March 26 (Bloomberg) — JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and UBS AG were among more than a dozen Wall Street firms involved in a conspiracy to pay below-market interest rates to U.S. state and local governments on investments, according to documents filed in a U.S. Justice Department criminal antitrust case.

A government list of previously unidentified “co- conspirators” contains more than two dozen bankers at firms also including Bank of America Corp., Bear Stearns Cos., Societe Generale, two of General Electric Co.’s financial businesses and Salomon Smith Barney, the former unit of Citigroup Inc., according to documents filed in U.S. District Court in Manhattan on March 24.

The papers were filed by attorneys for a former employee of CDR Financial Products Inc., an advisory firm indicted in October. The attorneys, as part of their legal filing, identified the roster as being provided by the government. The document is labeled “list of co-conspirators.”

None of the firms or individuals named on the list has been charged with wrongdoing. The court records mark the first time these companies have been identified as co-conspirators. They provide the broadest look yet at alleged collusion in the $2.8 trillion municipal securities market that the government says delivered profits to Wall Street at taxpayers’ expense.

‘Sufficient Evidence’

“If the government is saying they are co-conspirators, the government believes they have sufficient evidence that they can show they were part of the conspiracy,” said Richard Donovan, a partner at New York-based law firm Kelley Drye & Warren LLP and co-chair of its antitrust practice. Donovan isn’t involved in the case.

The government’s case centers on investments known as guaranteed investment contracts that cities, states and school districts buy with the money they receive through municipal bond sales. Some $400 billion of municipal bonds are issued each year, and localities use the contracts to earn a return on some of the money until they need it for construction or other projects.

The Internal Revenue Service sometimes collects earnings on those investments and requires that they be awarded by competitive bidding to ensure that governments receive a fair return. The government charges that CDR ran sham auctions that allowed the banks to pay below-market interest rates to local governments.

CDR Fights Case

CDR, a Los Angeles-based local-government adviser, was indicted in October along with David Rubin, Zevi Wolmark and Evan Zarefsky, three current or former executives. The company and the three men have denied wrongdoing. Since last month, three former CDR employees who weren’t charged in the initial indictment have pleaded guilty and agreed to cooperate with the Justice Department.

More than a dozen financial firms are also facing civil suits filed by municipalities over the alleged conspiracy. Yesterday, U.S. District Judge Victor Marrero in Manhattan refused to toss out a lawsuit brought by Mississippi and other bond issuers.

Brian Marchiony, a spokesman for JPMorgan in New York; Doug Morris, a spokesman for UBS in New York; and Danielle Romero- Apsilos, a spokeswoman for Citigroup in New York, all declined to comment. A Societe Generale spokesman, Jim Galvin; Lehman spokeswoman Kimberly MacLeod, and GE Capital spokesman Ned Reynolds in Stamford, Connecticut, also declined to comment. Bank of America spokeswoman Shirley Norton in San Francisco declined to comment. Bear Stearns was bought by JPMorgan in 2008, the same year Lehman Brothers collapsed.

‘Absolute Disaster’

Laura Sweeney, a Justice Department spokeswoman in Washington, declined to comment.

Banks may choose to cooperate with prosecutors because in light of the government bailout funds they’ve received “a guilty plea would just be an absolute disaster for some of these companies,” said Nathan Muyskens, a partner at Shook, Hardy & Bacon in Washington and former trial attorney with the Federal Trade Commission’s Bureau of Competition.

“There have been antitrust investigations where there have been companies involved that were just never indicted,” he said in a phone interview.

At the same time, the government will probably focus on seeking to convict individual bankers, he said.

“When someone goes to jail for five years, that resonates,” he said. “When a company pays $200 million, it’s simply a balance sheet issue. Jail time is what captures corporate America’s attention.”

Lawyers’ Filing

In a court filing yesterday, defense lawyers said they “inadvertently” included the names of individual and company co-conspirators in a motion asking the court to compel the government to provide more specific evidence of the alleged misconduct. They asked the court to strike the entire exhibit in which the list appears. Judge Marrero granted the request.

The government’s probe became public in 2006 when federal investigators raided CDR and two competitors and issued subpoenas to more than a dozen firms. The “co-conspirators” on the list released in court this week also included Wachovia Corp., which was purchased by San Francisco-based Wells Fargo & Co. in 2008. Elise Wilkinson, a Wells Fargo spokeswoman in Charlotte, North Carolina, didn’t return a call today seeking comment.

October Indictments

The indictments released in October didn’t identify any of the sellers of the investment contracts involved in the alleged conspiracy. They were identified only as Provider A and Provider B. They paid kickbacks to CDR after winning investment deals brokered by the firm, according to the indictments.

The firms did this by paying sham fees tied to financial transactions entered into with other companies, prosecutors said. Kickbacks were paid from 2001 to 2005, ranging from $4,500 to $475,000 each, according to the Justice Department.

According to the list contained in the court filing this week, the investment contracts involved were created by units of GE and divisions of Financial Security Assurance Holdings Ltd., a bond insurer formerly part of Brussels-based lender Dexia SA.

