Archive for the ‘Banks and Financial Industry’ Category

As I read John Carney’s piece on CNBC.com (“In Defense of Morgan Stanley’s ‘Nuclear Holocaust'”) I decided a rebuttal of his opinion should be a post on this blog.

Among the news items this week was the release, in a civil trial, of the text of certain emails that were sent among staff at Morgan Stanley pertaining to the internally perceived quality of a mortgage backed CDO that they were preparing for the market. The emails speculated on an appropriate name for the CDO and included such labels as “Subprime Meltdown.” The emails were brought to light in a lawsuit by a Taiwanese bank that had invested in part of that CDO.

The original story was written by Jesse Eisinger in ProPublica on January 23rd and was also published by the New York Times’ DealBook that same day.

While there is a lot to ‘bite’ on, ethically speaking, in the story itself, I was particularly amazed by the defense of Morgan Stanley written by John Carney, Senior Editor at CNBC.com. Mr. Carney’s article attempts to defend Morgan Stanley from having done anything wrong. The core of his argument can be found in this statement: “There’s a big difference between selling a product to a retail investor and a bank, even a Taiwanese bank.”

Setting aside the obvious disrespectful phrase “even a Taiwanese bank” (implying that a Taiwanese bank is inherently not as competent as its Western counterparts), I find it incredible that anyone could hold out a distinction of this sort as a basis of a defense. At its foundation, this defense is the inevitable result of the caveat emptor (“buyer beware”) attitude that has permeated the financial industry for so long.

Carney goes on to say that it was no secret in the industry that Morgan Stanley was bearish on mortgage debt and that the bank had published articles on the approaching bubble as early as August of 2006. Evidently none of those articles reached the desk of then Federal Reserve chief Alan Greenspan. We all know that there were many contrary opinions within expert economic circles at that time.

Carney then points out that it is common practice, even today, for a bank to sell products to its customers that it does not itself believe to be good investments. In other words, everyone does this so therefore it is OK.

This defense of the bank’s actions is filled with flaws. I want to discuss those using my model for ethical standards, the Seven Layers of Integrity®. Quotations below are from his article, referenced above, and I encourage you to read his entire article.

The Law and Contracts and Agreements

We have laws and regulations governing the selling of securities to investors. A key focus of those rules is the attempt to ensure that the buyer is fully aware of the risks of the securities. That risk discussion is to be found in the prospectus or offering documents, not in “notes” from one of the company’s analysts appearing in an overall market assessment or industry hearsay that the bank was a bear on mortgages in general. The risks of the specific security being offered, not just the broad market or industry risks, should have been highlighted. The fact that fully $415 million of the $500 million package ended up being worthless and that this apparently came as a surprise to the buyer would raise the question of what was and was not revealed. The fact, via the emails in question, that the bank’s own staff who were putting the offering together believed it to be highly likely to default is tantamount to the bank itself knowing that the product being offered on the market was completely speculative and extremely risky. Is that how they categorized it?

The argument that these securities were not being sold to retail investors implies that for “sophisticated financial institutions” an investment bank can be less scrupulous, less transparent, in presenting the risks involved. I am not a registered financial broker or the like, and would invite the perspective of someone who is, but I am highly skeptical that an appropriate discussion of risk can be bypassed when the bank presenting the offering believes the securities to be highly risky. If that is actually acceptable, it should not be.

Professional Standards

I would like to think that people in the banking industry who hold certain securities licenses have professional ethical standards that they should adhere to just as CPA s and attorneys do. I would like to think that independence and objectivity would be part of those standards, along with placing your clients’ interests above your own. I don’t see any of that being observed in this case, nor does Mr. Carney’s defense even attempt to address those issues, other than pointing to an industry standard.

Industry Standards

The argument that “the investment banks have typically allowed clients to take the opposite sides of trades, even when they regard one side of the trade as misguided” states a current industry standard of expected behavior.  As I point out in our book, industry standards can and do violate the standards found in the Law, Contracts, Professional Standards and the other layers in my model. When they do, and this is one case where I believe strongly that they are in conflict, the industry standard will ultimately be changed.  I look forward to that day.

Community Standards – The Investing Public

Neither Mr. Carney nor anyone else can state without qualification that there were no retail investors involved. The odds are high that some were involved, albeit indirectly. For example, there could well have been retail investors holding shares of the purchasing bank that saw their investment in those shares hit when this CDO and others like it proved to be worth so much less on the bank’s books. And in general the losses on mortgage backed CDOs that were bought by municipalities, pension funds and other entities have affected retail investors and the non-investing public alike.

