“The Most Opaque Investment Schemes Ever Devised”: Cities And States Paying Massive Secret Fees To Wall Street
California’s report said $440 million. New Jersey’s said $600 million. In Pennsylvania, the tally is $700 million. Those Wall Street fees paid by public workers’ pension systems have kicked off an intensifying debate over whether such expenses are necessary. Now, a report from an industry-friendly source says those huge levies represent only a fraction of the true amounts being raked in by Wall Street firms from state and local governments.
“Less than one-half of the very substantial [private equity] costs incurred by U.S. pension funds are currently being disclosed,” says the report from CEM, whose website says the financial analysis firm “serve(s) over 350 blue-chip corporate and government clients worldwide.”
Currently, about 9 percent — or $270 billion — of America’s $3 trillion public pension fund assets are invested in private equity firms. With the financial industry’s standard 2 percent management fee, that quarter-trillion dollars generates roughly $5.4 billion in annual management fees for the private equity industry — and that’s not including additional “performance” fees paid on investment returns. If CEM’s calculations are applied uniformly, it could mean taxpayers and retirees may actually be paying double — more than $10 billion a year.
Public officials are overseeing this massive payout to Wall Street at the very moment many of those same officials are demanding big cuts to retirees’ promised pension benefits.
“With billions of public worker and taxpayer dollars put at risk in the highest-cost, most opaque investment schemes ever devised by Wall Street for a decade now, investigations that hold Wall Street profiteers accountable are long, long overdue,” said former Securities and Exchange Commission attorney Ted Siedle.
Private equity firms have argued that their fees are worth the expense, because they supposedly deliver returns for investors that beat low-fee index funds, which track the broader stock market. But those private equity returns are typically self-reported by the firms over the life of those longer-term investments, meaning there are few ways to verify whether the returns are real. Indeed, a recent study from George Washington University argued that private equity firms are using their self-reporting authority to mislead investors into believing their returns are smoother and more consistent than they actually are.
In a 2014 speech, the SEC’s top examiner, Andrew Bowden, sounded the alarm about undisclosed fees in the private equity industry, saying the agency had discovered “violations of law or material weaknesses in controls over 50 percent of the time” at firms it had evaluated.
To date, however, the SEC has taken few actions to crack down on the practices, but some states are starting to step up their oversight.
In New Jersey, for instance, pension trustees announced a formal investigation of Gov. Chris Christie’s administration after evidence surfaced suggesting that the Republican administration has not been disclosing all state pension fees paid to financial firms.
In Rhode Island, the new state treasurer, Seth Magaziner, a Democrat, recently published a review of all the fees that state’s beleaguered pension fund has paid. The analysis revealed that the former financial firm of Democratic Governor Gina Raimondo is charging the state’s pension fund the highest fee rate of any firm in its asset class.
In Pennsylvania, the new Democratic governor, Tom Wolf used his first budget address to call for the state “to stop excessive fees to Wall Street managers.”
These moves are shining a spotlight on one of the most lucrative yet little-noticed Wall Street schemes. With so much money at issue – and with pensioners retirement income on the line — that scrutiny is long overdue.
By: David Sirota, Senior Writer at the International Business Times; The National Memo, April 24, 2015
“Is Corruption A Constitutional Right?”: Public Pension Contracts Would Be For Sale To The Highest Bidder
Wall Street is one of the biggest sources of funding for presidential campaigns, and many of the Republican Party’s potential 2016 contenders are governors, from Chris Christie of New Jersey and Rick Perry of Texas to Bobby Jindal of Louisiana and Scott Walker of Wisconsin. And so, last week, the GOP filed a federal lawsuit aimed at overturning the pay-to-play law that bars those governors from raising campaign money from Wall Street executives who manage their states’ pension funds.
In the case, New York and Tennessee’s Republican parties are represented by two former Bush administration officials, one of whose firms just won the Supreme Court case invalidating campaign contribution limits on large donors. In their complaint, the parties argue that people managing state pension money have a First Amendment right to make large donations to state officials who award those lucrative money management contracts.
