"End of Wall Street Boom" - Must-read history

[JackRiddler]

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What a beautiful article summing up MF Global as the opening act of "Subprime Collapse II: Sovereign Bonds." Thanks to semper occultus for posting it in the new Schadenfreude thread,

"Gerald Celente Gold Account Emptied By MF Global."
posting.php?mode=quote&f=8&p=435777

As I've been saying, the banking animal could not have acted any differently after all the rewards it received for burning the world, the first time. They have kept running the same model of borrow cheap at enormous leverage to buy high-return junk and sell it to idiots as non-junk while insuring it with default swaps, all the while pretending this can go on forever. The next crash has always been in the coming, and I've called it too many times, but it's so close now that Goldman Morgan et al. this month felt compelled to directly seize power in two European countries, so far. (See chart below.)

Buckle up – Credit Crunch 2

By Golem XIV on November 17, 2011

I am sorry this is such a lengthy article. But I offer it as an explanation and understanding of what is going on that the bankers DO NOT want you to have.

I think it may now be time to buckle up and read that little card that tells you how to assume the crash position.

In a nut shell we are already in the midst of another credit and bank funding crunch. Of course all the talk from the bankers, such as Buiter at Citi and the tin hat brigade at Deutsche Bank is all about how it is all the fault of nations. But it’s not quite so wonderfully simple as that.

Already one multi billion dollar brokerage, MF Global, has collapsed. One Trillion dollar bank, UniCredit, is teetering on the edge of collapse, and two European nations, Italy and Spain, each with enough debt to bring down Europe are desperately trying to borrow euros from the ECB and dollars from the Fed.

Just this morning Spanish bond yields are shooting up well in to unsustainable territory. And French yields are also in motion. Like a train sliding backwards over a precipice, as each carriage goes over so the weight pulling down grows and the weight resisting decreases. And the engine at the front, the ECB/Germany has to think can I still pull all this back up or should I cut the coupling and save myself at least.

There is a crisis and it is in Europe , but the ‘contagion’ is not at all what our cretinous media and brain rotted politicians are telling us it is. The contagion the markets are worried about is bank contagion. Nations’ borrowing woes are the radioactive material, but the banks built the bomb.

Here’s what I mean. What I want to show is that what is happening is almost a carbon copy of what the banks did in the lead up to Credit Crunch 1. They have done the same again only this time with sovereign bonds instead of American mortgages. This is another sub prime and once again it has been engineered by the banks.

To understand why the rise in borrowing costs in Italy and Spain, as well as worries about Greece, have suddenly become a ‘contagion’ that the bankers speak of in apocalyptic terms we have to understand why and how MF Global imploded. This might seem like a sideways diversion but it’s not.

The collapse of MF Global is our window in to what is actually frightening the bankers.

MF Global was not only a huge brokerage it was one of the gilded Primary Dealers. That is, the largest and most trusted banks or brokerages chosen to for their size and stability, to deal everyday with the Fed to help it sell America’s trillions of debt. MF Global was run by Jon Corzine former head of Investment Banking at Goldman Sachs and one time governor of New Jersey. But please don’t get any ideas that there is a revolving door between finance and government.

And yet MF Global collapsed. According to The Guardian it did so because of lax oversight which had not noticed or been bothered by the fact that at the time of its demise,

…MF Global had liabilities at the end of June of $44.4bn against only $1.4bn in equity.

The familiar trope of ‘lax oversight’ goes along with ‘rogue trader’ as the explanation the bankers can live with and are happy for you to accept. ‘Lax oversight’ like ‘rogue trader’ scape-goats one or two people and deflects any questions of whether what happened was a direct consequence of what the banks do and how they chose to do it as a group and profession.

What is undeniable is the massive leverage. Now we need to ask what underpinned this leverage. For that we turn to a report from AP which I picked up at The Business Insider With the Headline, “MF Global Is The First Big US Victim Of The Europe Crisis”. This article began the – It’s a crisis of European nations’ story-line. It begins with the statement,

“The European debt crisis has claimed its first big casualty on Wall Street…”

But how exactly? Much later in the article comes this,

MF had amassed net exposure of $6.29 billion in debt issued by Italy, Spain, Belgium, Portugal and Ireland. Of that, $1.37 billion was from Portugal and Ireland, which already were bailed out by European authorities. More than half was from Italy, whose borrowing costs increased in recent days as investors grew concerned about its finances. (My emphasis)

Now no one had forced MF Global to buy these bonds. MF Global could just as easily have bought German bonds. Only they would have given far less of a return. What MF Global had been doing was buying up dodgy bonds on the secondary market that other people were selling. Picking them up cheap and expecting them to be bailed out.

So now we have massive leverage resting on sub-prime assets, this time bonds not mortgages, which the company had specifically sought out. And it sought them out for the same reasons sub prime mortgages had been sought after – their high risk made them more lucrative than safe ones. Same greed, same idiocy. Same people.

But Corzine wasn’t done yet. Oh no, not by a long way.

MF Global was also following the exact same finding model as Bear Stearns did, as Lehman’s did, as Northern Rock did and as countless others did. They relied for a huge part of their day to day funding on short term borrowing. Why go for short term borrowing which in retrospect seems so unstable – in that as soon as you have a problem you have so little time to sort it before you run out of money? Why, because it’s cheap. Of course. So you buy risky because it’s cheap to buy and offers high return (until it explodes that is) and then you borrow short also because its cheap but unstable. Banking genius at work having ‘learned those lessons’ from 08!

But wait there’s more as explained here by professional accountants in forensic detail. I will give you the short version.

MF Global was borrowing to finance itself but with what collateral? Remember Lehman bothers and their infamous repo 105? For those who don’t, repo is where you ‘sell’ as asset but with a fixed agreement to buy it back at an agreed slightly higher price at a set time. So although it is ‘sold’ it is actually a loan because the asset comes back and the money is returned with interest. All banks use repo for overnight and short term funding.