Interpersonal Standards and Spiritual Values

Not even raised by Mr. Carney as something to be defended, so the only flaw is that he doesn’t even mention them. Interpersonally, no one buys a second time from someone they had to sue. Spiritually, as I have said before, there is no spiritual value I am aware of that justifies what the banking industry has done to the global economy and millions of individuals in the name of greater profits for its own pockets.


Mr. Carney’s defense makes it clear that in his mind Morgan Stanley did little wrong, save for failing to teach their staff to not send emails of this sort. I don’t consider hiding bad actions to be a virtue.

For my part, and likely a large percentage of the retail investor market, the revelations coming from this lawsuit are of little surprise and may simply confirm our worst suspicions. There are so many instances of ethical failures and deception in this real world example that a reasonable person can only conclude that what the bank did in this case was simply wrong.  It is one more reason why so many of us are reluctant to return to the market even now as it is clearing the decks for new highs.

Wall Street has tarnished itself mightily, doesn’t even realize it and most likely doesn’t even care.

Other Assessments

Two other interesting opinions on the ethics of the investment banking industry are

“Wall Street Ethics Codes Make Me Want to Inhale” by Susan Antilla of Bloomberg News

“The Market Has Spoken, and It Is Rigged” by Simon Johnson, Professor of Entrepreneurship, M.I.T. Sloan School

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Yesterday’s Sunday New York Times’ business section featured a lengthy article on the proposed takeover of the New York Stock Exchange by an Atlanta based company with the unfortunate three letter acronym of ICE. Here are parts of this story that caught my attention.

ICE, the IntercontinentalExchange, is located in a modest, nondescript office building in Atlanta. There are not enough employees working there to fill the building – at least two other companies have marquees out front. ICE personnel eat their lunch in the same cafeteria with those other companies’ employees. The small personnel footprint is a direct result of the computer based management of the exchanges that ICE already has. This fact has caused anxiety among the traders on the floor of the NYSE who still handle the orders.

While ICE founder and CEO Jeffrey Sprecher maintains that he knows investors will still want a human being on the other end of the phone overseeing the trading, I doubt that he will need as many such people physically present on the pricey NYSE trading floor as opposed to sitting at computers in Atlanta or anywhere else. In short the computer leverage that is already a powerful force in the trading process is likely to increase.

At the same time, Sprecher recognizes that the flash crashes that occasionally occur with individual stocks and less frequently with an entire market, are not a good thing for the long haul. According to the Times’ story, ICE “has been praised as one of the first exchanges to put limits on lightning-quick, high-frequency trading.” Having that mind-set at the helm should be welcomed by investors, and would lend some hope to addressing the ethical issues of high-frequency trading that we have discussed in a prior post.

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The Wrapper On 2012

What a year it was. I started this blog and its associated Twitter account, @ethicsbite, in March and since that time have covered and commented on an amazing number of stories. When I scroll down the list of tweets I realize first hand the extent of ethically questionable (and many times illegal) corporate behavior in our country. Ponzi schemes, insider trading, money laundering and (in the UK) phone hacking are among the illegal. Providing financial advice to clients while your own firm profits by the reverse position is unprofessional. Manipulating the rate determination for an international banking benchmark is likely a violation of regulations. I’ll stop there as the full list would no doubt cause my readers to move on. So we’ll switch to sex.

The Petraeus sex scandal seemed to dominate the corporate ethics news at the end of the year. The New York Times story regarding Walmart’s Mexico operations was more significant in scale.  But all of that was eclipsed by juicy, titillating tales from Washington, Tampa and Afghanistan.

2012 Awards

In addition to being amazed at the plethora of unethical activity, I have marveled at the crassness of the people involved. One has to wonder how they would explain their actions to Mom.

In terms of sheer and utter crassness, the 2012 award truly has to go to the News of the World, whose employees allegedly hacked into the cell phone of a young British girl who had disappeared, then proceeded to delete some of the messages on her cell phone so they could capture potential new incoming messages. Her parents detected that something was going on and informed the police. That case led to the demise of one Rebekah Brooks, a Rupert Murdoch “protégé” and the editor of News of the World. Ms. Brooks and her husband’s relationship with David Cameron, the British Prime Minister, tainted 10 Downing Street and created a political situation that could not be ignored. As the investigation continued, Rupert found himself testifying at Parliament and Ms. Brooks was formally charged in May, together with her husband and four others, with conspiring to interfere with the investigation. She allegedly attempted to carry off the evidence in boxes she took out of News of the World’s offices. Moreover it has turned out that phone hacking may have been a relatively common tool at News of the World as close to 200 individuals, many of them celebrities and political figures, have filed suit over the hacking of their personal cell phones. News of the World was shut down by Mr. Murdoch and he subsequently re-organized the News Corp. entity.

