The Final Compromise

This past week saw Majority Leader Sen. Harry Reid attempt to ram the Financial Reform Bill through the Senate with no further amendments or discussion by calling for the vote. The tally came to "57 to 42 in favor, three votes shy of the 60 needed to overcome a filibuster," as reported by the Washington Post's Brady Dennis and Shailagh Murray. Two republicans voted with the majority Democrats while two Democrats voted against. When Reid saw how things were going he voted "no" himself which, according to Senate voting rules, provides him with the
opportunity to call for the vote again on Thursday afternoon. The current forecast is that financial reform will finally be passed in the senate after three weeks of debate and relatively non-partisan negotiations compared to what happened with the Healthcare Reform Bill.

This is good, but according to an article by Alain Sherter entitled “End Game: Senate 'Compromise' is Gutting Financial Reform” there are many parts of the bill that have been altered considerably. He says that, “this has really been a massacre of what was originally a fairly decent bill.” According to Sherter, we would have been better off if the bill had been passed sooner, without so much adversity and alteration. Sherter's opinion is somewhat at odds to that of other analysts who, as we reported May 18th, see the Obama administration's original
bill as still basically intact. However, as we warned in our last post and as Sherter has found, the compromises are continuing in the Senate thereby threatening to erode the legislation further.

One part of the bill that Alain mentions that has been negatively altered is the Consumer Financial Protection Agency (CFPA). Apart from the fact that we mentioned a few days ago that the CFPA would be under the Fed - a bit like putting the fox to guard the hen house - it is also a problem that the rules of the CFPA as defined in the current bill could be vetoed by other financial regulators which erodes the power of the CFPA to oversee the banking system. Another key part of the bill that he mentions has to do with states gaining more authority to be
able to regulate national banks. The problem is that it also makes it easier for the banking regulators to stop states from being able to investigate consumer protection cases, which is dangerous.

An amendment to the bill proposed by McCain-Cantwell proposes to bring back the Depression-era legislation called the “Glass-Steagall Act” which Congress repealed in 1999 and which some people believe has led to the excesses that caused to financial system crash. This act separated commercial and investment banking, but it was repealed, and is being rejected again now, because it would “harm big U.S banks’ competitiveness.” It sounds like a good idea but, sadly, the banking lobby is very active against bring this legislation back to life and so far, it’s not supported in the Senate despite the bi-partisan support by McCain-Cantwell.

There is some kind of financial reform being passed, which is a good thing but, overall, Sherter says that the main goal it to correct some of the problems from the past, not to simply create new laws. It seems that the financial reform has not had the success that everyone originally might have hoped for. All the fighting over the bill didn’t seem to bring the bill to a good conclusion, it seems that in order to compromise a lot of important parts were changed or removed. It’s sad that the parties were not able to work together in unity to create strong
new legislation, it seems that in the end we got a watered down version of what the reform should have been. And this is where we leave the story, some reform has been passed, but it is not satisfactory to all. There are also some elements yet to be decided.

On Thursday May 20, 2010 the Wall Street Journal reported that the U.S. Senate "approved the most extensive overhaul of financial-sector regulation since the 1930s, hoping to avoid a repeat of the financial crisis that hit the U.S. economy starting in 2007." Since the House of Representatives passed a bill in December that is focused on the same purpose, the two bills will now go to Conference Committee where anything can happen to the legislation. Nevertheless, Barney Franks was heard on CNBC last night predicting that the reconciled bill will be signed by the President "before the 4th of July." Also speaking on CNBC, Nouriel Roubini assess the bill as “cosmetic” and predicted that it won’t prevent another crisis.

For more information see:
Wall Street Journal
CNBC Frank
CNBC Roubini
Alain Sherter
Washington Post

What SHOULD We Reform?