Lehman’s was using repo but exaggerating the worth of its assets to ‘borrow’ more than they were worth. They came unstuck when creditors would no longer accept their valuations of their assets or, in fact, accept them at all. MF Global was using its dodgy European bonds as collateral. It was marking them to mythic – sorry – model valuations and repo-ing them. But it gets better. The particular type of repo it was using was ‘repo to maturity’. Which simply means the agreement was that the short term repo was to be rolled over and renewed all the way until the bond matured. This is legal. But I should point out the the law was written by the financial firms themselves. The key fact is that repo to maturity is supposed to be done ONLY with absolutely AAA rated bonds like American bonds. MF Global was using it with Italian, Greek and Spanish bonds. Pretending they were AAA even as it was buying them up at prices which recognized they were very far from AAA. And the international accounting standards boards and regulators either didn’t ‘notice’ or did and sanctioned it.

Now what this meant was that MF Global was showing the repo’s as actual sales. Naughty, yes, but terrible? Well, yes. Terrible enough that much of it was hidden off balance sheet. You see by booking them as a sale the company was claiming that the risk associated with them (remember they are dodgy bonds from struggling countries) was also gone. Sold to the ‘buyer’. But there was no buyer. They were only repo’d.

I say ’only’ but in fact MF Global was happy they were only repo’d. It was more lucrative than selling them. And in fact this is in may ways the point of the deal MF was doing. You see the ‘interest’ MF was getting on the bonds, because they were dodgy, was quite high. This was the whole reason for buying them. Whereas the interest charged on short term repo is quite low. So MF Global was buying dodgy bonds which gave high interest and using them to borrow at a lower rate. Not only did this borrowing enable it to leverage itself more and more, but it was even making money on the deal; from the fact that the interest it was getting on the bond was higher than it was paying to borrow, using them as collateral. It seems convoluted and it is. But this is what the bankers call arbitrage and is why they think they are so clever. Understand it and you too could be a proper banker.

However, they ignored one thing. The same thing as Lehman’s ignored. No matter what accounting trickery they got up to, the bonds were not sold they were repo’s which meant that the risk (of the bonds declining in value) remained with MF Global. In fact the risk was now much greater. Not only was there the original risk of the dodgy bonds losing value, they now had an additional, greater risk because they had taken out further loans using the dodgy bonds as collateral. And from the leverage we looked at earlier know just how much MF Global had multiplied the risk.

So when the value of Italy’s and Spain’s bonds began to decline, their value as collateral declined and MF Global was asked to provide additional capital/cash to make up the difference. This is what is called a ‘margin call’. And these margin calls killed MF Global. They couldn’t come up with any more cash because they had none (they’d spent it all buying dodgy bonds) and couldn’t borrow any more because all they had were those bonds whose value was going down not up and a simply insane leverage which geared those losses up till they had the power to crush.

So now we have almost every aspect of the original sub-prime credit crunch reproduced by the same people who did it the first time and were never punished or even rebuked but instead were allowed to reward themselves with millions in bonuses.

So to summarize, MF Global invested in sub prime. Only this time sub prime bonds not mortgages. It leveraged them hideously, pretended it had off-loaded the risk when it hadn’t and then got caught when the value of the bonds went down and counldn’t pay the debts it had taken on using the bonds as collateral. Sorry to belabour the point but I want you to see how this really is subrpime all over again.

And like the original sub prime it means when one bank goes down it leaves all those to whom it owes money, with their own losses.

So now let’s move on from MF Global, because as some wag commented, you never find just one cockroach in a dirty kitchen. Which logic nearly killed a second brokerage, Jeffries. Its stock collapsed on the rumour that it too had bought up lots of European bonds. Jeffries had to take the amazing step of publishing every single position in bonds that it had. Only then did its stock recover.

Since then other banks have been less forthcoming about their exposure, namely Goldman Sachs and JP Morgan. Only they are not so much suspected of having lots of European bonds themselves as having perhaps provided the one part of the whole sub prime crisis we have not so far mentioned, CDS insurance. Goldman and JP Morgan are among the world’s largest derivatives traders. And they revealed that between them they have sold ‘protection’ on over $5 trillion globally. No one knows how much of this is on dodgy European debt and neither Goldman nor JP Morgan is saying.

In sub prime credit crunch 1 it was AIG that provided much of the short term funding and much of the CDS protection. This time who knows who are the main providers. But one thing you can be sure of, there will have been a great deal of it sold. Because it would have been sold using the same logic which inspired MF Global to buy the debt. The logic which said, these are countries too big to fail so in the end they will be bailed out even if democracy has to be suspended to ensure it. If you believed that logic then you wold have sold CDS protection and pocketed the premium.

So that, I believe is all aspects of sub prime accounted for. You can now see that while sovereign bonds and debts may be the fissile material the bomb itself and its explosive potential was constructed by the banks just as they did last time following the same blue-print and same greed.

And how soon might it go off. For that we end with UniCredit. Last quarter the trillion euro bank suddenly posted a ‘surprise’ 10.6 billion euro loss in just this last quarter! It’s bonds are now trading as junk while it faces having to raise another 51 billion euros to re-finance its debt in just the next year. That, to me spells BOOOOM! It is only the first. It certainly won’t be the last. There will be others and they may be along fairly soon.

Why did UniCredit suddenly make such a loss? What was happening during the last quarter? Well Spanish and Italian bonds have lost a lot of value. what do you think, might UniCredit have been holding a lot of them? Surely not I hear you cry. Who would be so stupid. UniCredit blames the loss on its Kazakhstan and Ukraine units. What would those units have been doing to wrack up such monumental losses? UniCredit is now trying desperately to sell bits of itself.

The banks know what is going on. They each know the risks and losses they are hiding and know if they have them then so do the others. Exactly as in Credit crunch1 interbank lending is frozen with both libor and repo markets in disarray.

I suggest these are the real reasons the banks are in an absolute panic and are shrieking about how the ECB MUST print and print now and why elections and voting of any kind at all must NOT be allowed to upset the smooth imposition of the bank’s required plan. There is contagion but it is bank contagion, its sub prime greed and failure all over again.

Source: The Independent
http://www.independent.co.uk/news/busin ... 64091.html

The graphic is from the same article Winston Smith posted above - read it!

