Thursday, April 8, 2010

Incompetence Amongst the Regulators

Everybody knows that Harry Markopolis tried many times to inform the SEC about the fraudulent Ponzi scheme that Bernard Madoff was running. But they ignored him.

Here's a bit from a NY Times op-ed piece by Michael J. Burry who ran the very successful hedge fund Scion Capital:
ALAN GREENSPAN, the former chairman of the Federal Reserve, proclaimed last month that no one could have predicted the housing bubble. “Everybody missed it,” he said, “academia, the Federal Reserve, all regulators.”

But that is not how I remember it. Back in 2005 and 2006, I argued as forcefully as I could, in letters to clients of my investment firm, Scion Capital, that the mortgage market would melt down in the second half of 2007, causing substantial damage to the economy. My prediction was based on my research into the residential mortgage market and mortgage-backed securities. After studying the regulatory filings related to those securities, I waited for the lenders to offer the most risky mortgages conceivable to the least qualified buyers. I knew that would mark the beginning of the end of the housing bubble; it would mean that prices had risen — with the expansion of easy mortgage lending — as high as they could go.


By mid-2005, I had so much confidence in my analysis that I staked my reputation on it. That is, I purchased credit default swaps — a type of insurance — on billions of dollars worth of both subprime mortgage-backed securities and the bonds of many of the financial companies that would be devastated when the real estate bubble burst. As the value of the bonds fell, the value of the credit default swaps would rise. Our swaps covered many of the firms that failed or nearly failed, including the insurer American International Group and the mortgage lenders Fannie Mae and Freddie Mac.

I entered these trades carefully. Suspecting that my Wall Street counterparties might not be able or willing to pay up when the time came, I used six counterparties to minimize my exposure to any one of them. I also specifically avoided using Lehman Brothers and Bear Stearns as counterparties, as I viewed both to be mortally exposed to the crisis I foresaw.

What’s more, I demanded daily collateral settlement — if positions moved in our favor, I wanted cash posted to our account the next day. This was something I knew that Goldman Sachs and other derivatives dealers did not demand of AAA-rated A.I.G.

I believed that the collapse of the subprime mortgage market would ultimately lead to huge failures among the largest financial institutions. But at the time almost no one else thought these trades would work out in my favor.

During 2007, under constant pressure from my investors, I liquidated most of our credit default swaps at a substantial profit. By early 2008, I feared the effects of government intervention and exited all our remaining credit default positions — by auctioning them to the many Wall Street banks that were themselves by then desperate to buy protection against default. This was well in advance of the government bailouts. Because I had been operating in the face of strong opposition from both my investors and the Wall Street community, it took everything I had to see these trades through to completion. Disheartened on many fronts, I shut down Scion Capital in 2008.
Both the SEC and the Federal Reserve failed their responsibilities as regulators. But I've heard of no heads that have rolled. The cumulative cost of this failure to regulate is estimated at six trillion dollars. That is an astronomical sum. But no heads have rolled.

I'm so glad that petty crooks who rob the corner store get 5 to 20 years in jail for their heinous crime of robbing a couple of hundred bucks, or roughly 1 year for every 20 bucks. A guy like Bernie Madoff got 150 years for robbing $65 billion, or one year for every $433 million. Alan Greenspan destroys $6 trillion and nothing happens.

You get the picture. The bigger the crime, the less the time. Why is that? I'm guessing that the guys who run the system sympathize with the "professional" types who do the big crimes. They just can't face being "too tough" on them. But some petty hoodlum. Well, that guy is scum and rotting the rest of his life in a jail is too good for him!

I really hate the hypocrisy of the "justice system" that offers neither justice or provides anything like systematic justice.

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