In the past few weeks we have been following the Financial Reform Legislation in Congress. We began with a look at "what happened?" that has caused Congress to rethink Financial Regulation by looking at the investment industry's poster child Bernie Madoff. That was when we realized that something is seriously amiss in the US Financial System. Since then we have focused on the legislative process, trying to understand what Congress is up to, and this week we will continue to do that, but first let's take a quick look at what economists say we SHOULD be reforming. We don't want to reform the wrong thing do we?

Let's begin with an amusing perspective by Mandelman (Martin Andelman*) who is just amazed to learn that "we went from the worst financial catastrophe...since the Great Depression, to Happy-Days-Are-Here-Again-Bonuses-and-Profitability on Wall Street in under 18 months." And all this was accomplished without "financial reforms...second economic stimulus bill…tax cuts… the banks....lending again" The wondrous thing about this recovery is that "foreclosures don’t seem to matter...we even figured out how to have a “jobless” recovery." He has heard that the Europeans are in trouble but reassures them "not too worry...we’ll be...sending our guys over there to show you all how to fix things up in a jiffy…faster than you can say “Geithner, Bernanke and Bair… Oh my!”." And so onwards down the yellow brick road we skip.

However amidst all this recovery merriment, a prominent economist like Joseph Stiglitz describes himself as "depressed" about financial reform and "warns of leaving too much discretion to regulators." During the Kings College Cambridge Institute for New Economic Thinking conference Stiglitz explained that "just as the mainstream was accepting the concept of market efficiency that same theory was being questioned by new economic thinking. We have created a set of models that provides a better description of how the economy performs than the mainstream models." Regarding financial reform in the US he said, “To big to fail - or too intertwined to fail – is a problem. Those banks don’t lose whichever way things go – if they win they profit if they fail, the taxpayer pays for their mistakes…we know how to fix this problem…there are no social costs, and there are great benefits.”

So if Congress is not listening to Stiglizt who are they listening to? What about the Squam Lake Working Group on Financial Regulation? - "a nonpartisan, unaffiliated group of fifteen academics who have come together to offer guidance on the reform of financial regulation." What do they advise? Their April 2010 post advises that "Runs by prime-brokerage clients and counter-parties were a central cause of the global financial crisis. These runs precipitated the failures of Bear Stearns and Lehman Brothers by substantially reducing the broker's liquidity. This Working Paper...argues for higher regulatory liquidity requirements for dealer banks that use assets of clients and counter-parties as a source of liquidity." Looking through their website it seems they have been providing profound advice to the US government since the crisis hit the headlines. Is the government listening?

There are some signs that the government is listening. For example, at the Federal Reserve of Cleveland, Ohio, Executive Vice President and Chief Policy Officer, Mark S. Sniderman is listening to Squam Lake Member Anil Kashyap who is famous for insightful reporting on the 2008 crisis even as it unfolded. When asked by Sniderman "What are the top three to five places to focus for financial reform that you and your colleagues are recommending?" Kashyap responds, "I would say the single biggest thing would be a resolution authority" and he refers to the current situation with Greek Debt as a problem that would be solved by the resolution authority. (Ref: Resolution Trust Corp.) As the interview with Kashyap develops he focuses on transparency and information sharing by the Fed so that economists, especially regulators, can have sufficient information to make good decisions. Then he admits that even good information is not enough, "One thing we learned about this process is that having many officials talk about something for a really long time doesn’t matter. Fannie and Freddie were slow-moving train wrecks. Every single official in the Treasury and the Fed had been talking about the problem for years, but they didn’t have a way to do anything about it. And the result was that it was allowed to fester. So disclosing information to the market can help, but there’s got to be some scope for following up if the actions you want to be taken aren’t taken and if the untoward or reckless behavior continues, so that there are consequences. Information is good, but you’ve got to be able to follow through."

And that brings us to the deeper issue of Fannie and Freddie. The economics world is abuzz over a paper by George Mason economics professor, Russell Roberts, who is proposing that the financial reform must go deeper than Wall Street; "In the United States we like to believe we are a capitalist society based on individual responsibility. But we are what we do. Not what we say we are. Not what we wish to be. But what we do. And what we do in the United States is make it easy to gamble with other people’s money—particularly borrowed money—by making sure that almost everybody who makes bad loans gets his money back anyway. The financial crisis of 2008 was a natural result of these perverse incentives. We must return to the natural incentives of profit and loss if we want to prevent future crises."