With the $3 trillion public pension system controlled by elected officials now generating billions of dollars worth of annual management fees for Wall Street, Securities and Exchange Commission regulators originally passed the rule to make sure retirees’ money wasn’t being handed out based on politicians’ desire to pay back their campaign donors.
“Elected officials who allow political contributions to play a role in the management of these assets and who use these assets to reward contributors violate the public trust,” says the preamble of the rule, which restricts not only campaign donations directly to state officials, but also contributions to political parties.
In the complaint aiming to overturn that rule, the GOP plaintiffs argue that the SEC does not have the campaign finance expertise to properly enforce the rule. The complaint further argues that the rule itself creates an “impermissible choice” between “exercising a First Amendment right and retaining the ability to engage in professional activities.” The existing rule could limit governors’ ability to raise money from Wall Street in any presidential race.
In an interview with Bloomberg Businessweek, a spokesman for one of the Republican plaintiffs suggested that in order to compete for campaign resources, his party’s elected officials need to be able to raise money from the Wall Street managers who receive contracts from those officials.
“We see [the current SEC rule] as something that has been a great detriment to our ability to help out candidates,” said Jason Weingarten of the Republican Party of New York — the state whose pay-to-play pension scandal in 2010 originally prompted the SEC rule.
The suit comes only a few weeks after the SEC issued its first fines under the rule — against a firm whose executives made campaign donations to Pennsylvania governor Tom Corbett, a Republican, and Philadelphia mayor Michael Nutter, a Democrat. The company in question was managing Pennsylvania and Philadelphia pension money. In a statement on that case, the SEC promised more enforcement of the pay-to-play rule in the future.
“We will use all available enforcement tools to ensure that public pension funds are protected from any potential corrupting influences,” said Andrew Ceresney, director of the SEC Enforcement Division. “As we have done with broker-dealers, we will hold investment advisers strictly liable for pay-to-play violations.”
The GOP lawsuit aims to stop that promise from becoming a reality. In predicating that suit on a First Amendment argument, those Republicans are forwarding a disturbing legal theory: Essentially, they are arguing that Wall Street has a constitutional right to influence politicians and the investment decisions those politicians make on behalf of pensioners.
If that theory is upheld by the courts, it will no doubt help Republican presidential candidates raise lots of financial-industry cash — but it could also mean that public pension contracts will now be for sale to the highest bidder.
By: David Sirota, Staff Writer at PandoDaily; The National Memo, August 15, 2014
“Keeping Regulation At Bay”: One More Step Toward The Next Meltdown
The delaying tactics we told you about nearly two years ago have worked beautifully. The bailout worked (if not for homeowners, at least for the banks). It worked so well that the underlying problems that led to the financial crisis have remained largely ignored.
The regulations that have been written (and continue to languish during their extended comment period) are on their way to being eliminated or weakened yet again by Congress. The House helped out this week by passing a bill (HR 4413) that ensures that if any regulations do get approved, they will be difficult to enforce.
As we reported back in 2012, JPMorgan Chase in London managed to avoid examination and enforcement by the Commodities Futures Trading Commission simply by labeling their massive speculation in credit default swaps as “portfolio hedging.” It was a loophole big enough for a whale to swim through.
Another loophole made enormous by HR 4413 is the cutoff separating “end users” from “swap dealers.” In the CFTC draft regulations written after Dodd-Frank initiated oversight on the swap business, any market player with more than $100 million in swaps per year was considered a dealer, and subject to stricter oversight and capital requirements.
After the industry complained, the CFTC agreed to delay that stronger oversight for two years and put in a temporary $8 billion cap that was due to drop to $100 million later this year. The bill that passed the House makes that $8 billion cap permanent. Now any firm that wants to do $100 billion in business without regulation has the option to create 13 separate companies.
