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In the financial industry, deregulation has been a disaster. So has regulation. Damned if you do, damned if you don’t. In the past decade, the big Wall Street banks have concocted one highly complex swindle after another to conceal their own liabilities and those of their clients, including companies, cities, and countries. But the regulators have stood by and let it happen — even stating in writing that extremely dubious financial instruments were okay.

Feckless regulation and reckless banking have gone hand in hand.

Early this month, the New York Times ran an op-ed by four law professors telling how Wall Street has bullied its regulators. The Enron debacle of 2001 had revealed how the big banks created complex products whose only purpose was to help companies transform their debt into capital or revenue — rather like changing feces into chocolate ice cream. Shareholders of shaky companies and citizens of debt-besotted cities and countries have been completely bamboozled by phony maneuvers that have been going on for years.

“Complexity was what made it possible to hide debt, avoid capital requirements, and evade taxes,” said the Times. I have said for years that “contrived complexity is the essence of white-collar fraud,” and Wall Street derivatives cooked up by MIT mathematics Ph.D.s are a classic example of the genre.

The various bank regulators, including the Federal Reserve, felt they had to react to the public uproar over Enron. In 2004, they issued a milquetoast statement on complex instruments. But the pronouncement said these products should not be used to evade the law and financial institutions should be sure that buyers of the instruments understood them.

The banks howled. The regulators caved. In 2006, the weak-kneed regulators came out with another explanatory paper, “Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities” (italics mine). Get this: the regulators defined “complex structured finance” transactions as those that “lack economic or business purpose” and are “designed or used primarily for questionable accounting, regulatory or tax objectives.” Asked the professors in the Times, “How does one propose ‘sound practices’ for practices that are inherently unsound?” Good question.

The professors stated their own opinion: “Products having no economic purpose except to achieve questionable accounting” or products that customers will use to “issue materially misleading financial statements” should be prohibited. That’s a no-brainer. Illegalities should be illegal. But the regulators didn’t ban them. It was like a preacher singing the praises of sin.

No wonder the banks went loco creating products that led to fraud. It was hardly surprising that the banks’ irresponsible product creation, gambling, and piling up of debt almost pushed the world’s economy off the cliff — and still might.

American taxpayers rescued the crooked financial institutions, which then used the money partly to hire lobbyists to thwart reform. I asked San Diego financial experts about our banking dilemma: laissez-faire doesn’t work, but neither does regulation. What can we do? “Banks should be broken up so no bank is ever too big to fail again,” says Carlsbad money manager E. James Welsh. The most complex instruments — derivatives — “should be standardized and traded through a central clearing house.” Regulators would referee the process.

Del Mar’s Arthur Lipper III, who belongs to a longtime powerful Wall Street family, says whistle-blowers should be rewarded as fraud penalties are increased. “It is only in creating whistle-blowing rewards and severe penalties for those involved in breaching regulations that regulatory enforcement can be timely and successful,” says Lipper. “Once identified, the guilty parties and abettors — including involved law and accounting firms — should be dealt with harshly.”

Agrees San Diegan Gary Aguirre, former investigator for the Securities and Exchange Commission, “Call anybody in the SEC and ask what’s the best way to deter violations of securities laws, and 90 percent will say, ‘Put them [violators] in jail.’”

In 1999, Congress passed the Gramm-Leach-Bliley Act, which repealed parts of the Glass-Steagall Act of 1933. Glass-Steagall had mandated the separation of investment and commercial banks. The 1999 act allowed the various Wall Street firms — investment banks, securities firms, and insurance companies — to consolidate. Gramm-Leach-Bliley gave big banks “a pass to the gaming tables some call the financial markets,” says Aguirre, who is now in a pitched battle with his former employer, the Securities and Exchange Commission. While at the agency, Aguirre had wanted to interview one of Wall Street’s biggest big shots; top-level bureaucrats at the agency blocked the move and fired Aguirre. Congressional investigators and the agency’s own internal inspector general said Aguirre was right to press for the interview and his firing was unjust. But the agency is still fighting his claim before the Merit Systems Protection Board.

