SEC Conceals Far More Than You Ever Imagined: Forbes

Edward Siedle, Contributor

Today we learned that an SEC whistleblower recently came forward to Congress with compelling evidence that the Commission over the past two decades has been systematically destroying records of its Division of Enforcement’s preliminary investigations once they are closed. Records related to past inquiries into insider trading, fraud and market manipulation against companies like Goldman Sachs, Deutsche Bank and AIG have disappeared from history.
While that tip-of-the-iceberg revelation may be upsetting, those of us who are familiar with SEC internal record policies have long known that far more information regarding investment crimes has been systematically withheld by the SEC from the public.
In 2000 I wrote an article entitled, “No Freedom of Information When It Comes to Money Managers” which addressed an issue that had bothered me since I began my career as a young staff attorney with the Securities and Exchange Commission. That is, while the SEC through its routine examinations of securities dealers and money managers and special investigations has over the decades accumulated a treasure trove of information regarding industry wrongdoing, the Commission has consistently and vigorously resisted making this damning information available to investors.
Ironically, an agency created to compel disclosure of material information to investors has morphed into the single most formidable opponent to disclosure of that information to investors.
The federal securities laws establish a two-tier disclosure system. Certain information must be disclosed by the regulated to the SEC and investors; other more sensitive information need only be disclosed or made available to the SEC. However, the SEC could, if it chose, make almost all of the information it collects from companies available to the public.
For example, investment advisers regularly, every three to five years, undergo inspection by the SEC for compliance with the federal securities laws. There are few surprises to the industry here; the inspection manual the SEC examiners use is made available to the industry and private companies offer mock SEC examinations for a fee.
Upon completion of an inspection by the SEC, the agency issues a letter detailing the firm’s deficiencies, if any. Given the complexity of the industry and its corresponding regulatory scheme, few firms are deficiency-free. The letters firms receive from the SEC upon completion of the inspection are not disclosed to the investing public.  I regularly review firm deficiency letters on behalf of pensions and have rejected firms based upon revelations in these letters.
If, in the Commission’s opinion, a firm’s deficiencies are extremely serious, an “enforcement” action may be recommended against the firm. At this point, there is ample opportunity for the firm, represented by counsel, to negotiate, settle, or lobby its way out of the “enforcement” recommendation. If the matter is not resolved between the firm and the agency and an enforcement action proceeds, eventually, but not necessarily, the matter may be disclosed to the public. The SEC frequently agrees to delay damaging public disclosures. Violations the SEC uncovers in an examination but determines to be less serious are never disclosed to the public.

Thanks to the SEC, the results of SEC inspections of money managers are not available to the public under the Freedom of Information Act. In 1997, the U.S. District Court for the District of Colorado in Berliner, et al v. SEC, granted a motion by the SEC to dismiss a complaint filed requesting the production of documents related to an SEC examination of an investment adviser whose registration was revoked by the SEC and was defunct.
The plaintiff alleged that the SEC examination related to a large-scale securities fraud perpetrated by the adviser. The SEC examination produced 325 pages of documents. While the court noted that “FOIA reflects a general philosophy of full agency disclosure unless information is exempted under clearly delineated statutory language” and that “disclosure, not secrecy, was the dominant objective of FOIA,” the court nevertheless ruled that the results of inspections of investment advisors were exempt from disclosure under FOIA..
Why did the court rule that such information should be held from public scrutiny?
Here’s where our story gets weird. The court referred to testimony from the SEC that “revealing the confidential commercial and personal information contained in SEC examination reports relating to investment advisors would have a devastating effect on the SEC’s ability to regulate investment advisors and would cause embarrassment to clients whose private financial records would become subject to public scrutiny.”
That right: The Commission testified against disclosure to investors. Even the judge wrote that he wasn’t convinced revealing the information would be “devastating” to the SEC, but he did share some of the agency’s concerns. The record does not indicate any investor advocacy group testified as to the benefits investors would derive from disclosure.
The argument against disclosure that prevailed in this case is familiar and tired. That is, in order to foster an environment of “full cooperation” between the agency and the entities it regulates, sensitive details collected by the SEC should be held secret.
There are major flaws in this argument. First, there is no environment of “full cooperation” between securities dealers or money managers and the SEC today. Firms regularly withhold information from the Commission regarding illegalities under the attorney-client privilege and by other means. What exists today between the SEC and the regulated is selective or limited cooperation. Of course, brokerages and investment managers will always cooperate with regulators to a degree because if they don’t, they’ll face harsher treatment.
Second, the court, while professing to be concerned about the embarrassment of clients of managers and not managers themselves, never considered an alternative that would have required disclosure of all information but the names of clients. What was really being addressed was whether Wall Street would lose credibility if all its wrongdoing was subject to public scrutiny. What would be the effect upon the financial markets if the rules were suddenly changed? Does concealment that fosters confidence benefit or harm investors? The court didn’t want to open up a Pandora’s box.
As I said in 2000, concealment of violations, illegalities and improprieties, is misleading and harmful to investors. The odds that investors will make successful investment decisions are greatly enhanced when the regularity of improprieties is apparent. Nothing is gained by secrecy and the SEC should be the last voice supporting nondisclosure.

