Mar 06 2012
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Financial Crisis

SEC’s Latest Pocket Change Settlement

Nearly four years later Wall Street still remembers when Bear Stearns spiraled into insolvency in March of 2008. The collapse of the investment banking giant was only the beginning of what was later recognized as one of the greatest meltdowns in the history of Wall Street, subsequently followed by global financial crisis and recession.

Today the market is showing signs of improvement and most investors have moved on from the turbulent era of mortgage-based securities. But one agency is still pursuing the worst offenders of 2008, and it’s taking its battles to court.

The U.S. Securities and Exchange Commission continues to file both criminal and civil charges against some of the largest investment banks – including those who long ceased to exist – for reckless and sometimes fraudulent behavior that contributed to the collapse of the subprime-mortgage market.

But the agency’s adopted practices of quickly settling cases for immaterial sums without the defendant confirming or denying wrongdoing has raised a few eyebrows leaving people wondering – is the agency being too lenient?

The Securities and Exchange Commission’s latest settlement serves as a perfect example. Two former Bear Stearns hedge fund managers Matthew Tannin and Ralph Cioffi have agreed to settle a civil case brought by the SEC for $1.05 million. As part of the settlement, neither of the two executives had to admit wrongdoing.

The SEC attorney John Worland announced at the Federal District Court hearing that Cioffi agreed to pay $800,000 and accept a three-year ban from the securities industry while Tannin agreed to a $250,000 payment and a two-year ban, according to Bloomberg Law.

This wasn’t the first time the two hedge-fund managers have seen the courtroom. In 2009 Tannin and Cioffi were found not guilty of criminal charges brought by the U.S. Department of Justice. Federal prosecutors had accused the two men of fraudulent acts and misrepresentation with regard to the health and composition of their portfolios.

According to the complaint document, Cioffi and Tannin “deceived their own investors by fraudulently concealing from them the full extent of the funds’ deepening troubles.” It continued to allege that the two portfolio managers persuaded existing investors not to withdraw their money from the fund by “consistently misrepresenting the level of redemptions from the funds, the current state, and/or the composition of the funds’ portfolios.”

Ralph R. Cioffi, a 52-year-old resident of Tenafly, NJ, was asked in 2003 by Bear Stearns Asset Management to head up their two newly started hedge funds (the Bear Stearns High-Grade Structured Credit Strategies Fund and the Enhanced Leveraged Fund). Matthew M. Tannin, a 46-year-old resident of New York, NY, was brought into the fund in 2003 to assist Cioffi. Neither of the two men possessed any prior experience as a trader or hedge fund manager, according to the complaint.

The complaint went on to claim that Cioffi redeemed $2 million of his personal investment in the Enhanced Leverage Fund while falsely expressing his confidence in the funds and encouraging investors to add money to their portfolios. Similarly, Tannin repeatedly told investors that he was adding his own investment to the funds, when in reality he was trying to conceal the funds’ poor performance.

Without investor knowledge, the funds had taken highly leveraged positions in collateralized debt obligations based on subprime mortgage-backed securities. The true composition of the portfolios was concealed from investors during quarterly conference calls to discuss funds’ performance.

The funds collapsed in June 2007 as a result of high exposure to risky subprime mortgage loans, causing investor losses of approximately $1.8 billion. The two managers were aware of the deteriorating subprime market as evidenced by their repeated email exchange about the funds’ poor performance.

According to the complaint, Cioffi sent the following email to the funds’ economist on March 15, 2007 with the subject line “fear”:

“I’m fearful of these markets… As we discussed it may not be a meltdown for the general economy but in our world it will be. Wall Street will be hammered with law suits. Dealers will lose millions and the CDO business will not be the same for years.”

It was clear that through heavily investing in risky securities the two fund managers contributed to the collapse of the funds. Furthermore, they mislead investors and lied about the funds’ actual performance. Still, despite acute evidence of reckless behavior and subsequent investor loss of billions of dollars, the criminal charges were dropped and the SEC agreed to a mere $1 million settlement.

The Cioffi/Tannin case highlights the recent controversy surrounding the agency, which has been largely criticized for quickly settling the cases for immaterial sums of money without making the defendant either confirm or deny the charges.

