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Buffett Exits Entire Credit Default Swap Exposure, As Citi’s Appetite For Derivative Destruction Surges

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It was considered one of the bigger paradoxes for years. Back in 2003, Warren Buffett famously dubbed derivatives “financial weapons of mass destruction” and yet over the next several years went ahead and entered a number of the contracts, including both equities and credit, ostensibly by selling CDS to collect monthly premiums, although not to the same degree as AIG, which infamously had to be bailed out due to massive losses on its CDS book.

The billionaire had argued that agreements he made were attractive because they gave him money up front that he could invest. Berkshire’s derivatives also differed from contracts that brought down other financial institutions during the 2008 credit crisis, because he had less onerous collateral requirements.

However, at least when it comes to CDS, after several years of Berkshire trimming its credit derivative exposure, it is now completely out, and as Bloomberg reports the Omaha billionaire “just took another step to simplify Berkshire Hathaway Inc.’s stockpile of derivatives.”

The company paid $195 million in July to wind down the last contract in which Omaha, Nebraska-based Berkshire provided protection against losses on bonds, according to a regulatory filing Friday that didn’t identify the counterparty. As of June 30, the maximum risk on that credit-default agreement was about $7.8 billion.”

For years, the billionaire has been winding down derivatives or letting them expire. In 2012, he struck a deal to terminate contracts linked to municipal bonds. Others tied to corporate debt expired the following year.

While not as bad as AIG, Berkshire’s derivatives have been the source of some pain. Bloomberg notes that in 2008, the SEC asked Berkshire to make “more robust disclosure” on how it valued the contracts, which the company eventually did. The following year, Moody’s Investors Service and Fitch Ratings cited derivatives when the ratings firms stripped Berkshire of its top credit grade. Changes in the values of the contracts are reflected on Berkshire’s income statement, sometimes causing wild swings in quarterly profit.

“That was a very interesting chapter for Berkshire and its shareholders,” said David Rolfe, chief investment officer at Wedgewood Partners, a Berkshire investor that oversees about $7.8 billion. “And it looks like that chapter is winding down.” Perhaps because Berkshire’s last CDS had such a long potential lifespan that it could’ve continued under the next chief executive officer, that Buffett may wondered  “why even bother someone with that?” Rolfe said.

The contract covered in the July agreement was written in 2008 and related to municipal debt issues with maturities from 2019 to 2054, according to regulatory filings. Buffett didn’t respond to a request for comment outside normal business hours.

Buffett has repeatedly told shareholders to look past the fluctuations from derivatives and focus instead on the underlying earnings for Berkshire’s dozens of businesses, from railroad BNSF to ice-cream chain Dairy Queen. On Friday, the company reported that operating earnings climbed 18 percent to $4.61 billion in the second quarter, driven by gains at insurance and manufacturing businesses.

Perhaps Buffett is worried about sharp fluctuations on the securities, which are essentially a bond short. “When you have to mark these contracts to market in a downturn like 2008, it gives the appearance that Berkshire’s fortress balance sheet is weakened,” said Richard Cook at Cook & Bynum Capital Management, which oversees about $350 million including Berkshire shares. “I would prefer Buffett to have as much flexibility as possible when the tide rolls out.”

Despite exiting CDS, Buffett still has equity-linked derivative exposure, as Berkshire still has some derivatives tied to the performance of stock indexes. Potential liabilities on those agreements have narrowed in recent years as markets rallied. Liabilities on the equity index puts – which expire between June 2018 and early 2026 – stood at about $4.4 billion at the end of the second quarter, Bloomberg reports.

Some of Berkshire’s energy businesses also use derivatives to hedge fuel costs. But Buffett has been downplaying the role the contracts will play at his company when he’s no longer around. “I don’t think there’ll be much of a derivatives book” under a new CEO, he said at Berkshire’s annual shareholder meeting in 2012. “There are a few operating businesses that will have minor positions.”

And with Buffett unwinding, something must be accumulating a position. One possible suspect is Citigroup. According to a Bloomberg report on Friday, Citigroup, the U.S. bank with the most derivatives, purchased a portfolio of credit-default swaps from retreating rival Credit Suisse Group AG, two people with knowledge of the matter said. 

Credit Suisse said last week it had agreed to sell the positions, which consist of about 54,000 trades, to an unidentified buyer, reducing its leverage exposure by $5 billion. The gross notional value of the portfolio is about $380 billion, said people with knowledge of the assets, who asked not to be identified because the size of the portfolio or identity of the buyer aren’t public.

Credit Suisse Chief Executive Officer Tidjane Thiam is pulling out of some securities businesses as he seeks to boost the bank’s capital ratios and rein in a culture he said took too much risk before he joined. The deal shows how some of the biggest U.S. banks are looking to gain market share in trading from the restructurings of European rivals, including Credit Suisse and Deutsche Bank AG.

In order to boost returns, Citi has been on a CDS buying spree in recent months. In 2015, the bank bought about $250 billion in notional value of credit derivatives from Deutsche Bank last year and was in talks with the German bank to buy more, Bloomberg reported in March. The New York-based firm had $2.1 trillion of notional credit derivatives, and more total derivatives than any other U.S. lender, at the end of March, according to a report from the Office of the Comptroller of the Currency.

The portfolio encompassed all the CDS the Swiss bank had in its strategic resolution unit, the part of the firm it’s winding down, while it still has some credit derivatives in the ongoing trading business. Credit Suisse wants to reduce leverage exposure at the SRU by about 70 percent over the next three years, Chief Financial Officer David Mathers said last week. That measure was $148 billion at the end of June, down from $167 billion at March 31.

As a reminder, one of the reasons why Deutsche Bank has seen its stock pressured in recent months is due to investor concerns over its derviative exposure, something we first pointed out in 2013. And while unwinding a quarter trillion in derivative is a welcome start, the German banks still has tens of trillions in residual derivative exposure left, whose breakdown is largely unknown, and which may result in another risk flare up episode in coming quarters should there be a dramatic reversal in key underlying financial metrics such as interest rates.

For now, however, what we do know is that as Berkshire is unwinding Citi is, well, winding, in a long telegraphed move. Recall that at the end of 2014 it was revealed that none other than Citigroup lawyers had insert language in the Omnibus language which allowed financial institutions to trade certain financial derivatives from subsidiaries that are insured by the Federal Deposit Insurance Corp, explicitly putting taxpayers on the hook for losses caused by these contracts.

 

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So what explains Citi’s relentless appetite to add derivative exposure on its balance sheet? Simple: because depositors, and thus taxpayers, are on the hook at the FDIC-insured entity – as the bank assured when it drafted the appropriate legislation – as they were before the 2008 financial crash and subsequent bailout.


18 Years Later – Pam Martens Sends Another Warning To The Fed & The Clintons

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It is the same players that we saw enabling reckless behavior in 1998: Citigroup, the Fed, and the Clinton-led Wall Street Democrats. And, as Jesse notes, here we are again, almost eighteen years later, watching the same short term, selfish characteristics by the big money banks putting the entire economy of productive individuals at risk again

"There’s something big and scary going on behind the scenes but, as usual, the public isn’t reading about it on the front pages of the newspapers." Pam Martens and Russ Martens warn that big banks and big insurers send scary signals…

Yesterday, the broad stock market, as measured by the Standard and Poor’s 500 Index, declined a modest 0.29 percent while big Wall Street banks like Citigroup and JPMorgan Chase fell by triple that amount. Bank of America, which bought the big retail brokerage firm, Merrill Lynch, in the midst of the 2008 crash, fell by 8.6 times the rate of the decline in the S&P to give up 2.50 percent.

 

 

 

Equally noteworthy, two major insurers, MetLife and Prudential Financial, saw percentage market losses far in excess of the S&P. MetLife declined by 2.74 percent while Prudential Financial lost 1.68 percent. Prudential Financial has been named a Systemically Important Financial Institution (SIFI) by the Financial Stability Oversight Council. MetLife had received the same designation but won a court battle to rescind the designation. The U.S. government is appealing.

The vote of no confidence on down market days in the complex U.S. banks that hold both insured deposits from Mom and Pop savers while also making huge derivative gambles is a repeat of the action we saw earlier this year. On February 3, 2016, four big Wall Street banks (Bank of America, Citigroup, Goldman Sachs and Morgan Stanley) set 12-month lows in intraday trading – far outpacing the declines in the broader market index as measured by the S&P 500. The banks have recovered some since then but are nowhere near setting record highs as the broader market indices have of late.

These mega banks should be a barometer of the overall health of the stock market and the U.S. economy. After all, these are the banks that are making corporate loans, underwriting corporate stock and bond issues, and doling out credit to consumers. If the mega banks are experiencing air pockets of buying interest in declining markets, this does not bode well for either the market or the U.S. economy.

The price performance of MetLife should also be a red flag that perhaps the Financial Stability Oversight Council got it right when it designated the firm a SIFI.

There is at least one potential concern that is contaminating market perception of the stability of these banks. That’s the fact that despite all of the promises that the Dodd-Frank financial reform legislation would rein in the Wild West derivative trading at these banks, no such thing has happened.

Dodd-Frank was supposed to push the derivatives out of the commercial banks which hold the insured deposits to prevent another taxpayer bailout, the so-called “push out” rule. But in December of 2014, Citigroup was able to sneak legislation into the must-pass spending bill to keep the government running that overturned the push-out rule. The Congressman who placed the provision into the spending bill on behalf of Citigroup was Kevin Yoder of Kansas. The non-partisan Center for Responsive Politics shows  “Securities and Investment” as the number one industry contributing to Yoder’s campaign committee and leadership PAC.

Using its insured bank’s balance sheet as ballast, Citigroup’s bank holding company now ranks as the largest holder of all derivatives in the U.S. According to the Comptroller of the Currency, the very bank that blew itself up in 2008 and received the largest taxpayer bailout in history, now holds $55 trillion in notional amount of derivatives.

But far more alarming is the type of derivatives Citigroup appears hell bent on gaining market share in trading. Last week we reported that Citigroup is plowing into credit default swaps, the very derivatives that blew up the big insurance company, AIG, in 2008 and forced a government bailout of AIG to the tune of $185 billion. We noted on August 4:

“According to the data, Citigroup now has $2.08 trillion in Credit Derivatives (the vast majority of which are Credit Default Swaps). Only JPMorgan is bigger with $3.1 trillion in credit derivatives. Equally frightening, the vast majority of these are private contracts between financial institutions (Over-the-Counter) where regulators lack the granular details of the deals. President Obama falsely promised the American people that derivatives would be moved onto exchanges with proper capital and transparency following the Dodd-Frank financial reform legislation in 2010. That has not happened. The vast majority of all derivatives are still traded in the dark.

 

Not only are Citigroup’s Federal regulators allowing it to engage in this high risk trading but they are actually allowing Citigroup to purchase the high risk positions of a deeply troubled bank – Deutsche Bank. Risk Magazine reports… that Citigroup bought $250 billion of Credit Default Swaps from Deutsche Bank in 2013. Bloomberg News also reported on the $250 billion Citigroup purchase from Deutsche Bank.”

The ink was barely dry on our article when the very next day, Bloomberg News reporters Jeff Voegeli and Donal Griffin wrote that Citigroup had “purchased a portfolio of credit-default swaps from retreating rival Credit Suisse Group AG” which had a notional value (face amount) of $380 billion.

To many rational minds, $250 billion here, $380 billion there, pretty soon you’re talking about real money – and real potential for blowups like those seen in 2008.

On March 8 of this year, the Office of Financial Research, which was created under the Dodd-Frank legislation to monitor the buildup of systemic financial risks, released a study on Credit Default Swaps. Its findings were deeply troubling.

The report effectively suggested that the Federal Reserve was conducting its stress tests all wrong. The researchers noted that the Fed’s stress test is looking at only the bank holding company’s “direct counterparty concentrations” for credit default swaps rather than the indirect fallout. The authors found that “indirect effects can be as much as nine times larger than the direct impact” on the bank holding company, and ignoring that reality “could understate the stress on banks.”

That study may have sent a shot across the bow of the Fed, alerting it to nip in the bud any cascading effect from loss of confidence in the European banks that are holding credit default swaps. Both European banks that sold Citigroup their credit default swaps (Deutsche Bank and Credit Suisse) have seen their share price implode over the past 12 months. Deutsche Bank’s stock has lost 56 percent of its value over the past 12 months while Credit Suisse is down by 58 percent based on mid morning trading.

But if the Fed is attempting to ring fence credit default swaps by allowing Citigroup to be the buyer of last resort, that has the potential to spread panic not contain it. Citi is, after all, the bank that brought us this mess by muscling through the repeal of the Glass-Steagall Act.

*  *  *

Below is the testimony of Pam Martens to the Federal Reserve on June 26, 1998, imploring it not to support the repeal of the Glass-Steagall Act and usher in an era where Wall Street banks like Citigroup could own both insured deposits at its commercial bank as well as engage in high risk trading at its investment bank

How Long Can Economic Reality Be Ignored?

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Submitted by Paul Craig Roberts via Strategic-Culture.org,

Trump and Hitlery have come out with the obligatory “economic plans.” Neither them nor their advisors, have any idea about what really needs to be done, but this is of no concern to the media.

The presstitutes operate according to “pay and say.” They say what they are paid to say and that is whatever serves the corporations and the government. This means that the presstitutes like Hitlery’s economic plan and do not like Trump’s.

Yesterday I listened to the NPR presstitutes say how Trump pretends to be in favor of free trade but really is against it, because he is against all the free trade agreements such as NAFTA, the Trans-Pacific and Trans-Atlantic partnerships. The presstitutes don’t know that these are not trade agreements. NAFTA is a “give away American jobs” agreement, and the so-called partnerships give away the sovereignty of countries in order to award global corporations immunity from laws.

As I have reported on many occasions, the Oligarchs’ government lies to us about everything, including economic statistics. For example, we are told that we have been enjoying an economic recovery since June, 2009, that we are more or less at full employment with an unemployment rate of 5% or less, and that there is no inflation. We are told this despite the facts that the “recovery” is based on the under-reporting of the inflation rate, the unemployment rate is 23%, and inflation is high.

GDP is measured in current prices. If GDP rises 3% this year over last year, the output of real goods and services might have risen 3% or prices might have gone up by 3% or real output might have dropped but is masked by price increases. To know what really happened the nominal GDP number has to be deflated by the amount of inflation.

In times past we could get a reasonable idea of how the economy was doing, because the measure of inflation was reasonable. That is no longer the case. Various “reforms” have taken inflation out of the measures of inflation. For example, if the price of an item in the inflation index goes up, the item is taken out and a cheaper item put in its place. Alternatively, the price rise is called a “quality improvement” and not counted as a price rise.

In other words, by defining inflation away, price increases are transformed into an increase in real output.

The same thing happens to the measure of unemployment. Unemployment simply isn’t counted by the reported unemployment rate. No matter how long and hard an unemployed person has looked for a job, if that person hasn’t job hunted in the past four weeks the person is not considered to be unemployed. This is how the unemployment rate is said to be 5% when the labor-force participation rate has collapsed, half of American 25-year-olds live with their parents, and more Americans age 24-34 live with parents than independently.

Financial reporters never inquire why government statistics are designed to provide an incorrect picture of the economy. Anyone who purchases food, clothing, visits a hardware store, and pays repair bills and utility bills knows that there is a lot of inflation. Consider prescription drugs. AARP reports that the annual cost of prescription drugs used by retirees has risen from $5,571 in 2006 to $11,341 in 2013, but their incomes have not kept up. Indeed, the main reason for “reforming” the measurement of inflation was to eliminate COLA adjustments to Social Security benefits.

Charles Hugh Smith has come up with a clever way of estimating the real rate of inflation—the Burrito Index. From 2001 to 2016 the cost of a burrito has risen 160 percent from $2.50 to $6.50. During these 15 years the officially measured rate of inflation is 35 percent.

And it is not only burritos. The cost of higher education has risen 137% since 2000. The Milliman Medical Index shows medical costs to have risen far above official inflation from 2005 to 2016. The costs of medical insurance, trash collection, you name it, are dramatically higher than the official rate of inflation.

Food, tuition and medical costs are major outlays for households. Add zero interest on savings to the problem of coping with major cost increases when real incomes are stagnant and falling. For example, grandparents cannot help grandchildren with their student loan debt when zero interest rates force grandparents to draw down their savings in order to supplement essentially frozen Social Security benefits during a time of high inflation. Savings are being taken out of the economy. Many families exist by paying only the minimum payment on their credit card balance, which means that their debt grows monthly.

Real economists, if there were any, looking at the real economic picture would see an economy collapsing into widespread debt deflation and impoverishment. Debt deflation is when consumers after they service their debts have no discretionary income left with which to drive the economy with purchases.

The reason that Americans have no income from their savings is that public authorities put the welfare of a handful of “banks too big to fail” above the welfare of the American people. The enormous liquidity created by the Federal Reserve has gone into the financial system where it has driven up the prices of financial instruments. There has been a stock market recovery but not an economic recovery.

In the past liquidity implied economic growth. When the Federal Reserve loosened monetary policy, the increase in consumer demand caused an increase in the output of goods and services. Stock prices would rise anticipating higher profits. But in recent years financial markets have not been driven by fundamentals, which are adverse, but by the liquidity that the Federal Reserve has pumped into the banking system in order to save a handful of over-sized banks and insurance giant AIG, all of which should have been allowed to fail. The liquidity had to go somewhere and it went into the prices of stocks and bonds, causing a tremendous asset inflation.

What sense does it make to have zero interest rates when high inflation is eating away the real value of money? What sense does it make to have high price/earnings ratios when the consumer market cannot expand? What sense does it make to have a stable dollar when the Federal Reserve has created far more dollars than the economy has created goods and services? What sense does it make to undermine the financial condition of pension funds and insurance companies with zero interest rates, leaving them with no fixed income hedge against the stock market?

It makes no sense. We are in a trap in which collapse seems the only way out. If interest rates reflected the real rate of inflation, the hundreds of trillions in derivatives would blow up, the stock market would collapse, unemployment could not be hidden with under-measurement, budget deficits would rise. What would public authorities do?

When crisis hits, what happens to corporations that used profits and borrowed money, that is, debt, to buy back their own stocks in order to keep the price high and, thereby, executive bonuses high and shareholders happy and disinclined to support takeovers? Chaos and its companion Fear take over from Contentment. Hell breaks loose.

Is more money printed? Does the money find its way into consumer prices? Do we experience simultaneously massive inflation and massive unemployment?

Don’t expect the presstitutes, the politicians, or Wall Street to confront any of these questions.

When the crisis occurs, it will be blamed on Russia or China.

What Hedge Funds Bought And Sold In Q2: The Full 13-F Summary

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Today is the deadline for hedge funds to submit their Q2 13-F filings. Among the more notable changes was the previously reported 55% increase in Warren Buffett's Apple shares, offset by the cut in his Wal-Mart stake; Elliott's addition to stakes in security firms Qualys, Fortinet, CyberArk; ValueAct's new stakes in Morgan Stanley, Seagate; Tiger's exit of Netflix; Jana addition of Time Inc, and Soros' cut of his gold miner positions.

Below is a summary courtesy of Bloomberg of 2Q equity holdings from Jun 30 13-F filings by the most prominent hedge funds, with some of the new, added, cut and exited positions for each; some stakes may have previously been reported in separate filings.

  • ADAGE CAPITAL
  • New stakes in SLB, LNKD, LMT, LLL, SO
  • Boosts AMZN, MON, MLM, WR, JNJ
  • Cuts SYF, IR, AAPL, RTN, DAL
  • No longer shows TGT, SABR, XYL, CW, ROK

APPALOOSA MANAGEMENT

  • New stakes in WDC, USFD
  • Boosts AGN, MHK, ALL, SYF, FOXA
  • Cuts HCA, AMLP, ETP, LUV, KMI
  • No longer shows DAL, FB, BAC, PFE, RRC

BALYASNY ASSET MANAGEMENT

  • New stakes in UNP, OLN, TJX, WFT, LMT
  • Boosts BABA, AAP, GOOGL, V, MRK
  • Cuts CSX, MPC, NSC, STLD, FB
  • No longer shows PCLN, NUE, KBR, SON, DHR

BAUPOST GROUP

  • New stakes in C, LVNTA, CAR, BATRK, SRAQ
  • Boosts EMC, TBPH, PRTK, AGN
  • Cuts AR, PYPL, INVA, NG
  • No longer shows SRAQU, LQ, BXE, GNW

BERKSHIRE HATHAWAY

  • New stakes in LSXMK, LSXMA, LMCK, LMCA
  • Boosts AAPL, LILA, LBTYA, LILAK, PSX
  • Cuts WMT, SU, VRSN, DE, CHTR

BLUE HARBOUR

  • New stakes in INOV
  • Boosts XLNX, MDRX, GSM, AGCO
  • Cuts BW, ISBC
  • No longer shows WCN, VRNT, IWM, SPY, CHS

BLUEMOUNTAIN

  • New stakes in AGN, WLTW, CFCOU, CI, UVXY
  • Boosts SERV, JCI, MDVN, TPX, GLD
  • Cuts FNF, VRNT, IMS, APD, HLF
  • No longer shows TWC, TERP, HYG, SAFM, EURN

BRIDGEWATER ASSOCIATES

  • New stakes in JNJ, PH, CVS, VFC, IVZ
  • Boosts EWZ, ABX, LYB, GG, SPLS
  • Cuts EEM, VWO, VMW, MSFT, DIS
  • No longer shows MU, RL, T, QCOM, POT

BULLDOG

  • New stakes in LGI, KHI, KMM
  • Boosts STC, SZC, DCA
  • Cuts LBF, EMG, SVVC, XRDC
  • No longer shows CLDC, SOR, DDF, NXEO, WHLRW

COATUE MANAGEMENT

  • New stakes in LBRDK, TREE, SYMC, LILAK, LILA
  • Boosts PYPL, EXPE, LBTYK, AKAM, LBTYA
  • Cuts MSFT, ADBE, GOOG, FB, JD
  • No longer shows CHTR, HTZ, CAR, QIHU, DDD

CORVEX MANAGEMENT

  • New stakes in BEAV, JCI, MON, EVHC, KSU, WWAV
  • Boosts BLL, P, TMH, COMM, NOMD
  • Cuts VER, GOOGL, FNF
  • No longer shows PFE, EQC, VRX, AGN, GLPI

DUQUESNE FAMILY OFFICE

  • New stakes in HAL, ABBV, FCX, AA, DE
  • Boosts HDB
  • Cuts FB, EEM, AMZN
  • No longer shows KO, PM, SO, DUK, GOOGL

ELLIOTT MANAGEMENT

  • New stakes in MON, LOCK, IMPV, PHM, MENT
  • Boosts CAB, AGN
  • Cuts IPG, SBS, RYAAY, RRTS, NBHC
  • No longer shows QLIK, PFE, BXLT, ODP, PAH

EMINENCE CAPITAL

  • New stakes in USFD, CCE, STZ, WEN, DLTR
  • Boosts ICE, MON, ANTM, ZNGA, BERY
  • Cuts YHOO, LNKD, BIDU, ARRS, TTWO
  • No longer shows CCL, WBS, ZBRA, WYNN, RL

ETON PARK CAPITAL

  • New stakes in MDVN, MON, ORLY, BABA, AFI
  • Boosts MSFT, SYT, HYG, ADBE, MHK
  • Cuts GLD, SBAC, EMC, ODP
  • No longer shows AGN, CI, IM, SPLS, GLPI

FAIRHOLME CAPITAL

  • Boosts BAC, JOE, SRSC, SHOS, LE
  • Cuts SHLDW, SRG
  • No longer shows DNOW

GATES FOUNDATION

  • Boosts LILAK, LILA
  • Cuts BRK/B

GLENVIEW CAPITAL MANAGEMENT

  • New stakes in IMS, WMB, Q, DD, FDC
  • Boosts HUM, CHTR, HTZ, LBTYK, LBTYA
  • Cuts WOOF, TEVA, DOW, TMO, MAN
  • No longer shows TWC, MCK, ARMK, PNR, CDNS

GREENLIGHT CAPITAL

  • New stakes in CPN, RAD, AYA, PRGO, ABC
  • Boosts MYL, CC, HTS, AER, CYH
  • Cuts AAPL, KORS, TWX, VOD, TERP
  • No longer shows M, AGN, AGNC, EMC, BAX

HIGHFIELDS CAPITAL MANAGEMENT

  • New stakes in HLT, XLI, MSFT, AGN, BP
  • Boosts TEVA, WMB, TSLA, MAR, HTZ
  • Cuts CBS, ICE, TRIP, PEP, EMC
  • No longer shows MCD, TWC, DIS, BXLT, BK

