Connecting the Dots to the Budding Wall Street Crisis

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by Pam Martens and Russ Martens, Wall St On Parade:

We’re going to do today what mainstream media has failed to do for the American people so far this year — as well as prior to the onset of the 2008 financial collapse on Wall Street. We’re going to connect the dots that strongly suggest that both the U.S. and global financial system have a real problem occurring right under the fogged lenses of Congress.

Dot 1 — Freezing Customers Out of their Mutual Fund. Let’s start with our reporting on July 11 of this year, titled Is There a Stealth Financial Crisis? Alarm Bells Are Ringing. In that article we pointed out that one of Britain’s high profile money managers, Neil Woodford, had frozen customer withdrawals from his flagship $4.7 billion Woodford Equity Income Fund. The latest news is that the fund is not expected to reopen until at least December and we wouldn’t hold your breath on that. One of the key problems was the fund’s hefty positions in illiquid stocks that were hard to value. We further pointed out that in the same balmy months of the summer of 2007, when the serious Wall Street crisis was being largely ignored by mainstream media, the U.S. investment bank, Bear Stearns, shuttered two of its hedge funds which had held about $1.5 billion of investor funds, announcing that they were mostly worthless. That was followed the next month by France’s largest publicly traded bank, BNP Paribas, announcing that it was freezing withdrawals from three of its funds, citing “evaporation of liquidity” and the inability “to value certain assets.”

Dot 2 – Hard to Value Assets on Bank Balance Sheets. Illiquid or

Dot 2 – Hard to Value Assets on Bank Balance Sheets. Illiquid or hard to value investments on the books of the banks in the U.S. are called “Level 3” assets. The Office of the Comptroller of the Currency (OCC) doesn’t think that’s a problem at U.S. banks. In its most recent quarterly report for the period ending June 30, 2019, the OCC states that Level 3 trading assets at U.S. banks “peaked at $204.1 billion at the end of 2008” and are now a very tame $27 billion.

The OCC allows your contentment with those numbers to last for a full 5 seconds before adding this: “Because banks cannot observe inputs into the models that determine the fair value of these illiquid exposures, banks use their own assumptions in determining their fair values.”

If you know anything about JPMorgan mismarking its $6.2 billion in losses on derivatives in the London Whale scandal in 2012 or Citigroup misstating by tens of billions of dollars its subprime losses hiding out in off-balance-sheet Structured Investment Vehicles (SIVS) in the Cayman Islands in 2008, then you might take the OCC’s assessment of Level 3 containment with a grain of salt.

Here’s two other good examples of how U.S. markets have lost their efficient pricing mechanism. On Wednesday, March 12, 2008 Bear Stearns closed at $61.58. Two days later, the stock market decided it was worth half that amount and the stock closed on Friday, March 14, 2008 at $30.85 a share. On the following Monday JPMorgan Chase purchased the company for $2 a share – valuing its fair market value $28.85 below its last traded price in public markets. (Eventually, JPMorgan Chase would raise its takeover price to $10 a share.)

Now you might be thinking that the Bear Stearns story is just a quirk of a squirrely market in the throes of a budding financial crisis. That is true. But it is also true that inefficient markets breed corruption and corruption breeds big financial crashes, especially when risk for the entire U.S. banking system has been concentrated at five mega banks on Wall Street.

With that in mind, let’s take a look at what happened last month with WeWork’s aborted initial public offering. The company was initially supposed to go public with a market valuation of somewhere between $67 billion and $47 billion. That’s a pretty big spread in itself. But then, it turned out, it couldn’t even go public at a $12 billion valuation because of its dodgy self-dealings with its CEO, Adam Neumann, and a highly questionable business model of taking on commercial office leases long-term and then sub-leasing the space short term. This was not an IPO being underwritten by some little boiler room on a Wall Street side street. The two lead underwriters were JPMorgan Chase and Goldman Sachs. WeWork was represented in the IPO by one of the most sophisticated law firms in America: Skadden Arps, Slate, Meagher & Flom. The Wall Street bank underwriters were represented by an equally sophisticated law firm, Simpson, Thacher & Bartlett. And yet among these seasoned investment professionals, no one had a clue how to accurately value this company or there was a plan to simply fleece the public.  JPMorgan Chase was also an investor in the private shares of this company, whose value was highly likely mismarked on its books.

Dot 3 — A Shaky, Interconnected Mega Bank. What could cause a nascent financial problem to bloom into a full scale crisis really fast? How about a large universal bank holding lots of mom and pop deposits alongside trillions of dollars in high risk derivatives that are interconnected to other key global banks, as its stock price bleeds away. That’s what happened to Citigroup in 2008 and that’s what is happening to Deutsche Bank today. (See The Fed and Wall Street Have their Worry Beads Out Over Deutsche Bank’s “Bad Bank” Idea.)

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