Wray: Timmy-Gate: Did Geithner Help Hide Lehman Fraud?

By L. Randall Wray, a Professor of Economics at the University of Missouri-Kansas City who writes at New Economic Perspectives

Just when you thought that nothing could stink more than Timothy Geithner’s handling of the AIG bailout, a new report details how Geithner’s New York Fed allowed Lehman Brothers to use an accounting gimmick to hide debt. The report, which runs to 2200 pages, was released by Anton Valukas, the court-appointed examiner. It actually makes the AIG bailout look tame by comparison. It is now crystal clear why Geithner’s Treasury as well as Bernanke’s Fed refuse to allow any light to shine on the massive cover-up underway.

Recall that the New York Fed arranged for AIG to pay one hundred cents on the dollar on bad debts to its counterparties—benefiting Goldman Sachs and a handful of other favored Wall Street firms. The purported reason is that Geithner so feared any negative repercussions resulting from debt write-downs that he wanted Uncle Sam to make sure that Wall Street banks could not lose on bad bets. Now we find that Geithner’s NYFed supported Lehman’s efforts to conceal the extent of its problems. Not only did the NYFed fail to blow the whistle on flagrant accounting tricks, it also helped to hide Lehman’s illiquid assets on the Fed’s balance sheet to make its position look better. Note that the NY Fed had increased its supervision to the point that it was going over Lehman’s books daily; further, it continued to take trash off the books of Lehman right up to the bitter end, helping to perpetuate the fraud that was designed to maintain the pretense that Lehman was not massively insolvent.

Geithner told Congress that he has never been a regulator. That is a quite honest assessment of his job performance, although it is completely inaccurate as a description of his duties as President of the NYFed. Apparently, Geithner has never met an accounting gimmick that he does not like, if it appears to improve the reported finances of a Wall Street firm. We will leave to the side his own checkered past as a taxpayer, although one might question the wisdom of appointing someone who is apparently insufficiently skilled to file accurate tax returns to a position as our nation’s chief tax collector. What is far more troubling is that he now heads the Treasury—which means that he is not only responsible for managing two regulatory units (the FDIC and OCC), but also that he has got hold of the government’s purse strings. How many more billions or trillions will he commit to a futile effort to help Wall Street avoid its losses?

Geithner has denied that he played any direct role in the AIG bail-out—a somewhat implausible claim given that he was the President of the NYFed and given that this was a monumental and unprecedented action to funnel government funds to AIG’s counterparties. He may try to deny involvement in the Lehman deals. (Again, this is implausible. Lehman executives claimed they “gave full and complete financial information to government agencies”, and that the government never raised significant objections or directed that Lehman take any corrective action. In fairness, the SEC also overlooked any problems at Lehman. But here is what is so astounding about the gimmicks: Lehman used “Repo 105” to temporarily move liabilities off its balance sheet—essentially pretending to sell them although it promised to immediately buy them back. The abuse was so flagrant that no US law firm would sign off on the practice, fearing that creditors and stockholders would have grounds for lawsuits on the basis that this caused a “material misrepresentation” of Lehman’s financial statements. The court-appointed examiner hired to look into the failure of Lehman found “materially misleading” accounting and “actionable balance sheet manipulation.” (here) But just as Arthur Andersen had signed off on Enron’s scams, Ernst & Young found no problem with Lehman.

In short, this was an Enron-style, go directly to jail and do not pass go, sort of fraud. Lehman’s had been using this trick since 2001. It looked fine to Timmy’s Fed, which extended loans allowing Lehman to flip bad assets onto the Fed’s balance sheet to keep the fraud going.

More generally, this revelation drives home three related points. First, the scandal is on-going and it is huge. President Obama must hold Geithner accountable. He must determine what did Geithner know, and when did he know it. All internal documents and emails related to the AIG bailout and the attempt to keep Lehman afloat need to be released. Further, Obama must ask what has Geithner done to favor his clients on Wall Street? It now looks like even the Fed BOG, not just the NYFed, is involved in the cover-up. It is in the interest of the Obama administration to come clean. It is hard to believe that it does not already have sufficient cause to fire Geithner. In terms of dollar costs to the government, this is surely the biggest scandal in US history. It terms of sheer sleaze does it rank with Watergate? I suppose that depends on whether you believe that political hit lists and spying that had no real impact on the outcome of an election is as bad as a wholesale handing-over of government and the economy to Wall Street.