ICAHN ASSOCIATES

  • New stakes in AGN
  • Boosts AIG, XRX, IEP
  • Cuts HTZ, NUAN, PYPAL
  • No longer shows ENZN, SSEIQ

ICONIQ CAPITAL

  • New stakes in TPX, LNKD, TSLA, PXD, IWO,
  • Boosts VEA, ACWV, VTI, ACWI, XLE
  • Cuts BABA, VWO, FB, IJR, IVV
  • No longer shows UNH, IWM

JANA PARTNERS

  • New stakes in LBRDK, CCE, EXPE, HRS, PF, TIME
  • Boosts CSRA, HDS
  • Cuts WBA, MSFT, GOOG, CAG, CSC
  • No longer shows PFE, SRCL, LVNTA, AGN, TDG

KERRISDALE ADVISERS

  • New stakes in SERV, ANSS, JCI, SSNC, SLV
  • Boosts LXFT, STC, MENT, GPC, PYPL
  • Cuts PRXL, SPGI, CTSH, MCK, EBAY
  • No longer shows SPY, INFO, YELP, Q, SAM

LAKEWOOD CAPITAL

  • New stakes in CHTR, CI
  • Boosts COF, C, MA, ORCL, CDK
  • Cuts IM, GS, FDX, CFG, TSE
  • No longer shows TWC, AGN, QRVO

LANSDOWNE PARTNERS

  • New stakes in ABX, LUK, NEM, COP, EIX
  • Boosts DIS, FB, JPM, UTX, NKE
  • Cuts WFC, V, GOOGL, LNKD, CMCSA
  • No longer shows AAPL, RACE, CME, CLVS, OXFD

LEONARD GREEN

  • Cuts SHAK
  • No longer shows KSS, JWN

LONE PINE CAPITAL

  • New stakes in SHPG, ATVI, SHW
  • Boosts YUM, MNST, PCLN, BUD, DLTR
  • Cuts MSFT, GOOGL, FLT, NOC, FB
  • No longer shows JD, AGN, BXLT, ILMN, HZNP

LONG POND CAPITAL

  • New stakes in MAR, EQR, ESS, LEN, MSG
  • Boosts PGRE, PFSI, CBG
  • Cuts TCO, FCE/A, SFR, BPOP, HLT
  • No longer shows CLNY, AMH, CAA, SRG, NMIH

MARCATO CAPITAL

  • New stakes in SIG, CSC, ABTL
  • Boosts EPIQ, CBPX, BLDR, VRTS, LIND
  • Cuts BK, M, URI, BID, TPHS
  • No longer shows RLGY, SFR

MAVERICK CAPITAL

  • New stakes in PM, WCN, CSC, MYL, JACK
  • Boosts PFE, AXP, UHS, LRCX, FB
  • Cuts LBTYK, AGN, NWL, ADBE, KSU
  • No longer shows ST, AVGO, HDS, PCRX

MELVIN CAPITAL

  • New stakes in PCLN, SBUX, WMT, DE
  • Boosts AMZN, DLTR, AAP, CRM, V
  • Cuts LOW, FB, SIG, ADBE
  • No longer shows EXPE, NKE, HD, COST

MILLENNIUM MANAGEMENT

  • New stakes in AMZN, WMB, VZ, WCN, CCE
  • Boosts CHTR, HAL, EXC, AET, XEL
  • Cuts YHOO, DISH, EXPE, T, WR
  • No longer shows TWC, NFX, AEE, CTRP, CERN

MOORE CAPITAL

  • New stakes in EWZ, BAC, C, JPM, CAG
  • Boosts AMZN, FB, APC, CMA,JCI
  • Cuts CTRP, HD, XLP,BABA, XLU
  • No longer shows GOOGL, XHB, FXI,BG, HYG

OMEGA ADVISORS

  • New stakes in ARRS, SHPG, C, NFLX, EPD
  • Boosts PVH, FNF, SLW, EA, ETFC
  • Cuts RLGY, CIM, ASH, AIG, AER
  • No longer shows SIRI, GILD, XLP, GLPI, AAPL

PASSPORT CAPITAL

  • New stakes in AGN, LBTYK, CSCO, HAL, SLW
  • Boosts CHTR, YHOO, SRE, FLEX, TAP
  • Cuts CF, TSM, MSFT, PFE, RTN
  • No longer shows CMCSA, JNJ, BMY, MRK, QVCA

PAULSON & CO

  • New stakes in EMC, VMW, TTWO, SNY, JNJ
  • Boosts SGYP, VRX, FB, ALXN, DXCM
  • Cuts AGN, TMUS, PRGO, TEVA, SHPG
  • No longer shows TWC, LRCX, POST, CIT, CVC

PERRY CORP.

  • New stakes in STJ
  • Boosts AER
  • Cuts ALLY, AIG, BLL, TWX
  • No longer shows HCA, SE, UAM

PERSHING SQUARE

  • Cuts ZTS, CP

POINT72 ASSET MANAGEMENT

  • New stakes in AVGO, INTC, CMG, CPN, SWN
  • Boosts AMZN, TSO, KAR, XEC, ROP
  • Cuts FB, NFLX, LOW, TWX, MNST
  • No longer shows GOOGL, CTL, VRTX, ADI, TSRO

POINTSTATE CAPITAL

  • New stakes in AVGO, MON, UNP, EGN, ENDP
  • Boosts AMZN, TEVA, STZ, GDX, SWN
  • Cuts AGN, MCD, CHTR, CLVS, CMCSA
  • No longer shows LYB, LNG, ABBV, MDVN, NOC

SACHEM HEAD

  • New stakes in EVHC, GOOGL, MIK
  • Boosts CHTR, FLT
  • Cuts AGN, TMH, AKRX
  • No longer shows PTC

SANDELL ASSET

  • New stakes in CVT, LNKD, VA, IM, MDVN
  • Boosts HOT, YHOO, FCS, CIT, ALLY
  • Cuts BOBE, MEG
  • No longer shows TVPT

SOROS FUND MANAGEMENT

  • New stakes in LBRDK, ROVI, GLD, CSAL, SUPV
  • Boosts DISH, EXAR, MODN, SYNA, CBPO
  • Cuts ABX, VIAV, EBAY, ZTS, AGRO
  • No longer shows EQIX, TWC, FB, BXLT, RACE

STARBOARD VALUE

  • New stakes in BLOX, DK, PNK, MKTO
  • Boosts AAP, WRK, IWN
  • Cuts DRI, M, NSP, FCPT, CW
  • No longer shows ACM

TEMASEK

  • New stakes in BEAV, IBN, NTLA
  • Boosts BABA, UNVR
  • Cuts Q
  • No longer shows FIS, MON

TIGER GLOBAL

  • Boosts CHTR, AMZN, PCLN, QSR
  • Cuts AAPL, SQ, FLT, PSTG, XRS
  • No longer shows NFLX, DATA, XON, GME, Z

THIRD POINT

  • New stakes in FB, CHTR, MON, SHW, SHPG
  • Boosts TDG, STZ, BUD, DHR, NOMD
  • Cuts DOW, GOOGL, YUM, TAP
  • No longer shows ROP, AVGO, SIG

TRIAN FUND

  • Boosts MDLZ, SYY, BK, PNR, GE
  • Cuts DD
  • No longer shows LM

TUDOR INVESTMENT

  • New stakes in V, FICO, STJ, DWA, PXD
  • Boosts HOLX, ESRX, POST, LNKD, PVTB
  • Cuts BCR, MRK, TRU, MDVN, TSS
  • No longer shows SPY, TWC, FIS, WMT, EEM

VALUEACT

  • New stakes in MS, TRN, AFI, STX
  • Boosts BHI, ADS, WLTW, CBG, MSFT
  • Cuts MSCI
  • No longer shows MSI, AGU, ADBE

VIKING GLOBAL

  • New stakes in ICE, MSFT, RICE, AIG, HIG
  • Boosts BIIB, TMUS, MA, APC, NWL
  • Cuts AGN, TEVA, AET, GOOGL, NFLX
  • No longer shows ANTM, TDG, PRU, ENDP, CB

“Clinton Foundation Is Charity Fraud Of Epic Proportions”, Analyst Charges In Stunning Takedown

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In early May, we introduced readers to Charles Ortel, a Wall Street analyst who uncovered financial discrepancies at General Electric before its stock crashed in 2008, and whom the Sunday Times of London described as “one of the finest analysts of financial statements on the planet” in a 2009 story detailing the troubles at AIG. Having moved on beyond simple corporate fraud, Ortel spent the past year and a half digging into something more relevant to the current US situation:”charities”, and specifically the Clinton Foundation’s public records, federal and state-level tax filings, and donor disclosures

Four months ago, Ortel began releasing his preliminary findings in the first of a series of up to 40 planned reports on his website. His allegation was simple: “this is a charity fraud.”

To learn more about the Clinton Foundation, Ortel decided to “take it apart and see how it worked” and he has been doing that ever since February 2015. 

“I decided, as I did with GE, let’s pick one that’s complicated,” said Ortel. “The Clinton Foundation is complicated, but it’s really very small compared to GE.”

When Ortel tried to match up the Clinton Foundation’s tax filings with the disclosure reports from its major donors, he said he started to find problems. That includes records from the foundation’s many offshoots—including the Clinton Health Access Initiative and the Clinton Global Initiative—as well as its foreign subsidiaries.

“I decided it would be fun to cross-check what their donors thought they did when they donated to the Clinton Foundation, and that’s when I got really irritated,” he said. “There are massive discrepancies between what some of the major donors say they gave to the Clinton Foundation to do, and what the Clinton Foundation said what they got from the donors and what they did with it.”

As previously reported, last year the Clinton Foundation was forced to issue corrected tax filings for several years to correct donation errors. But Ortel said many of the discrepancies remain. “I’m against charity fraud. I think people in both parties are against charity fraud, and this is a charity fraud,” he said.

To be sure, Ortel’s efforts were to be commended: digging through the foundation’s numbers can not have been easy, considering that the nation’s most influential charity watchdog put the Clinton Foundation on its “watch list” of problematic nonprofits in 2015. Furthermore, the Clinton family’s mega-charity took in more than $140 million in grants and pledges in 2013 but spent just $9 million on direct aid. That’s because the organization spent the vast bulk of its windfall on “administration, travel, salaries and bonuses”, with the fattest payouts going to family friends.

“It seems like the Clinton Foundation operates as a slush fund for the Clintons,” said Bill Allison, a senior fellow at the Sunlight Foundation, a government watchdog group where progressive Democrat and Fordham Law professor Zephyr Teachout was once an organizing director.

* * *

Overnight, on his website, Ortel released the long-awaited executive summary of his numerous, and at time confusing, findings: “Beginning today, and regularly thereafter, numerous detailed Exhibits will examine the known public record of the Clinton Charity Network within the context of applicable state, federal, and foreign laws.”

And while we await the upcoming exhibits to his summary, here are the main highlights from the executive summary, which we urge all visitors – who have an even passing interest in the effort that has consumed the Clintons’ time and energy for the two decades, and brought them substantial wealth – to read.

* * *

EXECUTIVE SUMMARY

 

Understanding the Clinton Foundation Public Record in Proper Context: 1997 to Present

 

To informed analysts, the Clinton Foundation appears to be a rogue charity that has neither been organized nor operated lawfully from inception in October 1997 to date–as you will grow to realize, it is a case study in international charity fraud, of mammoth proportions.

 

In particular, the Clinton Foundation has never been validly authorized to pursue tax-exempt purposes other than as a presidential archive and research facility based in Little Rock, Arkansas. Moreover, its operations have never been controlled by independent trustees and its financial results have never been properly audited by independent accountants.

 

In contrast to this stark reality, Bill Clinton recently continued a long pattern of dissembling, likening himself to Robin Hood and dismissing critics of his “philanthropic” post-presidency, despite mounting concerns over perceived conflicts of interest and irregularities.

 

Normally, evaluating the efficacy of a charity objectively is performed looking closely into hard facts only -specifically, determining whether monies spent upon “program service expenditures” actually have furthered the limited, authorized “tax-exempt purposes” of entities such as the Bill, Hillary, and Chelsea Clinton Foundation, its subsidiaries, its joint ventures, and its affiliates (together, the “Clinton Charity Network”).

 

But, popular former presidents of the United States retain “bully pulpits” from which they certainly can spin sweet-sounding themes to a general audience and media that is not sufficiently acquainted with the strict laws and regulations that do, in fact , tether trustees of a tax-exempt organization to following only a mission that has been validly pre-approved by the Internal Revenue Service, on the basis of a complete and truthful application.

 

This Executive Summary carries forward a process of demonstrating that the Clinton Foundation illegally veered from its IRS-authorized mission within days of Bill Clinton’s departure from the White House in January 2001, using publicly available information which, in certain cases, has been purposefully omitted or obscured in disclosures offered through the Clinton Foundation website, its principal public portal.

 

Getting to Reality

 

The question of whether a federally authorized nonprofit corporation has been validly organized and operated is a question of fact, best answered through close review of the record.

 

Without having access to helpful corroborative materials (including board minutes, donor solicitation presentations, after-action reports to donors, management representation letters to accountants, internal memoranda, and communications with key counterparties), this Executive Summary previews 40 detailed Exhibits that dissect portions of the public record concerning activities of the Clinton Charity Network.

 

Determined review of these 40 Exhibits that deal primarily with the period 23 October 1997 (when the Clinton Foundation was organized) through 2011 (when attempts to re-organize the Clinton Foundation were most active) demonstrates beyond reasonable doubt that the Clinton Charity Network was neither organized nor operated lawfully.

 

As the following IRS publication states clearly, a nonprofit corporation must pass both an “organizational test” and an “operational test” to be legitimately exempt from federal income taxes.

 

“The Dual Test: Organized and Operated

 

1. IRC 501(c)(3) requires an organization to be both “organized” and “operated” exclusively for one or more IRC 501(c)(3) purposes. If the organization fails either the organizational test or the operational test, it is not exempt. Reg. 1.501(c)(3)–1(a)(1).

 

2. The organizational test concerns the organization’s articles of organization or comparable governing document. The operational test concerns the organization’s activities. A deficiency in an organization’s governing document cannot be cured by the organization’s actual operations. Likewise, an organization whose activities are not within the statute will not qualify for exemption by virtue of a well written charter. Reg. 1.501(c)(3)–1(b)(1)(iv).”

 

The Clinton Foundation and each part of the Clinton Charity Network fails either the organizational test, the operational test, or both of these tests. The consequences for failing to meet either the organizational test or the operational test are severe. In normal circumstances, a charity would have its tax-exempt status revoked retroactively.

 

The “charity” would then have to refile its tax returns and pay corporate income taxes upon any profits earned from the date its authorization is revoked, forward to the present.

 

Donors who took tax deductions in the relevant time periods would owe personal income taxes on contributions they had made.

 

And, a raft of criminal as well as civil sanctions would likely ensue, whose financial consequences might, or might not be mitigated by insurance.

 

What the Public Record Reveals about Clinton Foundation Entities

 

To understand the full extent of illegal activities involving Clinton Foundation entities and personnel, you must resist unvetted words and numbers published in press releases, marketing brochures, and filings to state, federal, and foreign governments, the latter having been submitted under penalties of perjury.

 

Instead, you must concentrate upon “stubborn facts”–information whose veracity you can confirm, for yourself.

 

Though allies of the Clinton family, and some extended family members believe otherwise, in truth: “…whatever may be our wishes, our inclinations, or the dictates of our passions, you cannot alter the state of facts and evidence.”

 

What does available evidence reveal about the scale and scope of frauds committed and ongoing by the Clinton Foundation Charity Network?

* * *

At this point, Ortel previews the 40 detailed Exhibits which will be published starting September 7 on www.charlesortel.com. As a preview of the extensive analysis contained in these Exhibits, “these Exhibits document an escalating pattern of lawlessness and suggest that trustees of entities in the Clinton Charity Network exhibited gross negligence and reckless disregard in performance of their solemn duties.”

The exhibits can be read in their entirety in the pdf attached at the bottom of this post.

Instead, we fast forward to Ortel’s conclusion:

The scope and scale of illegal activities carried out by trustees, executives, significant donors, and professional advisors in the names of Clinton Foundation entities are only evident when you consider abundant information in the public domain and then read the body of laws that serves as a framework for regulating charities and their solicitation efforts.

 

All told, declared donations to Clinton Foundation entities from 1997 through 2014 are greater than $2 billion; but this vast amount is likely a pittance when compared to sums sent to affiliated “charities” and relief efforts around the world. Though required by strict laws, no part of the Clinton Charity Network (including affiliates and joint ventures) has ever procured a comprehensive, independent, and compliant audit of its financial results.

 

No part of the Clinton Charity Network is controlled by experienced and independent trustees who can defend against conflicts of interest–in consequence Clinton charities regularly are used illegally to create substantial “private gain”, and to advance the political interests of the Clinton wing of the Democratic Party.

 

Unless and until an independent conservator is appointed by the Arkansas State Attorney General, the public will not know the true dimensions of a fraud that started in Bill Clinton’s home state and in Washington, D.C., then metastasized, and spread around the world.

 

His stunning summary: “An educated guess, based upon ongoing analysis of the public record begun in February 2015, is that the Clinton Foundation entities are part of a network that has defrauded donors and created illegal private gains of approximately $100 billion in combined magnitude, and possibly more, since 23 October 1997.”

* * *

Ortel leaves us with some critical questions:

  • Why was the Clinton Charity Network allowed to expand the scope of its illegal activities between 20 January 2001 and 20 January 2009, when George W. Bush served as president?
  • Why has the administration of Barack Obama allowed the Clinton Charity Fraud Network to grow even more, in bold violation of state, federal, and foreign laws from 20 January 2009 to present?
  • Why did Valerie Jarrett and the Obama Administration bother with the pretense of signing a legal document, late in 2008, purporting to regulate potential conflicts of interest between Hillary Clinton in her role as Secretary of State , and the Clinton Foundation, when this document was false, misleading, incomplete, and manifestly unenforceable?
  • Why is the IRS still resisting full-scale audits of the Clinton Charity Network?

The answer is surprising and simple–once again, Americans and regulators around the world appear to have fallen victim to the “Big Lie” strategy.

* * *

Ortel’s appeal to readers is simple:

Charity fraud on international scale, led by persons who must know better, should not stand unprosecuted. Will it?

 

You can make the crucial difference. Raise your voice.

 

Contact government officials now who have not yet done enough to regulate the rogue Clinton Charity Network.

* * *

Ortel’s full executive summary is below (pdf link), and those who wish to follow the release of the detailed exhibits can do so at Ortel’s website

This Is How Much Liquidity Deutsche Bank Has At This Moment, And What Happens Next

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It is not solvency, or the lack of capital – a vague, synthetic, and usually quite arbitrary concept, determined by regulators – that kills a bank; it is – as Dick Fuld will tell anyone who bothers to listen – the loss of (access to) liquidity: cold, hard, fungible (something Jon Corzine knew all too well when he commingled and was caught) cash, that pushes a bank into its grave, usually quite rapidly: recall that it took Lehman just a few days for its stock to plunge from the high double digits to zero.

It is also liquidity, or rather concerns about it, that sent Deutsche Bank stock crashing to new all time lows earlier today: after all, the investing world already knew for nearly two weeks that its capitalization is insufficient. As we reported earlier this week, it was a report by Citigroup, among many other, that found how badly undercapitalized the German lender is, noting that DB’s “leverage ratio, at 3.4%, looks even worse relative to the 4.5% company target by 2018” and calculated that while he only models €2.9bn in litigation charges over 2H16-2017 – far less than the $14 billion settlement figure proposed by the DOJ – and includes a successful disposal of a 70% stake in Postbank at end-2017 for 0.4x book he still only reaches a CET 1 ratio of 11.6% by end-2018, meaning the bank would have a Tier 1 capital €3bn shortfall to the company target of 12.5%, and a leverage ratio of 3.9%, resulting in an €8bn shortfall to the target of 4.5%.

When Citi’s note exposing DB’s undercapitalization came out, it had precisely zero impact on the price of DB stock. Why? Because as we said above, capitalization – and solvency – tends to be a largely worthless, pro-forma concept. However, when Bloomberg reported today that select funds have withdrawn “some excess cash and positions held at the lender” the stock immediately plunged: the reason is that this had everything to do with not only DB’s suddenly crashing liquidity, but the pernicious feedback loop, where once a source of liquidity leaves, the departure tends to spook other such sources, leading to an outward bound liquidity cascade. Again: just ask Lehman (and AIG) for the details.

Which then brings us to the $64 trillion (roughly the same amount as DB’s gross notional derivative exposure) question: since DB is suddenly experiencing a sharp “liquidity event”, how much liquidity does Deutsche Bank have access to as of this moment, to offset this event? The answer would allow us to calculate how long DB may have in a worst case scenario if we knew the rate of liquidity outflow.

For the answer, we go to a just released note by Goldman Sachs, which admits that it is now facing “crisis” questions from clients, among which “can a large European bank face a liquidity event” to wit”

Deutsche Bank stands at the center of the European financial system – it is a major counterpart of all relevant European banks, and broader. Recent reports of potential litigation hits have compounded capital concerns, and raised the overall level of market anxiety. “Crisis” questions are being asked: “is there risk of a financial crisis re-run” and “can a large European bank face a liquidity event”?

So what is the answer: how much liquidity does Deutsche Bank have access to? The answer is two fold, with the first part focusing on central bank, in this case ECB, backstops in both $ and €. 

Goldman starts with an overview of said back-stops, summarized below. These facilities are available to all Eurozone banks (and, naturally, also to Deutsche Bank) – they are generous in terms of volume (full allotment), price (fixed rate at 0%) and tenure (from short term, all the way to 4-years). These ECB facilities are key to ensuring the bank’s long-term funding stability, in Goldman’s view, and were put in place following the funding market fallout in 2007, in order to contain the effects from the Lehman crisis. They were further bolstered to contain the Eurozone sovereign crisis in 2011-12. All of the liquidity provisions remain in place, and broadly, they fall into the following two categories:

  1. Regular market operations: 1-week Main Refinancing Operations or “MRO” (priced @0%), and 3-month Long Term Refinancing Operations or “LTRO” (@0%);
  2. Non-standard measures, which split between € funding facilities with 4-year Targeted LTROs (@0%, with the option to fall to -0.4% if lending targets are met) and the emergency liquidity assistance to solvent financial institutions and a US$ funding facility: 1-week US$ MRO (@0.86%).

Stepping away from the ECB – because if Deutsche is forced to come crawling to Draghi and beg for central bank liquidity assistance to continue as a going concern, the outcome may be just as dire (recall the stigma associated with US banks using the Fed’s Discount Window) especially since  unlike Lehman, DB has nearly €600 billion in deposits which are susceptible to a retail depositor run – what about Deutsche Bank’s own liquidity position? It is this which appears to be concerning the market most, because as Goldman writes, following the Bloomberg report that hedge fund clients have pulled excess cash, the market has reacted aggressively (ADR down 6.7%), indicating concerns have moved from DBK’s equity to question the resilience of the banks’ funding position.

Below, Goldman provides an overview of DBK’s liquidity position, noting that its last reported liquidity reserve stood at €223 bn or ~20% of its total assets. DBK’s high quality liquid assets (or HQLA) balance stood at €196 bn or 16% of its total assets; its liquidity coverage ratio (“LCR”) stood at 124%. DBK’s LCR is above that of many largest European banks (BNP 112%), as well as US banks (Citigroup
121%).

Here is the breakdown:

  • Liquidity reserve: €223 bn, or ~20% of total assets. In total, DBK’s liquidity reserve stood at €223 bn, representing ~20% of the banks total net assets (where assets are US GAAP equivalent). The 2Q16 level of liquidity reserve compares to €65 bn in 2007, showing that DBK has grown its liquidity reserve by 3.4x from pre-crisis levels.
  • Cash: €125 bn. The liquidity reserve breaks down between €125 bn of cash and cash equivalents, and €98 bn of securities, available for use at the central banks. As highlighted in Exhibit 2, the € portion of the securities can be used to obtain liquidity of varied duration (between O/N to 4-years) at a cost of 0% (and as low as -40 bp, if lending benchmarks are met).
  • LCR: 124%. DBK’s Liquidity Coverage ratio stood at 124%, which is ~1.5x the current regulatory minimum, and a cut above the 2019 fully-loaded requirement of 100%. This compares favorably to, say, Citigroup (121%), BNP (112%). Other US banks (e.g. JPM, BofA) do not disclose their LCR other than to say that they are “compliant”, suggesting LCR is at or above 100%.

