Michael Burry, who accurately predicted the housing calamity long before anyone else, offers insight into the behavior of crowds, and those that move against them.

Michael Lewis' article in Vanity Fair, here, is a short tease for his new book, The Big Short, which exposes how Michael Burry, a hedge fund manager, accurately predicted the housing debacle far in advance of the actual crisis. The Vanity Fair article reveals how Burry single-handedly outmaneuvered Wall Street’s elite, and how this success has not ingratiated him to those he took to task.

Burry, a Stanford educated physician, is undoubtedly very smart, but this is not why Burry was able to see what others could not. It is Burry’s questioning, contrarian nature that led him to perform substantial due-diligence into an assumption that others had taken for granted: that housing was on an epic, sustained run that would never cease.

Burry’s story is a tale of two unique, if interrelated, phases. The first phase involved Burry’s tenacious slog through a thicket of documents, prospectuses and textbooks, looking for clues to the impending disaster and performing bank credit analysis on the home loans that he was analyzing, the same analysis that should have been performed by the issuing banks, but wasn’t. The second phase, convincing Wall Street to create financial products so that he could short the market, was pure genius.

Michael Burry’s analysis of the housing market and his conclusions are due primarily to his dogged due-diligence, pure and simple. This effort was nothing short of herculean in scope but otherwise unremarkable and tedious, and was the product of Burry’s tireless review of thousands of documents. Once completed, though, this due-diligence provided Burry the platform for the unshakeable faith in his ability to detect patterns and draw conclusions from within the housing bubble, and ignore the conventional and usually mistaken wisdom of crowds.

 

Category: The Economy
A recent study by three University of North Carolina researchers indicates that market short sellers profit from their enhanced ability to discern publicly available information, not from market manipulation or insider knowledge.

Common wisdom is that short sellers, those market participants attempting to capitalize on the misfortunes of individual stocks, manipulate or shape negative information to their benefit. The study, reviewed here in the New York Times, and published here, reveals that short sellers are merely very astute and perform a very high level of due diligence. These "informed traders" do not merely time the markets and information, and therefore, obtain unfair advantages over other market participants. Rather, short sellers perform effective due diligence and often prognosticate future failure or scams.

The researchers looked for evidence that short sellers' informational advantages were due to timing, and looked for evidence of abnormal short selling ahead of news events in the U.S. over the 2005-2007 period. They found no such patterns, and noted that the "ratio of short sales to total volume is nearly constant around news events." The researchers actually found that "there is a significant increase in short selling AFTER the news event" which indicates that the short sellers are trading on publicly available information.

 

Category: Wall Street Fraud
Saturday, 20 March 2010 20:36

The Edge of Empire

A profound essay suggests that empires operate somewhere between order and chaos, and there comes a moment when great empires can be collapsed by seemingly minor disruptions.

Niall Ferguson, the Laurence Tisch Professor of History at Harvard University, has written a profound analysis of the destruction of empires for the journal Foreign Affairs, reprinted here. Ferguson posits that an empire's slide into chaos is abrupt and disruptive, rather than gradual and cyclical, as traditionally thought.  

Historically, scholars seemed unified around the notion of gradual decline and phased transitions:

  1. A series of five paintings by Thomas Cole, which hang in the New York Historical Society, depict the fall of empires as a process moving through five stages: lush wilderness, a nascent agrarian idyll, an opulent merchant society, destruction from invading armies, to collapse and desolation in abandoned land.
  2. Historians Giambattista Vico, Oswald Spengler, and Arnold Toynbee share a common vision of destruction as seasonal and rhythmic. Paul Kennedy’s The Rise and Fall of the Great Powers discusses the phenomenon of “imperial overstretch”, the notion that great powers overextend themselves, economically and militarily, and create the very seeds of their destruction.
  3. Similarly, anthropologist Jared Diamond proposes a “green” theory of collapse: that empires destroy themselves by abusing their natural environments. Ferguson notes that Diamond falls prey to the same blunder that traditional historians have made, that whether the cause of collapse is economical, cultural or ecological, it occurs over a protracted period of time, often centuries.
  4. The decline of the Roman empire has been attributed to long-term, collective failures that converged to cause its collapse.
  5. Protracted decline prevents leaders from making changes, as the pain of making immediate and often costly changes is too high when contrasted to the alternative, leaving these issues to future generations to resolve.
  6. The threats facing the United States are often characterized as long-term in nature, the “slow march of demographics”, the economics of an aging population that will eventually overwhelm economic sustainability.