In his conclusion Roberts hits the nail on the head and drives it home, "An unpleasant but unavoidable conclusion of this paper is that Wall Street was (and remains) a giant government-sanctioned Ponzi scheme. Homebuyers borrowed money from lenders who got their money from Fannie Mae, Freddie Mac, and banks that borrowed money from investors who expected to be reimbursed by the politicians who took that money from taxpayers. Almost everyone made money from this deal except the group left holding the bag—the taxpayers." (Now you know why we started our blog by taking the time to describe Bernie Madoff's elaborate deception - he is not an exception he is the canary in the mine!). Roberts calls our system, not capitalism but "crony capitalism" and he sees the politicians and Wall St ensuring their own self-interest at the expense of the taxpayer regardless of the regulations and capital requirements. Quoting F. A. Hayek he reminds us, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” and therefore suggests that instead of trying to reform a system that we don't even understand he recommends "letting the natural restraints of capitalism reemerge". Roberts provides a list of "some changes that would move us away from crony capitalism and toward the real thing." I can only hope that Congress is listening but my hope is faint.

Now, what were we talking about? Oh yes, the Restoring American Financial Stability Act of 2010 (S.3217). And what are they focused on in that Bill? The Senate bill largely reflects the administration's initial blueprint, despite the fervent efforts of lobbyists and lawmakers of all stripes to alter it. Senator Dodd believes that "we are on the cusp of doing something pretty significant." Republicans agree that the bill looks likely to pass and that some Republican senators will vote to approve. Sen. Bob Corker (R-Tenn.) doesn't support the current Senate bill and negotiated with Dodd to improve the bill, because "it unnecessarily expands government power and does not address the core causes of the crisis." The bill creates an independent consumer protection agency whose mandate will be to protect borrowers from predatory creditors,. The bill also establishes oversight of the derivatives market and provides for the government to wind down large, failing firms, known as "Too Big To Fail". On the House side of Congress, compromises were made in the bill, "such as exempting auto dealers and real-estate brokers from direct oversight by the new consumer agency." There was a time in Dodd's Senate Bill process when Dodd proposed dismantling the bank supervisory responsibilities of the Federal Reserve, for instance. But months later, the current draft not only preserves nearly all of the Fed's regulatory powers, it also places the new consumer bureau under the Fed's umbrella and enhances the central bank's powers to oversee risks to the financial system. The Financial Oligarchy has not only survived the crisis that they helped to create and never foresaw but they are actually empowered!

Nevertheless, there is some good news; The Volker Rule has so far survived "curbing the activities of big Wall Street banks, including a ban on owning hedge funds." But it's not over yet. Lobbying continues with the aim to weaken the Volcker Rule. Another lobbying target is the controversial provision that could force banks to spin off their derivatives operations. Another part of the houses bill still under debate is the auto dealer exemptions and there is also a drive to re-institute the Depression-era Glass-Steagall Act, which separated commercial banking from investment banking - since there is a perception that the financial system went wild since that act was repealed. There is a possibility that both houses of Congress will move quickly this week to pass the bill in the Senate and that the house will vote to pass the Senate bill. However many things can happen to derail that plan. If the bill goes to conference, significant changes could emerge. Whether it sails through this week or goes through a longer conference committee process, there is a general air of expectation that the Financial Reform act of 2010 will soon be passed by Congress and signed by President Obama.

We hope that Congress is defining financial reforms that will help avoid such financial catastrophes in the future; however, we must be aware that whatever Congress does right now will not affect our economy for years to come.