Related Posts:

• No One's Fulltime Job: Speech at Florida Atlantic University, School of Accounting (June 1, 2006 )
• Hidden Crimes; Too Many Secrets: How Money Managers Hide Illegalities From Investors (August 1, 2000)

I think this COULD have been better written.  The point is someone (foolscrow) is seriously exposing a very serious issue on a particular wavelength which strongly support.  People really must "get up to speed' on their knowledge re bank$ter$.  I have done a banking dossier since 2007 on www.ladybroadoak.blogspot.com and a peak dollar, peak oil. (read: Klusterfuck) swicki on the same.  Rarely have I seen articles taking the broad view of The Problem.


It's too long to publish in full, but it would make dynamite weekend reading for anyone willing to accept his somewhat black and white thinking.  It is indeed a criminal syndicate above the law and not so much "evil."  A full understanding of ponzi schemes is SO essential.


So a brief excerpt and then YOU hit the link . 

Beware The Risen People, Part 1 of 3: Global Banking – A Criminal Syndicate Of Tyrants And Thieves!

by Gabriel Donohoe

[On the evening before his execution by a British firing squad for his part in the Easter Rebellion in Dublin in 1916, Padraic Pearse etched a few lines from his own poem, "The Rebel", on the wall of his cell...

And I say to my people's masters: Beware
Beware of the thing that is coming,
Beware of the risen people
Who shall take what ye would not give...
Ye that have harried and held,
Ye that have bullied and bribed.
Tyrants… hypocrites… liars!

Pearse's words were directed at the rulers of the British Empire, but today they can be addressed to a cadre of criminal bankers and their political puppets who would impose financial slavery on us all.]

The World Awakens!

In a time of unprecedented global awakening, the peoples of the nations are rapidly becoming aware of how they’ve been kept in financial bondage for centuries. The veils of deception and fraud carefully woven by a malevolent Money Power[1] are being torn apart like spider web in a gale. The outrageous criminality imposed upon mankind for generations is finally exposed for all to see.

People are fast discovering how a cunning cabal of banksters[2] conned them into giving up their labour, their property, and their freedom. They now see how years of their precious energy and toil have been stolen from them by financial terrorists who have long kept humanity in a wretched state of debt, misery, and fear.

But now the tide of wakefulness is rising fast. A tsunami of anger and indignation is beginning to roll towards the banksters and their political camp followers. A worldwide revolution against villainy and corruption grows by the day. The masses are demanding truth and justice, and the cry of their fury is fearsome and foreboding.

Fraudsters beware! Beware of the hordes who are rising from their slumber. Beware of the people who have caught you pillaging. Beware of the wrath of the betrayed. Beware of the thing that is coming… tyrants… hypocrites… liars!