Ferguson suggests that the cyclical nature of destruction as a theory of empire collapse is fundamentally flawed. Empires are complex societies, delicate social, cultural and economic systems that operate fluidly, organically, and in a state of delicate stasis. Sudden, often small events or circumstances, such as those described by Nassim Taleb in The Black Swan, can disrupt this equilibrium and create a crisis of such magnitude that the entire organism collapses.

It is these “proximate triggers” that we must be concerned about, that can cause wide-spread conflagration and destruction of complex systems. Small inputs to these systems can “produce huge, often unanticipated changes – what scientists call the amplifier effect.” “When things go wrong in complex systems, the scale of disruption is nearly impossible to anticipate.”

Category: The Economy
State pension funds are significantly magnifying risk and manipulating their expected rates of returns in order to reduce massive shortfalls between actual pension funds on-hand and expected pension liabilities to their retirees.

Following the Pew Center's Trillion Dollar Gap report on the pension crisis, The New York Times reports, here, that states continue to purposely distort their expected rates of return to prevent their already large pension funding shortfalls from growing steeply. Significantly, states are also concentrating greater portions of their assets in a riskier range of investments, such as commodity futures, junk bonds, foreign stocks, deeply discounted mortgage-backed securities and margin investing in an effort to seek higher returns.

The outright inflation of expected rates of return on pension assets, often pegged at over 8 percent, allows governments to diminish their annual cash contributions to the plans, but ultimately succeeds only in deferring the pain to later years. The fiction of inflated returns on pension assets temporarily closes the funding shortfall and allows governments to ease their current budgetary constraints, but fails to address the fundamental urgency of the crisis: that pensions and retiree health care benefits are grossly underfunded.

Category: The Economy
A trillion dollar gap exists between states' pension and health care promises to their current and future retirees and the funds on hand to pay for these liabilities.

Taxpayers have, for decades, been induced into believing that unfunded pension plan increases were painless methods of increasing employee pay, especially pay for unionized workers.  Deferring the pain has left state and local governments with a massive, unfunded liability, though, and could bankrupt many state governments.

The report, published by the Pew Center on the States highlights the chasm between the promises made to government employees throughout the last three decades and the stark choices that will have to be made to pay for these benefits in the coming decades. These choices will exacerbate tensions between state government stakeholders, their citizens and employees.

The gap is roughly divided into two benefit components, pension costs and health care benefits. These benefits will increase steeply over the next few decades and will burden states and local governments with very difficult choices, namely, whether to dramatically raise new revenue by increasing the tax burden or slash services to their constituents, or a combination of both.

Category: The Economy
Tuesday, 16 February 2010 01:04

Housing Death Spiral, Pt. II

Local governments and real estate trade groups acknowledge that they are extremely worried about the inevitable withdrawal of federal assistance from the US housing markets.

The New York Times, reports here, that cities hit hardest by the collapse of the real estate bubble face significantly more distress in the coming years, as the federal government gradually removes the massive subsidies that have prevented a complete collapse of the residential real estate market, and with it, the economy. To the extent that the real estate market is functioning at all, it "is doing so only because of the emergency programs, which have pushed down interest rates on mortgages and offered buyers a substantial tax credit."

Notably, that aid has included the following:

  1. The Federal Reserve has purchased over $ 1 trillion in mortgage securities to provide liquidity to the mortgage markets. These purchases have also forcibly and artificially pushed down mortgage rates. The scope of these purchases is unprecedented.
  2. The Federal Housing Administration insures loans from buyers that have provided only minimal down payments. Studies note that buyers having little "skin" in the housing game are the first ones to walk away from their properties.
  3. The first time buyer home tax credit, which is set to expire in the spring of 2010. This credit has merely cannibalized sales from one period to another, as buyers attempt to take advantage of the credit. The net effect of the expiration of this credit will be that future sales will dip by the same number of sales that were driven by the tax credit. Essentially, the tax credit has robbed sales from future periods to artificially inflate the current period. These are little more than timing differences.

