal auditor.

 The environment from the top of the chain—derivatives gang leaders—to the bottom of the chain—subprime, no-doc loan officers—became "criminogenic," Black says. The only real response? Aggressive prosecution of "elites" at all stages in this twisted mess. Black says sentences should not be the light, six-month slaps that white-collar criminals usually get, or the Madoff-style penthouse arrest. . . .

Black suggests that derivatives should be "unwound" and that the payouts cease: "Close out the positions—most of them have no social utility." And where there has been fraud, he adds, "clawback makes perfect sense." That would include taking back the ludicrously large bonuses and other forms of compensation given to CEOs at bailed-out companies.

No one knows how much could be clawed back from the soiled derivatives reap. Clearly, it's not $600 trillion. William Bergman, formerly a market analyst at the Chicago Fed in "netting"—what's left after financial institutions pay each other off for ongoing deals and debts—makes a "guess" that perhaps only 5 percent could be recouped, which he concedes is unfortunately low. Still, that's $30 trillion, a huge number, more than 10 times what the Fed can deploy and over twice the U.S. gross domestic product. Such a sum, if recovered through the criminal justice process, could ease the liquidity crisis and actually get the credit arteries flowing.

Now, here's the really, really good part. Umm, "good" is not the correct word; more like troubling. Very troubling.

Does Obama's choice for Attorney General, Eric Holder, have the tenacity and will to tackle the widest fraud in American history? Parts of his background don't necessarily augur well: He worked on a pardon for Marc Rich, the fugitive billionaire tax evader once on the FBI's Most Wanted List whom Clinton cleared. After leaving the Clinton era's Justice Department, Holder went to work for Covington & Burling, a D.C. firm that represents corporate heavies including Big Tobacco. He defended Chiquita Brands in a notorious case, in which it paid a $25 million fine for using terrorists in Columbia as security. Holder fits well within the gaggle of elite D.C. lawyers who move back and forth between government and defending corporate criminals. He doesn't exactly have the sort of résumé that startles robber barons.


There's much, much more there. Like the glaring conflicts of interest of former Treasury Secretary Hank Paulson. So please, go read it.

What Cooked the World's Economy? It wasn't your overdue mortgage.

By James Lieber


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good post

he must be reading EP. We've had derivatives posts here for some time and know it is the cause of the collapse. ;)

The problem with the damn things, like most things, they are so difficult to explain!

I hope Frontline makes a documentary on this.

Cooking the World Economy; Who?

This article is indeed full of useful information. I agree with SOME of the article writers conclusions and draw a few of my own.
Derivatives are not going to cook the world's economy in spite of the massive amounts of money involved. The main problem still is mortgages and other loans for which the house or other security, was overvalued due to a classic "bubble" situation; and are now resuming their true values in relationship to income and GDP. This is a serious problem, as actual monetary value, which had been artificially "created" as the assetts rose in value and people borrowed against that value, is now in the process of being destroyed. There are enough trillions involved, to "cook the world's economy".
Derivatives, though, never had any inherent value as an assett like a house or a security or a share. They are like an insurance policy or a bet. We could add up the value of all the world's insurance policies and it would be higher than the $600 trillion value estimated for derivatives. A hypothetical event involving that that all insurance policies had to be paid out on, would be a similar catastrophe to all derivatives having to be paid out on; ignoring, of course, the destruction of assetts that required the insurance policies to be paid out on.
An even better analogy, is the gambling industry. If they suddenly and miraculously had to pay out on long odds on all bets placed with them simultaneously, they would of course be broke, and the people who had placed the bets would not get to collect their winnings. This is exactly what should happen with derivatives. I agree completely with the article writer that it is immoral and illegal that taxpayers money be used to pay out on these gambles. I agree too that prosecutions are in order if there was collusion between the dealers and/or the financial institution management; and the "counterparty" to the derivative.
But the net effect on the world economy is close to neutral, as what happens is that a whole lot of money gets transferred from some players in the system to some other players in the system. Sure, some have lost and some have won; but unlike with assett value bubbles, there has not suddenly been a whole lot of monetary value just evaporate. The "winners" have to do something with the money they have won. That is another question that the article writer should be asking, besides who these "winners" are: what are these "winners" doing with the money? Then we will see what part of the world's economy is being stimulated at the expense of those who have been on the losing end of the gambles, which includes of course the investors in the financial institutions that have collapsed. Of course, they might be buying gold.......
These investors were in all likelihood enjoying the handsome returns that resulted from the derivatives trade; therefore there is an element of morality in the risk factor coming back to bite them now. I think the article writer is too willing to prejudge fraudulent intentions on the part of the derivative dealers. Every level of this morass involved people acting perfectly knowingly on the assumption that house prices can never fall; the writers of subprime mortgages, house buyers, speculators, the bundlers of "CDO"'s and other securities; the purchasers of those securities; and the sellers of the derivatives and credit default swaps that were an "insurance" against the failure of those securities.
The only people in this whole process who laid their money on the line in a calculated gamble that there was a bubble about to burst, are the people who BOUGHT the derivatives as fast as the industry created them. The article writer is absolutely correct in insisting that the identity of these people become known. But even so, prosecution may not be justified.
These people are "guilty" of being able to assess a fake economic boom over which almost everybody else had lost their heads; note that there was no lack of warnings concerning this situation from hundreds of experts of which Ron Paul is merely a well-known example. Such people can hardly be blamed for taking the attitude that, "oh well, if you won't listen to me, don't blame me for making a pile on the side out of my superior wisdom".
Others will have kept their thoughts to themselves and quietly profited. I am picking that George Soros and John Paulson will be among the big winners. If Ron Paul and Peter Schiff and Paul Kasriel and Nouriel Roubini and the hundreds of other people we refused to listen to have profited from our stupidity, so be it. Another possibility is that clever "sovereign" operators such as the Chinese or the Saudis or the Russians are involved, perhaps even as a form of war on the USA.
The fact that Henry Paulson went down on bended knees pleading for the money to pay some of these "counterparties" out, gets one thinking.