What price the new democracy? Goldman Sachs conquers Europe

Stephen Foley
Friday, 18 November 2011

The ascension of Mario Monti to the Italian prime ministership is remarkable for more reasons than it is possible to count....

[/quote]

[Bruce Dazzling]

I know that Coast to Coast isn't particularly rigorous, but last night there was a pretty interesting interview with William K. Black, and it wasn't presided over by George Noory, which is always a help.

The interview starts @ 7:14.

[JackRiddler]

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The xkcd nut makes himself useful with this humonguous chart on the relative quantities of money (and money-values, which is what much if not most of what is depicted here actually is, e.g. the theoretical prices of whole NYC boroughs). Pretty cool, just impossible to display on screen. In fact, attempting to load the full size graphic just caused my machine to stall, it must be like 100 megs compressed. For the first time I'm actually considering paying money for one of his posters.



Page
http://store.xkcd.com/xkcd/#MoneyPoster

Graphic with steering (sort of okay to view)
http://xkcd.com/980/huge/#x=-672&y=-192&z=5

Poster purchase
http://store.xkcd.com/xkcd/#MoneyPoster

I see he explains, "It started as a project to understand taxes and government spending, and turned into a rather extensive research project. With upwards of 200 sources and 150,000 tiny boxes, it's best appreciated in poster form. The 36"x24" high-quality poster print allows you to stand back and, all at once, take in the entire world economy."

Yeah, well that last bit is exaggerated but it's great for seeing relative quantities.

I fully understand what he means. In 1990 I did something similar: attempted to portray major money flows within the US political economy (no valuations, just a year's GDP as exchanged between the major institutions, corps, groups, state agencies, etc.). I started on a page. Then I taped together two pages. Then four. Soon enough I'd purchased an A2 pad (each is 8 x A4) and started taping them into 3x3 arrays. The result took 3 weeks. For the next version I put up A2's enough to cover a 4-meter wall ceiling to floor, and started making copies of state and nation maps (I'd decided I'd include breakdowns by states and metro areas, and trade relations with the whole world) and a hundred other items for the ultimate collage. Never did get very far with the final version, in part because I conceived the at-least mild insanity of trying to model the whole thing in a single visual (books have a purpose after all), but also because the intensity of this passion started fading... story of my life. Though not the whole of it.

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[StarmanSkye]

Jack: That looks like it might be a useful, eye-catching & informative visual aid to back-up an Occupy placard.

Its DAMN tuff getting a good overall sense of just what a deep mess the world is in thanks to the antisocial blackheart financial conmen who rigged the eceonomics game and plundered the working/middle classes thru manipulating vulture capitalism for the most selfish of motives -- they OUGHT to be treated as history's biggest EVER criminal masterminds and financial terrorists -- yet so far no senior execs have been indicted and no wall street financiers or banks have gone to jail.

The following interview is v. good, breaking a lot of info down for us curious insomniacs by ex-regulator, financial and legal scholar/professor Black. Its more complete than the C to C part 1/4 interview Bruce Dazzling recently cited (and for which parts 2-4 weren't available, or at least weren't posted as of when I looked).



Black's blog:
http://neweconomicperspectives.blogspot.com/

[semper occultus]

Risks emerging from shadows look worryingly like 2008

By John Plender

www.ft.com

Wednesday November 23 2011

The risk managers who contribute to the Bank of England’s regular systemic risk survey are twitchy. The probability of a future high impact event in the UK financial system has, they believe, increased sharply in the second half of 2011 to stand at the highest level since the survey began in July 2008.

No doubt in common with their counterparts in continental Europe and North America, these market practitioners see sovereign risk and the risk of an economic downturn as the most worrying threats to the financial system. The one change in the top five risks identified in the survey since the first half of the year is that the risk of financial institution failure has put in an appearance.

All this feels uncomfortably like 2008 when fear triumphed mightily over greed. The implicit risk in all these perceived risks is that they become self-fulfilling prophesies. Nobody will spend and invest if they think we are back in a financial hurricane. Lower economic growth could then make the sovereign debt crisis even harder to resolve. The sense of déjà vu is reinforced by the insouciance of bankers who set absurdly ambitious targets for return on equity and continue to pay out big bonuses. Another less noticed, but worrying, throw back to pre-crisis days concerns the structure of the financial system – namely that the shadow banking system is in great shape.

A recent report by the Financial Stability Board, the Basel-based global watchdog, points out that the assets of non-bank credit intermediaries in Australia, Canada, Japan, Korea, the UK, the US and the eurozone grew from $27,000bn in 2002 to an astonishing $60,000bn in 2007. This opaque sector, which plays host to many of the banks’ more toxic securitised activities, then took a knock, declining to $56,000bn in 2008. Yet by 2010 it had bounced back to $60,000bn.

The FSB reckons that the shadow banking system constitutes 25-30 per cent of the total financial system. Predictably enough, the US has the largest shadow banking sector, with assets of $24,000bn in 2010, although its share of the total assets in 11 leading countries studied by the FSB has declined to 46 per cent from 54 per cent in 2005. Equally predictably, the UK comes second with a 13 per cent share of the total. And this understates the scale of the systemic issue because some non-banks that are not credit intermediaries engage in proprietary trading that could damage counterparties in the conventional banking system.

Much of this activity outside the regulatory perimeter involves credit intermediation chains in which conventional banks play a part. The shadow banks also run risks such as maturity transformation, liquidity transformation, credit risk transfer and leverage. This poses a huge challenge for regulators because there are limitations in the flow of funds data that make it hard to identify these risks. And there must be every possibility that in seeking to meet their over-ambitious return on equity targets bankers will push more business into the shadows to escape the tougher capital requirements that result from re-regulation.

The irony here is that the growth of the shadow banking system was powered in the first place by the Basel capital adequacy regime, which encouraged banks to economise on capital by pushing assets off the balance sheet into the shadows. The latest version of the rules – Basel III – will, if anything, increase the incentive to engage in regulatory arbitrage because it has raised capital requirements.

The FSB’s efforts to map the shadow banking system and monitor non-bank credit intermediation are welcome, as are its efforts to improve the quality of the data.

