Reading through the thousands and thousands of pages of Valukas' report has proven, as we suspected early today, quite entertaining. After having first uncovered the Repo 105 accounting gimmick, and E&Y (and, in a normal society, Tim Geithner) coffin nail, we are convinced that this is just the tip of the iceberg, and sure enough, as we read along, more stunners come to light. We will update this post with new discoveries, but for now, we present the episode of the Fenway Tri-Party Repo Market Clusterfuck ("FTPRMC"), The Part Where Lehman Lied To Its Shareholders, And The SEC Gets The Middle Finger (Again), and the parable of Ben Bernanke's And His Scale Of 0 To 100 Of Systemic Fuckedupedness.

1. The Fenway Tri-Party Repo Market Clusterfuck ("FTPRMC" or "The Clusterfuck")



In the days before Lehman filed for bankruptcy, JPM, which was a tri-party clearing bank, in a relationship we discussed long before most had even heard the name Anton Valuklas in our piece from October "A Rare Glimpse Into The Fed's Discount Window Courtesy of The Brewing Lehman-Barclays Scandal", started to escalate its collateral demands, in a foreshadowing of what was soon going to happen to AIG. Notwithstanding that this action may result in credible legal action against JPM, as, in the words of Valukas, "The Examiner concludes that there may be a colorable claim against one clearing bank – JPMorgan – arising from these collateral demands in 2008", we uncover something quite brilliant as to the quality of assets backing up collateral posted in the tri-party repo system. Note this is not the Repo 105 synthetic contraption, which apparently nobody had heard about before, not Geithner, not anybody at the FRBNY, not even Dick Fuld; this is a pure plain vanilla matched repo obligation, and a core component of the $3 trillion shadow banking system, which again was the topic of our prior post on this topic. Back then we ventured to guess that nearly worthless assets are used "on occassion" by assorted tri-party repo participants, and collateralized by JPM as clearing party, and ultimately by the Fed as end party on the other side of a tri-party repo. Little did we know just how far the stench went, and that worthless assets (and we do mean worthless) are very likely the norm. To wit from the report:

On September 11, JPMorgan executives met to discuss significant valuation problems with securities that Lehman had posted as collateral over the summer. JPMorgan concluded that the collateral was not worth nearly what Lehman had claimed it was worth, and decided to request an additional $5 billion in cash collateral from Lehman that day. The request was communicated in an executive?level phone call, and Lehman posted $5 billion in cash to JPMorgan by the afternoon of Friday, September 12. Around the same time, JPMorgan learned that a security known as Fenway, which Lehman had posted to JPMorgan at a stated value of $3 billion, was actually asset?backed commercial paper credit?enhanced by Lehman (that is, it was Lehman, rather than a third party, that effectively guaranteed principal and interest payments). JPMorgan concluded that Fenway was worth practically nothing as collateral.

At this point anyone who has even half a brain is feeling their front lobe liquefy. And in case one's brain is still semi-solid, lets simplify - Lehman was pledging as collateral "assets" whose explicit worth was contingent on Lehman's viability! Surely someone at Lehman brothers must have known about this. And the fact that they were so brazen as to suggest something that, as JPM rightfully concluded, was worthless in a catch 22 valuation, highlights the level of criminality and stupidity that serves at the backbone of what people assume is a sound and credible $3 trillion + shadow economy. This also means that should anyone ever delve into the collateral that banks hand off to each other in exchange for the tens of trillions in daily liquidity to gun the SPYs higher, they will find very little of actual value.

Oh, and just in case Lehman creditors and owners of billions of Lehman sub claims trading in the low double digits feel like suing someone, we fully expect that Jamie Dimon will soon be getting a summons. From the examiner:

Finally, the Examiner concludes that the evidence may support the existence of a colorable claim – but not a strong claim – that JPMorgan breached the implied covenant of good faith and fair dealing by making excessive collateral requests to Lehman in September 2008. A trier of fact would have to consider evidence that the collateral requests were reasonable and that Lehman waived any claims by complying with the requests.

2.The Part Where Lehman Lied To Its Shareholders, And The SEC Gets The Middle Finger (Again)

There used to be a thing about lying in public regulatory filings. We don't remember when the rule was phased out precisely, or when the SEC said that all its enforcement officers (roughly 2 of them) are going on a lifelong vacation to eunuch country, allowing the market to self-regulate, but we distinctly recall that lying to one's investors was marginally frowned upon courtesy of the Exchange Acts of 1933/34 (no, not the Gold confiscation act), even before the advent of Tiny Tim to the Throne Treasury And Tax Trickery. The reason why we are modestly perturbed is the following Valukas disclosure:

Lehman represented in regulatory filings and in public disclosures that it maintained a liquidity pool that was intended to cover expected cash outflows for 12 months in a stressed liquidity environment and was available to mitigate the loss of secured funding capacity. After the Bear Stearns crisis in March 2008, it became acutely apparent to Lehman that any disruption in liquidity could be catastrophic; Lehman thus paid careful attention to its liquidity pool and how it was described to the market.

