Hudson Castle: Lehman’s Secret Risk-Shielding Tricks
The NYT digs up a secret Lehman Brothers memo about Hudson Castle — part of a financial system that enabled banks to exchange investments for cash to finance their operations — and mislead investors to make their finances appear stronger than they actually were.
NYT:
Critics say that such deals helped Lehman and other banks temporarily transfer their exposure to the risky investments tied to subprime mortgages and commercial real estate. Even now, a year and a half after Lehman’s collapse, major banks still undertake such transactions with businesses whose names, like Hudson Castle’s, are rarely mentioned outside of footnotes in financial statements, if at all.
The graphic below is a simplified explanatory of how the risk hiding worked:
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chart courtesy of NYT
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Source:
Lehman Channeled Risks Through ‘Alter Ego’ Firm
LOUISE STORY and ERIC DASH
NYT, April 12, 2010
http://www.nytimes.com/2010/04/13/business/13lehman.html
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April 13th, 2010 at 7:42 am
Yes, it would seem that when you own the government like Wall Street does then Enron accounting is perfectly acceptable. SPE’s and off-balance sheet accounting were considered a good thing because they would allow banks to lend more by reducing the necessary reserve requirements. You see from the above that what it really has become is a way to hide bad assets and boost earnings and bonuses.
I saw that Cognos was on here harping yesterday about the banks having such a large amount of reserves in excess of non-performing loans. The funny thing is that he didn’t tell you that it is the banks that determine whether or not they want to pursue a foreclosure and hence determine a loan non-performing. Essentially they can have half their debtors be behind on their payments, stick their head in the sand, and claim the loans performing. Sgt Schultz accounting, “I see nothing!!!” That is precisely what has been going on during the past three years. Add to it if they do pursue a foreclosure and get the home the property taxes etc are all their responsibility and they could be holding the overpriced cookie cutter box of dreams either for years until the local housing market recovers, or selling at a 30-40% loss if they dump it immediately.
April 13th, 2010 at 7:49 am
This morning, Iceland released its long awaited report on just what happened with its banks: Report of the Special Investigation Commission (aka Black Report). While it’s mostly in Icelandic, there is a limited English language section:
http://rna.althingi.is/ – Icelandic
http://sic.althingi.is/ – English
For an overview in English:
http://sic.althingi.is/pdf/RNAvefVidauki3Enska.pdf – Iceland’s Failed Banks: A Post-Mortem by Mark J. Flannery, Ph.D., University of Florida
I see little reason to believe the underlying core problems are any different here in the US.
April 13th, 2010 at 7:52 am
A simpler view would be to eliminate the Lehman trade of cash for commercial paper on the right, replace the cash with commercial paper on the left – Lehman traded assets (probably the ones of questionable value) for commercial paper which it then used to secure loans form JPM. Looks like a nice way to move poor quality assets off the balance sheet and get cash from JPM (and others). Seems very Enron-like.
April 13th, 2010 at 8:47 am
The Financial Accounting Standards Board (FASB) needs to be added to the list of accomplices. How do professionals permit these types of things to happen? (I naively ask)
Worse yet these types of manipulations are still going on:
Banks Lower Debt Levels Just Before Quarterly Reports
http://washingtonindependent.com/81739/banks-lower-debt-levels-just-before-quarterly-reports
April 13th, 2010 at 8:48 am
Why are they still free ranging subjects?
April 13th, 2010 at 8:51 am
good thing there’s, already, been sufficient “Radical De-Regulation is to Blame”/”Regulatory Agencies have been G*tted” thought-stream chaffing..
for, now, simple Questions, single blips, as “Weren’t We paying (supposed) Public Servants to serve as Regulators?” are lost, to the backgound.
http://www.amazon.com/Science-Liberty-Democracy-Reason-Nature/dp/0060781505
http://www.amazon.com/s/ref=nb_sb_noss?url=search-alias%3Dstripbooks&field-keywords=Popper+Open+Societies
to be abbreviated, Sometimes, it’s best to start at the Beginning..
April 13th, 2010 at 9:06 am
Notice that two of the three “cash” arrows point away from Lehman. The whole purpose for the shenanigans is the third cash arrow that points to Lehman. It’s really nothing but a bit of financial engineering that would be considered money-laundering if it were undertaken by a drug cartel.
These are the type of “financial innovations” that yielded a financial collapse. Yet all we did was prop everything up again with another “cash” arrow, this one pointing to insolvent financial firms from the US Federal Reserve. Simply a way to enhance the prospect for illusory stability and economic growth.
Yet surely, the foundation is sound. It’s really not still crumbling. “It’s over”.
April 13th, 2010 at 9:07 am
I recently read that the United States has 4% of the world’s population and 25% of the world’s incarcerated population. With all this white collar crime I begin to understand why this is the case.
But then again, living in a socialist country like France (heard on CNBC that it’s a bad place) must be a punishment in itself, so I guess I shouldn’t compare apples to pommes.
April 13th, 2010 at 9:15 am
Just like irrelevant rating agencies, FASB has become a joke! The whole Banking industry is a giant ‘smoke and mirror’ game condoned by the regulators for the past several years! Market zoomed back up 70+ on the basis of shenanigan reports of varying kind, accepted by the investing community!
If there is third party audit, the whole Banking industry is sitting on ‘quick sand’ of stability certified by captive regulators!
AMERICA, the Best Democracy Money can Buy – a Govt by, of and for Banksters!