Yet the most intractable problems in bank regulation are those that involve cross-border risks and boundary problems. That, incidentally, raises questions, too, about the efficacy of the ring fencing approach recommended by Britain’s Independent Commission on Banking, for if a financial system is divided between low risk and high risk sectors, the onset of risk aversion could arguably make a crisis worse. This is because panic usually starts in the high-risk sector as it did in 2007 with structured investment vehicles and conduits. Creditors withdraw money and put it into the lower risk part of the system, which increases funding pressure at the high-risk end. That in turn leads to forced sales and downward price spirals.

As Charles Goodhart of the London School of Economics has argued, the existence of a boundary almost guarantees a cycle of flows into the less regulated sector during cyclical expansions and disruptive reversals during a crisis.

The law of unintended consequences applies as much to re-regulation as to liberalisation – especially where opacity rules, as in the shadow banking system.

[2012 Countdown]

[justdrew]

not sure where else this should go...

http://en.wikipedia.org/wiki/Paradox_of_thrift

November 25, 2011, 8:50 am
Death By Accounting Identity by Paul Krugman

Martin Wolf has a somewhat despairing-sounding column this morning, in effect pleading with the Cameron government to admit that the laws of arithmetic must apply. Good luck with that.

Martin writes,

If the private sector is seeking to run down its debts, it is hard for the government to do so, too, because everybody cannot spend less than their income. That is the “paradox of thrift”. No, it is not a novel idea.

Ah, but for the past two years leaders in the Eurozone, Britain, and the US Republican party have subscribed to the following plan:

1. Slash government spending

2. ??????

3. Prosperity!

For a while ???? was framed in terms of the doctrine of expansionary austerity: slash spending and the confidence fairy would make private-sector spending rise. At this point, however, few still believe in this doctrine. Also, in the euro area it was hard to see how things would work even if the confidence fairy made an appearance; how was that supposed to resolve the large payments imbalances between the core and the periphery?

But even as the intellectual foundations, such as they were, for the austerity plan have been demolished, the plan itself remains unchanged.

[2012 Countdown]

I don't think I mentioned this anywhere, and not sure if this means anything, but...

I work in a field that sometimes has european clients. This work involves printing and pricing produced, denominated in euros, usually.
We have had some reorders to print the same thing, but this time asking us to remove all euro symbols. Make of it what you will.

[justdrew]

one possible explanation for why Germany (and others) are having trouble selling their bonds, could be that globally there's only so much money available for sovereign debt purchases and the US is sopping up all the money. and too much other monies are tied up in gambling debts, err... I mean derivatives.

[2012 Countdown]

Uploaded by capitaldamagecom on Nov 25, 2011
Sarah Montague talks to Steve Keen, one of the few economists to have predicted the global financial crisis, about the possibility of another Great Depression, and how to avoid it.

'Another Great Depression is all but inevitable' - that's the view of Steve Keen. He's been called the 'Merchant of Gloom', but he's one of the few economists to have predicted the global financial crisis. While he used to be a lone voice in challenging the economic consensus, more and more people are now listening to him. His way of avoiding depression? Write off the debt, bankrupt the banks, nationalise the financial system, and start all over again. He talks to Sarah Montague.

==


Steve Keen On Parasitic Bankers, Deluded Economists, and Why “We Are Already In The Second Great Depression”
Submitted by Tyler Durden on 11/27/2011 12:20 -0500

Everything that 'deluded' orthodox economists have done so far has been designed to aid the creditors (who remain the problem) while Steve Keen, the most familiar face of the non-orthodox economists, sees the only solution to this crisis as aiding the debtors. His interview with BBC’s HardTalk this week covers a great deal of ground from modern debt jubilees (and how they should be structured), the Tea-Party and Occupy movements (and his growing fear of historically repeating the endgames of previous economic and social disenfranchisements), and the parasitic nature of our existing financial sector.

He is unequivocal on the outcome of the status quo, as he has been for many years, citing politicians as reactors not leaders with the view that the youth movements we are seeing will force change of leadership to enable non-orthodox solutions to our simple problem – too much private debt. “Write off the private debts, nationalize the banking system, and start all over again” is his starting point but his ideas on implementation warrant some attention as he attempts to promote creative instability and reduce the destructive instabilities of capitalism – recognizing that our world is not in equilibrium as every Keynesian economist would believe but inherently cyclical and unstable.

http://www.zerohedge.com/news/steve-kee ... s-and-why-“we-are-already-second-great-depression

[StarmanSkye]

GREAT interview of non-orthodox economist Steven Keen -- some very fresh, plain-thinking that reflects many insights I've been nurturing, esp. re: the crucial importance of changing the balance of power from creditors to debtors and eliminating speculation on asset appreciation and relative currency imbalances as drivers of investment -- investment MUST be channeled towards innovation, production, commerce and constructive activity. Wall Street & central banks have shifted their investment strategy towards bubble-speculation, which has incited use of derivatives as a technique for insuring & deflecting risk. Its about time the public recognize the biggest problem we face, which drives just about every crisis and conflict in the world today, is parasite capitalism -- the exact opposite of an authentically 'free' market.

Its quite eye-opening to hear someone credible recognizing we are IN a defacto depression. In truth, we are in the process of sitting in the coach-cars watching our train go-off the bridge in slow-motion -- HOPING we might somehow avoid a hard-landing when we finally hit the ground at the end of the arc's momentum-driven crash, when 50 years of defective thinking enabling this historic fraud leads to its inevitable conclusion.

[JackRiddler]

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NYT provides an interesting glimpse into the various (legal) means the billionaire class has for hiding, offshoring and transforming their fortunes so that they can maintain control over generations while avoiding taxation and profiling themselves as philanthropists. Note that the story, which may bespeak some ulterior motive in targeting Ronald Lauder, presents Buffett and Gates as critics of some of the means Lauder employs in securing his fortune's perpetuation; but the story could have just as easily been about how Gates and Buffett themselves use some of the other tools from the same kit to achieve the same purpose with their own fortunes.

If this graphic makes the page too wide, someone please tell me what to do to fix it.




