The Scam Wall Street Learned from the Mafia | Hacker News Reader

The Scam Wall Street Learned from the Mafia

rollingstone.com

199 pointsMaxGabriel71 comments

Perhaps most amazing is many people's apparent assumption that banks would never engage in this kind of behavior.

It seems the most cynical predictions and explanations of large bank behavior are likely to be the ones closest to the truth.

There are people who think three bid systems actually work? Everyone I've ever talked to about three bid systems knows they mostly exist to give a faint dusting of propriety to the fact that somehow the mayor's brother in law is always the guy winning the contract.

Are there roads in your town? Do you think they were paved by the honest lowest bidder?

Do you have a link that explains what exactly a "three bid system" is? The top hit on Google for the term describes a card game...

My understanding is that it is simply a closed bid system where three separate banks submit bids (interest rate that will pay on sums invested with them) with the highest one winning.

In general, you want to buy something. You have to get a quote from at least three vendors, then you pick the lowest. For contracts, like to build something, paint city hall, whatever, you solicit bids by publishing a notice in the local paper. Usually the bids are sealed, which "guarantees" people make a fair bid without undercutting their competitor by a dollar.

What are you trying to say? The argument that "everyone knows it's crooked" does not make it legal. It does not make a prosecution impossible.

Of all the ways that municipalities and hospitals and whatnot get cheated, banks skimming a little interest is among the least interesting. What would have been interesting is a nice shiny pie chart showing where all the graft goes, but that would relegate this particular scandal to a sideshow.

"least interesting" or "smallest amount of money" ? They're not necessarily the same.

In the article, Matt Taibbi says it's "a business worth $3.7 trillion". A few percentage points of that is still interesting amounts.

You're pretty far off, here.

I used to be in an elected position and would sign off on stuff like this. The "lowest bid" thing does actually tend to be enforced, at least where I was, and it was a huge pain in our butt for totally different reasons.

You're presuming that every deal is a gladhanded corruption thing. Sometimes, but not most of the time. Often we would know what we wanted, have a good deal for it, it's not a very significant purchase (like a $500 piece of equipment or somethign), but we have to spend hours of employees' time getting ahold of 3 options so that we can get the one we were going to get anyways.

The way worse situation is on big ticket items, like your example of roads or other big capital projects. Where I was they are actually done by the lowest bidder, by law. But we'd wind up paying way more than that, because in order to become the "lowest bidder", the contractor would have to unrealistically underbid and then run way over on the contract. At that point, we'd be screwed and it's usually a better idea to pay a little more to finish the project than to sue and have a half-finished project sitting there while you burn 6-7 figures on legal bills. Contractors with the professional integrity to give an honest estimate were unlikely to get the gig, because of the lowest bid law.

The lowest (or highest, in this case) bid was also enforced in this case. I totally agree with your point about small purchases, I've also dealt with it in the situation where you could walk down to Staples and buy something for $200, but we'd spend $300 because that was the best offer from an approved vendor.

Any reason not to do an open bid instead?

Also, I'm more familiar with commercial than federal contracts. Did your contracts have not-to-exceed clauses or any penalties built in to manage overrun issues?

If I bid $100 and you see it, you can bid $99 and win. The theory is that if you can't see my bid, you'll bid $80 instead because you don't know how low to go.

> Perhaps most amazing is many people's apparent assumption that banks would never engage in this kind of behavior.

I was sort-of witness to a shouting match between a well educated son and his hard-working working-class rest of the family over the fact that banks give out let's say ~ten times as much as they actually have. They called him stupid, outrageous and how could any company possibly do this and they can certainly not run their small wood-shops and small companies like that so how should a bank be able to do that? Mind you, these are average good natured law abiding folks, the kind that certainly is the majority of the population.

This goes to show that there certainly is a vast amount of blind trust in banks in the average population; looks like acting all serious-business and putting on a suit AND being able to control or at least have an important stake in a lot of major aspects of working-class citizens' lives (tight budgets, making ends meet) makes for a powerful combination.

