Bottom Line: Matt Taibbi of The Rolling Stone has broken a powerful story about fraud (“fixing” auctions in the municipal bond market) by big investment banks stealing from municipalities. It also implicates politicians accepting bribes. It’s worth a read, and also asking “Why are we hearing about this through an entertainment magazine and not the financial press?”
[I’m still working on the “Alternatives with a Social Return for your Bond Investments” post as part of my Mission Related Investing for the Rest of Us series, but this post preempted that one.]
The Rolling Stone has a powerful financial investigative journalism piece in the July 5, 2012 issue called “The Scam Wall Street Learned From the Mafia.” It details a trial in New York with the conviction of 3 “bit players” in what appears to be a routine practice among the larger investment banks (“not just GE, but J.P. Morgan Chase, Bank of America, UBS, Lehman Brothers, Bear Stearns, Wachovia and more”) of fixing the bids on the interest rates that the banks offered cities and states across the country for the bonds they sold on the cities’ behalf. Instead of letting the highest bidder win, the banks conducting the auction would provide guidance to the bidders, telling them the minimum bid they would need to win the auction, and in other cases, asking potential bidders not to submit real bids (in exchange for the opportunity to win an uncontested auction elsewhere). The winning bidders would provide kickbacks to the banks on unrelated transactions.
Given the size of these dollar amounts, even a small rate difference (the examples in the article were about .04%) makes a huge dollar difference, money taken straight from the depressed city coffers, fattening the profits of these banks. The article makes the point that it was so common that the bankers had even stopped remembering it was wrong. They carried on discussions on phone calls they knew to be taped. Even the defense at the trial was something along the lines of “Hey, maybe this was the fair price. How do you know?”
So, today I’m feeling let down:
- Let down that the banks would resort to this level of criminality. (Here, I especially include GE, in which I am a shareholder.)
- Let down by the financial press and mainstream media. Why am I hearing about this through The Rolling Stone? Can the entertainment press really do a better job of covering financial investigative stories? Maybe they can. Author Matt Taibbi’s previous article on “The Real Housewives of Wall Street” was another memorable expose on people with dubious credentials claiming TARP funds.
- Let down by Bill Richardson, former Governor of New Mexico and Democratic Presidential candidate. He is cited in the article as taking $100,000 in campaign contributions (to his PAC) and subsequently awarding $1M contract to the firm (“Tell the big guy I’m going to hire you guys,”) while paying a second firm to actually do the work. I’d met Gov. Richardson on the campaign trail, and been impressed enough to make a contribution to his campaign. Guess I am not the best judge of character.
Changes to make things better
- Public funding of campaigns (whoa, subliminal slip there…. I’d originally typed “auctions”). The Richardson example is yet another of how the need for campaign fund raising is corrupting the business of government.
- Stronger enforcement of these laws, with greater penalties to the banks (and potentially splitting them up so that if we needed to wind down a bank because of its criminal behavior it can’t claim that doing so would pull the economy down with it.) Personal liability needs to be increased somehow as well, though I’m not sure how.
- Moving to a different/more transparent auction format. “Sealed bid, highest bidder wins” auctions can be subject to strategic bidding with companies understating their real value in order to try to minimize the price they pay for a winning bid. If they understate it by too much, they can end up losing to a firm that values it lower. Google uses a second price bid system for their Adwords. Under that scheme, each bidder has the incentive to bid his or her true value for the good, knowing that whether they win depends on that, but the price paid depends on the competitive bidders’ values. Ironically, the bid shaving described in the article is almost the same effect that moving to a second price auction would have (the winning bidder would pay the price of the second highest bidder). EXCEPT: 1) The firms need to know the rules of the auction so that they submit their real values as bids and 2) NO WAY should some priviliged bidders be permitted to see the bids of others prior to the close of the auction.