The kickbacks were paid out of fees generated by transactions entered into with two financial institutions that weren’t identified in the October court filing. The March 24 list filed by the defense named the two firms as UBS and Royal Bank of Canada.

Dexia Sale

Dexia completed the sale of FSA’s bond-insurance business in July to Assured Guaranty Ltd. of Hamilton, Bermuda, while retaining its outstanding investment contracts.

Thierry Martiny, a spokesman for Dexia in Brussels, declined to comment. FSA, based in New York, was the biggest insurer of U.S. municipal bonds in 2007 and 2008.

“We have no comment,” said Betsy Castenir, a spokeswoman for Assured Guaranty in New York, in an e-mail response. “Dexia has responsibility for the liabilities of the Financial Products business.”

Royal Bank of Canada “has been fully cooperating with the government,” Kevin Foster, a spokesman for the bank in New York, said in an e-mailed statement. “We have no knowledge or evidence of wrongdoing by any of our employees.”

The case is U.S. v. Rubin/Chambers, Dunhill Insurance Services Inc., 09-CR-01058, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: William Selway in San Francisco at wselway@bloomberg.net; Martin Z. Braun in New York at mbraun6@bloomberg.net

Last Updated: March 26, 2010 13:09 EDT

Just how far that review would go is the subject of debate in the Senate.

The Valukas report found clear evidence that the New York Fed knew that Lehman was sending it garbage that it had no intention to market. In other words, the baskets of assets were created for the specific purpose of selling to the Fed for far more than they were worth.

Lehman knew it too: “No intention to market” was scrawled on one of the internal presentations about the assets. A separate bank, Citigroup, later characterized the assets as “bottom of the barrel” and “junk” when Lehman tried to push them their way, according to the report.

If Lehman hadn’t gone bankrupt anyway, the public would have no knowledge of this backdoor bailout. “It’s just fortuitous that we found out about this through a bankruptcy proceeding and a trustee that was willing to allow and pay for some digging,” said Grayson. “Do we really just have to hope for the best, that whenever the Fed does something wrong, we might someday find out about it?”

Geithner himself was aware that there was a gap between what Lehman claimed the assets were worth and what they were really worth. “The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in ‘collateral damage’ by demonstrating weakness and exposing air’ in the marks,” Geithner said, according to the report.

The assets, called “Freedom CLOs”, were sold to the Fed’s “Primary Dealer Credit Facility,” according to the report.

Lehman immediately recognized the value of what the Fed had set up. A day after the PDCF was announced, an internal Lehman analysis suggested that “the new ‘Primary Dealer Credit Facility’ is a LOT bigger deal than it is being played to be.” The facility could be a used as “as a warehouse for all types of collateral, we should have plenty of flexibility to structure and rethink CLO/CDO structures.”

It was a get-out-of-debt scheme and could “serve as a ‘warehouse’ for short term securities [b]acked by corporate loans [and] “MAY BE THE ‘EXIT STRATEGY’ FUNDING SOURCE WE NEED TO GET NEW COMPETITION IN THE CORPORATE LOAN MARKET,” according to the Lehman analysis.

But not one that Lehman felt like discussing with the public. “Given that the press has not focused (yet) on the Fed window in relation to the [Freedom] CLO, I’d suggest deleting the reference in the summary below,” CEO Dick Fuld wrote in an April 4, 2008 email uncovered by the report. “Press will be in attendance at the shareholder meeting and my concern is that volunteering this information would result in a story.”

Fuld has declared himself vindicated by the report.

The Fed won’t say how much more toxic “garbage” is in the Fed’s “warehouse” and that also concerns Grayson.

“The Fed’s balance sheet is a cartoon version of what’s actually inside,” said Grayson.
“We only get to basically do autopsies on the carcasses of the Fed’s failures, but what we don’t find out is when they show favoritism to companies that do not end up in bankruptcy.”

The Treasury didn’t immediately respond to a request for comment. Below is the relevant section of the report:

(c) In Addition to a Liquidity Backstop, Lehman Viewed the PDCF as an Outlet for Its Illiquid Positions
The PDCF not only provided Lehman with a ready response to those who speculated it would go the way of Bear Stearns, but also a potential vehicle to finance its illiquid corporate and real estate loans. A day after the PDCF became operational, Lehman personnel commented: “I think the new ‘Primary Dealer Credit Facility’ is a LOT bigger deal than it is being played to be . . . .” They mused that if Lehman could use the PDCF “as a warehouse for all types of collateral, we should have plenty of flexibility to structure and rethink CLO/CDO structures . . . .” Additionally, by viewing the PDCF as “available to serve as a ‘warehouse’ for short term securities [b]acked by corporate loans,” the facility “MAY BE THE ‘EXIT STRATEGY’ FUNDING SOURCE WE NEED TO GET NEW COMPETITION IN THE CORPORATE LOAN MARKET.”