Sources
Mandelman *Martin Andelman is cited for his humor not for his knowledge
Stiglizt
Anil Kashyap
Russel Roberts
WashingtonPost

Amendments Galore

This week is another tough week for the Financial Reform Bill. PBS NewsHour reports that over the past two days, more than 200 amendments have been filed for the bill. Some of the major amendments that have passed, as reported by PBS, are: Regional Feds Retain Oversight, Small Business Exempt from Consumer Regulation, Auditing the Fed, and Banning ‘Liar-Loans’ and Mortgage Kickbacks.

Here is a quick explanation of each amendment:

Regional Feds Retain Oversight – This allows smaller regional banks to determine what agency will be regulating them; the FDIC or The Fed.

Small Business Exempt from Consumer Regulation – This allows small business to be exempt from oversight if they meet the “three-prong-test.” The three prongs consist of; (1) Selling non-financial products (anything not linked to finances), (2) not securing consumer debt and (3) must be a NAICS approved small business.

Auditing the Fed – The senate is now allowed to perform a one-time audit on the Financial Reserve.

Banning ‘Liar-Loans’ and Mortgage Kickbacks – Now lenders are forced to make sure the person or company asking for the loan has the income and ability to pay back the loan.

“The Economist” reported that the bill appears to be getting more and more radical as amendments are added. Rules are getting more stringent for banks, credit card, and lending companies; it is getting to the point where some of these companies may not be able to afford staying in business. Regulations, such as one that would require separate swaps-units in a single company, are supposedly not supported by the administration as well as regulation agencies.

Democrats are hoping to have the bill completely passed by next week, but they have met some heavy opposition. Republicans are not, in any way, satisfied with the way the bill was written and are not comfortable passing it until they have made changes to make the bill more acceptable. However, every time the Republicans come up with a viable change, Democrats band together and shut it down. The Talking Points Memo believes that this may be headed in the same direction as the Financial Reform Bill from April, and that is a filibuster. This time Republicans have more to filibuster with by saying that there needs to be more debate.

Party leaders have agreed on one thing, this bill will eventually pass. There are two ways it could go, the first is if Republicans can’t hang on long enough and a more liberal bill is passed and the other is if Republicans hold strong, forcing the Democrats to allow them some changes. There is no telling how it will turn out, and when the bill will actually pass. Many people are speculating that it will have to wait until after next week’s primary elections, and perhaps the primaries will have an effect on how the bill turns out.

The Financial Reform Fight

The struggle over financial reform continues as democrats and republicans continue to fight for what they want. No one seems to be willing to compromise. Many democrats are in full support of the bank reform bill, and many liberals feel that this new legislation is the chance to stop corruption in “big banking”.

The Senate began trying to move forward on the legislation on Wednesday. They added an amendment to allow the government to “dismantle risky financial firms without bailing them out”. This was a strong attack on big banks. Republicans have a very different plan, they want to put limitations on the power that an agency for protecting consumers could have. They want the rules of the agency to be subject to approval by a banking regulator. The White House objected saying, "nothing more than a lobbyist-influenced defense of the status quo and an attempt to water down the consumer protections "nothing more than a lobbyist-influenced defense of the status quo and an attempt to water down the consumer protections". Some experts feel even more extremely, that it is a detriment to consumers as opposed to a help to consumers.

The main goal of the Democrats seems to be to break up the big banks. Many liberals feel that it is critical to do so. Some feel that big banks are greedy, and they are looking to take away the power that big banks have. They see this legislation as a big and rare opportunity to stop the greediness of the big banks. One way they propose to do this is by limiting their deposits and other liabilities.

Over all, it looks like the parties are having a hard time coming to an agreement on the course of action in the future concerning this legislation. Liberal democrats and conservative Republicans seem to have such extremely different points of view on what is to be done. As of now it seems unclear how they will be able to come to a compromise. As we see it, there will be a lot of sacrifice required on both ends for them to be able to meet in the middle. We will just have to wait and see how it goes.