From the point of view of the people who profit from the lack of regulation, streamlining the lack of oversight is financially sound. After all, real estate values in waterfront Greenwich estates, the Hamptons, and even Park Avenue will likely suffer if bankers and hedge fund managers make less money.
For those who trade in opaque markets, profits are maximized when some participants have information that their customers and competitors don’t have. An open market with published prices and capital reserves would limit profits and return on equity. Complying with regulations and keeping records available for supervisory review costs money. It all cuts into profits.
And if profits get squeezed by an overbearing, overregulating government, how can a valuable part of our capital markets survive? It’s not cheap, after all, to employ the people needed to execute this business that virtually no one understands and that the government doesn’t want to regulate.
Remember when AIG Financial Products blew up? Even though there were traders, accountants, clerks, lawyers and others from Lehman who found themselves jobless, the Treasury Department decided to pay more than a million dollars in bonus payments to each of the valuable AIG employees that had bet so big, and so badly.
Thankfully, the lobbyists hired by the industry have figured out how to keep the business profitable, and how to turn the task of complying with new regulations into a potential new profit center. They helped incorporate a brilliant strategy into HR 4413, and got 265 members of the House to vote for it.
The CFTC will be required to create and publish cost-benefit studies prior to adopting new compliance policies, and those studies will be subject to judicial review. That will take some time. After the CFTC rules go into effect, market participants will be free to argue that the cost estimates were inaccurate. Because the studies are subject to judicial review, the companies being regulated can theoretically get the government to pay them for any additional costs they incur when complying. With a little creative accounting, maybe the swap dealers will turn a profit on compliance departments.
While the delaying tactics written into the bill keep regulation at bay, trading in credit default swaps will continue as it has, with the risks it has, here and abroad. Over half of the hundreds of trillions of dollars in swaps on the books of our banks belong to foreign subsidiaries. A condition of the new bill requires the CFTC and the SEC to certify that derivatives regulations are not already in place in those foreign jurisdictions before they become subject to the new “regulations.” All a bank or hedge fund needs to do is dispute the nature of existing derivatives regulations in their legal places of business overseas, and any oversight can come to a grinding halt while they all work it out. In the meantime, they can enter into lots of credit default swap contracts.
Perhaps the most brilliant part of HR 4413 is hidden in the budget. The congressionally mandated increased workload has no accompanying increase in the commission’s budget. It won’t be easy to run thousands of legal and economic analyses without the people to do it or the money to hire them.
Speaking of people, the bill passed in the House also peculiarly reinvents the org chart. Key regulatory and enforcement personnel currently report directly to the commissioner of the CFTC, but under the new law, those people would instead report to five different members of the commission. Hiring, firing, and departmental budgeting will be decided by all five members together.
Have you ever reported to five bosses at the same time? I did, for about a year, and it’s nearly impossible to get anything done.
By the way, in case you thought our government didn’t have a sense of humor, Congress tells us we can call HR 4413 the “Customer Protection and End User Relief Act.”
Correction: The “hundreds of trillions of dollars” figure cited in the 12th paragraph refers to all swaps, not just credit default swaps as this post originally stated.
By: Howard Hill, Former Investment Banker, The National Memo, June 27, 2014
“Giving Wall Street More Leeway”: How Paul Ryan’s Budget Paves The Way For Another Financial Crisis
Representative Paul Ryan released his budget blueprint this week, and fans of his work were no doubt pleased: it called for $5 trillion in spending cuts over the next decade, focused heavily on domestic, non-military spending. Safety net programs like Medicaid and food stamps would face savage cuts, and the Affordable Health Care Act would be repealed entirely. Meanwhile, both corporate and individual tax rates would be lowered.
It is easy to make the case that the rich get richer and the poor get poorer under Ryan’s so-called “Path to Prosperity” plan: one needs only to look at the literally trillions cut from Medicaid and food stamps while the rich pay much less in taxes.
But it’s important to refine that point and note that the financial sector in particular gets many special favors in the Ryan plan. After all, it is one of Ryan’s leading benefactors and he can even be spotted sipping $350 bottles of wine with industry leaders from time to time. And his budget is no doubt a path to prosperity for them.