What did Timmy know, and when did he know it?

Point number two. Lehman used an innovation, “Repo 105” to hide debt. The whole Greek debt fiasco was caused by Goldman, et. al., who helped hide government debt. Whether legal or illegal, Wall Street has for many years been producing financial instruments designed to mislead shareholders, creditors, and regulators about the true financial position of its clients. Note that Lehman’s counterparties in this fraud included JP Morgan and Citigroup (who actually precipitated Lehman’s final failure when they finally called in their loans). It always takes at least three to tango: the firm that wants to hide debt, the counterparty that temporarily takes it off their books, and the accounting firm that provides the kiss of approval.

Worse, after aiding and abetting such deception, Goldman and other Wall Street institutions then place bets (using another nefarious innovation, credit default swaps) against their clients, wagering that they will not be able to service the debts—which are greater than the market believes them to be. Does that sound something like insider trading? How can regulators permit such actions?

What did Timmy know, and when did he know it?

Third point. To the extent that debt is hidden, financial institution balance sheets present an overly rosy picture—of course, that is the purpose of the financial “innovations”. Enron did it; AIG did it; Lehman did it. What about Bank of America, Citi, JP Morgan, Wells Fargo and Goldman? We now know that the New York Fed subjected Lehman to three wimpy “stress tests”, all of which it failed. Timmy’s Fed then allowed Lehman to construct its own sure-to-pass “stress” test. (We know, of course, that the test was absolutely meaningless because, well, Lehman passed the test and then immediately failed spectacularly. Timmy then let the biggest banks run their own stress tests, which they (surprise, surprise) managed to pass.

What did Timmy know, and when did he know it?

As our all-time favorite Fed Chairman Alan Greenspan liked to put it, “history shows” that when financial institutions pass their own stress tests, they are actually massively insolvent. There is no reason to believe that this time will be different. Mike Konczal reports that there is every reason to believe the biggest banks are hiding huge losses on second liens. These are second mortgages or home equity loans that amount to about $1 trillion of which almost half are held by the top four banks. Since the first principal of a mortgage is paid first, it is likely that much of the second liens are worthless. Yet banks are carrying these on their books at 86 to 87 percent of face value—which was necessary to allow them to pass the stress tests. Konczal shows that at a more reasonable loss rate of 40% to 60%, the four largest banks would have “an extra $150 billion hole in the balance sheet”. I won’t go into the policy conundrum implied for President Obama’s plan for principal reduction to help homeowners (the banks will not allow renegotiation of underwater mortgages because that would force them to recognize losses on the second liens).

Of greater importance is the recognition that all of the big banks are probably insolvent. Another financial crisis is nearly certain to hit in coming months—probably before summer. The belief that together Geithner and Bernanke have resolved the crisis and that they have put the economy on a path to recovery will be exposed as wishful thinking. In the bigger scheme of things, this is only 1931. We have a long way to go before bank assets (and nonbank debts) are written down sufficiently to allow a real recovery. In other words, a Minsky-Fisher debt deflation is still in the cards.

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  1. mario

    “In short, this was an Enron-style, go directly to jail and do not pass go, sort of fraud.”

    Totally agree.

  2. arby

    This is embezzlement…. a betrayal of fiduciary duty and responsibility to the taxpayer … is it not?

  3. Francois T

    Three things are being nakedly exposed for all to see here:

    1) The colossal incompetence and slothfulness of the mainstream media. Where are these people on this affair? Someone feeding at the media trough wouldn’t have a freaking clue about Timmy and the NY Fed role in this nonfeasance saga. Once again, expert blogs is where the important information come from.

    2) The Obama Administration and Congress unbelievable capacity of either deluding themselves, or thinking the people can be deluded ad vitam aeternam into a false sense of security. How do they think their prospects of staying in power will be when the next crisis starts?

    3) Wall Street is hopeless and must be reformed in depth.

    1. PhilBen

      I think we are long passed looking to the mainstream media to protect the average american. If anything, mainstream media in its current form is part of the problem.

