The military 'solution'

Jul 13, 2012

By Tom Engelhardt

Americans may feel more distant from war than at any time since World War II began. Certainly, a smaller percentage of us - less than 1% - serves in the military in this all-volunteer era of ours and, on the face of it, Washington's constant warring in distant lands seems barely to touch the lives of most Americans.

And yet the militarization of the United States and the strengthening of the National Security Complex continues to accelerate. The Pentagon is, by now, a world unto itself, with a staggering budget at a moment when no other power or combination of powers comes near to challenging this country's might.

In the era following the attacks of September 11, 2001, the

military-industrial complex has been thoroughly mobilized under the rubric of "privatization" and now goes to war with the Pentagon. With its US$80 billion-plus budget, the intelligence bureaucracy has simply exploded. There are so many competing agencies and outfits, surrounded by a universe of private intelligence contractors, all swathed in a penumbra of secrecy, and they have grown so large, mainly under the Pentagon's aegis, that you could say intelligence is now a ruling way of life in Washington - and it, too, is being thoroughly militarized.

Even the once-civilian Central Intelligence Agency has undergone a process of para-militarization and now runs its own "covert" drone wars in Pakistan and elsewhere. Its director, a widely hailed retired four-star general, was previously the US war commander in Iraq and then Afghanistan, just as the national intelligence director who oversees the whole intelligence labyrinth is a retired US Air Force lieutenant-general.

In a sense, even the military has been "militarized". In these last years, a secret army of special-operations forces, 60,000 or more strong and still expanding, has grown like an incubus inside the regular armed forces. As the CIA's drones have become the president's private air force, so the special-ops troops are his private army, and are now given free rein to go about the business of war in their own cocoon of secrecy in areas far removed from what are normally considered America's war zones.

Diplomacy, too, has been militarized. Diplomats work ever more closely with the military, while the State Department is transforming itself into an unofficial arm of the Pentagon - as the secretary of state is happy to admit - as well as of the weapons industry

And keep in mind that we now have two Pentagons, thanks to the establishment of the Department of Homeland Security (DHS), which is focused, among other things, on militarizing the southern border. Meanwhile, with the help of the DHS, local police forces nationwide have, over the past decade, been significantly up-armored and have, in the name of fighting terrorism, gained a distinctly military patina. They have ever more access to elaborate weaponry and gadgets, including billions of dollars of surplus military equipment of every sort, often being funneled to once-peaceable small-town police departments.

The military solution in the Greater Middle East
in the US is hardly a new phenomenon.
It can be traced back decades, but the process hit warp speed in in the years after the September 11 attacks, even if the country still lacks the classic look of a militarized society. Almost unnoticed has been an accompanying transformation of the mindset of Washington - what might be called the militarization of solutions.

If the institutions of US life and governance are increasingly militarized, then it shouldn't be surprising that the problems facing the country are ever more often framed in militarized terms and that the only solutions considered are similarly militarized. This paucity of imagination, this constraining of what might be possible, seems especially evident in the Greater Middle East.


In fact, Washington's record there, seldom if ever collected in one place, should be eye-opening. Start with a dose of irony: Before the invasion of Iraq in 2003, it was a commonplace among neo-conservatives to label the region extending across the oil heartlands of the planet, from North Africa to the Chinese border in Central Asia, "the arc of instability". After a decade in which Washington has applied its military might and thoroughly militarized solutions to the region, that decade-old world now looks remarkably "stable".

.Here, in shorthand, is a little regional scorecard of what US militarization has meant in the Greater Middle East, 2001-2012:

Pakistan: The US has faced a multitude of complex problems in this nuclear nation beset with insurgent movements, its tribal areas providing sanctuary to both Afghan and Pakistani rebels and jihadis, and its intelligence service entangled in a complicated relationship with the Taliban leadership as well as other rebel groups fighting in Afghanistan. Washington's response has been - as Secretary of Defense Leon Panetta recently labeled it - war. In 2004, the George W Bush administration launched a drone assassination campaign in the country's tribal borderlands largely focused on al-Qaeda leaders (combined with a few cross-border special-forces raids). Those rare robotic air strikes have since expanded into something like a full-scale covert drone war that is killing civilians, is intensely unpopular throughout Pakistan, and by now is clearly meant to punish the Pakistani leadership for its transgressions as well.