Where does this liquidity come from? Exhibit 3 above examines DBK’s funding composition – this is relevant in the context of media reports highlighting a decline in prime brokerage balances (Bloomberg, September 29). These include:

  • Lowest volatility funding: 57%. Lowest volatility sources of funding – retail deposits, transaction banking balances (corporate and institutional deposits from corporate banking relationships) and equity account for 57% of total funding. Over half of the groups’ funding therefore, stems from this source.
  • Low volatility funds: 15%. Debt securities in issue account for 14% of total funding. Together with the previous category, “lowest” and “low” volatility funding accounts for 72% of total funding.
  • Other customers – this includes prime brokerage cash balance – 7%. The total amount of “other customer” funds, which includes: fiduciary, self-funding structures (e.g. X-markets), margin/Prime Brokerage cash balances (shown on a net basis (see DBK 2015 annual report, p178). Importantly, this represents ~7% of total funding, and is 3.1x covered with the liquidity reserve.
  • Other parts of funding – unsecured wholesale, secured funding – account for the residual.

In other words, all else equal, even in a worst case Prime Brokerage situation, one where all €71 billion in “other customer” funds flee, DB should still have about €152 billion of the €223 billion in liquidity reserve as of June 30, once again assuming there have been no other changes. Stated simply, if the hedge fund outflow accelerates and depletes all the liquidity at the Prime Brokerage division, DB would part with about a third (just over  €70 billion) of its €220 billion liquidity reserve.

Some other observations: even if one assumes the full loss of PB balances, DB would still have a Liquidity coverage ratio (“LCR”) of 124%.  The LCR is equivalent to HQLA/net stressed outflows over 30 day period. This ratio shows the banks’ ability to meet stressed funding conditions over a period of 1 month. For Deutsche bank, the LCR stood at 124% with the ratio composed of:

  1. High Quality Liquid Assets (HQLAs) of €196 bn. These include Level 1 assets (the most liquid securities which include cash and equivalents, bonds issued or guaranteed by a government and certain covered bonds); Level 2A assets, which are subject to a haircut (third country government bonds, bonds issued by public entities, EU covered bonds, non-EU covered bonds, corporate bonds) and Level 2B assets (high quality securitisations, corporate bonds, other high quality covered bonds).
  2. The net stressed outflows: €158 bn as of 2Q16 (YE15 €161 bn). DBK’s net stressed outflows amounted to €161 bn at year-end 2015, and include an assumption of loss of prime brokerage deposits. As per Commission Delegated Regulation (EU) 2015/61 “Deposits arising out of a correspondent banking relationship or from the provision of prime brokerage services shall not be treated as an operational deposit and shall receive a 100 % outflow rate.”
  3. The minimum level is 100% (effective 2018) and is phased in gradually from 2015; the 2016 requirement is 70%.

Of course, the “stressed outflow over a 30 day period” is an assumption, one which can accelerate rapidly, especially if the stock price of DB continues to fall crushing what is any bank’s most critical asset: counterparty confidence, either from retail investors or institutional peers.

Still, what the above calculations reveals is that the Bloomberg report suggest that while substantial, the Prime Brokerage outflow would not be, on its own, deadly.  But therein lies the rub: since any bank’s collapse is a procyclical event in which liquidity flees in all directions, with a speed that is usually inversely proportional to the stock price, the lower the price of DB goes (and the higher its CDS), the more dire its liquidity situation.

However, as noted above, the biggest threat to DB is not so much its hedge fund client base, whose damage potential is limited, but the depositor base. Again: while Lehman failed, it did so as a result of its corporate counterparties suffocating the bank by rapidly pulling out their liquidity lines. Lehman, however, was lucky in that it didn’t have retail depositors: it death would have likely come far faster as the capital panic was not limited to institutions but also included a retail depositor bank run.

This is where Deutsche Bank is very different from Lehman, and far riskier, because if the institutional panic spreads to the depositor base, which as the table below shows amounts to some €566 billion in total, and €307 billion in retail deposits…

 

… then all bets are off.

Which is why it is so critical for Angela Merkel to halt the plunging stock price, an indicator DB’s retail clients, simplistically (and not erroneously) now equate with the bank’s viability, and the lower the price drops, the faster they will pull their deposits, the quicker DB’s liquidity hits zero, the faster the self-fulfilling prophecy of Deutsche Bank’s death is confirmed.

Which ultimately means that DB really has four options: raise capital (sell equity, convert CoCos, which may results in an even bigger drop in the stock price due to dilution or concerns the liquidity raise may not be sufficient), approach the ECB for a liquidity bridge (this may also backfire as counterparties scramble to flee a central bank-backstopped institution), appeal for a state bailout (Merkel has so far said “Nein”) or implement a bail-in, eliminating billions in unsecured claims (and deposits) and leading to a full-blown systemic bank run as depositors everywhere rush to withdraw their savings, leading to a collapse of the fractional reserve banking mode (in which there is only 10 cents in physical deliverable cash for every dollar in depositor claims). 

Which of the four choices Deutsche Bank will pick should become clear in the coming days. Until it does, it will keep the market on edge and quite volatile, because as Jeff Gundlach explained today, a “do nothing” scenario is no longer an option for CEO John Cryan as the market will keep pushing the price of DB lower until it either fails, or is bailed out.

Never Before Seen Secret Memo On AIG Bailout From Fed’s Tarullo To Obama Revealed In Podesta Emails

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The fall of 2008 was a hectic time, when in the aftermath of the Lehman failure, the entire financial system was on the verge of collapse and only the biggest Fed/taxpayer-backed bailout in history avoided an all out depression. Today, as a result of the latest, 12th Podesta leak, we find that then president-elect Barack Obama was also being intimately briefed with unfolding events.

In a previously never before seen confidential memo, sent on November 9, 2008 from current Fed governor Dan Tarullo addressed to Barack Obama, Tarullo send John Podesta an email in which Tarullo, who at the time was not employed by the Fed and was Professor of Law at Georgetown University Law Center, reveals what Hank Paulson and Ben Bernanke in which Tarullo was told on a “confidential basis that, before the markets open tomorrow morning, they will be announcing a significant restructuring of the AIG bailout package.  They are taking this step in order to avoid what they asserted would be a systemic crisis.

The step in question involved the TARP investment of $40 billion in preferred shares in AIG to avoid a collapse of the failed insurer as a result of an imminent ratings downgrade. “This sum will be used to allow AIG to begin repaying the money it has borrowed from the Fed facility.  They will thereby reduce the amount of debt on AIG’s balance sheet and thus avoid the ratings downgrade.   Until AIG can begin selling assets, however, it will continue to draw on the Fed liquidity facility, just not in the amounts originally provided.”

Tarullo tells Obama that “there will likely be some criticism from economic and market observers, because this restructuring has relaxed the terms of financing for AIG without additional taxpayer benefits (in the form of additional warrants, for example).” He adds that “Paulson and Bernanke emphasized that they were not happy about having to do this, and both said that the current approach is the one they would originally have taken in September had the TARP been in place.

While the subsequent details of the revised bailout are familiar, what is not known is the implicit “request” made by Tarullo: that when Obama officially becomes president on January 20, he does not undo the “modification” to the AIG bailout as otherwise the markets would be “unnerved”…

As to our reaction – we surely do not want to unnerve markets by saying anything that would suggest your Treasury Department would undo this modification after January 20.  However, the combination of the questionable terms of the original Fed lending and failure to increase the effective stake of taxpayers as part of this deal means that we should avoid saying anything that would identify us with this move.  Our position is perhaps best framed as regret that it was necessary to make these changes in the September arrangement.

… with the most concerning part of the exchange: “we should avoid saying anything that would identify us with this move.”

More optical collusion, all for the sake of preserving market stability? Potential improper, collusive behavior aside, what we would like to know is how Dan Tarullo, who was not a coworker of either Hank Paulson or Ben Bernanke was privy to this information which was shared to him on a “confidential basis” by the then-Treasury Secretary Paulson and then Fed Chair Ben Bernanke, and while we are asking, we wonder what other collusion has taken place between Tarullo and the executive branch off the record?

Finally, in what capacity is Tarullo sharing confidential Treasury and Fed information with the president elect, who in November 2008 was still a private citizen?

As a reminder, Tarullo took office at the Fed on January 28, 2009, one week after Barack Obama was inaugurated.

Here is the full confidential memo released by Tarullo:

CONFIDENTIAL
November 9, 2008

 

MEMORANDUM FOR THE PRESIDENT-ELECT
FROM:    Dan Tarullo
SUBJECT:    Restructuring of AIG Deal

 

I received a call earlier this evening from Secretary Paulson and Chairman Bernanke informing me on a confidential basis that, before the markets open tomorrow morning, they will be announcing a significant restructuring of the AIG bailout package.  They are taking this step in order to avoid what they asserted would be a systemic crisis.

 

They apparently were anticipating a downgrading of AIG’s debt to below investment grade status.  Had this occurred, they believe (reasonably, in my view) that a run on AIG would almost certainly have ensued.  The essentials of the restructuring are that the Treasury will be using the TARP to make a $40 billion investment of preferred stock into AIG.  This sum will be used to allow AIG to begin repaying the money it has borrowed from the Fed facility.  They will thereby reduce the amount of debt on AIG’s balance sheet and thus avoid the ratings downgrade.   Until AIG can begin selling assets, however, it will continue to draw on the Fed liquidity facility, just not in the amounts originally provided.

 

Paulson and Bernanke emphasized that they were not happy about having to do this, and both said that the current approach is the one they would originally have taken in September had the TARP been in place.  There is something to this point, although I observe that some believed (rightly, it turns out) that the terms of the original Fed facility were too onerous.. 

 

There will likely be some criticism from economic and market observers, because this restructuring has relaxed the terms of financing for AIG without additional taxpayer benefits (in the form of additional warrants, for example).  Moreover, although Secretary Paulson emphasized that the terms of the injection of preferred stock were less favorable than those of the initial rounds of investments last month in Citi, Goldman, etc., my understanding is that Treasury will be initially waiving payments of dividends.

 

As to our reaction – we surely do not want to unnerve markets by saying anything that would suggest your Treasury Department would undo this modification after January 20.  However, the combination of the questionable terms of the original Fed lending and failure to increase the effective stake of taxpayers as part of this deal means that we should avoid saying anything that would identify us with this move.  Our position is perhaps best framed as regret that it was necessary to make these changes in the September arrangement.

 

If you would like to discuss this further, my numbers are home (XXX-XXX-XXXX) or cell (XXX-XXX-XXXX)

Wikileaks Releases Part 13 Of Podesta Data Dump; Total Emails Released Is Now 23,423

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The third and final debate may have come and gone, but the daily Wiki Podesta dump continues. 

In the now traditional daily routine moments ago Wikileaks released yet another 3,000 emails in Part 13 of its ongoing Podesta Email dump, which brings the total number of released emails to 23,423

Previous dumps of Podesta emails have included examples of collusion between the campaign and the media, disparaging comments about Bernie Sanders and copies of speeches given to Wall Street bankers, including Goldman Sachs.

Among yesterday’s most dramatic revelations were more confirmations of collusion and coordination with the media, a never before seen 2008 memo between Fed governor Tarullo and president-elect Obama discussing the AIG bailout, a shocking revelation into Bill Clinton’s conflicts of interest at Teneo, and the missing link of Hillary’s email deletions, confirming she had instructed the deletion of emails from the start, refuting her previous testimony.

Among the emails released in today’s batch is is yet another confirmation from Teneo’s Doug Band going on a bender accusing the foundation of even more conflicts of interest:

Also I signed a conflict of interest policy as a board member of cgi On it, I wrote that my wife designs bags for cgi, and loses money doing so plus donating her time And that teneo represents 4 cgi sponsors, 3 of which teneo brought to cgi .

 

Oddly, wjc does not have to sign such a document even though he is personally paid by 3 cgi sponsors, gets many expensive gifts from them, some that are at home etc I could add 500 different examples of things like this and while I removed lasry bc they are all on the offense, I get the sense that they are trying to put some sort of wrong doing on me after the audit as a crutch to change things and if I don’t mention things like lasry where they all have issues, I may regret it.

* * *

Here is John Podesta’s wife Mary discussing Hillary’s comments on “wiping the server

I just watched the video of Hillary in Vegas last week talking about wiping the server with a cloth. It’s was scarier than I expected, particularly because her hostility reminds me of how ridiculous Mom can be about technology which drives the 3 of us crazy (and i imagine other younger people have parents like that!)

* * *

In another email John Podesta says that an excuse for having the email server at home “would fall apart under scrutiny“:

“IRS was hacked. I think the State Department was hacked. Sony hacked. Banks hacked. As we try and close the Benghazi Chapter and the email drip drip. Is there ever a moment in TiMe not to Defend the decision but layout the fact….HRC servers were not hacked. Know this is s naive thought but just thinking.”

To which Podesta responds: Reluctant to go there. Makes it seem like she consciously went to the home server for security reasons which would fall apart under scrutiny.

* * *

An akward moment arises for Podesta following an email which seems to catch the Clinton campaign manager in a “speed dating” adventure:

 Hi John, Hmmm so since this is my first Speed Dating experience I have no idea what one is supposed to say in a ‘Hi There’ / follow up email / thingy. I’m not even sure what the etiquette is, is there a polite waiting period? At any rate, I was glad to have received your details in the email as you seemed lovely! I would like to catch up again, if you’d like to. That’s pretty much it. Hope you are enjoying your Saturday! Happy last week of term! Cheers Kim

* * *

An email from Huma Abedin to Robby Mook and Podesta from January 2015 discussed Morocco donating to the Clinton Foundation’s Clinton Global Initiative (CGI) to get access to Clinton.

“Just to give you some context, the condition upon which the Moroccans agreed to host the meeting was her participation,” says Abedin. “If hrc was not part of it, meeting was a non-starter.”

Clinton had announced the meeting in 2014. Abedin says the meeting had been Clinton’s idea. “Our office approached the Moroccans and they 100 percent believe they are doing this at her request,” Abedin continues. “The King has personally committed approx $12 million both for the endowment and to support the meeting.”

A politico report from April 2015 reveals Clinton had been scheduled to attend a Clinton Global Initiative Middle East and Africa Meeting in May, but that a Foundation official told Politico it was unlikely she would attend. Clinton’s State Department accused Morocco of “arbitrary arrests and corruption” in 2011. “She created this mess and she knows it,” Abedin adds.

* * *



Global Stocks, Peso, Oil Drop On Trump Fears; Safe Havens Rise Ahead Of Fed Announcement

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Global stocks, S&P futures, the Mexican peso, the Korean Won and crude oil all fell as traders were spooked by polls suggesting a tightening race and Trump momentum ahead of next week’s American presidential election. The yen and Swiss franc gained, as did global bond markets and gold as investors flocked to safe haven assets.

The MSCI All Country World Index sank to its lowest since July Bloomberg observes, as shares slumped in Europe and Asia with futures foreshadowing a seventh day of losses for U.S. equities. The yen rose for a second day, while the Swiss franc and gold were near their highest levels in almost a month. Political upheaval weighed on South Korea’s currency, and New Zealand’s dollar strengthened after jobs data. Treasuries rose ahead of a Federal Reserve policy decision and crude oil fell after a report showed American stockpiles expanded.

The risk off catalyst was yesterday’s ABC/WaPo tracking poll which showed Republican Donald Trump with 46 percent support to Democrat Hillary Clinton’s 45 percent, putting him ahead for the first time since May. A Bank of America Corp. index tracking volatility expectations in equities, bonds, currencies and commodities rose for five days through Monday, the longest run of increases since before the British vote to quit the European Union.

 

The flight to safety has led to a bid for both European bonds

 

… and the traditional safe haven, the Swiss franc.

“Having had their fingers horribly burnt with the Brexit vote in June, financial markets appear to be starting to pare some risk in the lead up to next week’s U.S. Presidential vote, in the event that in circumstances that would probably have been unthinkable a week or so ago, that Donald Trump could win the U.S. Presidency,” Michael Hewson, chief market analyst at CMC Markets, writes in note.

Adding to today’s risk is the conclusion of the November FOMC meeting, which however is expected to reveal nothing new when the Fed presents its latest statement at 2pm. While the Fed is expected to leave interest rates unchanged when a two-day meeting concludes Wednesday, futures indicate a 68% chance of a rate hike by year-end and investors will be on the lookout for any hints the authority may give regarding the policy outlook. Bloomberg’s dollar index fell for a fourth day as some analysts said a Trump victory could spur volatility in financial markets and reduce the odds of a rate increase next month.

“The markets’ anxiety levels have moved up a gear,” adds Chris Weston, Melbourne-based chief market strategist at IG Ltd. This “suggests the bears have the upper hand, with the buying drying up and funds keeping their cash deployed for more certain times,” he said.

At 2pm all eyes will turn to the Fed where the FOMC outcome is due. Clearly this has been completely overshadowed by the election campaign and expectations of a policy move are unsurprisingly very low. The bigger question is how much of a green light signal do we get for December? The market is still pricing in a 70%ish probability for a December hike and so as DB’s Peter Hooper notes, the signal perhaps needn’t be stronger tonight than it has been already.

Looking at stocks, the Stoxx Europe 600 Index slid 0.7 percent as of 8:11 a.m. London time, falling for an eighth day ahead of the release of manufacturing data for the euro area. A.P. Moller-Maersk A/S tumbled by the most since June after the owner of the world’s largest container line reported a 43 percent drop in third-quarter profit.

The MSCI Asia Pacific Index fell by the most since September, with Japanese shares retreating from a six-month high before the nation’s financial markets shut Thursday for a holiday. Sony Corp. sank to a two-month low after the Japanese electronics maker’s quarterly profit missed estimates and Sumitomo Electric Industries Ltd. tumbled 12 percent after the company lowered its full-year earnings target. “The Trump risk is in revival,” said Chihiro Ohta, a Tokyo-based senior strategist at SMBC Nikko Securities Inc. “With Trump, there always follows an uneasiness over whether policies will be managed properly in the U.S., and given the holiday tomorrow in Japan, there’s no need to build positions at an uncertain time like this.”

Futures on the S&P 500 Index fell 0.2 percent ahead of the Fed decision and results from companies including Alibaba Group Holding Ltd. and Facebook Inc. 

Safe-haven demand boosted sovereign bonds, with 10-year yields falling across most of the developed world. The yield on 10Y Treasuries fell two basis points to 1.81 percent, after touching a five-month high of 1.88 percent in the last session. It’s unlikely the rate will climb too far past 2 percent anytime soon given how the American economy is performing, according to Jim Caron at Morgan Stanley Investment Management, which oversees $406 billion.

“Nobody really believes that rates can just rise very very quickly, or that bond prices can fall off a cliff,” Caron, who is based in New York, said Tuesday on Bloomberg Television. “You’re not seeing the growth. You’re not really seeing the inflation.”

* * *

Bulletin Headline Summary from RanSquawk

  • European equities enter the US crossover as US election fears, softness in peripheral banks and lower energy prices hamper sentiment
  • USD losses have been extended, with EUR/USD testing 1.1100 and USD/CHF dipping below .9700
  • Looking ahead, highlights include the German jobs report, ADP employment change, DoE inventories and FOMC rate decision

Market Snapshot

  • S&P 500 futures down 0.2% to 2100
  • Stoxx 600 down 0.6% to 333
  • FTSE 100 down 0.4% to 6891
  • DAX down 0.8% to 10440
  • German 10Yr yield down 4bps to 0.14%
  • Italian 10Yr yield down 4bps to 1.71%
  • Spanish 10Yr yield down 6bps to 1.24%
  • S&P GSCI Index down 1% to 356.8
  • MSCI Asia Pacific down 1.1% to 138
  • Nikkei 225 down 1.8% to 17135
  • Hang Seng down 1.5% to 22811
  • Shanghai Composite down 0.6% to 3103
  • S&P/ASX 200 down 1.2% to 5229
  • US 10-yr yield down 3bps to 1.8%
  • Dollar Index down 0.13% to 97.57
  • WTI Crude futures down 1.5% to $45.98
  • Brent Futures down 1.4% to $47.46
  • Gold spot up 0.6% to $1,296
  • Silver spot up 0.6% to $18.48

Top Global Headlines

  • Top Economists Spar Over Trump as Tighter Race Sinks U.S. Stocks
  • Carney May Have Bigger U.K. Inflation Worries Than the Pound: Brexit supply shock could put a squeeze on the economy
  • CIC Group Said to Mull Bid for $6 Billion Property Owner GLP: Singapore-based industrial property owner fell below IPO price
  • Valeant Said to Be in Talks for Sale of Salix to Takeda
  • Tullow CEO Resuming African Oil Exploration Amid Debt Reduction: Net debt to be reduced by about $1 billion in next few years
  • November Fed Hike Odds Tanked on Economic and Political Events: Political risk and steady-as-she-goes data made markets doubt a hike
  • Delta, United Said to Near Avianca Bids Amid Elliott Talks: Colombian airline mulls options including sale of control
  • JPMorgan Beats Goldman With Bond-Market Maneuvering in Toronto: Barclays, Citi, Deutsche Bank also left out of some trades
  • AEP’s First Loss in a Decade Is the Latest Sign of Coal’s Demise: Follows Duke Energy, Southern in shifting away from coal
  • Lockheed’s F-35 Said to Need $500 Million More for Development: Pentagon officials says funds to be requested in next budget
  • Tesla Sees SolarCity Boost Within 3 Years as Musk Hits Critics: Acquisition target increased cash in third quarter, Tesla says

Looking at regional markets, we start in Asia where stocks saw spill-over selling from its global counterparts amid weakness in oil and political jitters after the latest ABC News/Washington Post poll showed  rump ahead for the first time since May. This pressured the ASX 200 (-1.2%) and Nikkei 225 (-1.8%) from the open with the latter also hampered by JPY strength and disappointing earnings, including an 86% drop in Sony’s net profit. Shanghai Comp. (-0.6%) and Hang Seng (-1.4%) conformed to the downbeat tone as financials suffered while the PBoC also reduced its liquidity operations. 10yr JGBs traded marginally higher as the risk averse sentiment spurred safe-haven buying, while participants also digested an enhanced liquidity auction which posted an increase in b/c from prior.

Top Asian News

  • Park Dumps Premier, Finance Chief to Stem Korea Scandal Fallout: Prosecution to seek arrest of Park’s friend in scandal
  • Tata Empire Split in Two as Mistry Stays Chairman of Units: Tata Motors, Tata Power say Mistry is still chairman
  • China’s Corn Pile Shrinks as Output Drops Most in 16 Years: Even with less from China, world supplies will be biggest ever
  • Standard Chartered’s Tough Years in India Are Over, Kanwal Says: Loan impairments in the country had dragged on profit
  • Hong Kong Election Heats Up as Candidates Await China’s Blessing: Meet the contenders vying to lead the financial hub
  • China Losing Emerging Markets Engine Complicates Exports Outlook: Commodity price rally raises hopes demand will pick up

US election jitters stemming from yesterday’s ABC national poll also weighed on Europe equities this morning. While sentiment has also been gripped by the weakness in financials, largely due to the softness seen in peripheral banks after bailout plans for the troubled Italian lender, Monti Paschi had been withdrawn and in turn this saw the banks shares temporarily halted for trade. Elsewhere oil prices remain pressured after last night’s API crude oil inventory report post a large build of 9.3mln. In credit markets, bunds are sharply higher this morning amid the risk averse sentiment with yields bull steepening across the curve, while volumes are somewhat lighter given that participants are awaiting the FOMC decision at 1800GMT.

Top European News

  • Euro-Area Manufacturing Gathers Speed as Price Pressures Build: A Purchasing Managers’ Index for factories rose to 53.5 from 52.6 in September, exceeding an Oct. 24 estimate of 53.3
  • German Unemployment Falls to Record Low as Economy Ploughs On: Joblessness fell by 13,000 in October vs estimated 1,000 drop
  • At Societe Generale, Returns From Car Leasing Dwarf Banking: Equity-derivatives leader generates best profits from autos

In FX, the most notable move was that of the Mexico’s peso which slid as much as 0.8 percent versus the greenback to its weakest level since Oct. 7. The currency loses ground when support builds for Trump, who has said he would revisit the North American Free Trade Agreement that governs commerce between the U.S. and Mexico. The Republican candidate’s prospects have improved since it was announced Friday that the Federal Bureau of Investigation had reopened a probe of Clinton’s use of private e-mail while Secretary of State. Before the FBI announcement, “the market had pretty much priced out most of the risk of Donald Trump becoming president,” said Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. “Obviously, the markets had to reassess that view now.” In South Korea, the won dropped as much as 1.1 percent to its weakest level since July as South Korean President Park Geun-hye replaced her prime minister and finance chief on Wednesday to help stem the fallout from a political scandal that threatens her grip on power. The yen climbed 0.5 percent against the dollar, after surging 0.6 percent in the last session. The franc also added 0.5 percent following a 1.4 percent jump that marked its biggest gain in about five months. Against the euro, Switzerland’s currency was headed for its strongest close in more than a year.

