Think Brazil’s scandals have nothing to do with US banks? Guess again.

This weekend, millions of Brazilians took to major city streets (again) to protest the hydra of corruption gushing from Petrobras, Brazil’s largest oil company and the government amidst deepening economic recession. Calls for the impeachment of sitting Workers’ Party (PT) president (and former Chair of Petrobras), Dilma Rousseff filled the air.  (I can’t wait to see the frenetic state of things when I swing by there  in two weeks for talks and book research.)

It’s tempting to consider the spectacle as isolated to Brazil’s unique brand of political-corporate collusion, where pillaging state-run companies to line pockets of power players is standard practice.  But that doesn't do the whole story justice.  

In the US, bartering government contracts or certain legislation for billions of dollars of political donations falls under the umbrella of legalized bribery, better known as campaign contributions, including via SuperPacs, the elite’s favorite political currency thanks to Citizens United. Political stars leave Washington for cushy corporate board posts or lucrative speaking engagements, sometimes en route back to DC.

It’s similar in Brazil, where former President “Lula” allegedly bagged $8 million in post-presidential speaking gigs from six companies. Bill Clinton nabbed about $105 million since he left the White House. Exact comparisons of how much of either of those sets of fees were connected to companies practicing corporate corruption will be a topic for my book, or another time. One country’s public sector scandal is another country’s private sector cost of doing business. Let’s not pretend otherwise.

Details aside, establishment corruption is a global virus. It may fester in a certain spot for longer periods or in greater concentration for awhile, but it’s omnipresent. It morphs to adapt to its environment and leaders. It moves like liquid. Because it links money and power, its also snakes through banks and political parties of all persuasions all over.  For now, the scene is Brazil, but the corruption under scrutiny is bigger than Brazil.

Broken Promises

(A version of the next section appeared in the February Issue of Strategic Intelligence where you can see sneak peaks of Artisans of Money and follow my colleagues, Jim Rickards and Tres Knippa.)

Things once looked so promising for Petrobras, Brazil’s state-run mega-oil company. In July 2006, the discovery of a massive pre-salt layer, 300 kilometers off the coast had the potential to transform Brazil into a leading oil producer.

The notion of “oil autonomy” even played a prominent role in Brazil’s 2010 presidential campaign. That platform helped secure the presidency for Lula’s protégé, Dilma Rousseff, who also happened to chair Petrobras’ board of directors from 2003 to 2010. Petrobras was destined to become the biggest oil company in the world.

Naturally, everyone wanted a piece of it. Multinational banks wanted to finance it.  Speculators and pension fund managers bet on its success. Two years after the US financial crisis cratered the global banking system,  the energy sector provided mega banks fresh opportunity to manufactured and leverage debt. Subprime mortgages had gone cold. Oil was hot.  Petrobras was really hot.

On September 24, 2010, Petrobras raised $70 billion in the largest share issue ever. Three of the Big Six US banks, Bank of America/Merrill Lynch, Citigroup, and Morgan Stanley, while simultaneously facing multi-billion dollar fraud suits in the US were global book runners. Brazilian bank, Banco Bradesco lead the offering. Banco Itau was another global book runner.

Brazil’s Enron: The Unraveling of Petrobras: 2014

In the energy and finance sectors, the bigger they are, the more crimes they’ve committed. Just as US energy company Enron imploded in a haze of fraud in 2001, Petrobras followed suit. In March 2014, Brazilian investigators discovered certain Petrobras employees had taken kickbacks for awarding lucrative contracts. Petrobras sourced the bribe money the old–fashioned way - cooking its books; inflating contract payments and artificially inflating asset levels. Potential fraud totaled $30 billion over a 15-year period and became the focus of national probes and international lawsuits.

 On March 17, 2014, Brazilian Federal Police arrested two men as part of "Operation Carwash," a federal investigation into associated money laundering activities. Paulo Roberto Costa, former head of Petrobras’ refining and supply department, and Alberto Youssef, infamous Brazilian money launderer, were convicted and later sentenced to 12 and 8 years in prison respectively for having masterminded the web of corruption. They were also allegedly involved in money laundering operations for the PMDB (Brazilian Democratic Movement Party) and right wing PP (Progressive Party).