But presumably these "working class" peopel had a morgage that is highly leveraged - did they not see the diference?

33% (or slightly more) of homeowners have no mortgage at all.

Edit - Some sources:

http://www.ritholtz.com/blog/2012/04/debunking-the-housing-r...

http://www.irishexaminer.com/ireland/kfsneyqlidgb/rss2/

Well don't forget that in the USA housing is reltivly cheap.

Realy moded down try looking at house prices in London compared to SV before you pull the trigger

That's precisely it. Normal people interpret loans as loans. Bank has money. Bank loans money. Bank makes interest to get more money.

They're participating in the system, and not only do they have no clue how it works, but believe it works in a way that it hasn't for generations.

I apologize if I misunderstand your claim (or if you are not actually supporting this claim), "that banks give out let's say ~ten times as much as they actually have". I've heard others make the claim that banks loan out more than they have in deposits, and I'm responding to that claim.

This is not true. As far as I can tell, this misconception stems from the correct notion that banking (fractional reserve banking) expands the money supply. This is sometimes extrapolated to "banks create money" and then to "banks loan out more money than they have".

Banks do not "give out" "~ten times" their deposits. They give out (for sufficiently large banks) 90% of their deposits [1] in exchange for obligations to repay. The money supply expansion that results from this (Alan deposits $100, bank loans $90 of Alan's money to Bob who gives it to Charlie who deposits it in a bank, which loans out $81 of Charlie's money to Dan, etc.) is the ten time expansion that you're probably alluding to; but the bank can't know that Charlie's money is money that it lent to Bob.

The banks are not doing anything wrong here; there's a larger argument about the societal benefits of banking, and whether banks should be restricted in how they give out their money, but starting with distorted facts makes these discussions very confusing.

[1] http://www.federalreserve.gov/monetarypolicy/reservereq.htm

Well, the defendants also admitted doing all this, but still didn't though there was anything wrong about it because they were expert investment bankers. That's quite amazing too.

It's because we don't feel comfortable telling people who wear suits and ties and working in high-rises that they're going to jail because they followed the prevailing ethics in their neigborhood. We have no problem sending black people or sweaty guys with ethnic names to jail just because they were joiners who went blindly along with the prevailing social mores in their social group, but we only send investment bankers to jail if we can prove they knowingly sunk lower than other investment bankers. We allow the Wall Street subculture to set the standard for its own behavior, and we consider that the desired normal state of things. Instead of reluctantly intervening to "send a message" once in a while when the corruption becomes too egregious to ignore, we should recognize that the complexity and lucrativeness of the finance industry makes Wall Street a natural locus of crime that requires constant attention. Just like a bad neighborhood or a bus station bathroom.

That means we need a proactive and well-funded SEC, of course.

'Wall Street does X' and 'the Mafia does X' does not in any way imply that Wall Street learned X from the Mafia - and there's no evidence in the article, either. Typical Tabibi bombast.

I suspect bid-rigging, while unethical, is pretty common behavior given this type of auction mechanic - all the buyers are knowledgeable and known to each other, while the seller is relatively ignorant and only participates in the market rarely.

You don't have to 'suspect' it was just shown. in court. that's what the article was about.

The sentence you replied to? It doesn't mean what you think it means.

You are missing the point; titling the article "The Scam Wall Street Learned From the Mafia" is a rhetorical device used by the author to illustrate the criminal nature of what went on and draw parallels to activity that is commonly understood by the average person to be unethical. The author isn't trying to suggest that these banks literally learned this from the mafia.

"the crimes the defendants and their co-conspirators committed were virtually indistinguishable from the kind of thuggery practiced for decades by the Mafia, which has long made manipulation of public bids for things like garbage collection and construction contracts a cornerstone of its business."

Actually, headlines are usually (like, almost always) written by an editor and not the author. So Tabibi should be off the hook on that count.

Actually, as a former trader, bid rigging is a big no-no. There is a fine line, ofcourse, e.g. the IPO process's inherent factoring of IPO investors over the issuer or M&A process'a tendency to work off bankers' relationships. But this is unambiguously wrong.