For more information see- In These Times

Now Its Wall Street Reform

The Senate hearing with Goldman Sachs contributes substantially to the atmosphere in which the “financial overhaul” bill is progressing in Congress starting with the fact that “Wall Street Reform” is now the name by which Democrats would prefer it to be known, having found that this name resonates beneficially for them with the American public. Sitting through the Senate hearing with Goldman Sachs some patterns began to stand out. The patronizing air of the Goldman management, repeating again and again that they only deal with “sophisticated investors”, and “these are very complex transactions”, implied that “you Senators just wouldn’t understand”. We hope and believe that the Senators do indeed understand the American laws that Goldman Sachs has broken and are getting some good ideas about what laws are needed to strengthen the American financial system so as to avoid such the games that Wall Street is playing with our money.

We weren’t the only ones who found Goldman’s patronizing manner with the Senate unconvincing. Heidi Moore writes, “They seemed to be saying, ‘It's a high-stakes game for experienced players; they all know the real rules; the public shouldn't care. Don't fret over the higher workings of the princes of finance, because it's not as though Mom and Pop lost money in their deals’.” Moore’s explains very clearly what Goldman are accused of: “Giving favored financial treatment to Paulson's firm, allowing him to advise on the creation of a security, Abacus, that he wanted to fail; Goldman later sold it to investors who wanted the security to succeed, but it didn't tell them Paulson had played a role in creating the thing and shorted it to bet it would fail. To sell the deal, Goldman apparently withheld information about Paulson's involvement from the buyers, including Royal Bank of Scotland and Germany's IKB Deutsche Industriebank. The buyers lost about $1 billion on the deal, according to the Securities and Exchange Commission”.

As Moore points out, “Economists call this ‘informational asymmetry’”… everyone else calls it "not telling the whole story". We call it deception because, as we all know, America's securities laws require disclosing all risks to potential buyers. The money invested on Wall Street by “institutional investors” such a pension fund managers are investing the hard earned money belonging to millions of individuals so this prevarication about “sophisticated investors” is a red herring (distraction). The ethical and legal standards for Wall St. should be at least as high as those for Main St. and perhaps higher as the average deal on Wall St. affects more people than the average deal on Main St.

Another Washington Post commentator, Ezra Klein, provides a great insight, “they're so intent on proving that what they did was legal that they can't see that what they did was wrong…they played by the market's rules: Make as much money as you can without going to jail.” The great insight that Klein has is that the American public are interested in “fairness”, while, as we now know “fairness is not…how Wall Street makes decisions. Banks mislead customers, make money from betting against housing bubbles they helped fuel, get bailed out with taxpayer dollars and then pay out massive bonuses to their executives while the rest of the country is mired in a recession that they caused.” Thanks to Mr. Klein for saying it so well. He goes on to explain that this scenario was particularly “unfair to Main Street rather than Wall Street. Americans think they were punished for Wall Street's sins…they want reform that will bring this industry more in line with fundamental values.” You have got us pegged Mr. Klein.

Klein helps us to understand that “the real divide over Wall Street Reform is not so much a partisan political party divide as “between those who think that the financial sector's business model needs to change and those who think that we can get by giving regulators more information and power so they can better police Wall Street.” In this regard, the banking committee started from the later position and is moving towards the “change” position. Sen. Blanche Lincoln a Democrat from Arkansas, proposed wording for the bill that “actually bars banks that get cheap government funds from trading in derivative swaps.” The other part of the legislation that would bring substantial “change” is the Consumer Financial Protection Agency, an independent watchdog meant to ensure that financial firms don't rip off consumers, which we reported on a few days ago in our post The Fight Over Bank Reform Outreach and which at that time was a point over which the Republicans were balking. Now Republicans have included it in their bill as well. We are in the "business model needs to change' camp and happy to see Congress coming closer to consensus on this point.

