The Sanders Report on the GAO Audit on Major Conflicts of Interest at the Federal Reserve

U.S. Senator Bernie Sanders (I-Vt.)
Washington, DC
October 19, 2011

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Excerpt via Senator Sanders–

The report by the non-partisan research arm of Congress did not name but unambiguously described several individual cases involving Fed directors that created the appearance of a conflict of interest, including:

• Stephen Friedman In 2008, the New York Fed approved an application from Goldman Sachs to become a bank holding company giving it access to cheap Fed loans. During the same period, Friedman, chairman of the New York Fed, sat on the Goldman Sachs board of directors and owned Goldman stock, something the Fed’s rules prohibited. He received a waiver in late 2008 that was not made public. After Friedman received the waiver, he continued to purchase stock in Goldman from November 2008 through January of 2009 unbeknownst to the Fed, according to the GAO.
• Jeffrey Immelt The Federal Reserve Bank of New York consulted with General Electric on the creation of the Commercial Paper Funding Facility. The Fed later provided $16 billion in financing for GE under the emergency lending program while Immelt, GE’s CEO, served as a director on the board of the Federal Reserve Bank of New York.
• Jamie Dimon The CEO of JP Morgan Chase served on the board of the Federal Reserve Bank of New York at the same time that his bank received emergency loans from the Fed and was used by the Fed as a clearing bank for the Fed’s emergency lending programs. In 2008, the Fed provided JP Morgan Chase with $29 billion in financing to acquire Bear Stearns.At the time, Dimon persuaded the Fed to provide JP Morgan Chase with an 18-month exemption from risk-based leverage and capital requirements. He also convinced the Fed to take risky mortgage-related assets off of Bear Stearns balance sheet before JP Morgan Chase acquired this troubled investment bank.

By: David Dayen

I could barely suppress a laugh when reading about Bank of America CEO Brian Moynihan begging Tim Geithner to settle the foreclosure fraud issue so they can get out from under their liability. As Yves Smith points out, if Tim Geithner had the power to get Bank of America out of their mess, he surely would have done it by now, before their stock dipped 36% in the last three weeks. Geithner simply doesn’t have jurisdiction over state courts, where many judges are simply not going to allow foreclosures when standing to foreclose cannot be proven (Moynihan apparently distinguished on a conference call between “states where foreclosure can take place” and “states where foreclosure is going through very slowly,” and he might as well have been distinguishing between states that respect the rule of law and states that don’t). Geithner may try, but he cannot compel Attorneys General in both parties to settle for pennies on the dollar and relinquish all of their liability for consumer protection violations and fraud upon state courts. He cannot influence investors who see a giant meal ticket in the form of forcing big banks to repurchase faulty mortgage backed securities. If there was a magic bullet in this debacle, it would already have been fired.

[FDL]

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REUTERS–

The Federal Reserve Bank of New York is investigating whether Goldman Sachs’ (GS.N) mortgage servicing arm did not conduct proper reviews before denying borrowers the option to lower their payments under a government loan modification programme.

In its quarterly filing with the SEC earlier this month, Goldman said regulators had sought information on the foreclosure and servicing protocols and activities of its mortgage servicing unit Litton Loan Servicing.

“We are in possession of the letter and are conducting an inquiry,” a NY Fed spokesperson told Reuters, referring to a letter from a Litton employee sent to the NY Fed by the Financial Times. A spokesperson for Goldman Sachs declined to comment when contacted by Reuters.

The New York Fed will instead sell the assets individually and in blocks, the regulator said yesterday in a statement posted on its website. BlackRock Inc. (BLK), the New York Fed’s investment manager, will issue the first bid list next week, according to the statement.

“We had anticipated we would have the opportunity to buy these assets at a fair price by January 2011 and earn a return on them for the benefit of the U.S. taxpayer,” Mark Herr, a spokesman for New York-based AIG, said in an e-mailed statement. “Now, we must make up for lost time and lost earnings.”

One by one these will soon all come out…

Fraction of an Excerpt from BLOOMBERG:

Richard M. Bowen, former chief underwriter for Citigroup’s consumer-lending group, said he warned his superiors of concerns that some types of loans in securities didn’t conform with representations and warranties in 2006 and 2007.

“In mid-2006, I discovered that over 60 percent of these mortgages purchased and sold were defective,” Bowen testified on April 7 before the Financial Crisis Inquiry Commission created by Congress. “Defective mortgages increased during 2007 to over 80 percent of production.”

<SNIP>

“The potential for owners to challenge lenders on foreclosure improprieties certainly is there,” Pallotta said. “Even if it turns out that the banks were right in 99 percent of these foreclosures, the additional diligence on their part, going forward, is going to cost them more money.”

The litigation over buybacks, also known as putbacks, can also pit big banks against each other. Last month, Deutsche Bank AG, acting as a trustee, refiled a lawsuit over misrepresented mortgages in $34 billion of Washington Mutual Inc. mortgage securities, with $165 billion in original balances.

The new suit in the U.S. District Court for the District of Columbia included JPMorgan as a defendant, after the Federal Deposit Insurance Corp. said that JPMorgan was wrongly claiming its insurance fund had agreed to cover the liabilities, according to the amended complaint.

Continue reading…BLOOMBERG

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By Jody Shenn – Oct 19, 2010 5:27 PM ET

Pacific Investment Management Co., BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America Corp. to repurchase soured mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp. unit, people familiar with the matter said.

A group of bondholders wrote a letter to Bank of America and Bank of New York Mellon Corp., the debt’s trustee, citing alleged failures by Countrywide to service loans properly, their lawyer said yesterday in a statement that didn’t name the firms. The New York Fed acquired mortgage debt through its 2008 rescues of Bear Stearns Cos. and American International Group Inc.

Investors are stepping up efforts to recoup losses on mortgage bonds, which plummeted in value amid the worst slump in home prices since the 1930s. Last month, BNY Mellon declined to investigate mortgage files in response to a demand from the bondholder group, which has since expanded. Countrywide’s servicing failures, including insufficient record keeping, may open the door for investors to seek repurchases by bypassing the trustee, said Kathy Patrick, their lawyer at Gibbs & Bruns LLP.

“We now are in a position where we have to start a clock ticking,” Patrick, who is based in Houston, said today in a telephone interview.

If the issues aren’t fixed within 60 days, BNY Mellon should declare Countrywide in default on its servicing contracts, Patrick said.

Continue reading…BLOOMBERG

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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.