Where this becomes classic Taibbi is in his implication that this is business as usual on Wall Street (it's the only place in America I know of where someone's word is worth billions of dollars, with the paperwork coming after a verbal agreement much of the time).

Sure and there are chinese walls etc but if there is the possibility of making huge amounts of money someone within the structure will attempt to subvert those controls. The question is to what extent firms seek to root out those practices or if they become part of the culture and (unofficially of course) accepted.

The current cases involving LIBOR rigging (http://www.bloomberg.com/news/2011-11-23/london-banks-seen-r...) seem to mirror this article and the debate over Goldman Sachs possible collusion with hedge funds trading against CDOs in 2008 seem to point to the need to ask serious questions about how banks and investment firms conduct themselves.

If you had read the article you'd have seen the scheme relied on corrupt brokers to share bid information between buyers. This obviously suggests that without the corrupt broker, the buyers wouldn't have been able to rig the bids, despite all of them being knowledgeable and knowing each other (in so much as BofA knows of SocGen etc.).

I think the Mafia tag sticks. The brokers bribed politicians in return for being given control over shopping a municipality's bond money to the banks. They then took kickbacks from the banks to rig that bidding process. That sounds like organised crime to me.

I hate to ask, but might there be a tl:dr; summary? That's a lot of text. I'm interested, but I don't really want to spend that much time on storytelling.

Cities/Town/States gets money from bond sales and need a place to store the money because it doesn't get used at once. They held auctions and banks would submit bids to hold the money at a certain interest rate. Banks colluded to lower their bids instead of competing fairly.

Banks participated in a three bid system for municipal business. It ended the same way all three bid systems do.

I can reduce it to two words: bid rigging

There, I just saved you like an hour.

As the other replies have said, it boils down to bid rigging. What's interesting about it is the sheer scale. It apparently has been going on for at least 10 years, affects every state in the US and the banks have likely scimmed billions of dollars from it. What's particularly galling is that the entities they have stolen this money from are schools, hospitals, ports etc. Basically, another example of the already rich brazenly lining their pockets yet further with misappropriated public money. All the time hiding behind the supposed "complexity" of what they do and showing apparently no shame or remorse.

the source

http://www.justice.gov/atr/cases/f261600/261602.htm

Some of these sections are a little confusing. Can someone help me out? Hopefully Planet Money on NPR will do an episode on it soon :)

"So it goes to Wall Street, which issues a bond in your town's name to raise $100 million, attracting cash from investors all over the globe"

Why would investors put money into a school? Are they hoping for returns on their investmant later on like shares in a company? I can't image the profit margins on a school would be very lucrative. Why would people invest in these projects?

"While that unspent money is sitting in the town's account, local officials go looking for a financial company on Wall Street to invest it for them."

So the town raised money for a school which they then invest back into wallstreet, to make money? That seems like an odd process. Would it not be possible for towns to say "We are going to build a $300 million dollar theme park", get the money, and say "construction isn't due to start until, oh I don't know, 2023?", meanwhile just earning huge amounts of interest?

"the broker would tell the prearranged "winner" what the other two bids were" If the three banks are colluding, why does the broker need to be the one to pass on the information of what the other bids where? Can't the banks just talk to each other directly and plan in advance what they are going to bid?

The investors don't care about the school, they care about the interest payments they will receive. Bonds are often considered lower risk because the income is fixed.

Earning "huge" amounts of interest is exactly what they are doing. They get cash, they put it back in the bank. The lawsuit is about the "huge" interest rate being rigged.

Oh, you ask why they don't do that and never build the project? Because they're paying interest on it in excess of whatever they're earning. The earned interest is only to minimize the cost of sitting on the borrowed money.

Using a broker to decide the winner leaves less paper trail. It'd be weird for three competing banks to have a three way call every time this happened.

That clears a lot of it up. Cheers!