Costa’s role in the corruption was international. In 2006, under his direction, a sketchy US acquisition took place. Petrobras purchased Houston-based refinery company, Pasadena, for $1.2 billion, about 30 times its worth. The purchase began at ten times its prior value, or $360 million for 50% of Pasadena, to be shared with Belgium energy firm, Astra. By July 2012, Petrobras paid an extra $820.5 million for its stake. 

On July 23 2014, Brazil’s public-spending watchdog organization, Union Accounting Tribunal (TCU) determined that Petrobras had overpaid for Pasadena. The kicker? Dilma had approved the purchase while Minister of Energy and president of Petrobras’ board of directors. It was a decision that was either crooked or dumb, or both.

Three months later, on October 29, 2014, Veja Magazine published illegally leaked testimony from Youssef accusing Rousseff and Lula of knowing details about Petrobras’ corruption 48 hours before the Presidential election. She won again anyway, but by a much slimmer margin. Petrobras didn’t do so well. During 2014, Petrobras stock dropped by 37.9%.  The decline continued.

More Unraveling and International Ire: 2015

By early 2015, not only was Petrobras mired in scandal, but also its foreign investors were livid. Lawsuits for billions of dollars of losses due to investors having been “misinformed” about Petrobras' true condition were stacking up.

Certain American banks were not blameless. Though they will argue it in the courts, they helped inflate Petrobras' debt burden without appropriate due-diligence, and advised clients to invest in Petrobras. Just like with Enron: big banks helped the firm become the sham it was and shareholders paid the price. That government corruption was also involved was either the cake or the icing depending on your point of view.

In New York, US Judge Jed Rakoff consolidated all the lawsuits against Petrobras and its bankers – Citigroup Global Markets, JP Morgan Securities and Morgan Stanley - into one large class action.

The nine largest Petrobras’ American Depository Shares (ADS) holders claimed losses of more than $50 million each. Amongst claimants were US pensions funds already engaged in suits against US banks for subprime related fraud, such as the Ohio Public Employees Retirement fund. The Bill and Melinda Gates Foundation sued Petrobras. So did Pimco. The list is pretty long. Your pension fund may very well be on it.

Money!

With oil prices diving and scandal escalating, Petrobras needed money to make interest payments. Petrobras owes about $135 billion in loans and bonds (some estimates are lower) to banks and investors. China, Brazil’s largest trade partner came to its rescue last spring. On April 1, 2015, Petrobras signed a $3.5 billion financing agreement with the China Development Bank as part of a broader oil cooperation agreement with China. (On February 26, 2016, China Development Bank produced another lifeline –a $10 billion loan in return for oil supply that covers all Petrobras’ debt needs this year.)

China’s generosity stoked a competitive urge amongst US-Euro banks. There’s a reason for the phrase “throwing good money after bad” especially when it’s other people’s good money. On June 1, 2015, Petrobras issued $2.5 billion worth of a 100-year “century” bond with an annual yield of 8.45%. Deutsche Bank and J.P. Morgan coordinated operations for the first century bond issued by a Latin American company since 1997.

Foreign investor demand rendered the issue 5 times over-subscribed. Yet, mid-scandal Petrobras projections were based on crude oil prices of $60 and $70 per barrel for 2015 and 2016 when in fact oil prices closed 2015 nearer to $35 per barrel.

Big Banks were there to collect when the music stopped, too. On June 3, 2015, two years after Bank of America called Petrobras the “most indebted company in the world,” Petrobras invited it to run a $5 billion asset sale.

On July 17, 2015, Petrobras selected five banks to lead the IPO of BR Distribuidora, Petrobras’ fuel distribution unit that controls Brazil's largest gasoline network. They were Citigroup, Banco Bradesco, ItaúUnibanco, Banco do Brasil and BTG Pactual. 

You’ll notice that all three major US bank participants in the 2010 share issue bagged lucrative roles in Petrobras’ demise; Citigroup in the IPO spin-off, JPM Chase in the century bond issue, and Bank of America in the assets sales.

