Time to “Fire” Mary Jo White: SEC Covers Up for Bank Capital Accounting Scam Promoted by Her Former Firm, Debevoise

Pam Martens and Russ Martens published a mind-boggling expose yesterday on how the SEC is refusing to stop an abuse by major banks that increases systemic risk. Large banks are continuing to fake their capital levels, via a ruse called a “capital relief trade” with hedge and pension funds. And Mary Jo White, the chairman of the SEC, is aware of this practice, which undermines the safety and soundness of financial institutions, and has done squat about it.

White is not just head of the SEC but also a member of the Financial Stability Oversight Council. She is undermining it and financial reform generally by her failure to take on this practice. Pam Martens and Russ Martens also charge the SEC chairman and her director of enforcement, Andrew Ceresney, with cronyism, since they both hail from the law firm Debevoise, which is an active player in this practice.

As much as there has been considerable consternation over Mary Jo White’s numerous lapses, like hiding behind the need for more data as an excuse for doing nothing about high frequency trading, her failure to secure more admissions of wrongdoing in SEC settlements, and her refusal to comply with Dodd Frank by virtue of too freely issuing waivers for mandatory sanctions, even to recidivist bad actors, this dereliction of duty is considerably more serious, because it increases systemic risk in a direct, tangible way.* Remember that technically permissible balance sheet fakery at Lehman, also known as Repo 105, allowed it to mask how sick it was.

One of the excuses for the weakness of Dodd Frank was that if financial firms had high enough equity levels, all the other ways of reducing risk became less important. The Wall Street Journal quoted Geithner’s reform approach that he set forth in 2009:

“The most simple way to frame it is: capital, capital, capital,” Treasury Secretary Timothy Geithner told Congress last year. “You want capital requirements designed so that, given how uncertain we are about the future of the world, [and] given how much ignorance we fundamentally have about some elements of risk, that there is a much greater cushion to absorb loss and to save us from the consequences of mistaken judgment.”

Thus capital relief trades undermine the government’s chosen first line of defense against bank failure. From the Martens’ article:

For more than two years now, SEC Chair Mary Jo White has been aware that the most dangerous banks on Wall Street, which are publicly traded securities, have been engaging in “capital relief trades” with hedge funds and private equity firms to dress up the appearance of stronger capital while keeping the deteriorating assets on their books. But neither White nor her Director of Enforcement, Andrew Ceresney, have put a halt to the practice.

And it provides an example of how one of the weakest too big to fail banks, Citigroup, has engaged in this practice. Recall that Citi was the only one of the five largest banks to fail the stress test twice in three years and have its plans to increase dividends and buy back stock rejected. Again from the Martens’ account:

In February 2013, Bloomberg News reported one of these eyebrow-raising trades between Citigroup – the bank that blew itself up in 2008 with hidden derivative deals – and Blackstone Group, a private-equity firm. Blackstone had insured Citigroup against initial losses on $1.2 billion of shipping loans, allowing Citigroup to lower the amount of capital the bank had to set aside by 96 percent. The problematic loans remained on Citigroup’s balance sheet according to Bloomberg News.

Mind you, $1.2 billion is small beer compared to the $50 billion in Lehman Repo 105 trades at its peak. But the flip side is that this is the one of the very few examples of this type of transaction that has come to light. How much more risk has been shifted to unregulated entities like private equity and hedge funds? Recall that AIG has an AAA balance sheet and was considered a financial powerhouse. By contrast, these risks presumably sit at specific private equity and hedge funds, and a $1.2 billion risk is certain to loom large relative to total fund size. These entities aren’t supervised for safety and soundness and thus aren’t held to any requirement that will assure that they can meet liquidity demands in the event that Citigroup or one of its peers that has entered into similar trades hits a financial iceberg yet again. Recall one of the lessons of the crisis: when a hedge fund is hit with losses, it also receives investor redemptions, which put many once high-flying funds into a death spiral. And the icing on the cake is that retirees and endowments are major investors in these “alternative” investments and thus the main ultimate risk bearers.

The article describes the undisclosed, glaring conflict of interest:

While White and Ceresney have allowed these risky capital relief trades to proliferate in the dark, their former law firm has been gushing over the trades and drumming up business for the murky area. In a Debevoise publication sent to clients in 2013, the law firm indicated it had experience in these deals and said they “appear to be particularly good opportunities for funds to generate revenue by providing targeted credit support, while retaining the ability to actively deploy capital as needed.”

Debevoise added further: “While it remains to be seen if transactions of this type can be structured in ways that are appropriate and attractive for a traditional private equity fund, it is yet another example of the innovative emerging opportunities for capital providers to make effective use of balance sheet capital as banking organizations adjust to the post-crisis regulatory paradigm.”

