How Banks Cooked Their Books – With Bank Regulators’ Compliance / Complicity / Conspiracy ???

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By David Caploe PhD, Chief Political Economist,

Ever since the run-up to / outbreak / and aftermath of Black September 2008, we have argued the crisis in the US has SIX aspects: financial / economic / ideological / political / media / intellectual-academic.

By David Caploe PhD, Chief Political Economist,

Ever since the run-up to / outbreak / and aftermath of Black September 2008, we have argued the crisis in the US has SIX aspects: financial / economic / ideological / political / media / intellectual-academic.

By David Caploe PhD, Chief Political Economist,

Ever since the run-up to / outbreak / and aftermath of Black September 2008, we have argued the crisis in the US has SIX aspects: financial / economic / ideological / political / media / intellectual-academic.

While we generally have focused on the first five aspects of this on-going mess, a substantively fabulous Op-Ed piece in the New York Times — underscores at least ONE side of the intellectual / academic aspect of this crisis

The article is by professors from four different law schools around the US, [br]

and shows in chilling and convincing detail how the entire regulatory apparatus allegedly keeping an eye on banks / hedge funds / large corporations et al

were actively complicit in allowing them to get away with, literally, murder, at least in the financial economic realm.

Unfortunately, it’s often almost impossible to tell what they’re saying.

And this is due largely to the bizarre central fact that – for a “profession” in which “writing” is THE key to career advancement – almost all academic writing is hard to read at best, and downright impenetrable at worst.

My guess is that the editors at the Times Op-Ed page had to work long and hard to get this piece into even MINIMALLY clear enough shape to be understandable for a public audience.

And it’s good they did so, because the substance is absolutely crucial.

The only problem is that reading it makes it almost impossible to understand what is, in fact, a powerful and significant basic point:

In the aftermath of Black September 2008, there was a lot of moaning about how one major factor in the financial collapse of Bear Stearns in the spring and Lehman in the fall was the FAILURE of the relevant regulatory agencies —

the Federal Reserve / the SEC / Treasury / Comptroller of the Currency / Office of Thrift Supervision / and FDIC –

to work together.

The authors here argue that these institutions HAD, in fact, been working together, since at least 2004 —

but in such a way as to FACILITATE, rather than forestall, the financial disaster that erupted in Black September.

The initiating event for this co-operation — or is it conspiracy 😉 ??? — was the Enron fiasco of 2001.

This essentially laid out clearly the template for a whole range of deceptive and illegal accounting practices available to big corporations, financial or not,

although as we know from what Goldman Sachs was doing with the Greek government at that same time,

Enron was far from the ONLY major corporation engaging in systematic financial chicanery.

In the aftermath of Enron, they argue, the various elements of the regulatory apparatus realized they had to at least LOOK like they were doing something to make sure nothing like this happened again.

What ensued was a complex round-e-lay between the regulators on one side, and the banking / insurance industries on the other, that began in 2004 and continued until 2006.

The initial feint by the regulators wasn’t exactly regulation, but more like a position paper, whose guidelines they thought the bankers should adopt, but wouldn’t force them to, and whose focus was “complexity” in financial instruments.

Despite what the authors call the “mildness” of the regulator’s suggestions, especially given what Enron had exposed,

the banks and other financial institutions reacted strongly against it,

mobilizing their army of lobbyists to bombard the agencies involved with negative comments.

Most importantly, in one of the few relatively clear passages of the entire piece:


The banks understood that the statement threatened the virtually regulation-free zone they had won for other forms of complex structured finance, particularly collateralized debt obligations.

So the industry condemned the 2004 proposal, and the regulators caved.

They agreed to think it over — for two more years.


And what they came up with two years later, in 2006 — remember, two years before Bear Stearns in the spring and then Black September — had the allegedly regulated cheering,

as this other — rare — relatively clear passage indicates:


Gone was the requirement to ensure that customers understood these instruments

and that the banks document that they would not be used to phony-up a company’s books.

The focus on complexity was also gone, as was the concern over transactions “with significant leverage” —

that is, deals with little real cash underneath, another unfortunate deletion because attending to excessive leverage would have served us well.

Instead, the only products that the banks were asked to handle with special care were so narrowly defined and so obviously fraudulent that suggesting that they could be sold at all was outrageous.

These included “circular transfers of risk … that lack economic substance” and transactions that “involve oral or undocumented agreements that … would have a material impact on regulatory, tax or accounting treatment” …

To this day, that final interagency statement (which was adopted in 2007) has not been repealed or replaced.

It can still be found on the S.E.C. Web site, along with the letters from industry representatives praising the 2006 draft.


Now, here’s where the real scandal comes in, albeit not only in the way the authors intend:


The site also has a single letter begging the agencies not to adopt that draft statement — a letter the four of us wrote.


From their point of view, of course, the scandal is that their prescient warning against the “statement” —

again, remember, these were more suggestions than regulations —

was ignored, overwhelmed by the effusive compliments from the financial sector.

But we think there’s another, just as significant, reason to be scandalized:

the fact that, despite the literally thousands of law schools and economics departments across the US,

only FOUR law professors had enough concern about the state of the US financial system to even take the time to participate in,

however flawed the result, what even the authors seem to describe as at least a relatively transparent public process,

with, given Enron, obvious implications for the financial and economic health of not just America, but as a result of its central role in the global political economy, the entire world.

Put bluntly, it seems that literally thousands of academics —

whose work was DIRECTLY related to the matters at hand here —

felt they had more important things to do with their hard-earned and much advertised “expertise” than what they are SUPPOSED to do — namely, WRITE

about a measure that, some two years later, would bring the entire world political economy to its knees.

What on earth could be more important to these people than using their knowledge to help educate at least the regulators — if not the public at large — about such a crucial issue ???

In our view, THIS is the real scandal of conventional academia in general, and the economics “profession” in particular:

That they make reasonable salaries — and have contracts for lifetime employment — allegedly based on their mastery of legal and / or economic subject matter —

and we won’t even mention the dominance of the so-called “law and economics” movement that pervades law school faculties today —

and still NOT MORE THAN FOUR of them in the entire country — and NO “professional” economists —

took the time and effort to, again, do what they’re paid to do — since it’s certainly not teach 😉 — namely, write — about a matter of self-evident GLOBAL economic significance.

Think about THAT the next time you write out a check for your kid’s tuition to a university.

Which is why we think this Op-Ed piece — with its crucial substance, no matter how poorly expressed and organized —

is a PERFECT example of how the academic / intellectual aspect of the current American crisis is just as important as the financial / economic / ideological / political ones:

with thousands of law school professors — many explicitly claiming allegiance to the “law and economics” movement — and even more “professional” economists,

only FOUR IN THE ENTIRE COUNTRY even bothered to participate in a public process whose outcome could, even at the time, be seen to be crucial for the future of the world political economy.

In our view, that’s as much of a scandal as the pathetic performance by the alleged regulators of the finance sector,

who seem more enablers of blatantly fraudulent practices than their watchdogs in the public interest.

David Caploe PhD

Chief Political Economist

About David Caploe PRO INVESTOR

Honors AB in Social Theory from Harvard and a PhD in International Political Economy from Princeton.