      There is really only two options left to protect our rights and punish these crooks. One is for the american people to take matters seriously and get active at all levels of govt. We cannot rely on our “representatives” to represent us, we must get involved, voice our discontent and hold everyone accountable.

      Second is that the courts, at least the lower courts as the US Supreme Court has been well purchased and politicized, may still hold enough decent judges to be our last chance against the two corrupted branches of govt. With Congress and The Presidency seemingly bought and sold, its only the courts that can challenge their corruption and force light into the darkness.

      It was the courts ordered examiner that revealed the ugliness. We need more court cases all over the country challenging all aspects of our govt corruption.

      1. Stevielee

        The “mainstream media” is nothing more than a couple of multi-pronged, for-profit corporations peddling highly filtered and selective information/disinformation – packaged as ‘news’- successfully delivering the majority of our willfully ill-informed populace to their ever insatiable paymaster advertisers. That’s really all they ever have been and will be. To expect any of these huge, oligarchal propaganda front companies to somehow start telling the masses what’s realy going on with our ‘ruling class’ is just not gonna happen.
        Their job will always, always be to buttress, cover-up, subterfuge, distract and sell stuff.
        All we have now is the non-corporate blogs and a few, struggling independent news agencies. Anything else is just eye witless snooze.

  4. debbiepug

    This paragraph taken from Dodd’s Financial Reform Bill,and supported by Geithner(?):

    “- Increases Accountability at the New York Federal Reserve Bank: The president of the New York Federal Reserve Bank will be appointed by the President of the United States, with the advice and consent of the Senate. The New York Federal Reserve president is a permanent member of the Federal Open Market Committee, the Bank executes open market operations and is an important source of information on capital markets, and the Bank supervises many important bank holding companies. However, the president of the New York Federal Reserve Bank is currently chosen by the Bank’s directors, 6 of whom are elected by member banks in that

    a.k.a The Geithner Prevention Rule.
    If that isn’t a “no confidence” vote by Dodd for that “I was unaware” dolt, I don’t know what is.

    1. anon

      Interesting. I read it as more of a way to extort more bribes (aka campaign contributions) for Senators and the President.

  5. Anonymous

    Hasn’t the Fed already done the 105 dance itself with
    the banks MBS? Give the banks reserves to shore
    up their balance sheet, while the Fed holds the MBS and
    mark-to-pretend the price?….yeah, that’s it.

    And isn’t the Fed intending to do the same with MBSmoney market accounts?

    this is innovation, right?

  6. e

    None of this is going to matter in the near future.

    This is about the desire to crash, to rebuild anew.

    And this won’t be a democracy, and people will be viewed as “management problems”.

    I honestly see a trend developping: people blinded by idealism will be in for major disapointment if they somehow manage to survive, il a litteral way.

    No reforms are on the horizon. This is about looting a sinking ship, and getting away on what is perceived as life rafts.

    The functionally homeless have a leg up on the rest of America.

    This will be the end of that experiment in democratic ideals.

  7. tulip tiptoes

    “What did Timmy know, and when did he know it?”

    sounds like a mantra to me
    slips so nicely off the tongue, doesn’t it?
    nice one

  8. Jackrabbit

    Maybe Lehman was too far gone by the time the Fed arrived on the scene. But if so, the Fed was in a position to demand, and assist in, an orderly unwind. Instead, we got a failure of Lehman and AIG, a near collapse of the financial system and a bailout of AIG that paid out creditors (primarily Goldman) 100%.

    The Fed had months to raise the alarm about Lehman. If Goldman Sachs was privy to the all-but-certain collapse of Lehman, wouldn’t Goldman seek to arrange that AIG received a bailout instead of Lehman?

    One could imagine Goldman’s strategizing as follows: if Lehman is helped, then the ensuing public outcry makes it difficult to help another nonbank financial company (AIG) in a way that benefits Goldman and others BUT if Lehman precipitates a financial crisis, AIG gets a bailout and everything is swept under the rug.

    Interesting to say the least, that at the time, the Chairman of the NYFed was a Director of Goldman Sachs (and former CEO), and the Secretary of the Treasury was a former CEO of Goldman Sachs.

    A lot of people have questioned why AIG was saved and Lehman was not (and have implied that it was due to AIG’s importance to Goldman) but now that we know how deeply involved the Fed was in Lehman’s final months, the questions become more pertinent.