In November of 2011 Federal Judge Jed S. Rakoff struck down a proposed $285 million settlement between SEC and Citigroup, calling the penalty “pocket change” for the investment bank giant, according to NYTimes’ Dealbook. Similar to Rakoff, opponents of the agency’s adopted practices frequently question why the SEC decides on such a modest settlement and lesser charges despite allegations of fraud.

Cioffi’s lawyer, Edward Little of Hughes Hubbard & Reed LLP, and Tannin’s lawyer, Nina Beattie of Brune & Richard LLP, declined to comment.

Dec 12 2011
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Business & Economy

Extended Unemployment

Currently millions of unemployed Americans are anxiously waiting to see whether Congress will extend federal unemployment benefits. If lawmakers don’t act, some 5 million people will stop getting checks next year, with nearly 2 million of them exhausting their benefits as soon as January.

During major economic downturns, Congress authorizes federal unemployment benefits to supplement state jobless benefits. First approved in June of 2008, federal unemployment programs have since been lengthened and extended through the end of 2011 in light of continuous staggering economy.

When a person first becomes unemployed, they file for state unemployment benefits. Once the state benefits are exhausted, they start collecting the federal unemployment benefits, which consist of up to 53 weeks of emergency compensation, divided into four tiers, and up to another 20 weeks of extended benefits.

Roughly 18 million Americans have collected federal benefits over the past four years. The most recent 13-month extension, passed last December, kept 7 million people on the rolls. But unless Congress approves the next extension, those who reach the end of their state and federal benefits will not be able to apply for additional compensation.

Financing unemployment benefits can be costly. Jobless Americans have collected a staggering $434 billion in unemployment benefits over the past four years, with taxpayers financing roughly $185 billion. Going into 2012, the Congressional Budget Office estimates that it will cost additional $44 billion to extend benefits through the end of the year.

Advocates of the extension claim that unemployment benefits are critical in light of the slow economic recovery and continuous high employment. The jobless depend on these checks to feed their families and pay their mortgage or rental obligations. Some also say that unemployment benefits boost spending in the economy, thus indirectly creating additional jobs.

Opponents of the extension say that the length of unemployment benefits is excessive and likely discourages jobless workers from actively looking for new jobs. An extension also comes with a real economic cost that is acutely apparent with the government running a massive budget deficit.

What advocates overlook is that unemployment benefits do not boost the overall economy because no additional wealth is created. The government finances its spending through taxing or borrowing from elsewhere in the economy. The unemployed do spend more than they otherwise would without the benefits, but that takes away the spending power of other tax payers financing the unemployment programs. As a result, those tax payers choose not invest their funds in the private sector, which could potentially create jobs in the long run.

Most unemployed workers want similar jobs that they had lost – with comparable compensation, located in the same city and with similar job responsibilities. Extended unemployment benefits allow people to spend more time looking for these jobs as oppose to casting a wider net. Perhaps without the extension, people will start exploring other options and find work faster than they otherwise would with the cushion of their unemployment checks. And that’s precisely what will help the unemployment numbers and boost the economy.

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Dec 09 2011
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Business & Economy

GDP winners and losers

The Economist published an interesting statistic about GDP growth per person, a measure that gives the best indicator of economic progress – or lack thereof. The three fastest-growing countries – Equatorial Guinea, Azerbaijan and Turkmenistan – contribute their GDP growth to abundance of natural resources and the past decade’s boom in commodity prices. Haiti and Zimbabwe showed negative growth due to political chaos and ruin dominating both nations in the last decade.

GDP growth per person ranking widely depends on population growth. Although United States grew faster than Japan since 2001, the two countries have comparable GPD per person growth due to Japan’s population shrinking and American population rising.

Dec 07 2011
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Business & Economy

Banking on Basel

Multiple market participants concerned with the worrisome events happening in Europe are calling for more regulatory rules. But others say that regulation is counterproductive because it encourages financial institutions to hold risk-free securities that do not require them to raise additional capital.

Banks in the U.S., Europe and other developed countries function under a regulatory regime known as the Basel bank capital standards. Basel rules define how capital requirements should be calculated and how much capital commercial banks are required to hold against certain kinds of assets. Banks are responsible for matching the capital requirements with the risk associated with each underlying asset class.

This is exactly what caused the problem during the 2008 financial crisis. Because financial institutions had substantially lower capital requirements for holding mortgage-backed securities than for corporate loans (Basel requirements in 2008 were 1.6% and 8%, respectively), banks loaded up on the very asset class that collapsed in value when the U.S. housing bubble deflated in 2007.