 

Category: The Economy
Friday, 12 February 2010 05:00

Screaming Fraud at Every Turn

Scott Rothstein's mess appears to deepen, as the largest Ponzi scheme ever attributed to a US lawyer increasingly appears to involve the law firm partners.

The wreckage of the law firm appears to have ensnared many of the partners, as the Miami Herald reports, here. The lawyers for the bankruptcy trustee, Charles Lichtman and Paul Singerman, allege that many transactions involving the partners were fraudulent and seek to recoup those amounts on behalf of the creditors and the bankruptcy estate.

Examples of alleged fraudulent activity by the partners include:

  1. The movement of firm funds over the past four years through "the systematic trading of checks with the law firm and payment of third parties with law firm funds".
  2. $475,000 in loans to partner Russell Adler, who purchased a New York apartment with his wife, just two months before the collapse of the Ponzi scheme.
  3. Partner Stuart Rosenfeldt charged $1 million of jewelry to his firm-issued American Express card to pay for 72 pieces of jewelry for his wife, including home furnishings, clothes, vacations, restaurant meals, exotic reptiles, etc.
  4. Rosenfeldt also transferred at least $690,000 in purported loans or salary payments to his wife on 30 separate occasions.
  5. Many of the partners received hundreds of thousands of dollars in bonuses in 2008, and immediately contributed the funds to the GOP presidential nominees John McCain and Sarah Palin.
  6. Rosenfeltd and partner Steven Lippman "typically deposited their [law firm] loan checks and then quickly turned around and disbursed the money back to the firm".
  7. Rosenfeldt also used some of his "$9 million in loans to write a check for $61,500 to Kendall Sports Bar", in which Rothstein had in interest with club owner Stephen Caputi.
  8. The law firm loaned Lippman almost $9 million, who wrote checks to third parties, including Kendall Sports Bar, directly to Rothstein, to Banyon, the largest Rothstein investor, and to Albert Peter, a business partner of Rothstein's.

 

Category: Financial Fraud
Friday, 05 February 2010 05:03

Housing Death Spiral

Housing has been in a death spiral for a few years, and the latest evidence suggests that government support is the only thing keeping the housing market from complete collapse.

Facts are facts, and the fact that housing has been on government sponsored life-support for a few years has been under-reported and ignored. The housing marketplace has not improved, and is being kept alive only through massive government intervention and systemic support. As this support is gradually withdrawn, the housing market will continue to weaken. The pincer-like effects of continuing unemployment and increased foreclosure activity will multiply the effects of the gradual withdrawal of government aid.

The New York Times, reports here, that the nationalization of Fannie Mae and Freddie Mac fifteen months ago has resulted in massive government subsidies to these organizations. Fannie and Freddie, as they are commonly known, are stockholder-owned corporations chartered by Congress as government-sponsored enterprises (GSE's). In September 2007, these GSE's were placed into conservatorship of the Federal Housing Finance Agency. As of 2008, Fannie Mae and Freddie Mac owned or guaranteed about half of the U.S.'s $12 trillion mortgage market.

The controversy over Fannie and Freddie is fueled by the fact that the government has conveniently omitted their massive liabilities, estimated at nearly $5-8 trillion in debt and guarantees, from the Federal government's financial statements. Recording their liabilities on government financial statements would dramatically increase gross federal liabilities and further weaken the US dollar, as sovereign investment funds would lose faith in the U.S.'s ability to repay these massive debts.

Category: The Economy
Wednesday, 03 February 2010 04:34

Starving the Beast

Republicans have prevailed in their efforts to rein-in future spending, as deficit-saddled US governments will find it nearly impossible to increase spending for at least the next 10 years.

The New York Times reports, here, that the Obama administration has released startling budget predictions that anticipate massive budget deficits, through at least 2020, which will render the United States nearly impotent in its ability to create new domestic initiatives to alleviate our current crisis or develop new social programs. These deficits will strangle future governments' ability to initiate new programs or provide aid to stagnant states or industrial sectors.

Starving the Beast, which refers to Republican's fiscal policy of using budget deficits via tax cuts to force future reductions in the size of government, may ultimately prevail. Bush-era tax cuts, coupled with massive spending created by 2 wars, will result in budget deficits far into the future. These deficits have been largely funded by the Chinese, who have recently demonstrated their anxiety over the situation by admonishing the US government repeatedly.