  9. fiscalliberal

    While some changes proposed by Dodd will probably make it through, the effectiveness will be eliminated by late night exemptions. So- the industry, regulaters and congress do not seem to be able to learn from the past.

    Possibly the only thing we have with us in the future is people shorting companies. I have come to understand they are the canary’s in the coal mine. We are going to have to go through another financial crisis to get better legislation

  10. maniam

    1.”..It was not accidental [the 1929 stock-market “crash”]. It was a carefully contrived occurrence. … The international bankers sought to bring about a condition of despair here so that they might emerge as rulers of us all.”
    2.”.What is needed here is a return to the Constitution of the United States. We need to have a complete divorce of Bank and State. The old struggle that was fought out here in Jackson’s day must be fought over again… The Federal Reserve Act should be repealed and the Federal Reserve Banks, having violated their charters, should be liquidated immediately. Faithless Government officers who have violated their oaths of office should be impeached and brought to trial. Unless this is done by us, I predict that the American people, outraged, robbed, pillaged, insulted, and betrayed as they are in their own land, will rise in their wrath and send a President here who will sweep the money changers out of the temple.”
    -louis mcfadden.
    will they get away this time?

  11. Doc Holiday

    The reason we have an economic systemic collapse, is because the system was built on synthetic financial instruments which were never recognized or regulated. People like Geithner, Greenspan, Paulson and Bernanke did all they could to save the banks which had built houses of cards. It is the treason-like collusion within the system that needs to be examined now, i.e., we know the banks are still insolvent, the country is insolvent, the regulations didn’t work — and now, it’s time to start over and clean up the mess. The best way to deal with reality, is nationalize the banks and fire everyone in the Treasury Department connected to Geithner. Then, fire everyone connected to Bernanke and then “change” all of Obama’s economic team. From there, shut down FASB and raid SIFMA and the American Bankers Association — and fine every lobby group that was involved with TARP — and crap, might as well toss Paulson in prison for tax evasion, bring Bush to trial, take back every cent from TARP ever given away …. and ahhhh, give polygraphs to every congress-crook and senate-shister and whoever fails will be hung for treason … hmmm, am I leaving anyone out…. might as well give polygraphs to everyone at DOJ, FBI, FDIC, SEC, DOL ….. and ahhh, have all wall street corporations be audited for the last 10 years, and place in prison anyone that violated real accounting law …. that’s a start, then we go off shore and deal with fraud and hunt down pirates and vaporize all derivates connected to bullshit (are yah listening Warren)… amen and out.

    “Correlation trading has spread through the psyche of the financial markets like a highly infectious thought virus,” wrote derivatives guru Janet Tavakoli in 2006.

  12. maniam

    please inform paul krugman re “taking on china” and andrew evans pritchad re “is china spoiling for a showdown with america”that the enemies are within.
    or are they on the international bankers’payroll?

  13. Hugh

    Summers and Geithner maintain that the financial industry is sound and that it is only, or principally, suffering from a crisis of confidence. Exposing them all as crooks would not help engender confidence and so I don’t see any push to investigate or prosecute anyone. I mean if Obama won’t even investigate torture, bank fraud even as massive as what we see here is surely not in the cards.

    I agree that the banks are insolvent and that debt deflation is in our future, but this is an election year and efforts will be made to hold things together until after the first Tuesday in November.

    1. carol

      Hugh: “..but this is an election year ..”

      every other year is an election year!
      This is abused by Congress to do nothing, ever (other than some pork wasting).

      Last year was not an election year, and what did we get? Nothing! No change, no regulation, no nothing.
      Anyway, what does an election change? You can vote out the bad incumbent, and get a newby (from the same or the other party) who is as captured by Wall Street.

      1. Doug Terpstra

        [S]elections are designed to preserve the corrupt status quo, and the Supine Court ensured it by allowing unlimited corporate political campaigning.

        Behold, the ink was barely dry on this act of treason when Clarence Thomas’ wife, Virginia, launched a conservative lobbying firm. Clearly, there is no longer any need for pretense at hiding such rank corruption.


  14. Doc Holiday

    Wall street banks are drug dealers that are being bailed out for fraud!