Lehman did indeed create securitizations for the PDCF with a view toward treating the new facility as a “warehouse” for its illiquid leveraged loans. In March 2008, Lehman packaged 66 corporate loans to create the “Freedom CLO.” The transaction consisted of two tranches: a $2.26 billion senior note, priced at par, rated single A, and designed to be PDCF eligible, and an unrated $570 million equity tranche. The loans that Freedom “repackaged” included high?yield leveraged loans, which Lehman had difficulty moving off its books, and included unsecured loans to Countrywide Financial Corp.

Lehman did not intend to market its Freedom CLO, or other similar securitizations, to investors. Rather, Lehman created the CLOs exclusively to pledge to the PDCF. An internal presentation documenting the securitization process for Freedom and similar CLOs named “Spruce” and “Thalia,” noted that the “[r]epackage[d] portfolio of HY [high yield leveraged loans]” constituting the securitizations, “are not meant to be marketed.”

Handwriting from an unknown source underlines this sentence and notes at the margin: “No intention to market.”

Lehman may have also managed its disclosures to ensure that the public did not become aware that the CLOs were not created to be sold on the open market, but rather were intended solely to be pledged to the PDCF. An April 4, 2008 email containing edits to talking points concerning the Freedom CLO to be delivered by Fuld stated:

“Given that the press has not focused (yet) on the Fed window in relation to the [Freedom] CLO, I’d suggest deleting the reference in the summary below. Press will be in attendance at the shareholder meeting and my concern is that volunteering this information would result in a story.”

It is unclear, based solely on the e?mail, why a reference linking the FRBNY’s liquidity facility to the Freedom CLO was deleted. One explanation could be that Lehman did not want the public to learn that it had securitized illiquid loans exclusively to be pledged to the PDCF. Another reason may have been to hide the fact that Lehman needed to access the PDCF in the first place, given that accessing the securities dealers’ lender of last resort could have negative signaling implications.

The FRBNY was aware that Lehman viewed the PDCF not only as a liquidity backstop for financing quality assets, but also as a means to finance its illiquid assets. Describing a March 20, 2008 meeting between the FRBNY and Lehman’s senior management, FRBNY examiner Jan Voigts wrote that Lehman “intended to use the PDCF as both a backstop, and business opportunity.” With respect to the Freedom securitization in particular, Voigts wrote that Lehman saw the PDCF

as an opportunity to move illiquid assets into a securitization that would be PDCF eligible. They [Lehman] also noted they intended to create 2 or 3 additional PDCF eligible securitizations. We avoided comment on the securitization but noted the firm’s intention to use the PDCF as an opportunity to finance assets they could not finance elsewhere.

Thus, the FRBNY was aware that Lehman viewed the PDCF as an opportunity to finance its repackaged illiquid corporate loans. The Examiner’s investigation has not determined whether the FRBNY also understood that these Freedom-style securitizations were never intended for sale on the broader market.

In response to a question from FRBNY analyst Patricia Mosser on whether Voigts knew “if they [Lehman] intend to pledge to triparty or PDCF,”5359 Voigts replied that the Freedom CLO was “created with the PDCF in mind.”

According to internal Lehman documents, Lehman did in fact pledge the Freedom CLO to the PDCF. On three dates, March 24, 25 and 26, 2008, Lehman pledged the Freedom CLO to the FRBNY on an overnight basis, and received $2.13 billion for each transfer.5361 FRBNY discussions concerning the CLO’s underlying assets, however, took place on or around April 9, 20085362 — more than a week after the FRBNY began accepting the CLO.

UPDATE: Tyler Durden at Zero Hedge has been all over this scandal.

Get HuffPost Business On Twitter, Facebook, and Google Buzz! Know something we don’t? E-mail us at huffpostbiz@gmail.comsopping up junk loans that the investment bank couldn’t sell in the market, according to a report from court-appointed examiner Anton R. Valukas.

March 20 (Bloomberg) — The Federal Reserve Board removed an exemption it had given to six banks at the start of the crisis in 2007 aimed at boosting liquidity in financing markets for securities backed by mortgage- and asset-backed securities.

The so-called 23-A exemptions, named after a section of the Federal Reserve Act that limits such trades to protect bank depositors, were granted days after the Fed cut the discount rate by half a percentage point on Aug. 17, 2007. Their removal, announced yesterday in Washington, is part of a broad wind-down of emergency liquidity backstops by the Fed as markets normalize.

The decision in 2007 underscores how Fed officials defined the mortgage-market disruptions that year as partly driven by liquidity constraints. In hindsight, some analysts say that diagnosis turned out to be wrong.

“It was a way to prevent further deleveraging of the financial system, but that happened anyway,” said Dino Kos, managing director at Portales Partners LLC and former head of the New York Fed’s open market operations. “The underlying problem was solvency. The Fed was slow to recognize that.”

The Fed ended the exemptions in nearly identical letters to the Royal Bank of Scotland Plc, Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., Deutsche Bank AG, and Barclays Bank Plc posted on its Web site.

Backstop Liquidity

The Fed’s intent in 2007 was to provide backstop liquidity for financial markets through the discount window. In a chain of credit, investors would obtain collateralized loans from dealers, dealers would obtain collateralized loans from banks, and then banks could pledge collateral to the Fed’s discount window for 30-day credit. In Citigroup’s case, the exemption allowed such lending to its securities unit up to $25 billion.

