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Saturday, February 9, 2013

World View: Libor-Rigging Scandal, Lying on Wall Street

by John J. Xenakis

8 Feb 2013, 3:17 AM PDT

Dept. of Justice announces civil lawsuit against S&P ratings
Royal Bank of Scotland fined $612 million for Libor-rigging
The moral bankruptcy of Libor-rigging traders
Ron Baron, Baron Capital, doubles down on lying about stock valuations

Dept. of Justice announces civil lawsuit against S&P ratings

Results of investment-grade subprime mortgage-backed securities issued in 2005-2007 (Bloomberg)
Results of investment-grade subprime mortgage-backed securities issued in 2005-2007 (Bloomberg)
As we've been saying for a long time, the Obama administration has adamantly refused to even investigate, let alone prosecute, American bankers for the financial crisis, even where there's massive evidence of fraud. (See "Financial Crisis Inquiry hearings provide 'smoking gun' evidence of widespread criminal fraud" from 2010.) I've described two reasons for this: One is that Generation-Xers, having had bad experiences with the criminal justice system in the 1980s, are unwilling to prosecute other Gen-Xers; the second is that the Obama administration benefited greatly through criminal activities of bankers because of campaign contributions.
Now the tide seems to be turning. It's becoming overwhelmingly clear that the crimes of Gen-Xers were so egregious that blaming Boomers no longer makes sense in many cases. And the presidential campaign is over, so there'll be no more political contributions for a while anyway.
On Wednesday, the Justice Dept. filed a civil lawsuit charging Standard & Poors Financial Services with effectively colluding with banks to give invalid AAA ratings to synthetic securities backed by subprime mortgages. According to e-mail messages, S&P knew as early as 2004 that their models were wrong, but they kept the invalid models anyway so that they could continue issuing AAA ratings. (See"A primer on financial engineering and structured finance" from 2008.)
The result of this fraud was disastrous, as shown by the chart above, which shows the default rate of investment grade subprime mortgage-backed securities issued in 2005-2007. AAA rated securities were downgraded (equivalent to a default) 80% of the time, even though the ratings models assume that an AAA default rate of less than 0.1%. Even BBB rated securities are supposed to downgrade or default only 1% of the time, but 100% of them failed. USA Today and Dept. of Justice and Text of lawsuit (PDF)

Royal Bank of Scotland fined $612 million for Libor-rigging

Libor (London Interbank Offered Rate) is the benchmark interest rate used in the pricing of some 1/3 of $1 quadrillion in financial instruments worldwide, so even a small change in the Libor rate can affect trillion of dollars in securities. There are about 20 banks in Europe and N. America that compare rates every day to come up with the Libor index for that day. What was revealed last year was that bankers at Barclays were purposely rigging Libor rates in order to control the values of securities that they bought and sold, in order to make vast profits. The bankers setting Libor rates at the 20 banks knew each other and did favors for each other -- raising or lowering Libor rates by small amounts so that they could all profit -- in what is being called the biggest financial fraud of all time.
For example, an e-mail message from one UBS to a trader in 2008 says:

"I need you to keep it [Libor] as low as possible. If you do that ... I’ll pay you, you know, $50,000, $100,000 ... whatever you want ... I’m a man of my word."
According to former Fed Chairman Alan Greenspan:

"Through all of my experience, what I never contemplated was that there were bankers who would purposely misrepresent facts to banking authorities. You were honor bound to report accurately, and it never entered my mind that, aside from a fringe element, it would be otherwise. I was wrong."
Greenspan is part of the Silent generation that survived the Great Depression and World War II. The reason that he was wrong is because he never dreamed that Generation-X would be so much more lacking in ethics and morals than his own generation.
On Wednesday, the Royal Bank of Scotland (RBS) was fined $612 million for "widespread misconduct" in the same Libor scandal. One RBS employee jokingly texted: "I'm like a whores' drawers. I'll send lunch around for everybody." The RBS traders were so stupid that they continued rigging Libor even after the investigation had started.Guardian (London) and Bloomberg

The moral bankruptcy of Libor-rigging traders

The stupidity, depravity and debauchery of the Libor-rigging traders is so egregious, that the public may actually be catching on to what happened. According to the Economist:

"They were said to be among the most talented of their generation, recruited after exhaustive interviews and grueling internships. They worked at firms prepared to spend small fortunes to attract and retain them lest they take their skills elsewhere. Yet the moral bankruptcy of traders implicated in the rigging of the London Interbank Offered Rate (LIBOR), one of the world’s most important interest rates, is matched only by the incompetence with which they covered their tracks.Take traders at the Royal Bank of Scotland (RBS), who left a trail of evidence in a trove of e-mails and audio recordings detailing how they set about trying to manipulate LIBOR, even after they knew investigators were looking into the issue. “We’re just not allowed to have those conversations over Bloomberg anymore,” said one trader, laughingly, in a call to another who a little earlier had asked in writing for a rigged rate. “Its [sic] just amazing how libor fixing can make you that much money,” was the verdict of another trader. ...
The scandal has also hardened the views of regulators and politicians."
If the views of regulators and politicians are really becoming "hardened," then we can expect to see a lot more investigations and prosecutions. The Economist