Similarly, today’s European crisis poses the same problem, with the only difference being that mortgage-based securities have been replaced by sovereign debt, which under the Basel rules has a zero-risk weight. Therefore holding sovereign debt provides banks with interest-earning investments without substantial additional capital requirements. The debt of weaker governments, such as Greece and Italy, is particular popular because it offers higher yields.

The obvious problem is that in an attempt to conform to regulatory requirements, all banks start adjusting their holdings in favor of risk-free securities thus destroying the natural diversification that is typical for a well-balanced portfolio. Then when a financial crisis sweeps through the system, those same banks end up uniformly holding risky assets, such as the subprime mortgage debt-backed securities or sovereign debt, and the financial system ends up being more vulnerable to systemic breakdowns.

In short, sure – there is an obvious need for more regulation to prevent MF Global-like disasters. However, as it stands now, the Basel regulatory regime is counterproductive to the healthy economy. What the financial system needs is a well-planned and carefully thought-out regulatory plan that will regulate financial institutions and leave no loopholes to get around the capital requirement rules.

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Nov 22 2011
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Life & Culture

Turkey by numbers

There are few holidays cherished more in America than Thanksgiving. It’s a time when we can get together with family, reflect on what we’re most thankful and stuff ourselves with delicious food. But how often do we actually stop and think about how much money is spent each year on this beloved holiday? Here are some facts on Thanksgiving economics:

  • 248 million turkeys raised in the U.S. in 2011 – 46 million turkeys eaten on Thanksgiving day (~19%)
  • Average cost of a turkey is $1.35 per pound; at the average weight of 16 pounds, the total cost is ~$875.8 million across the U.S.
  • A 16-pound turkey takes 4 hours to make; average american eats ~13.3 pounds of turkey
  • 60 million boxes of Stove Top stuffing are sold each Thanksgiving at $2.99 per box – for a total cost of $179.4 million
  • Cranberry production up 20% this year; 3.5 billion individual cranberries harvested a year
  • Ocean Spray® sells 72 million cans of cranberry sauce during the holiday season; at $2.39 per can, the total cost is $172.1 million
  • COSTCO® sells one million pumpkin pies during Thanksgiving week; at $5.99 a pie, the total cost is $5.9 million
  • Pumpkin prices are up $3.03 due to harvest challenges posed by Hurricane Irene
  • More than 40% of all food produced in America is not eaten – 29 million tons of edible food wasted each year
Nov 22 2011
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Business & Economy

Who the Heck Are the “Top 1%”?!

The question on everyone’s mind is – who exactly are the “top 1%”? Nicole Lapin offers her perspective during a CNN Newsroom segment (summarized on her blog). Do you agree?

1. To get into the “top 1%” of Americans you don’t need to be a billionaire or millionaire or half-millionaire. The minimum wage earners in that group make about $343k/year.

2. Financial services professionals (a.k.a. “Wall Street”) average $311k/year — so they technically don’t make it into the top 1% if you look at the mean.

3. Financial services professionals don’t actually make up a majority of the “top 1%” of Americans.

4. The biggest chunk of the “top 1%” are executives and managers outside financial services at 31%; medical professionals make up 16%; financial services professionals make up 14%; 9% lawyers.

5. The “top 1%” of wage earners earn 17% of the nation’s income.

Nov 15 2011
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New York City

In New York City, Address is everything

It seems like the world is falling apart – retirement savings destroyed, European countries defaulting, unemployment levels skyrocketing.

Evidently, New York City is exempt from the world’s financial turmoil. Miraculously untouched, New Yorkers continue to dine at exclusive restaurants, shop at designer stores, and spend on luxurious apartments.

Recession? What recession? Not in New York City.

According to a quarterly rental report put out by CitiHabitats, a leading real estate brokerage company, New York’s rental market is booming. Third quarter 2011 rental rates went up 7.3% compared to prior year, while vacancy rates continue to drop.

Specifically, CitiHabitats identified West Village, SoHo/Tribeca and Chelsea as the top three most expensive neighborhoods in the city.

No surprise there. After all, who doesn’t want to live in an exposed brick apartment on a cobble stone, tree-lined city block next to Extra Virgin? Or parade a sky-high-ceiling loft in SoHo across the street from the newly opened Mondrian SoHo?