Fearful of the risen people, the criminal syndicates who run the world from behind the facade of governments and suborned global institutions are terrified of losing their ill-gotten wealth and privileges, and perhaps their lives.

Zbigniew Brzezinski, a Bilderberger and co-founder of the Trilateral Commission, recently addressed the Council on Foreign Relations in Montreal and warned his fellow elitist villains about this new “global political awakening”[3].

Brzezinski said: “For the first time in all of human history mankind is politically awakened – that’s a total new reality – it has not been so for most of human history.”

Brzezinski bewailed the fact that the whole world had awakened politically and was now “consciously aware of global inequities, inequalities, lack of respect, exploitation.” He lamented that an enlightened people would no longer tolerate financial slavery and serfdom nor would they allow the stealthy move towards a single world currency which would mean complete domination of the world by the international banksters.

ttp://foolscrow.wordpress.com/2011/07/21/beware-the-risen-people-part-1-of-3-global-banking-%E2%80%93-a-criminal-syndicate-of-tyrants-and-thieves/

How to Liberate America from Wall Street Rule: David Korten

How is it that our nation is awash in money, but too broke to provide jobs and services?

by David Korten

The dominant story of the current political debate is that the government is broke. We can’t afford to pay for public services, put people to work, or service the public debt. Yet as a nation, we are awash in money. A defective system of money, banking, and finance just puts it in the wrong places.(Image by Beverly & Pack)

Raising taxes on the rich and implementing financial reforms are essential elements of the solution to our seemingly intractable fiscal and economic crisis. Yet proposals currently on the table fall far short of the need.

A newly released report of the New Economy Working Group, coordinated by the Institute for Policy Studies in Washington, DC, goes beyond the current debate  to call for a deep restructuring of the institutions to which we as a society give the power to create and allocate money. How to Liberate America from Wall Street Rule spells out the steps required to rebuild a system of community-based and accountable institutions devoted to financing productive activities that create good jobs for Americans and generate real community wealth.

Over the past 30 years, virtually all the benefit of U.S. economic growth has gone to the richest 1 percent of Americans. Effective tax rates for the very rich are at historic lows andmany of the most profitable corporations pay no taxes at all. 

Despite the financial crash of 2008, the financial assets of America’s billionaires and the idle cash of the most profitable corporations are now at historic highs. Their biggest challenge is figuring out where to park all their cash.

Unfortunately, most of those who hold the cash and the corporations they control have lost interest in long-term investments that build and expand strong enterprises. The substantial majority of trades in financial markets are made by high-speed computers in securities held for fractions of a second. Business pundits still refer to this trading as investment. It bears no resemblance, however, to the investment required to put people to work rebuilding a strong America.

Corporations are using their stores of cash primarily to buy back their own stock, acquire control of other companies, invest in off-shoring yet more American jobs, and pay generous dividends to shareholders and outsized bonuses to management.

It was not always so. In response to the Great Depression, our country enacted financial reforms that put in place a system of money, banking, and investment based on community banks, mutual savings and loans, and credit unions. These institutions provided financial services to local Main Street economies that employed Americans to produce and trade real goods and services in response to community needs and opportunities.

This system, which Wall Street interests dismiss as quaint and antiquated, financed the U.S. victory in World War II, the creation of a strong American middle class, an unprecedented period of economic stability and prosperity, and the investments that made America the world’s undisputed industrial and technological leader.

We can’t afford to pay for public services, put people to work, or service the public debt. Yet as a nation, we are awash in money.

In the 1970’s Wall Street interests began pushing a deregulation agenda that led to a transfer of financial power from Main Street to Wall Street. Wall Street’s mega-banks lost interest in real investment and developed a new business model. They now specialize in charging excessive fees and usurious interest rates, providing leverage to speculators, speculating for their own accounts, luring the unwary into mortgages they cannot afford, bundling junk mortgages to sell them as triple-A securities, betting against the clients to whom they sell the overrated securities, extracting subsidies and bailouts from government, laundering money from drug and arms traders, and offshoring their profits to avoid taxes.