In commodities, crude oil fell 0.7% to a one-month low in New York after API data showed American inventories increased by 9.3 million barrels last week. Organization of Petroleum Exporting Countries members Libya and Nigeria are boosting output, providing a challenge to the group’s effort to finalize an agreement to curb production and stabilize prices. Gold added 0.5 percent, after surging 0.9 percent on Tuesday. The Bloomberg Industrial Metals Subindex fell for the first time in eight days, as zinc retreated from a five-year high in London and aluminum slid from its highest close since June 2015. “We’re in a bit of a risk-off mode again as markets readjust to the chances of a Trump presidency,” said Michael McCarthy, chief market strategist at CMC Markets in Sydney. “The outlook for the global economy is still fragile and hits to sentiment can have an immediate, negative effect across the markets, and that includes the base metals.”

Looking at today’s calendar, in the US the sole key data release is the October ADP employment change reading where expectations are sitting at 165k. The main event is however reserved for the FOMC meeting outcome due at 2pm ET. As a reminder, there is no post-statement press conference scheduled. There’s not much else to highlight away from the data aside from earnings. 38 S&P 500 companies are on the cards today with the highlights including Facebook MetLife and AIG, all due in the evening.

US Event Calendar

  • 7am: MBA Mortgage Applications, Oct. 28 (prior -4.1%)
  • 8:15am: ADP Employment Change, Oct., est. 165k (prior 154k)
  • 9:45am: ISM New York, Oct. (prior 49.6)
  • 10:30am: DOE Energy Inventories
  • 2pm: FOMC Rate Decision

DB’s Jim Reid concludes the overnight wrap

By this time next week we may know who the next US president is going to be. However if it’s close the results may take a few more hours to decipher. For the sake of all our sanity let’s hope we don’t get a repeat of the 2000 election where the result wasn’t known until a month and four days after America went to the polls. Due to the ‘hanging chads’ the election result was in legal dispute for weeks. I remember travelling the world that month with people from all corners utterly perplexed as to how the battle to be the leader of the free world could turn out in the way it did. 16 years on there are many with similar thoughts but for maybe different reasons.

Yesterday election blues hit the market as an ABC News/Washington Post tracking poll placed Trump 1% ahead of Clinton at 46% to 45% – his first lead in this poll since May. The previous ABC News/Washington poll which came out over the weekend had Clinton ahead by the same amount. The chatter in the market yesterday was that although Clinton was still a clear favourite, the probabilities of her winning seemed to be similar to that of the UK staying in the EU just prior to June’s referendum. So once bitten twice shy for many.

The ABC News/Washington Post survey appears to be the poll which is most widely reported right now. Yesterday’s survey covered 1,128 “likely voters” over October 27-30th which means that the sample is still slightly overlapping those FBI headlines from Friday. It’s also worth noting that the current 1% separating the two candidates is well within the survey’s 3% margin of sampling error. In other words, it’s extremely close. Interestingly the same poll also showed that only 45% of Clinton supporters are now “very enthusiastic” about Clinton, compared to 52% in the last survey. It’s the reverse for Trump supporters where 53% are now “very enthusiastic” compared to 49% previously. So momentum has seemingly swung on this poll.

The chips are certainly coming off the table in markets heading into next week. Yesterday the S&P 500 fell -0.68% meaning it has now closed down for six days in a row for the first time since August 2015. Yesterday’s decline was the largest in what is a -1.84% cumulative losing streak over this period. It wasn’t much better in Europe where the Stoxx 600 plunged -1.07% and is now down seven days in a row for the first time since February this year. Disappointing results from BP and Standard Chartered didn’t help. The VIX also rose nearly 9% yesterday and is now at the highest level since June. Credit was under pressure with the FT also reporting that two of the largest HY ETF’s suffered their sixth successive day of outflows. In FX the Greenback had its worst day in nearly 2 months with the US Dollar index closing -0.76% as investors flocked to the Yen (+0.64%), Swiss Franc (+1.39%) and Gold (+0.86%). The Dollar did however have a much better day relative to a cross section of emerging market currencies. Most notable was the loss for the Mexican Peso (-1.73%) while the South African Rand, Brazilian Real and Colombian Peso were all down at least -1%.

One market where perhaps the election outcome implications are a little less clear for is US Treasuries. Yesterday the 10y yield was up as much as 5bps by the early afternoon, touching an intraday high of 1.877% before then paring all of that move into the close to finish little changed around 1.827%. The manufacturing data was supportive with the PMI revised up a little (to 53.4 from 53.2) and the ISM manufacturing print for October rising 0.4pts to 51.9 (vs. 51.7 expected). That said the details were a bit more mixed and showed new orders reversing (to 52.1 from 55.1) but employment climbing (to 52.9 from 49.7). The latter clearly a positive ahead of payrolls on Friday.

With that in mind it’s also worth keeping an eye on today’s ADP employment change report where the consensus for October is sitting at 165k versus 154k the month prior. Later this evening however all eyes turn to the Fed where the FOMC outcome is due. Clearly this has been completely overshadowed by the election campaign and expectations of a policy move are unsurprisingly very low. The bigger question is how much of a green light signal do we get for December? The market is still pricing in a 70%ish probability for a December hike and so as DB’s Peter Hooper notes, the signal perhaps needn’t be stronger tonight than it has been already. 7pm GMT for that one.

Switching now to the latest in Asia this morning where equity markets have taken their cue from the weak US session yesterday. The Nikkei (-1.66%), Hang Seng (-1.30%), Shanghai Comp (-0.49%), Kospi (-1.34%) and ASX (-1.49%) have all sold off. Credit indices in Asia, Japan and Australia are also 1-2bps wider while US equity index futures have also weakened. Gold (+0.22%) is a touch higher while Oil continues to trade weaker this morning. WTI is -0.92% as we type and a little above $46/bbl following a -0.41% decline yesterday. The exception in the energy complex though is Gasoline which rallied +4.55% yesterday following the news of a large pipeline explosion and fire in Alabama.

Moving on. It’s worth drawing attention to a piece from our Euro economists on how likely a shift from monetary to fiscal policy is in the region. A large coordinated fiscal stimulus across euro-area countries could bring lasting benefits to growth and unemployment. Will it happen? Not according to them. Based on current rules even Germany’s fiscal space is not higher than 1% of German GDP. That said, they show that there would be scope to modify tax systems and spending choices to favour potential growth in France and the peripheral country. Unfortunately, the rise of the populist parties is not conducive for those hoping for an optimisation of fiscal policy.

Before we look at the day ahead, the remaining data in the US yesterday was fairly mixed. On the positive side, total vehicle sales rose to an annualized rate of 17.90m in October from 17.65m in the month prior. Meanwhile the IBD/TIPP economic optimism reading was little changed in November at 51.4. Finally, the disappointing data was the latest construction spending report. Spending was reported as declining -0.4% mom versus expectations of a +0.5% increase. The only data in Europe was reserved for the UK where the October manufacturing PMI declined just over 1pt and a little more than expected to 54.3 (vs. 54.5 expected).

Looking at today’s calendar, this morning we kick off in the UK where the Nationwide house price index for October will be released. Following that we’ll get the final revisions to the manufacturing PMI’s for the Euro area, Germany and France along with a first look at the data for the periphery. Germany’s latest unemployment data will also be out this morning. This afternoon in the US the sole data release is the October ADP employment change reading where expectations are sitting at 165k. The main event is however reserved for this evening with the aforementioned FOMC meeting outcome at 7pm GMT. As a reminder, there is no post-statement press conference scheduled. There’s not much else to highlight away from the data aside from earnings. 38 S&P 500 companies are on the cards today with the highlights including Facebook MetLife and AIG, all due in the evening.

Daniel Tarullo, Fed’s “Regulatory Point Man”, Unexpectedly Resigns

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Last October, as part of the Podesta email leaks, we disclosed the particularly close relationship between Fed governor Dan Tarullo and Barack Obama, which emerged as part of a previously undisclosed memo involving the AIG bailout. We speculated that as a result of this now public disclosure it was possible that Tarullo's days at the Fed were numbered should Donald Trump win the election. Trump won, and moments ago Dan Tarullo unexpectedly announced that he is resigning in early April, just days after the Fed's general counsel Alvarez also announced that he is departing the Fed.

What makes Tarullo's resignation particularly notable is that Tarullo has been the Fed's "regulatory point man" since 2009, suggesting some regulatory friction has emerged.

In light of Trump's vow to crush Wall Street regulations, one can see why Tarullo thought his services are no longer necessary.

Tarullo’s brief resignation letter to Fed Chairwoman Janet Yellen didn’t give a reason for his departure. He said he has been privileged to serve at the Fed for eight years. The letter said his resignation will take effect “on or about” April 5.

As the WSJ further notes, "Tarullo’s future has been a matter of debate in the financial sector. He was appointed by President Barack Obama in January 2009 and overhauled the way the Fed oversees the largest U.S. banks.

His term doesn’t expire until 2022, but President Donald Trump is widely expected to appoint someone else to the currently vacant post of Federal Reserve vice chairman in charge of bank oversight.

 

Mr. Tarullo has effectively filled that role, even without that title. A Trump nominee likely would challenge Mr. Tarullo’s influence.

In a statement, Yellen said that "Dan led the Fed's work to craft a new framework for ensuring the safety and soundness of our financial system following the financial crisis and made invaluable contributions across the entire range of the Fed's responsibilities."

"My colleagues and I will truly miss his deep expertise, impeccable judgment, wise insight, and strategic counsel."

Tarullo, 64, was appointed to the Board by President Obama for an unexpired term ending January 31, 2022. During his time on the Board, he served as Chairman of the Board's Committee on Supervision and Regulation. He was also Chairman of the Financial Stability Board's Standing Committee on Supervisory and Regulatory Cooperation.

In his brief departure letter, Tarullo just said two sentences:

"After more than eight years as a member of the Board of Governors of the Federal Reserve System, I intend to resign my position on or around April 5, 2017. It has been a great privilege to work with former Chairman Bemanke and Chair Yellen during such a challenging period for the nation's economy and financial system."

* * *

With his departure, the market appears even more confident that a substantial crackdown on Wall Street regulations is imminent, and has pushed stocks to new all time highs.

 

Steve ‘Big Short’ Eisman: Smart, Lucky, Abrasive (& Now One Of Them)

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Authored by Jim Quinn via The Burning Platform blog,

I loved Michael Lewis’ book – The Big Short – about the 2008 Wall Street created global financial catastrophe, that is still impacting the little guys on Main Street eight years after it was supposedly resolved by Paulson, Bernanke and Obama. I even wrote an article about it called The Big Short: How Wall Street Destroyed Main Street. I also loved one of the main characters in the book – Frontpoint Partners hedge fund manager Steve Eisman – a foul mouthed, highly skeptical, open minded guy who figured out the fraudulent subprime mortgage scheme and shorted the crap out of the derivatives backing the fraud, making hundreds of millions in the process.

I had the opportunity to attend a 90 minute talk by Steve Eisman last night where he discussed the financial crisis, the response by the Fed and government, and the future for the financial industry. My perception of him, based on the book and movie, was he was a cantankerous asshole who didn’t care what anyone thought about him. My perception matched what I experienced. He was dropping f-bombs, insulting the institution hosting his talk, making fun of business school students (he graduated with a liberal arts degree) and dismissing any question he found to be stupid.

He was very funny. You could tell immediately he was smart and very opinionated. He was confident in his area of expertise. His diagnosis of what happened leading up to the financial implosion was dead on. He correctly tied the entire debacle to ridiculous levels of leverage taken on by Wall Street banks, warped incentives for financial industry employees and rating agencies, and Federal Reserve regulators asleep at the wheel, convinced Wall Street could regulate itself. I think he was too easy on the people who knowingly committed fraud to buy houses they knew they couldn’t afford. He said they were lured into the fraud by the unscrupulous mortgage industry. It takes two to tango.

He described how the credit standards continued to descend as the Wall Street doomsday machine needed more product to convert into toxic derivative products, rated AAA by the greedy worthless rating agencies, so they could sell the weapons of mass destruction to unsuspecting pension funds, mutual funds, and little old ladies. He openly despised Alan Greenspan as the worst Fed Chairman in history and blames him for the lack of regulation leading up to the crisis.

The slimy mortgage originators offered teaser rates of 3% to migrant workers so they could purchase a $700,000 home with nothing down and no proof of income. After three years the rate would adjust to 9%. The underwriters rated the loans based on the 3%, not the 9%. The home occupier had to pay 4 or 5 basis up front to get the loan. Since they could never afford the 9%, they had to refinance and pay another 4 or 5 basis points. The same loan would get repackaged twice into derivatives, while the shysters made out like bandits.

“In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $724,000.” ? Michael Lewis, The Big Short

This subprime slime was the fuse destined to blow up the system, but it was the Wall Street leverage which created the nuclear bomb attached to the fuse. He described how the Wall Street banks were leveraged 10 to 1 in 2000. By 2007 they were leveraged 33 to 1. And most of the assets on their balance sheet were toxic debt slime. Eisman was a Wall Street guy and understood their mindset. When he would point out how stupid these decisions were, the Wall Street big swinging dicks would respond they made $50 million last year and he didn’t. They were smart because they were rich.

The arrogant pricks who ran Wall Street firms mistook their self pronounced brilliant results for leverage propelled fake profits. Levering up your firm with toxic un-payable debt made you look brilliant in the short term, but created a debt bomb destined to blow up the world. Greed, hubris, ignorance of the products they were creating, complete lack of risk management, and the immoral culture of Wall Street led to the worst financial crisis in world history. Eisman’s diagnosis of the causes was perfect.

In my opinion, his positive response to how Paulson, Bernanke and the Obama administration “solved” the crisis was disingenuous, proof he’s a Wall Street guy at heart, and not the defender of the little guy as described by Steve Carrell, who portrayed him in the movie:

“I think he [Eisman] seems himself as a defender of justice and righteousness, while at the same time being conflicted.”

In the movie he was portrayed as the moral compass. After hearing his praise for the awesome job Paulson did by saving the criminal Wall Street banks with taxpayer money, I think the justice and righteousness stuff is overdone. Earlier in his talk he said banks existed to “fuck you” – his exact words. Then later he says we had to save them or the world would have ended. He spun the same old narrative that if you didn’t save AIG, Goldman, GE, and the rest of the corrupt Wall Street cabal, unemployment would have been 30% instead of the 10% it eventually reached. I guess he believes the BLS bullshit that unemployment is currently 4.7%.

Other smart people, not beholden to Wall Street (he works for Neuberger Berman), argue that we could have had an orderly liquidation of the Wall Street banks that took too much risk and levered themselves 33 to 1. The people on Main Street didn’t lever themselves 33 to 1, but we got to bail them out. Rewarding failure encourages more failure. There were over 8,000 banks in the US and it was only 10 or 20 who almost destroyed the world. They should have paid the price for their criminality and recklessness. Their executives should have gone to jail. Not one did.

I began to realize Eisman is a liberal Democrat when he enthusiastically praised Elizabeth Warren as a champion of the people and how Dodd Frank has completely reined in the Wall Street banks. He positively gushed about his friend Daniel Tarullo, the Fed’s chairman of the Federal Financial Institutions Examination Council. He expounded on how tough he has been on the Wall Street banks and his gotten them under control. Meanwhile, they continue to pay billions in fines for their criminal acts and Michael Lewis’ other bestseller – Flashboys – documents the continued rigging of markets and criminality on Wall Street.

His defense of Wall Street as it’s constituted today reminded me of the Upton Sinclair quote:

“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” 

He is a creature of Wall Street who depends on their good graces for his continued income. He wouldn’t even name Bill Miller as the idiot mutual fund manger who bought Bear Stearns as it was about to go under, because his compliance manager said he shouldn’t do so. It was at this point I realized he wasn’t some prescient sage who understands the markets better than the average schmuck. He got lucky. It wasn’t even his idea to short the subprime market derivatives. Greg Lippman from Deutsche Bank sold the idea to him in February 2006. He just acted on the advice.

His dismissal of overturning the Glass Steagall Act as a cause, Fannie & Freddie’s role in the crisis, and the fact this was a calculated control fraud deserving of prison sentences for hundreds of Wall Street executives, changed my view of the man in a matter of minutes. I find liberal minded people like himself are sometimes excellent at diagnosing problems, but their solutions either exacerbate the problem or ignore the real problem.

He said nothing about how Bernanke & Geithner’s threats to the FASB, resulting in the suspension of mark to market accounting, marked the exact bottom of the market. From that point onward, the Wall Street banks, along with Fannie and Freddie, could value their assets at whatever they wanted – mark to fantasy. Amazingly, the banks and the insolvent mortgage companies immediately started reporting billions of fake profits. Loan loss reserves were relieved, while Fannie & Freddie made billions in fake payments to the Treasury, artificially decreasing annual deficits.

Eisman, the man of the people, said nothing about how real median household income is lower today than it was at the height of the crisis, while Wall Street bonus pools are at record highs. He said nothing about senior citizens who used to count on 5% money market returns to scrape by now getting .25% because the Fed used ZIRP to save the Wall Street banks. Eisman is an extremely rich Wall Streeter. He wouldn’t know how to find Main Street, even with a GPS. He was surely blindsided by the deplorables, outside his NYC bubble, electing Trump as a reaction to the screwjob they received from Wall Street, the Fed and the Obama administration.

His laid back view of the Wall Street banks and how great their balance sheets are, with leverage of only 11 to 1, completely ignores the fact the Fed bought $3.6 trillion of their toxic debt at one hundred cents on the dollar, and the Obama administration took on $10 trillion of national debt to give the economy the appearance of recovery – while the majority are still experiencing a recession, except for Eisman’s Wall Street cronies. He had no problem with Wall Street hedge funds buying up all the foreclosed homes, driving prices higher to fix Wall Street balance sheets, and renting them back to the poor people he pretends to care about.

No mention from Steve about why the economy requires emergency level interest rates, nine years after the crisis. He seems sanguine about a $20 trillion national debt, where normalization of interest rates would blow up the world again. He thinks the US banking industry is the safest it has ever been in history. Isn’t it funny that he did an interview a few weeks ago revealing he is long the banking industry? He is just talking his book, just like every other Wall Street chameleon.

Even though stock valuations are at highs only seen in 1929, 2000, and 2007, Eisman sees no stock market bubble. He expects stocks to go higher due to Trump’s tax cuts and deregulation plans. Even though home prices are nearing 2005 levels again, he sees no real estate bubble. He sees no subprime auto loan bubble. He sees no student loan bubble – he said it’s the government’s problem, as if the government gets their money from someone other than the people. He doesn’t care about the debt bubble, because he’s an equity guy. This type of vision might explain why his hedge fund venture after Frontpoint – Emrys Partners – went under in two years.

My experience of seeing Steve Eisman in person was a letdown. I expected some sort of visionary superhero and I got an abrasive, myopic, captured Wall Street guy, parroting the Wall Street line that all is well, the future is bright, debt doesn’t matter, and stocks always go higher. I left the venue wondering whether I have the bad case of cognitive dissonance and can’t see how great things are, or whether Steve has the bad case of cognitive dissonance. I guess time will tell.

There are two things I learned.

  1. Its better to be lucky than smart.
  2. Wall Street will never change.

“What are the odds that people will make smart decisions about money if they don’t need to make smart decisions–if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they’re still all wrong.” ? Michael Lewis, The Big Short

Bharara Joins The Trump “Resistance”: Asks If Any Public Servants Will Dare Say No To The President

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It appears the so-called 'resistance' is coalescing around a number of fired-by-Trump formerly powerful Obama administration officials desperate to maintain the tyrannical Trump narrative. The latest is infamous non-prosecutor of Wall Street's worst Preet Bharara who questions: Are there still public servants who are prepared to say no to the president?

 

The U.S. attorney for the Southern District of New York from 2009 until he was fired by Trump this March takes to The Washington Post's echo chamber to pen an opinion piece proclaiming Trump's actions over Comey's firing (his old boss and friend) as damaging to faith in the rule of law, suggesting some ideas to fix his tyrannical ways…

He begins with an anecdote to set the scene for historical precedent

The most dramatic hearing I helped to arrange as chief counsel to a Senate subcommittee took place 10 years ago Monday, when James B. Comey, then deputy attorney general in the George W. Bush administration, described how he and FBI Director Robert Mueller intervened at the hospital bedside of Attorney General John Ashcroft.

 

The encounter occurred in 2004, after White House Chief of Staff Andrew H. Card Jr. and White House Counsel Alberto R. Gonzales tried to overrule Comey’s and Mueller’s legal objection to a secret terrorist surveillance program.

 

When the White House nonetheless sought the ailing Ashcroft’s blessing to proceed, Comey prepared to resign. Ultimately, Comey and Mueller prevailed.

And then explains how terrible things have become…

Jim Comey was once my boss and remains my friend. I know that many people are mad at him. He has at different times become a cause for people’s frustration and anger on both sides of the aisle. Some of those people may have a point. But on this unsettling anniversary of that testimony, I am proud to know a man who had the courage to say no to a president.

 

in the tumult of this time, the question whose answer we should perhaps fear the most is the one evoked by that showdown: Are there still public servants who are prepared to say no to the president?

So having raised that question spuriously, let's go back to yet another instance of an event in which a Republican White House did something the so-called progressive left did not appreciate…

Now, as the country once again wonders whether justice can be nonpolitical and whether its leaders understand the most basic principles of prosecutorial independence and the rule of law, I recall yet another firestorm that erupted 10 years ago over the abrupt and poorly explained firing of top Justice Department officials in the midst of sensitive investigations.

 

The 2007 affair was not Watergate, the more popular parallel invoked lately, but the lessons of that spring, after the Bush administration inexplicably fired more than eight of its own U.S. attorneys, are worth recalling.

 

When the actions became public, people suspected political interference and obstruction. Democrats were the most vocal, but some Republicans asked questions, too. The uproar intensified as it became clear that the initial explanations were mere pretext, and the White House couldn’t keep its story straight. Public confidence ebbed, and Congress began to investigate.

 

In response, the Senate launched a bipartisan (yes, bipartisan) investigation into those firings and the politicization of the Justice Department. Early on, the then-deputy attorney general — Comey was gone by then — looked senators in the eye and said the U.S. attorneys were fired for cause; although such appointees certainly serve at will, this assertion turned out to be demonstrably false. We learned that the U.S. attorney in New Mexico, David C. Iglesias, was fired soon after receiving an improper call from Republican Sen. Pete V. Domenici pushing him to bring political corruption cases before the election. We learned that Justice Department officials in Washington had improperly applied a conservative ideological litmus test to attorneys seeking career positions, to immigration judges and even to the hiring of interns.

 

Ultimately, amid the drumbeat of revelations, every top leader of the department stepped down under a cloud. Finally, Gonzales himself resigned. Strict protocols were put in place severely limiting White House contacts with Justice officials on criminal matters. The blow to the morale and reputation of the department was incalculable.

First things first, may we suggest that "the country" for which you speak of is not busily wondering "whether justice can be nonpolitical" – instead they are busily wondering where the next paycheck is coming from, how they will pay soaring healthcare costs and put a shelter over their families heads.. but of course, thats' not the Washington narrative-du-jour. Which brings us back to today…

For me, the past week has been deja vu all over again. To restore faith in the rule of law, three obvious things must happen:

 

First, we need a truly bipartisan investigation in Congress. That means no partisan nonsense — just a commitment to finding the facts, whatever they may be, proving (or disproving) Russian interference in our election and anything related. Congress is a check and a balance, and never more important than when a bullying chief executive used to his own way seems not to remember the co-equal status of the other two branches.

 

Second, the new FBI director must be apolitical and sensitive to the law-enforcement mission, not someone with a long record of reflexive partisanship or commentary on the very investigative issues that will come before the bureau. Unfortunately, some of the candidates paraded by cameras this past weekend reality-show style fall into that category. I can’t think of anything worse for FBI morale, for truth-finding or for public trust. More than ever the FBI needs a strong and stabilizing hand, which means somebody who has not spent most of his or her career pandering for votes, groveling for cash or putting party over principle.