    Remember the good ol days when Lehman was boosting cash flow…..

    According to the indictment, since 1995 Villanueva and his son were alleged to have deposited large amounts of narcotics proceeds into foreign and United States bank and brokerage accounts. They are said to have then enlisted the assistance of Marquez to conceal their ownership and avoid the detection of the funds by law enforcement.

    Marquez is alleged to have used her positions at Serfin Securities, a Mexican investment firm with offices in New York, and later with Lehman Brothers to establish offshore corporations structured to conceal the narcotics proceeds and their ownership by Villanueva and his son. The seizure and forfeiture of the accounts, estimated to total about $45 million, are being sought.

    >> Anyone here think this is not done by other wall street banks — to this very day? Does anyone think that CDO’s and CDS are not used to supercharge money laundering by the wall street drug cartel — which is backed by the Treasury?

  15. Hoofin

    We are looking at this in hindsight.

    In early 2008, I don’t think Geithner’s people or the SEC would have even considered a massive fraud. Their focus was probably only on “net capital” as against the size of haircuts Lehman would have to take in the market on some of its assets.

    This is why they did the Freedom CLO, apparently.

    I worked in Lehman Japan in 2007 through one of these amorphous “professional service firms”. The fixed-income control unit didn’t understand the yen-carry trade (that is, why so much yen was being repo’ed and sent to the Lehman Brothers Europe unit). They had some accounting issue unrelated to “Repo 105”, and I think it’s the one Warren Buffett described as Lehman’s “$100 million Japan problem” when he turned down Dick Fuld’s offer to invest.

    Did, for example, Lehman Japan’s CFO Enrico Corsalini see Repo 105 go through the ledger? He must have–there were trades so designated, and the term was used in the unit. But they looked like all the other repurchase agreements: money in, in exchange for a liability, and a transfer of the collateral in the meantime. (And again, by way of comparison, these folks had a tough time getting a grip on the more plain vanilla yen-carry repo activity, which was legitimate.)

    My guess is that the recorded Repo 105’s on subsidiary branch ledgers made thin net capital even thinner (since the adjustment happened manually in consolidating the Europe sub with the New York holding company.) This would have been worrisome, but again, it wouldn’t point to fraud.

    Repo 105 and schemes such as that only work when only a very few people know what the real truth is. Ask Madoff.

    Whoever ordered the manual adjustment knew. Fuld probably knew. Regulators were probably put on the trail of other crises, and it looks like there were several.

    1. Yves Smith Post author

      That is a key point, that the management information systems would have recorded Repo 105 normally, the shenanigans occurred when the data in management/operating reports was turned into external financial reports

      However there is a separate issue. Lehman has a roughly $150 billion hole in its balance sheet (positive net worth of $24 B at the end of 2Q vs. roughly $130 billion of losses when it failed). Repo 105 did not CAUSE losses, it DISGUISED leverage, really, negative net worth.

      Yet the Fed gave it three stress tests that it failed, and still arranged for a device that allowed Lehman to “pass” stress tests.

      So the issue with the Fed is the failure to deal with Lehman’s clearly unacceptably weak financial position, not Repo 105 per se.

      1. Siggy

        Very good, perfect read of the balance sheet once the transactions are properly accounted for.

        One could also have asserted; Say all that real estate, those values look aggressive. What say we give them a haircut of say 20%, voila you are in the toilet. Would that assertion have been out of hand? Hardly. They bought the income stuff on roughly a 6% cap. Unless we have a booming economy and a serious lack of supply in the real estate sector, that dog won’t hunt! A realistic cap would have been north of 8%, that suggests an overvaluation of at least 30%.

        On the other hand, we all know that the market will sit these ne’er do wells to their just desserts. Or, is this latest revelation less a revelation and more of the milstone of justice grinding slowly and finely?

  16. emca

    All the questions here and abroad. Tip-top of the iceberg. Who’s going to look underwater for the rest?

    Tim and Ben and friends may be the front line impeding investigation, but its there’s only one from which reform can flow. Unless the presidency lends direction to serious and thorough investigation, all remains substantially as is. Its not just Obama, just Obama (as he stares saintly into the heavens second only to Jesus in adulation of the faithful), but anyone of any party, with any predisposition toward a minimal sense of decency and fair play. They, the President, will have to take risk, be forthright and lead if there is to be resolution of this tragedy.

