View Full Version : Economics BAC, Citi's Jan/Feb Profits an AIG scam?

03-30-2009, 07:21 PM
Exclusive: Big Banks' Recent Profitability Due to AIG Scam? 71 comments
by: Tyler Durden March 30, 2009 | about stocks: AIG / BAC / C / JPM
Tyler Durden

Exclusive: Big Banks' Recent Profitability Due to AIG Scam? 71 comments

Hedge is rarely speechless, but after receiving this email from a correlation desk trader, we simply had to hold a moment of silence for the phenomenal scam that continues unabated in the financial markets, and now has the full oversight and blessing of the U.S. government, which in turn keeps on duping U.S. taxpayers into believing everything is good.

I present the insider perspective of trader Lou (who wishes to remain anonymous) in its entirety:

AIG-FP accumulated thousands of trades over the years, all essentially consisted of selling default protection. This was done via a number of structures with really only one criteria - rated at least AA- (if it fit these criteria all OK - as far as I could tell credit assessment was completely outsourced to the rating agencies).

Main products they took on were always levered credit risk, credit-linked notes (collateral and CDS both had to be at least AA-, no joint probability stuff) and AAA or super senior portfolio swaps. Portfolio swaps were either corporate synthetic CDO or asset backed, effectively sub-prime wraps (as per news stories regarding GS and DB).

Credit linked notes are done through single-name CDS desks and a cash desk (for the note collateral) and the portfolio swaps are done through the correlation desk. These trades were done is almost every jurisdiction - wherever AIG had an office they had IB salespeople covering them.

Correlation desks just back their risk out via the single names desks - the correlation desk manages the delta/gamma according to their correlation model. So correlation desks carry model risk but very little market risk.

I was mostly involved in the corporate synthetic CDO side.

During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent - these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever."

As these trades are unwound, the correlation desk needs to unwind the single name risk through the single name desks - effectively the AIG-FP unwinds caused massive single name protection buying. This caused single name credit to massively underperform equities - run a chart from say last September to current of say S&P 500 and Itraxx - credit has underperformed massively. This is largely due to AIG-FP unwinds.

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period.

For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman's terms:

AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.

In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JP Morgan Chase (JPM), Citi (C), and BofA (BAC), regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this "one time profit", which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity (soon coming to a prospectus near you), also funded by taxpayers' money flows into the market. If the administration is truly aware of all these events (and if Zero Hedge knows about it, it is safe to say Tim Geithner also got the memo), then the potential fallout would be staggering once this information makes the light of day.

And the conspiracy thickens.

Thanks to an intrepid reader who pointed this out, a month ago ISDA published an amended close out protocol. This protocol would allow non-market close outs, i.e. CDS trade crosses that were not alligned with market bid/offers

The purpose of the Protocol is to permit parties to agree upfront that in the event of a counterparty default, they will use Close-Out Amount valuation methodology to value trades. Close-Out Amount valuation, which was introduced in the 2002 ISDA Master Agreement, differs from the Market Quotation approach in that it allows participants more flexibility in valuation where market quotations may be difficult to obtain.

Of course ISDA made it seems that it was doing a favor to industry participants, very likely dictating under the gun:

Industry participants observed the significant benefits of the Close-Out Amount approach following the default of Lehman Brothers. In launching the Close-Out Amount Protocol, ISDA is facilitating amendment of existing 1992 ISDA Master Agreements by replacing Market Quotation and, if elected, Loss with the Close-Out Amount approach.

"This is yet another example of ISDA helping the industry to coalesce around more efficient and effective practices, while maintaining flexibility," said Robert Pickel, Executive Director and Chief Executive Officer, ISDA. "The Protocol permits parties to value trades in the way that is most appropriate, which greatly enhances smooth functioning of the market in testing circumstances."

And, lo and behold, on the list of adhering parties, AIG takes front and center stage (together with several other parties that probably deserve the microscope treatment).
So - in simple terms, ISDA, which is the only effective supervisor of the Over The Counter CDS market, is giving its blessing for trades to occur (cross) below where there is a realistic market bid, or higher than the offer. In traditional equity markets this is a highly illegal practice. ISDA is allowing retrospective arbitrary trades to have occurred at whatever price any two parties agree on, so long as the very vague necessary and sufficient condition of "market quotations may be difficult to obtain" is met. As anyone who follows CDS trading knows, this can be extrapolated to virtually any specific single-name, index or structured product easily. In essence ISDA gave its blessing for below the radar fund transfers of questionable legality. The curious timing of this decision and the alleged abuse of CDS transaction marks by and among AIG and the big banks, is striking to say the least.