See, the thing about "representing" is that if one know said representation is flawed and/or purposefully misleading, the one in charge (in this case Dick Fuld) would stand trial with civil and criminal charges. Which is exactly what happened:

Lehman reported the size of its liquidity pool as $34 billion at the end of first quarter 2008, $45 billion at the end of second quarter, and $42 billion at the end of the third quarter. Lehman represented that its liquidity pool was unencumbered – that it was composed of assets that could be “monetized at short notice in all market environments.”

The Examiner’s investigation of Lehman’s transfer of collateral to its lenders in the summer of 2008 revealed a critical connection between the billions of dollars in cash and assets provided as collateral and Lehman’s reported liquidity. At first, Lehman carefully structured certain of its collateral pledges so that the assets would continue to appear to be readily available (i.e., the Overnight Account at JPMorgan, the $2 billion comfort deposit to Citi, and the three?day notice provision with BofA). Witness interviews and documents confirm that Lehman’s clearing banks required this collateral and without it would have ceased providing clearing and settlement services to Lehman or, at the very least, would have required Lehman to prefund its trades. The market impact of either of those outcomes could have been catastrophic for Lehman. Lehman also included formally encumbered collateral in its liquidity pool. Lehman included the almost $1 billion posted to HSBC and secured by the U.K. Cash Deeds in its liquidity pool; Lehman included the $500 million in collateral formally pledged to BofA; Lehman included an additional $8 billion in collateral posted to JPMorgan and secured by the September Agreements; and Lehman continued to include the $2 billion at Citi, even after the Guaranty and DCSA amendments.

So of the $42 billion represented as being unencumbered in Lehman's liquidity pool, a stunning $11.5 billion was, in fact, encumbered. To say that this was information that potential Lehman investor might have wanted to have up until such time as Lehman filed for bankruptcy, is a wry understatement. And somehow the Syndicate Encouraging Corruption, aka SEC, has found this materially criminal misrepresentation to be, well, immaterial, and demand recompense from exactly zero Lehman executives.

And maybe if the above is insufficient, how about this observation, which should promptly force Mr. Fuld to buy a one-way ticket out of the US at some point tonight:

By early August 2008, JPMorgan had learned that Lehman had pledged self-priced CDOs as collateral over the course of the summer. By August 9, to meet JPMorgan’s margin requirements, Lehman had pledged $9.7 billion of collateral, $5.8 billion of which were CDOs priced by Lehman, mostly at face value. JPMorgan expressed concern as to the quality of the assets that Lehman had pledged and, consequently, Lehman offered to review its valuations. Although JPMorgan remained concerned that the CDOs were not acceptable collateral, Lehman informed JPMorgan that it had no other collateral to pledge. The fact that Lehman did not have other assets to pledge raised some concerns at JPMorgan about Lehman’s liquidity.

So scratch what we said above. Lehman's real liquidity pool was not $42 - $11.5 = $30.5 billion in Q3, it was bloody zero! Misrepresenting your available liquidity reserve by 25% is one thing, and probably would lead to a misdemeanor charge, a slap on the wrist, and a fine that can be satisfied by pledging Fuld's Porsche to the New York Superior Court. Yet disclosing at $42 when in reality it was $0, should be sufficient (again, in a normal society) for populist screams demanding euthanasia (or malthanasia, especially as pertains to a variety of Manhattan-based Chief Executives).

And, the zinger: guess who supervised the liquidity pool:

The SEC and FRBNY both monitored Lehman’s liquidity. The SEC monitored to verify that Lehman’s liquidity pool was unrestricted and could be monetized quickly, [which as shown above was not the case, meaning a case of criminal negligence can be brought against the SEC] while the FRBNY monitored Lehman’s liquidity as a potential lender. While both agencies theoretically had access to the same information, they did not necessarily share the information they collected with one another.

Oh but get this:

A former senior SEC CSE [Consolidated Supervised Entities] staff member, Matthew Eichner, told the Examiner that the Liquidity Inspections Scope Memorandum was never formally implemented as part of the CSE Program.

Well done, SEC, well done. While surely less exciting than tranny porn, doing your job may have well saved investors a few hundred million dollars. Oh, and just in case you thought the SEC is not an expert in scapegoating as well, think again. The culprit this time: Bear Stearns.