Ronald Lauder with the well-known Klimt painting (my ex-wife had a poster of it) he bought for $135 million.

http://www.nytimes.com/2011/11/27/busin ... nted=print

November 26, 2011
A Family’s Billions, Artfully Sheltered

By DAVID KOCIENIEWSKI


As he stood in the opulent marble foyer of a Fifth Avenue mansion late last month, greeting the coterie of prominent guests arriving at his private art gallery, Ronald S. Lauder was doing more than just being a gracious host.

To celebrate the 10th anniversary of the Neue Galerie, Mr. Lauder’s museum of Austrian and German art, he exhibited many of the treasures of a personal collection valued at more than $1 billion, including works by Van Gogh, Cézanne and Matisse, and a Klimt portrait he bought five years ago for $135 million.

Yet for Mr. Lauder, an heir to the Estée Lauder fortune whose net worth is estimated at more than $3.1 billion, the evening went beyond social and cultural significance. As is often the case with his activities, just beneath the surface was a shrewd use of the United States tax code. By donating his art to his private foundation, Mr. Lauder has qualified for deductions worth tens of millions of dollars in federal income taxes over the years, savings that help defray the hundreds of millions he has spent creating one of New York City’s cultural gems.

The charitable deductions generated by Mr. Lauder — whose donations have aided causes as varied as hospitals and efforts to rebuild Jewish identity in Eastern Europe — are just one facet of a sophisticated tax strategy used to preserve a fortune that Forbes magazine says makes him the world’s 362nd wealthiest person. From offshore havens to a tax-sheltering stock deal so audacious that Congress later enacted a law forbidding the tactic, Mr. Lauder has for decades aggressively taken advantage of tax breaks that are useful only for the most affluent.

The debate over whether to reduce tax shelters and preferences for the rich is one of the most volatile in Washington and will move to the presidential campaign, now that repeated attempts in Congress to strike a grand bargain over spending cuts and an overhaul of the tax code have failed.

A handful of billionaires like Warren E. Buffett and Bill Gates have joined Democrats in calling for an elimination of the breaks, saying that the current system adds to the budget deficit, contributes to the widening income gap between the richest and the rest of society, and shifts the tax burden onto small businesses and the middle class. Republicans have resisted, saying the tax increases on the wealthy would harm the economy and cost jobs.

An examination of public documents involving Mr. Lauder’s companies, investments and charities offers a glimpse of the wide array of legal options for the world’s wealthiest citizens to avoid taxes both at home and abroad.

His vast holdings — which include hundreds of millions in stock, one of the world’s largest private collections of medieval armor, homes in Washington, D.C., and on Park Avenue as well as oceanfront mansions in Palm Beach and the Hamptons — are organized in a labyrinth of trusts, limited liability corporations and holding companies, some of which his lawyers acknowledge are intended for tax purposes. The cable television network he built in Central Europe, CME Enterprises, maintains an official headquarters in the tax haven of Bermuda, where it does not operate any stations.

And earlier this year, Mr. Lauder used his stake in the family business, Estée Lauder Companies, to create a tax shelter to avoid as much as $10 million in federal income tax for years. In June, regulatory filings show, Mr. Lauder entered into a sophisticated contract to sell $72 million of stock to an investment bank in 2014 at a price of about 75 percent of its current value in exchange for cash now. The transaction, known as a variable prepaid forward, minimizes potential losses for shareholders and gives them access to cash. But because the I.R.S. does not classify this as a sale, it allows investors like Mr. Lauder to defer paying taxes for years.

It was a common tax reduction strategy for chief executives and wealthy shareholders a decade ago, but in 2006 the I.R.S. said it appeared to be an abusive tax shelter and issued tighter restrictions to regulate the practice. That ruling was enough to persuade most wealthy taxpayers to abandon the technique, according to tax lawyers and records at the Securities and Exchange Commission.

Advisers to Mr. Lauder maintain that his deal “was made in compliance with published I.R.S. guidance on these types of transactions and was fully reported as required by S.E.C. rules,” said his spokesman, Gary Lewi.

In theory, Mr. Lauder is scheduled to pay taxes on the $72 million when the shares are actually delivered in 2014. But tax experts say wealthy taxpayers can use other accounting techniques to further defer their payment.

The tax burden on the nation’s superelite has steadily declined in recent decades, according to a sliver of data released annually by the I.R.S. The effective federal income tax rate for the 400 wealthiest taxpayers, representing the top 0.000258 percent, fell from about 30 percent in 1995 to 18 percent in 2008, the most recent data available.

When Mr. Lauder ran unsuccessfully for the Republican nomination for mayor of New York and released his tax return to the public, he reported paying 30 percent in total federal, state and city taxes on about $30 million in income in 1988. At the time, his net worth was estimated at nearly a quarter of a billion dollars.

Mr. Lauder’s more recent tax returns remain private, and he declined to make them available for this article.

The Family Fortune

Mr. Lauder, now 67, was born into a storied American fortune. His mother, Estée Lauder, the daughter of Eastern European immigrants, began selling homemade beauty creams at a few New York City hair salons in the 1940s and built her product line into a multibillion-dollar global empire.

As the son of a fabulously wealthy fashion icon, Mr. Lauder developed aristocratic tastes — and grand aspirations — at an early age. He summered in Vienna as a boy, developing a passion for Austrian art and medieval armor. At age 13, he bought his first Schiele with money from his bar mitzvah. Mr. Lauder grew so enthralled by politics as a young man that he told friends he dreamed of becoming the first Jewish president of the United States.

After studying in Brussels and Paris and at the Wharton School at the University of Pennsylvania, he joined the family business in 1964 and served in a variety of limited roles. While his older brother Leonard rose to become Estée Lauder’s chief executive, Ronald engaged in a variety of pursuits: becoming a major Republican fund-raiser; serving a rocky tenure as ambassador to Austria; running for mayor, an unsuccessful bid in which he spent $363 for each vote he received; and starting an assortment of business ventures in Eastern Europe, one of which went bankrupt during the technology bubble.