This wholesale manipulation of markets, investors and taxpayers has gone on long enough.

KC native
03-30-2009, 09:11 PM
Wow, this is more of a bail out than I had assumed (provided that Tyler is correct). I had figured this was limited more to foreign banks so as not to piss off the world. This is some real sleight of hand bullshit. I don't doubt Tyler Durden's work as he has been a great writer for awhile now. For the slow ones, it's a pseudonym. We in the finance world have to be careful in what we put out with our real names because compliance can fire us for posting unapproved opinions/analysis etc.

03-30-2009, 10:02 PM
JFC. That is all I can say.

03-30-2009, 10:35 PM
this is working great! we need to do more of it asap!

KC native
03-31-2009, 09:38 AM
And to make matters worse FASB is about to cave on mark to market accounting.

Mark-to-Market Lobby Buoys Bank Profits 20% as FASB May Say Yes
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By Ian Katz and Jesse Westbrook

March 30 (Bloomberg) -- Four days after U.S. lawmakers berated Financial Accounting Standards Board Chairman Robert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. by more than 20 percent.

The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.

FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.

Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” said Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York. “I’d say there was a pretty close cause and effect.”

Willens, investor-advocate groups including the CFA Institute in Charlottesville, Virginia, and former U.S. Securities and Exchange Commission Chairman Arthur Levitt oppose changes that would enable banks to put off reporting losses.

‘Outrageous Threats’

“What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.

FASB spokesman Neal McGarity said the proposal allowing significant judgment was “in the works prior to the Washington hearing and was merely accelerated for the first quarter, instead of the second quarter.” The plan on impaired investments “was an attempt to address an important financial reporting issue that has emerged from the financial crisis,” he said.

Mary Schapiro, sworn in as SEC chairman in January, testified to Congress on March 11 that the agency recommends “more judgment in the application, so that assets are not being written down to fire-sale prices.”

Unrealized Losses

Goldman Sachs Group Inc. investment strategist Abby Joseph Cohen and Nouriel Roubini, the New York University professor who predicted last year’s economic crisis, made bearish forecasts last week about the outlook for the banking industry. Cohen says banks aren’t yet “in the clear,” and Roubini expects the government to nationalize more lenders as the economy contracts. The 24-member KBW Bank Index rose 21 percent in March, after slumping 75 percent during the prior 12 months.

By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent, Willens said. Companies weighed down by mortgage- backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus.

“This could turn net losses into significant net gains,” Dietrich said. “It may well swing the difference as to whether bank earnings are strong this quarter, or flat to negative.”

‘Unintended Consequences’

Citigroup had $1.6 billion of losses last year for so- called Alt-A mortgages, according to the company’s annual report. That loss would be erased with the new FASB rules, Dietrich said.

Bank of America Corp. in Charlotte, North Carolina, reported “income before income taxes” last year of $4.4 billion. The FASB proposal on impaired securities would increase that figure by about $3.5 billion, or the amount of “other- than-temporary” losses that the company recognized, Dietrich said. The new rule would mean the loss would be stripped out of net income, boosting earnings, though it would still be reported in financial statements.

“We’re studying the proposals,” Bank of America spokesman Scott Silvestri said. Citigroup spokesman Michael Hanretta declined to comment.

While helping lenders report higher earnings, FASB’s changes may hurt Treasury Secretary Timothy Geithner’s plan to remove distressed assets from bank balance sheets, Dietrich said. Allowing companies to hold on to assets without writing them down could discourage them from selling the securities, which would work against Treasury’s objective to resuscitate markets, he said.

“It’s one of the unintended consequences of having the FASB bow to political pressure,” Dietrich said.

Bank Lobbying

Fair-value requires companies to set values on most securities each quarter based on market prices. Banks argue that the rule doesn’t make sense when trading has dried up because it forces them to write down assets to less than they’re worth.

“Mark-to-market is fundamentally not about a quote on a screen,” Richard Kovacevich, chairman of San Francisco-based Wells Fargo & Co., said in a March 13 speech.

Conrad Hewitt, a former chief accountant at the SEC who stepped down in January, said representatives from the ABA, American International Group Inc., Fannie Mae and Freddie Mac all lobbied him over the past two years to suspend the fair- value rule.

Executives “would come to me in the afternoon with the argument, ‘You’ve got to suspend it,’” Hewitt said in a March 25 interview. The SEC, which oversees FASB, would reject their demands, and “the next morning their lobbyists would go to Congress,” he said.

‘Is That Fair?’