Frustrated by what they consider Pakistani intransigence, elements in the US military and intelligence community are reportedly pressing to add a new set of cross-border joint special operations/Afghan commando raids to the present incendiary mix. US air strikes from Afghanistan that killed 24 Pakistani soldiers last November, with no apologies offered for seven months, brought to a boil a crisis in relations between Washington and Islamabad, with the Pakistani government closing off the country to US war supplies headed for Afghanistan. (That added a couple of billion dollars to the Pentagon's expenses there before the crisis was ended with a grudging apology this week.) The whole process has clearly contributed to the destabilization of nuclear Pakistan.

Afghanistan: After a November 2001 invasion (light on invading US troops), the United States opted for a full-scale occupation and reconstruction of the country. In the process, it managed to spur the reconstruction and reconstitution of the previously deeply unpopular and defeated Taliban movement. An insurgent war followed. Despite a massive surge of US forces, CIA agents, special-operations troops, and private contractors into the country, the calling in of air power in a major way, and the expansion of a program of "night raids" by special-ops types and the CIA, success has not followed. By the end of 2014, the US is scheduled to withdraw its main combat forces from what is likely to be a thoroughly destabilized country.

.Iran: In a program long aimed at regime change (but officially focused on the country's nuclear program), the US has clamped energy sanctions - often seen as an act of war - on Iran, supported a special-operations campaign of unknown proportions (including cross-border actions), run a massive CIA drone surveillance program in the country's skies, and (with the Israelis) loosed at least two major malware "worms" against the computer systems and centrifuges of its nuclear facilities, which even the Pentagon defines as acts of war. It has also backed a massive buildup of US naval and air power in the Persian Gulf and of military bases in countries on Iran's peripheries, along with "comprehensive multi-option war-planning" for a possible 2013 strike at Iran's nuclear facilities. (Though little is known about it, an assassination campaign against Iranian nuclear scientists has usually been blamed on the Israelis. Now that the joint US-Israeli authorship of acts of cyberwar against Iran has been confirmed, however, it is at least reasonable to wonder whether the US might also have had a hand in these killings.) All of this has brought the region to the edge of yet more war, while in no obvious way shaking the Iranian regime.

Iraq: The US invaded in March 2003, occupying the country. It fought (and in essence lost) an eight-year-long counterinsurgency war, withdrawing its last troops at the end of 2011, but leaving

behind in Baghdad the world's largest, most militarized embassy. The country, now an ally and trading partner of Iran, remains remarkably unreconstructed and significantly destabilized, with regular bombing campaigns in its cities.

Kuwait: Just across the border from Iraq, the US has continued a buildup of forces. In the future, according to a US Senate report, there could be up to 13,000 American personnel permanently stationed in the country.


Yemen: Washington, long a supporter of the country's strongman ruler, now backs the successor regime. (In Yemen, as elsewhere, Washington has been deeply uncomfortable with Arab Spring-style democracy movements among its allies.) For years, it has had an air campaign under way in the southern part of the country aimed at insurgents linked to al-Qaeda in the Arabian Peninsula (AQAP). More recently, it has put at least small numbers of special operations troops on the ground there as advisers and trainers and has escalated a combined CIA drone and US Air Force manned-plane air campaign in southern Yemen. There have been at least 23 air strikes already this year, evidently causing significant civilian casualties, reportedly radicalizing southerners, increasing support for AQAP, and helping further destabilize this impoverished and desperate land.

Bahrain: Home of the US 5th Fleet, tiny Bahrain, facing a democratic uprising of its repressed Shi'ite majority, called in the Saudi military on a mission of suppression. The US has offered military aid and support to the ruling Sunni monarchy.

Syria: In radically destabilized Syria, where a democracy uprising has morphed into a civil war with sectarian overtones that threatens to destabilize the region further, including Lebanon and Iraq, the CIA has now been dispatched to the Turkish border. Its job: to direct weapons to rebels of Washington's choice (assuming that the CIA, with its dubious record, can sort the democrats from the jihadis). The weapons themselves are arriving, according to the New York Times, via a "network of intermediaries including Syria's Muslim Brotherhood and paid for by Turkey, Saudi Arabia and Qatar". It's a project that has "this can't end well" written all over it.