While the family’s wealth was created by hard work and ingenuity, it was bolstered by aggressive tax planning, a skill that has become Ronald Lauder’s specialty. When Mr. Lauder’s father, Joseph, died in 1983, family members fought the I.R.S. for more than a decade to reduce their estate tax. The dispute involved a block of shares bequeathed to the family — the estate valued it at $29 million, while the I.R.S. placed it at $89.5 million. A panel of judges ultimately decided on $50 million, a decision that saved the estate more than $20 million in taxes.

Estée Lauder Companies went public in 1995, and Ronald Lauder and his mother cashed in hundreds of millions of dollars in stock but managed to sidestep paying tens of millions in federal capital gains taxes by using a hedging technique known as shorting against the box.

Together, Mr. Lauder and his mother borrowed 13.8 million shares of company stock from relatives and sold them to the public during the offering at $26 a share. Selling borrowed shares in this way is referred to as a short position. Since the Lauders retained their own shares, the maneuver allowed them to have a neutral position in the stock, not subject to price swings. Under I.R.S. rules at the time, they avoided paying as much as $95 million in capital gains taxes that might otherwise have been due had they sold their own shares.

Such transactions allowed investors to cash in their shareholdings without paying taxes. But the Lauders’ use of the technique was so aggressive that Congress enacted a law afterward that limited the length of the tax deferral. And the Lauders eventually paid tens of millions in stock from the transaction.

Still, the family’s tax planning was effective enough that after Estée Lauder died in 2004, she passed down nearly $4 billion to her heirs, according to tax experts who studied the case and estimated that the estate was taxed at an effective rate of 16 percent — about a third of the top estate tax rate at the time.

Ronald Lauder has not been a director of the company since 2009, but he still serves as the president of its Clinique Laboratories subdivision. He also sublets a full floor of office space from Estée Lauder, on the 42nd story of the General Motors Building in Manhattan, which serves as the hub for the matrix of foundations, investment funds, partnerships and trusts used to control his businesses and personal finances.

His stake in Estée Lauder Companies, according to regulatory filings, is valued at more than $600 million. Nearly $400 million of that stock is pledged to secure various lines of credit. Many financial planners consider it imprudent for principal shareholders in a company to borrow against their stock. But it remains a popular way for wealthy taxpayers to get cash out of their holdings without selling and paying taxes.

There is a certain irony that Mr. Lauder has used $72 million worth of his Estée Lauder shares to carry out his latest state-of-the-art tax reduction tactic. These contracts emerged as a popular tool about a decade ago and were developed by accountants and tax planners after Congress closed down the loophole on the Estée Lauder public offering. The I.R.S. began cracking down on these contracts in 2008, and has pursued a prominent case against the billionaire Philip Anschutz, who used one to avoid more than $140 million in federal taxes.

Whether or not the I.R.S. agrees with Mr. Lauder’s contention that his contract is legitimate, some tax policy experts say the deal illustrates how the wealthy take advantage of the system.

“There’s real truth to the idea that the tax code for the 1 percent is different from the tax code for the 99 percent,” said Victor Fleischer, a law professor at the University of Colorado. “Any taxpayer lucky enough to have appreciated property is usually put to a choice: cash out and pay some tax, or hold the property and risk the vagaries of the market. Only the truly rich can use derivatives to get the best of both worlds — lots of cash and very little risk.”

While Mr. Lauder’s stock holdings in publicly traded companies show some of his tactics, much of his wealth is harder to examine because it is controlled by a maze of privately held trusts and companies. Court documents, S.E.C. filings and property tax records spotlight a few of the more ordinary tax breaks used by affluent people.

Significant portions of his inherited stock are held in family trusts, which reduce the ultimate estate tax. Mr. Lauder and his wife have also established their own family trusts, allowing them to bequeath their wealth to their heirs with minimal taxes.

Other trusts and partnerships control his real estate properties in Palm Beach and the Hamptons and at 740 Park Avenue, a building that was once home to John D. Rockefeller, and is known as one of the world’s wealthiest apartment buildings.

United States tax law allows taxpayers to deduct mortgage interest on one’s homes up to $1.1 million in debt. Households with more than $1 million in income claimed more than $27 billion in such deductions from 2006 to ’09, according to a report this month by Senator Tom Coburn of Oklahoma, who said some wealthy taxpayers even deducted mortgage interest on their yachts.

And there is no limit on the amount of property taxes that can be deducted from federal income. So Mr. Lauder is entitled to deduct the $400,000 he pays annually on his Palm Beach mansion as well as what he pays on his home on Park Avenue and his holdings in the Hamptons.

“This welfare for the well-off — costing billions of dollars a year — is being paid for with the taxes of the less fortunate, many who are working two jobs just to make ends meet, and i.o.u.’s to be paid off by future generations,” said Senator Coburn, a Republican, who has called for limits on tax breaks for high earners.

Mr. Lauder deducts property taxes on all of his holdings, his spokesman said. Mr. Lauder declined to say how much that reduced his federal taxes, but said he did not receive tax benefits in some years because of the alternative minimum tax and other limits.

Charity and Tax Breaks

A week before the opening at the Neue Galerie last month, Mr. Lauder appeared at another gala, 40 blocks south, at the New York Public Library, to receive the Carnegie Foundation’s Medal of Philanthropy.

The program honored people who have given profusely to charities, including Mr. Lauder’s brother Leonard and his wife, Evelyn (who died Nov. 12), whose causes include the Whitney Museum and the pink ribbon campaign for breast cancer awareness.

Ronald Lauder and his wife, Jo Carole, were honored for a variety of contributions: the work of their joint foundation supporting hospitals, rebuilding monuments and refurbishing American embassies around the world — more than a quarter of a billion dollars over the last five years, according to his spokesman.

The Ronald S. Lauder Foundation has donated tens of millions of dollars to rebuild Jewish communities devastated by the Holocaust and communist rule. Mr. Lauder has also given to a variety of Jewish and Israeli organizations, including the World Jewish Congress, where he has served as president since 2007. Richard Parsons, the former Time Warner chairman, presented the award, calling Mr. Lauder and his wife two of “the nation’s pre-eminent supporters of the arts and civic causes.”

Mr. Lauder said his life was changed 25 years ago when he visited a kindergarten in Austria and met a classroom full of Jewish children who were refugees from Russia. Still, he said he found it odd to be referred to as a philanthropist.