 

Finally, I join in the common-sense call for an independent and uncompromised special counsel to oversee the Russia investigation. Given the manner of Comey’s firing and the pretextual reasons proffered for it, there is no other way. My former colleague, now-Deputy Attorney General Rod J. Rosenstein, is a respected career prosecutor but has mostly deserved the doubts he generated with his peculiar press-release-style memo purporting to explain Comey’s sudden sacking. He can still fix it. The move would not only ensure the independence of the investigation, but also provide evidence of Rosenstein’s own independence.

Bharara ends strong with some 'constitutional'-sounding rhetoric that leaves one questioning everything about American life if Trump is left to run wild over 'law and order' – like trying to enforce immigration laws, trade agreements, and

History will judge this moment. It’s not too late to get it right, and justice demands it.

Chilling words of self-reinforcing terror.

*  *  *

As a reminder, here are some recent thoughts on Mr Bharara from respected journalist Jesse Eisenger – who is not afraid to throw a few punches of truthiness about the former prosecutor…

After his election in 1968, President Richard Nixon asked Robert Morgenthau, the US Attorney for the Southern District of New York, to resign. Morgenthau refused to leave voluntarily, saying it degraded the office to treat it as a patronage position.

Nixon’s move precipitated a political crisis. The president named a replacement. Powerful politicians lined up to support Morgenthau. Morgenthau had taken on mobsters and power brokers. He had repeatedly prosecuted Roy Cohn, the sleazy New York lawyer who had been Senator Joe McCarthy’s right-hand man. (One of Cohn’s clients and protégés was a young New York City real estate developer named Donald Trump.) When Cohn complained that Morgenthau had a vendetta against him, Morgenthau replied, “A man is not immune from prosecution merely because a United States Attorney happens not to like him.”

Morgenthau carried that confrontational attitude to the world of business. He pioneered the Southern District’s approach to corporate crime. When his prosecutors took on corporate fraud, they did not reach settlements that called for fines, the current fashion these days. They filed criminal charges against the executives responsible.

Before Morgenthau, the Department of Justice focused on two-bit corporate misdeeds—Ponzi schemes and boiler room operations. Morgenthau changed that. His prosecutors went after CEOs and their enablers—the accountants and lawyers who abetted the frauds or looked the other way. “How do you justify prosecuting a nineteen-year old who sells drugs on a street corner when you say it’s too complicated to go after the people who move the money?” he once asked.

Morgenthau’s years as United States Attorney were followed by political success. He was elected New York County District Attorney in 1974, the first of seven consecutive terms for that office.

There are parallels between Morgenthau, and Preet Bharara, the U.S. attorney for the Southern District who was fired by President Trump this weekend.

Like Morgenthau, the 48-year old Bharara leaves the office of US Attorney for the Southern District celebrated for taking on corrupt and powerful politicians. Bharara prosecuted two of the infamous “three men in a room” who ran New York state: Sheldon Silver, the Democratic speaker of the assembly and Dean Skelos, the Republican Senate majority leader.

He won convictions of a startling array of local politicians, carrying on the work of the Moreland Commission, an ethics inquiry created and then dismissed by New York’s Gov. Andrew Cuomo. (This weekend, Bharara cryptically tweeted that “I know what the Moreland Commission must have felt like,” a suggestion that he was fired as he was pursuing cases pointed at Trump or his allies.)

But the record shows that Bharara was much less aggressive when it came to confronting Wall Street’s misdeeds.

President Obama appointed Bharara in 2009, amid the wreckage of the worst financial crisis since the Great Depression. He inherited ongoing investigations into the collapse, including a probe against Lehman Brothers.

He also inherited something he and his young charges found more alluring: insider-trading cases against hedge fund managers. His office focused obsessively on those. At one point, the Southern District racked up a record of 85-0 in those cases. (Appeals courts would later throw out two prominent convictions, infuriating him and dealing blows to several other cases.)

Hedge funds are safer targets. The firms aren’t enmeshed in the global financial markets in the way that giant banks are. Insider trading cases are relatively easy to win and don’t address systemic abuses that helped bring down the financial system.

Even there his record was more mixed than is popularly understood. As Sheelah Kolhatkar demonstrates in her propulsive and riveting “Black Edge,” when it came to bringing his biggest whale to justice, Steve Cohen of SAC Capital, the Southern District blinked. They did not charge him, only securing a guilty plea from his firm.

Present and former prosecutors say Bharara did not give much emphasis to investigations arising from the financial meltdown, an approach shared by his boss, Attorney General Eric Holder. Justice Department insiders say many of those inquiries withered not because they were unpromising, but because they had little support.

Bharara missed an opportunity by not bringing any significant criminal charges against individuals in the wake of the collapses of Lehman, investment bank Merrill Lynch, the insurer AIG, the mortgage securities and collateralized debt obligation businesses, or the myriad public misrepresentations from bank CEOs about their finances.

Bharara and senior officials in Washington argue that there were no criminal cases to file after the 2008 crisis. But the U.S. attorney’s office in Manhattan did pursue significant civil cases against the banks for their mortgage activities, cases that had to proove misconduct by the “preponderance of the evidence.” And DOJ did win guilty pleas from the banks themselves, an indication that prosecutors might have been able to charge individuals for their part in crimes their institutions had acknowledged. Academics who studied those years, including Columbia’s Tomasz Piskorski and James Witkin and Chicago’s Amit Seru found widespread patterns of fraud in the mortgage business.

The exception makes this failure all the more puzzling. As I detailed in 2014, Bharara’s office brought one case for misconduct during the financial crisis — against a mid-level banker. Prosecutors charged Kareem Serageldin of Credit Suisse with overseeing traders who knowingly misrepresented the value of mortgage securities. Serageldin pleaded guilty and went to prison.

Serageldin’s colleagues in the industry and others familiar with Credit Suisse found it hard to believe that he was the only person involved in that particular fraud.

Bharara’s reluctance to pursue senior executives was seen in other investigations of big banks. His office wrested a $1.7 billion fine from JPMorgan Chase over its complicity in the Bernie Madoff Ponzi scheme, but it brought no charges against individual bankers.

One odd aspect of his tenure was the Southern District’s willingness to defer to other jurisdictions when it came to Wall Street cases.

Historically, the SDNY has been the leading enforcers of securities laws, nicknamed the “sovereign district” for its propensity to grab corporate fraud cases from elsewhere on the flimsiest of jurisdictional pretexts. Under Bharara, the southern district let other U.S. attorneys claim investigations into residential mortgage-backed securities, the instruments at the heart of the financial crisis. Those other offices were not nearly as versed in complex financial cases as their colleagues in Manhattan. In addition, Bharara’s office ceded post-financial crisis investigations into foreign exchange and global interest rate manipulation to prosecutors working from the Justice Department’s headquarters.

Like Morgenthau, Bharara was a prominent figure in the New York landscape, given to well-orchestrated press conferences and memorable sound bites. Like Morgenthau, he did not leave office quietly, even thought the president has a longstanding right to name his own U.S. attorneys. And like Morgenthau, he may try to parlay his martyrdom into elective office.

But if he runs on his record of convictions, as prosecutors often do, voters might want to consider as well the list of possible targets he never pursued.

Bill Miller Says He’s Invested 1% Of His Net Worth In Bitcoin

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Former Legg Mason investing guru Bill Miller’s Opportunity Trust is back on top this year thanks to bets on a hodgepodge of stocks including Apple Inc., J.P Morgan Chase & Co. and Restoration Hardware. Just weeks after his Opportunity Trust was named No. 1 among diversified funds with at least $1 billion in assets, Forbes is out with a glowing profile of the 67-year-old value investor. In it, Miller makes a surprising claim – one that, if accurate, could very well help restore his legacy after a spotty string of years. Back in 2014, Miller said he invested 1% of his net worth in bitcoin. Forbes neglected to reveal Miller’s net worth, though it claimed that Miller is looking at a 1,000% return.

Indeed, it looks like Miller is once again having an investing “moment,” finding relief after a decade of returns ranging from lukewarm to disastrous. His winning streak began after Miller last year ended a 35-year relationship with Baltimore’s Legg Mason, buying out the company’s stake in three funds.

Here's Forbes:

“Indeed, Miller still has a keen eye for change. In 2014, he put 1% of his net worth into Bitcoin, judging that the digital currency's potential for large-scale economic disruption (see Forbes' cover story on the coin revolution) outweighed the risk of a total loss. He's up nearly tenfold, and Bitcoin is now a top holding of his hedge fund.”

Miller’s Opportunity fund, a mutual fund that doesn't hold any bitcoin, is also having a stellar year thanks in large part to Miller’s purchase of Apple call options with a strike price of $100. Miller also has a large stake in Amazon that has performed well this year. Miller told Forbes he expects the e-commerce giant's market cap to rise five- or sixfold within a decade. A handful of the fund's top-performing picks are detailed in this chart:

Of course, there’s a reason why Miller can take risks like betting on bitcoin: He’s the largest investor in each of his funs, leaving him free to think “big thoughts,” according to Forbes.

“…[This] past February, Miller completed the buyout of a partnership he had formed with Legg Mason to manage the Opportunity Trust and a small income fund. His family-owned Miller Value Partners now runs the Opportunity Trust, a separate $120 million hedge fund and the $116 million Miller Income Fund, managed by his son, 36-year-old Bill Miller IV.

 

Miller is the biggest investor in all three funds and can do what he likes–thinking big thoughts and placing big and often contrarian bets–without worrying about marketing or bosses. "I was at Legg Mason for 35 years and ran the Value Trust for 30 years. This is better," he says. "Here it is much more about just growing the assets and not trying to get a constant inflow of new clients and doing pitches."

In a revelation that should alarm anyone investing with Miller, Forbes claims his funds are doing little to hedge against a sudden drop in equity prices, meaning that Miller is vulnerable to history repeating itself. Miller rose to investing fame thanks to his record-setting feat of topping the market benchmark for 15 years straight between 1991 and 2005. However, he accrued massive losses during the crisis and the early years of the recovery. By the end of 2008, Value Trust had lost nearly two thirds of its value, wiping out most of Miller's outperformance over the previous two decades. It came roaring back in 2009 and 2010, according to Forbes, but investors had already abandoned the fund, and Miller was by then the poster boy for the folly of paying active managers high fees to beat the market.

…heading into the 2007-08 financial crisis, Miller owned everything that would soon turn toxic: subprime mortgage lender Countrywide, now-defunct Lehman Brothers and Bear Stearns, bond insurers, home builders and even AIG. When conditions worsened, he once again doubled down, mistakenly believing (he now says) that the Federal Reserve could end the crisis quickly by injecting liquidity, when the real problem was asset values.”

The string of stunning losses led to Miller’s ouster from the Legg Mason Capital Management Value Trust in 2011, which he had managed since the early 1990s. However, circumstances are different this time. Miller is in control, meaning that if a string of losses send the outside money running for cover, he will be left alone to go down with the ship.

Government By Goldman

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Authored by Gary Rivlin and Michael Hudson via The Intercept, in partnership with The Investigative Fund,

Steve Bannon was in the room the day Donald Trump first fell for Gary Cohn. So were Reince Priebus, Jared Kushner, and Trump’s pick for secretary of Treasury, Steve Mnuchin. It was the end of November, three weeks after Trump’s improbable victory, and Cohn, then still the president of Goldman Sachs, was at Trump Tower presumably at the invitation of Kushner, with whom he was friendly. Cohn was there to offer his views about jobs and the economy. But, like the man he was there to meet, he was at heart a salesman.

On the campaign trail, Trump had spoken often about the importance of investing in infrastructure. Yet the president-elect had apparently failed to appreciate that the government would need to come up with hundreds of billions of dollars to fund his plans. Cohn, brash and bold, wired to attack any moneymaking opportunity, pitched a fix that would put Wall Street firms at the center: Private-industry partners could help infrastructure get fixed, saving the federal government from going deeper into debt. The way the moment was captured by the New York Times, among other publications, Trump was dumbfounded. “Is this true?” he asked. Was a trillion-dollar infrastructure plan likely to increase the deficit by a trillion dollars? Confronted by nodding heads, an unhappy president-elect said, “Why did I have to wait to have this guy tell me?”

Within two weeks, the transition team announced that Cohn would take over as director of the president’s National Economic Council.

Goldman Sachs President Gary Cohn arrives for a meeting with President-elect Donald Trump at Trump Tower in New York,  Nov. 29, 2016.

Photo: Bryan R. Smith/AFP/Getty Images

1. GOLDMAN ALWAYS WINS

Goldman Sachs had been a favorite cudgel for candidate Trump – the symbol of a government that favors Wall Street over its citizenry. Trump proclaimed that Hillary Clinton was in the firm’s pockets, as was Ted Cruz. It was Goldman Sachs that Trump singled out when he railed against a system rigged in favor of the global elite — one that “robbed our working class, stripped our country of wealth, and put money into the pockets of a handful of large corporations and political entities.” Cohn, as president and chief operating officer of Goldman Sachs, had been at the heart of it all. Aggressive and relentless, a former aluminum siding salesman and commodities broker with a nose for making money, Cohn had turned Goldman’s sleepy home loan unit into what a Senate staffer called “one of the largest mortgage trading desks in the world.” There, he aggressively pushed his sales team to sell mortgage-backed securities to unaware investors even as he watched over “the big short,” Goldman’s decision to bet billions of dollars that the market would collapse.

Now Cohn would be coordinating economic policy for the populist president.

The conflicts between the two men were striking. Cohn ran a giant investment bank with offices in financial capitals around the globe, one deeply committed to a world with few economic borders. Trump’s nationalist campaign contradicted everything Goldman Sachs and its top executives represented on the global stage.

Trump raged against “offshoring” by American companies during the 2016 campaign. He even threatened “retribution,”­ a 35 percent tariff on any goods imported into the United States by a company that had moved jobs overseas. But Cohn laid out Goldman’s very different view of offshoring at an investor conference in Naples, Florida, in November. There, Cohn explained unapologetically that Goldman had offshored its back-office staff, including payroll and IT, to Bangalore, India, now home to the firm’s largest office outside New York City: “We hire people there because they work for cents on the dollar versus what people work for in the United States.”

Candidate Trump promised to create millions of new jobs, vowing to be “the greatest jobs president that God ever created.” Cohn, as Goldman Sachs’s president and COO, oversaw the firm’s mergers and acquisitions business that had, over the previous three years, led to the loss of at least 22,000 U.S. jobs, according to a study by two advocacy groups. Early in his candidacy, Trump described as “disgusting” Pfizer’s decision to buy a smaller Irish competitor in order to execute a “corporate inversion,” a maneuver in which a U.S. company moves its headquarters overseas to reduce its tax burden. The Pfizer deal ultimately fell through. But in 2016, in the heat of the campaign, Goldman advised on a megadeal that saw Johnson Controls, a Fortune 500 company based in Milwaukee, buy the Ireland-based Tyco International with the same goal. A few months later, with Goldman’s help, Johnson Controls had executed its inversion.

With Cohn’s appointment, Trump now had three Goldman Sachs alums in top positions inside his administration: Steve Bannon, who was a vice president at Goldman when he left the firm in 1990, as chief strategist, and Steve Mnuchin, who had spent 17 years at Goldman, as Treasury secretary. And there were more to come. A few weeks later, another Goldman partner, Dina Powell, joined the White House as a senior counselor for economic initiatives. Goldman was a longtime client of Jay Clayton, Trump’s choice to chair the Securities and Exchange Commission; Clayton had represented Goldman after the 2008 financial crisis, and his wife Gretchen worked there as a wealth management adviser. And there was the brief, colorful tenure of Anthony Scaramucci as White House communications director: Scaramucci had been a vice president at Goldman Sachs before leaving to co-found his own investment company.

Even before Scaramucci, Sen. Elizabeth Warren, D-Mass., had joked that enough Goldman alum were working for the Trump administration to open a branch office in the White House.

“There was a devastating financial crisis just over eight years ago,” Warren said. “Goldman Sachs was at the heart of that crisis. The idea that the president is now going to turn over the country’s economic policy to a senior Goldman executive turns my stomach.” Prior administrations often had one or two people from Goldman serving in top positions. George W. Bush at one point had three. At its peak, the Trump administration effectively had six.

Earlier this summer, Trump boasted about his team of economic advisers at a rally in Cedar Rapids, Iowa. “This is the president of Goldman Sachs. Smart,” Trump said. “Having him represent us! He went from massive paydays to peanuts.”

Trump waved off anyone who might question his decision to rely on the very people he had demonized. “Somebody said, ‘Why did you appoint a rich person to be in charge of the economy?’ … I said: ‘Because that’s the kind of thinking we want.’” He needed “great, brilliant business minds … so the world doesn’t take advantage of us.” How else could he get the job done? “I love all people, rich or poor, but in those particular positions, I just don’t want a poor person.”

“Does that make sense?” Trump asked. The crowd cheered.

Director of the National Economic Council Gary Cohn (L) listens to President Donald Trump deliver opening remarks during a meeting with business leaders in the Roosevelt Room at the White House on Jan. 23, 2017 in Washington, D.C.

Photo: Chip Somodevilla/Getty Images

Years of financial disclosure forms confirm that Cohn is indeed very rich. At the end of 2016, he owned some 900,000 shares of Goldman Sachs stock, a stake worth around $220 million on the day Trump announced his appointment. Plus, he’d sold a million more Goldman shares over the previous half-dozen years. In 2007 alone, the year of the big short, Goldman Sachs paid him nearly $73 million — more than the firm paid CEO Lloyd Blankfein. The disclosure forms Cohn filled out to join the administration indicate he owned assets valued at $252 million to $611 million. That may or may not include the $65 million parting gift Goldman’s board of directors gave him for “outstanding leadership” just days before Trump was sworn in.

Like anyone taking a top job in the Trump administration, Cohn was required to sign a pledge vowing not to participate for the next two years in any matter “that is directly and substantially related to my former employer or former clients, including regulations and contracts.” But presidents have sometimes issued waivers to these requirements, and it is unclear whether the Trump administration is making such waivers public.

Sens. Warren and Tammy Baldwin, a Democrat from Wisconsin, sent Cohn a letter a few days later. They brought up the $65 million bonus and asked him to publicly recuse himself from any issue that could have a direct or “significant indirect” impact on his old firm. Cohn never responded to the letter, and if he has ever received a waiver, it has not been made available to the public or the Office of Government Ethics.

“Consistent with the Trump administration’s stringent ethics rules, Mr. Cohn will recuse himself from participating in any matter directly involving his former employer, Goldman Sachs,” White House spokesperson Natalie Strom said. “The White House will not comment further.”

The White House declined requests to make Cohn available for an interview and declined to answer a detailed set of questions.

Cohn shared the podium with fellow Goldman alum Mnuchin (the two made partner there the same year) when the administration unveiled its new tax plan, one that, if the past is prelude, had the potential to save Goldman more than $1 billion a year in corporate taxes. The president had promised to “do a number” on financial reforms implemented after the 2008 subprime crisis, including one that threatened to cost Goldman several billion dollars a year in revenues. Under Cohn, the administration has introduced new rules easing initial public offerings — a Goldman Sachs specialty dating back to the start of the last century, when the firm handled the IPOs of Sears, Roebuck; F. W. Woolworth; and Studebaker. As Trump’s top economic policy adviser, Cohn can exert influence over regulatory agencies that have shaken billions in penalties and settlements out of Goldman Sachs in recent years. And his former colleagues inside Goldman’s Public Sector and Infrastructure group likely appreciate the Trump administration’s infrastructure plan, which is more or less exactly as Cohn first pitched it inside Trump Tower in November.

“It’s hard to see how Gary Cohn recusing himself would solve a lot of these conflicts because nearly every major decision of his job would have a significant impact, likely billions of dollars, on Goldman Sachs and its executives,” said Tyler Gellasch, an attorney and former Senate staffer who helped draft Dodd-Frank, the landmark financial reform law passed in the wake of the financial meltdown. “Goldman touches nearly every aspect of the economy, from selling U.S. treasuries to helping companies go public, and the National Economic Council advises on all of that.”

In the wake of last month’s white supremacist rally in Charlottesville, Virginia, Cohn confessed to the Financial Times that he has “come under enormous pressure both to resign and to remain.” But the man who the Washington Post has dubbed Trump’s “moderate voice” declared that neo-Nazis would not force “this Jew” to leave his job. “As a patriotic American, I am reluctant to leave my post as director of the National Economic Council,” Cohn told FT. “I feel a duty to fulfill my commitment to work on behalf of the American people.”

Or at least a few of them. The Trump economic agenda, it turns out, is largely the Goldman agenda, one with the potential to deliver any number of gifts to the firm that made Cohn colossally rich. If Cohn stays, it will be to pursue an agenda of aggressive financial deregulation and massive corporate tax cuts — he seeks to slash rates by 57 percent — that would dramatically increase profits for large financial players like Goldman. It is an agenda as radical in its scope and impact as Bannon’s was.

Republican presidential candidate Donald Trump holds up a copy of his book “The Art of the Deal,” given to him by a fan as he speaks during a campaign stop on Saturday, Nov. 21, 2015 in Birmingham, Ala.

Photo: Eric Schultz/AP

2. ALPHA MALES

Donald Trump, the “blue-collar billionaire,” has taken great pains to write grit and toughness into his privileged biography. He talks of military schools and visits to construction sites with his father and wrote in “The Art of the Deal” that in the second grade, “I actually gave a teacher a black eye. I punched my music teacher because I didn’t think he knew anything about music and I almost got expelled.” Yet when the authors of the book “Trump Revealed: An American Journey of Ambition, Ego, Money, and Power” spoke to several of his childhood friends, none of them recalled the incident. Trump himself crumpled when asked about the incident during the 2016 campaign: “When I say ‘punch,’ when you’re that age, nobody punches very hard.”

Gary Cohn, however, is the middle-class kid and self-made millionaire Trump imagines himself to be. It appears that Cohn actually did slug a grade-school teacher in the face. “I was being abused,” Cohn told author Malcolm Gladwell, who interviewed him for his book, “David and Goliath: Underdogs, Misfits, and the Art of Battling Giants,” back when Cohn was still president of Goldman Sachs. As a child, Cohn struggled with dyslexia, a reading disorder people didn’t understand much about when Cohn attended school in the 1970s in a suburb outside Cleveland. “You’re a 6- or 7- or 8-year-old-kid, and you’re in a public-school setting, and everyone thinks you’re an idiot,” Cohn confessed to Gladwell. “You’d try to get up every morning and say, today is going to be better, but after you do that a couple of years, you realize that today is going to be no different than yesterday.” One time when he was in the fourth grade, a teacher put him under her desk, rolled her chair close, and started kicking him, Cohn said. “I pushed the chair back, hit her in the face, and walked out.”

While Trump’s father was a wealthy real estate developer, Cohn’s father was an electrician. When Trump sought to get into the casino business, his father loaned him $14 million. When Cohn couldn’t find a job after graduating from college, all his father could do was find him one selling aluminum siding. While Trump has the instincts of a reality show producer and an eye for spectacle, Cohn prefers to operate in the shadows.

But they likely recognize much of themselves in the other. Both Cohn and Trump are alpha males — men of action unlikely to be found holed up in an office reading through stacks of policy reports. In fact, neither seems to be much of a reader. Cohn told Gladwell it would take him roughly six hours to read just 22 pages; he ended his time with the author by wishing him luck on “your book I’m not going to read.” Both have a transactional view of politics. Trump switched his voter registration between Democratic, Republican, and independent seven times between 1999 and 2012. In the 2000s, his foundation gave $100,000 to the Clinton Foundation, and he contributed $4,700 to Hillary Clinton’s senatorial campaigns. He even bought and refurbished a golf course in Westchester County a few miles from the Clinton home, in part, Trump once admitted, to ingratiate himself with the Clintons. Cohn is a registered Democrat who has given at least $275,000 to Democrats over the years, including to the campaigns of Hillary Clinton and Barack Obama, but also around $250,000 to Republicans, including Senate Majority Leader Mitch McConnell and Florida Sen. Marco Rubio.

There are also striking similarities in their business histories. Both have a knack for weathering scandals and setbacks and coming out on top. Trump has filed for bankruptcy four times, started a long list of failed businesses (casinos, an airline, a football team, a steak company), but managed, through his best-selling books and highly rated reality TV show, to recast himself as the world’s greatest businessman. During Cohn’s tenure as president, Goldman Sachs faced lawsuits and federal investigations that resulted in $9 billion in fines for misconduct in the run-up to the subprime meltdown. Goldman not only survived but thrived, posting record profits — and Cohn was rewarded with handsome bonuses and a position at the top of the new administration.