Somalia: Long a failed state, Somalia has suffered, among other things, through a US-fostered Ethiopian invasion back in 2006 (and another more recently), drone attacks, CIA and special-forces operations, a complicated US program to subsidize a force of African (especially Ugandan) troops in the capital and support for a Kenyan invasion in the south - each step in the process seemingly leading to further fragmentation, further radicalization, and greater extremism.

Egypt: Ever since Tahrir Square, Washington has been focused on its close ties with the Egyptian military high command (key figures from which visit Washington every year) and on the billions of dollars in military aid it continues to provide to that military, despite the way it has usurped democratic rule.

Libya: The administration of President Barack Obama called in the US Air Force (along with air power from North Atlantic Treaty Organization allies) to support an inchoate uprising and destroy the regime of longtime strongman Muammar Gaddafi. In this they were successful. The long-term results remain unknown. (See, for instance, the Islamist revolt in destabilized neighboring Mali.)

How to set the planet on fire and learn nothing

This remains a partial list, lacking, to give but one example, the web of drone bases being set up from Seychelles and Ethiopia to the Arabian Peninsula - clearly meant for expanded drone wars across the region. Nonetheless, it is a remarkable example of the general ineffectiveness of applying military or militarized solutions to the problems of a region far from your own shores. From Pakistan and Afghanistan to Yemen and Somalia, the evidence is already in: Such "solutions" solve little or nothing, and in a remarkable number of cases seem only to increase the instability of a country and a region, as well as the misery of masses of people.

And yet the general lack of success from 2002 on and a deepening frustration in Washington have just led to a stronger conviction that some re-calibrated version of a military solution (greater surges, lesser surges, no invasions but special forces and drones, smaller "footprint", larger naval presence, etc) is the only reasonable way to go.

In fact, military solutions of every sort have such a deep-seated grip on Washington that the focus there might be termed obsessive. This has been particularly obvious when it comes to the CIA's drone wars. Back in the Vietnam War years, president Lyndon Johnson was said to have driven his generals crazy by "micromanaging" the conflict, especially in weekly lunch meetings in which he insisted on picking specific targets for the air campaign against North Vietnam.


These days, however, Johnson almost looks like a laissez-faire war president. After all, thanks to the New York Times, we know that the White House has a "nominating" process to compile a "kill list" of terror suspects, and that the president himself decides which drone air attacks should then be launched, not target area by target area, but individual by individual. He is choosing specific individuals to kill in the Pakistani, Yemeni and Somali backlands.

It should be considered a sign of the times that, whatever shock this news may have caused in Washington (mainly because of possible administration leaks about the nature of the "covert" drone program), few have even mentioned presidential micromanaging, nor, it seems, are any generals up in arms. Some may have found the "nomination" process shocking, but rare are those who seem to think it strange that a president of the United States should be involved in choosing individuals (including US citizens) for assassination-by-drone in distant lands.

The truth is that such "solutions", first tested in the Greater Middle East, are now being applied (even if, as yet, in far more modest ways) from Africa to Central America. In Africa, I suspect you could track the growing destabilization of parts of that continent to the setting up of a US command for the region (Africom) in 2007 and in subsequent years the slow movement of drones, special-forces operatives, private contractors and others into a region that already has problems enough.

Here's a 2012 American reality, then: As a great power, the US has an increasingly limited toolkit, into which it is reaching far more often for ever more similar tools. The idea that the globe is a chessboard, that Washington is in control of the game, and that each militarized move it makes will have a reasonably predictable result couldn't be more dangerous. The evidence of the past decade is clear enough: There is little less predictable or more likely to go awry than the application of military force and militarized solutions, which are cumulatively incendiary in unexpected ways, and in the end threaten to set whole regions on fire. None of this, however, seems to register in Washington.

The United States is commonly said to be a great power in decline, but the militarization of US policy - and thinking - at home and abroad is not. It has Washington, now a capital of perpetual war, in its grip.

This process began, after the September 11 attacks, with the soaring romanticism of the Bush administration about, as the president put it, the power of the "greatest force for human liberation the world has ever known" (aka the US military) to change the world. It was a fundamental conviction of Bush and his top officials that the most powerful military on the planet could bring any state in the Greater Middle East to heel in a "cakewalk".