Eichner said that the SEC only “sampled” the CSE’s liquidity pools to ensure that the firms’ representations were accurate. Eichner stated that this sampling was not statistically significant, and that he never received any report indicating that Lehman did not pass these sampling tests. Eichner said that the SEC never had the opportunity to implement fully the steps set forth in the Liquidity Inspections Scope Memorandum because of the chaos surrounding Bear Stearns’ near collapse. The SEC was aware in June 2008 that Lehman’s liquidity pool included a $2 billion “comfort” deposit at Citigroup. The SEC staff viewed Lehman’s inclusion of that deposit in its liquidity pool as problematic, and discounted the value of the pool accordingly. Nevertheless, there is no evidence that the SEC directed Lehman to remove the comfort deposit from its calculation of reported liquidity. Eichner told the Examiner that “we applied a much different standard [for including assets in the liquidity pool] than anyone else,” and that the SEC “was very comfortable living with a world where the numbers in the public were the ones the firms worked out with their accountants.”

In other words, the SEC was well aware that Lehman was materially misrepresenting the one most critical part of its financial situtation to the entire world, and did nothing about it! The SEC should be disbanded for this gross, criminal negligence, and all of its senior executives sent into exile.

As for those other occassions when even the SEC was not aware of what was going on, it finally got the memo... On the Thursday before Lehman filed.

The SEC was not aware of any significant issues with Lehman’s liquidity pool until September 12, 2008, when officials learned that a large portion of Lehman’s liquidity pool had been allocated to its clearing banks to induce them to continue providing essential clearing services. In a September 12, 2008 e?mail, one SEC analyst wrote: Key point: Lehman’s liquidity pool is almost totally locked up with clearing banks to cover intraday credit ($15bnjpm, $10bn with others like citi and bofa). with This is a really big problem.

Luckily, nothing, NOTHING, escapes the staff of the SEC where anything greater than a single digit IQ is grounds for immediate termination.

Valukas himself pours some oil on the fire of material market misrepresentation:

The exhibit below shows that the public market (for debt and equity) indicated that Lehman was insolvent on a balance sheet basis (1) between July 11 and July 15, 2008 (around the time of the IndyMac collapse); (2) on July 28, 2008; (3) on several dates between August 19 and August 28, 2008 (during certain KDB rumors and when certain customers were leaving); (4) on September 4, 2008; (5) and on all dates on and after September 8, 2008 (Fannie and Freddie failed on September 7;the termination of KDB talks became publicly known on September 9).There is evidence, however, that the markets were not fully informed with regard to Lehman’s true liquidity position, because of issues such as Repo 105 and Lehman’s liquidity pool.6095 Accounting for this potential for misinformation would result in findings of less solvency on all dates impacted by the misinformation.

How much more do we need to uncover before there is a riot next to SEC's offices if, after all this, it still does nothing?

3. Where We Learn About Ben Bernanke's Scale Of 0 To 100 Of Systemic Fuckedupedness

From the report:

Bernanke told the Examiner: “I speak for myself, and I think I can speak for others, that at no time did we say, ‘We could save Lehman, but we won’t.’ Our concern was about the financial system, and we knew the implications for the greater financial system would be catastrophic, and it was.”5838 According to Bernanke, a “range of views” existed about the likely effect of Lehman’s failure on the economy. If the effect was measured on a scale of 0 to 100, some thought a Lehman failure would be a “minor disruption” – in the 1?15 range. Bernanke’s own view was in the 90?95 range. However, the actual effect turned out to be “maybe 140.” “It was worse than almost anybody expected."

We are eagerly awaiting the purchase of the www.amiinsolventornot.com domain, and its prompt funding by Menlo Partners, into a site where every bank is rated by the community on a scale of 0 to 100, with 140 reserved exclusively for the Federal Reserve.

Oh and remember how Paulson in his memoirs blamed it all on the UK? Well, Bernanke just implicitly did the same: and we were wondering where Greece learning to scapegoat so well.

The Examiner asked Bernanke whether, in hindsight, he believed that he or the Fed could have done anything different that might have saved Lehman. Bernanke responded that he should have been more engaged in dealings with the U.K. about Barclays’ pre?bankruptcy efforts to acquire Lehman. Nevertheless, Bernanke did not believe that the Fed had the legal authority to bail out Lehman in September 2008. He noted that a Federal Reserve Bank such as the FRBNY could make a loan only if it was satisfactorily secured, that is, that the bank could reasonably expect a 100 percent return. Bernanke said a “fundamental impediment” existed for Lehman: By mid?September, Lehman lacked not just “standard” collateral, but “any” collateral.

So the Fed was factualy certain of Lehman's insolvency in advance of the firm's bankruptcy, and yet it did nothing to notify the SEC, or to remove Lehman from the tri-party repo system, where the firm was stuck for weeks after its bankruptcy, leaving JPM and Barclays to fight over the CCC-rated scraps of paper that were fundamentally collateralized with taxpayer money. What a shitshow.

More to come.

P.S. we wont reference which volume the selections above come from just to make the lives of all the other mainstream, and otherwise, media (and in some very amusing and loss-generating cases, both at the same time) who have an uncanny desire to copy and paste from ZH without attribution just a little more difficult.

