Article provided courtest of Seeking Alpha.com
For those who are intimidated by the complexity of the esoteric $59 trillion credit default swaps market (CDS), let me explain in raw layman’s terms the likely nature and significance of the Department of Justice’s antitrust inquiry into Markit, a company owned by more than a dozen Wall powerhouses including Goldman Sachs (GS) and JP Morgan (JPM): The DOJ wants to know whether Markit’s owners manipulated the company’s pricing data and index formulation to enrich themselves and screw their customers.
If the Obama Administration has the conviction and political temerity to investigate and prosecute the wrongdoing the DOJ suspects, it could forever change the “heads I win, tales you lose,” way the big Wall Street firms do business and could result in billions of dollars in fines and restitution, not to mention possible jail sentences.
Although no one has yet been accused of any wrongdoing, having cut my teeth at the Federal Trade Commission litigating antitrust cases (including the one that attacked “Big Oil’s” price-fixing scheme), I can say with considerable authority that the DOJ hasn’t opened this investigation merely on a hunch. The potential for wrongdoing is enormous because Markit determines the critical month-end pricing that major financial institutions use to “mark” their CDS securities; Markit also compiles critical indexes and the company’s Wall Street owners could benefit greatly if they have input on how these indexes are compiled and weighed.
Even those with unlimited charity in their hearts should find it difficult to give the big Wall Street firms the benefit of the doubt. There are countless examples of these firms putting their interests ahead of their customers. In 1996, NASDAQ market makers settled an antitrust case for more than $1 billion because they were artificially widening the spread on stock trades so they could pocket additional commissions. Wall Street’s manipulation of the IPO market during the dot.com boom provides yet another example. And let’s not forget Wall Street’s rigging of the auction rate securities market.
It’s one thing to launch an investigation, having the political will to see it through is another. Wall Street’s influence in Washington is immeasurable and there is some disturbing evidence that Congress and the Fed serve at the pleasure of Goldman Sachs and not the other way around. The financial consequences Markit’s owners could suffer is immense if wrongdoing can be found and proven.
Wall Street firms have long regarded regulators as mere gnats that can easily be swatted away. If the DOJ aggressively investigates and pursues this investigation and holds the big Wall Street firms criminally and financially accountable for any wrongdoing, President Obama will have indeed made good on his pledge to achieve “Change We Can Believe In.”
Jason: Call me skeptical, but $500 M in banking campaign contributions through an extension lobbyist network provides a lot of political cover. If President Obama wanted to restore market confidence, he would have called for an audit of the Federal Reserve, issued greenback and publically pushed for investigations put on a fast-track. Instead, I speculate the banks will all be nationalized after the 2010 mid-term elections. That in and of itself might be a good thing if the current political environment did not look so corrupt. Nationalization will be another way to hide the truth from the public and give the final bill (alongside all the other ones) to the taxpayers.
8 Comments
Franks n Beans
Why doesnt anyone on these blogs give Obama a chance?
In the Know
I had high hopes for President Obama but he has broken every campaign promise made. Confidence must be restored to the investment community outside of the insiders which happen to be the too-big-to-fail banks on taxpayer training wheels and still manipulating the market. The Administration is listening to the wrong people, no different then President Bush.
JasonRines
To Frank: The President's plummeting approval rating is a reflection of too many promises made that his plans would quickly turn the economy around. The actual plans themselves after election and published online are still vague on this issue. Legislation he is authorizing is anti-business in a depression when jobs are still being shed at 500k clip per month. Finally, those of us whom study history show the same mistakes of not holding the banksters accountable in the 1930's the same as today. Certainly the President could have used his political capital to have done far more then suggesting giving further powers to the Federal Reserve to hide looting from Wall St. investment banks. He is demonstrating the suggestions by some he is beyond far left and is a Communist. I think of it like this, that a nation becomes corrupt, it's leadership loots the Treasury and a police state is formed to quell the inevitable civil unrest. While inexperienced, Obama is smart and despite how difficult it would have been, done the right thing and rallied the American people.
quan trang
your leadership in washington was directly involved in highly illegal activities even by our standards here in the east. the american people will have to clean up its own backyard and dont expect any sympathy from the world in your hardships. you get the government you elect.
jlounsbury59
Let me give my simple minded view of how the CDS scheme went astray. It is a great oversimplification, but let's consider two firms: A and B. The firm A sees a chance to make some easy money by selling a credit guarantee to B. After all, B is a AAA super bank with great profitablilty. So A agrees to sell a guarantee of $100 billion of B's debt issuance for five years for a 5% premium. In A's mind, B can never suffer defaults more than 2 or 3% based on historical records, so this is $2 -$3 billion free money.
Now B sees that it no longer has any exposure for default on $100 billion so it goes right out and places another $100 billion in loans and debt based securities to maintain its max leverage position. By paying $5 billion to A for "insurance", B has enabled another $25 billion (or more) of income over the next five years. The market for placing high quality debt has been degraded by all the debt issued previously, so the new debt is issued to lower quality borrowers.
With the system now stretched, defaults start to increase. The defaults depress economic activity, which triggers more defaults. The historical limit assumed by A is exceeded and soon A has no more assets to back the CDS guarantees. That leaves B with double the leverage they assumed existed after buying the CDS protection. All this happens in a market that exceeds the historical pattern maxima for defaults. And the valuation of the still performing assets must be written down to reflect continuing growth of defaults. Once the dam is broken, A & B are swept under by balance sheets that show massively negative net worth. They are insolvent and the negative net worth is falling further in cascades as defaults continue to accumulate.
Now, the accounting community comes to the "rescue". They say that accounting rules can be changed so that future defaults can be assumed non-existent. Recognize the value that assets would have if debt performance continued at the levels of the past quarter. That improves the balance sheets because the financial institutions can always assume things will never get worse than what they have been. This doesn't improve anything unless the economy improves and defaults actual melt away. Otherwise, the day of reckoning is simply postponed.
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therooster
Jason, I couldn't agree more with the comment you wrote after the posted article. I'm sensing an awareness of the banking system's corrrupt ways, but I also sense that the blame may be falling on the fact that the banking system is private. The problem should not be thought of as being on a private vs nationalized axiom , but should be viewed from the centralized vs decentralized axiom, one that allows for true competition in the form of decentralization. That would mean entering assets back into banking, however. Can you imagine ?
The danger in the banking system is structural. It's not necessarily the ownership. Centralization focuses power to the point of absolute power.
Getreal
Like Eric Holder DOJ is actually going to investigate and why the DOJ? Self answering question. Why not the SEC conducting the investigation? Good point on the lobbyist money. Did any other industry provide 1/2 B in political contributions?