Today, in the wake of two failed wars on the Eurasian continent, a de-romanticized version of that conviction has become the deeply embedded, increasingly humdrum way of life of a militarized Washington. It will remain so.

If Barack Obama, the man who got Osama bin Laden, is re-elected, nothing of significance is likely to change in this regard. If Mitt Romney wins the presidency, the process is likely to accelerate, possibly moving from global misfire, failure and obsession to extreme global fantasy, with consequences - from Iran to Russia to China - difficult now to imagine.

Tom Engelhardt, co-founder of the American Empire Project and author of The United States of Fear as well as The End of Victory Culture, runs the Nation Institute's TomDispatch.com. His latest book, co-authored with Nick Turse, is Terminator Planet: The First History of Drone Warfare, 2001-2050.

(Copyright 2012 Tom Engelhardt.)

Forget About QE3, Look To The 'Fiscal Cliff' For Gold's Next Big Move

July 13, 2012

Tim Iacono


Well, maybe the word "forget" is the wrong word to use here since, more so than at any other time in history, the direction of the gold price has been driven by expectations about whether the Federal Reserve will launch a new round of money printing or not, however, investors seem to have already forgotten that the Fed was largely out of the picture when the gold price rose to a record high late last summer.

It was fractious debt ceiling debate and downgrade of U.S. credit that sent the trade weighted dollar sharply lower along with domestic equity markets while the yellow metal was soaring toward the $2,000 mark as shown below and this sort of thing could happen again this year.

(click to enlarge)


Once the U.S. government had "kicked the can down the road" one more time, markets settled down, the dollar rose along with equity markets as the gold price plunged, investors regaining confidence in the world's reserve currency once again while eschewing what has served as a global currency for thousands of years.

Is there any reason to think that, with the fiscal choices staring policy makers down later this year now even more extreme, elected officials will do any better this time around?

Whatever they decide to do, it is likely to be positive for the gold price.

If, as most suspect, a lame-duck Congress again forestalls major decisions about taxes and spending by again extending all the programs that were extended last summer, this is likely to be negative for the dollar and positive for all risk assets, including gold.

Recall what happened the last time that a lame-duck Congress met in December of 2010 and agreed to spend nearly a trillion dollars more of borrowed money - the price of nearly everything soared in what some fondly look back upon as "a December to remember".

If elected officials dicker, much like they did last summer during the debt ceiling debate, look for the dollar to tumble and take U.S. stocks along with it while the price of gold soars. After some sort of an agreement is reached in the new Congress in 2013, financial markets will likely recover and the gold price will plummet, but who knows how high it might have climbed by then.

An extreme outlier possibility would be for Congress to enact credible long-term reforms while, at the same time, providing near-term stimulus via an extension to the existing programs, however, given their track record since that was attempted about a year ago, it's not clear that this is possible.

JPM Admits CIO Group Consistently Mismarked Hundreds Of Billions In CDS In Effort To Artificially Boost Profits

Submitted by Tyler Durden

on 07/13/2012 06:52 -0400

Back on May 30 we wrote "The Second Act Of The JPM CIO Fiasco Has Arrived - Mismarking Hundreds Of Billions In Credit Default Swaps" in which we made it abundantly clear that due to the Over The Counter nature of CDS one can easily make up whatever marks one wants in order to boost the P&L impact of a given position, this is precisely what JPM was doing in order to boost its P&L?

As of moments ago this too has been proven to be the case. From a just filed very shocking 8K which takes the "Whale" saga to a whole new level. To wit: 'the recently discovered information raises questions about the integrity of the trader marks, and suggests that certain individuals may have been seeking to avoid showing the full amount of the losses being incurred in the portfolio during the first quarter. As a result, the Firm is no longer confident that the trader marks used to prepare the Firm's reported first quarter results (although within the established thresholds) reflect good faith estimates of fair value at quarter end."
As a result of this, regulators who now are only 3 years behind the curve, are most likely snooping to inquire not only how JPM did it (call us: we can brief you in 2 minutes), but who else has been doing this? Hint: everyone.