    At least Obama, when knowing hounds are on scent, will throw all present to ‘dem dogs to avoid contamination by association. Not what would recommend you to a place beyond the theater of absurdity, of moral flaccidity and verbal flatulence, but hey, can we be choosy?

  17. lawgrace

    FALSE foreclosure proceedings filed under Lehman Brothers’ name, additional way to COOK the BOOKS, see:



  18. nowhereman

    I’m a simple man, with simple ideas. I feel like Joe everybody, except, I follow this blog and am privy to information that everyone should have access to. Yet, they don’t. The MSM have let America down and are a major impediment to the resolution of our problems.
    I am horrified, I am devastated, I can only hope that somehow the information the American public needs, is disseminated.
    This blog is a beacon. Let it shine.
    I got my copy of Econed today. When I finish reading it I will donate it to my Public Library in the hopes that maybe someone else, if just one someone else is given the information they need to start their own search for the truth behind this great FRAUD. This is not another Depression, no it’s the great Banking Fraud.
    It can’t be dealt with until it is recognized for what it truly is.
    The system has failed, and we can’t fix it until we realize this fundamental truth. We need indictments, and we need them soon, or else there is no hope what-so-ever.

  19. fresno dan

    “How many more billions or trillions will he commit to a futile effort to help Wall Street avoid its losses?”

    A. Uh, to infinity and beyond?
    B. let every taxpayer know, whether it wishes banks well or ill, that the treasury shall pay any price, bear any burden, buy any CDS, support any bank holding company, oppose any financial reform, in order to assure the survival and the success of Goldman Sachs.
    C. Not one red cent more! Ow, OWWW!!!! I hurt myself laughing…call 911!

  20. dwight baker

    Poor spoon fed Tim. Raised in China, been in the big bucks all his life, totally out of his league working in the public eye. I know this for sure he is not to be trusted in any way.

    Now he has our checkbook what does that tell anyone sane. We need to get it back.


  21. mario

    “Of greater importance is the recognition that all of the big banks are probably insolvent.”

    “There might be situations in which lying will produce greater overall good than telling the truth. In this situation it would be ethically right to tell a lie” (utalitarian ethics)

  22. moslof

    Anywhere in the government these days it is much more important to “look good” than to “be good”. An entire generation of managers has matured under this thinking and it is a great loss.

    1. mario

      That’s precisely why they paid as much as they get paid. Executive compensation needs to reflect all the risks.

  23. Anton

    I am a first time poster and long time reader. I’d like to thank Prof. Wray, the other contributors here at NC, and especially Yves for the light they have been shedding on the current economic woes that are wracking the economy.

    I am not what anyone would deem “economically literate,” and this blog, and others like it are tremendously important to me since they explain the current crisis and the crimes and mistakes committed by our leaders in terms that even I can understand.

    Having said, that I wonder if someone with a better working knowledge of subject can answer some questions I have about the NYFeds involvement with Lehman and how it relates to larger bailouts orchestrated by Geithner once he became Treasury Secretary.

    Under Geithner the NYFed allowed Lehman to hide their financial troubles. If I understand correctly, one of the ways they did this was granting them generous loans for junk assets.

    This has been widely reported in a number of blogs. What I have not yet seen addressed, and what I find puzzling since I am not an economist, is WHY would Geithner and the NYFed do this? WHY would they allow Lehman’s fraud to continue when they knew about it? WHY would they facilitate the fraud? Was Geithner hoping that he could reinflate Lehman’s bubble in a vain attempt to stave off the collapse that did in fact occur? To me, it looks like the NYFed was attepting to use smoke and mirrors to heal a company that was fundamentally broken.

    Once Geithner left the NYFed and failed upwards to become the Secretary of the Treasury he began to bail out more banks using methods that, to my untrained eye, look remarkably similar to the methods he used to prevent Lehman from imploding. Am I mistaken to think that Geithner’s efforts upon taking command of the U.S. Treasury are Lehman writ large? In other words is he using smoke and mirrors to again make ailing companies seem healthy while making no substantial effort to address the fundamental problems?

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