The financial community doesn’t seem to realize yet, as Klein explains so well, that “In 2008, Americans were forced to buy a pretty large ownership stake in the financial system because it had gotten so out of control, and now, as partial owners and continual back stoppers, they want to remake the business into something they are comfortable insuring.” We believe that the creation of the Consumer Financial Protection Agency is the most important and potentially most powerful component of the Wall Street Reform (Financial Overhaul) bill currently being developed in Congress because the Congress is not able to spend the time necessary to work out all of the small details of what needs to be done. This will be a very intensive technical process and will be an on-going process that will require the competency and work of dedicated experts. The sooner the Consumer Financial Protection Agency is established the sooner it can get to work on its mandate.

For more information please see:
Big Money: Debunking the myth of the 'sophisticated investor Heidi Moore Sunday, May 2, 2010 With financial reform for Wall Street, fair is fair Ezra Klein May 2, 2010

A Bipartisan Future?

"It is my hope that the majority's avowed interest in improving this legislation on the Senate floor is genuine and the partisan gamesmanship is over", Senate Minority Leader Mitch McConnell said in a statement a few days ago, and I am sure many Americans would agree with him. This comment comes after Senator Dodd and Senator Shelby, along with several other senators, were unable to come to a bipartisan compromise in the Senate Banking Committee (See The Fight Over Bank Reform Outreach for more information on this). 

 

Republicans have decided to cease filibustering, and instead, change the bill on the floor of the senate through amendments. While Democrats have the ability to just pass the bill through with little opposition, it appears as though that will not be the case. Multiple senators, such as Ben Nelson (D – Nebraska), are threatening to vote against the bill if their concerns are not met. Even though Democrats are saying that they will consider amendments made by the Republicans, Republicans are dubious. They feel that instead of being heard, the amendments will just be overruled. 

 

Tom Hamburger, with the Los Angeles Times, touched on another issue that this Overhaul Bill is going to cause: a war. Not the type of war with guns and bullets flying everywhere, but rather a war of persuasion. Lobbyists are lacing up their boots for their climb up Capitol Hill. Economists are saying this may be one of the costliest lobby-wars ever seen. One of the major players in the lobbying game is everyone’s favorite company; Goldman Sachs put forth $1.15 million towards lobbying in the first three months of this year, and there is little doubt that they will lobby to defeat this financial overhaul bill. The Obama White House and Treasury Department insist that this bill should not be filled with loop holes and exemptions for specific companies. We will soon see. Senator Dodd stated that the next two weeks will primarily be focused on the debating and voting on the Financial Overhaul Bill. He also said that he would like it passed by the 14^th of this month. However, as we have seen in the past, the legislative process is not always effective in meeting such deadlines. 

 

As we said earlier, we will see what will happen.

 

Special thanks to our resources for this post:

The Wall Street Journal

The Los Angeles Times

The Washington Post

Rotor News

The Fight Over Bank Reform Outreach

One of the more recent financial reform bills in congress was for bank reform. The legislation that progressive democrats are pushing for is to create an independent agency that would protect banking borrowers from lenders that could be potentially abusive. Republicans and some democrats want to either create the protection as part of the banking system or not create it at all. On Monday, the Republican Party representatives on the Senate Banking Committee chose to vote against sending the legislation to the Senate floor.

Senator Bob Corker feels that by doing this they made a mistake. He believes that they should have negotiated on what the legislation would contain, rather than outright opposing it. He sees this piece of legislation as very important, and thinks that negotiation would have been a much better approach than denying it outright. Because the Democrats have the majority, the legislation was sent to the Senate floor despite the opposition of the Republican Party. As he sees it, the Republicans did nothing to profit by denying the legislation.

Because of their choice to vote against the legislation, the Republican Party was not able to participate in making amendments. There was no final agreement of the two parties. Instead, the legislation was brought to the senate purely through the fact that the Democrats have the majority.

On the Senate Banking Committee 13 Democrats voted for the legislation and 10 Republicans against. They tried negotiating but, in the end, the Republican members of the committee decided not to suggest amendments. The chairman of the Senate Banking Committee, Christopher Dodd said that the Republicans made the choice to say no, so he obviously made the choice to go ahead without their input.