AIG’s near-collapse in September prompted a $182.5 billion government rescue of what was once the world’s largest insurer. Earlier that month, the Federal Housing Finance Agency put Fannie Mae and Freddie Mac under its control after the worst housing slump since the Great Depression threatened the survival of the mortgage-finance companies.

Banks and insurers wanted to value securities at prices they bought them for, Hewitt said. His response: “If you carry them at 100 percent of what your purchase price was and they are worth 50 percent, is that fair to the investor?”

Hewitt said nothing the SEC and FASB did curtailed the lobbying by financial companies, including issuing guidelines on how to price assets when no market exists and conducting a congressionally mandated study of fair-value accounting.

“I don’t think there was anything that would have pacified them,” short of a suspension, he said.

Bank of New York

Efforts to change accounting rules continued after the election of President Barack Obama. Bank of New York Chief Executive Officer Robert Kelly spoke with Gary Gensler, a Treasury official during the Clinton administration who was asked by the transition team to evaluate the SEC. Kelly said in an interview that while he opposes suspending mark-to-market accounting, he discussed with Gensler ways to lessen its impact. Gensler, who has since been nominated to chair the Commodity Futures Trading Commission, declined to comment.

Bank of New York would be one of the biggest beneficiaries of FASB’s proposed changes, said Jeff Davis, director of research at Chicago-based brokerage Howe Barnes Hoefer & Arnett. The company’s earnings were reduced by $1.6 billion last year from writedowns for mortgage-backed securities, according to its annual report. The bank, which said it expects to ultimately lose about $535 million on the assets, blamed the disparity on “market illiquidity.”

House Hearing

At a March 12 hearing of a House Financial Services subcommittee, lawmakers showed impatience with FASB.

“You do understand the message that we’re sending?” panel chairman Paul Kanjorski, a Pennsylvania Democrat, asked Herz.

“Yes, I absolutely do, sir,” Herz replied.

After hesitating, Herz said he would try to get a new fair- value rule finished within three weeks.

“The financial institutions and their trade groups have been lobbying heavily,” Herz said in an interview after the hearing. “Investors don’t lobby heavily.”

The political action committees of banks including Citigroup, Bank of America, Bank of New York Mellon, Wells Fargo and banking trade groups contributed money to Kanjorski’s re- election campaign last year, according to the Federal Election Commission. Citigroup gave $6,500, Bank of America $7,000, Bank of New York $8,000 and Wells Fargo $13,000.

Kanjorski spokeswoman Abigail McDonough didn’t return calls seeking comment.

Atlanta Lender

Three days before the hearing, 31 financial-industry groups sent a letter to committee chairman Barney Frank and Alabama Representative Spencer Bachus, the panel’s ranking Republican, emphasizing “the need to correct the unintended consequences of mark-to-market accounting.” The organizations included the ABA, the National Association of Realtors and the 12 Federal Home Loan banks, the government-chartered cooperatives owned by U.S. financial companies.

The Federal Home Loan Bank of Atlanta, which Kanjorski cited at his hearing as an institution hurt by fair-value accounting, would also stand to gain from FASB’s proposals.

The company, one of 12 regional institutions that provide low-cost financing to 8,000 member banks, absorbed an $87.3 million writedown on three mortgage-backed securities after determining it would not collect all the cash the assets were supposed to generate, according to a November SEC filing.

Under the FASB proposal, the reduction in the bank’s earnings would be much closer to the $44,000 that the company expects to lose, according to Brian Harris, a senior vice president at Moody’s Investors Service in New York.

‘Raging Inferno’

“It potentially moves the accounting closer to where we saw the economics of these transactions,” Harris said in a March 24 interview. “We don’t see a risk to their debt securities.”

Also endorsing the letter was the Pennsylvania Association of Community Bankers. Thomas Bailey, the group’s chairman and CEO of Brentwood Bank in Bethel Park, Pennsylvania, told the subcommittee that using fair-value accounting “in these times, is much like throwing gasoline on a raging inferno.”

Among the banks most negatively affected by unrealized losses are Wells Fargo, PNC Financial Services Group Inc. in Pittsburgh, Minneapolis-based U.S. Bancorp and M&T Bank Corp. in Buffalo, Robert W. Baird & Co. analyst David George wrote in a March 20 note to clients.

FASB’s proposals, he wrote, would “potentially provide cover for some banks that might otherwise need to raise government capital.”

To contact the reporter on this story: Ian Katz in Washington at ikatz2@bloomberg.net; Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.
Last Updated: March 29, 2009 20:01 EDT