> How and when the government got hold of those tapes is still unclear; the prosecution is not commenting on the case

Didn't Wikileaks say they had some BofA documents/conversations that were maliciously "deleted" before they went public?

Google AdWords lowers highest CPC ad bid to "the second highest bid + $0.01".

These banks did essentially the same with their bids, just without consent from their clients.

Here in Kenya our politicians are the thieves cheating the public out of millions, in America it seems your bankers are the crooks

The scam could only continue with the aid of politicians. Big banks told their employees to donate money to the politicians (and later paid them back the money they 'donated'). Or they gave away 'gifts' like Superbol Tickets and limo-treatments. The politicians receive the money/gifts after which they will "advice the City or County" what bank is to handle the swap-deals. There turned out to be $66 return for every dollar the banks 'invested' in the politicians.

No, it's politicians as well. They tend to work for each other.

this fills me with righteous anger

Matt Taibbi is awful. This article, and all of his others, are hyperbolic demagoguery. This one is particular is so bad that I can't even bring myself to tear it apart line by line. You're doing yourself an injustice by reading it. Unless you take pleasure in misinforming yourself and becoming angered over falsehoods, you're just playing into the hands of a particularly nefarious and persistent rabble-rouser.

Your doing us an injustice by not tearing it apart. Help us, inform us. He may be a rabble rouser prone to hyperbole, but that by itself doesn't mean what he's writing is false. Look past the drama and tell us what's incorrect.

You're all doing us an injustice by not flagging it so that it and other off-topic articles like it are not relentlessly expunged from this site.

I'll give you that 75% of this article is unnecessary hyperbole which adds nothing to the central message.

The central message is very interesting though.

But without the hyperbole, people won't get engaged, they won't get angry.

Now, to some extent that engagement is being sought in order to sell Rolling Stone, but I think that both Matt and the Rolling Stone editors believe that they're talking about something that matters & that people should be angry about. Hence the hyperbole.

If they wrote a dry academic paper and published it in some economics journal somewhere it might contain exactly the same information but it would have negligible impact.

> But without the hyperbole, people won't get engaged, they won't get angry.

As above, "getting people angry" about stuff that is very tangentially related to hacker news is a good indication it's a bad fit for this site. There are so many other sites on the internet to discuss politics, economics and things of that ilk. In the grand scheme of things, those topics are more important than "hacker news" and could easily "crowd out" our "dry" discussions of computers and startups here.

If they wanted to get people angry, they should follow the money and show where all the money used to build a new hospital goes, but Taibbi's axe doesn't grind that way.

Bear in mind that RS is a magazine, not a newspaper. It's not just supposed to inform you, it's also meant to be a nice read.

"[Top executives were] plunged into years of nut-crushing negotiations [...]"

Perhaps unnecessary hyperbole, but entertaining nonetheless. If you want "just the facts" without the hyperbole, read the indictment [1]. FWIW, I find the RS article to be a more pleasant read.

[1]: http://www.justice.gov/atr/cases/f261600/261602.htm

Yeah, sentences like "this was like the scam in Office Space, multiplied by a factor of about 10 gazillion: Banks stole pennies at a time from towns all over America, only they did it a few hundred bazillion time" struck me as really poorly written.

Which bits do you have a problem with exactly (or do you work in finance and the article has just rubbed you up the wrong way)? If you strip out the Rolling Stone literary tone and just focus on the facts of the article, "The Scam Wall Street Learned From the Mafia" is a fairly accurate title.

So municipalities tried to game the system by instituting closed auctions instead of the open ones, and then got mad, when it turned out that some parties are willing to pay to peek into the sealed bids? An open auction system would not have created the peeking problem in the first place.

Both parties tried to institute unreasonable complexity to get an upper hand.

Can you explain further? What do you mean by "closed" and "open" auction?

AFAIK, they outsourced the auction process to a third-party company specializing in conducting auctions. That company and the bidders colluded to defraud municipalities. Corrupt auctioneers also paid bribes to politicians to get hired as as auctioneers.

Do you really not see anything wrong with this picture?