“The goal was to stop the hemorrhaging of risk capital,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “Investors were being forced out of the securities market because they couldn’t fund their positions, even in higher-quality assets in some cases.”

Using mortgage bonds without government-backed guarantees as collateral for private-market financing began to get more difficult in August 2007 following the collapse of two Bear Stearns Cos. hedge funds.

As terms for loans secured by mortgage bonds got “massively” tighter, haircuts, or the excess in collateral above the amount borrowed, on AAA home-loan securities rose that month from as little as 3 percent to as much as 10 percent, according to a UBS AG report.

Lehman Collapse

By February 2008, haircuts climbed to 20 percent, investor Luminent Mortgage Capital Inc. said at the time. After Lehman Brothers Holdings Inc. collapsed in September 2008, the loans almost disappeared.

“These activities were intended to allow the bank to extend credit to market participants in need of short-term liquidity to finance” holdings of mortgage loans and asset- backed securities, said the Fed board’s letter dated yesterday to Kathleen Juhase, associate general counsel of JPMorgan. “In light of this normalization of the term for discount window loans, the Board has terminated the temporary section 23-A exemption.”

The “normalization” refers to the Fed’s reduction in the term of discount window loans to overnight credit starting two days ago from a month previously.

The Fed eventually loaned directly to securities firms and opened the discount window to primary dealers in March 2008. Borrowings under the Primary Dealer Credit Facility soared to $146.5 billion on Oct. 1, 2008, following the collapse of Lehman Brothers two weeks earlier. Borrowings fell to zero in May 2009. The Fed closed the facility last month, along with three other emergency liquidity backstops.

Discount Rate

The Fed also raised the discount rate a quarter point in February to 0.75 percent, moving it closer to its normal spread over the federal funds rate of 1 percentage point.

The one interest rate the Fed hasn’t changed since the depths of the crisis is the benchmark lending rate. Officials kept the target for overnight loans among banks in a range of zero to 0.25 percent on March 16, where it has stood since December 2008, while retaining a pledge to keep rates low “for an extended period.”

Removing the 23-A exemptions shows the Fed wants to get “back to normal,” said Laurence Meyer, a former Fed governor and vice chairman of Macroeconomic Advisers LLC in Washington. “Everything has gone back to normal except monetary policy.”

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net

Last Updated: March 20, 2010 00:00 EDT

SHOCK & AWE …I’m betting! Thanks to Bloomberg for the lawsuit to DISCLOSE! Notice how both Bloomberg & Huffington are always the ones who go after the banksters…Because they probably don’t use the banksters to fund them!

By David Glovin and Bob Van Voris

March 19 (Bloomberg) — The Federal Reserve Board must disclose documents identifying financial firms that might have collapsed without the largest U.S. government bailout ever, a federal appeals court said.

The U.S. Court of Appeals in Manhattan ruled today that the Fed must release records of the unprecedented $2 trillion U.S. loan program launched primarily after the 2008 collapse of Lehman Brothers Holdings Inc. The ruling upholds a decision of a lower-court judge, who in August ordered that the information be released.

The Fed had argued that disclosure of the documents threatens to stigmatize borrowers and cause them “severe and irreparable competitive injury,” discouraging banks in distress from seeking help. A three-judge panel of the appeals court rejected that argument in a unanimous decision.

The U.S. Freedom of Information Act, or FOIA, “sets forth no basis for the exemption the Board asks us to read into it,” U.S. Circuit Chief Judge Dennis Jacobs wrote in the opinion. “If the Board believes such an exemption would better serve the national interest, it should ask Congress to amend the statute.”

The opinion may not be the final word in the bid for the documents, which was launched by Bloomberg LP, the parent of Bloomberg News, with a November 2008 lawsuit. The Fed may seek a rehearing or appeal to the full appeals court and eventually petition the U.S. Supreme Court.

Right to Know

If today’s ruling is upheld or not appealed by the Fed, it will have to disclose the requested records. That may lead to “catastrophic” results, including demands for the instant disclosure of banks seeking help from the Fed, resulting in a “death sentence” for such financial institutions, said Chris Kotowski, a bank analyst at Oppenheimer & Co. in New York.

“Whenever the Fed extends funds to a bank, it should be disclosed in private to the Congressional oversight committees, but to release it to the public I think would be a horrific mistake,” Kotowski said in an interview. “It would stigmatize the banks, it would lead to all kinds of second-guessing of the Fed, and I don’t see what public purpose is served by it.”

Senator Bernie Sanders, an Independent from Vermont, said the decision was a “major victory” for U.S. taxpayers.

“This money does not belong to the Federal Reserve,” Sanders said in a statement. “It belongs to the American people, and the American people have a right to know where more than $2 trillion of their money has gone.”

Fed Review

The Fed is reviewing the decision and considering its options for reconsideration or appeal, Fed spokesman David Skidmore said.