Cohn’s path to the White House started with a tale of brass and bluster that would make Trump the salesman proud. Still in his 20s and stuck selling aluminum siding, Cohn made a play that would change his life. In the fall of 1982, while visiting the company’s home office on Long Island, he stole a day from work and headed to the U.S. commodities exchange in Manhattan, hoping to talk himself into a job. He overheard an important-looking man say he was heading to LaGuardia Airport; Cohn blurted out that he was headed there, too. He jumped into a cab with the man and, Cohn told Gladwell, who devoted six pages of “David and Goliath” to Cohn’s underdog rise, “I lied all the way to the airport.” The man confided to Cohn that his firm had just put him in charge of a market, options, that he knew little about. Cohn likely knew even less, but he assured his backseat companion that he could get him up to speed. Cohn then spent the weekend reading and re-reading a book called “Options as a Strategic Investment.” Within the week, he’d been hired as the man’s assistant.

Cohn soon learned enough to venture off on his own and established himself as an independent silver trader on the floor of the New York Commodities Exchange. In 1990, Goldman Sachs, arguably the most elite firm on Wall Street, offered him a job.

The Goldman Sachs & Co. logo at the company’s booth on the floor of the New York Stock Exchange in New York City, on Friday, July 19, 2013.

Photo: Scott Eells/Bloomberg/Getty Images

Goldman Sachs was founded in the years just after the American Civil War. Marcus Goldman, a Jewish immigrant from Germany, leased a cellar office next to a coal chute in 1869. There, in an office one block from Wall Street, he bought the bad debt of local businesses that needed quick cash. His son-in-law, Samuel Sachs, joined the firm in 1882. A generation later, in 1906, the firm made its first mark, arranging for the public sale of shares in Sears, Roebuck. Goldman Sachs’s influence over politics dates back at least to 1914. That year, Henry Goldman, the founder’s son, was invited to advise Woodrow Wilson’s administration about the creation of a central bank, mandated by the Federal Reserve Act, which had passed the previous year. Goldman Sachs men have played important roles in U.S. government ever since.

There was the occasional scandal, such as Goldman Sachs’s role in the 1970 collapse of Penn Central railroad, then the largest corporate bankruptcy in U.S. history. Still, the firm built a reputation as a sober, elite partnership that served its clients ably. In 1979, when John Whitehead, a senior partner and co-chairman, set to paper what he called Goldman’s “Business Principles,” he began with the firm’s most cherished belief: The client’s interests come before all else.

Two years later, Goldman took a step that signaled the beginning of the end of that culture. In the fall of 1981, Goldman purchased J. Aron & Co., a commodities trading firm. Some within the partnership were against the acquisition, worried over how profane, often crude, trading culture would mix with Goldman’s restrained, well-mannered way of doing business. “We were street fighters,” one former J. Aron partner told Fortune magazine in 2008.

The J. Aron team moved into the Goldman Sachs offices in lower Manhattan, but didn’t adopt its culture. Within a few years, it was producing well over $1 billion a year in profits. They were 300 employees inside a firm of 6,000, but were posting one-third of Goldman’s total profits. The cultural shift, it turned out, was moving in the other direction. J. Aron, according to a book by Charles D. Ellis, a former Goldman consultant, brought to Goldman “a trading culture that would become dominant in the firm.”

Lloyd Blankfein, who ascended to chairman and CEO in in 2006, started his Goldman career at J. Aron, a year after Goldman acquired the firm. “We didn’t have the word ‘client’ or ‘customer’ at the old J. Aron,” Blankfein told Fortune magazine two years after taking over as CEO. “We had counter-parties.” Cohn joined J. Aron eight years after Blankfein did, in 1990. Four years later, Blankfein was put in charge of the firm’s Fixed Income, Currency, and Commodities division, which included J. Aron. Cohn, loyal and hard-working, with an instinct for connecting with people who can help him, became Blankfein’s “corporate problem solver.”

The emergence of “Bad Goldman” — and Cohn’s central role in that drama — is really the story of the rise of the traders inside the firm. “As trading came to be a bigger part of Wall Street, I noticed that the vision changed,” said Robert Kaplan, a former Goldman Sachs vice chairman, who left in 2006 after working at the firm for 23 years. “The leaders were saying the same words, but they started to change incentives away from the value-added vision and tilt more to making money first. If making money is your vision, what lengths will you not go?”

At the height of the dot-com years, a debate raged within the firm. The firm underwrote dozens of technology IPOs, including Microsoft and Yahoo, in the 1980s and 1990s, minting an untold number of multimillionaires and the occasional billionaire. Some of the companies they were bringing public generated no profits at all, while Goldman was generating up to $3 billion in profits a year. It seemed inevitable that some within Goldman Sachs began to dream of jettisoning the Goldman’s century-old partnership structure and taking their firm public, too. Jon Corzine was running the firm then — he would later go into politics in the Goldman tradition, first as a U.S. senator and then as New Jersey governor — and was four-square in favor of going public. Corzine’s second in command, Henry Paulson — who would go on to serve as Treasury secretary — was against the idea. But Corzine ordered up a study that supported his view that remaining private stifled Goldman’s competitive opportunities and promoted Paulson to co-senior partner. Paulson soon got on board. In May 1999, Goldman sold $3.7 billion worth of shares in the company. At the end of the first day of trading, Corzine’s and Paulson’s stakes in the firm were each worth $205 million. Cohn’s and Mnuchin’s shares were each worth $112 million. And Blankfein ended up with $168 million in company stock.

Like any publicly traded company, there would now be pressure on Goldman Sachs to make its quarterly numbers and “maximize shareholder value.” Discarding the partner model also meant the loss of a valuable restraint on risk-taking and bad behavior. Under the old system, any losses or fines came out of the partners’ pockets. In the early 1990s, for example, the firm was involved in transactions with Robert Maxwell, a London-based media mogul who was accused of stealing hundreds of millions of pounds from his companies’ pension funds. The $253 million that Goldman Sachs paid to settle lawsuits brought by pension funds over its involvement was split among the firm’s 84 limited partners. Now any losses are paid by a publicly traded entity owned by shareholders, with no direct financial liability for the decision-makers themselves. In theory, Goldman could claw back bonuses in response to executives’ bad behavior. But in 2016, when Goldman paid over $5 billion to settle charges brought by the Justice Department that the firm misled customers in the sale of a subprime mortgage product during Cohn’s time overseeing that unit, the Goldman board declined to dock Cohn’s pay. Instead, the company awarded him a $5.5 million cash bonus and another $12.6 million in company stock.

The Goldman Sachs Group Inc. executives, from right, Gary Cohn, president and co-chief operating officer, Lloyd Blankfein, chairman and chief executive officer, and Jon Winkelreid, president and co-chief operating officer, appear in a 2006 annual report arranged for a photograph in New York, on June 16, 2008.

Photo: Daniel Acker/Bloomberg/Getty Images

As Blankfein moved up the corporate hierarchy, Cohn rose along with him. When Blankfein was made vice chairman in charge of the firm’s multibillion-dollar global commodities business and its equities division, Cohn took over as co-head of FICC, Blankfein’s previous position. That meant Cohn was overseeing not just J. Aron and the firm’s commodities business, but also its currency trades and bond sales. By the start of 2004, Blankfein was promoted to president and COO, and Cohn was named co-head of global securities. At that point, Cohn had authority over the mortgage-trading desk. Under Cohn, the firm aggressively moved into the subprime mortgage market, using Goldman’s own money and that of its customers to help stoke the housing bubble.

Goldman was already enabling subprime predators, such as Ameriquest and New Century Financial, by providing them with the cash infusions they needed to scale up their lending to individual home buyers. Cohn would steer the firm deeper into the subprime frenzy by setting up Goldman as a patron of some of these same mortgage originators. During his tenure, Goldman snapped up loans from New Century, Countrywide, and other notorious mortgage originators and bundled them into deals with opaque names, such as ABACUS and GSAMP. Under Cohn’s watchful eye, Goldman’s brokers then funneled slices to customers they sold on the wisdom of holding mortgage-backed securities in their portfolios.

One such creation, GSAA Home Equity Trust 2006-2, illustrates Goldman’s disregard for the quality of loans it was buying and packaging into security deals. Created in early 2006, the investment vehicle was made up of more than $1 billion in home loans Goldman had bought from Ameriquest, one of the nation’s largest and most aggressive subprime lenders. By that point, the lender already had set aside $325 million to settle a probe by attorneys general and banking regulators in 49 states, who accused Ameriquest of misleading thousands of borrowers about the costs of their loans and falsifying home appraisals and other key documents. Yet GSAA Home Equity Trust 2006-2 was filled with Ameriquest loans made to more than 3,000 homeowners in Arizona, Illinois, Florida, and elsewhere. By the end of 2008, 65 percent of the roughly 1,400 borrowers whose loans remained in the deal were in default, had filed for bankruptcy, or had been targeted for foreclosure.

In just three years, Goldman Sachs had increased its trading volume by a factor of 50, which the Wall Street Journal attributed to “Cohn’s successful push to rev up risk-taking and use of Goldman’s own capital to make a profit” — what the industry calls proprietary trading, or prop trading. The 2010 Journal article quoted Justin Gmelich, then the firm’s mortgage chief, who said of Cohn, “He reshaped the culture of the mortgage department into more of a trading environment.” In 2005, with Cohn overseeing the firm’s home loan desk, Goldman underwrote $103 billion in mortgage-backed securities and other more esoteric products, such as collateralized debt obligations, which often were priced based on giant pools of home loans. The following year, the firm underwrote deals worth $131 billion.

In 2006, CEO Henry Paulson left the firm to join George W. Bush’s cabinet as Treasury secretary. Blankfein, Cohn’s mentor and friend, took Paulson’s place. By tradition, Blankfein, a trader, should have elevated someone from the investment banking side to serve as his No. 2, so both sides of the firm would be represented in the top leadership. Instead he named Cohn, his long-time loyalist, and Jon Winkelried, who also had history on the trading side, as co-presidents and co-COOs. Winkelried, who had started at Goldman eight years before Cohn, had probably earned the right to hold those titles by himself. But Cohn had the advantage of his relationship with the CEO. Blankfein and Cohn vacationed together in the Caribbean and Mexico, owned homes near each other in the Hamptons, and their children attended the same school. Winkelreid was out in two years. The bromance between his fellow No. 2 and the top boss may have proved too much.

With Blankfein and Cohn at the top, the transformation of Goldman Sachs was complete. By 2009, investment banking had shrunk to barely 10 percent of the firm’s revenues. Richard Marin, a former executive at Bear Stearns, a Goldman competitor that wouldn’t survive the mortgage meltdown, saw Cohn as “the root of the problem.” Explained Marin, “When you become arrogant in a trading sense, you begin to think that everybody’s a counterparty, not a customer, not a client. And as a counterparty, you’re allowed to rip their face off.”

Weeds grow in the driveway of a foreclosed home May 7, 2009 in Antioch, Calif.

Photo: Justin Sullivan/Getty Images

3. THE BIG SHORT

People inside Goldman Sachs were growing nervous. It was the fall of 2006 and, as Daniel Sparks, the Goldman partner overseeing the firm’s 400-person mortgage trading department, wrote in an email to several colleagues, “Subprime market getting hit hard.” The firm had lent millions to New Century, a mortgage lender dealing in the higher-risk subprime market. And now New Century was late on payments. Sparks could see that the wobbly housing market was having an impact on his department. For 10 consecutive trading days, his people had lost money. The dollar amounts were small to a behemoth like Goldman: between $5 million and $30 million a day. But the trend made Sparks jittery enough to share his concerns with the Goldman’s top executives: President Gary Cohn; David Viniar, the firm’s chief financial officer; and CEO Lloyd Blankfein.

Sparks, a Cohn protégé, was running the mortgage desk that his mentor, only a few years earlier, had built into a major profit center for the bank. In 2006 and 2007, a report by the Senate Permanent Subcommittee on Investigations found, the two “maintained frequent, direct contact” as Goldman worked to jettison the billions in subprime loans it had on its book. “One of my jobs at the time was to make sure Gary and David and Lloyd knew what was going on,” Sparks told William Cohan, author of the 2011 book “Money and Power: How Goldman Sachs Came to Rule the World.” “They don’t like surprises.” Viniar summoned around 20 traders and managers to a 30th floor conference room inside Goldman headquarters in lower Manhattan. It was there, on an unseasonably warm Thursday in December 2006, that the firm decided to initiate what people inside Goldman would eventually dub “the big short.”

One name tossed around during the three-hour meeting was that of John Paulson. Paulson (no relation to Goldman’s former CEO) would later attain infamy when it was revealed that his firm, Paulson & Co., made roughly $15 billion betting against the mortgage market. (His personal take was nearly $4 billion.) At that point, though, Paulson was a little-known hedge fund manager who crossed Goldman’s radar when he asked the firm to create a product that would allow him to take a “short position” on the real estate market — laying down bets that a large number of mortgage investments were going to plummet in value. Goldman sold Paulson what’s called a credit-default swap, essentially an insurance policy that would pay off if homeowners defaulted on their mortgages in large enough numbers. The firm would create several more swaps on his behalf in the intervening months. Eventually, as mortgage defaults began to mount, people inside Goldman Sachs came to see Paulson as more of a prophet than a patsy. Some sitting around the conference table that December day wanted to follow his lead.

“There will be big opportunities the next several months,” one Goldman manager at the meeting wrote enthusiastically in an email sent shortly after it ended. Sparks weighed in by email later that night. He wanted to make sure Goldman had enough “dry powder” — cash on hand — to be “ready for the good opportunities that are coming.” That Sunday, Sparks copied Cohn on an email reporting the firm’s progress on laying down short positions against mortgage-backed securities it had put together. The trading desk had already made $1.5 billion in short bets, “but still more work to do.”

Cohn was a member of Goldman’s board of directors during this critical time and second in command of the bank. At that point, Cohn and Blankfein, along with the board and other top executives, had several options. They might have shared their concerns about the mortgage market in a filing with the SEC, which requires publicly traded companies to reveal “triggering events that accelerate or increase a direct financial obligation” or might cause “impairments” to the bottom line. They might have warned clients who had invested in mortgage-backed securities to consider extracting themselves before they suffered too much financial damage. At the very least, Goldman could have stopped peddling mortgage-backed securities that its own mortgage trading desk suspected might soon collapse in value.

Instead, Cohn and his colleagues decided to take care of Goldman Sachs.

Goldman would not have suffered the reputational damage that it did — or paid multiple billions in federal fines — if the firm, anticipating the impending crisis, had merely shorted the housing market in the hopes of making billions. That is what investment banks do: spot ways to make money that others don’t see. The money managers and traders featured in the film “The Big Short” did the same — and they were cast as brave contrarians. Yet unlike the investors featured in the film, Goldman had itself helped inflate the housing bubble — buying tens of billions of dollars in subprime mortgages over the previous several years for bundling into bonds they sold to investors. And unlike these investors, Goldman’s people were not warning anyone who would listen about the disaster about to hit. As federal investigations found, the firm, which still claims “our clients’ interests always come first” as a core principle, failed to disclose that its top people saw disaster in the very products its salespeople were continuing to hawk.

Goldman still held billions of mortgages on its books in December 2006 — mortgages that Cohn and other Goldman executives suspected would soon be worth much less than the firm had paid for them. So, while Cohn was overseeing one team inside Goldman Sachs preoccupied with implementing the big short, he was in regular contact with others scrambling to offload its subprime inventory. One Goldman trader described the mortgage-backed securities they were selling as “shitty.” Another complained in an email that they were being asked to “distribute junk that nobody was dumb enough to take first time around.” A December 28 email from Fabrice “Fabulous Fab” Tourre, a Goldman vice president later convicted of fraud, instructed traders to focus on less astute, “buy and hold” investors rather than “sophisticated hedge funds” that “will be on the same side of the trade as we will.”

Gary Cohn, president and chief operating officer of Goldman Sachs Group Inc. (R) and Craig Broderick, managing director and head of credit, market and operational risk with Goldman Sachs, during a Financial Crisis Inquiry Commission hearing on the role of derivatives in the financial crisis, on June 30, 2010.

Photo: Andrew Harrer/Bloomberg/Getty Images

At Goldman Sachs, Cohn was known as a hands-on boss who made it his business to walk the floors, talking directly with traders and risk managers scattered throughout the firm. “Blankfein’s role has always been the salesperson and big-thinker conceptualizer,” said Dick Bove, a veteran Wall Street analyst who has covered Goldman Sachs for decades. “Gary was the guy dealing with the day-to-day operations. Gary was running the company.” While making his rounds, Cohn would sometimes hike a leg up on a trader’s desk, his crotch practically in the person’s face.

At 6-foot- 2, bullet-headed and bald with a heavy jaw and a fighter’s face, Cohn cut a large figure inside Goldman. Profiles over the years would describe him as aggressive, abrasive, gruff, domineering — the firm’s “attack dog.” He was the missile Blankfein launched when he needed to deliver bad news or enforce discipline. Cohn embodied the new Goldman: the man who would run through a brick wall if it meant a big payoff for the bank.

A Bloomberg profile described his typical day as 11 or 12 hours in the office, a bank-related dinner, then phone calls and emails until midnight. “The old adage that hard work will get you what you want is 100 percent true,” Cohn said in a 2009 commencement address at American University. “Work hard, ask questions, and take risk.”

There’s no record of how often Cohn visited his stomping grounds after hours in the early months of 2007, but emails reveal an executive demanding — and getting — regular updates. On February 7, one of the largest originators of subprime loans, HSBC, reported a greater than anticipated rise in troubled loans in its portfolio, and another, New Century, restated its earnings for the previous three quarters to “correct errors.” Sparks wrote an email to Cohn and others the next morning to reassure them that his team was closely monitoring the pricing of the company’s “scratch-and-dent book” and already had a handle on which loans were defaults and which could still be securitized and offloaded onto customers. An impatient Cohn sent a two-word email at 5 o’clock that evening: “Any update?” The next day, an internal memo circulated that listed dozens of mortgage-backed securities with the exhortation, “Let all of the respective desks know how we can be helpful in moving these bonds.” A week later, Sparks updated Cohn on the billions in shorts his firm had bought but warned that it was hurting sales of its “pipeline of CDOs,” the collateralized debt obligations the firm had created in order to sell the mortgages still on its books.

In early March, Cohn was among those who received an email spelling out the mortgage products the firm still held. The stockpile included $1.7 billion in mortgage-related securities, along with $1.3 billion in subprime home loans and $4.3 billion in “Alt-A” loans that fall between prime and subprime on the risk scale. Goldman was “net short,” according to that same email, with $13 billion in short positions, but its exposure to the mortgage market was still considerable. Sparks and others continued to update Cohn on their success offloading securities backed by subprime mortgages through the third quarter of 2007. One product Goldman priced at $94 a share on March 31, 2007 was worth just $15 five months later. Pension funds and insurance companies were among those losing billions of dollars on securities Goldman put together and endorsed as a safe, AAA-rated investments.

U.S. Treasury Secretary Henry M. Paulson steps off the stage Dec. 6, 2007 after a press conference on subprime mortgage loans at the Treasury Department in Washington, D.C.

Photo: Mandel Ngan/AFP/Getty Images

The third quarter of 2007 was ugly. A pair of Bear Stearns hedge funds failed. Merrill Lynch reported $2.2 billion in losses — its largest quarterly loss ever. Merrill’s CEO warned that the bank faced another $8 billion in potential losses due to the firm’s exposure to subprime mortgages and resigned several weeks later. The roiling credit crisis also took down the CEO of Citigroup, which reported $6.5 billion in losses and then weeks later, warned of $8 billion to $11 billion in additional subprime-related write-downs.

And then there was Goldman Sachs, which reported a $2.9 billion profit that quarter. For the moment, the financial press seemed in awe of Blankfein, Cohn, and the rest of the team running the firm. Fortune headlined an article “How Goldman Sachs Defies Gravity” that said Goldman’s “huge, shrewd bet” against the mortgage market “would seem to confirm the view Goldman is the nimblest, and perhaps the smartest, brokerage on Wall Street.” A Goldman press release drily noted that “significant losses” in some areas — the subprime mortgages it hadn’t managed to unload — had been “more than offset by gains on short mortgage products.” A Goldman trader who played a central role in the big short was not so demure when making the case for a big bonus that year. John Paulson was “definitely the man in this space,” he conceded, but he’d helped make Goldman “#1 on the street by a wide margin.”

Disaster struck nine months into 2008 with the collapse of Lehman Brothers, in large part the result of its exposure to subprime losses. Hank Paulson, the Treasury secretary and former Goldman CEO, spent a weekend meeting with would-be suitors willing to take over a storied bank that on paper was now worth virtually nothing. He couldn’t find a buyer. Nor could officials from the Federal Reserve, who were also working overtime to save the investment bank, founded in 1850, that was even older than Goldman Sachs. Shortly after midnight on Monday, September 15, 2008, Lehman announced that it would file for bankruptcy protection when the courts in New York opened that morning — the largest bankruptcy in U.S. history.

Goldman Sachs wasn’t immune from the crisis. The week before Lehman’s fall, Goldman’s stock had topped $161 a share. By Wednesday, it dropped to below $100. It had avoided some big losses by betting against the mortgage market, but the wider financial crisis was wreaking havoc on its other investments. On paper, Cohn had personally lost tens of millions of dollars. He hunkered down in an office with a view of Goldman’s trading floor and worked the phone, trying to change the minds of major investors who were pulling their money from Goldman, fearful of anything riskier than stashing their cash in a mattress.

The next week, Goldman converted from a free-standing investment bank to a bank holding company, which made it, in the eyes of regulators, no different from Wells Fargo, JPMorgan Chase, or any other retail bank. That gave the firm access to cheap capital through the Fed but would also bring increased scrutiny from regulators. The bank took a $10 billion bailout from the Troubled Asset Relief Program and another $5 billion from Warren Buffett, in return for an annual dividend of 10 percent and access to discounted company stock. The firm raised additional billions through a public stock offering.

The biggest threat to Goldman was the economic health of the American International Group. Among other products, AIG sold insurance to protect against defaults on mortgage assets, which had been central to Goldman’s big short. Of the $80 billion in U.S. mortgage assets that AIG insured during the housing bubble, Goldman bought protection from AIG on roughly $33 billion, according to the Wall Street Journal. When Lehman went into bankruptcy, its creditors received 11 cents on the dollar. Executives at AIG, in a frantic effort to avoid bankruptcy, had floated the idea of pushing its creditors to accept 40 to 60 cents on the dollar; there was speculation creditors like Goldman would receive as little as 25 percent. Goldman and its clients were looking at multibillion-dollar hits to their bottom line — a potentially fatal blow.

But as Goldman learned a century ago, it pays to have friends in high places. The day after Lehman went bankrupt, the Bush administration announced an $85 billion bailout of AIG in return for a majority stake in the company. The next day, Paulson obtained a waiver regarding interactions with his former firm because, the Treasury secretary said, “It became clear that we had some very significant issues with Goldman Sachs.” Paulson’s calendar, the New York Times reported, showed that the week of the AIG bailout, he and Blankfein spoke two dozen times. While creditors around the globe were being forced to settle for much less than they were owed, AIG paid its counterparties 100 cents on the dollar. AIG ended up being the single largest private recipient of TARP funding. It received additional billions in rescue funds from the New York Federal Reserve Bank, whose board chair Stephen Friedman was a former Goldman executive who still sat on the firm’s board. The U.S. Treasury ended up with greater than a 90 percent share of AIG, and the U.S. government, using taxpayer dollars, paid in full on the insurance policies financial institutions bought to protect themselves from steep declines in real estate prices — chief among them, Goldman Sachs. All told, Goldman received at least $22.9 billion in public bailouts, including $10 billion in TARP funds and $12.9 billion in taxpayer-funded payments from AIG.

Goldman, once again, had come out on top.

Goldman Sachs Group Inc. headquarters stands in New York City, on Oct. 12, 2016.

Photo: Mark Kauzlarich/Bloomberg/Getty Images

4. THE VAMPIRE SQUID

Goldman Sachs repaid repaid its $10 billion bailout partway through 2009, less than 12 months after the loan was made. Other banks in the U.S. and abroad were still struggling but not Goldman, which reported a record $19.8 billion in pre-tax profits that year, and $12.9 billion the next. Gary Cohn went without a bonus in 2008, left to scrape by on his $600,000 salary. Once free of government interference, the Goldman board (which included Cohn himself) paid him a $9 million bonus in 2009 and an $18 million bonus in 2010.