Both Aguirre and Lipper point to the so-called revolving door: lawyers at the regulatory agencies protect crooks, then go to work for $2 million a year for Wall Street law firms or brokerage houses. “As long as it is the Wall Street law and investment banking firms which are the likely future employers of many employees of regulating agencies, it is unlikely there is going to be stringent enforcement,” says Lipper. The Wall Street law firms completely control the Securities and Exchange Commission, says Aguirre. On Friday the agency made damaging charges against powerhouse Goldman Sachs; to establish credibility, the agency must not back down.

Welsh points out that as the housing bubble inflated, mortgage originators packaged and sold the loans to Wall Street, which then securitized them and peddled them to investors. So lenders had no incentive to make sure the borrower could pay off the mortgage. “Go back to the old lending standards, which required buyers to allocate no more than 33 percent of their income for a mortgage payment,” says Welsh. And once again, mortgage originators must verify borrowers’ income — no more liar loans. Mortgage originators should be forced to hold 5 percent of the mortgage “and be first to absorb any loss.” And rating agencies, which gave AAA ratings to securitized mortgages that were a bunch of junk “should be paid by the buyers, not the issuers.” It’s amazing that this blatant conflict of interest has gone on so long.

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Comments

Anon92107 April 21, 2010 @ 12:46 p.m.

"But will anything be done? “The odds of any of these changes becoming reality is near 0 percent,” says Welsh. “Both political parties are owned by powerful lobbies” — and Wall Street’s lobbies are among the most potent."

Don, you've made this conclusion thousands of times in as many ways over the decades and the fact is that's all that needs to be said to reach the ultimate conclusion that American Democracy is "damned" to decline and fall like most others before ours because we keep proving that voters aren't intelligent enough to vote.

And we just do not have enough people in government who are dedicated and capable of saving America for future generations, so nothing will be done because it is probably already to late to protect enough resources and environment to sustain acceptable quality life for much longer.

One worst case scenario to prove this is Mayor Sanders who is destroying public safety and health resources as fast as he can just to save his own fortune gained from corrupt politics his entire professional life.

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Don Bauder April 21, 2010 @ 12:54 p.m.

Response to post #1: Government employees used to claim, at least, that they were "public servants," working in the "public interest." But look at all the grossly overpaid City of San Diego employees, with obscene pension benefits. Their resistance to reform, even as the City lies close to bankruptcy, proves how little they care about the public interest. It's the same in L.A. and hundreds of other U.S. cities. Best, Don Bauder

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a2zresource April 21, 2010 @ 4:39 p.m.

If the odds are pretty much zero on anything being done to protect us from extreme bankers hooked on exotics like derivatives and other "synthetic" products, then reasonable people need to find ways to exists economically without a banking system that has a tendency to march lockstep off a cliff every so often. That goes for mega-insurance giants like AIG.

If the business is too big to fail, then it's probably too big to care if it ever does a legitimate service for most of its individual customers. Likewise, it probably is a business that most of us won't miss when its gone anyways.

In Encantostan, there seems to be a brisk trade in baked goods for labor-intensive services, home remodeling for auto repairs, and bartering in general. Personally, I only swap for goods that have depreciated to the point of having only minimal salvage value... it reduces tax liability in a barter deal to trade things at zero value for zero value.

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Don Bauder April 21, 2010 @ 5:49 p.m.

Response to post #3: I think we will get a financial reform package -- possibly this year. It may have some teeth; don't count on too much. I think it might call for derivatives to be traded publicly on an exchange that will be somewhat regulated. At some point, Wall Street may be forced to examine synthetics, which in my opinion are strictly gambling, having nothing to do with investing. Down the road, mortgage reform could come, too. Best, Don Bauder

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Don Bauder April 21, 2010 @ 8:22 p.m.

Response to post #5: I heard that Krugman interview and was impressed. I am a regular follower of his columns. Of course that is what happening: the Republicans are huddling with Wall Street. Their strategy: claim that it is really the Republicans that want to abolish "too big to fail." This is, of course, another political lie. The Democrats want to cash in on the public's hatred of Wall Street. The Republicans want to help Wall Street but try to convince the public they are actually more for reform than Democrats are. It's startlingly disingenuous, even for Washington. I don't know whether it will fly. Best, Don Bauder

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Fred Williams April 21, 2010 @ 9:15 p.m.

Take the time to watch this video:

http://mitworld.mit.edu/video/760

The former chief economist of the IMF speaking at MIT...talks about regulatory capture.