Moreover, in three crucial ways Ryan’s budget not only gives Wall Street more leeway to act recklessly, but makes it more likely that average Americans face the consequences.
Cutting the Securities and Exchange Commission budget: Already, the head of the SEC is complaining that her agency’s budget is not nearly adequate to police the country’s massive financial sector. In a speech earlier this year at SEC headquarters, director Mary Jo White said, “our funding falls significantly short of the level we need to fulfill our mission to investors, companies and the markets.” The SEC has only 4,200 employees, but must regulate eighteen different stock exchanges and over 25,000 different market participants—and the agency’s responsibilities are growing thanks to new mandates from the Dodd-Frank financial reform legislation.
Ryan has a much different take in his budget: he thinks the SEC is just too big. He doesn’t apply a dollar figure, but makes it clear the agency’s already meager budget should be substantially “streamlined.”
“In the run-up to the financial crisis and its aftermath, the SEC repeatedly failed to fulfill any part of its mission,” his blueprint notes, ticking off a familiar list of whiffs, from the unsound nature of Bear Stearns and Lehman Brothers to the Ponzi schemes run by Allen Stanford and Bernie Madoff.
So far, so good. But Ryan goes on: “These failures have taken place despite significant increases in funding at the SEC, which has seen its budget increase almost sixty-six percent since 2004.”
Apparently, the extra money was the problem. “This resolution questions the premise that more funding for the SEC means better, smarter regulation. Adding reams of regulations to the books and scores of regulators to the payrolls will not provide greater transparency, consumer protection and enforcement for increasingly complex markets. Instead, the SEC should streamline and make more efficient its operations and resources.”
In short: since the SEC failed to adequately police Wall Street at a time its budget was increasing, the magic solution would be to cut the agency’s budget, because ipso facto the agency’s performance would get better.
This line of thinking would not be unfamiliar to those who follow Ryan’s recommendations for federal anti-poverty programs, and it’s just as wrong here as it is there. As the agency’s director herself pointed out (on several different occasions), the SEC plainly needs more resources to conduct better regulation of a huge financial sector. Ryan provides no evidence, aside from that odd logical twist, that reducing the number of SEC staffers poring over filings from hedge funds would somehow increase oversight of those outfits.
Transferring the Consumer Financial Protection Bureau budget to Congress: Here Ryan resurrects a longstanding GOP proposal: that Congress, not the Federal Reserve, should fund the CFPB.
As it stands now, the bureau’s budget is essentially guaranteed. It can ask the Federal Reserve for funding up to a certain cap, and that request cannot be denied. The caps are fixed percentages of the Fed’s operating expenses. This guarantees autonomy from a Congress where many members (like, say, Ryan) are elected thanks to campaign contributions from the big financial institutions the CFPB polices.
Ryan claims to have a problem with this arrangement only because the Federal Reserve’s profits are supposed to be returned to the Treasury to reduce the deficit, but instead a portion of them are siphoned off to a new bureaucracy—one in which he suggests via scare quotes is ineffective. “Now, instead of directing these remittances to reduce the deficit, Dodd-Frank requires diverting a portion of them to pay for a new bureaucracy with the authority to write far-reaching rules on financial products and restrict credit to the very customers it seeks to ‘protect,’” says the blueprint.
CFPB funding would thus be transferred to Congress under the Ryan plan, and subject to annual appropriations. He doesn’t say what Congress should do with that budget once its under legislators control, but one needs only to look to his SEC budget proposals to get a sense of what would likely happen.
Ensuring Taxpayer Bailouts of Big Banks: This is another up-is-down situation where a lot of unpacking of Ryan’s language is needed. His budget says:
Although the proponents of Dodd-Frank went to great lengths to denounce bailouts, this law only sustains them. The Federal Deposit Insurance Corporation now has the authority to access taxpayer dollars in order to bail out the creditors of large, ‘‘systemically significant’’ financial institutions. This resolution calls for ending this regime, now enshrined into law, which paves the way for future bailouts. House Republicans put forth an enhanced bankruptcy alternative that—instead of rewarding corporate failure with taxpayer dollars—would place the responsibility for large, failing firms in the hands of the shareholders who own them, the managers who run them, and the creditors who finance them.