Please sign the Credo petition, Tell President Obama: Time for Mary Jo White to go. More important, call or e-mail your Senators and Representative and tell them about the Martens’ bombshell. You can find Senate contact information here and House contact details here.

Mary Jo White has done nothing to stop the type of bad practices that blew up the financial system in 2008. She is so clearly unwilling to do her job that she needs to be fired.

Update: My bad (failure of early AM drafting) to not say that the President cannot fire White. However, I also cannot imagine that if she were to hit a firestorm of criticism and the President were to call her in and say that the public had lost confidence in her, the odds are high that her resignation would be forthcoming.

* As much as HFT and dark pools have produced the worst possible market structure for public equities, the low use of borrowing in the US stock markets means it is not a source of systemic risk.

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  1. James Levy

    Conservative thinker Francis Fukuyama recently published a book wherein he argues that one of the fundamental problems of our time is that regulators can no longer regulate and government agencies can no longer govern. His argument is that corporations hijacked an environmentalist strategy of taking everything to court, and courts have been excessively deferential to the claims of corporations and ignore the importance of governing institutions being able to perform their functions clearly and robustly. The inability to enforce laws eventually undermines respect for the law and increases the likelihood and brazenness of gaming and/or skirting the law. I find myself in agreement with this thesis. Using the courts to decide issues that are by nature much more political than classically judicial has turned out to be a blind alley. It has overwhelmingly empowered those with the best lawyers and the deepest pockets. And it has turned the regulation of corporations into a negotiation, where corporations use litigation or the threat thereof to tie the hands of regulators and turn all regulatory interactions into a game of “let’s make a deal” rather than “follow the law or else.” BTW, William Greider (no conservative) saw much of this coming years ago in his book Who Will Tell the People?

    1. Steve H.

      A note on this: the ‘citizens suit’ clauses were originally included in environmental legislation as an explicit acknowledgment that regulators had insufficient resources to provide complete coverage on environmental malpractice.

    2. hemeantwell

      At its core the Fukuyama argument repeats Ted Lowi’s in his book The End of Liberalism, published in 1969. Lowi highlighted a sequential process of “bargaining on the law, bargaining on the rule derived from the law, then bargaining on the application of the rule” that led to policy implementation disappearing into an interest group-controlled administrative limbo. Fukuyama is tacking on the judicial phase. However, from the Lowi standpoint going to the courts might not necessarily be yet another phase of interest group intervention, but rather a way to get the original intent of the law enforced. Given that possibility, his reference to environmentalists, who I can imagine using the courts to secure enforcement, can easily become scurrilous if not applied with caution.

      1. James Levy

        Thank you! I met Lowi once and heard him talk.

        I think Fukuyama’s point was much like the way corporations glommed onto equal protection/14th Amendment and then, in conjunction with amenable courts, ran with it, they’ve hijacked that which was intended to aid regular people in gaining redress and placed an earlier strategy employed for environment and civil rights cases and used it to confound and nullify regulations of industry and above all finance. Since Fukuyama’s favorite case for a superb, independent bureaucracy undermined by corporations is the Forestry Service, I don’t think we can assume that he is anti-environment.

  2. Ben Johannson

    This can be looked at as a variation on the Tobashi scheme, given that making it look like you have enough capital to absorb losses and hiding actual losses are really the same thing — in both situations you are making your organization look stronger than it is. Unless she’s lazy or dense White cannot possibly be unaware of this and neither possibility is a good enough reason to cut her slack for not doing her job.

  3. mcc777c2

    This was why Mary Jo White was chosen to head the SEC. Obama and his owners in the financial community knew she wouldn’t do her job and hold bad actors(all of the TBTF banks) responsible for their lies and fraudulent behavior.

    1. Larry

      Bingo. I would say that comment hits the nail on the head. Obama has demonstrated amply over his presidency where his true politics lie by his appointments to head key regulatory agencies and cabinet positions. You don’t get appointed to the SEC on Obama’s watch by being a dogged regulator. You keep the punch bowl full and try to make sure the music never stops playing.

      1. dk

        Not completely disagreeing, but I think this misses an important nuance: Obama trusts his staff and advisers, and his staff and advisers are compromised.

        This creates a “team” mentality, where the nominal leader defends the decisions of his staff, often without comprehensive review or sufficient skepticism. It’s the same mutual ass-covering circle-jerk one finds throughout the corporate/private sector.