The consequences include the erosion of the middle class, an extreme concentration of wealth and power, a costly financial collapse, persistent high unemployment, housing foreclosures, collapsing environmental systems, the hollowing out of U.S. industrial, technological, and research capacity, huge public and international trade deficits, and the corruption of our political institutions.

Wall Street profited at every step and declared its experiment with deregulation and tax cuts for the wealthy a great success. It now argues for extending the same measures even further.

How to Liberate America from Wall Street Rule spells out details of a six-part policy agenda to rebuild a sensible system of community-based and accountable financial services institutions.

1. Break up the mega-banks and implement tax and regulatory policies that favorcommunity financial institutions, with a preference for those organized as cooperatives or as for-profits owned by nonprofit foundations.
2. Establish state-owned partnership banks in each of the 50 states, patterned after theBank of North Dakota. These would serve as depositories for state financial assets to use in partnership with community financial institutions to fund local farms and businesses.
3. Restructure the Federal Reserve to function under strict standards of transparency and public scrutiny, with General Accounting Office audits and Congressional oversight.
4. Direct all new money created by the Federal Reserve to a Federal Recovery and Reconstruction Bank rather than the current practice of directing it as a subsidy to Wall Street banks. The FRRB would have a mandate to fund essential green infrastructure projects as designated by Congress.
5. Rewrite international trade and investment rules to support national ownership, economic self-reliance, and economic self-determination.
6. Implement appropriate regulatory and fiscal measures to secure the integrity of financial markets and the money/banking system.

How to Liberate America from Wall Street Rule is the product of extended discussions among representatives of a diverse group of organizations committed to deepening and reframing the conversation on financial reform to focus attention on the serious financial system restructuring required to build a strong new American economy adequate to the social and environmental challenges of the 21st century. It may be freely shared, reproduced and distributed with appropriate citations.

Read the report: How to Liberate America from Wall Street Rule

This work is licensed under a Creative Commons License

AMEN to all of the above.

F Buckley Lofton responds to Shaemus Cooke (Brilliant!)

F Buckley Lofton June 12  

(International Clearinghouse)

The Rich are part of the Issue. Only marginally, not the only source of the Problem. However, your commentary is critical to our thinking about the Issue. It describes the process, mechanism and aftermath but not the specific. In 1929, the Depression was caused by the so-called “greed of Wall Street.” It hasn’t changed nor is it likely to with current policies and attitudes. Criminality is so widespread as to be beyond belief – and in both Political Parties. It’s greed after all. Whether it’s an “Inside Job” or a “House of Cards” or “The Shock Doctrine,” the outcome is the same: economic devastation for most of us. Evidenced in the “something for nothing” mentality, there are people working hard to do the trades and working hard to rig the system. How is the System rigged? Just ask how much the wholesale Bankers are leveraged and WHO allowed it (WTFAI)? The Government is run by Senators and Congressmen that are largely wealthy, due to the wholesale Bankers, who control the Message. A simple reveal of where these Representative do “their Banking” will tell you. The rest is pasted in as a specific view of the Issue as follows:

The fix is one way to put it. Put another way, Hyman Minsky’s Financial Instability Hypothesis – as Commodities go up (they doubled 2002-2006) the World gets poorer. His analogy stretched back to the 1970-1974 Commodity rise with consequent results. Now, the Goldman Sachs’ and Morgan Stanley’s are raping us again. Predominantly, an SEC Rule change in June 2004, screwed the Economy and the United States blind. This was regarding Net Capital Rules (of Wholesale Banks…aka Banksters) that allowed Securities on the Balance Sheet to be leveraged at an Amount of 40:1 versus Traditional Banks by Statute are held to 10:1. Then, in 2007, another SEC Decision was to eliminate the “uptick rule.” This required every Short Sale to be transacted a Price higher than the Price of the previous trade. Having Banksters in charge of our National Security or Economy is like handing over your daughters to rapists for “safe keeping.” “Just trust us.” 