While Starving the Beast was widely discounted and ridiculed as impractical or unsustainable throughout the Reagan and Bush era, it appears that the massive budget deficits created by the wars, coupled with the Bush era tax cuts, will have the same practical effect throughout the next decade.

The resulting deficits will largely succeed in choking future administrations, including Obama, from increasing or initiating domestic spending programs, especially while America fights a 2 front war. What are the practical implications of this? Future administrations, and Congress, will have to either make drastic cuts in expenditures or raise taxes, or a combination of both.

Category: The Economy
The Florida Bar has initiated investigations of 35 of Scott Rothstein's partners, investigating trust account misdeeds and misappropriations.

The Miami-Herald has reported, here, that Florida Bar investigators are focusing on the equity and non-equity partners of the failed firm, which served as the foundation for Scott Rothstein's $ 1 billion Ponzi scheme, one of the largest in Florida history, and whether any of the partners misappropriated client trust funds or otherwise lied about the status of those funds.

That the investigation has turned to Scott Rothstein's former partners is unsurprising, given the massive nature of the Ponzi scheme that unfolded at their feet. Without concrete evidence of complicit behavior, investigators are likely wielding the only tool at their disposal: the trust accounts and the annual certifications that occur when lawyers renew their Florida Bar memberships. The highly technical focus on these largely perfunctory certifications is evidence that investigators have been unable to directly tie partners or other attorneys to the massive, $1 billion Ponzi scheme, and are seeking creative, if technical, links that tie these attorneys to the fraud.

Category: Financial Fraud
Wednesday, 23 December 2009 06:50

Duplicity in our Decade

Frank Rich of the New York Times writes, here, that the narrative of our decade has been defined by how easily we've all been duped by the con-artists in our midst. Collectively, Americans have become inured to the deception that surrounds our social, commercial, cultural and economic relationships.

Our vacuous minds have purposely ignored the fraying of these relationships and the resulting impact on our country because acknowledging this reality would require a painful acceptance of the cancer that is slowly consuming our society.

Rich notes that we have witnessed a decade of scam, fraud and misfortune in the likes of Citigroup, Fanny Mae, Ted Haggard, Enron, Madoff, Drier, housing, Stanford, AIG, Barry Bonds and Iraq, to name a few, and that Tiger Wood's fraud is merely the culmination of this era. Tiger's demise is all the more pronounced, writes Rich, because of his "sham beatific image, questioned by almost no one until it collapsed".

Rich emphasizes, though, that it is not Tiger's hypocrisy and our collective disappointment at yet another fallen hero that is remarkable, but the canyon-like gulf between Tiger's public image as a "paragon of businesslike discipline" and his "maniacally reckless life". A worse breach, though, reveals the lie of Tiger's near-obsessive dedication to building trust as the cornerstone of his public image, and also of Tiger as the paragon of corporate resoluteness and self-discipline.

Trust and its destruction have defined these frauds. Tiger purposely cultivated an image of trust and self-discipline, and ultimately became Accenture's standard bearer. Similarly, Enron, AIG, Fanny Mae and Madoff collectively hyped trust and reliability as the cornerstones of their businesses. Rich notes that "We keep being fooled by our leaders in all sectors of American life, over and over" and that after Enron, our financial leaders and government regulators should have been more careful in monitoring our financial landscape and critically analyzing the developing housing bubble.

Category: Wall Street Fraud
Monday, 14 December 2009 06:25

Miami Earns Its Reputation as Fraud Capital

South Florida is awash in illegal money, and even federal investigators can no longer ignore this area as the center of corruption.

Miami continues to uphold its well-earned reputation as being the capital of vice and corruption, as the Herald writes, here. Miami is the epicenter of Medicare corruption, yet again, and has become the focus of federal efforts to reduce fraud. According to the Herald, Medicare "paid $520 million to Miami-Dade healthcare agencies for treating diabetic patients, more than what the agency spent in the rest of the country combined". Think about that, Medicare spent more in Miami-Dade than the rest of the country!