“We’re obviously pleased with the court’s decision, which is an important affirmation of the public’s right to know what its government is up to,” said Thomas Golden, a partner at New York-based Willkie Farr & Gallagher LLP and Bloomberg’s outside counsel.

The court was asked to decide whether loan records are covered by FOIA. Historically, the type of government documents sought in the case has been protected from public disclosure because they might reveal competitive trade secrets.

The Fed had argued that it could withhold the information under an exemption that allows federal agencies to refuse disclosure of “trade secrets and commercial or financial information obtained from a person and privileged or confidential.”

Payment Processors

The Clearing House Association, which processes payments among banks, joined the case and sided with the Fed. The group includes ABN Amro Bank NV, a unit of Royal Bank of Scotland Plc, Bank of America Corp., The Bank of New York Mellon Corp., Citigroup Inc., Deutsche Bank AG, HSBC Holdings Plc, JPMorgan Chase & Co., US Bancorp and Wells Fargo & Co.

Paul Saltzman, general counsel for the Clearing House, said the decision did not address the “fundamental issue” of whether disclosure would “competitively harm” borrower banks.

“The Second Circuit declined to follow the decisions of other circuit courts recognizing that disclosure of certain confidential information can impair the effectiveness of government programs, such as lending programs,” Saltzman said in a statement.

The Clearing House is considering whether to ask for a rehearing by the full Second Circuit and, ultimately, review by the U.S. Supreme Court, he said.

Deep Crisis

Oscar Suris, a spokesman for Wells Fargo, JPMorgan spokeswoman Jennifer Zuccarelli, Bank of New York Mellon spokesman Kevin Heine, HSBC spokeswoman Juanita Gutierrez and RBS spokeswoman Linda Harper all declined to comment. Deutsche Bank spokesman Ronald Weichert couldn’t immediately comment. Bank of America declined to comment, Scott Silvestri said. Citigroup spokeswoman Shannon Bell declined to comment. U.S. Bancorp spokesman Steve Dale didn’t return phone and e-mail messages seeking comment.

Bloomberg, majority-owned by New York Mayor Michael Bloomberg, sued after the Fed refused to name the firms it lent to or disclose loan amounts or assets used as collateral under its lending programs. Most of the loans were made in response to the deepest financial crisis since the Great Depression.

Lawyers for Bloomberg argued in court that the public has the right to know basic information about the “unprecedented and highly controversial use” of public money.

“Bloomberg has been trying for almost two years to break down a brick wall of secrecy in order to vindicate the public’s right to learn basic information,” Golden wrote in court filings.

Potential Harm

Banks and the Fed warned that bailed-out lenders may be hurt if the documents are made public, causing a run or a sell- off by investors. Disclosure may hamstring the Fed’s ability to deal with another crisis, they also argued.

Much of the debate at the appeals court argument on Jan. 11 centered on the potential harm to banks if it was revealed that they borrowed from the Fed’s so-called discount window. Matthew Collette, a lawyer for the government, said banks don’t do that unless they have liquidity problems.

FOIA requires federal agencies to make government documents available to the press and public. An exception to the statute protects trade secrets and privileged or confidential financial data. In her Aug. 24 ruling, U.S. District Judge Loretta Preska in New York said the exception didn’t apply because there’s no proof banks would suffer.

Tripartite Test

In its opinion today, the appeals court said that the exception applies only if the agency can satisfy a three-part test. The information must be a trade secret or commercial or financial in character; must be obtained from a person; and must be privileged or confidential, according to the opinion.

The court said that the information sought by Bloomberg was not “obtained from” the borrowing banks. It rejected an alternative argument the individual Federal Reserve Banks are “persons,” for purposes of the law because they would not suffer the kind of harm required under the “privileged and confidential” requirement of the exemption.

In a related case, U.S. District Judge Alvin Hellerstein in New York previously sided with the Fed and refused to order the agency to release Fed documents that Fox News Network sought. The appeals court today returned that case to Hellerstein and told him to order the Fed to conduct further searches for documents and determine whether the documents should be disclosed.

“We are pleased that this information is finally, and rightfully, going to be made available to the American public,” said Kevin Magee, Executive Vice President of Fox Business Network, in a statement.

Balance Sheet Debt

The Fed’s balance sheet debt doubled after lending standards were relaxed following Lehman’s failure on Sept. 15, 2008. That year, the Fed began extending credit directly to companies that weren’t banks for the first time since the 1930s. Total central bank lending exceeded $2 trillion for the first time on Nov. 6, 2008, reaching $2.14 trillion on Sept. 23, 2009.

More than a dozen other groups or companies filed friend- of-the-court briefs. Those arguing for disclosure of the records included the American Society of News Editors and individual news organizations.

“It’s gratifying that the court recognizes the considerable interest in knowing what is being done with our tax dollars,” said Lucy Dalglish, executive director of the Reporters Committee for Freedom of the Press in Arlington, Virginia.

“We’ve learned some powerful lessons in the last 18 months that citizens need to pay more attention to what’s going on in the financial world. This decision will make it easier to do that.”

The case is Bloomberg LP v. Board of Governors of the Federal Reserve System, 09-04083, U.S. Court of Appeals for the Second Circuit (New York).

