Tavakoli: There should be thousands of felony indictments

Janet Tavakoli wants to end the ongoing fraud in the financial markets. Her summary of the reasons for the current disaster: Fraud, abuse, lack of acknowledgement of flawed models and how easily the system is gamed, in about equal measure.

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German Business News: You are a critic on the derivatives in general as you see this more of a speculation than a hedge. Do we have to expect the derivatives blow up the financial system?

Janet Tavakoli.

Janet Tavakoli.

Janet Tavakoli: I’ve written a couple of books on derivatives, the first was in 1997 called CREDIT DERIVATIVES. Obviously I believe they have utility. But the purpose has been corrupted by speculators who often dominate derivatives markets to such an extent that derivatives can be useless and even counterproductive as a hedge. For example, I wrote the SEC in 2007 about a product called Constant Proportion Debt Obligations (CPDOs). Pension funds in the United States had their hedges against corporate credit risk turned against them due to distortions created by speculators that pushed “AAA” rated products called CPDOs, which were actually worthy of a junk rating. Not only were pension funds hurt, but within a year of my letter rating agencies downgraded CPDOs to junk. Investors in CPDOs lost 90% of their principal. Yet there has been no punishment for the rating agencies and no meaningful financial reform of banks that created these corrupt products.

What is the key problem with the derivatives?

Fraud, abuse, lack of acknowledgement of flawed models and how easily the system is gamed, in about equal measure. Combined with the inherent leverage, it makes for a volatile and destructive combination when things go wrong. But when things go right, people will claim genius when they are merely leveraging a balance sheet.

In you new book The New Robber Barons you claim that there is an oligarchy where a few people folks is committing simple fraud to earn money like hell. Can you elaborate on this?

I’m sorry if I gave the impression that only a few folks have been involved in fraud in the United States. There should be thousands of felony indictments.

You want to see more “jail time” for investment bankers. Why?

More jail time? How about ANY jail time.

What about accountability? How come that someone like Jon Corzine can get away by saying: “Sorry, I simply don’t know where the money went?”

Corzine raised a lot of money for then Senator Obama’s campaign and now President Obama’s campaign. He has also raised a lot of money for the Democratic party. In the United States if you raise a lot of money for either party, it seems to be a get-out-of-jail free card. Both parties in the United States love people who raise money. Let’s not upset the money-raisers by letting them know they can be prosecuted.

What about the bosses: Did Jamie Dimon push his people to go for more and riskier bets?

Jamie Dimon pushed his people to make money for the bank. But the models have known flaws. Those who manipulate the models’ assumptions—and therefore have a lot of control over the profit and loss numbers they report—have an incentive to report good numbers and reduced risk. What is that incentive? The tens of millions of dollars in bonuses that Dimon paid them last year. Yet, oversight was clearly absent. That’s Jamie’s responsibility.

Jamie Dimon has become the funniest man on Wall Street. He appeared on Meet the Press, a well-watched Sunday morning news program. Here’s an example of a question and Dimon’s answer. I’m sorry to say that the crash test dummy that interviewed Dimon accepted this non-answer. But I have to give Dimon points for being unintentionally hilarious:

Question: “How did this happen?”

Dimon’s Answer: “First of all, there was one warning signal — if you look back from today, there were other red flags. That particular red flag — you know, we made a mistake, we got very defensive and people started justifying everything we did. You know, the benefit in life is to say, ‘Maybe you made a mistake, let’s dig deep.’ And the mistake had been brewing for a while, so it wasn’t just any one thing.” (I’m not making this up; these were Jamie Dimon’s exact words.)

I’m inspired to ask for a new financial regulation. If a CEO is going to be corrupt, he must be entertaining.

What about regulation? Why does it fail?

Lack of enforcement for starters.

What needs to be done to stop the global Ponzi scheme?

In global venues where Ponzi schemes are illegal, the laws should be enforced.

Talking about Europe: Is the European sovereign debt crisis also a result of the Ponzi scheme?

When I use the words “Ponzi scheme,” I’m being very specific: New money from new investors is used to pay off old investors in an already-failed business model. The thing about fraud is that it informs everything it touches, and you see multiple kinds of frauds erupt within the same overall fraud. That’s what THE NEW ROBBER BARONS is all about.

I discuss the European sovereign debt crisis in the book, but I don’t call it a Ponzi scheme, and I wouldn’t dismiss the various problems with an inaccurate label.

In Europe, we have a former Goldman Sachs guy running the ECB, another on is running the Italian government. The Spanish minister for economy is the former Lehman director for Spain. Is this coincidence? Why do these guys go to politics?

There’s no better way to capture a country’s treasury than to go into politics.

As an investment advisor: Do you tell your clients to get out of the sovereign debt market?

I don’t advise individuals. I manage my own private money. I will change over to money management before year-end. My current focus is on risk issues in general and I consult to financial institutions on risk and when they get into disputes with each other. I consulted with people shorting some sovereign credits using credit derivatives, for example. We wanted to mitigate the risk of people manipulating the contract language. But I always have a view on credit.

You say that inflation destroys wealth. Do you expect massive inflation for Europe within the next years?

Europe is likely to experience stranguflation. The price of assets you own will go down due to asset deflation and the price of things you want and need will likely go up due to money printing to fill the hole in banks’ balance sheets.

In Europe, we will have the ESM, a permanent bailout fund for the Eurozone. The ESM is a vehicle without transparency and control. Is this a new playground for more Ponzi activities?

What do you think is likely to happen if you give a stranger control of a huge sum of money without transparency and control? Moreover, this stranger has already observed that financial thieves and those who lie about money and risk never face criminal charges and never serve time in jail. The press never disgraces them, and they get their faces on the cover of glossy magazines. Sycophants line up to tell them how brilliant they are. Good luck with the ESM; I’m sure it will be well-managed. Oder?

Should Germany leave the Euro?

Funny, I thought you’d ask whether Greece should leave the Euro. It may not be Germany’s choice.

Do you think we will see a crash of the financial system, or are there ways to stop the “slow motion train wreck”, as Roubini puts it?

If decent people don’t demand decency from our leaders, how do you think it will end?

Janet Tavakoli is the founder and president of Tavakoli Structured Finance, Inc. (TSF), a Chicago based consulting firm providing expert experience to maximize the value of derivatives and structured products and avoid getting burned. TSF consults for financial institutions, institutional investors, and hedge funds.

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