Expert on Structured Finance and Derivatives: Rampant Fraud and Ponzi Scheme Caused Crisis

Janet Tavakoli is one of the foremost experts on structured finance and derivatives.

Tavakoli made an outstanding presentation to the IMF last week on the fraud which led to the financial crisis.

Tavakoli was kind enough to send me a summary of the IMF presentation (and to give me permission to reprint the summary).

Making many of the same points that William K. Black (senior S&L regulator and professor of law and economics) has made about fraud and the big picture of what has occurred in the current as well as the S&L crisis – see this and this – Tavakoli told the IMF:

Wall Street gave mortgage lenders large credit lines (similar to credit card debt) and packaged the loans into private-label residential mortgage backed securities (RMBS). Most of the RMBS was rated “AAA” … But many RMBSs were backed by portfolios comprising risky fraud-riddled loans. Most of the “AAA” investment was imperiled, and subordinated “investment grade” components were worthless. Wall Street disguised these toxic “investments” with new value-destroying securitizations and derivatives.

Meanwhile, collapsing mortgage lenders paid high dividends to shareholders (old investors) and interest on credit lines to Wall Street (old investors) with money raised from new investors in doomed securities. New money allowed Wall Street to temporarily hide losses and pay enormous bonuses. This is a classic Ponzi scheme…

A large share of certain banks’ tax-subsidized profits is due as reparation to unsophisticated investors, the U.S. taxpayers...

By the end of 2006, public reports of implosions of large mortgage lenders eliminated CEOs’ plausible deniability. By January 2007, many (including me) publicly challenged the failure to account for losses. Instead, toxic securitization accelerated in the first half of 2007—classic malfeasance as a Ponzi scheme collapses…

In the spring of 2007, the Fed and the U.K.’s FSA reported that the degree of leverage in the global financial system was less than at the time of Long Term Capital Management, but in reality it was much greater. They are now repeating their mistakes. Winston Churchill said we must alert somnolent authority to novel dangers; but our regulators are complacent, and the dangers are not novel.[Remember: Tavakoli is an expert on various forms of leverage, such as securitization and derivatives. So if she is warning about too much leverage, we should take her seriously]

Wall Street supplies a swinging door of jobs for its financial regulators, and—in the case of many members of Congress and our Presidents—campaign contributions. This dependence is known as “capture,” and the result is that instead of reigning in Wall Street, dependent thinking enables mayhem.

In the recent Ponzi scheme only the agents—mortgage lenders, rating agencies, fund managers, securitization professionals, CFOs, CEOs, and other fee or bonus beneficiaries—prospered. Controls and risk management were undermined. The financial institutions and their shareholders, for which these agents are failed stewards, collapsed. Investors in toxic securitizations lost money. Had regulators done their jobs, they would have shut down Wall Street’s financial meth labs, and the Ponzi scheme would have quickly choked to death from lack of monetary oxygen.

After the Savings and Loan crisis of the late 1980’s, there were more than 1,000 felony indictments of senior officers. Recent fraud is much more widespread and costly. The consequences are much greater. Congress needs to fund investigations. Regulators need to get tough on crime.

Troubled financial entities should be put into receivership and restructured. Old shareholders will be wiped out. Debt-holders will take a haircut (discount) along with a debt for new equity swap to recapitalize the entity. But the job won’t be complete until we separate high risk activities from traditional banking in a return to a Glass-Steagall like structure with regulators that indict fraudsters, snuff out systemic fraud, and allow honest bankers to prosper.

The fact that many U.S. banks stuck to traditional banking and protected shareholders during this crisis is under-publicized, but their prudence worked.

We have the solutions. We need the will to implement them.

And if you haven’t yet watched it, here is Tavakoli’s must-see interview with Max Keiser:


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  • I watched this video on YouTube. – – because it wouldn't load with my hand-crank dial-up Internet access (@ $6.95 a month). And to comment for some reason, I now have to load up IE, because FireFox suddenly provides no comment box on the GW blog comment page.WE make-do until we die, which is the ultimate compromise with this uncompromizing reality.Enjoy the party, as well as the view you have of it.The young lady's commentary is astute. Her conclusion that we are closer to armageddon than ever, is a toss of her soft economist's hands -up into the far-more-than just the economists'-air that allows her to femininely aspirate while she anticipates some imaginary final compromize.Of course Tavakoli is trying to diagnose economic symptoms to decipher the larger picture that only leaves her aghast at the prospects she sees between her near-shuttered economist's blinders. Tavakoli further grasps for credibility by laying blame at the feet of many of her economic kin -the dead horses- who have failed to right the collapsed hull of the pragmatic-nightmare ship-of-fools.If there is anything to add to the feeble comprehension of those who are demanding to follow the path of this mythical beast, -a beast characterized by a bizarre belief in some firm understanding that can relate current events to the economic reality some carry around in their mental satchel- it should be easily conjured-up and imagined by considering these perspectives discussed by Tavakoli and Keiser -from- the perspective of our many and varied foreign counterparts in the world economy, each who are suffering all the more uncertainty about what these imaginary things might mean for their own distessed and collapsing economies -as they too are imagined to support their own struggling societies.Ultimately however, as I have stated before, -and- as I will likely feel compelled to state again, there is no cogent understanding to be had, chasing it down with the economic dogs on this mental avenue, Aristotle Street.The problem is the collapse of all the pragmatically-built-up "solutions" that have been allowed to accumulate and dominate our thinking and our societies over decades and centuries of empirical thought -each made by empirical reason and its processes that have come up far short of either gauging -or- governing reality for us.We are not gods, fools.Anyone truly interested in discovering the ever-elusive path toward truth, should begin by casting off the lies of scientific reason entirely, and then start by embracing the new epistemological outgrowth arising from the failure and the ashes of every empiricism.There will be no immediate green shoots coming out of the ashes and burning embers of the collapsed structures of our massively failed epistemological understanding of reality.Seek Categorical Knowledge, those truths that are true without exception. Build upon them.The credit economy is dead.Seek Categorical Knowledge, those truths that are true without exception.Every bureaucracy is categorically immoral, public -or- private.Science is what built it all up and made it so impossibly unsteady that it can do nothing now -but- come crashing down killing many.Science is dead.It was a stupid and immoral idea to begin with.Again, fools, we are NOT gods.And as clever as each are, -NEITHER Tavakoli and Keiser are anything more than commentators making small-talk about the spectacle of the ongoing calamity.We live in interesting times.

  • Janet Tavakoli adds an expert opinion to the documentation that Karl Denninger has been assembling at The Market Ticker and Zero Hedge has been following, too. Not qualifying as "experts," these "blogs" have been criticized as spreading conspiracy theories. Well, it turns out maybe not so much, according to Tavakoli.Apparently the only remedy to this pervasive fraud will be civil suits brought by the aggrieved to recover damages. Our captured government doesn't seem interested in pursuing a matter that involves big political donors and those who hold the key to the revolving door.

  • Just another alienated Marxist crying about capitalism. Where is the data to prove that all this "fraud" occured?

  • An Incredible Sad Paradox of the First Half Black U.S. President:

  • The evidence of the fraud is the billions of dollars of "AAA" MBSes that are now around 40 cents on the dollar. Duh!

  • Interesting comments. If you want some other structured finance expert opinions, go to

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