A close second place in crassness would be Chesapeake Energy’s founder, Aubrey McClendon. Mr. McClendon showed little bounds in his use of the company’s money and making a name for himself with it. From such relatively small amounts as corporate payment of his personal staff (to be reimbursed at year end without interest on the amounts advanced) to the millions of dollars he authorized be invested in a local NBA team and the construction of a shopping mall that just happened to have eateries owned by Mr. McClendon, the CEO continually used corporate funds to “match” expenditures from his personal wealth to foster his interests. Chesapeake by this time was a publicly held company traded on the NASDAQ and the CEO’s use of money in this manner should have been overseen by the Board. But as is often the case, the Board was beholding to the CEO.  Chesapeake’s stock fell on bad times (from around $34 on 8/1/2011 to around $17 on 12/14/2012), four new independent board members were elected and McClendon was stripped of his Chairman title. But those who paid the cost were the shareholders, of course.

What Will We See In 2013?

Here are our predictions: Rebekah Brooks will go to trial. JPMorgan will further increase its reserve for bad trades by “The Whale.” No one in the investment banking industry will go to jail for anything other than insider trading. Goldman Sachs will continue to be bad. The global economy will continue to improve. Slowly. More dirt will come out regarding Walmart’s non-US operations. Somewhere in the US a bank will go under.

And there will be at least one big sex scandal.

As the French say, “the more things change, the more they stay the same.”

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Today’s biggest news on the corporate ethics front was the federal government’s settlement with Bank of America and other large banks related in part to their foreclosure processes.

According the Reuters story:

  • “The [foreclosure] reviews had already cost more than $1.5 billion. They turned up evidence that around 6.5 percent of the loan files contained some error requiring compensation, but most of those errors involved payouts much less than $125,000.”
  • Under the settlement the banks will provide “up to $125,000 to homeowners whose homes were being foreclosed when the paperwork problems emerged.”
  • Bank of America “also announced about $11.6 billion of settlements with … Fannie Mae to end allegations the bank improperly sold mortgages that later soured, and to resolve questions about foreclosure delays.”
  • “The bank is moving closer to the day when it can stop worrying about mortgages and start focusing on growth, analysts and investors said.”

This is great news for BoA and the other banks involved and the investors who lost money on the mortgage backed CDOs and other vehicles. They can get back to growth.

As for the people, often “sub-prime” mortgagees, who went through the traumas of foreclosure – locked out of their homes, their furniture on the street or ruined, their credit destroyed – the most they can get is up to $125,000. And how were they foreclosed on? Illegally. Paperwork not processed properly. Mortgages that had been sold to investors without a legal trail of ownership of the collateral – the home. Unable to pay for lawyers and court fees to protect their rights. Being told to re-finance and then foreclosed on when they followed the bank’s directions. We all remember reading those stories in the paper don’t we? And let us not forget our soldiers in uniform overseas whose homes were foreclosed in spite of clear federal law prohibiting that from happening.

Yes this was a great settlement for some and a life altering event for others.

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It is said that great events can test one’s character. This week’s storm has provided – and will continue to provide – a test of our national ethics. So far we are doing well. Professional ethics at its best has come to the fore in the past few days:

  • The actions of the NYU Langone Medical Center – doctors, nurses, staff and administrators – in reacting to the loss of power was an effort they can always be proud of. Saving the lives of young babies who were dependent upon respirators that no longer functioned; removing their patients down the dark stairwells from many floors up; and maintaining throughout a sense of order and calm was ethical professional behavior at its best.
  • The New York Fire Department, the people who never say “we can’t,” fought a raging fire in Queens at the edge of the incoming ocean in the midst of the storm.
  • The brave helicopter pilots and rescuers from the Coast Guard saved all but two of the crew of the Bounty, plucking them one by one from the massive waves in the Atlantic.

These and untold others are the many heroes we have among us. People who risked their lives to save others.

Now we have another test that will soon be upon us – a test of corporate and political ethics. The one that comes when ordinary citizens file their insurance claims.

We have some good friends who lost their home to Hurricane Katrina years ago. They were lucky enough to be out of town at the time; neighbors who stayed were never seen again. When they were able to return there was nothing left but a handful of personal items and a lot of memories. A total loss.

Many years later they were still fighting the insurance company who had their policy. Read the fine print. Disaster is tricky. Was their home destroyed by flooding? Or was it the wind? Or was it the storm surge? No camera was there to record what happened. No neighbor could serve as an eye witness. You think you have insurance… but you don’t.