“I did what I wanted to do,” he said. “What I thought was right.”

A Passion for Art

In the United States, Mr. Lauder has focused on what he calls his greatest passion — art.

In 1976, at age 32, his generous donations helped him become the youngest trustee of the Metropolitan Museum of Art. He later served as chairman of the Museum of Modern Art and remains an honorary chairman. He has donated and lent artwork to an assortment of museums. Part of his collection of lavishly decorated ceremonial armor is on display at the Met, in a gallery named for him.

As all art collectors may, Mr. Lauder is entitled to deduct the full market value of artworks donated to museums. (For years, Mr. Lauder availed himself of a quirk in the tax code that allowed donors to take a deduction for donating a portion of an artwork, without actually turning over the art. That break, known as fractional donation, was eliminated in 2006.) The tax code also allows artwork in offices to be deducted as a business expense.

Unlike some wealthy collectors who are criticized for using tax breaks to underwrite private collections that offer little access to the public, Mr. Lauder is widely praised for making his artwork a community asset.

The Neue Galerie, created by Mr. Lauder and Serge Sabarsky, who died in 1996, in a mansion once owned by Cornelia Vanderbilt, offers public viewing of an exquisite collection, worth more than $200 million even before Mr. Lauder added dozens of pieces for its 10th anniversary.

Sheldon Cohen, a former I.R.S. commissioner, said that when used as intended, the tax code’s breaks for art collectors balance private interests with the public good.

“If an art collector makes significant contributions, and the public actually gets access to the works they are donating, then the major thing the collector gets is prestige and social status,” said Mr. Cohen, now a lawyer in Washington.

At times, Mr. Lauder’s efforts to enhance his art collection have coincided with tax avoidance techniques.

In 2006, three months after he agreed to pay $135 million, a record at the time, for the Klimt painting “Adele Bloch-Bauer I,” Mr. Lauder sold a $190 million stake in his broadcast network CME.

When asked about the sale, Mr. Lauder’s spokesman said the proceeds were taxable in the United States at the full capital gains rate. Even then, though, CME’s complex corporate structure — it operates in Central Europe, is organized as a Netherlands holding company, keeps its headquarters in Bermuda and routed the $190 million sale through two Cayman Island companies — allowed Mr. Lauder to minimize taxes in countries outside the United States where it does business.

Some tax reform advocates say that it is unfair that the wealthiest can subsidize their lifestyles using myriad offshore maneuvers and complex accounting strategies.

“It’s admirable when people back their charitable impulses up with donations,” said Scott Klinger, tax policy director of the group Business for Shared Prosperity. “But the tax code shouldn’t allow the wealthy the kind of loopholes that let them, essentially, force other taxpayers to underwrite donations to their pet causes.”

[JackRiddler]

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Department of You Can't Make This Stuff Up, Case No. 90471:

http://bottomline.msnbc.msn.com/_news/2 ... 25-billion

Former AIG chief sues U.S. for $25 billion



Choi Jae-Ku/AFP/Getty Images

Maurice "Hank" Greenberg, former chairman of American International Group (shown in 2003 file photo), is back in court with a lawsuit against the federal government.
By Martha C. White

(This story has been updated to include a response from the U.S. Treasury Department.)

Former American International Group CEO Maurice "Hank" Greenberg thinks he got a raw deal, and he wants the government to pay up. Greenberg filed a lawsuit in the U.S. Court of Federal Claims asserting that the government bailout and takeover of the insurance giant was an unconstitutional seizure of private property, The Wall Street Journal reported Monday. Greenberg's Starr International Co., which used to be AIG's biggest stakeholder, is seeking $25 billion in damages, based on the value of the 80 percent stake in AIG the government took after providing it with an $182 billion bailout.

Those funds allowed AIG to pay off counterparties like Goldman Sachs in full and reward executives with $165 million in bonuses in 2008, even though AIG lost $61.7 billion in the fourth quarter of that year. This situation raised considerable ire among both the public and investors. AIG's own value plummeted and it was reduced to selling off assets to pay back the government, both moves of which hurt Greenberg's stake in the firm.

An AIG representative declined to comment on the suit via email. The Treasury Department called the government's intervention "necessary, legal, and constitutional" in a statement issued Monday afternoon. "We are reviewing the lawsuit and expect to defend our actions vigorously,” it said.

This isn't Greenberg's first legal tussle with the government, and it's not the first time he's clashed with his former company. Greenberg left AIG in 2005 after an accounting fraud investigation was launched by then-Attorney General Eliot Spitzer. The criminal charges didn't stick, but in 2009, Greenberg paid $15 million to the Securities and Exchange Commission for accounting violations. Also in that year, a federal judge ruled that Greenberg was entitled to $4.3 billion in AIG shares the company had sued in an attempt to recover.

Anyone see Alex Gibney's Client 9? Greenberg was one of the film's ad-hoc billionaire's council filmed winking and crowing that they may have heard rumors about who engineered the fall of Eliot Spitzer.

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[JackRiddler]

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In keeping with the theme of billionaire strategies... using foundation grants to leverage even larger sums of public money. One of the key fields for the likes of Gates and now Zuckerberg is what I've called the war on teachers.

http://www.nytimes.com/2011/11/27/sunda ... nted=print

November 26, 2011
Policy-Making Billionaires

By NICHOLAS CONFESSORE

OVER the past 30 years, as the gap between wealthy and poor grew ever wider, total philanthropic giving almost tripled, according to annual estimates published by the Giving USA Foundation and the Center on Philanthropy at Indiana University. In an age of widening partisanship and plummeting trust in government, this outpouring of philanthropy has produced a distinct breed of philanthropist: The policy-making billionaire.

Bill Gates, the Microsoft co-founder, has invested more than $13 billion in public health initiatives around the world through his foundation. William E. Conway Jr., a founder of the Carlyle Group investment company, is planning to give away $1 billion of his personal fortune, and is said to be considering how his money can aid in financing major infrastructure projects.