The US-lead suit against Petrobras and its bankers will get increasingly hostile.  On October 6, 2015, banks challenged the plaintiffs’ claims and tried to get the case dismissed. Rakoff said “No.” The suit is awaiting a trial date. (Petrobras Securities Litigation, U.S. District Court, Southern District of New York, No. 14-09662.)

Petrobras has denied all allegations and claims to be the victim of a plot against it by contractors and corrupt politicians. On October 20, 2015, a pro-government commission cleared Dilma of wrongdoings, but that ship remains in the harbor. Both Dilma and Lula could be called for testimony as the US case unfolds.

Other Problems

On December 22, 2015, newly appointed Minister of Finance, N. Barbosa, announced Petrobras didn’t need a government injection – just higher oil prices. The next day, Brazil's antitrust authority, CADE, opened its own investigations into contract rigging associated with the 21 companies and 59 execs already under criminal probe.

Petrobras’ problems have hampered Brazil on multiple levels beyond scandal and an estimated $30 billion in GDP losses. Due to ongoing investigations, Petrobras stopped payments to other firms, including rigging companies. That sent some into bankruptcy and others to the brink, a factor that will depress their share prices and cause more defaults in 2016. Related sectors remain imperiled, including the steel, construction and banking sectors.

In addition, Brazil’s pension funds are in crisis. Unemployment and inflation, over 10 percent for the first time in 12 years, are rising sharply, despite high interest rates fashioned to contain inflation. Debt, defaults, jobs losses, lawsuits and currency devaluation don’t paint a rosy picture.

Three investigations about Lula’s connections with two companies prosecuted in Carwash Operation (OAS and Odebrecht) were opened on February 11, 2016, involving his country estate and beachfront apartment as well as other family holdings. On March 4, 2016, police stormed Lula’s home to take him in for questioning. Because it’s Brazil, the drama drove the Real and local markets higher; the idea of an imminent end to Dilma seen (by markets and many Brazilians, including her former supporters) as a preferred alternative to the opposition party’s own equally corrupt leader.

Dilma has proven resilient so far, but political instability over her Petrobras relationship and alleged “dipping” into state bank funds to pay other expenses, will continue to darken the doorstep of Brazil’s political system. We have 30 days to see whether her other coalition partner, the more centrist PMDB party, backs away from her, signaling a major reshuffling in Brasilia. Yet it’s not like members of the opposition party are scandal-free. Which brings us back to the trio of money, power and corruption, it may have geographical or cultural nuances, but its stench is universal.

Big Banks: Big Fines: Business As Usual

Last week, the Department of Justice announced that five major global banks had agreed to cop parent-level guilty pleas that rendered them all official corporate felons. The banks will pay more than $2.5 billion of criminal fines on top of a slew of past fines, plus regulatory and other fines of $3.1 billion, on top of a slew of past fines. It doesn't take a genius to see the pattern. Crime. Wrist-slap. Rinse. Repeat.

Here’s the thing. These kinds of penalties cause no financial damage; the profit was booked and releveraged long ago. The costs of the fines were set-aside in tax-deductible reserves awaiting this moment. Pleading guilty to one-count of felony level price rigging yet being allowed to maintain their status also alters nothing. These foreign currency exchange (FX) market manipulators – or “The Cartel” as they call themselves - Citicorp, JPMorgan Chase,  Barclays, The Royal Bank of Scotland, and UBS AG (who also received a $203 million fine for breaching its prior LIBOR manipulation settlement) will feel this punishment like an elephant feels a gnat, maybe even less.

As is customary after these sorts of fines are announced, the Department of Justice, aided in its investigations by a host of international regulatory and judicial bodies that are financed with taxpayer dollars and missed what was going on for years, waxed triumphant.

“Today’s historic resolutions,” remarked newly appointed Attorney General, Loretta Lynch, “serve as a stark reminder that this Department of Justice intends to vigorously prosecute all those who tilt the economic system in their favor; who subvert our marketplaces; and who enrich themselves at the expense of American consumers.”

She claimed that the penalties levied against these banks were commensurate with the “long-running and egregious nature of their anticompetitive conduct.” She further added that they “should deter competitors in the future from chasing profits without regard to fairness, to the law, or to the public welfare.”

