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Generational Dynamics Web Log for 2-Feb-08
Feds open criminal fraud investigation against investment bank UBS AG

Web Log - February, 2008

Feds open criminal fraud investigation against investment bank UBS AG

The allegation: UBS "mismarked" CDOs to defraud investors

According to a Wall Street Journal article, Federal criminal prosecutors and the SEC are investigating whether Swiss bank UBS AG, Europe's largest bank, intentionally misled investors by overpricing mortgage-backed securities (CDOs):

"The SEC, deepening its own set of investigations into whether Wall Street firms improperly mispriced mortgage securities, recently upgraded probes of UBS and Merrill Lynch & Co. into formal investigations, people familiar with the matter say. ...

The investigations could raise the stakes for Wall Street in the multiple probes examining whether financial firms deliberately misvalued, or "mismarked," massive holdings of mortgage securities. ...

There is also a broader effort by the Justice Department to look into whether there was fraud in originating, packaging and selling mortgage-related products. The Federal Bureau of Investigation has said it has opened criminal inquires into 14 companies as part of an investigation of the subprime-mortgage crisis. The FBI wouldn't identify the companies under investigation. ...

In its investigations, the SEC also is delving into whether Wall Street firms placed higher values on securities they own than those they placed in customer holdings, the people say. The SEC previously has said it has opened roughly three dozen investigations tied to the downturn of the subprime market, which primarily is tied to borrowers with poor credit histories.

In the SEC's UBS investigation, the agency is examining, among other things, a situation last year in which a trader at a now-defunct hedge fund of UBS's Dillon Read unit was confronted and then ousted after he valued mortgage securities at prices below the value assigned to the same securities elsewhere at UBS. In late October, the SEC interviewed the Dillon Read trader following a front-page article in The Wall Street Journal detailing the incident, according to a person close to the situation. The SEC has issued subpoenas in the UBS probe since, according to a person familiar with the matter."

It's worth taking a moment to discuss the implications of this as a criminal investigation.

The article that I wrote last night, "Massachusetts sues Merrill Lynch for fraud," refers to a civil action. This means that nobody goes to jail, but it's much easier to prove, since the standard of proof is a "preponderance of evidence."

Now we're hearing more and more about criminal investigations. If the prosecutors win a criminal case, then the defendants can go to jail, but the standard of proof is much higher: The evidence has to prove the allegations "beyond a reasonable doubt."

Those of you who are nostalgic for the 90s will recall that O.J. Simpson was acquitted of murder in criminal court, where the standard of proof was very high, but was found responsible for murder in civil court, where the standard of proof was low.

We can expect UBS AG and other targets of criminal complaints to mount a strong defense against these criminal charges. We can imagine the argument in court to go something like the following:

UBS: "Hey look, we're the real victims here. After all, we've lost $14 billion ourselves, writing down CDOs in our own portfolio.

If we were intentionally deceiving investors, then we wouldn't have had these CDOs ourselves."

Prosecutor: "That doesn't prove anything except that you had motive to defraud investors, since you wanted to recoup some of your own losses by selling the worthless securities to someone else.

You people are the expert. Your financial engineers created these CDOs, and your salesmen sold them. You must have known what you were doing, but you did it anyway because you were making billions of dollars in fees and commissions.

It's been obvious since 2005 that we were in a housing bubble, and in 2006 that the bubble was deflating.

In fact, you kept selling these CDOs well into the middle of 2007, at a time when your experts must have known that the sales were fraudulent."

UBS: "Well, if it was so obvious, then how come Federal regulators didn't say so? If we're guilty of fraud, then so are the Federal regulators, the ratings agencies, the bond insurers, and lots of other banks who were doing to same thing we were."

Now, there you see the problem. The massive "subprime" fraud that's been going on has not been perpetrated by one bank or one small group of people. It was condoned and encouraged by government "oversight" agencies who didn't want to spoil the party. It was condoned and encouraged by these VERY SAME prosecutors who, through their inaction, permitted the obviously fraudulent activities to continue. It's still being continued by government officials who condone and encourage various bailouts and other mechanisms to permit banks to continue to "mismark" worthless CDOs by means of phony market sales.

The fraud was perpetrated by an entire generation -- the nihilistic, self-destructive Generation-X, under the noses of their equally guilty Boomer bosses, who exhibited "Lenscap Stupidity" by letting the fraud continue because they were all making so darn much money.

So that's going to be the problem for prosecutors: They're just as guilty as the people that they're prosecuting.

In Hannah Arendt's monumental study of the Nazi Germany in the book, The Origins of Totalitarianism (p. 335), she describes the enormous level of corruption at the time, and how it was reflected in Bertolt Brecht's play, The Three-Penny Opera [Dreigroschenoper], which presented gangsters as respectable businessmen and respectable businessmen as gangsters.

The theme song for the play was "Erst kommt das Fressen, dann kommt die Moral." I've been struggling for some time now to capture the meaning of this sentence, using my inadequate knowledge of German, supplanted by various online dictionaries and translators.

There's apparently an "official" translation of this phrase as "A hungry man has no conscience," but that translation is far too benign to match Brecht's cynicism. The people we're talking about were never hungry.

A word for word literal translation is the following: "First people gorge themselves, then comes the morality." That makes more sense, and we might simplify the translation further as: "First comes gluttony, then comes morality."

That is indeed what we're seeing today. The same generations of people who benefited from the massive fraud at all levels of the real estate bubble are now the same people who are calling for retribution. There are winners and losers in the mortgage fraud. The winners want to keep the bubble going, and are willing to commit fraud to do so. Once a winner becomes a loser by losing everything -- and only then -- he wants to punish the winners.

The massive fraud that has been taking place is matched today by the massive lenscap stupidity of people in denial. Investors are hoping against hope that the champagne party will return to the stock market, and the bubble will grow again. Cities and towns all over the country are holding useless Finance Committee meetings, completely oblivious to the fact that falling real estate prices and rising unemployment will soon cut their local budgets by 50% or more.

From the point of view of Generational Dynamics, there's no question at all of what's coming: A generational stock market panic and crash, leading to a new 1930s style Great Depression. It might happen next week, next month or next year -- predicting the exact date is impossible, since it depends on chaotic events -- but it's coming with absolute certainty, and it will be made much worse by the continuing gorging by massive numbers of people in denial. Afterwards, there'll be plenty of morality to deal with. (2-Feb-08) Permanent Link
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Generational Dynamics Web Log for 2-Feb-08 Feds open criminal fraud investigation against investment bank UBS AG

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Generational Dynamics Web Log for 2-Feb-08
Feds open criminal fraud investigation against investment bank UBS AG