“What’s going on at a broader level is a sense of, ‘Hey, we can be much more effective and efficient than government in doing things,’ ” said Leslie Lenkowsky, a professor of philanthropic studies and public affairs at Indiana. “And it’s become more pervasive in recent years.”

In keeping with the anti-government spirit of the times, the new philanthropists — some with roots in the loosely libertarian milieu of Silicon Valley or Wall Street — share a disdain for established politics and an impatience with the slow churn of old-fashioned policy making. Last month, the Starbucks executive Howard Schultz, whose net worth approaches $750 million, proposed using Starbucks’ corporate foundation and customer donations to create an economic development and job training program for the unemployed, one that he hopes can generate tens of millions of dollars in loans to small business.

“As corporate citizens of the world, it is our responsibility — our duty — to serve the communities where we do business,” Mr. Schultz wrote, “by helping to improve, for example, the quality of citizens’ education, employment, health care, safety, and overall daily life, plus future prospects.”

But the very loftiness of such ambitions raises a significant question: Can even the very wealthiest philanthropists finance public services on the scale necessary to achieve social change — that is, on the scale of government itself?

One way to make that happen: Instead of seeking to supplant what government does, philanthropists can finance advocacy to change it. When philanthropic dollars are applied to lobbying for programs, they can have an enormous leveraging effect on public dollars.

A coming study by the National Committee for Responsive Philanthropy, which advocates giving that aids the poor, looked at 100 social welfare organizations in 13 states. The groups spent about $230 million on advocacy and organizing for minimum wage laws, expanding tax credits for the working poor, and other programs. Those efforts, the study found, produced more than $26 billion in direct and indirect benefits to individuals, a “return on investment” of about 115 to one.

“I get it — there’s frustration when there’s gridlock, and sometimes people want to give money where government won’t,” said Aaron Dorfman, executive director of the National Committee for Responsive Philanthropy. “But most philanthropists realize that good philanthropy can never be a substitute for government spending.”

A version of this thinking has long guided conservative political philanthropists, whose distaste for government has not blinded them to the value of influencing it, and whose money helped create an entire infrastructure of research organizations in Washington in the 1980s and ’90s dedicated to shrinking government. In the last decade or so, it has also become received wisdom on the political left, as some major liberal donors began to shift money out of traditional charity and into political advocacy.

Increasingly, the same spirit is animating some of the largest philanthropies in the country. After early experiments with directly financing new experimental schools around the country, for example, some of the biggest advocates for charter schools, including the Gates Foundation and the Broad Foundation of Eli and Edythe Broad, shifted gears several years ago and began pouring billions of dollars into advocacy at the federal, state and local levels. One result: The Obama administration’s $4.3 billion “Race to the Top” grant program, whose rules prohibited states from limiting the number of charter schools.

Of course, depending on the beholder, such philanthropy can seem either extraordinarily benevolent or extraordinarily undemocratic. The education scholar Diane Ravitch, in her book “The Death and Life of the Great American School System,” criticized the charter advocates as a “billionaire boys’ club,” exerting enormous influence over education policy with little accountability.

“It’s sort of influence-peddling writ large,” said Richard L. Brodsky, a senior fellow at the liberal-leaning research organization Demos and a former New York State assemblyman. “The notion that the society is better served by the super-rich exercising their charitable instincts is in the end anti-democratic.”

A middle path may be suggested by two other recent philanthropic efforts. Last fall, Mark Zuckerberg, a founder of Facebook, volunteered to contribute $100 million in seed money to Newark’s troubled public schools. The city hopes to match this with other private money in an effort that would pump about $200 million over five years into a school system with an annual budget of about a billion dollars. And in August, Mayor Michael R. Bloomberg of New York said he would pump $30 million of his own fortune into initiatives aimed at helping young black and Hispanic men, matched by $30 million from a fellow billionaire, George Soros, and about $68 million in city funds.

The new effort, dubbed the Young Men’s Initiative, will funnel money through an array of programs, from social services to alternatives to incarceration for juvenile offenders, that affect a group of New Yorkers who are disproportionately incarcerated and unemployed. How the money is spent will be determined by government.

Linda I. Gibbs, the city’s deputy mayor for health and human services, said, “Nobody in this conversation, whether from the Bloomberg Philanthropies or the Soros Foundation, is saying, ‘No, that’s not a good idea, we think you should be doing this, instead.’ ”

Officials in New York and Newark say the money from private sources will not replace existing public programs, but will instead allow rapid experimentation with new approaches to old and seemingly intractable problems, at no cost to taxpayers. Whatever proves most effective can then be rolled out on a larger scale, they argue, using public dollars.

“We’re not thinking about philanthropic dollars as a replacement for public dollars,” Cami Anderson, the Newark schools superintendent, said in an e-mail. “We are thinking about using it for things that need to be accelerated — where only private dollars can uniquely facilitate innovation because of the restrictions in government money sources.”

For example, some of Mr. Zuckerberg’s grant is going toward gathering reams of data to pilot a new grading system.

“It’s very expensive to do it, but once it is done, the cost goes way down,” Ms. Anderson said. “Do I need a huge data team at Newark Public Schools in perpetuity? No — but I need one now to ensure we have fair systems of accountability.” Part of the appeal is that the money comes with less red tape. This could also mean less transparency: The private foundation that controls the Zuckerberg grant refused to divulge how the money would be spent — until a group of parents sued the city. The Zuckerberg grant, Ms. Anderson said, will lead to more experimentation, and it is school officials who will be deciding where to experiment.

Nicholas Confessore is a political reporter for The New York Times.

[seemslikeadream]

NYC judge rejects $285M SEC-Citigroup agreement
By Larry Neumeister
Associated Press / November 28, 2011

NEW YORK—A federal judge in New York has struck down a $285 million settlement that Citigroup reached with the Securities and Exchange Commission, citing a need for truth about the financial markets.

Judge Jed Rakoff rejected the settlement Monday. The deal would have imposed penalties on Citigroup even as it allowed the company to deny allegations that it misled investors on a complex mortgage investment. The SEC has accused the bank of betting against the investment in 2007 and making $160 million, while investors lost millions.

The judge wrote that there is an overriding public interest in knowing the truth about the financial markets. He set a July 16 trial date for the case.