Yet the once venerated firm was now the subject of jokes on the late-night talk shows. David Letterman broadcast a “Goldman Sachs Top 10 Excuses” list (No. 9: “You’re saying ‘fraud’ like it’s a bad thing.”). Rolling Stone’s Matt Taibbi described the bank as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money,” a devastating moniker that followed Goldman into the business pages. After news leaked that the firm might pay its people a record $16.7 billion in bonuses in 2009, even President Barack Obama, for whom the firm had been a top campaign donor, began to turn against Goldman, telling “60 Minutes,” “I did not run for office to be helping out a bunch of fat-cat bankers on Wall Street.”

“They’re still puzzled why is it that people are mad at the banks,” Obama said. “Well, let’s see. You guys are drawing down $10, $20 million bonuses after America went through the worst economic year that it’s gone through in decades, and you guys caused the problem.”

Goldman was also facing an onslaught of investigations and lawsuits over behavior that had helped precipitate the financial crisis. Class actions and other lawsuits filed by pension funds and other investors accused Goldman of abusing their trust, making “false and misleading statements,” and failing to conduct basic due diligence on the loans underlying the products it peddled. At least 25 of these suits named Cohn as a defendant.

State and federal regulators joined the fray. The SEC accused Goldman of deception in its marketing of opaque investments called “synthetic collateralized debt obligations,” the values of which were tied to bundles of actual mortgages. These were the deals Goldman had arranged in 2006 on behalf of John Paulson so he could short the U.S. housing market. Goldman, it turned out, had allowed Paulson to cherry-pick poor-quality loans at the greatest risk of defaulting — a fact Goldman did not share with potential investors. “Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio,” the SEC’s enforcement director at the time said, “telling other investors that the securities were selected by an independent, objective third party.”

Suddenly, Cohn and other Goldman officials were downplaying the big short. In June 2010, Cohn testified before the Financial Crisis Inquiry Commission, created by Congress to investigate the causes of the nation’s worst economic collapse since the Great Depression. Cohn asked the commissioners how anyone could claim the firm had bet against its clients when “during the two years of the financial crisis, Goldman Sachs lost $1.2 billion in its residential mortgage-related business”? His statement was technically true, but Cohn failed to mention the billions of dollars the firm pocketed by betting the mortgage market would collapse. Senate investigators later calculated that, at its peak, Goldman had $13.9 billion in short positions that would only pay off in the event of a steep drop in the mortgage market, positions that produced a record $3.7 billion in profits.

Two weeks after Cohn’s testimony, Goldman agreed to pay the SEC $550 million to settle charges of securities fraud — then the largest penalty assessed against a financial services firm in the agency’s history. Goldman admitted no wrongdoing, acknowledging only that its marketing materials “contained incomplete information.” Goldman paid $60 million in fines and restitution to settle an investigation by the Massachusetts attorney general into the financial backing the firm had offered to predatory mortgage lenders. The bank set aside another $330 million to assist people who lost their homes thanks to questionable foreclosure practices at a Goldman loan-servicing subsidiary. Goldman agreed to billions of dollars in additional settlements with state and federal agencies relating to its sale of dicey mortgage-backed securities. The firm finally acknowledged that it had failed to conduct basic due diligence on the loans its was selling customers and, once it became aware of the hazards, did not disclose them.

In the final report produced by the Senate’s Permanent Subcommittee on Investigations, Goldman Sachs was mentioned an extraordinary 2,495 times, and Gary Cohn 89 times. A Goldman Sachs representative declined to respond to queries on the record.

President Barack Obama with Sen. Christopher Dodd, D-Conn., (C) and Rep. Barney Frank, D-Mass., (C-R) after signing the Dodd-Frank Act in Washington, July 21, 2010.

Photo: Doug Mills/The New York Times/Redux

The investigations and fines were a blow to Goldman’s reputation and its bottom line, but the regulatory reforms being debated had the potential to threaten Goldman’s entire business model. Even before the 2008 crash, the firm’s lobbying spending had grown under Lloyd Blankfein and Cohn. By 2010, the year financial reforms were being drafted, Goldman spent $4.6 million for the services of 49 lobbyists. Their ranks included some of the most well-connected figures in Washington, including Democrat Richard Gephardt, a former House majority leader, and Republican Trent Lott, a former Senate majority leader, who had stepped down from the Senate two years earlier.

Despite all those lobbyists on the payroll, Goldman made its case primarily through proxies during the debate over financial reform. “The name Goldman Sachs was so radioactive it worked to their disadvantage to be tied to an issue,” said Marcus Stanley, then a staffer for Democratic Sen. Barbara Boxer and now policy director of Americans for Financial Reform. Instead, Goldman lobbied through industry groups.

Goldman’s people likely knew that all of Wall Street’s lobbying might could not stop the passage of the sprawling 2010 legislative package dubbed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Obama was putting his muscle behind reform — “We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge, risky bets that are subsidized by taxpayers,” he said in one speech — and the Democrats enjoyed majorities in both houses of Congress. “For Goldman Sachs, the battle was over the final language,” said Dennis Kelleher of Better Markets, a Washington, D.C., lobby group that pushes for tighter financial reforms. “That way they at least had a fighting chance in the next round, when everyone turned their attention to the regulators.”

There was a lot for Goldman Sachs to dislike about Dodd-Frank. There were small annoyances, such as “say on pay,” which ordered companies to give shareholders input on executive compensation, a source of potential embarrassment to a company that gave out $73 million in compensation for a single year’s work — as Goldman paid Cohn in 2007. There were large annoyances, such as the requirement that financial institutions deemed too big to fail, like Goldman, create a wind-down plan in case of disaster. There were the measures that would interfere with Goldman’s core businesses, such as a provision instructing the Commodity Futures Trading Commission to regulate the trading of derivatives. And yet nothing mattered to Goldman quite like the Volcker Rule, which would protect banks’ solvency by limiting their freedom to make speculative trades with their own money. Unless Goldman could initiate what Stanley called the “complexity two-step” — win a carve-out so a new rule wouldn’t interfere with legitimate business and then use that carve-out to render a rule toothless — Volcker would slam the door shut on the entire direction in which Blankfein and Cohn had taken Goldman.

It was 5:30 a.m. on Friday, June 25, 2010, when a joint House-Senate conference committee approved the final language of Dodd-Frank. By Sunday, an industry attorney named Annette Nazareth — a former top SEC official whose firm counts Goldman Sachs among its clients — had already sent off a heavily annotated copy of the 848-page bill to colleagues at her old agency. It was just the first salvo in a lobbying juggernaut.

Within a few months, Cohn himself was in Washington to meet with a governor of the Federal Reserve, one of the key agencies charged with implementing Volcker. The visitors log at the CFTC, the agency Dodd-Frank put in charge of derivatives reform, shows that Cohn traveled to D.C. to personally meet with CFTC staffers at least six times between 2010 and 2016. Cohn also came to the capital for meetings at the SEC, another agency responsible for the Volcker Rule. There, he met with SEC chair Mary Jo White and other commissioners. “I seem to be in Washington every week trying to explain to them the unintended consequences of overregulation,” Cohn said in a talk he gave to business students at Sacred Heart University in 2015.

“Gary was the tip of the spear for Goldman to beat back regulatory reform,” said Kelleher, the financial reform lobbyist. “I used to pass him going into different agencies. They brought him in when they wanted the big gun to finish off, to kill the wounded.”

Democrats lost their majority in the House that November, and Goldman threw its weight behind the spate of Republican bills that followed, aimed at taking apart Dodd-Frank piece by piece. Goldman spent more than $4 million for the services of 45 lobbyists in 2011 and $3.5 million a year in 2012 and 2013. Its lobbying spending was nearly as high in the years after passage of Dodd-Frank as it was the year the bill was introduced.

Goldman lobbyists dug in on a range of issues that would become top priorities for Republicans in the wake of Donald Trump’s electoral victory. Records from the Center for Responsive Politics show that Goldman lobbyists worked to promote corporate tax cuts, such as on the Tax Increase Prevention Act of 2014 and Senate legislation aimed at extending some $200 billion in tax cuts for individuals and businesses. Goldman lobbied for a bill to fund economically critical infrastructure projects, presumably on behalf of its Public Sector and Infrastructure group. Goldman had seven lobbyists working on the JOBS Act, which would make it easier for companies to go public, another bottom-line issue to a company that underwrote $27 billion in IPOs last year. In 2016, Goldman had eight lobbyists dedicated to the Financial CHOICE Act, which would have undone most of Dodd-Frank in one fell swoop — a bill the House revived in April.

Yet defanging the Volcker Rule remained the firm’s top priority. Promoted by former Fed Chair Paul Volcker, the rule would prohibit banks from committing more than 3 percent of their core assets to in-house private equity and hedge funds in the business of buying up properties and businesses with the goal of selling them at a profit. One harbinger of the financial crisis had been the collapse in the summer of 2007 of a pair of Bear Stearns hedge funds that had invested heavily in subprime loans. That 3 percent cap would have had a big impact on Goldman, which maintained a separate private equity group and operated its own internal hedge funds. But it was the restrictions Volcker placed on proprietary trading that most threatened Goldman.

Prop trading was a profit center inside many large banks, but nowhere was it as critical as at Goldman. A 2011 report by one Wall Street analyst revealed that prop trading accounted for an 8 percent share of JPMorgan Chase’s annual revenues, 9 percent of Bank of America’s, and 27 percent of Morgan Stanley’s. But prop trading made up 48 percent of Goldman’s. By one estimate, the Volcker Rule could cost Goldman Sachs $3.7 billion in revenue a year.

When regulators finalized a new Volcker Rule in 2013, Better Markets declared it a “major defeat for Wall Street.” Yet the victory for reformers was precarious. “Just changing a few words could dramatically change the scope of the rule — to the tune of billions of dollars for some firms,” said former Senate staffer Tyler Gellasch, who helped write the rule. Volcker gave banks until July 2015 — the five-year anniversary of Dodd-Frank — to bring themselves into compliance. Yet apparently the Volcker Rule had been written for other financial institutions, not elite firms like Goldman Sachs. “Goldman Sachs has been on a shopping spree with its own money,” began a New York Times article in January 2015. The bank used its own funds to buy a mall in Utah, apartments in Spain, and a European ink company. Paul Volcker expressed disappointment that banks were still making big proprietary bets, as did the two senators most responsible for writing the rule into law. That June, Cohn appeared to reassure investors that Goldman would find a workaround. Speaking at an investor conference, he said Goldman was “transforming our equity investing activities to continue to meet client needs while complying with Volcker.”

Goldman had five years to prepare for some version of a Volcker Rule. Yet a loophole granted banks sufficient time to dispose of “illiquid assets” without causing undue harm — a loophole that might even cover the assets Goldman had only recently purchased, despite the impending compliance deadline. The Fed nonetheless granted the firm additional time to sell illiquid investments worth billions of dollars. “Goldman is brilliant at exercising access and influence without fingerprints,” Kelleher said.

By mid-2016, Goldman, along with Morgan Stanley and JPMorgan Chase, was petitioning the Fed for an additional five years to comply with Volcker — which would take the banks well into a new administration. All Blankfein and Cohn had to do was wait for a new Congress and a new president who might back their efforts to flush all of Dodd-Frank. Then Goldman could continue the risky and lucrative habits it had adopted since traders like Cohn had taken over the firm — the financial crisis be damned — and continue raking in billions in profits each year.

Lloyd Blankfein, chair and CEO of Goldman Sachs, (L) stands on stage with former U.S. Secretary of State Hillary Clinton during the 2014 Clinton Global Initiative annual meeting in New York on Sept. 24, 2014.

Photo: Stephen Chernin/AFP/Getty Images

Goldman’s political giving changed in the wake of Dodd-Frank. Dating back to at least 1990, according to the Center for Responsive Politics, people associated with the firm and its political action committees contributed more to Democrats than Republicans. Yet in the years since financial reform, Goldman, once Obama’s second-largest political donor, shifted its campaign contributions to Republicans. During the 2008 election cycle, for instance, Goldman’s people and PACs contributed $4.8 million to Democrats and $1.7 million to Republicans. By the 2012 cycle, the opposite happened, with Goldman giving $5.6 million to Republicans and $1.8 million to Democrats. Cohn’s personal giving followed the same path. Cohn gave $26,700 to the Democratic Senatorial Campaign Committee in 2006 and $55,500 during the 2008 election cycle, and none to its GOP equivalent. But Cohn donated $30,800 to the National Republican Senatorial Committee in 2012 and another $33,400 to the National Republican Congressional Committee in 2015, without contributing a dime to the DSCC. Cohn gave $5,000 to Massachusetts Republican Scott Brown weeks after news broke that Elizabeth Warren — an outspoken critic of Goldman and other Wall Street players — might try to capture his U.S. Senate seat, which she did in 2012.

Goldman Sachs, under Cohn and Blankfein, was hardly chastened, continuing to play fast and loose with existing rules even as it plunged millions of dollars into fending off new ones. In 2010, the SEC ran a sting operation looking for banks willing to trade favorable assessments by its stock analysts for a piece of a Toys R Us IPO if the company went public. Goldman took the bait, for which they would pay a $5 million fine. An employee working out of Goldman’s Boston office drafted speeches, vetted a running mate, and negotiated campaign contracts for the state treasurer during his run for Massachusetts governor in 2010, despite a rule forbidding municipal bond dealers from making significant political contributions to officials who can award them business. According to the SEC, Goldman had underwritten $9 billion in bonds for Massachusetts in the previous two years, generating $7.5 million in fees. Goldman paid $12 million to settle the matter in 2012.

Just two years later, Goldman officials were again summoned by the Senate Permanent Subcommittee on Investigations to address charges that the bank under Cohn and Blankfein had boosted its profits by building a “virtual monopoly” in order to inflate aluminum prices by as much as $3 billion.

The last few years have brought more unwanted attention. In 2015, the U.S. Justice Department launched an investigation into Goldman’s role in the alleged theft of billions of dollars from a development fund the firm had helped create for the government of Malaysia. Federal regulators in New York state fined Goldman $50 million because its leaders failed to effectively supervise a banker who leaked stolen confidential government information from the Fed, which hit the firm with another $36.3 million in penalties. In December, the CFTC fined Goldman $120 million for trying to rig interest rates to profit the firm.

Politically, 2016 would prove a strange year for Goldman. Bernie Sanders clobbered Hillary Clinton for pocketing hundreds of thousands of dollars in speaking fees from Goldman, while Trump attacked Ted Cruz for being “in bed with” Goldman Sachs. (Cruz’s wife Heidi was a managing director in Goldman’s Houston office until she took leave to work on her husband’s presidential campaign.) Goldman would have “total control” over Clinton, Trump said at a February 2016 rally, a point his campaign reinforced in a two-minute ad that ran the weekend before Election Day. An image of Blankfein flashed across the screen as Trump warned about the global forces that “robbed our working class.”

Goldman’s giving in the presidential race appears to reflect polls predicting a Clinton win and the firm’s desire for a political restart on deregulation. People who identified themselves as Goldman Sachs employees gave less than $5,000 to the Trump campaign compared to the $341,000 that the firm’s people and PACs contributed to Clinton. Goldman Sachs is relatively small compared to retail banking giants.

Yet, according to the Center for Responsive Politics, no bank outspent Goldman Sachs during the 2016 political cycle. Its PACs and people associated with the firm made $5.6 million in political contributions in 2015 and 2016. Even including all donations to Clinton, 62 percent of Goldman’s giving ended up in the coffers of Republican candidates, parties, or conservative outside groups.

President Donald Trump speaks to community bankers as Director of the National Economic Council Gary Cohn (2nd R) and White House Chief of Staff Reince Priebus (R) listen during an event at the Kennedy Garden of the White House on May 1, 2017 in Washington, D.C.

Photo: Alex Wong/Getty Images

5. TROJAN HORSE

There’s ultimately no great mystery why Donald Trump selected Gary Cohn for a top post in his administration, despite his angry rhetoric about Goldman Sachs. There’s the high regard the president holds for anyone who is rich — and the instant legitimacy Cohn conferred upon the administration within business circles. Cohn’s appointment reassured bond markets about the unpredictable new president and lent his administration credibility it lacked among Fortune 100 CEOs, none of whom had donated to his campaign. Ego may also have played a role. Goldman Sachs would never do business with Trump, the developer who resorted to foreign banks and second-tier lenders to bankroll his projects. Now Goldman’s president would be among those serving in his royal court.

Who can say precisely why Cohn, a Democrat, said yes when Trump asked him to be his top economic aide? No doubt Cohn has been asking himself that question in recent weeks. But he’d hit a ceiling at Goldman Sachs. In September 2015, Goldman announced that Blankfein had lymphoma, ramping up speculation that Cohn would take over the firm. Yet four months later, after undergoing chemotherapy, Blankfein was back in his office and plainly not going anywhere. Cohn was 56 years old when he was invited to Trump Tower. An influential job inside the White House meant a face-saving exit — and one offering a huge financial advantage.

Trump spoke of the great financial price Cohn paid to join him in the White House during his speech in Cedar Rapids. But something like the opposite was true. A huge amount of Cohn’s wealth was tied up in Goldman stock. By entering government, he could sell his stake in the firm to comply with federal ethics laws. That way he could diversify his holdings and avoid roughly $50 million in capital gains taxes —  at least until he sold the replacement assets.

A job in the White House might also prove an outlet for his frustrations with politicians and regulators intent on reining in the worst impulses of Wall Street. Trump was Trump, but he had also vowed to dismantle financial reform. “Dodd-Frank has made it impossible for bankers to function,” Trump said during the campaign. The new president had the potential to serve as a vessel for Goldman’s corporate interests.

“Maybe the one thing that holds this administration together is a belief that markets know best, and the least regulation is the best regulation,” said Dennis Kelleher of Better Markets. “Goldman’s interests fit with that very nicely.”

U.S. Treasury Secretary Steven Mnuchin testifies before the House Appropriations Committee’s Financial Services and General Government Subcommittee in the Rayburn House Office Building on Capitol Hill on June 12, 2017 in Washington, D.C.

Photo: Chip Somodevilla/Getty Images

Trump had given Steve Mnuchin, his campaign finance chair, the grander title. But taking over as Treasury secretary meant being confirmed by the Senate. Mnuchin’s confirmation vote was delayed after it was revealed that he’d neglected to list $95 million in assets (including homes in New York, Los Angeles, and the Hamptons) on his Senate Finance Committee disclosure forms and failed to disclose his ties to an offshore hedge fund registered in the Cayman Islands. Mnuchin was not confirmed until mid-February. The president’s pick for commerce secretary, Wilbur Ross, a financier who had bailed out several of Trump’s casinos a few decades earlier, was not confirmed until the end of February.

As a presidential aide, Cohn did not need Senate approval. He was part of the skeletal crew that arrived at the White House on day one, giving him a critical head start on wielding his clout and cultivating his relationship with the new president. At that point, Trump was summoning Cohn to the Oval Office for impromptu meetings as many as five times a day.

In early February, Trump signed an executive order giving his Treasury secretary 120 days to give him a hit list of regulations the administration could eliminate. But with Mnuchin yet to be confirmed, the task appeared to land in Cohn’s eager hands. He was standing at the president’s shoulder when Trump said, “We expect to be cutting a lot out of Dodd-Frank.” Shares in Goldman Sachs, which had jumped by 28 percent after the election, rose another $6 a share that day. Soon Cohn was coordinating Trump’s plans not only for rolling back regulations, but also for creating jobs and slashing taxes. He met with a health care specialist, along with House Speaker Paul Ryan and other Republican leaders, to discuss alternatives to the Affordable Care Act.

Proximity is power inside any White House, especially in this one, where policy often seems shaped by Trump’s last conversation. Treasury is several blocks away, while Cohn’s office was in the West Wing, directly across the hall from Bannon’s. Operating within a chaotic administration, Cohn was reportedly energized and focused, working around the clock. Cohn is a tenacious practitioner who, after ascending to the heights of Goldman Sachs, could teach a master class on the art of seizing a leadership vacuum and building alliances. On day 39 of the new administration, the White House sent out a press release introducing the “best-in-class team” Cohn had assembled “to drive President Trump’s bold plan for job creation and economic growth.” The 13 advisers included familiar figures who had worked for George W. Bush or his father, but they also included at least three former lobbyists so conflicted they would need an ethics waiver to work in the White House. For instance, Michael Catanzaro, the man Cohn chose to oversee energy policy, was until last year a lobbyist for such oil, gas, and coal companies as Devon Energy and Talen Energy. Shahira Knight had been a lobbyist for Fidelity, the mutual fund giant, before joining Cohn’s team.

Cohn’s strategy in those early months was to make himself indispensable to the new president. Cohn emerged as one of the few people around Trump comfortable interrupting him during a meeting or openly disagreeing on points of policy. The New York Times reported that Trump often turned to Cohn during a meeting and asked him directly, “What do you want to do?” Early on, Trump referred to Cohn as “one of my geniuses” — a quote Reuters attributed to a “source close to Cohn.”

Soon, major media were painting Cohn as a leading centrist inside the Trump White House because he had staked out positions on immigration, international alliances, and global warming at odds with Bannon’s hard-right nationalism. Bannon and his allies only bolstered this narrative by characterizing “Carbon Tax Cohn” and his allies, Jared Kushner and Ivanka Trump, as interlopers — “the Democrats,” as some inside the White House called them. “Within Trump’s Inner Circle, a Moderate Voice Captures the President’s Ear,” read the headline of a Cohn profile in the Washington Post.

“Led by Gary Cohn and Dina Powell — two former Goldman Sachs executives often aligned with Trump’s elder daughter and his son-in-law — the group and its broad network of allies are the targets of suspicion, loathing and jealousy from their more ideological West Wing colleagues,” the Washington Post reported. Fueling the rage of the ideologues, Cohn and his allies were largely winning. Trump dropped Bannon from the National Security Council and elevated Powell to deputy national security adviser. When, after Charlottesville, false reports leaked that Cohn was so disgusted with the president he was resigning, blue-chip stocks slid down. Instead, Bannon was out. Cohn, despite reports that he invoked Trump’s wrath for critical remarks to the Financial Times, was still in and expected to deliver the president a win on corporate taxes.

National Economic Council Director Gary Cohn arrives at a Wall Street heliport while traveling with President Donald Trump on May 4, 2017 in New York City.

Photo: Brendan Smialowski/AFP/Getty Images

On the day it was announced that he was joining the Trump administration, Cohn said on a goodbye podcast for Goldman Sachs, “You look at the size of our capital. You look at the size of our balance sheet. You look at the size of our people — it’s just enormous.” More than $40 billion had flowed into the bank in 2016, bringing the bank’s assets under management to a record $1.38 trillion. That meant pressure to find ways to put that money to work — an enormous challenge if regulators finally shut down Goldman’s prop trading arm.

How exactly could Cohn recuse himself from matters involving Goldman when almost every aspect of his job has the potential to either grow Goldman’s profits and inflate its stock price — or tank them both?

“To the extent Goldman Sachs is a direct party in a matter, Gary will recuse himself,” a source familiar with the situation said. But, the source added, “As NEC director, Gary is going to touch on matters on the day-to-day economy as a whole and Goldman Sachs is a participant in the economy, thus Gary will indirectly touch on things that affect Goldman Sachs along with other banks and institutions.”

Yet rather than publicly recuse himself on attempts to undo Dodd-Frank, Cohn has led the charge from inside the White House. On that matter, Cohn is a walking, talking conflict of interest.

While at Goldman, Cohn had personally met with officials at the Commodity Futures Trading Commission to discuss the derivatives reform plank of Dodd-Frank, an arena in which Goldman is a dominant player. He had taken issue with rules imposed by Dodd-Frank that require banks to keep more capital on hand. Requiring banks to hold more money in reserve made them “unequivocally” safer than before 2008, he said in a 2015 interview while still Goldman’s president, but he complained that Goldman was now able to lend less money, hurting profits. And then there’s the Volcker Rule. Cohn, while still president of the firm, had traveled to D.C. at least twice to personally lobby regulators about its implementation.

These days, it can be hard to tell whether Cohn is speaking as a high-ranking White House official or a former Goldman Sachs executive.

In the wake of Trump’s February call for a rollback in financial regulations, Cohn vowed in an interview with Bloomberg TV, “We’re going to attack all aspects of Dodd-Frank.” The first example he gave: the Volcker Rule, which he cast as harmful to the country’s competitive advantage. In an interview that same day with Fox Business, he homed in on another Goldman obsession: Dodd-Frank’s capital requirements. “Banks are forced to hoard money because they are forced to hoard capital, and they can’t take any risks,” he said. Mortgage, auto, credit card lending, and commercial lending are all up since 2010. Yet Cohn told Fox viewers, “We need to get banks back in the lending business, that’s our No. 1 objective.”