He asks the rhetorical question, "If you were given official permission to drive as fast as you like with no fines, wouldn't you be tempted?"

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SurfPuppy619 April 21, 2010 @ 9:39 p.m.

“Banks should be broken up so no bank is ever too big to fail again,” says Carlsbad money manager E. James Welsh.

Amen to that!

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Don Bauder April 22, 2010 @ 7:14 a.m.

Response to post #7: The banks worked it so they could conceal their liabilities through extremely dubious maneuvers -- some offshore -- as regulators looked the other way. The SEC is thinking of stopping banks from hiding their liabilities just before their quarterly reports, then putting them back on the books after shareholders are duped. Best, Don Bauder

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Don Bauder April 22, 2010 @ 7:15 a.m.

Response to post #8: "Too big to fail" AND "too interconnected to fail" have to go. Best, Don Bauder

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Twister April 22, 2010 @ 11:41 a.m.

Digression, Diversion, Division, Deception--and Stonewalling, these are the elements of the art of manipulation.

While discussion that goes somewhere (point-by-point responsiveness rather than disconnected comments) helps to move the ball down the field, just yakety-yak disperses scarce energy that could be used to build toward actual action. This apparently disconnected comment, for example, is either relevant to the core of what works and doesn't work or it isn't. It can be judged by the whine index--is it just whining, just "opinion," or does it address a relevant generic function (or dysfunction)? Does it provide a foundation even though it clearly does not add a single block to the wall?

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Don Bauder April 22, 2010 @ 12:59 p.m.

Response to post #11: If you're too old and feeble to add a brick to the wall, then whining is one's only alternative. Only a relative handful have the power to add a brick to the wall. Best, Don Bauder

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zollner April 22, 2010 @ 4:10 p.m.

This country has been screwed since 1913 when the Federal Reserve Act was passed. We gave away our right to print and coin our own money according to the Constitution. Lincoln paid for the entire Civil War with the 'Green Back" after he went to the Bankers and they wanted to charge him outrageous interest rates.Wilson sold this country down the river to get elected, by taking money from the Bankers. Unless we get rid of the Fed and take back our right to run our own finances we will continue to have endless wars and endless interest payments to the international bankers.

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Don Bauder April 22, 2010 @ 6:07 p.m.

Respose to post #13: To be sure, the Fed has made many bad moves, but a government-run central bank can be worse. Look at the history of some Latin American central banks inflating the currency every time a crisis came along. Best, Don Bauder

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Don Bauder April 23, 2010 @ 6:42 a.m.

Response to post #15: Wars and inflation go together. Ditto for taxes. And ditto for economic booms. Best, Don Bauder

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SurfPuppy619 April 23, 2010 @ 8:13 a.m.

we will continue to have endless wars and endless interest payments to the international bankers

Well, before 1980 we were the largest creditor nation in the world-and always had been. Since then we have become the largest debtor nation (and that won't be changing anytime soon).

So you cannot really claim that the Fed is the reason we have huge interest and debt owed to others countries. Terrible fiscal policy is the reason IMO.

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Don Bauder April 23, 2010 @ 9:38 a.m.

Response to post #17: Bad fiscal policy is one reason the U.S. is such a big debtor nation. One major reason is that consumption is 70% of the economy; we encourage consumption and discourage savings, greatly to support countries such as China that are financing us. Best, Don Bauder

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Twister April 24, 2010 @ 7 p.m.

Re: 12

Don, you have built a skyscraper of the intellect, and helped us all build toward a level of understanding of a dismal "science" that is deliberately writ in code by the truly evil and insane. Without you I would be in a padded cell. As it is, I am just wandering in the wilderness, but that's not your fault.

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a2zresource April 24, 2010 @ 8:50 p.m.

" 'Wall Street bankers are not your friends and cannot be trusted to do the right thing' " (#5).

Corporations such as large banks are literally artificial persons with certain rights under the laws of their states of incorporation (as opposed to natural persons such as you, me, or even the "illegal alien"). Acts of the state of incorporation (such as creating artificial persons) must be respected by other states per US Constitution Article IV. In each state, the corporation's first duty by law is to its shareholders.

Peculiarly, a corporation's first duty is not to the state that created it nor the laws of the several United States separately or as the Union. This would make a corporation a poorly-disciplined militia member if there was ever an emergency need for its services. Recent history shows that more often it is the corporation that needs the bailout due to its own "bigness", as if we had a beneficial interest in keeping alive the economic equivalent of a malignant life-sucking tumor.