To contact the reporters on this story: David Glovin in New York at dglovin@bloomberg.net; Bob Van Voris in New York at vanvoris@bloomberg.net.

Last Updated: March 19, 2010 16:15 EDT

also see  huffington post articles on this

This in combination with A.K. Barnett-Hart’s Thesis make’s one hell of a Discovery.

 
LEGAL AND ECONOMIC ISSUES IN
SUBPRIME LITIGATION

Jennifer E. Bethel*
Allen Ferrell**
Gang Hu***

Discussion Paper No. 612

03/2008

Harvard Law School Cambridge, MA 02138

This paper explores the economic and legal causes and consequences of recent difficulties in the subprime mortgage market. We provide basic descriptive statistics and institutional details on the mortgage origination process, mortgage-backed securities (MBS), and collateralized debt obligations (CDOs). We examine a number of aspects of these markets, including the identity of MBS and CDO sponsors, CDO trustees, CDO liquidations, MBS insured and registered amounts, the evolution of MBS tranche structure over time, mortgage originations, underwriting quality of mortgage originations, and write-downs of investment banks. In light of this discussion, the paper then addresses questions as to how these difficulties might have not been foreseen, and some of the main legal issues that will play an important role in the extensive subprime litigation (summarized in the paper) that is underway, including the Rule 10b-5 class actions that have already been filed against the investment banks, pending ERISA litigation, the causes-of-action available to MBS and CDO purchasers, and litigation against the rating agencies. In the course of this discussion, the paper highlights three distinctions that will likely prove central in the resolution of this litigation: The distinction between reasonable ex ante expectations and the occurrence of ex post losses; the distinction between the transparency of the quality of the underlying assets being securitized and the transparency as to which market participants are exposed to subprime losses; and, finally, the distinction between what investors and market participants knew versus what individual entities in the structured finance process knew, particularly as to macroeconomic issues such as the state of the national housing market. ex ante expectations and the occurrence of ex post losses; the distinction between the transparency of the quality of the underlying assets being securitized and the transparency as to which market participants are exposed to subprime losses; and, finally, the distinction between what investors and market participants knew versus what individual entities in the structured finance process knew, particularly as to macroeconomic issues such as the state of the national housing market. 

March 15, 2010, 4:59 PM ET

Michael Lewis’s ‘The Big Short’? Read the Harvard Thesis Instead!

By Peter Lattman

Deal Journal has yet to read “The Big Short,” Michael Lewis’s yarn on the financial crisis that hit stores today. We did, however, read his acknowledgments, where Lewis praises “A.K. Barnett-Hart, a Harvard undergraduate who had just  written a thesis about the market for subprime mortgage-backed CDOs that remains more interesting than any single piece of Wall Street research on the subject.”

While unsure if we can stomach yet another book on the crisis, a killer thesis on the topic? Now that piqued our curiosity. We tracked down Barnett-Hart, a 24-year-old financial analyst at a large New York investment bank. She met us for coffee last week to discuss her thesis, “The Story of the CDO Market Meltdown: An Empirical Analysis.” Handed in a year ago this week at the depths of the market collapse, the paper was awarded summa cum laude and won virtually every thesis honor, including the Harvard Hoopes Prize for outstanding scholarly work.

Last October, Barnett-Hart, already pulling all-nighters at the bank (we agreed to not name her employer), received a call from Lewis, who had heard about her thesis from a Harvard doctoral student. Lewis was blown away.

“It was a classic example of the innocent going to Wall Street and asking the right questions,” said Mr. Lewis, who in his 20s wrote “Liar’s Poker,” considered a defining book on Wall Street culture. “Her thesis shows there were ways to discover things that everyone should have wanted to know. That it took a 22-year-old Harvard student to find them out is just outrageous.”

Barnett-Hart says she wasn’t the most obvious candidate to produce such scholarship. She grew up in Boulder, Colo., the daughter of a physics professor and full-time homemaker. A gifted violinist, Barnett-Hart deferred admission at Harvard to attend Juilliard, where she was accepted into a program studying the violin under Itzhak Perlman. After a year, she headed to Cambridge, Mass., for a broader education. There, with vague designs on being pre-Med, she randomly took “Ec 10,” the legendary introductory economics course taught by Martin Feldstein.

“I thought maybe this would help me, like, learn to manage my money or something,” said Barnett-Hart, digging into a granola parfait at Le Pain Quotidien. She enjoyed how the subject mixed current events with history, got an A (natch) and declared economics her concentration.

Barnett-Hart’s interest in CDOs stemmed from a summer job at an investment bank in the summer of 2008 between junior and senior years. During a rotation on the mortgage securitization desk, she noticed everyone was in a complete panic. “These CDOs had contaminated everything,” she said. “The stock market was collapsing and these securities were affecting the broader economy. At that moment I became obsessed and decided I wanted to write about the financial crisis.”