Because in other words, we have just discovered that the two key components of the entire CDS market: the LIBOR base and market "marks" have been bogus at best, and realistically, fraud. And one wonders why no bank ever will let CDS trade on an exchange...

On July 13, 2012, JPMorgan Chase & Co. reported that it will restate its previously-filed interim financial statements for the first quarter of 2012. The restatement will have the effect of reducing the Firm's reported net income for the 2012 first quarter by $459 million. The restatement relates to valuations of certain positions in the synthetic credit portfolio of the Firm's Chief Investment Office. The Firm's year-to-date principal transactions revenue, total net revenue and net income and the year-to-date principal transaction revenue, total net revenue and net income of the Firm's Chief Investment Office ("CIO") will remain unchanged as a result of the restatement. The Firm reached the determination to restate on July 12, 2012, following management review of the matter with the Audit Committee of the Firm's Board of Directors on the same day.

The restatement results from information that has recently come to the Firm's attention in connection with management's internal review of activities related to CIO's synthetic credit portfolio. Under Firm policy, the positions in the portfolio are to be marked at fair value, based on the traders' reasonable judgment as to the prices at which transactions could occur. As an independent check on those marks, the CIO's valuation control group ("VCG"), a finance function within CIO, verifies that the traders' marks are within pre-established price testing thresholds around external "mid-market" benchmarks and, if not, adjusts trader marks outside the relevant threshold. The thresholds consider market bid/offer spreads and are intended to establish a range of reasonable fair value estimates for each relevant position. At March 31, 2012, the trader marks, subject to the VCG verification process, formed the basis for preparing the Firm's reported first quarter results.

However, the recently discovered information raises questions about the integrity of the trader marks, and suggests that certain individuals may have been seeking to avoid showing the full amount of the losses being incurred in the portfolio during the first quarter. As a result, the Firm is no longer confident that the trader marks used to prepare the Firm's reported first quarter results (although within the established thresholds) reflect good faith estimates of fair value at quarter end.

The Firm has consequently concluded that the Firm's previously-filed interim financial statements for the first quarter of 2012 should no longer be relied upon, and the Firm will be filing an amendment to its Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, as soon as practicable, but not later than it files its Quarterly Report on Form 10-Q for the quarter ended June 30, 2012. The financial statements included in the amended Quarterly Report on Form 10-Q will reflect adjusted valuations of the positions in the synthetic credit portfolio as of March 31, 2012, based upon external "mid-market" benchmarks, adjusted for liquidity considerations. While there are a range of acceptable values for such positions, the Firm believes this approach represents an objective valuation and is reasonable under the circumstances.

As a result of the restatement, the impact of the trading losses related to the synthetic credit portfolio on the Corporate/Private Equity sector during the first quarter will increase, as noted in the table above, but this increase will serve to reduce the impact of these losses on the Corporate/Private Equity sector during the second quarter by a corresponding amount. Accordingly, as noted above, CIO's year-to-date principal transactions revenue, total net revenue and net income and the Firm's year-to-date principal transactions revenue, total net revenue and net income will remain unchanged by the restatement.

The valuation errors had an immaterial effect on the Firm's balance sheet. CIO's Value at Risk model used, as inputs, independent marks for a majority of the positions in the synthetic credit portfolio and daily trader marks related to a limited number of positions in the portfolio. The Firm believes that if CIO's VaR were re-calculated for the first quarter of 2012, the re-computed CIO VaR numbers would not be materially different from those reported in the Firm's Quarterly Report on Form 10-Q for the 2012 first quarter. At June 30, 2012, average VaR for CIO was $177 million for the quarter then-ended, and was $153 million for the six months then-ended. For the Firm, average total VaR was $201 million for the quarter ended June 30, 2012, and was $186 million for the six months ended June 30, 2012. For the same reason, the Firm believes the valuation irregularities had an immaterial impact on the Firm's risk-weighted assets. However, as a result of the restatement, the Firm's Basel I Tier I common ratio will be reduced by 4 basis points to 10.3% and its Estimated Basel III Tier I common ratio will be reduced by 3 basis points to 8.1%, at March 31, 2012.