The Herald noted that the county is home to just 2% of the nation's diabetic patients eligible for Medicare. The assessment that Miami-Dade represents a disproportionate amount of medicare and health-care fraud throughout the United States has, incredibly, taken federal investigators decades to reach. But, there's more: 1) "Miami-Dade providers accounted for over half of the $1 billion paid out nationally in 2008 for the treatment of homebound patients with diabetes and related illnesses"; 2) "The county's percentage of diabetics is lower than the rate of in other Florida areas with heavy elderly populations; 3) "No other part of the country…comes close to Miami-Dade, which is dubbed the nation's healthcare fraud capital; 4) "Medicare spends more than $15 billion on all home-care services nationwide, with one of every $15 spend in Miami-Dade"; 5) "Medicare's average cost for each home healthcare patient with diabetes runs $11,928 every two months…that's 32 times the national average cost of $378".

Category: Financial Fraud
Tuesday, 08 December 2009 07:36

The Failure of Crowds

Allen Stanford's Ponzi scheme is a stark reminder of our collective inability to discern wisdom from crowd behavior, especially when making financial decisions.

The Miami Herald published an expose, here, of Allen Stanford's final, desperate days to prop-up Stanford International Bank, in Antigua. Stanford Bank had sold $7 billion worth of fake certificate of deposits to unsuspecting investors, including the Libyan government, which was defrauded of nearly $140 million. The well-researched story, covering nearly 2 full-spread newspaper pages, details Stanford's increasing desperation and failed attempts to attract additional investors to his Ponzi scheme in its final days.

In searching for a theme, a unifying theory of Stanford's fraud, it became apparent that there was none. Stanford's fraud was brilliant for its massive scale, its sheer audacity and the garish opulence of Stanford's monthly personal expenditures, but sophisticated it was not. In fact, Stanford's scam was frighteningly simple: as long as sufficient investors were lured into depositing their savings at Stanford International and the stock market continued to escalate, Stanford and his group could continue to live extravagant lives of leisure and deception. The fraud would continue as long as inflows of funds, or investors providing new sources of cash, exceeded outflows of funds, or investors redeeming their certificate of deposits. As in Bernie Madoff's fraud, which likely occurred for 3 decades, Stanford's fraud, which occurred over a decade, would collapse as soon as this dynamic was inverted, or outflows representing redemptions exceeded investor inflows.

Category: Financial Fraud
Sunday, 29 November 2009 22:58

Societe Generale's Doomsday Scenario

Societe Generale recently published a white paper that purports to be a "worst-case-scenario" of economic predictions, but which ultimately makes a persuasive case for an economic meltdown akin to that experienced by Japan throughout its "lost decade" of the 1990's.

The report is primarily aimed at presenting its clients with practical financial guidance should this scenario prevail, but provides extensive historical and analytical comparisons to the current economy and Japan's lost decade. Among the striking comparisons and economic features of both the US and Japanese crises, these are the most compelling:

  1. Ballooning public debt: "Debt is the main constraint on US GDP growth, but reducing the excessive debt burden is likely to stall economic activity." Lower government spending will limit consumption and GDP;
  2. End of bear market rally: The rally was "fueled by restocking and fiscal stimulus". Normal consumer spending will be unable to pick up the slack;
  3. Deflation is the real immediate risk, not inflation: "The printing of money by western economies has been used only to replace the credit destroyed";
  4. Banking crisis;
  5. Property bubble: the largest asset bubble in the nation's history spawned massive, artificial consumption which will likely not be replaced;
  6. Corporate debt crisis;
  7. High valuations going in;
  8. Stock market crash;
  9. Low interest rates.
Category: The Economy
Saturday, 28 November 2009 19:50

Rothstein's Onion Peeled Back

The many layers of Scott Rothstein's Ponzi scheme continue to be peeled back, revealing a tangled web of Madoff-like feeder funds, alleged co-conspirators, and vast sums of money being transferred throughout the world.

The Miami Herald reports, here, that Rothstein moved money to Venezuela, Switzerland and Morocco, and used dummy Delaware corporations to disguise his ownership stakes in real estate holdings and other assets. The Miami Herald also reports, here, that a feeder fund may have contributed close to $2 billion to Rothstein over a 2 year period.