The Net Effect is a repeat of these conditions presently. A refusal to investigate by Regulatory Bodies, you know that “look forward and not back agenda” by Obama, has left the country vulnerable. The Economy is once again on the ropes…due to the Commodities Exchanges and Oil being juggled into the stratosphere. The fictitious Leverage Ratio is largely unenforceable due to the speed at which holdings are changing. Margin Calls are fundamentally crushing when leveraged at anything over 20:1, let alone the Bear Stearns and Lehman Bro’s at 50:1 or 45:1. 

Minsky’s Hypothesis is actually a restatement of the Heisenberg Uncertainty Principle. You can determine your Position (in the Market) but you can’t state your Velocity (of Trades) with precision or certainty. OR: You can state the Velocity of your Trades, but you are damned if you can show what your position (credit or liquidity) is in the Market. 

The only way for a Quantum State to be Economically feasible is a “snapshot moment” that is a controlled hiatus or period of assessment throughout the Trading Day [every two hours?]. Computers run by Regulators are the only bastion to the Barbarians at the Gates.

Sooo – there are two distinct types of traders. The industrial or commercial sector and the speculative or gambling sector. Goldman Sachs grossly underestimates the fees and profit taking by speculators. They currently control the Media Message and have more money than god to do whatever they damn well please. They have every reason to underestimate because they are largely guilty of market manipulation – a crime. Most Americans (how about 95%?) have no idea that this arena is the cause of the 2007-2008 Collapse (Depression). That was understood clearly by Paulson when he said there was to be NO INVESTIGATIONS for the TARP bailouts. Funny how that is. The number of Congressman (Senate Millionaires/ Billionaires Club and the pipsqueak Representative Millionaire Shills) that have Accounts with Goldman Sachs or Morgan Stanley or…..is fairly complete and ruinously duplicit to our Economy. The Public is largely duped by information and misdirection by the Oil Industry and paid message byte stooges that largely lie about “the Chinese and Indians driving up the Prices.” It is Speculators. (Remember: January 2008, Oil at $150/Bbl. and by May 2008, it’s at $30/Bbl.. Nice.] Period. 

Computer buys and trades are phenomenally fast and cannot be stopped with the current level of inadequate controls. The leveraged positions of these Banksters is WAY over 45:1, still. The suggested controls now present? Not likely to help.

 Removal of the Oil Contracts from speculation is IN THE INTEREST OF NATIONAL SECURITY. And placing National Security in the hands or decisions of Foreign Nationals or the Good Corporate Citizen is like giving your daughters to….that same analogy…..and expecting everything to be okay. Not likely. Or giving this market over to Corporatist Multi-Nationals is trusting their amoral behaviors will be good for the “free market,” which Bernanke has made very clear, doesn’t exist without the Fed’s “help.” (Hence the attack on Grayson by the Billionaires Club.) 

Nationalize the American Oil Industry to get a track on Renewable Energy (because if you take a Survey as to whether the American People believe these Fossil Fuel Schmoos will EVER develop or allow development of RE solutions???? Not likely). 

Reduce Capital Gains taxes to 10% and regulate the Leveraging scrupulously.

Shake the Cookie Jar Loose. All those Patents that have been seized under National Security over the last sixty years that pertain to Energy….(under the Invention Security Act of 1951…No One Know about that? One of the greatest scams perpetrated against the American People by dozens of government agencies and services……hugely fraudulent.) 

But then, who cares? Certainly not the Republican puppets of these more-money-than-God imbeciles that have de-railed virtually every good thing in this country for their gain. And sent tens of millions of Jobs overseas…and created NAFTA…..and changed banks into swindling operations where it is your problem (identity theft, huge maximized overdraft fees, PayDay Loans, hacked computer systems, MERS mortgages, etc.) and no one else is experiencing that problem? So, in that vein, if you get the Plague, get your own cure. My hope is that the Republicans get a Plague of Party defectors, realizing that these are the same idiots that refuse to correct the Economy or investigate the corruption…because they are the corruption.