Dodd tried to negotiate with the top Republican of the committee, Richard Shelby, without success. So then Dodd tried negotiating with Corker but that was unsuccessful as well. Corker and Shelby both didn’t want an independent agency to be created to protect borrowers at banks for lenders that are abusive.

Corker feels that the way that things went with the attempts at negotiations for the legislation were not good at all, and now he’s just trying to figure out how to fix it. There still needs to be some Party negotiations, but he feels that the way that the bill left the committee is going to make the process harder for the road ahead with this legislation.

Columnist Simon Johnson has his own reservations. He feels that Dodd is forcing the legislation and that it will not actually work out in the long run. He thinks that it will give too much power to the big banking companies. He thinks that the committee is, in truth, too afraid to debate the issue. Anyway we look at it, this situation is not looking good.

For more information see:
http://www.huffingtonpost.com/2010/03/25/bob-corker-republican-on_n_512600.html

http://www.huffingtonpost.com/simon-johnson/financial-reform-will-we_b_512824.html

SEC Track Record: Oversight or Oversight?

Breaking news: April 27, 2010 - Goldman Sachs sworn testimony before Senate Permanent Subcommittee on Investigations. See it  More information

SEC Track Record: Oversight or Oversight?

Have you heard the one about Goldman Sachs? - they made the Iceland volcano erupt and did pretty well shorting airlines.

That's the kind of joke that helps us to understand the truth. Goldman is in the news a lot lately and so is the SEC. Last week, the SEC charged Goldman with fraud, to which Goldman responding by blaming one employee. Then, coincidentally, news of SEC staffers viewing porn websites during work hours hit the headlines. It may appear that SEC is being really tough on financial institution now - and perhaps the New SEC is indeed intent on fulfilling their mandate on behalf of the US taxpayers, however, if they are performing well, that's new - it hasn't always been so and until very recently the SEC looked more like the lap dog of the financial industry than a regulatory agency conducting oversight on behalf of Congress.

As we move into a period of intense dialog and discussion of Congressional financial reform which is also being called "financial overhaul" and "Wall St Reform", it might be useful to remember exactly how the financial crisis evolved. We could do a thorough review of the sequence of events, from the loosening of credit regulations over the past several decades, to the development of derivatives, to the sub-prime mortgage spree in the early "naughties", to its collapse, to the collapsing of the perpetrators of the derivatives to the buyouts and socialistic taxpayer bailouts that saved the "capitalists" from their self-inflicted wounds. But so much has been written about those events that we would like to bring new light by focusing on the bellwether, "poster child" for the financial crisis, Bernie Madoff. To get the inside scoop regarding just what Bernie did and how he got away with it until the financial system collapse "outed" him, let's refer to Harry Markopolous, the whistle-blower who reported Madoff to the SEC starting in May 2000.

According to his run-away best-selling financial thriller, "No One Would Listen", Markopolous tells the story of his first introduction to investing with Madoff Securities., "I glanced at the numbers...I knew immediately that the numbers made no sense...contained so many glaring errors that I didn't see how it could be functional, let alone profitable...I told Frank, '...this is bogus...this is a fraud.". That was late 1999. Markopolous is a "quant" - a Quantitative Analyst - a mathematical genius, who spent the next few months considering whether there was any possibly way to legitimately define a financial product that could compete with Madoff's investments. He decide that, "the problem was creating a product that could compete with a Ponzi scheme". To releieve himself of the pressure to create a product that was impossible to create he decide to report Madoff to the SEC.

Preparing his case thoroughly yet leaving out the calculus and linear algebra he made his presentation as simple and easy to understand as he could while still providing the facts of the case. In May 2000, Markopolous met with the SEC Senior Enforcement Attorney, Grant Ward. It soon became clear to Markopolous that the SEC man didn't understand the market and investment issues that he was explaining and didn't even have sufficient curiosity to ask questions. The meeting was a failure. Markopolous realized that, "At that moment I still didn't have the slightest idea how truly incompetent the SEC was" but over the next 8 and a half years he would learn that lesson. Though he tried many more times to provide detailed analysis of Madoff's Ponzi scheme to the SEC they would not listen. Despite two articles - one in Wall St Journal and one in Barrons - that described the Madoff Ponzi scheme in full with help from Markopolous' - the SEC never understood, or worse, understood and yet chose to not close Madoff down.Which is worse? - incompetence or corruption? The end results are much the same.