Back at Harvard, against the backdrop of the financial system’s near-total collapse, Barnett-Hart approached professors with an idea of writing a thesis about CDOs and their role in the crisis. “Everyone discouraged me because they said I’d never be able to find the data,” she said. “I was urged to do something more narrow, more focused, more knowable. That made me more determined.”

She emailed scores of Harvard alumni. One pointed her toward LehmanLive, a comprehensive database on CDOs. She received scores of other data leads. She began putting together charts and visuals, holding off on analysis until she began to see patterns–how Merrill Lynch and Citigroup were the top originators, how collateral became heavily concentrated in subprime mortgages and other CDOs, how the credit ratings procedures were flawed, etc.

“If you just randomly start regressing everything, you can end up doing an unlimited amount of regressions,” she said, rolling her eyes. She says nearly all the work was in the research; once completed,  she jammed out the paper in a couple of weeks.

“It’s an incredibly impressive piece of work,” said Jeremy Stein, a Harvard economics professor who included the thesis on a reading list for a course he’s teaching this semester on the financial crisis. “She pulled together an enormous amount of information in a way that’s both intelligent and accessible.”

Barnett-Hart’s thesis is highly critical of Wall Street and “their irresponsible underwriting practices.” So how is it that she can work for the very institutions that helped create the notorious CDOs she wrote about?

“After writing my thesis, it became clear to me that the culture at these investment banks needed to change and that incentives needed to be realigned to reward more than just short-term profit seeking,” she wrote in an email. “And how would Wall Street ever change, I thought, if the people that work there do not change? What these banks needed is for outsiders to come in with a fresh perspective, question the way business was done, and bring a new appreciation for the true purpose of an investment bank – providing necessary financial services, not creating unnecessary products to bolster their own profits.”

Ah, the innocence of youth.

Here is a copy of the thesis: 2009-CDOmeltdown

March 11, 2010, 6:15 PM ET

‘Hail Mary’ to Warren Buffett: Untold Details of Lehman’s Fall

By Matt Phillips

Doubtless, historians will be going over the mammoth 2,200 page report from the Lehman bankruptcy examiner for years to come.

But we bloggers are writing the first draft now. And there’s plenty of good fodder on Lehman’s final days, including fresh details on its effort to get support from billionaire investor Warren Buffett.

Now, it’s well known that Lehman reached out to Buffett in its final months. The Journal’s Scott Patterson wrote about the Oracle’s decision to pass on Lehman in a story back in December.

But the level of detail provided by this report is pretty astounding. It offers a pretty amazing snapshot of Buffett’s conversation with Lehman CEO Dick Fuld as well as a remarkable window on how the Oracle negotiates during times of crisis.

The report really reads like a novel, so we’ll just give you the sections here:

Fuld and Buffett spoke on Friday, March 28, 2008. They discussed Buffett investing at least $2 billion in Lehman. Two items immediately concerned Buffet during his conversation with Fuld. First, Buffett wanted Lehman executives to buy under the same terms as Buffett. Fuld explained to the Examiner that he was reluctant to require a significant buy?in from Lehman executives, because they already received much of their compensation in stock. However, Buffett took it as a negative that Fuld suggested that Lehman executives were not willing to participate in a significant way. Second, Buffett did not like that Fuld complained about short sellers. Buffett thought that blaming short sellers was indicative of a failure to admit one’s own problems.

Following his conversation with Buffett, Fuld asked Paulson to call Buffett, which Paulson reluctantly did. Buffett told the Examiner that during that call, Paulson signaled that he would like Buffett to invest in Lehman, but Paulson “did not load the dice.” Buffett spent the rest of Friday, March 28, 2008, reviewing Lehman’s 10?K and noting problems with some of Lehman’s assets. Buffett’s concerns centered around Lehman’s real estate and high yield investments, lending?related commitments derivatives and their related credit?market risk, Level III assets and Lehman’s securitization activity. On Saturday, March 29, 2008, Buffett learned of a $100 million problem in Japan that Fuld had not mentioned during their discussions, and Buffett was concerned that Fuld had not been forthcoming about the issue. The problems Buffett saw in the 10?K along with Fuld’s failure to alert Buffett to the issue in Japan cemented Buffett’s decision not to invest in Lehman.

At some point in their conversations, Fuld and Buffett also discovered that there had been a miscommunication about the conversion price. Buffett was interested only in convertible preferred shares. Buffett told Fuld that he was willing to agree to a $40 conversion price per share, while Fuld thought Buffett was offering to buy in at “up? 40,” or 40% above the current market price, which would have been about $56 per share. On Friday, March 28, 2008, Lehman’s stock closed at $37.87. Fuld spoke to Lehman’s Executive Committee and several Board members about his conversations with Buffett. Lehman recognized that an investment by Buffett would provide a “stamp of approval.” However, Lehman already had better offers for its April capital raise, and Lehman did not think it could give a better deal to Buffett at the same time it gave a less attractive deal to others. On Monday, March 31, 2008, before Buffett could tell Fuld that he was not interested, Fuld called Buffett to say that Lehman could not accept his terms.