So, let’s consider a Reform Measure to get things straight – for once. As alluded above, every Quarter Trading Session (1 hour: 45 minutes, or so), every firm that trades on the Commodities Exchanges would be displayed showing their Hedge Ratio (IN BIG RED NUMBERS) and their current Contract/Trade Numbers. Of course other pertinent Computer figures that our “OH SO” diligent Regulators are feign to undertake, would be PROMINENTLY DISPLAYED EVERY TWO HOURS. After all, IT IS ABOUT TRANSPARENCY, RIGHT BERNANKE/GEITHNER, ET.AL.??????? 

And then, the SEC, CFTC or Others can actually step in and halt over leveraged trading. Otherwise, kiss your collective asses goodbye to the Banksters.

Hey EVERYONE KEEP MAKING THOSE MARGIN CALLS!!!!! 

The Rich AND the Government (by not instituting IMMEDIATE CONTROLS) are destroying the Economy.

BANK DOSSIER: A Beginners Guide to Shadow Banking, Financial Crisis and Repo

By Mike Whitney

June 12 2011 "Information Clearing House"  What if I told you that the financial crisis could be explained in just two words? Would you believe me?It's true, and oddly enough, neither of the words is "subprime".


So, what are the words?Bank run. 


The financial crisis was actually a run on the banking system. Only it wasn't a run in the usual sense of the word where jittery depositors line up on the street waiting to withdraw their savings, but a run on the shadow banking system where traditional banks get their funding via short-term loans in what's called the "repo market". (short for "repurchase agreement") The shadow banking system has become a critical part of the infrastructure of the modern financial system. It provides a way for banks to move credit risk off their balance sheets, thus reducing the amount of capital they need to support their operations. 


The banks argue that this new system has made credit cheaper for borrowers which, in turn, generates more activity and growth in the economy. But, of course, the risks are much greater too, as we can see from trillions of dollars that were lost following the meltdown of 2008. These risks cannot be contained as long as shadow banks remain unregulated.


So, when did the crisis actually begin?Well, most people would point to September 15, 2008, the day that Lehman Brothers defaulted and markets went into free fall. But that's not when the trouble actually started. The trouble began a full year earlier on August 9, 2007, as Pimco's Paul McCulley recalls in his comments at the 19th Annual Hyman Minsky Conference. Here's an excerpt from the speech:


"On August 9, 2007, game over. If you have to pick a day for the Minsky Moment, it was August 9. And, actually, it didn’t happen here in the United States. It happened in France, when Paribas Bank (BNP) said that it could not value the toxic mortgage assets in three of its off-balance sheet vehicles, and that, therefore, the liability holders, who thought they could get out at any time, were frozen. I remember the day like my son’s birthday. And that happens every year. Because the unraveling started on that day. In fact, it was later that month that I actually coined the term “Shadow Banking System” at the Fed’s annual symposium in Jackson Hole....while the run commenced on August 9th of 2007, it was pretty much an orderly run up until September 15, 2008. And it was orderly primarily because the Fed.... evoked Section 13-3 of the Federal Reserve Act in March of 2008 in order to facilitate the merger of under-a-run Bear Stearns into JPMorgan. 


Concurrently, the Fed opened its balance sheet to the biggest shadow banks of all, the investment banks that were primary dealers, including most important, the big five. It was called the Primary Dealer Credit Facility....The Fed created a whole host of facilities to stop the run. In fact, they expanded the Primary Dealer Credit Facility to what are known as Schedule 2 assets, which meant that dealers could rediscount anything at the Fed that they could borrow against in the tri-party repo market.