A logical corollary to this is that corporate officers and corporate legal counsel must be viewed with true suspicion, for they serve a master that which does not uphold the law as its first duty. This probably why corporations were rarely created by the English Crown up until the time when California Civil Code section 22.2 deemed all English common law as precedent unless our own legislature or the people take up the task of making law in the sovereign state of California (http://www.leginfo.ca.gov/cgi-bin/displaycode?section=civ&group=00001-01000&file=22-22.2).

The Crown understood the danger of arbitrarily creating other "kings" or viceroyalties of realms at least partially carved out of his own.

The only financial institution to be trusted is the one which makes all of its natural customers -- or better, all natural persons in its state of incorporation -- stockholders at the time of it's creation, In that way, the corporation will then be bound by law to the interests of everyone as residents of the service area or state it serves.

By that definition, we should be able to trust credit unions when their interests coincide with our own...

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Don Bauder April 24, 2010 @ 9:26 p.m.

Response to post #19: Those Wall Street folks are evil but they aren't insane. They have all their faculties, and then some. It's just that they apply their brainpower full time to relieving others of their money -- ethics and honesty be damned. Best, Don Bauder

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Don Bauder April 24, 2010 @ 9:35 p.m.

Response to post #20: Very interesting interpretation. I have always liked credit unions. Does your logic apply to cooperatives and mutual insurance companies? Incidentally, I'm not sure that in all 50 states a board's only constituency is its shareholders. It certainly is true in Delaware, where so many companies are incorporated. The Delaware courts are notorious in upholding that mentality. But I believe that some states are enlightened and recognize that boards have other allegiances. That used to be true. But I may be wrong on that now. Correct me if I am. Best, Don Bauder

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a2zresource April 24, 2010 @ 10:39 p.m.

RE #22:

I think I just set myself up to looking at lots of state corporation codes...

Mutuals were the only thing I liked when I attempted to take the California insurance agents' course, as part of becoming a recruited Primerica independent operator before the collapse. I can sleep well now because I chose to not finish and work under that Citi component.

Cooperatives seem OK as well.

I just don't like setting up corporations as entities in places where obedience to the state (and thus the intent of state law as the express will of the people) is not the paramount interest of officers and counsel. In my opinion, that problem goes a long way to explaining CCDC and SEDC as corporations masquerading as redevelopment agencies but not really under City control.

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Don Bauder April 25, 2010 @ 7:54 a.m.

Response to post #23: I have always considered Primerica a pyramid scheme. Yet Citi paid a bundle for it. And I agree that CCDC, in particular, is not under City control, effectively. It was never meant to be. From the beginning (it was set up under Pete Wilson), CCDC was designed as a vehicle to pour money downtown and enrich real estate developers. CCDC's staff has always been filled with people from the real estate development industry. They rotate in and out of private sector development jobs. Here they are trying to lift their cap so the City can subsidize two-thirds to three-fourths of a stadium for the Chargers, while firefighting is scaled back, other services are slashed, and neighborhoods are completely ignored. CCDC should be abolished. Best, Don Bauder

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Twister April 25, 2010 @ 10:03 a.m.

Fie upon ALL fiefdoms, especially the Port "District."

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Twister April 25, 2010 @ 10:24 a.m.

'Management must be judged not only by the quarterly dividend, but by innovative plans to stay in business, protect investment, ensure future dividends, and provide more jobs through improved products and services. "Long-term commitment to new learning and new philosophy is required of any management that seeks transformation. The timid and the fainthearted, and the people that expect quick results, are doomed to disappointment."' http://en.wikipedia.org/wiki/W._Edwar...

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Don Bauder April 25, 2010 @ 8:38 p.m.

Response to post #25: You are so right. The Port is a fiefdom with an extremely shabby record through the years. Best, Don Bauder

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Don Bauder April 25, 2010 @ 8:41 p.m.

Response to post #26: Good theory. But most companies today focus on one thing: pleasing Wall Street with the next quarter's revenue and earnings per share. There is almost no long-term thinking on Wall Street. Unfortunately, that drifts down to the corporations, too. Best, Don Bauder

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TeaDrinker April 28, 2010 @ 11:23 a.m.

