Wall Street’s Pitiful Penance

When the tide goes out you see who is swimming naked.Warren Buffet

On September 15, 2008 Lehman Brothers collapsed and the GFC began in earnest. Since then a lot of Wall Street’s dirty linen has been aired via the legal system, congressional hearings, documentaries and books.

Michael Hudson is one such author. Hudson wrote The Monster: How a Gang of Predatory Lenders and Wall Street Banksters Fleeced America – and Spawned a Global Crisis.

This is an extract from the book’s introduction:

As a loan officer at Ameriquest, (Mark) Glover worked on commission. He knew the only way to earn the six-figure income Ameriquest had promised him was to come up with tricks for pushing deals through the mortgage-financing pipeline that began with Ameriquest and extended through Wall Street’s most respected investment houses.

The book describes how Ameriquest (one of the US’s leading sub-prime lenders) had a ‘boiler-room’ like sales culture. Salespeople used fraudulent and deceptive practices to persuade people to enter into new loans. Citigroup bought Ameriquest in September 2007 (this was the peak of the market – typical institutional timing).

On April 7, 2010 Mr. Richard Bowen (former senior vice-president and business chief underwriter with CitiMortgage Inc.) gave testimony to the US Financial Crisis Inquiry Commission Hearing on Subprime lending and Securitisation and Government Sponsored Enterprises. The following is an extract from Mr. Bowen’s testimony:

In mid-2006 I discovered that over 60% of these mortgages purchased and sold were defective. Because Citi had given reps (representations) and warrants to the investors that the mortgages were not defective, the investors could force Citi to repurchase many billions of dollars of these defective assets.

‘This situation represented a large potential risk to the shareholders of Citigroup. I started issuing warnings in June of 2006 and attempted to get management to address these critical risk issues. These warnings continued through 2007 and went to all levels of the Consumer Lending Group. We continued to purchase and sell to investors’ even larger volumes of mortgages through 2007. And defective mortgages increased during 2007 to over 80% of production.

Here is a former senior vice-president of Citigroup testifying that he warned management in 2006 and 2007 that 60% to 80% of the mortgages Citi were on-selling to investors were duds. Naturally investors are angry.

In this culture of greed, Wall Street’s moral compass had well and truly lost its bearings. Any dissenting voices would not be tolerated – the culture was one of ‘to get along, you have to go along’.

For their boom time sins, Wall Street has been forced to pay a few billions in fines. These fines are small change to an industry that made a record profit of $42 billion last quarter (this equates to $14 billion per month).

To add insult to injury, the US financial sector has made these record profits off the back of taxpayer-funded largesse – the very same taxpayers they fleeced pre-2008.

All Reward and No Risk – Perfect

The public airing of Wall Street’s shonky practices may have left a few red-faced, but a seven figure bonus tends to diminish the embarrassment factor. Wall Street still operates by its one and only guiding principle – to separate investors from their money – and rewards those who successfully achieve this objective.

It is this guiding principle that has stymied Bernanke’s grand plan of reviving the US economy. Wall Street is using the Federal Reserve’s cheap and easy money to enrich themselves.

Since 2008 a disproportionate amount of the Fed’s freshly minted $3.6 trillion has flowed to Wall Street.

The following US household income chart from MotherJones.com shows the top 0.01% of households receiving over $23.8 million. Compare this to the 90% of US households receiving less than $30,000 per annum.

click to enlarge

In a capitalist society those who take the risks should be rewarded. I have no problem with that concept. However, Wall Street does not operate on this capitalist ideal.

They blow up billions of dollars and are rewarded handsomely for this. They bring the financial sector to the brink of destruction and are rescued by the taxpayer. The subsequent Fed funded recovery brings further bounty to these pirates.

As an example, in December 2008 Goldman Sachs shares plummeted to a record low. Perfect timing for the bank’s senior executives to receive 36 million share options – 10 times the amount they received in the previous year. With the aid of a taxpayer-funded recovery, these privileged few have cleaned up.

Why QE Has Failed the US

This is the problem with Bernanke’s theoretical solution to aid US economic recovery – those standing closest to the source receive the lion’s share and Main Street picks over the scraps.

A recent paper released by the US Economic Policy Institute observed ‘the wage and benefit growth of the vast majority, including white-collar and blue-collar workers and those with and without a college degree, has stagnated as the fruits of overall growth have accrued disproportionately to the richest households.

The paper also stated, ‘Between 2002 and 2012 wages were stagnant or declining for the entire bottom 70 per cent of the wage distribution.

This wage stagnation is why QE is doomed to fail, and I suspect is destined to become a permanent policy tool for the current and future administrations.

Below is a chart from the World Bank, comparing US household final consumption expenditure to the rest of the world.

The World Bank definition of household final consumption expenditure (formerly private consumption) is’the market value of all goods and services, including durable products (such as cars, washing machines, and home computers), purchased by households.

The US economy is highly dependent upon the consumer spending.


With stagnating income levels (for the majority), the inability to use the home as an ATM, greater levels of welfare dependency (food stamps, disability payments etc), and retiring baby boomers, how does the US economy ‘grow’?

It is obvious it can’t do it on its own; otherwise Bernanke would have turned the tap off by now. The US economy looks like it is going to be hooked up to its intravenous drip for a long time to come.

But to be on the safe side, Wall Street will continue to send its operatives to infiltrate position of power within the White House and the Federal Reserve. Better to have someone on the inside just in case some independent thinker decides to do something rash – you know, pay down debt, completely finish QE or god forbid punish banking CEOs with jail terms.

Possible Game Plan

What is the take on all of this?

  1. The financial sector will continue to take risks with our money for their reward.
  2. Official retribution for any transgressions is likely to be viewed as an inconvenience rather than a call for cultural change.
  3. Wall Street will continue to influence policy makers with political donations, the threat of ‘too big to fail’ and its own people (Paulson, Geithner, Summers et al) on the inside.
  4. The next financial crisis (probably triggered by a Sovereign default ricocheting through the bond market) will see even more demands from Wall Street to ‘save the system’.
  5. QE is here to stay as a policy tool to plug the budget deficit – the shortfall between declining tax revenues and rising entitlement (welfare and healthcare) spending.
  6. Wage increases for the majority are unlikely given the depressed economic conditions. This creates a self-defeating loop.

Probable outcomes:

  1. Wall Street does what it always does and milks the markets for all they’re worth.
  2. This creates excessive risk in the system that leads to the inevitable correction.
  3. Wall Street has had plenty of Fed supplied fuel to stoke the market fire with, so the market correction promises to be a substantial one.
  4. In the near term this creates a price depression.
  5. The continuation of QE (and don’t be surprised if QE is increased rather than decreased) should release the inflation genie from the bottle over the longer term.

The timeframe for these probable outcomes is unknown. However, thanks to the stupidity of central bank academics and the short-term focus of easily influenced politicians, every day the system is being further destabilised.

No doubt in the years to come more paper and print will be dedicated to this chapter in economic history. The main players will not be treated kindly.

This is cold comfort for those who fail to navigate their way through the treacherous waters that lie ahead of us. Unlike Wall Street executives they will have to live with the consequences of their investment decisions.


Vern Gowdie+
for The Daily Reckoning Australia


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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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