Concurrently, the FDIC stepped up to the plate, doing two incredibly important things. Number one, they totally uncapped deposit insurance on transaction accounts, which meant that the notion of uninsured depositors in transaction accounts became an oxymoron. If you were in a transaction account, there was no reason to run. And then the FDIC effectively became a monoline insurer to nonbank financials with its Temporary Liquidity Guarantee Program (TGLP) allowing both banks and shadow banks to issue unsecured debt with the full faith and credit of Uncle Sam for a 75 basis points fee. No surprise some $300 billion was issued.


So, bottom line, you had the Fed step up and provide its public good to the Shadow Banking System. You had the FDIC step up and do the same thing with its public good. And as Paul Volcker was noting this afternoon, you had the Treasury step up and provide a similar public good for the money market mutual funds, using the Foreign Exchange Stabilization Fund." ( After the Crisis: Planning a New Financial Structure, Paul McCulley, 19th Annual Hyman Minsky Conference, Zero Hedge)


This is a great description of what happened, but McCulley is a Managing Director at the country's biggest bond fund, so naturally his perspective is different than yours or mine. From a working man's point of view, this is what happened: The banks had been creating dodgy loans that they knew would never be repaid because the mortgage applicants weren't truly qualified to borrow as much money as they did. (Many of the applicants were called Ninjas...aka--"No income, no job, no assets") But the regulators and ratings agencies looked the other way because there was a lot of money involved and everyone was getting very rich. The dodgy loans were chopped up into securitized bonds (mainly Mortgage-Backed Securities) and sold to insurance companies, retirement funds and foreign investors. Then, on August 9, 2007, the Merry-go-round ground to a halt when Paribas Bank (BNP) stopped redemptions on assets that no one really knew how to value. (So, the crisis wasn't really a "panic" as much as it was a repricing event. The market had not yet repriced these toxic assets which were plunging in value on the ABX index.)


The problem was that the banks had been using these toxic assets to secure funding in the repo market. Now that their value was plunging, the banks were becoming increasingly less liquid and less inclined to deal with other banks that they knew were also in trouble. Keep in mind, that "according to Thomson Reuters, nearly $14 trillion worth of complex-securitized products were created," through this process which put the entire global financial system at risk. So, it wasn't just subprime mortgages (which only amounted to $1.5 trillion) that caused the meltdown, but the trillions of dollars in complex securitized bonds that had been traded through shadow intermediaries. As Anat R. Admati, Professor of Finance and Economics, Graduate School of Business at Stanford University said, "Housing policies alone, however, would not have led to the near insolvency of many banks and to the credit-market freeze. The key to these effects was the excessive leverage that pervaded, and continues to pervade, the financial industry."
("Fed scholars: A run on the repurchase market caused the financial crisis and will probably happen again", Repowatch)


Understanding how the repo market works is crucial, but it's also hard to grasp. So, let's use an analogy.Let's say I need some cash to finance some other business operations I have going. So, I go down to the local pawn shop with my custom-built Maserati, my original Chagall oil painting, and my collection of Renaissance gold coins. The pawnbroker takes one look at my trove and says he can lend me $25,000 for a week, but I'll have to pay him $26,000 to get my stuff back. I say, "Okay", and borrow the money. This allows me to keep my other business operations running. Then, a week later, I return to the pawn shop and repay the money I borrowed.


Okay, so far?


So, next week I go back to the pawn shop and try to get the same deal. Only this time, the dealer has done a little research and discovered that my custom Maserati is actually a late-model Yugo with a flashy paint job; my original Chagall is actually a paint-by-numbers fake I picked up at a flea market, and my collection of Renaissance gold coins, is actually a scattering of slot-machine slugs with a pyrite finish. So the dealer gets all huffy and says he'll only lend me half of what he had before, ($12,500) But that's a big problem for me, because now I don't have the money to fund my other operations or pay my employees. So I have to dig into savings (bank capital), which makes it harder for me to lend money to anyone else. As time goes on, I am forced to sell more of my personal belongings (assets) just to stay afloat.


