Crackdown on Wall Street: The Perp Walks Are Coming

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Crackdown on Wall Street: The Perp Walks Are Coming
By Elizabeth MacDonald
First of a series on the Crackdown on Wall Street

With the economy in a national nervous breakdown, with global losses mounting into the trillions of dollars, a top Wall Street executive in an interview echoes the Street’s water cooler talk when he asks:

“Where are the smartest guys in the room being hauled off in handcuffs?”

Specifically, executives say the markets have only seen high-profile perp walks in two cases, the two Bear Stearns hedge fund managers charged with securities fraud, and the two Credit Suisse brokers also charged with securities fraud in selling auction rate securities linked to subprime loans.

“We saw more executives hauled off at about this time during the accounting scandals [earlier this decade], WorldCom’s Bernie Ebbers, Enron’s [Ken] Lay and [Jeffrey] Skilling, Tyco’s Dennis Kozlowski,” one investor complains, in what’s likely an overstatement.

But top law enforcement officials have news for the markets.

The perp walks are coming–in fact expect 2009 to be a bonanza year for arrests, a Justice Dept. official says. Law enforcement officials say the bursting of the world’s biggest bubble has created a very crowded scene of the crime.

Reason for the delay: X-raying the bursting of the world’s biggest bubble in order to find out who to charge has proven to be devilishly more complex, more variegated, and involve bigger sums than ever before, says David Cardona, 52, head of the FBI’s criminal division in New York City, in an interview.

What should send a chill up Wall Street’s spine is the fact that the FBI is “looking at all market participants from top to bottom who helped construct” potentially fraudulent loans and asset-backed securities, wherever the evidence leads the agents, says Cardona, a veteran agent widely respected in the bureau for being a smart, savvy straight-shooter.

(Though given the massive Wall Street layoffs and the empty offices, the probes could prove to be a chill looking for a spine to shiver up, to quote former South Africa official Helen Suzman).

Will These Frauds Escape?

However, interviews with Wall Street executives show a deep concern that the biggest frauds of all may escape–not predatory loans, but predatory securitizations.

It’s the predatory securitizations that are the most complicated, with agents expert in terrorist and al Qaeda financing now working these cases. Cardona notes that the FBI has fully staffed both these investigation areas, adding that terrorism remains the worst threat to the US economy, with white collar frauds second.

Cardona, who came to the FBI’s New York office in May 2007 after running the bureau’s Miami office, is now riding herd on 400 agents who, overall, handle criminal cases.

Terrorist financing agents are well-equipped and needed on fraudulent securitizations more than ever.

That’s because tracking the purblind pools in securitization financing is similar to prowling through hawala financing, where money changes hands through an anonymous money transfer network in the usury-forbidden world of Muslim finance throughout the Middle East, Africa and Asia.

Fallout Grows

The International Monetary Fund now says the cost of this bubble potentially surmounts $2.2 tn, with financial companies the world over taking $975 bn in profit hits to date.

The $305 bn in profits earned by the top nine investment banks over the last three years has been easily vaporized by $323 bn in writedowns taken over the last year or so.

Top executives including Countrywide Financial’s Angelo Mozilo, former Merrill Lynch’s E. Stanley O’Neal, Citigroup’s Robert Rubin, Citigroup’s Charles O. Prince, all have walked out the door with lavish compensation packages built on fake profits earned during the bubble years.

Meanwhile, the bubble has caused the US to launch an estimated $8.4 tn in new facilities to deal with the crisis. That includes the Federal Reserve’s credit facilities, and the US Treasury its $700 bn TARP program, with to date 355 banks getting TARP funding, including seven private banks.

It also includes the guarantees the US government has now given in the way of backstops to $427 bn in bad assets at places like Bank of America, Citigroup and American International Group. And the Federal Reserve, now the world’s largest junk investor, has taken on about $81.5 bn in bad securities from Bear Stearns and AIG on its own books.

Also, the US government is set to debut an enormous $819 bn fiscal spending package to rescue the US economy from potentially the deepest downturn since the Great Depression.

And the US government may now set up a mega Bad Bank, a colossal dumpster, for the bad bank assets backed by subprime loans sliced and diced in Wall Street’s CDO deli machine.

The mortgage-backed bonds that were really only so much baloney, despite being rubberstamped by the credit rating agencies as triple-A, credit ratings agencies called the market’s “astrologers” by Janet Tavakoli, the structured finance specialist and author of “Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street” (2009).

Ironically, Wall Street’s compulsive financial engineering was supposed to limit the risk of financial contagion, but it didn’t work as the subprime crisis went viral and sickened all asset classes around the world.

Now some Justice Dept. officials fear that the federal bailout of the financial industry “may itself become a problem because it contains inadequate controls to deter fraud,” a top official warns.

The Perp Walks Are Coming

With the markets complacent for more than eight years, “what is happening now is the equivalent of turning the lights on in the kitchen and finding an avalanche of cockroaches,” says a Wall Street executive.

The magnitude of the bubble means the fraud cases are more sweeping than ever, from the small-bore mortgage loan frauds, or “white collar street crimes” as former Attorney General Michael Mukasey calls them, to Ponzi scams to hedge fund investigations to accounting frauds to structured finance and derivatives frauds.

The last are “very complicated,” the “most complicated I’ve ever personally seen,” says the FBI’s Cardona in an interview.

Overall, FBI Director Robert Mueller has testified that the FBI has already launched 24 investigations into major Wall Street firms and investment banks, including Bear Stearns, Credit Suisse, Fannie Mae, Freddie Mac, Lehman Brothers, and American International Group. The number is thought to have since grown to 26.

Just the FBI mortgage loan fraud caseload alone has more than doubled in three years, to about 1,700. About 200 FBI agents are assigned to these cases, up from 120 a year ago. The Securities & Exchange Commission has more than 50 pending civil investigations in the subprime area.

Meanwhile, Ponzi scams are surfacing fast and furiously, beyond the alleged $50 bn scam run by Bernard Madoff, as well as the three alleged Ponzi schemes run by Arthur Nadel, Nicholas Cosmo and Joseph Forte. “It’s only natural,” the FBI’s Cardona says, that with the bursting of the biggest bubble the world has ever seen, for the markets to now see a wave of Ponzi scams.

The SEC brought at least 23 Ponzi cases last year, up from 15 in 2007, with four already in the month of January alone.

The Commodity Futures Trading Commission prosecuted 15 Ponzi schemes in 2008 and expects that number to increase this year. And hedge funds remain squarely in the bulls’ eye.

The Hardest to Catch of All

But when it comes to potentially the most pervasive frauds of all, it could take years to catch all of the crooks, officials say.

Not predatory lending, but predatory securitizations.

Namely, the asset-backed bonds cooked up in Wall Street’s “financial meth labs,” structured finance expert Tavakoli notes in her new book, its byzantine CDO factories that pumped out bad bonds that have melted down savings accounts world wide and are just pure “hot molten evil,” as one investor calls them.

“It seems to me that some investment banks knowingly participated in predatory securitizations,” says Tavakoli in her book.

But although these securitizations are as transparent as a bucket of molasses, Wall Street executives who have worked on these deals and demand anonymity say there might be a way to catch the bad guys behind them.