Last?Ditch Effort with Buffett

[Hugh “Skip” E. McGee, III, the head of Lehman’s Investment Banking Division] contacted [President David L. Sokol, president of Berkshire Hathaway’s MidAmerican Energy] again in late August or early September 2008 and outlined Lehman’s “Gameplan” for survival, specifically SpinCo. During a subsequent telephone call with Sokol, McGee explained the “good bank/bad bank” scenario and stated that Lehman would need an investor. Sokol believed the e?mail and call were intended to induce Sokol to pass that information on to Buffett, so Sokol briefed Buffett on SpinCo. Buffett thought the idea would not solve Lehman’s problems.

Sometime during the week prior to Lehman’s bankruptcy, McGee again reached out to Sokol with what both Sokol and McGee described to the Examiner as a “Hail Mary” pass. McGee asked, “Do you have any ideas to save us?” Sokol, who was bear hunting in Alaska at the time, told McGee that he did not.

Judging by the inclusion of the largely irrelevant bear hunting detail at the end, we can tell that this report was written by a frustrated novelist. (And they did an amazing job.) But what we find most remarkable is the insight these sections offer on how Buffett assesses companies.

It’s simple–but not easy–as he combines 10-K analysis with probing questions to management.

Are they willing to put their own money at risk? Are they being upfront? Are they giving investors the full story?

Clearly Buffett didn’t think so.

Umm could we now say, we told you so?…Now on with Goldman and the rest of the dealers!

Huffington Post   |  Ryan McCarthy First Posted: 03-12-10 10:52 AM 

** UPDATE: Scroll down to see Dylan Ratigan’s segment **

The arcane “accounting gimmick” employed by Lehman Brothers as the firm failed in 2007 and 2008, was like “a drug” propelling the bank to conceal the true nature of its financial health, according to bankruptcy documents released yesterday.

As news organizations pore through the 2,200 pages of documents released by Anton Valukas, the examiner in charge of sifting through the most expensive bankruptcy in history, new details have surfaced about possible criminal actions by Lehman executives.

An executive referred to by Lehman execs as the firm’s “balance sheet” czar — who later went on to become the firm’s COO — likely had knowledge of the firm’s highly creative accounting maneuvers, notes The New York Times. Here’s the NYT:

“I am very aware … it is another drug we [are] on,” Herbert McDade wrote in an April 2008 e-mail cited by the examiner’s report. At other times, he is described as calling for a limit to the number of Repo 105 transactions.

At the center of the controversy is a technique called “Repo 105,” under which Lehman was able to move $50 billion off of its balance sheet in the second quarter of 2008 alone, MarketWatch reports. Here’s more from Market Watch:

[Repo 105 is] essentially a type of secured loan and is booked that way in the accounts — leading to an increase in both assets and liabilities. 

Lehman’s trick was to use a clause in the accounting rules to classify the deal as a sale, even though it was still obliged to repurchase the assets at a later date. That meant the assets disappeared from the balance sheet, and it could use the cash it received to temporarily pay down other liabilities…. [Repo 105] was crucial for maintaining the group’s credit rating as rating agencies and investors began to focus more on leverage and demanded lower risk.

In a series of e-mail messages cited by the examiner, one Lehman executive writes of Repo 105: “It’s basically window-dressing.” Another responds: “I see … so it’s legally do-able but doesn’t look good when we actually do it? Does the rest of the street do it? Also is that why we have so much BS [balance sheet] to Rates Europe?” The first executive replies: “Yes, No and yes. :)”

But these accounting techniques did not sit well with every Lehman executive. The Wall Street Journal passes along this nugget from the examiner’s report, which suggest that Ernst & Young, Lehman’s auditors, were not concerned about the firm’s use of Repo 105. Here’s the WSJ:

In May 2008, a Lehman Senior Vice President, Matthew Lee, wrote a letter to management alleging accounting improprieties;82 in the course of investigating the allegations, Ernst & Young was advised by Lee on June 12, 2008 that Lehman used $50 billion of Repo 105 transactions to temporarily move assets off balance sheet and quarter end.
The next day on June 13, 2008 Ernst & Young met with the Lehman Board Audit Committee but did not advise it about Lee’s assertions, despite an express direction from the Committee to advise on all allegations raised by Lee. Ernst & Young took virtually no action to investigate the Repo 105 allegations. Ernst & Young took no steps to question or challenge the non disclosure by Lehman of its use of $50 billion of temporary, off balance sheet transactions. Colorable claims exist that Ernst & Young did not meet professional standards, both in investigating Lee’s allegations and in connection with its audit and review of Lehman’s financial statements.”

NPR Marketplace reporter Alisa Roth said on Friday that it’s a “safe bet” that there will be “another big round of white-collar trials, like we had post-Enron.”

The question will be how far anybody can prove the responsibility extended. The report says “colorable claims” could be made against some Lehman execs and against Ernst & Young, the accountants. And by colorable claims, it means evidence that’s strong enough to potentially get a jury to award damages.

UPDATE: On Friday’s Dylan Ratigan Show, the MSNBC host delved into the Lehman saga with former New York Governor Eliot Spitzer, breaking down the firm’s fraudulent meltdown in easily-understandable terms.