Guest Essay: Capitalism: Acting in Good Faith

A guest essay from Henry Schoenberger, who joined us in January of 2012 to talk about his book “How We Got Swindled”.



How is a 6.3 “billion dollar bet” – “prudent?”  That’s what Corzine testified.

He, “always tried to do the right thing;” he placed the bet to make money because IM Gobal needed to become profitable, he testified. So he bet the store on the direction of the currency of five countries.   There was “no intent” to do the wrong thing – or misplace $1,200,000,000 of customer funds – it was just “chaotic.”  No admission of anything that could be construed as fraudulent behavior – just the empirical evidence of reality.

Is this acting in good faith toward his fiduciary responsibility to customers?  Let alone to his clear legal obligation to not co-mingle customer’s funds?  Funds which probably went down the drain to cover his positions going the wrong way.

Corzine is only testifying to set up a fraud defense, because prosecutors must prove willful intent – and Corzine is a man of prudence, as a former CEO of Goldman.

So huge leveraged betting on currency is not intentional, and is the right thing to do?  Hedge fund managers know currency bets are at the highest level of risk.  Speculation is never prudent, but volatile. More leverage equals geometrically more risk and more volatility.

Capitalism is on trial because of the way it is practiced at the expense of prudent behavior, and because so many Capitalists do not act in good faith.

To Act in Good Faith is a legal term and concept well defined by many areas of the law and established precedent.   Simply put – it is an implied covenant of fair dealing and not breaking (keeping) your word.  Significant SEC and Fed Bank Holding Company regulations stipulate the legal import and requirement to Act In Good Faith – which must be adhered to as significant regulations have the force of law behind them.

So where has acting in Good Faith gone?

The Lehman Bankruptcy in September of 2008 was the largest ever in US history.  The Federal Bankruptcy Court just approved a plan to emerge from chapter 11 for 65 billion dollars, but the fighting for assets and valuations is not over.

Lehman leveraged itself to death, and when the market hit the fan on September 8, 2008, by the 10th it was clear that Lehman could not sell – flip all the egregiously leveraged and worse than junk bond debt it assumed it could always sell – no matter what?

Different suitors stepped forward to ostensibly buy or bail out Lehman. However, it became clear Lehman had manipulated an accounting of financial risks, replete with fictitious valuations through Hudson Castle, an entity set up to get the bad stuff off Lehman’s balance sheet.  So with a myriad of other material issues – Lehman declared bankruptcy. The stock price now hovers at .025 cents.

Lehman Brothers did not practice Good Faith. And the Federal Bankruptcy Judge appointed an attorney from a prominent legal securities defense firm as the court’s Examiner.

The Examiner’s lengthy report reads like a brief in defense of Lehman.  Jenner and Block, where Anton R. Valukas, the court appointed “Examiner,” is a very senior partner with a high profile national public record of defending actions alleging “breach of fiduciary duty,” and “securities fraud.”

The Examiner’s report concluded: “…there was insufficient evidence to support a colorable claim for breach of Fiduciary Duty regarding Lehman’s valuation errors (lies?) … there was insufficient evidence that any Lehman officer acted with the necessary SCIENTER to impose liability.” Further the report concluded that Lehman had a “license to fail.” Which “establishes a future precedent” according to the Center for Policy and Research.   What an examiner, what a business builder for future securities defense work.

Scienter refers to intent or knowledge of wrong doing.

Lehman advanced the ridiculous and implausible notion that when it doubled its risk from $300,000,000,000 to $630,000,000,000 the “630 Billion was still “acceptable risk;” because it was “prepared to lose $4,000,000,000” instead of $2,200,000,000.  Does this ring true?

Because, Lehman was “prepared to lose” (not investors), the Examiner did not consider this as “reckless behavior.”  OK then – unbridled, geometric leverage to speculate in nuclear volatility is not reckless.  Thank God for an Examiner with enough uncommon sense to let Lehman off the hook because it was prepared!

In fairness to Lehman it had backed up its risk – hedged it! Hedged 40 times its fictitious net capital, or possibly a higher multiple, an even more specious posture toward acceptable.  Don’t forget September 2008 marks a date in history when it became public knowledge, for the first time, that financial engineered risk management was a cruel joke and clearly did not work.

Hedging is what you do when you know what you are going to do won’t work.

The Examiner’s extremely subjective value judgment (which read more like a legal defense) was:  Lehman’s risk reword ratio was justifiable. Because the reward justified the risk – he concluded, “The rewards outweighed the risk.” And this conclusion from one of the most prominent security defense attorneys in the US establishes a precedent  which could then be applied to any Bank Holding Company in the future that dies from gangrene due to a bowel explosion stemming from all their “manageable” and “worth it” mathematically risk measured, insane leverage.

Here’s a taste of Lehman’s not fraudulent practices:  more than doubling its balance sheet valuation of Archstone – 2 times above market value;  CDOs (“collaterized debt obligations)– termed asset backed securities, backed with either Swaps or pools of worse than junk bond real estate loans – had no real collateral considering any financial standards for what constitutes acceptable collateral for any bank in the US; fallacious accounting and the lack of collateral was not disclosed to investors, a severe violation of disclosure regulations; and the glaring lack of disclosure constitutes the “omission of significant information.”  Further the Examiner found that as the economic downturn worsened Lehman consistently flagrantly inflated the value of its assets; while it continued to grossly overstate its expected (projected) return on investments.  So was this accidental – because it was not intentional, as the Examiner has to conclude to let Lehman off the hook.

And Lehman was not alone in 2008 in their usual and customary business practices just described.  But Paulson and Congress made certain that our government bailed out Goldman and its (investors) counter parties, along with the other culprits.

The Examiner’s report was justified, because THE CENTER FOR POLICY RESEARCH furnished the 99% with an Oversight Report of 33 pages.  This is a Seaton Hall Law School “think tank?” and Mark Denbeaux, the Law Prof in charge – “…could find no legal reason to charge Lehman with misconduct.”  Of course, the Seaton lawyers pointed out that their opinion was, “Pursuant to the standard practice of the Center…”

No legal reason:  fallacious-fictitious risk management and fictitious valuations as policy.  To disguise – conceal the true value of assets and the actual nature of unbridled purely speculative risk?  No legal reason?  How about the lack of disclosure and the omission of significant information!

There have been a number of articles recently on these findings and the emergence of Lehman from chapter 11.  It is amazing how the ability to conduct critical thinking regarding the issuance of reports and legal conclusions is apparently missing in action.  Acceptance of so called experts is what got us into this mess. Acceptance of Econ PhDs return to Laissez-faire theories designed to promote fees for the ultra rich rather than sanity and fairness is still the rule.

To Act in Good Faith is missing in action.  As well as any critical analysis of so-called “risk management.”

It is not logical to mathematically measure risk because risk is subjective and qualitative; therefore can not be quantified.  The Examiner supported the gravitas of virtual mathematical risk measurement by noting and seemingly condemning – “…Lehman valued these investments through gut feelings.”  And their guts (based on greed) regarding unmitigated leverage were legally justified because they (Lehman) – “were prepared to lose.”

And Corzine testified his “bets were prudent.”  Just like bungee jumping without a cord.

The inscription on the tombstone of our devastated economy and the middle class should read – The rewards outweighed the risks. To Act in Good Faith is DEAD!

Henry Schoenberger is the author of How We Got Swindled By Wall Street Godfathers, Greed & Financial Darwinism ~ The 30-War Against the American Dream; including a foreword by David Satterfield, the former business editor of the Miami Herald, 2 times Pulitzer Prize-winner.