        Obama didn’t vet White himself, personally. He relies on trusted staff and advisers for these functions. Can the President perform every function of the office single-handed? No. The true measure of an elected (or candidate) is the nature and qualifications of the people they hire for their offices (or campaigns). These positions are rife with glad-handed sycophants of weak character (unless you count tribal loyalty as a positive trait), who may be able to recite principle (dogma) by rote but who often don’t even grasp the implications of the commitment they are supposed to fulfill. Business-as-usual, quantity-over-quality, make-the-team-look-good, and all the other quasi-merit modes apply. These folks are easy targets for anybody trying to trade “career benefits” for influence.

        I’m not trying to shift blame from Obama, I’m just saying that this is much bigger than any one person. The article correctly points out Andrew Ceresney’s role in this, we should be ready to look deeper and point out operators at the next layer below the “face”. It doesn’t excuse the executive, it just attacks the systemic aspect of these problems.

        1. JerseyJeffersonian

          Sorry, the old “If the Czar only knew” chestnut is not going to fly.

          Bottom line: Obama appointed this crop of people “rife with glad-handed sycophants of weak character” because he wanted just this sort of person in those staff positions making just these sorts of recommendations for positions of responsibility in the government/regulatory structures. I mean, in what other fashion could he ingratiate himself more effectively to the people from whom he looks to receive after the fact payoffs following his term in office?

          Obama is one of these people himself, and a narcissist to boot. So why in the world would he not want to create a staff that mirrored and acted upon his own shoddy, self-serving values.

          In his role as Grifter In Chief, I have come to expect no motivations or any outcomes achieved by this man that are not fully explicable by pervasive corruption.

    2. RUKidding

      Agree, but in effect, isn’t Mary Jo White actually DOING the job that she was hired to do? Posts like this are very informative, and I appreciate it. However, did anyone really expect White to behave differently than this?? I sure didn’t.

      Color me something that goes way beyond jaded and cynical.

      1. Doug Terpstra

        Yup, she’s doing exactly what Odious-O hired her to do, which is exactly what he hires his attorneys-generals to do as modern day Sheriffs of Nottingham, provide immunity for his investors.

        By all means, sign these petitions, but do so without hopium-induced delusions.

    3. Doug Terpstra

      Yes, indeed. When signing any petition to Obama, I can’t help but picture a very large dumpster, labeled “F**king Retarded Petitions” with a chute attached directly to the Oval office, very much like those his fellow charlatans have, labeled “Prayer Requests”, where all of their correspondence is filed after the checks are cashed. President Obama is well-endowed with aural orifices, but he only has ears for his true coconstituents

    4. ian

      I knew we were in trouble when Obama said “uhhhhh… you don’t mess with Mary Jo” at the press conference.

  4. SteveOh

    The premise of this piece is that no risk is actually transferred by derivatives (not that it actually discusses the structures at all so that the reader would have a clue)…that the whole product is a sham. If that were true we’d have much bigger problems.

    It’s a bit much to throw a blanket of assumptions over all of these trades, and if you would stretch farther than the SEC you would see that the bank regulators have been paying attention to these things a bit for a few years now (and given the safety and soundness implications, it’s their job not the SEC’s since the SEC really covers accounting policy and disclosure not safety and soundness of banks).

    1. Yves Smith Post author

      It is true that the SEC is not a prudential regulator. However, she as chairman sits on FSOC and thus has effectively has her job description extended by that additional role to include safety and soundness issues. It’s now on her desk too although not her primary focus. And since accounting intersects with safety and soundness, it’s disingenuous to say the two were unrelated.

      And despite your effort to insinuate otherwise, the risk is transferred. The trade has economic substance (as in a pure accounting gimmick) hence the concern re the liquidity and risk-bearing capacity of the counterparties is legitimate. For instance, from a 2013 article:

      Citigroup, Credit Suisse and UBS have recently completed such trades. Rather than selling the assets, potentially at a loss, the banks transfer a slice of the risk associated with the assets, usually loans. The buyers are typically hedge funds, whose investors are often pensions that manage the life savings of schoolteachers and city workers. The buyers agree to cover a percentage of losses on these assets for a fee, sometimes 15 percent a year or more.


      And as I pointed out, the product arguably IS a sham since no one is looking at the integrity of the entities that are absorbing these risks. If you have a guarantee written by a party who doesn’t look very capable absorbing losses, how good is it?

      As the piece points out, even an AAA rated counterarty, AIG (as well as AAA rated monolines) went bust when they played a guarantor role, which is exactly what these unrated, unsupervised counterparties are doing. Even better, it may be a circle jerk since hedge funds are often levered by their bank prime brokers, and PE firms increasingly get what amount to lines of credit, ostensibly for them to borrow short-term to make investments (as in to reduce the J-curve effect early in a fund’s life; the effect is to delay the capital call). But in reality, the terms of the credit agreement are sufficiently generous to allow for the general partner to borrow for other purposes, meaning just to lever up the fund more.