Roy Smith, a former Goldman partner now teaching at the NYU Stern School of Business, argues that Cohn should avoid the administration’s effort to unwind Dodd-Frank altogether, but “at a very minimum he has to excuse himself whenever the discussion turns to Volcker.” But Smith said he has trouble imagining Cohn leaving the room when Volcker comes up. “The hard part for someone like Cohn is that he knows where all the pain points are with Volcker and other parts of Dodd-Frank,” Smith said. “His every instinct would be to get involved.”

Beyond deregulation, two other pillars of Trump’s economic plan — cutting taxes and investing in infrastructure — would have dramatic impacts on Goldman’s bottom line.

Thanks to loopholes, many Fortune 500 corporations pay little or no corporate income tax at all. By contrast, Goldman Sachs typically pays taxes near the official 35 percent federal tax rate. In 2014, for instance, Goldman paid $3.9 billion in taxes on profits of $12.4 billion, or 31 percent. Last year, the firm’s tax bill was $2.7 billion on profits of $10.3 billion, or 28 percent. In that same Fox Business interview, Cohn said that “lower corporate taxes” was the White House’s “starting point” on tax reform; cuts to personal income taxes were a secondary concern.

Under the plan Cohn and Mnuchin announced last spring, what Cohn called “one of the biggest tax cuts in the American history,” corporate taxes would be capped at 15 percent. If Cohn succeeds, Goldman will save massive sums: At that rate, Goldman would have paid $2 billion less in taxes in 2014, $1.4 billion less in 2015, and $1.4 billion less in 2016. The Koch brothers’ network of political groups has already spent millions of dollars to promote the proposal. Even Blankfein, who the Trump campaign singled out in the commercial it ran in the final days of the campaign, acknowledged in a voicemail to employees that Trump’s commitment to tax cuts, deregulation, and infrastructure “will be good for our clients and our firm.”

The details of the president’s “$1 trillion” infrastructure plan are similarly favorable to Goldman. As laid out in the administration’s 2018 budget, the government would spend only $200 billion on infrastructure over the coming decade. By structuring “that funding to incentivize additional non-Federal funding” — tax breaks and deals that privatize roads, bridges, and airports — the government could take credit for “at least $1 trillion in total infrastructure spending,” the budget reads.

It was as if Cohn were still channeling his role as a leader of Goldman Sachs when, at the White House in May, he offered this advice to executives: “We say, ‘Hey, take a project you have right now, sell it off, privatize it, we know it will get maintained, and we’ll reward you for privatizing it.’” “The bigger the thing you privatize, the more money we’ll give you,” continued Cohn. By “we,” he clearly meant the federal government; by “you,” he appeared to be speaking, at least in part, about Goldman Sachs, whose Public Sector and Infrastructure group arranges the financing on large-scale public sector deals. “Goldman Sachs is one of the largest infrastructure fund managers globally,” according to infrastructure advisory firm InfraPPP Partners, “having raised more than $10 billion of capital since the inception of the business in 2006.” Lost in the infamous press conference the president gave in the lobby of Trump Tower a few days after Charlottesville, with Cohn and Mnuchin visibly uncomfortable at his right flank, were Trump’s remarks on infrastructure, the ostensible purpose of the event. The thrust was that the president would grease the wheels for project approvals by signing an executive order rolling back environmental impact requirements and other elements of an “overregulated permitting process.”

In countless other ways, Cohn is positioned to help the firm that has been so good to him over the years. The country’s National Economic Council adviser might caution a president against running too large a deficit, especially amid a healthy economy. But Goldman Sachs is in the business of finding investors to underwrite government debt. An economic adviser might caution a populist president that corporate inversions often cost jobs and tax revenue. Instead, Trump has ordered a review of policies Obama put in place to discourage them — good news for Cohn’s former colleagues. Transparency has been a watchword of initial public offerings dating back at least to the Securities and Exchange Act of 1934, but easing those rules, a step Goldman has sought, could potentially generate hundreds of millions of dollars in fees for investment banks such as Goldman. The SEC announced in June that it would allow any company going public to withhold details of its finances and strategies, an exemption previously available only to firms with under $1 billion in revenue — more good tidings for Goldman. Just loosening the rules for IPOs, said Tyler Gellasch, the former Senate staffer, “could mean hundreds of millions of dollars more to Goldman.”

In June, the Treasury Department released a statement of principles about the administration’s approach to financial regulation focused on promoting “liquid and vibrant markets.” Not surprisingly, the report included a call to ease capital requirements and substantially amend the Volcker Rule.

It’s Cohn’s influence over the country’s regulators that worries Dennis Kelleher, the financial reform lobbyist. “To him, what’s good for Wall Street is good for the economy,” Kelleher said of Cohn. “Maybe that makes sense when a guy has spent 26 years at Goldman, a company who has repaid his loyalties and sweat with a net worth in the hundreds of millions.” Kelleher recalls those who lost a home or a chunk of their retirement savings during a financial crisis that Cohn helped precipitate. “They’re still suffering,” he said. “Yet now Cohn’s in charge of the economy and talking about eliminating financial reform and basically putting the country back to where it was in 2005, as if 2008 didn’t happen. I’ve started the countdown clock to the next financial crash, which will make the last one look mild.”

Goldman Ramping Up Private Equity Investments To Offset Low Vol And Low Volume

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A Reuters article reports that Goldman is looking to make direct private-equity investments to compensate for weakness in trading.

Goldman Sachs Group Inc is ramping up its private-equity investments and going after smaller, high-growth targets as part of a broad plan to offset recent trading declines, three people familiar with the effort told Reuters. Goldman’s investment bank, which typically focuses on advising large companies on mergers and raising capital, is now looking to use Goldman’s own funds to finance a handful of small, promising companies in the near-term, the people said. Sponsored

The team scouting for deals is led by senior investment banker Kathy Elsesser, who earlier this year took on the project in addition to her role as global chair of consumer, retail and healthcare investment banking.

Goldman is hoping to repeat the success that the bank has had in the technology industries elsewhere, as Reuters explains.

The goal is to repeat Goldman’s past success with early-stage investments in tech companies such as Uber Technologies Inc. The latest effort, however, would target industries outside of Silicon Valley, said the people, who declined to be named because the strategy they were discussing was not yet public.

Anonymous sources indicated that individual investments will be in the tens of millions of dollars and will be financed from the company’s balance sheet – far smaller than investments it manages for clients. While the Volcker Rule limits banks’ ability to invest in private equity funds, however, there is no limit on direct investments in companies.

This might be a great idea by Goldman and people talking to Reuters emphasized the synergistic benefits from forging strong relationship with companies which management will subsequently look to IPO. However, we can’t help thinking that making investments in highly leveraged companies would have been less risky earlier in the current, long-in-the-tooth economic cycle. But pro-cyclical behavior is a defining characteristic of investment banks and Goldman is no exception (AIG cough). Some months ago, we remember speaking to a retiring private equity dealmaker who lamented the fierce competition between private equity bidders and the risk to future returns. He stated that although he could raise almost unlimited amounts of capital, deploying it in a responsible manner had never been more challenging.

The motivation for this move is Goldman’s aim to add about $5 billion in incremental revenue to offset the “slump in bond trading” as Reuters notes.

Even a successful effort is unlikely to make up for the billions of dollars of trading revenue Goldman has lost since 2009, analysts said. “They’ve admitted there is a potential problem long-term with revenue growth so they need to do something about it,” said Brian Kleinhanzl, a bank analyst with Keefe, Bruyette & Woods. “But it’s rare for things to move the needle too much with Goldman.” Those involved with the strategy characterized it as one of many ways Goldman is trying to use its own capital to boost returns, even if it is on a small scale.

Here is the chart of Goldman’s quarterly revenue from our discussion of Goldman’s 3Q 2017 results earlier this month.

 

We observed.

Discussing the ongoing weakness in FICC, Goldman explained that "net revenues in Fixed Income, Currency and Commodities Client Execution were $1.45 billion for the third quarter of 2017, 26% lower than the third quarter of 2016, due to significantly lower net revenues in commodities, interest rate products and credit products and lower net revenues in currencies, partially offset by higher net revenues in mortgages. Although market-making conditions improved in most businesses compared with the second quarter of 2017, Fixed Income, Currency and Commodities Client Execution continued to operate in a challenging environment characterized by low levels of volatility and low client activity.

Finally, there is an inference in the Reuters story that something of a power shift might be occurring in Goldman in favor of the investment bank.

Elsesser’s new role showcases the growing importance of Goldman’s investment bank, which is central to many of its new revenue initiatives. Under the leadership of co-heads Gregg Lemkau, Marc Nachmann and John Waldron, the business has strengthened its presence in cities such as Atlanta and Dallas, hired more senior dealmakers from Wall Street rivals, created a new team to pitch innovative ideas to big clients, and invested in technology. While the team works within Goldman’s investment bank, any income generated from its equity stakes will flow into Investing & Lending, which is not a business but a reporting category that shows the results of Goldman Sachs employing its own capital. Since the bank began reporting earnings that way, annual revenue from Investing & Lending has varied widely, from $2.1 billion to $7.5 billion. Through the first nine months of this year, Goldman’s Investing & Lending revenue has soared 90 percent. Private-equity gains helped the bank beat Wall Street third-quarter estimates even as trading revenue slumped. Some analysts are more optimistic about Goldman’s private-equity push than other initiatives, such as consumer lending or corporate hedging, where it has little to no experience.

“Part of Goldman’s core business is its ability to take equity stakes in companies they’re working with,” said Marty Mosby, an analyst with Vining Sparks. “It may create more volatile outcomes, but ultimately it’s more within their competency than other businesses they’re trying to get into.”

With rumors today that Cohn will definitely not get The Fed Chair position and will likely leave The White House, we suspect Goldman will need more than just regulatory relief hopes to 'manage' through the low vol, low volume new normal.


David Stockman Derides The Delirious Dozen Of 2017

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Authored by David Stockman via Contra Corner blog,

We have previously noted the massive market cap inflation and then stupendous collapse of the Delirious Dozen of 2000.

The latter included Microsoft, Cisco, Dell, Intel, GE, Yahoo, AIG and Juniper Networks – plus four others which didn't survive (Lucent, WorldCom, Global Crossing and Nortel).

Together they represented a classic blow-off top in the context of a central bank corrupted stock market. When the bubble neared its asymptote in early 2000, the $3.8 trillion of market cap represented by these 12 names was capturing most of the oxygen left in the casino. That is, the buying frenzy had narrowed to a smaller and smaller group of momo names.

 

That severe concentration pattern was starkly evident during the 40 months between Greenspan's December 1996 "irrational exuberance" speech and April 2000 (when he told the Senate no bubble was detectable). In that interval, the group's combined market cap soared from $600 billion to $3.8 trillion.

That represented, in turn, a virtually impossible 75% per annum growth rate for what were already mega-cap stocks. As it happened, in fact, $2.7 trillion or 71% of the group's bubble peak market cap vanished during the next two years.

What we didn't mention yesterday, however, is that this bubble top intumescence never really came back. In fact, the market cap of the eight surviving companies—all of which have continued to grow—-today stands at just $1.3 trillion or 34% of the 17-years ago peak.

Needless to say, that's because the market no longer affords the Delirious Dozen of 2000 valuation multiples that are even remotely in the same bubblicious zip code.

Thus, the eight survivors posted combined net income of $52.3 billion during the LTM period ending in September 2017. On the far side of the 1999-2000 tech bubble, therefore, current earnings turn out to be worth 25X—not the 75X recorded back then.

We revisit the rise and fall of these turn of the century high flyers because we believe the same process of market narrowing into a diminishing number of momo names is exactly what is happening again as we reach the asymptote of this latest and greatest central bank fueled bubble.

 

In fact, we have identified a new roster for the Delirious Dozen of 2017 – and have tracked their course over the last 40 months. During that interval, of course, Janet Yellen did not even bother to muse in public about "irrational exuberance" like Greenspan did.

That's undoubtedly because Fed orthodoxy now holds there just plain aren't any bubbles—apart from isolated segments like commercial real estate. To the contrary, the 12 geniuses on the FOMC have purportedly vanquished the business cycle entirely, thereby insuring an economic nirvana of perpetual full employment, world without end.

We think otherwise. Accordingly, our new Delirious Dozen consists of the FAANGs (Facebook, Apple, Amazon, Netflix and Google) plus seven additonal high flyers (Tesla, NVIDIA, Salesforce, Alibaba, UnitedHealth, Home Depot and Broadcom).

Not surprisingly, their combined market cap has soared from $1.7 trillion to $4.0 trillion during the last 40 months in a pattern which is highly reminiscent of the last go round. And for our money, that $2.3 trillion gain represents the same kind of bottled air.

Thus, Amazon is now valued at $550 billion and thereby trades at 293X its $1.9 billion of LTM net income. But all of that net income is attributable to its rent-a-cloud service (AWS) which is arguably worth $100 billion on a standalone basis.

That is to say, the great Bezos E-commerce juggernaut is implicitly valued at $450 billion, yet has not generated a dime of profit from the scorched earth its has left behind in retail land. That's what we call bottled air.

Likewise, Broadcom trades at 246X net income and Netflix is valued at 194X. These companies may well be the equal of Cisco and Intel as innovators and value generators with a long life of growth ahead.

But both are challenged by ferocious competitors, and have no more chance of sustaining their current absurd valuation multiples than did Cisco (200X then, 19X now) or Intel (60X then, 16X now).

Next consider Salesforce (CRM), which is currently valued at $77 billion, and Tesla, which sports a market cap of $54 billion. Yet both had large net losses during the latest 12 months. In fact, during the last five years, CRM has posted cumulative net losses of $650 million and Tesla has lost $3.3 billion.

Even if these two do manage to avoid the fate of Nortel and Global Crossing, the red ink stained charts below suggests that earning into their combined market cap of $131 billion will take more than a few miracles.

TSLA Net Income (TTM) Chart

Even Alibaba at 55X, NVIDIA at 50X, and Goggle and Facebook each at 35X are essentially defying math and the business cycle.

The latter two companies, in fact, may be the greatest thing since sliced bread, but they are also virtually 100% dependent upon advertising revenue. During the last recession, global ad spending plunged by nearly 9%, as shown below, and by more than 14% in the US alone.

Moreover, the digital capture of market share—of which is 85% is attributable to FB and GOOG—-has nearly run its course. Accordingly, no company in a cyclical 3-4% growth industry can sustain a 35X PE multiple for any appreciable period of time.

Image result for images of US advertising spend since 2006

Much the same can be said for Home Depot (HD), which is currently flying high, but is not capable of permanently sustaining a 25X PE multiple. In fact, its recent results have been flattered owing to the capture of significant market share from the collapse of Sears and due to elevated sales from a standard home improvement spending cycle that is now reaching its peak. Additionally, it has not yet been attacked head-on by Amazon (but that's surely coming).

But like much else at the current bubble top in the casino, Home Depot's elevated short-run gains have been confused for permanent growth capacity. However, the verdict on that is crystal clear: During the 11 years since the 2006 housing peak, HD's net income has grown from $6.1 billion to just $8.6 billion in the October 2017 LTM period.

That computes to a 3.2% per annum growth rate, and Home Depot's best years are surely behind it. After all, the tsunami of baby boom retires are emptying their nests, not renovating them.

At the same time, America's soon to be shrinking work force will face ever higher taxes to pay for the upkeep of the former, thereby sharply constraining the discretionary income of the overwhelming share of working households. Man caves and granite kitchen counter-tops are not likely to survive the generational squeeze looming ahead.

Accordingly, we believe that HD's days as a 25X PE stock are numbered.

In short, among the Delirious Dozen for 2017, only Apple has a reasonable multiple at 19X. But then again, Apple has been cycling along the flat line for more than three years at its towering sales level of $230 billion and $50 billion of net income.

Yet even today's casino recognizes that given Apple's monumental size, it is virtually impossible to move the growth needle; and that even one delayed or botched product cycle could cause its $50 billion of net income to take a not inconsiderable plunge.

AAPL Net Income (TTM) Chart

In short, aside from the unique case of Apple, the Delirious Dozen of 2017 are set-up for a repeat of the massive 2000-2002 deflation of bottled air. That is, in June 2014 the group (ex-Apple) had a market cap of $1.1 trillion, representing 34X its combined net income of $32 billion.

During the 40 months since then, the group's market cap has nearly tripled to $3.2 trillion, while its net income has climbed to $65 billion. Consequently, the group's PE multiple has now soared to 49X or to nearly the nosebleed level that pertained among the previous group of high flyers back in April 2000.

Needless to say, the business cycle has not been abolished and this expansion is now 101 months old. In fact, the chart below suggests it may be reaching its "sell-by" date.

But here's the thing. The bottled air resident among the Delirious Dozen of 2017 is where all the top of the bubble mania has again gotten concentrated.

So when the Black Swan, Orange Swan or Red Swan, as the case may be, finally arrives and they begin to sell AMZN, FB, TSLA or CRM—-look out below.

That's where Wall Street's next central bank fueled bloodbath is hiding in plain sight.

CME Unveils “Weirdest Chart Ever”

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Authored by Erik Norland via CME Group,

We freely admit: Figure 1 is probably the strangest chart that you will ever see, at least in finance. 

You may be wondering: did they throw blue spaghetti noodle on paper for inspiration and then write an economics article about it?  Or, have they spent too much time with disciples of psychologist Timothy Leary, a proponent of experimenting with psychedelic drugs?

Figure 1: Weirdest Chart Ever

We assure you that neither is the case.  The above chart represents three successive iterations of the VIX-yield curve cycle, a strange but powerful economic phenomenon that has persisted since at least the end of the 1980s and to which every fixed income and equity volatility trader should pay attention. Keep reading. We will break it down in much simpler fashion.  

What goes ‘round, comes ‘round

The cycle has four phases.  As with any circular motion, where to begin is arbitrary, so we will begin at the bottom of the economic cycle and work our way to mid-stage expansion.

  1. Recession: yield curve moves from flat to steep (upward slope), equity volatility is relatively high.
  2. Early-stage recovery: yield curve remains steep, equity volatility begins to fall.
  3. Mid-stage expansion: the yield curve starts to flatten, equity volatility remains low.
  4. Late-stage expansion: yield curve becomes even flatter, equity volatility soars as fears of recession dominate investor behavior.

The VIX is the index of implied volatility on S&P 500® options and its daily time series is extraordinarily choppy.  To see its relationship with the yield curve, we smooth them both by taking a two year (500 business day) moving average and then put the results into an “X to Y” scatterplot.  The result is quite extraordinary:  consistent counter-clockwise motion.

From our arbitrary starting point in a recession, the Federal Reserve (Fed) has responded to the economic downturn with much lower short-term rates.  Steep, upward sloping yield curves with short-term rates much lower than long-term bond yields eventually are associated with an economic recovery and lower equity-market volatility.  A sustained economic expansion, with relatively low equity-market volatility makes the Fed feel comfortable about removing monetary policy accommodation and flattening the yield curve (i.e., short-term rates moving higher with stable bond yields).  A tight monetary policy, flat yield-curve environment finally is associated with an economic downturn and massive correction in the equity and credit markets which sends volatility soaring.  High volatility and a crashing economy force the Fed to lower short-term rates and ease policy in order to assist in generating an economic recovery.  Wash.  Rinse.  Repeat. (Figures 2, 3, 4).  

This same four-stage cycle occurred (1) in the 1990-1999 period, ending in the “Tech Wreck” on Wall Street and an economic downturn with rising unemployment;

(2) in the 2000-2008 period, ending in the spectacular “Housing Bust” and Wall Street panic, triggering sharply rising unemployment;

and (3) the 2009-??? period in which we are now in stage four, with the Fed raising short-term rates, the yield curve starting to flatten, and the economic expansion looking a little long in the tooth.

That is, currently, the markets are in a phase that closely resembles the mid-expansion phases seen during the mid-1990s (1994-96) and the mid-2000s (2005-06).  As already noted, the Fed has commenced removing monetary accommodation.  Yield curves are flattening.  VIX remains unperturbed at extraordinarily low levels. This phase may persist another year or so as the yield curve continues to flatten and the VIX, most likely, remains low for a while longer.  How long this lasts depends upon the Fed and the economy.  The faster the Fed tightens, the more quickly the yield curve will flatten, and the more likely the markets will move to the next phase.

The next phase is the late-stage economic expansion.  By this time the yield curve will be quite flat.  VIX will start to rise from its current two-year moving average of around 12% to much higher levels, perhaps as much as 50% to 100% higher depending on the degree to which market participants fear a future recession.  The combination of a flat yield curve and higher equity volatility will probably also blow out credit spreads and choke off lending to certain sectors of the economy, which has the potential to provoke a sharp slowdown in economic activity and then another easing cycle.  

The Interplay of Fed policy and Economic Downturns

What makes this cycle tick is the interplay of Fed policy and economic downturns.  At the beginning of our cycle, rising unemployment in a recession triggers a Fed policy shift to much lower short-term interest rates.  Treasury bond yields typically decline as well with lower inflation expectations, although the drop in short-term rates far outweighs any bond rally.  Easier monetary policies are then associated with the end of the recession and start of the recovery.  At the end of the cycle in the late-stage economic expansion, it is fears of rising inflation associated with very low unemployment which is the catalyst for the Fed shifting to a tighter monetary policy.

While displaying some consistent themes, every “VIX – Yield Curve” cycle also responds to different external forces.  And, in some cases, the line of causality from late-stage economic expansion to recession is not so clear.

In the late 1990s, there was the exuberance of a market fueled by rising technology stock valuations even as earnings from these companies were only growing slowly.  The general view of the progression of events was that the Fed tightening triggered the “Tech Wreck” in stocks and that was the catalyst for the economic downturn.

The 2008-2009 economic disaster had a different story to tell.  This time, the 2003-2005 mid-stage expansion had featured a housing boom fueled by lax banking oversight and regulation, as well as, a 1% federal funds rate with a sharply upward sloping yield curve.  The Fed removed the monetary accommodation in 2005-2006, taking the federal funds rate to 5% and flattening the yield curve.  This action stalled the housing boom.  The straw that broke the camel’s back, or the catalyst for the deep recession, however, was the financial panic that occurred in September 2008 when the U.S. Fed and Treasury collaborated to put Lehman Brothers into bankruptcy and bail-out AIG to ensure certain other investment banks remain solvent. Compared to the previous period of rising unemployment in 2001-2003, 2008-2009 was characterized by massive de-leveraging across many sectors of the economy, leading to an exceptionally deep recession, now known as the “Great Recession”.

The current economic expansion, which started back in late 2009, is now the second longest on record in the post-WWII period.  And, it has displayed a number of different characteristics from our two previous “VIX – Yield Curve” cycles examined here.   As already mentioned, the 2008 crisis was a “financial de-leveraging” recession, which is typically deeper and does not display “V-Shaped” recoveries.  And, the slow pace of economic growth in the expansion led to the use of unconventional monetary policy (i.e., asset purchases or Quantitative Easing) by the Fed.  QE worked to raise asset prices and push volatility even lower but failed to encourage more economic growth or push inflation higher.  The QE phase distorted the shape of the yield curve by pushing bond yields lower.  The removal of monetary accommodation was delayed, although we are now observing this stage in action, and this time around it includes raising short-term rates as well as unwinding Quantitative Easing.

The last factor of note in this cycle is the persistence of low inflation.  The Fed typically views inflation as being pushed higher by low unemployment and tight labor markets, and that has not happened in this cycle, at least not yet.  Thus, the Yellen Fed has admitted to some confusion about the economic outlook and has been exceedingly cautious in raising short-term rates.  Indeed, the -Fed under Jerome Powell may even consider raising its long-term inflation target from 2% to, perhaps, 3% or 4%.  This would signal a desire by the Fed to stop raising short-term rates while it unwinds QE.  And, it might prolong the period of an upwardly sloped yield curve.

The alternative scenario is that the Fed tightens by a total of 75 basis points (bps) in 2018 (in addition to the 25 bps it has signaled for December 2017), as its “dot plot” suggests.  If rates were 100 bps or 1 percent higher by end of 2018, then that should put the current cycle on course to take a sharp right turn across the bottom of the graph. This might move up not only equity index volatility but also implied and realized volatility on all manner of products including high yield bonds, Treasuries, metals, currency and perhaps even energy and agricultural goods options.

As the saying goes: watch this space. 

Figure 6: Yield Curve Anticipates Economic Downturns

Bottom line:

  • Two-year average yield curve slopes and VIX levels move in a four-stage cycle.
  • Currently, we are in the mid-to-late expansion stage.
  • Additional Fed tightening will flatten the yield curve more, which will eventually provoke an explosion in volatility as the VIX’s average level might double from current levels.
  • It is likely the volatility will increase across a broad range of products including bonds, metals and currencies as well.

 

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