Edit: Removed paragraph with analogy involving ebay. Analogies suck, and it didn't really apply here.

An open auction is one where everyone's bids are public and visible to everyone hence allowing price discovery, contrasted with a closed auction, one where the bids are sealed and not disclosed to any other parties. It seemed from the article that the bids were submitted over the phone and known to the broker ahead of the conclusion of the auction, as opposed to a sealed first-price auction.

Just to be clear, telling the broker their bid instead of just sending it sealed is exactly the corruption that's being discussed in the article.

AFAIK, it wasn't legal for the bidders to tell the auctioneer what their bid was.

They're sealed bid auctions.

You can see what the others bid on eBay. If you choose to bid just a penny over the highest bid (as opposed to bidding up by a larger amount), you're unlikely to be prosecuted.

And the problem was that they became UNsealed auctions due to corruption.

After reading the article, are you saying that the auctioneer conducted a proper sealed auction?

AFAIK, it is the norm worldwide in private as well as public sectors for contracts to be given out via sealed bid auctions, as opposed to ebay-style open auctions.

The ebay-style process works for ebay because there are large number of potential buyers who don't know each other. IMHO, if multi-round open bidding is allowed for auctions like this with a limited number of possible bidders, price collusion is likely to occur even more easily.

Sealed auctions introduce inefficiencies in capital allocation. The parties writing the laws benefit from these inefficiencies, hence market's move to transparency is written up as collusion.

Switch to open auctions would remove incentives for corruption.

There will always be incentives for corruption. For instance, your money is not flowing to me at the moment, which I find to be highly inefficient.

Giving me all your money would remove the incentive to rob you.

Also, are you seriously appealing to anarchist idealism as a justification for bid-rigging? How many of these intellectuals who are using their brainpower to rip off local governments could keep their small fortunes for more than a month in a state of anarchy? They're precisely the kind of people who benefit the most from the existence of a state, so cry me a river at the injustice of them having to play by the state's rules.

mmm.. I don't get your point. Even in an open auction, bidders in an auction could still collude to submit lower bids and divide their winnings.

Problem is that there are only a couple of large banks who control a large portion of money. If there were more banks, one bank will eventually break the collusion and offer a competitive bids, and other banks will follow.

Yeah, you nailed the core of the problem. Banks don't so much "control" the money (most of such bonds flow to mutual funds and ETFs), it's just hard for average citizens to participate in the process. Large issuers have set up direct shops like http://www.buycaliforniabonds.com/

The municipalities didn't try to game any system. Any potential buyer who found closed auctions to be somehow unfair was free to choose not to participate. This is equivalent to what you're saying:

"The supermarket is trying to sell 20-oz sodas for $1.50 a pop, and now they get mad when I steal them instead? A policy of giving sodas away for free would not have created the stealing problem in the first place."

Saying the municipalities weren't trying to game the system, is not proven by saying you don't have to participate.

The statement that if you don't like the rules you don't have to participate plays to the nature of your position. This isn't a private business or private project, these are public municipalities that are spending tax payer dollars. In the name of transparency for voters they should not be able to hide what they're doing.

Wait, so it's the voters who are clamoring for the use of open auctions to determine what bank to invest public funds with? Um, no. As for "[hiding] what they're doing", what do you mean? The article mentions nothing about the municipalities hiding things from the public. If you're referring to the closed auctions, that's just a way of selling something that benefits the seller. It's not "closed" in any other sense.

So what you're saying is that, because a municipality is a public entity, it shouldn't be allowed to invest funds in a manner that would be perfectly acceptable for a private entity not because the entity's constituents disapprove, but because the banks don't like it? That's absurd. If buyers shouldn't be allowed to dictate the negotiation tactics of private sellers, they shouldn't be allowed to dictate the negotiation tactics of public sellers either. You seem to be conflating (or attempting to conflate?) the banks with the municipality's constituents. It's true that a municipality must answer to its constituents, but it doesn't have to answer to any private bank that feels like whining.

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