Sandy is a huge insurance industry event. Enormous. My bet is that some in the industry will do everything they can to forestall and avoid paying claims. Call me a cynic, but there is a history. We will see. And regardless of who wins on Tuesday, I don’t expect any substantive new legislation that oversees the writing of the fine print to eliminate the question marks and loopholes for future natural disaster victims.

Meantime, kudos go to the airline industry. They have fine print too, but they waived the $150 change fees for people who had to cancel or desired to cancel their travel. The airlines lost money on this one and their financial health is not nearly as strong as the insurers. The airlines lead the way.

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Remember Jeff Skilling, the former ENRON CEO now serving time in the federal pen? One of Skilling’s infamous remarks while CEO was this joke: “What’s the difference between the Titanic and California? The Titanic still had the lights on when it went down.” Skilling was referring to the audacious energy trading and hedging activity being conducted by Enron that drove up the spot prices for electricity, forcing California to pay dearly. Later on we found out that Enron traders often engaged in a “game” in which market demand was temporarily created by other Enron traders for the sole purpose of driving the prices up. Enron would then profit from a trade, with California energy buyers on the other end, and release their position. Cute, huh?

This past weekend, Michael Hiltzik had an article in the Los Angeles Times discussing JPMorgan Chase’s activity in the California energy market. Hiltzik’s article was focused predominantly on the legal maneuvers the big bank and its attorneys have been taking in response to a FERC investigation of their trading activity. But along the way, almost as a sidebar to his discussion, he describes the scale of  JPMorgan’s impact in this market:

  • The bank has trading rights related to ten power generation stations in the state
  • After the California Independent System Operator, which manages the wholesale power market for California, closed a regulatory loophole, the bank found another one to exploit, thereby costing ratepayers over $ 5 million in five days
  • The bank does not actually own any power plants

JPMorgan Chase has been allegedly exploiting “loopholes” in the trading regulations and forcing consumers to pay more for their home electric bill so the bank can have more profits — at least ENRON was in the “b’dness” as Texans put it. JPMorgan is a bank. It’s time to get the banks back to banking and out of trading commodities directly for their own profits. When banks and investment banks, acting as traders for their own accounts, increase prices that ordinary people pay for basic necessities such as food, clothing (via cotton), oil and electricity, the foundation of supply and demand based pricing slips away. For the big banks to generate profits by forcing consumers to pay higher prices than market supply and demand would have dictated is unethical.

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News of the World Still Making News

Rupert Murdoch may have shut down his phone hacking London tabloid, but that hasn’t stopped it from generating news. This month’s stories include:

  • Parent company News Corp. named a new person to its Board of Directors – Mr. Alvaro Uribe, a former president of Columbia. Appropriately enough Mr. Uribe’s former chief of staff was arrested last year in connection with a case involving illegal wiretapping.
  • A number of prominent individuals have recently filed their own lawsuits seeking damages for the alleged hacking of their own phones. Among the names are Neil Kinnock, former head of Britain’s Labour Party, Stephen Byers, a former cabinet minister, and an assortment of actors and other celebrities.  A total of 53 new claims were submitted earlier this month bringing the total to 174.

News in the World of Banking

  • JPMorgan Chase may have been recently added to the list of banks included in the Iran money laundering investigation.
  • JPMorgan is also facing growing pressure in the US Senate regarding the losses in its risk management operation.
  • Freddie Mac stands to recover several $ Billion-with-a-B from various banks which had entered into mortgage repurchase agreements with Freddie Mac.
  • And then there was/is Lehman Brothers. Remember those guys? Well what’s left of their company has just sued JPMorgan Chase for over $ 2 Billion related to derivatives obligations. Lehman is also fighting JPMChase over the $ 6 Billion the big bank claims they are owed by Lehman.
  • And last but not least in the world of banking, a report just out from Better Markets claims that Americans have lost a total of $12.8 TRILLION since the collapse of Lehman Brothers.
  • In the meantime, asset manager Blackrock was fined $ 15 million by a UK regulatory agency for not following certain rules aimed at protecting investors’ money in the event that Blackrock went under.

Observation: Every piece of harm the banking industry has done ends up being an aggregate multi-billion loss for investors and consumers. Every successful prosecution ends up with a multi-million dollar fine and no one going to jail. What’s wrong with this picture?

Justice in the News

  • Stanford Financial’s former chief investment officer, Laura Pendergest Holt, was sentenced to three years in prison for her involvement in the Houston company’s multi-year ponzi operation.
  • A whistle-blower who testified against UBS was awarded $104 million by a federal court. The case was a significant test of the government’s ability to successfully award individual whistle-blowers. The particular case involved UBS’ alleged attempts to entice US citizens to evade taxes. UBS had settled with the US by paying $780 million to avoid being prosecuted.

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