Management has determined that a material weakness existed in the Firm's internal control over financial reporting at March 31, 2012. During the first quarter of 2012, the size and characteristics of the synthetic credit portfolio changed significantly. These changes had a negative impact on the effectiveness of CIO's internal controls over valuation of the synthetic credit portfolio. Management has taken steps to remediate the internal control deficiencies, including enhancing management oversight over valuation matters. The control deficiencies were substantially remediated by June 30, 2012.

Management's internal review of these matters is ongoing. If the Firm obtains additional information material to its periodic financial reports, it will make appropriate disclosure.

Next up: we learn that just like Lieborgate, so was everyone else doing just what JPM admitted to doing as well.

In other news, there goes the entire CDS market.

* * *

For those who wish to learn more on this topic, here is what we said two months ago, predicting to the dot, all that was just confirmed above:

The Second Act Of The JPM CIO Fiasco Has Arrived - Mismarking Hundreds Of Billions In Credit Default Swaps

As anyone who has ever traded CDS (or any other OTC, non-exchange traded product) knows, when you have a short risk position, unless compliance tells you to and they rarely do as they have no idea what CDS is most of the time, you always mark the EOD price at the offer, and vice versa, on long risk positions, you always use the bid. That way the P&L always looks better. And for portfolios in which the DV01 is in the hundreds of thousands of dollars (or much, much more if your name was Bruno Iksil), marking at either side of an illiquid market can result in tens if not hundreds of millions of unrealistic profits booked in advance, simply to make one's book look better, mostly for year end bonus purposes. Apparently JPM's soon to be fired Bruno Iksil was no stranger to this: as Bloomberg reports, JPM's CIO unit "was valuing some of its trades at prices that differed from those of its investment bank, according to people familiar with the matter. The discrepancy between prices used by the chief investment office and JPMorgan’s credit-swaps dealer, the biggest in the U.S., may have obscured by hundreds of millions of dollars the magnitude of the loss before it was disclosed May 10, said one of the people, who asked not to be identified because they aren’t authorized to discuss the matter.

"I’ve never run into anything like that,” said Sanford C. Bernstein & Co.’s Brad Hintz in New York. “That’s why you have a centralized accounting group that’s comparing marks” between different parts of the bank “to make sure you don’t have any outliers,” said the former chief financial officer of Lehman Brothers Holdings Inc."

At this point, Zero Hedge assumes that Iksil was merely abusing the little loophole used by every CDS trader since time immemorial, which however on a TRSed position of $100 billion in notional, which based on our calculations has a DV01 of $200 million, means that the bid/ask spread itself is worth $500 million in profit (and not so much loss).

However, if what Bloomberg is implying is that Iksil was effectively overriding "real" marks, and using imaginary (or "forced") bids and asks, then that brings into question the validity of CDS marks reported by MarkIt, the same MarkIt partially owned by Goldman and... that's right, JP Morgan (more on MarkIt in a moment).

But first, back to Bloomberg:

Jennifer Zuccarelli, a spokeswoman for New York-based JPMorgan, declined to comment on whether the CIO and investment bank were using different prices.

All components of the synthetic credit portfolio in the chief investment office were mark-to-market,” she said.

The trades in question, made by a CIO group that included Bruno Iksil, nicknamed the London Whale because his positions grew so large, were on so-called tranches of credit-swap indexes, the people said.

Tranches allow investors to wager on varying degrees of risk among a pool of companies. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

Because JPMorgan had amassed such large positions, even a small change in how the prices were marked may have generated a big difference in the value of the trades, one of the people said.

While very little is known at this point, the realization that JPM did in fact abuse mark-to-market of a Level 1 security means that if Iksil's book was marked fairly, to mid-market alone, let alone to the real exit level opposite where it is most profitable (i.e., long risk as in the case of Bruno Iksil's IG9 holdings -> mark at offer, and vice versa), the losses would be materially greater, potentially up to hundreds of millions in the remarking process itself? And any further uncertainty about JPM's accrued losses, which we now know had to be covered up by tens of billions in asset sales from its portfolio (but, but JPM certainly did not need the cash) will merely add to the toxic spiral that is the pounding of JPM stock, coupled with further widening in IG9-10, which leads to even more JPM stock losses, which further blows out IG9-10 and so on.