Don--

Thanks again for ripping the blankets off of those in bed together. A number of us have been talking for years about the lack of responsibility, ethics,and accountability the current generation of govt. and business leaders have shown. Please tell me if there's a difference between the Wall St. crowd taking the country--and the world--for a roll,because they knew they could get away with it, and the San Diego City Manager, Council and Mayor rigging the pension system in their favor and just about so far bankrupting the City. They are all one of a kind: McGrory, Murphy, Golding,Uberraga, Herring, Ed Ryan, Webster, Lexin, etc. They all feel, I'm sure, that what they did was okay, even today. This local gang has had no sense of shame or remorse for what they have put the taxpayers through. And they are no different from those in Congress who are doing exactly the same thing.

Would that we could put these people in jail for what they have done. Elected officials wreak damage on society, and then walk away from the destruction, with huge pensions.

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Don Bauder April 28, 2010 @ 11:53 a.m.

Response to post #29: There are few if any differences between the weak regulators/bandit businesses on the national scene and the bureaucrats/establishment in San Diego. In both cases, government is doing the bidding of the business community instead of providing important referee services. Nationally, the financial industry almost led us to the brink beginning in 2007 and yet the milquetoast regulation will continue. San Diego is technically insolvent for some of the same reasons. There were no controls on business. Here's a prediction: there will be no meaningful regulation nationally, and we will have more bubbles and another crash in a few years. (Unemployment will stay high right through the entire period.) The San Diego business/bureaucrat nexus will go ahead and build a convention center expansion, new city hall complex, schoolbrary (even though there is a high school 9 blocks away) and Chargers stadium, despite the horrendous subsidy that will be necessary. The City will go broke. (Actually, it already is broke. It will just get much worse.) Both the national and local situations would have been better had government had the backbone to say "No!" Best, Don Bauder

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Twister April 30, 2010 @ 2:13 p.m.

Re 11 and 12

In 11, I was referring to my own post, not to anyone else's.

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Don Bauder April 30, 2010 @ 9:10 p.m.

Response to post #31: It was a comment that is relevant anywhere. Best, Don Bauder

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SurfPuppy619 April 30, 2010 @ 9:57 p.m.

Good theory. But most companies today focus on one thing: pleasing Wall Street with the next quarter's revenue and earnings per share

It is ALL short term gain today on Wall Street.

Goldman Sachs used to have a saying back in the 60's "Long term greed"...they didn't mind being called greedy as long as they held their positions LONG TERM.

Their philosophy was that the long term hold would take care of any dips and valleys of the short term. And it stabilized their positions and holdings.

They obviously tossed that philosophy out the window many years ago.

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Don Bauder May 1, 2010 @ 7:10 a.m.

Response to post #33: Goldman jettisoned long term thinking and so did everybody else on Wall Street. Best, Don Bauder

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jv333 May 30, 2010 @ 12:50 p.m.

Don ... all good stuff....and how much was paid for all of these de-regs to come into being? Hundred of millions of lobbying dollars. They are bought and paid for. Same as the Pvt Securities Litigation Reform Act of 1996. Same as the electricity de-reg in CA and other stats in the mid-09s.

Let's do some research and find out how many billions the oligopolies paid. Which takes us up to BP, Halliburton and how they gamed the system resulting in the tragic oil blowout in the Gulf.

And I say the 1995 "Get Lerach Act" came into being, less due to any abuses by Lerach and more due to the rationale and influence above. Why did the Act remove joint and several liability for corporate officers? Why did the Act remove the RICO statutes and criminal liability for accounting fraud? And how many millions did they filter into Capitol Hill? These are the questions that need some exploration.

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SurfPuppy619 May 30, 2010 @ 4:02 p.m.

Don ... all good stuff....and how much was paid for all of these de-regs to come into being? Hundred of millions of lobbying dollars.

Let's do some research and find out how many billions the oligopolies paid.

jv333, the trial lawyers associtation of America are one of the BIGGEST "lobbying" groups/special interest in the nation.

The ONLY reason the Learch bill was passed is b/c the lawyers were outspent, but make no doubt about it-they have bought plenty of their OWN legislation.

This country/state/county/city are bought and paid for with speical interest money.

There are 40K+ registered "lobbyists" in DC, that is something like 72 lobbyists for every elected official on the hill.

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