Responsibility for the failures in government regulation of the financial markets reaches the highest levels of those charged with enforcing the law. A recent article by Bloomberg News Columnist Jonathan Weil underscores the problem. Weil is incredulous that a senior federal official like William Paulson, the former Secretary of the Treasury, knowing that Lehman Brothers’ “toxic assets [were] worth far less than the value at which they were carried” on its books, would not disclose the facts, as he understood them, to federal regulators and law enforcement, so that they could investigate and, if appropriate, prosecute?
In his new book, “On the Brink,” Paulson describes how Lehman’s asset values were a gross distortion of the truth. He writes that Tim Geithner, then head of the New York Fed, “made clear that the Fed could not lend against Lehman’s dubious assets.” He writes that Lehman’s chief executive officer, Dick Fuld, “was still clinging to his belief in the value of his assets, but he was alone there.” Other banks, Paulson noted, refused to rescue Lehman because “they knew that to make the math work, they would have to make a loan secured by assets worth much less than their stated value.” Paulson observes that these assets “had been carried by Lehman at $52 billion, but after their analyses, Wall Street banks estimated their value at closer to $27 billion to $30 billion.” In sum, Paulson concludes, “the investment bank had been loaded with toxic assets worth far less than the value at which they were carried, creating a capital hole.”
Why then did Paulson never tell anyone at the Securities and Exchange Commission or the Justice Department that Lehman’s accounting might need to be investigated, wonders Weil? In his book, Paulson said he felt terrible for Fuld and other Lehman executives: “It was impossible not to sympathize with him. After all, I had run a financial institution; he had been one of my peers.” In response, Weil observes that: “Maybe a Treasury secretary who hadn’t been the CEO of Goldman Sachs Group Inc. would have viewed their plight less charitably.”
Weil points out that the government did not begin issuing grand-jury subpoenas until after Lehman collapsed, thereby allowing “dozens of employees ‘ to walk out the front door of Lehman’s midtown Manhattan headquarters carrying boxes full of files, on live TV no less. There’s no telling how much evidence was lost because the feds didn’t order the company to preserve documents sooner.”
There is a pattern here, writes Weil. Well before Bank of America’s acquisition of Merrill Lynch was completed on Jan. 1, 2009, Paulson and Federal Reserve Chairman Ben Bernanke had learned of billions of dollars of losses at Merrill that had not been disclosed. Neither Paulson nor Bernanke told the SEC. In fact, they also took pains to conceal it by not putting their plans for rescuing Bank of America in writing, for fear that doing so would require the government to disclose the matter itself.
Eventually, the SEC and New York Attorney General Andrew Cuomo’s office concluded that Bank of America had violated the disclosure rules. But Cuomo had to force the SEC’s hand by publishing his own investigation’s findings, including the details about what Paulson and Bernanke knew and when.
The requirement that publicly owned corporations disclose complete and accurate financial reports is part of the bedrock of U.S. securities laws. But that requirement is meaningless if the government will not enforce those laws when they’ve been broken.
Weil writes: “There’s been much talk the past two years about moral hazard, which is the risk that companies and their investors will behave more recklessly when they believe the government will bail them out. Less has been made of a similar hazard: The danger that powerful companies won’t follow the law when their executives believe the government won’t hold them to it.
The latter risk threatens not only our economy, but our democracy. There’s every reason to believe both kinds of danger are growing