Unfortunately, the media's focus has been on Rothstein's opulent living arrangements, including fancy cars, boats, condominiums, watches and mansions. These assets, as dramatic and sensationalistic as they are, represent but a miniscule portion of total contributions by investors. Even assuming that Rothstein accumulated $100 million in trinkets, baubles and cars, that still leaves the vast portion of the money unaccounted for. For those of us unaccustomed to wealth, it is incomprehensible to understand how difficult it is to spend vast sums of money on tangible goods and assets. No, most of the investors' funds were not spent on Rothstein's junkets, but were likely dissipated throughout the world in a flurry of wire transfers, and are quite likely parked in exotic locales that have poor regulatory structures or banking laws.

Category: Financial Fraud
Monday, 23 November 2009 22:51

Wall Street's Smarts Exposed

As Wall Street became the destination of choice for MIT and Harvard mathematicians and physicists throughout the last decade, alarm bells should have sounded at our regulatory and policy-making institutions.

An interesting op-ed piece by Calvin Trillin appeared in the New York Times recently, here, that caps a recent trend exposing the so-called genius of Wall Street as a fraud. Other Times writers, including Joe Nocera, here, Dennis Overbye, here, and Steve Lohr, here, have tackled the subject of Wall Street's smarts, but none as succinctly as Mr. Trillin. In the op-ed, Mr. Trillin claims to have met a man in a Manhattan bar who summarized the cause of the financial system's near-collapse: "Because smart guys had started working on Wall Street." This overly simplistic analysis became profoundly interesting as I continued reading, and developed into the following rubric:

  1. Fortune and academic standing on Wall Street are historically inversely correlated, with Wall Street's millionaires graduating in the lower third of their class;
  2. The lower third, who usually made generous livings on Wall Street, became enamored of potentially huge fortunes, and began leveraging their businesses;
  3. Top graduates, who typically became physicists or judges (tip money on Wall Street), instead began calculating arbitrage risks for hedge funds and other investors;
  4. The top graduates, who were very smart, invented credit default swaps and other derivatives, enabling the lower third to become obscenely wealthy;
  5. Wall Street nearly collapsed largely due to derivatives and credit default swaps developed by these very-smart people.
Category: Wall Street Fraud
Monday, 16 November 2009 19:32

The Millionaires Club

It bears worth repeating that the most interesting aspect of many of the recent Ponzi schemes that have surfaced, among them Bernie Madoff's and Scott Rothstein's, is not the motivation that propelled these individuals to commit these frauds, but the rationale of seemingly sophisticated investors and wealthy individuals to dispense with the due-diligence that would typically accompany investments in these funds.

This unexplored angle to these stories deserves significant scrutiny, not because it will prevent future fraudulent activity or greatly assist in the forensic examination of these crimes, but because it will shed light on the dynamics of human behavior and psychology, which are far more interesting and compelling. Most reporting of these stories attributes investor behavior to greed or the desire to earn outsize returns in a market largely devoid of enhanced earning vehicles.

This easy answer is convenient and may even be partially correct, but only strikes the surface of the dynamics and drivers that precipitated these frauds. Indeed, if greed was really the motivating factor for these investors, then it would be very easy in the future to trigger warning flags and alarms throughout the investment community once tell-tale characteristics or badges of fraud are detected, and prevent yet another scheme from hatching.

Unfortunately, human behavior is not nearly so linear, predictable or well-defined. Something much deeper, more profound, yet subtle was at play in at least these two frauds: our constant desire to receive attention from or align ourselves with elite membership in exclusive social organizations or clubs that are not otherwise available to "everyone else". It's really that simple.

Category: Financial Fraud
Friday, 13 November 2009 22:56

Is There Any Doubt Now?

Is there any doubt that the federal government is now propping up nearly the entire housing market?

The New York Times reported here that the Federal Housing Administration, FHA, the government agency whose loan-insurance programs have essentially prevented the entire housing market from collapsing, is in severe trouble and has dwindling cash reserves. The agency has admitted that its cash reserves had dwindled to 0.53 of the total portfolio of loans held, far below the mandated 2 percent minimum. The FHA has acted as a backstop for the nation's housing markets, ensuring that marginal buyers are approved for loans with minimal down payments.

The politicization of the goals and loan policies at FHA was nearly guaranteed following the collapse of the conventional housing market in 2007 and the federal takeover and subsequent bailout of Fannie Mae and Freddie Mac. Freddie and Fannie have been propped-up by the Federal Reserve for the last two years, which has purchased a significant percentage of the securitized mortgage products issued by the two agencies in the absence of conventional buyers. Now, FHA may require federal intervention to prevent its own collapse. With no plan for the eventual re-capitalization of Fannie or Freddie on the horizon, it is now virtually guaranteed that the federal government will continue to play the most important role in the nation's housing markets for years to come.