One thing we do know is that in a recent case of a UBS prop trader, caught mismarking his CDS book, there was some serious litigation involved, and major accusation of illegalilty. Once again, from Bloomberg:

Ramon Braga, a trader on the bank’s corporate-credit desk in London, was fired for collusion in the alteration of “marked-to-marketvalues of credit default swaps by Denis Minayev, UBS staff said at an employment tribunal yesterday. Minayev, a proprietary trader, “re-markedBraga’s trading book on 66 occasions, even though he shouldn’t have had the authority to do so, UBS investigator Richard Kennedy said.

If you shift one of those markers, it can give a completely false picture,” employment Judge Graeme Hodgson said at the hearing.

Braga, who is suing for unfair dismissal, was an inexperienced trader who was “thrown in at the deep end,” his lawyer, Amy Sander, said at the hearing. He wasn’t aware of many of the changes Minayev made, she said, and thought his actions were permitted by managers. Braga was also accused by UBS of “procuring a false broker quote,” she said.

UBS is already dealing with the fallout from what the bank said were unauthorized trades by London-based UBS employee Kweku Adoboli, which led to a $2.3 billion loss, regulatory probes and the resignation of Chief Executive Officer Oswald Gruebel. JPMorgan Chase & Co. (JPM) CEO Jamie Dimon said yesterday his New York-based firm suffered a $2 billion loss after a trading unit’segregiousfailure to manage risks.

Dominik Von Arx, a spokesman for Zurich-based UBS, said Braga “was a junior employee” in the bank’s fixed-income, currency and commodities unit.
“He was dismissed for gross misconduct in October 2011 following an investigation into alleged mismarking,” Von Arx said in an e-mailed statement. “UBS has zero tolerance for such behavior.”
During cross-examination of Braga today, UBS lawyer Bruce Carr said Braga had asked a broker friend to send him a quote that justified changes made to his valuation, after a colleague said the price was too high.

“You get an entirely unsolicited e-mail that happens to fit” the valuation, Carr said. “That’s quite a coincidence, isn’t it?”

Braga responded that his “dismissal shouldn’t be based on speculation or coincidences.”

The product being re-marked was a credit default swap on European industrial-company bonds, which was illiquid and difficult to value because it was rarely traded.

Lawyers for Braga questioned Paolo Croce, UBS’s European head of rates, at the continuation of the hearing today about the close relationship between proprietary traders such as Minayev, who trade with the bank’s money, and flow traders like Braga, who execute orders on behalf of clients.

All the other flow traders followed the direction of Mr. Minayev,” Braga’s lawyer said.

Croce said while flow and proprietary traders exchanged information, they weren’t supposed to take instructions on pricing.

Minayev had told Braga, “I need this to move,” according to Croce. “He told him ‘I’m down $9 million today.’”

Here are some preliminary question to set prosecutors on their marry way?

  • How many times did JPM's CIO office "procure a false quote"?

  • How many times did Iksil tell his middle office or subordinates: "I need this to move" - and if he kept it to himself, how many times did Iksil "make it move" on his own?

  • How many times did the CIO "shift the IG-9 market and give a completely false picture?"

  • How many times did Iksil get an external "quote" that overrode the official closing day MarkIt price, or, far worse, did JPM ever tell partially-owned MarkIt what mark to use for a given product, which would be an act of unprecedented illegality.

And this is just the beginning. The reality is that with this revelation it likely means that JPM is probably lying about the fair value of thousands if not millions of other OTC-based products. Which goes to one simple thing:

Non-existent internal controls!

Because while JPM can blame an entire prop trading office for a pair trade gone wrong, it will have a very tough time explaining how marks impacting billions in P&L could have sneaked past the middle and back office.

Which, however, is possible, at least in theory.

This brings us to MarkIt - a company that has long been in the public eye for being the primary source of CDS marks, which would be great if not for one small glitch: it is also partially owned by the same banks which stand to benefit if MarkIt "nudges" the market in one way or another.

The following report from Mark Mitchell from 2009 does a great job of exposing some of the potential dirt that MarkIt may be involved in, and raises some critical questions that have never been answered, and which if addressed in the past could have spared JPM shareholders, and potentially US taxpayers, billions in losses:

Did The Markit Group, A Black-Box Company Partially Owned By Goldman Sachs and JP Morgan, Devastate Markets?