Ron Baron, Baron Capital, doubles down on lying about stock valuations

Ron Baron, Baron Capital (CNBC)
Ron Baron, Baron Capital (CNBC)
The Libor-rigging scandal is only a small part of the sickness that's controlling Washington and Wall Street. Lying and fraud are the norm. I've repeated named names of so-called "experts" who lie openly about stock valuations. (See, for example, "14-Apr-12 World View -- Wharton School's Jeremy Siegel is lying about stock valuations" from earlier this year.) In today's world, respectable people are gangsters, and gangsters are treated as respectable people. One of those people whom I quoted lying was Ron Baron, chairman and CEO of Baron Capital. That was about a year ago.
Well, this week Baron was back on CNBC leaving me breathless as he blurted one ridiculous statement after another. Here's what he said (my transcription):

"14,000 is where we were in the Dow Jones [Industrial Average] in 2007, so it's been flat for five years. If you go back further than that to 1999, you'll see that for the last 13 years, it happens to be the worst period in the financial history of the united states. The market is up 20-30%, companies have gone up in earnings 2 1/2 times. the reason that has happened was because we started off in 1999 at 32 times earnings, we're now at 13 times earnings. So if you go back 100 years, 200 years, 50 years, the stock market normally trades between 10 and 20 times [earnings], and the median is 15 1/2. You're now 13, it was 32 - that's the highest it's ever been. So the market is now at an attractive level, compared to its median for a very long period of time. ...We've been through civil wars, we've been through world wars, we've been through depressions, deflations, inflations, and yet the stock market has grown 7% a year for 100 years, 200 years, and so do I think it's gonna change over the next 20 years or 30 years, no. And just every now and then you go through these periods of time where not much happens it happened - I started my career in 1970, between 1966 and 1982, the stock market traded between 1000 and 600, and then in March of 1982, we started Baron Capital, the Dow is 880, and in August of that year, went to 1000, and went on the way to 14000. What I think is the same sorta thing is gonna happen in the next 10 years maybe 20 years. Everyone who works in my firm and they're gonna have the same opportunities that I had in the 1980s and 1990s - they're about to have it."
This is absolutely breathtaking in its erroneousness, since many of the figures are lies.

  • He says that the P/E ratio in 1999 was 32. That's absolutely right, and by quoting that figure, he's proving that he's using the standard definition of the S&P 500 Price/Earnings ratio (using "one year reported earnings," not "future forward fantasy earnings.")
  • He says that the P/E ratio is now 13. That's a lie. According to the Wall Street Journal last week, the current P/E ratio is 17.92.
    WSJ P/E ratio, Friday, February 1, 2013
    WSJ P/E ratio, Friday, February 1, 2013
  • He says that it was 32 in 1999 and that was the "highest it's ever been." No, the highest it's ever been was in 2008, when it went over 100.
  • He says that the historical median P/E ratio is 15 1/2. No, that's a lie. It's 14.
  • He says that the market grows by 7% per year. No, that's another lie. I did that computation on my Dow Jones historical page, and the market grows by 4.5% per year, including inflation.
  • He says that the current P/E ratio is 13, and concludes that the market is underpriced, same as in 1982. No, that's another lie. In 1982, it was at 6.79, which is very low. Today it's at 17.92, which is far above the historical average.
  • So he says that stock market will grow in the next 10 years the way it did in the years after 1982. That's a calamitous miscalculation. As I've written many times, the P/E ratio has been well above average continuously since 1995, and by the Law of Mean Reversion, the market will crash to below Dow 3000, as the P/E ratio returns to its 1982 level. (See "1-Jan-13 World View -- 2013 Forecast: Financial Crisis and China Threat")
So what should we make of this breathtaking display of stupidity? Is Ron Baron just another debauched Libor-rigging crook who thinks it's fun to defraud anyone for his own personal gain? Or is he so stupid that he's unable to do long division, and is unable to figure out how to divide price by earnings to get the P/E ratio? Well, Dear Reader, whether it's crook or stupidity, this is not a person you should trust your money with.
You have to remember, Dear Reader, that the Libor-rigging scandal was not some unique circumstance. It's characteristic of the entire financial and political culture today, in Washington and on Wall Street, where massive fraud and screwing people is perfectly OK if you can get away with it. And we've all barely begun to pay the price.

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