But shouldn’t the latest financial market turmoil limit New Yorkers’ spending? Didn’t the Conference Board report that American consumer confidence dropped in October due to high unemployment, volatile market behavior, and uncertainty about job stability?

Not exactly. In fact, vacancy rates for the top three most expensive neighborhoods are the lowest on CitiHabitats list. Despite the whopping price of $8,463 and $6,249 for a three-bedroom apartment in SoHo and West Village, respectively, the vacancy rates are drastically lower compared to that of Upper West Side (but Lloyd Blankfein lives there, come on!) and Midtown East (clearly, we have underestimated the appeal of Brother Jimmy’s on a Sunday).

Speaking from personal experience, I can’t possibly discount the jolt of pride I feel when someone asks me where I live. “Sullivan and Prince,” I say. “Across the street from the Dutch – have you been yet? Great oysters.”

Back in August I gave up my banking salary and officially became a full-time student. Even then, I refused to give up my perfect exposed-brick (though absolutely tiny) apartment in SoHo. The rent is suffocating, but somehow I’m making it work. Perhaps it was eliminating my daily triple grande skinny hazelnut Starbucks latés (estimated annual savings of $1,966 – can you believe it?) or my twice-a-day cab rides to the Goldman building ($2,400 per year, plus additional savings of 300 calories a day in walking instead), but somehow I’m making it work. Because I know my SoHo apartment is well worth it.

Or so I tell myself. Once I actually take a step back and digest the cost, I’m appalled. Which student in their right state of mind would spend that much with no means of a steady income? But then I take a walk in my neighborhood on a Saturday afternoon. And suddenly, I understand those New Yorkers that pay as much as they do for their monthly rent because just like them, I love my city and I love my neighborhood.

Nov 15 2011
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Financial Crisis

Occupy No More

Authorities, citing health and safety concerns, attempted to tackle the continued occupation of Zuccotti Park on Tuesday morning, by ordering hundreds of demonstrators to vacate the park, arresting 70 protesters in the process.

Nov 10 2011
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Corporations

Vote Now!

Nov 10 2011
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Corporations

Two old friends: Corzine and Regulation

Congratulations, Mr. Corzine – you have caused more paralysis than the futures markets have seen in years. Hundreds of millions of dollars are still missing from customer accounts – $593 million as of Friday, to be exact. The fallout from MF Global’s bankruptcy is tremendous – money and trading positions frozen or potentially lost, with the CME Group still scrambling to transfer customers’ future accounts to other firms.

The shortfall in customer accounts, initially estimated at roughly $900 million, caused MF Global’s chaotic bankruptcy after a last-minute rescue deal with Interactive Brokers fell through. Ever since, regulators, traders and exchanges have been poring over MF Global’s books trying to locate the missing funds and get to the bottom of the regulatory probe of the collapsed firm.

The dominant issue that stands at the heart of the MF Global bankruptcy is lack of regulation on how firms invest the cash sitting in customer accounts. Specifically, most debates center on the Commodity Futures Trading Commission’s rule called Regulation 1.25, which covers how futures-commission merchants, such as MF Global, could invest customer funds. The CFTC has proposed a number of changes to the rule to  protect customer funds, including tighter restrictions on repo agreements.

Unsurprisingly, Jon Corzine, who resigned Friday as CEO of MF Global, strongly opposed tighter regulations, claiming that the proposed restrictions “were seeking to fix something that is not broken” and could potentially decrease the income derived from investing in customer funds.

No kidding. And look where this strategy got him. His company, which he aimed to turn into the next Goldman Sachs in the span of 5 years, is in shambles, battling bankruptcy and missing millions of dollars of client funds. His plans for expanding the future and commodities trading business involved taking more risk than would otherwise be tolerated by most CEO’s. And now his infamous political and financial career is probably over for good.

It didn’t help that regulators and auditors completely turned their backs on the lack of internal controls within MF Global, despite the alarming quarterly losses posted by the company. Clearly no one cared that the now-collapsed broker-dealer had violated requirements that meant to keep clients’ collateral separate from the company’s own accounts.

Coming from the banking world myself, I know how much the word “regulation” is frowned upon in the financial circles. However, I do think that in order to prevent firms like MF Global from collapsing the finance community needs more oversight and tighter rules on proprietary trading. Perhaps people will then stop blaming Wall Street and calling other banks and financial firms evil based on individual choices of one ambitious executive.

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