But they won’t deter anything. Of that particular pack and this particular time, UBS was the only firm that agreed to pay extra for repeat crimes, but the rest of the crew are all repeat offenders in their own right who have had no restrictions placed on their might or market share as a result.

On the urban streets, recidivists get thrown behind bars. In the hallowed corridors of banking, financial goliaths only have to say they’re sorry, pay a fine, and promise not to do it again. In the real world, being tarred a felon makes it harder to get a job, a mortgage, and a personal loan. In the financial realm, it means business as usual following mildly unpleasant press releases and tiny fines from proud arbiters of justice and vigilance.

Since the 2008 financial crisis, some $140 billion worth of settlements against major banks have been announced by the Department of Justice, international regulators and class action legal teams. A normal person could be forgiven for losing focus of the details. It gets fuzzy after mortgage fraud and money laundering. By the time we reach manipulating LIBOR (London-Interbank-Offering-Rate) or rigging FX rates, it can seem mind numbing. Consider this, anything that costs you money has been influenced or manipulated by the big banks. Why? Because of their size and ability to use it against, or on the gray line of the law, to their advantage.

For not one, but for more than five years, from December 2007 and January 2013, euro-dollar traders at Citicorp, JPMorgan, Barclays and RBS – “The Cartel” – used an exclusive electronic chat room to coordinate their trading of U.S. dollars and euros so as to manipulate the benchmark rates set at the 1:15 PM European Central Bank and 4:00 PM World Markets/Reuters fixing times in order to maximize their profits. 

They would withhold buying or selling euros or dollars if doing so would hurt open positions held by their co-conspirators. In the global game of profit extraction, these sometimes-competitors protected each other in a manner similar to two mafia families locking arms (or firing shots)  to keep a third away from encroaching on their territory.

Each bank will pay a fine “proportional to its involvement in the conspiracy.” Citicorp, who spent the longest time rigging the FX markets, from as early as December 2007 until at least January 2013, will pay a $925 million fine. Barclays will pay a $650 million fine and a $60 million criminal penalty for violating its 2012 non-prosecution agreement regarding LIBOR rigging. The firms will fire 8 people, though not the CEO.

JPMorgan Chase, involved from at least as early as July 2010 until January 2013, agreed to pay a $550 million fine; and RBS, involved from at least as early as December 2007 until at least April 2010, agreed to pay a $395 million fine. 

Citicorp, Barclays, JPMorgan Chase, RBS and UBS have each agreed to a three-year period of corporate probation and to cease all criminal activity. (I’ll take the under on  when the next set of criminal activity related settlements hits them. )

Adding in the $4.3 billion from their November, 2014 related settlements with US and European regulatory agencies, last week’s FX “resolutions” bring the total fines and penalties paid by these five banks –  just for their FX conduct – to about $10 billion. 

Citicorp settled for the largest criminal fine of $925 million, on top of a $342 million Fed penalty. The other banks were fined relative to the fractional portion of the crime time frame.  No jail sentences were imposed – not even a day of house arrest or ankle monitors.

Size does matter. Sort of. According to the agreements,  “the statutory maximum penalty which may be imposed upon conviction for a violation of Section One of the Sherman Antitrust Act is a fine in an amount equal to the greatest of: $100 million, twice the gross pecuniary gain the conspirators derived from the crime or twice the gross pecuniary loss caused to the victims of the crime by the conspirators.”

But since there’s no way the DOJ totaled all the fractional losses non-Cartel members felt over the five years (which would likely include your by the way), it means that they believe the five banks at most collectively made $5 billion over five years, or $1 billion each (give or take) or $200 million (give or take) each from FX manipulation per year. I’m calling hogwash on that; $200 million per year rigging FX rates would have been such a pocket change game that the Cartel would have lost interest in it quickly.

