The Scam Wall Street Learned From the Mafia

We are living in amazing times really.

I just posted on UK’s Libor rigging scam. The author of that Libor article says US atleast tried to analyse the causes of the crisis. UK hasn’t done anything like this.  There have been some commissions etc but were headed by people who ran banks/finance for most part of their lives.

I came across this fascinating piece on the recent scam in US. It is by Matt Taibbi who has written couple of pieces on the financial crisis.

Taibbi talks about a recent case in US which exposed a huge scam in municipal finances. Wall Street biggies have been looting the public for so many years. This scam hasn’t become  as famous as others but deserves to be read:

Someday, it will go down in history as the first trial of the modern American mafia. Of course, you won’t hear the recent financial corruption case, United States of America v. Carollo, Goldberg and Grimm, called anything like that. If you heard about it at all, you’re probably either in the municipal bond business or married to an antitrust lawyer. Even then, all you probably heard was that a threesome of bit players on Wall Street got convicted of obscure antitrust violations in one of the most inscrutable, jargon-packed legal snoozefests since the government’s massive case against Microsoft in the Nineties – not exactly the thrilling courtroom drama offered by the famed trials of old-school mobsters like Al Capone or Anthony “Tony Ducks” Corallo.

So what was the scam? In a way it was quite similar to LIBOR scam:

Say your town wants to build a new elementary school. So it goes to Wall Street, which issues a bond in your town’s name to raise $100 million, attracting cash from investors all over the globe. Once Wall Street raises all that money, it dumps it in a tax-exempt account, which your town then uses to pay builders, plumbers, the chalkboard company and whoever else winds up working on the project.

But here’s the catch: Most towns, when they raise all that money, don’t spend it all at once. Often it takes years to complete a construction project, and the last contractor isn’t paid until long after the original bond is issued. While that unspent money is sitting in the town’s account, local officials go looking for a financial company on Wall Street to invest it for them. 

To do that, officials hire a middleman firm known as a broker to set up a public auction and invite banks to compete for the town’s business. For the $100 million you borrowed on your elementary school bond, Bank A might offer you 5 percent interest. Bank B goes further and offers 5.25 percent. But Bank C, the winner of the auction, offers 5.5 percent.

These auctions were rigged:

In most cases, towns and cities, called issuers, are legally required to submit their bonds to a competitive auction of at least three banks, called providers. The scam Wall Street cooked up to beat this fair-market system was to devise phony auctions. Instead of submitting competitive bids and letting the highest rate win, providers like Chase, Bank of America and GE secretly divvied up the business of all the different cities and towns that came to Wall Street to borrow money. One company would be allowed to “win” the bid on an elementary school, the second would be handed a hospital, the third a hockey rink, and so on.

How did they rig the auctions? Simple: By bribing the auctioneers, those middlemen brokers hired to ensure the town got the best possible interest rate the market could offer. Instead of holding honest auctions in which none of the parties knew the size of one another’s bids, the broker would tell the pre­arranged “winner” what the other two bids were, allowing the bank to lower its offer and come in with an interest rate just high enough to “beat” its supposed competitors. This simple but effective cheat – telling the winner what its rivals had bid – was called giving them a “last look.” The winning bank would then reward the broker by providing it with kickbacks disguised as “fees” for swap deals that the brokers weren’t even involved in.

The amounts are very large:

The end result of this (at least) decade-long conspiracy was that towns and cities systematically lost, while banks and brokers won big. By shaving tiny fractions of a percent off their winning bids, the banks pocketed fantastic sums over the life of these multimillion-dollar bond deals. Lowering a bid by just one-100th of a percent, called a basis point, could cheat a town out of tens of thousands of dollars it would otherwise have earned on its bond deposits.

That doesn’t sound like much. But when added to the other fractions of a percent stolen from basically every other town in America on every other bond issued by Wall Street in the past 10 to 15 years, it starts to turn into an enormous sum of money. In short, this was like the scam in Office Space, multiplied by a factor of about 10 gazillion: Banks stole pennies at a time from towns all over America, only they did it a few hundred bazillion times.

Just like UK, US has also not moved anywhere on finance. I mean scams and crisis are part and parcel of capitalism. But the way financial firms have shamelessly used tactics to justify greed is something else. There is something seriously wrong with the way the sector has been run in the last couple of years…

 

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