      1. SteveOh

        Right – the bottom line is a question of whether risk is transferred away from the bank. Again, that’s really a bank regulator question – does it meet the requirements of the securitization framework for srt or the crm requirements? Those are things a bank’s prudential regulator examines, not the SEC. Accounting derecognition is a distinct question.

        The real question to ask with these transactions is whether they are intended to transfer risk or rather to defer recognition of losses over a longer period of time via high premiums. That latter issue is known to the regulators, the US ones wrote about it in 2011, and Basel issued something in 2013 in proposal form. You can look it up. The SEC plays no part here.

        It is not so simple to say that all of these trades are a sham. And MJW is the wrong target in any case, but yes, trendy to shoot at right now.

        1. monday1929

          You talk in accounting terms. When the System implodes, it becomes clear that yes, the banks have transferred the risk- to the Taxpayers. The Bankers don’t care about counter-party soundness. Why would they?

  5. Kokuanani

    This looks like an issue Elizabeth Warren could bring into the spotlight rather effectively.

    Did she cover this in prior communication with/about White? [If so please excuse my ignorance.]

    Even if Warren did, there’s nothing like a reminder of this bad news.

  6. cnchal

    From Wall Street on Parade:

    Citigroup had created seven off-balance-sheet Structured Investment Vehicles (SIVs), totaling $100 billion. Similar to Enron’s accounting, Citigroup did not show the SIVs in its public financial statements. This allowed it to avoid ponying up capital and reserves while enjoying income of approximately $100 million a year. After it was forced to acknowledge $50 billion of this hidden toxic sludge and move it back onto its balance sheet, its credit ratings were cut and its deterioration to a 99 cent stock commenced.

    Citigroup should have gone to zero, and been wiped out. These executives conspired to hide $100 billion to make an extra $100 million, a ratio of 100 to 1.

    Mary Jo White is like a police chief that gets a paycheck from the taxpayer, but actually works for the criminals.

    1. Doug Terpstra

      From Martens’ post, I first read “Blackstone had insured Citigroup … allowing Citigroup to lower the amount of capital the bank had to set aside [to] 96 percent.” and thought, big deal! Then I read it again. Save space for Mary Jo on the tumbrel.

  7. nat scientist

    Protecting the structures of plausible deny-ability are critical to the TBTFs she has pledged to protect. Citizens United keep the corporations superhuman entities; get over it or get the 28th Amendment.

    1. Carla

      Move to Amend’s proposed 28th Amendment:

      House Joint Resolution 48 introduced April 29, 2015

      Section 1. [Artificial Entities Such as Corporations Do Not Have Constitutional Rights]

      The rights protected by the Constitution of the United States are the rights of natural persons only.

      Artificial entities established by the laws of any State, the United States, or any foreign state shall have no rights under this Constitution and are subject to regulation by the People, through Federal, State, or local law.

      The privileges of artificial entities shall be determined by the People, through Federal, State, or local law, and shall not be construed to be inherent or inalienable.

      Section 2. [Money is Not Free Speech]

      Federal, State, and local government shall regulate, limit, or prohibit contributions and expenditures, including a candidate’s own contributions and expenditures, to ensure that all citizens, regardless of their economic status, have access to the political process, and that no person gains, as a result of their money, substantially more access or ability to influence in any way the election of any candidate for public office or any ballot measure.

      Federal, State, and local government shall require that any permissible contributions and expenditures be publicly disclosed.

      The judiciary shall not construe the spending of money to influence elections to be speech under the First Amendment.

      Initial Co-Sponsors are: Rick Nolan (MN), Mark Pocan (WI), Matthew Cartwright (PA), Jared Huffman (CA), Raul Grijalva (AZ), Keith Ellison (MN).

      Here’s a press release with more details:

  8. Lee

    According to those dictating policy, capital is key to securing financial stability within the Dodd-Frank regulatory framework. Increased capital requirements were begrudgingly put into Dodd-Frank as a way of staving off more draconian reforms, breaking up the systemically important [dangerous] financial institutions, for example. Yet, on this issue, the issue key to stabilizing systemic risk permeating from the SIFIs, regulators have repeatedly failed to align action with rhetoric. Remember the tepid regulatory [non]response to Goldman’s capital relief deal with Santander? http://www.nakedcapitalism.com/2014/09/fed-whistleblower-carmen-segarra-snowden-closing-journalistic-mind.html

    SIFIs are emboldened with each regulatory lapse to artificially prop up regulatory capital via increasingly brazen, complex, and opaque techniques, flooding the financial system with systemic risk. Moreover, permissible opacity of the financial markets has rendered impossible discovery of where the systemic risk is pooling.

