Jesse Eisinger: We’ve created a system that rewards bankers for skulduggery and fraud
In this interview Pullitzer-prize-winning US financial journalist Jesse Eisinger comments on the balance sheet obfuscation still favoured by America’s banks and on why no chief executive of a US bank, or indeed any other senior banker (with the possible exception of a couple in Ireland and Iceland), has been prosecuted or jailed for defrauding customers and fraudulently misrepresenting their assets before, during or after the global financial crisis.
The interview, conducted by the Atlantic’s business editor Derek Thompson, coincides with the publication of a lengthy article — ‘What’s Inside America’s Banks‘ — co-written by Eisinger and Frank Partnoy, professor of law and finance at the University of San Diego, which is the cover story of the current issue of The Atlantic.
In the article, Eisinger and Partnoy explore the dark underbelly of American finance, and have devoted a considerable amount of time and effort to going through the published financial statements of the San Francisco-based bank Wells Fargo, which bought Wachovia during the crisis and is currently favoured as an investment by the ‘Sage of Omaha’, Warren Buffett.
In the video interview (above), Eisinger said they found ‘layers and layers of impenetrability’ in the Wells Fargo 2011 annual report and accounts adding there were strong parallels with trying to get the bottom of Dante’s nine circles of Hell. He also said:-
‘it turns out that you can’t understand the securities on their balance sheet, and that this solid mortgage bank …. has enormous trading operations, and trading can be extremely volatile, you can suffer big, uncertain losses from it, and it turns out that Wells Fargo gets an enormous amount of its profits from trading, and trading in ways that are not clearly disclosed in any fashion to investors.’
Eisinger added that the system currently rewards banks for misleading their customers and investors. Asked by Thompson if some bankers, right now, sitting in C-suits and board rooms in the US should be in jail, Eisinger said yes.
‘My view is that banks did engage in criminal activity in the lead up to the financial crisis and after the financial crisis. And there are two broad activities: one is that they misled customers to sell them things that were misrepresented.
‘And the second activity is that, at the height of the crisis, I believe that several banks misrepresented to investors what the assets were worth. Now why we couldn’t have gotten some of the bankers for these kind of activities, [which were] very similar to what Ken Lay at Enron and Jeff Skilling were accused of and went to prison for, is a mystery of epic proportions. And it’s a terrible problem for the banking system, because we have eroded confidence in the banks, because we have said to anybody who knows anything about how the banks work [that] the incentives are to mislead, all of your incentives are to mislead your investors and your customers, and there is no incentive that you have to really be honest.’
By the way, I 100% agree with Jesse Eisinger on this. More and more people are waking up to the fact that it is a massive problem not just for the banks, but also for the wider economy and society. The natural consequence of the governmental and regulatory failure properly to get to grips with the rottenness at the heart of the banking system is likely to be further blow-ups that will make October 2008 seem like a minor tremor.
Delving into the Wells Fargo annual report, Eisinger and Portnoy reveal that ‘this folksy mortgage bank is displaying signs of having a split personality.’ Here are some edited highlights from their article.
It turns out that trading activities, the type associated with Wall Street firms like Goldman Sachs and Morgan Stanley, contribute significantly to each of Wells Fargo’s two categories of income. Almost $1.5 billion of its “interest income” comes from “trading assets”; another $9.1 billion results from “securities available for sale.”
One billion dollars of the bank’s “non-interest income” are “net gains from trading activities.” Another $1.5 billion is income from “equity investments.” Up and down the ledger, abstruse, all-embracing categories appear: “other fees earned from related activities,” “other interest income,” and just plain “other.” The income statement’s “other” catch-alls collectively amounted to $6.6 billion of Wells Fargo’s income in 2011. It will take the devoted reader 50 more pages to find out that the bank derives a big chunk of that “other” income from, yes, “trading activities.” The sheer volume of “trading” at Wells Fargo suggests that the bank is not what it seems.
…buried at the bottom of page 164 of Wells Fargo’s annual report is the following statement:
“In 2011, we incurred a $377 million loss on trading derivatives related to certain CDOs,” or collateralized debt obligations. Just a few years ago, a bank’s nine-figure loss on these sorts of complex financial instruments would have generated major headlines. Yet this one went unremarked-upon in the media, even by top investors, analysts, and financial pundits.
Perhaps they didn’t read all the way to page 164. Or perhaps they had become so numb from bigger bank losses that this one didn’t seem to matter. Whatever the reason, Wells Fargo’s massive CDO-derivatives loss was a multi-hundred-million-dollar tree falling silently in the financial forest. To paraphrase the late Senator Everett Dirksen, $377 million here and $377 million there, and pretty soon you’re talking about serious money.
Even conservatively run banks can be risky, as George Bailey learned in It’s a Wonderful Life. But the Bailey Building and Loan Association did not earn money from trading. Trading is an inherently opaque and volatile business. It is subject to the vagaries of the markets. And yet in the past two decades, as profits from traditional lending and brokering activities have been squeezed, banks have turned more and more to trading in order to make money.
… a second subcategory is “economic hedging.” An activity labelled “hedging” might sound soothing. Wells Fargo says it lost an inconsequential $1 million from economic hedging in 2011. So maybe there is nothing to worry about under this shell, either. In its pure form, hedging is supposed to reduce risk [but] hedges don’t always work as intended. They may not fully eliminate large risks that banks think they’ve taken care of. And they may inadvertently create new, hidden risks—“unknown unknowns,” if you will.
Because of all this complexity, some traders can disguise speculative positions as “hedges” and claim their purpose is to reduce risk, when in fact the traders are purposely taking on more risk to try to make a profit. That is what the traders within JP Morgan’s Chief Investment Office appear to have been doing. Was Wells Fargo’s “economic hedging” like buying straightforward insurance? Or was it more like speculation—what JP Morgan did? Do the reported numbers suggest low risk when in fact the opposite is true? The bank’s disclosures don’t answer these questions.
Finally we come to a third shell—and there’s unquestionably something to see under this one. It carries an innocuous label: “customer accommodation.” Wells Fargo made more than $1 billion from customer-accommodation trading in 2011. How did it make so much money merely by helping customers? This should be a plain-vanilla business: a broker sits between a buyer and a seller and takes a little cut of the transaction. But what we learned from the 2008 financial crisis, and what we keep learning from incidents such as the JPMorgan scandal, is that seemingly innocuous activities that appear highly profitable can be dangerous to a bank’s health—and to our economy.
… We asked Wells Fargo to explain its VIE disclosures, but its representatives once again simply pointed us back to the annual report. We specifically asked about the bank’s own reported corrections of these numbers (in one footnote, Wells Fargo cryptically says, “ ‘VIEs that we consolidate’ has been revised to correct previously reported amounts”). But the bank would not tell us anything about those corrections. From the annual report, one cannot determine which VIEs were involved, or how big the corrections were.
… These disclosures make even an ostensibly simple bank like Wells Fargo impossible to understand. Every major bank’s financial statements have some or all of these problems; many banks are much worse. This is an untenable situation. Kevin Warsh, formerly of the Fed, argues that the SEC should tell the biggest banks that their accounts are unacceptably opaque. “The banks should give a full, fair, and accurate account of their financial positions,” he says, “and they are failing that test.”the balance sheet obfuscation still favoured by America's