What's truly alarming, though, is FHA's rather transparent efforts to conceal the extent of its problems. By lowering its loan underwriting criteria and extending loans to larger pools of risky credit borrowers, the FHA is hoping to reduce the overall percentage of currently delinquent loans relative to its total loans outstanding.

In effect, the FHA is extending more loans to marginally poorer credit risks, inflating the size of its overall loan portfolio, and then claiming victory, as the overall percentage of its delinquent loans declines relative to total loans. This may, though, ultimately become a pyrrhic victory of sorts if the housing market continues to deteriorate and foreclosures continue to accelerate. FHA is essentially betting that it can outrun its problems by increasing the size of its balance sheet.

These are the same bets made by speculators and other investors at the height of the national euphoria that engulfed this nation, and it was painfully obvious how this dynamic played out. Politicizing FHA and forcing it to play an even greater role in the housing markets is a recipe for disaster.

Category: The Economy
Thursday, 05 November 2009 19:11

Has Anyone Learned Anything?

Another week, another Ponzi scheme emerges: Scott Rothstein, a prominent Broward County, Florida lawyer, has been accused of orchestrating a scheme to bilk investors of hundreds of millions of dollars.

The ruse involved the sale of legal settlements finalized by Rothstein, acting as plaintiffs' lawyer, to wealthy investors, who would pocket the difference between the present value amount paid to plaintiffs in legal cases and the future value of the installment amounts negotiated with defendants. The spread between the present value of the settlements and their future, installment value represented profit, and was marketed aggressively to high net-worth investors seeking high yields and returns. Broward County's Sun Sentinel, which has closely tracked the story, reported yesterday that a local bank, TD Bank, apparently maintained the bank accounts for the investment business.

What is remarkable about this purported fraud are the similarities it shares with other, recently discovered financial schemes: Bernard Madoff (fake investment accounts), Allen Stanford (fake certificates of deposit), Marc Dreier (fake securities and notes), Scott Rothstein (fake legal settlements) and a host of other, lesser known individuals, including recent allegations of missing funds leveled at Lewis Freeman, the Miami court receiver and forensic expert.

The substantive similarities between these schemes is remarkable: 1) The schemes themselves were all fairly unsophisticated and noteworthy for their relative simplicity; 2) they were perpetrated over many years and had long "shelf-lives"; 3) most involved industries that were either highly regulated (Madoff and Stanford) or faced Bar review of their activities (Dreier and Rothstein); 4) all involved highly sophisticated investors with the wherewithal and means to conduct extensive due diligence; 5) all involved schemes that should have been easily uncovered by even cursory due diligence or review, and 6) all involved "feeder funds" or hedge funds, which funneled other people's money into the fraudulent schemes.

Marc Dreier's scheme is remarkably similar to Mr. Rothstein's, in that both Mr. Rothstein and Mr. Dreier were prominent attorneys, and both attempted to sell bogus securities, notes or settlements to unsuspecting hedge funds or investors. Mr. Dreier's story is eloquently discussed by Vanity Fair's Bryan Burrough, and attempts to discern the motivation that propelled Mr. Dreier to steal hundred's of millions of dollars from unsuspecting hedge funds.

Category: Financial Fraud
Monday, 26 October 2009 20:47

Magical Thinking and Denial

Denial is a powerful emotion, especially when coupled with an avalanche of media hype and feel-good sensationalism.

Our economy has just weathered the most severe downturn in 70 years, and it's business as usual for Wall Street and bankers. The increasing disconnect between the pain of Main Street and Wall Street's prosperity is numbing, given the increasingly dour news befalling consumers. The current pain merely illustrates that for average Americans, the last 8 years was a mirage, an episode of magical thinking where debt became income and homes became assets.

Truth be told, though, this illusion has been repeated in every asset bubble of the last thousand years. The resulting collapse, was, sadly, completely predictable. Because humans have such short memories, the past repeats itself in almost eery lock-step, just ask the Dutch about those thousand-dollar tulips.

Category: Wall Street Fraud
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