For the next 8 and a half years, Markopolous tried to warn the government and individuals investors that Madoff was running a fraud, a Ponzi scheme. One of the aspects of the continuance of Madoff's scheming that puzzled him was that none of the major investment firms invested with him, including Merill Lynch, Citigroup, Morgan Stanley, etc. Moreover, a managing director at Goldman Sachs admitted to him that they didn't believe Madoff's returns were legitimate so they decided to not do business with him. The Goldman Director cited here might be Danial Holland III, referred to later in the book as a "derivatives expert" that Markopolous recommended to the Wall Street Journal on the basis that, "Goldman Sachs is one of the largest traders of equity derivatives and if they don't handle Madoff's flow or see it in the markets then something's rotten." The question is, "why didn't Goldman report Madoff to the SEC? - even when their hedge fund lost 22.5% in August 2007 while Bernie Madoff's investments didn't change?

And now we know that Madoff's Ponzi scheme is not the only doomed-to-failure investment that Goldman knew about. The "Tourre emails" they have just released tell us that they also knew that the sub-prime-backed derivatives packages that they were selling were also doomed. In trying to understand why people wouldn't listen to him despite the irrefutable facts of the case, he came to understand, "if he was a fraud, it brought into questions everything these people believed in ...for those people to admit that Bernie was a fraud meant admitting that everything they believed in was questionable...how could they have known about it and never tried to stop it while thousands of people lost billions of dollars?"And yet it seems that some of Wall Streets biggest players did know what Madoff was doing and did nothing to stop him. It is important to ask, "Why?".

When Madoff's Ponzi scheme broke down due to the international liquidity crisis in Autumn 2008, the media and the government could no longer ignore Markopolous - he was completely vindicated and praised for his perseverance in reporting Madoff's wrong-doing. 60 Minutes began to cover him for a documentary, Oprah wanted him on her program, Congress called on him to testify in a hearing and the SEC Inspector General asked him to cooperate in the investigation of the SEC's failure to regulate Madoff. In his testimony before the House Committee on Capital Markets, Insurance, and Government-Sponsored Enterprise, Markopolous pulled no punches, "the SEC is also captive to the industry it regulates...If a $50 billion Ponzi scheme doesn't make the SEC's priority list...then I want to know who sets their priorities...The SEC...has led our nation's financial system to the brink of collapse....they need to be replaced".

When the SEC leadership testified in the same hearing, they tried to excuse themselves, giving themselves credit for an "action pending" against Madoff. Rep. Ackerman responded, "You took action after the guy confessed...don't give yourself any pat on the back". According to the SEC Inspector General, "Every time an SEC investigator came up to his office he or she would ask for an employment application". When Markopolous initially reported Madoff's Ponzi scheme to the SEC he estimated that the amount of money invested with Madoff was about $7 billion. From the time that Markopolous initially report Madoff to the SEC until the time that Madoff turned himself in, at least $40 billion more was invested and ultimately lost.

Markopolous became a financial fraud investigator and has brought many other cases to justice. He may have been the whistle-blower behind the SEC's current charges against Goldman. One thing is sure, the SEC staffers as a group have not been very busy with their Congressional mandate to regulate the securities industry. While they were tasked with oversight of the financial industry they seemed to have committed a great many oversights while they were turning a blind eye to industry wrong-doing. What could they have been thinking? As Steven Colbert explained so succinctly, 'Why are government employees filing a civil suit against Goldman Sachs? That's just going to be embarrassing in a few years when they all go back to work at Goldman Sachs.’