JPM Chase’s press release didn’t mention the word ‘felony’ instead opting for the more demure term ‘violation.’ In keeping with his normal reaction to the financial crimes of his company, JPM Chase Chairman and CEO Jamie Dimon used the “bad-apple defense.” Calling this latest revelation of felonious activity a “disappointment,” he stated, “The lesson here is that the conduct of a small group of employees, or of even a single employee, can reflect badly on all of us, and have significant ramifications for the entire firm. That’s why we’ve redoubled our efforts to fortify our controls and enhance our historically strong culture.”

That’s not quite true. Not only was the supervisor of Foreign Exchange at JPMorgan not fired, but as Wall Street on Parade reported last week, that “individual, Troy Rohrbaugh, who has been head of Foreign Exchange at JPMorgan since 2005, is now serving in the dual role as Chair of the Foreign Exchange Committee at the New York Fed, helping his regulator establish best practices in foreign exchange trading.”

Stock values of the Cartel-Five banks only mildly underperformed the overall market on the day of the announcement, since their chieftains made it clear that money had already been set in reserve for these fines. They rebounded the next day.  In other news, last Tuesday, Jamie Dimon’s annual pay package of $20 million passed a shareholder vote.  

As for Citicorp, the firm’s settlement with the Federal Reserve included the entry of a cease and desist order (for criminal activity) and a civil penalty of $342 million. Citi also reached a separate settlement  in a related private class action suit for $394 million.

Michael Corbat, CEO of Citigroup, said, “The behavior that resulted in the settlements .. is an embarrassment to our firm, and stands in stark contrast to Citi’s values.” He added, “We will learn from this experience and continue building upon the changes that we have already made to our systems, controls, and monitoring processes.”

Investigations of other crimes continue. The EU, for instance, is re-evaluating its [4-year on hold] antitrust probe into whether 13 of the world’s largest banks conspired to shut exchanges out of the credit-default swaps (CDS) market in the years surrounding the financial crisis. Goldman Sachs. Bank of America, Deutsche Bank AG, JPMorgan Chase, Citigroup and HSBC Holdings are among the multiple-offender banks accused of colluding in this game from 2006 to 2009.

The upshot is this. These fines don’t matter. Felony pleas are a nice touch, but none of these punishments impose solid structural change, nor is any being suggested. Putting the fines in perspective, Citicorp's criminal fine of $925 million is equal to 1/20th of 1 percent of its assets. For JPM Chase, the fine of $550 million is equivalent to about 1/50^th of 1 percent of its assets.  Why would that deter anything?

Words of contrition from bank CEOs have repeatedly followed the unearthing of fresh crimes or settlements for correlated criminal or quasi-criminal behavior. Words of triumph from justice officials or regulators have proceeded more manipulations and discoveries. Aside from our tacit support for these banks by keeping our money with them or using them for more humble services, we citizens pay for the people-hours of public officials in a myriad of ways including funding the bodies that are supposed to keep us financially safe from bank shenanigans.

How many more crimes do these banks get to commit before these judicial and regulatory bodies, and the rest of Washington wakes up and breaks them up? Bigger banks, bigger crimes. Smaller banks, smaller crimes. At least, a size reduction would be a step in the right direction.

QE isn’t dying, it’s morphing

A funny thing happened on the way to the ‘end’ of the multi-trillion dollar bond buying program known as QE - the Fed chronicles. Aside from the shift to a globalization of QE via the European Central Bank (ECB) and Bank of Japan (BOJ) as I wrote about earlier, what lingers in the air of “post-taper” time is an absence of absence. For QE is not over. Instead, in the United States, the process has simply morphed from being predominantly executed by the Federal Reserve (Fed) to being executed by its major private bank members. Fed Chair, Janet Yellen, has failed to point this out in any of her speeches about the labor force, inflation, or inequality. 

The financial system has failed and remains a threat to us all. Only cheap money and the artificial inflation of asset values can make it appear temporarily healthy. Yet, the Fed (and the Obama Administration) continue to perpetuate the illusion that making the cost of (printed) money zero by any means has had a positive effect on the population at large, when in fact, all that has occurred is a pass-the-debt-ponzi-scheme co-engineered by the Fed and big US bank beneficiaries. That debt, caught in the crossfires of this central-private bank arrangement, is still doing nothing for American citizens or the broader national or global economy. 