This is precisely what happened to the banks during the financial crisis. Financial firms that had been providing full-value for securitized bonds (my Maserati) got worried that those bonds might contain toxic subprime loans (my Yugo). So they reduced the amount of money they would lend on the bonds. These so-called "haircuts" set-off a slow-motion panic that lasted for over a year, draining nearly $4 trillion from the shadow banking system. The problem was compounded by the fact that no one knew which bundles held the worst mortgages or which banks had the biggest pile of bonds. So, interbank lending slowed to a crawl, LIBOR skyrocketed, and the credit markets went into a deep-freeze. When Lehman Brothers defaulted on September 15, 2008, the downward spiral accelerated and the entire financial system crashed. That's why Fed chairman Ben Bernanke stepped in and provided blanket guarantees on the financial assets of banks and shadow banks alike.The essential problem with shadow banking is that it allows private industry (financial institutions) to generate as much credit as they want, thus, adding to the money supply, increasing economic activity, inflating gigantic asset-price bubbles, and setting the stage for a catastrophic meltdown. Economist James Hamilton explains how this works in a recent post titled "Follow The Money". Here's an excerpt:

"If you buy a mortgage-backed security (or collateralized debt obligation constructed from assorted MBS), you could then issue commercial paper against it to get most of your money back, essentially making the purchase self-financing. This was the idea behind the notorious off-balance sheet structured investment vehicles or conduits, which basically used money borrowed on the commercial paper market to buy various pieces of the mortgage securities created by the loan aggregators. The dollar value of outstanding asset-backed commercial paper nearly doubled between 2004 and 2007.“

Yale Professor Gary Gorton has also emphasized the importance of repo operations involving mortgage-related securities. If I buy a security, I can then pledge it as collateral to obtain a repo loan, again getting most of my money back and allowing the purchase to be mostly self-financing as long as I keep rolling over repos. 


Although I have not been able to find numbers on the volume of such transactions, it appears to have been quite substantial.“The question of how the house price run-up was funded thus has a pretty clear answer: Other People's Money. Because of so much money pouring into house purchases, the price was driven up." ("Follow The Money", James Hamilton, Econbrowser)


This is how Wall Street pumped up leverage to ungodly levels and steered the financial system off the cliff. The debt-instruments and repo market were used to create a humongous debt pyramid balanced precariously atop a few crumbs of capital.Consider this, from an article titled “Liquidity Crises – Understanding sources and limiting consequences: A theoretical framework,” by Robert E. Lucas, Jr. and Nancy L. Stokey:


"In August of 2008, the entire banking system held about $50 billion in actual cash reserves while clearing trades of $2,996 trillion per day. Yet every one of these trades involved an uncontingent promise to pay someone hard cash whenever he asked for it. If ever a system was “runnable,” this was it." (RepoWatch)


Are you kidding me? 


"$2,996 trillion" in daily trading was propped up an a paltry $50 billion in cash reserves!?! No wonder the system crashed. Even the slightest trace of doubt in the quality of the collateral being exchanged in the repo market, would automatically set off alarms and trigger a panic. And it did!


So, what is the likelihood of that happening again? Are we still in danger?Yes, we are. In fact, another crisis is probably unavoidable since congress has done nothing to address the repo problem or to make the necessary changes in regulation.


Policymakers need to raise capital requirements, toughen lending standards, and ensure that trading takes place on public platforms that can be monitored by government regulators. Also, financial institutions that function like banks must be regulated like banks. Otherwise, the banks will create more structured instruments that will (eventually) spark another bank run forcing the public to bail out the system once more.


As economics professors T. Sabri Öncü and Viral V. Acharya, professors say, "Leaving the repo market as it currently functions is not an alternative; if this market is not reformed and their participants not made to internalize the liquidity risk, runs on the repo will occur in the future, potentially leading to systemic crises." (RepoWatch)


The only way to prevent another financial crisis is to fix repo, but Dodd-Frank doesn't do that.