April 13th, 2010 at 10:16 am
I wish I were a bankster, I would use the money good things: a house extension with a bar, boobs for the wife and an expensive pedigree dog to let everyone I arrived.
But until then, its drinking on the patio, down pointers and a pound mutt.
April 13th, 2010 at 10:17 am
If Ness and his sidekick can get the bookkeeper before Capone’s thugs get him on that train, we can nail these guys!
April 13th, 2010 at 10:48 am
Cool!
So, uh, what’d Lehman do with all the cash? Oh, wait… nevermind.
April 13th, 2010 at 10:52 am
“Hudson Castle” is an apt name. Quite a few of the historic “castle” homes along the Hudson were built with robber baron money back in the day.
April 13th, 2010 at 11:22 am
Maybe I should create my own shell company, and borrow money from it.
April 13th, 2010 at 11:23 am
This is one type of structure (there are several) that can be used for “collateral washing” … the modern day financial version of the old “Triangular Trade” business … In this case, it is … “questionable/marginal assets” -> to acceptable assets -> to cash …
But the real culprits in this transaction are the Rating Agencies … the people that gave the Fenway Commercial Paper – backed by “questionable/marginal assets” – the A1/P1 rating.
Financial institutions are “capped” on the total amount of A2/P2 Commercial Parer that they can hold as an investment or as collateral for a loan/repo … JPM would not be able to hold a large Commercial Paper (CP) position – as collateral – unless it was rated A1/P1 by the Rating Agencies …
So … the real question is … “How could the Rating Agencies look at the “questionable/marginal assets” – taken as collateral to ‘back-stop’ the Fenway CP – and still give that Commercial Paper an A1/P1 rating?”
hmmm … maybe because they also rated the “questionable/marginal assets” – once upon a time – and now they would have to do some real soul searching about the whole ratings process – and maybe have to lower the ratings on significant amounts of debt instruments that they previously rated “Investment Grade” … a big concession that their ratings models weren’t as tight as they thought they were and a big loss of face and revenues going forward.
The only way this structure works is if the “questionable/marginal assets” can be converted into an acceptable asset that financial institutions and investors can hold “in size” … and the only way that happens is with an A1/P1 rating on the Fenway CP.
We can talk about greed, we can talk about Lehman management’s lack of judgment and risk management controls, we can talk about better credit analysis at the financial institutions that took the Fenway CP (they should have done their “homework” on the underlying “back-stop” instead of blindly relying on the Rating Agencies A1/P1 rating) … and the list can go on and on …
But – without the Rating Agencies A1/P1 on the Fenway CP – this “pig” never flies.
April 13th, 2010 at 11:48 am
Here’s something for all you Prisoners of Manhattan to do when the weather gets nice:
Lyndhurst (Jay Gould)
http://www.lyndhurst.org/home.html
http://www.americanheritage.com/articles/magazine/ah/1970/3/1970_3_46.shtml
Kykuit (Rockefellers)
http://www.hudsonvalley.org/content/view/12/42/
…and while you’re visiting Kykuit, check out Union Church with stained glass by Matisse and Chagall: http://www.hudsonvalley.org/content/view/17/47/
April 13th, 2010 at 11:52 am
>> I saw that Cognos was on here harping
Cognos works in the biz. Cue Upton Sinclair and skip his posts.
April 13th, 2010 at 11:55 am
How is this different than Enron’s scheme?
Why aren’t they being prosecuted and jailed?
April 13th, 2010 at 12:39 pm
Saroff’s rule (http://40yrs.blogspot.com/2010/04/saroffs-rule-once-again.html): If a financial transaction is complex enough to require that a news organization use a cartoon to explain it, its purpose is to deceive
April 13th, 2010 at 2:28 pm
Here is what I don’t understand. In securities law it is a violation to make (or assist in making) any misstatement or omission of material fact in connection with the sale of a security that would be relevant to a purchaser’s decision. The SEC and state securities authorities have civil enforcement authority, including issuing orders that suspend a person’s ability to work in the securities industry.
The creative-accounting wizards can claim all they want that this sort of game-playing is technically acceptable under FASB rules. However, the Rule 10b-5 standards are not governed by the FASB. The test is simply whether there is any misstatement or omission of a material fact. Let me humbly suggest that controlling one or more separate entities for the purpose of financial statement engineering fits the definition of an omission of material fact.
It should be obvious to anyone with a brain (or with children) that if there are no negative consequences to this sort of behavior then it will continue or even expand. Why don’t the securities authorities simply find the people involved and start handing out suspensions where appropriate, even lifetime suspensions?
Wall Street learned after the dot com implosion that the individuals involved would be given a mere slap on the wrist for all kinds of securities misrepresentations. Why is it a surprise that just a few years later they would do the same thing again?
April 13th, 2010 at 5:17 pm
I just skimmed through this and I now understand why I could never be an investment banker. Not smart enough to see through the smoke. All it really is is pass the parcel, isn’t it? Why make life so complex when it could be so simple wait oh! I know…because it’s fraud.
April 13th, 2010 at 7:57 pm
In the earlier discussion on this, I had asked the question “Which counterparty would pony up $50 Billion for LEH against poor quality assets” and suggested a need to “Follow the money”. As suspected, it is now becoming clear that there was no actual money and this was just another accounting scam.
Can we please put Off Balance sheet items, Conduits etc on the “Reform” list in addition to Mark-to-Market accounting for assets. I thought this lesson had been learned after Enron but here we go again.