The Fed is already the largest hedge fund in the world, with a book of $4.5 trillion of assets. These will plummet in value if rates rise.  Cue the banks that are gearing up their own (still small in comparison, but give them time) role in this big bamboozle. By doing so, they too are amassing additional risk with respect to interest rates rising, on top of all their other risk that counts on leveraging cheap money.

Only the naïve could possibly believe that the Fed and its key banks haven’t been in regular communication about this US Treasury security shell game.  Yet, aside from a few politicians, such as former Congressman Ron Paul, Congressman Sherrod Brown and Senators Bernie Sanders and Elizabeth Warren, the notion that Fed policy has helped bankers, rather than other people, remains largely divorced from bi-partisan political discussion. 

Adding more fuel to the central-private bank collusion fire, is the fact that the Fed is a paying client of the JPM Chase. The banking behemoth is bagging fees for holding and executing transactions on the $1.7 trillion New York Fed’s QE mortgage portfolio, as brilliantly exposed by Pam Martens and Russ Martens.

 Wouldn’t it be convenient if JPM Chase was also trading this massive mortgage book for its own profits? Or rather - why wouldn’t they be?  Who’s going to stop them – the Fed? Besides, they hold more trading assets than any other US bank, so why not trade the Fed’s securities ostensibly purchased to help the public - recover?

According to call report data compiled by the extremely thorough website www.BankRegData.com, nearly 97% of all bank trading assets (including US Treasuries) are held by just 10 banks, led by JPM Chase with 43.80% and followed by Citigroup at 24.51% of all bank trading assets.

Last quarter, US Treasuries were the fastest growing form of security bought by banks, increasing by 26.3% or $72 billion over the prior quarter. As the Fed tapered, banks stepped in to do their part in the coordinated Fed-private bank QE game. In the past year, banks have added $185.8 billion of US Treasuries to their books, more than doubling their share of government debt.

Just seven banks comprised nearly all ($70.5 billion) of this quarterly increase: State Street Bank, Capital One, JPM Chase, Wells Fargo, Bank of America, Bank of NY Mellon and Citigroup. By the end of the third quarter of 2014, Citigroup, with $95 billion, was the largest holder of US Treasuries, followed by Bank of America at $54.8 billion and Wells Fargo at $37.8 billion from nearly zero at the start of 2014. Bank of NY Mellon holds $25.3 billion and JPM Chase holds $15 billion US Treasuries.

This increase in US Treasury holdings reflects another easy money element of our federally subsidized banking system. Banks take deposits from individuals for which they pay close to zero in interest, in fact, charge customers fees for keeping their money  (courtesy of the Fed’s Zero-Interest-Rate policy.) They can turn that around to make a cool risk-free 2.3% by parking the money in 10-year US Treasuries. Why lend to Joe the Plumber, when the US government is providing such a great deal?

But, the recent timing here is key. Banks only started buying US Treasuries in earnest when the Fed announced its tapering plans. Thus, not only are they participants in the ZIRP game as recipients of cheap money, they are complicit in effecting monetary policy. As the data analyzed so expertly by Bill Moreland at www.BankRegData.com makes clear, there has been no taper.  Thus, the publicized reason for tapering – better job and economic growth – is also bogus.

During the third quarter, Wells Fargo and Bank of America matched Fed purchases of US Treasuries, keeping the total amount of US Treasuries in QE land neutral. With such orchestration to keep rates down and the prices of US Treasury securities up, all the talk about whether the labor force is strengthening or inflation exists or not is mere show. Banks haven’t even propped up the labor market in their own industry. They chopped 11,400 jobs last quarter. In the past two years, they cut 57,236 jobs.  

No sucessful candidate in either political party mentioned any of this during the mid-term elections. Yet, our political-financial system has gone from the dysfunctional to the failed to the surreal. Speculation, once left to individuals and investors, is now federally sponsored, subsidized and institutionalized.  When this sham finally buckles and the next shoe falls and rates do eventually rise, the stock market will tank, liquidity will die, and the broader economy will plunge into a worse Depression than before. We are not there yet because of these coordinated moves and the political force behind them. But we are on a precarious path to that inevitability.