Sounds good! But that would actually accomplish the exact opposite.
Indeed, Dodd-Frank gave the FDIC the power to wind down too-big-to-fail banks, which is called “resolution authority.” In a crisis, if a failing bank is deemed too big for traditional bankruptcy, a panel of bankruptcy judges can place it in receivership under the FDIC. That FDIC in turn then makes a plan for winding down the institution safely—something Barney Frank called a “death panel” for big banks.
Crucially, under this structure, taxpayers can’t end up paying for this wind down—Dodd-Frank explicitly forbids it. Any taxpayer money used upfront to ease the firm into bankruptcy would be recouped by a structured sale of the bank’s assets. (Note that Ryan sneakily says the FDIC has the authority to “access taxpayer dollars,” eliding the fact that in the end it has to pay them back.)
Ryan’s alternative is to end FDIC’s resolution authority and simply “place the responsibility for large, failing firms in the hands of the shareholders who own them, the managers who run them, and the creditors who finance them.”
That’s akin to just saying “it will all work out.” It is unlikely in the extreme that the shareholders and managers can somehow bail out a failing big bank, especially in a crisis. Inevitably, Congress and thus taxpayers would have to step in, without any of the established authority like asset sales that the FDIC now possesses.
Ryan’s plan would lead to more taxpayer bailouts of failing big banks—and by stripping down the budgets of the agencies meant to oversee those institutions, make failure more likely in the first place. But in the meantime, his friends on Wall Street could enjoy less regulation, less oversight, and more comfort that taxpayers will someday come to the rescue.
By: George Zornick, The Nation, April 2, 2014
“A Picture Of Massive Corruption And Cowardice”: The Decline Of The American Justice System
Jed Rakoff, a former prosecutor, has an interesting piece in the NYRB about why there have been no prosecutions of financial industry employees over the systemic fraud surrounding the financial crisis. The whole piece is worth a read, but here are the main points boiled down:
1) The FBI is consumed with terrorism, apparently cutting their financial fraud investigation force from over a thousand agents before 2001 to about 120 by 2007. Whether that’s justifiable or not, it does remind me of a line from one of the finest action movies of all time: “Jesus man, wake up! National security’s not the only thing going on in this country.”
2) Regulators and law enforcement, especially at the SEC, have been focused on insider trading cases and Ponzi schemes like the Madoff affair, which are easier to investigate and to prosecute. Mortgage and securities fraud, by contrast, are far more complex and difficult.
3) Government complicity. This isn’t a bad point, but Rakoff directs too much blame at subsidies for the poor. As I’ve written in the past, the whole government housing policy regime, most definitely including subsidies for the rich like the home mortgage interest deduction, are to blame as well.
4) A new trend in prosecuting companies instead of individuals. This seems unambiguously true, and it’s a reminder of how new trends in legal theories always seem to move in the direction of increased subsidies and decreased accountability for wealthy elites.
Those points are all fair enough. But taken together, I don’t think they go nearly far enough. As an instrumental account of the details of why these prosecutions aren’t happening, it makes a lot of sense. Though, for the record, they might not even be instrumentally true: according to a new David Kay Johnston report, the Justice Department has been running interference for JPMorgan Chase against Treasury investigators.
But in any case, make no mistake: added up, this is a picture of massive corruption and cowardice at the top levels of our law enforcement agencies. Because regardless of whatever structural trends are happening, no prosecutor with a single fair bone in her body could possible tolerate, oh I don’t know, a minor slap on the wrist for laundering money for drug traffickers and terrorists.
By: Ryan Cooper, Washington Monthly Political Animal, December 27, 2013
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