    1. Yves Smith Post author

      I suggest you read our Policies and consider how our moderation works. We are not capable of doing that since it would require all posts go into moderation and be approved by us. That isn’t how we have the site set up. So your charge is inaccurate.

      We have regular readers who are very much in synch with the site’s views whose comments go into moderation pretty much 100% of the time, and we have no idea why our software singles them out. They don’t violate any rules we’ve set up.

  9. Carolinian

    Good to see the great Pam Martens getting some digital ink. Today’s column hits another bullseye.


    One sharp-eyed New Yorker caught this red flag in Wylde’s pitch in the New York Times when she was spinning how vital Wall Street is to the city’s economy. Wylde wrote:

    “All told, the [financial services] industry accounts for 62 percent of private-sector wages in the city, and more than one-third of its $700 billion annual economic output. It contributes about $8 billion a year in city taxes — equivalent to the combined budgets of the city’s police, fire and sanitation departments — and one-quarter ($2.5 billion) of personal income taxes.”

    A comment was posted by “David H” noting the following interesting math in the above:

    “According to Ms. Wylde, the financial industry accounts for 62 percent of private-sector wages in the city, but only one quarter of personal income taxes. This strikes me as an empirical basis for a very different op-ed.”

    1. cnchal

      “All told, the [financial services] industry accounts for 62 percent of private-sector wages in the city, and more than one-third of its $700 billion annual economic output.

      Can we be generous and say $250 billion?

      Does that mean the non financial sector workers that make up the 38 percent of the remaining private sector wages, create slightly less than two thirds of it’s $700 billion annual economic output?

  10. Mel

    Not important, but “Off-Balance Sheet” is a splendid name for an accounting document, these days, anyhow.

  11. Vatch

    Wait a minute. I remember reading that in order to preserve the independence of the SEC, the SEC commissioners can’t be fired by the President. Is that true? If so, I hope they can be impeached by the Congress!

    The President designates the chairman of the SEC. Can he revoke that chairmanship? If that were to happen, Mary Jo White would still be one of the five commissioners, though.

    1. Yves Smith Post author

      I agree that is an error in the drafting, and I will issue an addendum. While Obama cannot fire White, if she gets enough adverse publicity, she could be pressured into resigning. I wanted to amplify the Credo petition as a way of creating heat and was remiss in not addressing the legal issue, that she cannot literally be fired.

      Of course, the bigger practical issue is that Obama doesn’t care whether White lives up to her promises during confirmation or not.

    2. Percy

      No, the President cannot remove a sitting SEC Commissioner, but he (or she) can change who is Chairman. At least this ought to be done at the first opportunity. And never forget how rapidly SEC Chairman Pitt resigned when the White House suggested that it would be appropriate for him to do so — for bad reasons, not good ones. Here the reason is a good one.

      1. Vatch

        Thanks. If Obama can change the chairman, I nominate Kara Stein to replace Mary Jo White as SEC chairman. The probability that Obama will do that is pretty close to zero, I’m afraid.

  12. phch

    The truth is that White is doing exactly what Obama wants her to be doing, which is to be a Potemkin watchdog. Obama and the Clintons and all the corporatist Democrats (and of course all the Repubs) know that money wins campaigns, and Wall Street has the money. The moment Obama turned down matching funds in July of 2008 the fix was in, and the Rubinites were safe. The sight of Paul Volker standing like a mute witness at the press conference where Obama introduced Geithner and the rest of his economic minions was pitiful. Remember this about Obama: after Emanuel left the White House to become Chicago’s neo-lib mayor, he appointed William Daley as WH chief of staff. A family member taught Daley in law school, and said he was as thick as a brick. His only value to Obama was to give JPM Chase (I think, might have been another TBTF bank that employed Daley as VP of influence peddling) a warm fuzzy feeling before the 2012 election. Daley after all was the man who helmed the Gore-Lieberman campaign in 2000, ’nuff said.

    I hope Elizabeth Warren adds this piece to her file on White and is a relentless pain in Obama’s ass. That’s probably the most we can hope for but it’s better than nothing. And vote for Bernie Sanders in your Dem primaries!


  13. Owen

    If the deals here work the same as the ones in Europe, the hedge fund or PE firm usually funds the deal up front – it will be backed by collateral in escrow which is available to cover the losses, so you don’t have the AIG / unfunded protection problem. It’s not so very different to offering vendor financing on the sale of an asset portfolio.

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