Last year, the media reported that New York Attorney General Andrew Cuomo had sent subpoenas to Markit Group as part of an investigation into possible manipulation of credit default swap prices by short sellers. This investigation, like Mr. Cuomo’s other investigations into market manipulation, have yielded no prosecutions.

The Department of Justice is reportedly investigating Markit Group for anti-trust violations. This investigation (which is reportedly focused on how Markit Group packages and sells its information) seems to acknowledge that Market Group has near-monopolistic control of information about credit default swap prices. However, if the press reports are correct, the DOJ has not considered the possible appeal of this monopolistic control to market manipulators.

Meanwhile, Henry Hu, the director of the Securities and Exchange Commission’s division of risk, has said that it has been nearly impossible for the SEC to conduct investigations into any matter concerning credit default swaps because the commission does not have access to any data on the trading of CDSs. In itself, this is a shocking admission. It is all the more shocking when one considers that the necessary data exists and might be in the hands of The Markit Group – a black box company based in London.

A thorough investigation of Markit Group is urgently required.

Here is what we know so far:

  • Markit Group was co-founded by Rony Grushka, Lance Uggla, and Kevin Gould. Prior to founding Markit Group, Mr. Grushka’s main line of business was investing in Bulgarian property developments. He recently resigned from the board of Orchid Developments Group, an Israeli-invested company based in Sophia, Bulgaria. Messrs. Uggla and Gould formerly worked for Toronto-Dominion Bank in Canada.

  • Markit Group’s founders also include four hedge funds. However, Markit Group refuses to disclose the names of those hedge funds. In response to an inquiry, a Markit Group spokesman said it was “corporate policy” to keep the names of the hedge funds secret, but he would not say why Markit Group had such a policy. It seems worth knowing whether those hedge funds have any influence over Markit Group’s published information or indexes, and whether those hedge funds are trading on that information. It would also be worth knowing whether those hedge funds or affiliated hedge funds have engaged in short selling of public companies whose debt and stock prices were profoundly affected by the information that Markit Group published.

  • Goldman Sachs (NYSE:GS), JP Morgan Chase (NYSE:JPM) and several other investment banks also have ownership stakes in Markit Group. The investment banks received their stakes in exchange for providing trading data to Markit Group. It would be worth knowing whether these investment banks engaged in short selling ahead of Markit Group’s published indexes and price quotations.

  • Markit Group is secretive about how it creates its indexes. In early 2008, The Wall Street Journal noted that the CMBX simplydoesn’t make sense” and that Markit Group’s indexesmight be exaggerating the amount of distress” in the home and commercial mortgage markets. In 2008, the average prediction for defaults on commercial mortgages was 2%. The CMBX implied that the default rate could be four times that level.

  • When short seller David Einhorn initiated his famous public attack on Lehman Brothers, one of his central arguments was that the CMBX (the index that was likely exaggerating the amount of distress”) proved that Lehman had overvalued the commercial mortgages on its books.

  • In March 2008, the Commercial Mortgage Securities Association sent a letter to Markit Group asking it disclose basic information about how the CMBX index is created and its daily trading volume. “The volatility in the CMBX index, caused by short sellers, distorts the true picture of the value of commercial-mortgage-backed securities,” the group said in a statement.

  • Markit Group is equally secretive about how it derives its “prices” for credit default swaps. A spokesman for the company spent close to one hour talking to Deep Capture. He did his job well and sounded like he was trying to be helpful. But he told us as little as possible.

  • However, in the course of this conversation, we did learn that Markit Group’sprices” are not actual, traded prices. They are mere quotations. The Markit Group has what it callscontributors” – hedge funds and broker-dealers that provide it with information. Markit Group has a grand total of 22contributors.” Deep Capture asked Markit Group’s spokesman for the names of these “contributors.” The spokesman said he would try to find out the names and call back later. He never called back.

  • The 22contributors” provide Markit Group with quotations, and these quotations become the Markit Group’sprice.” In other words, the “contributors” can quote any price for a CDS that they choose, regardless of whether anyone is actually willing to buy the CDS at that price. Markit Group looks at these quotations. Then it somehow decides which quotations make the most sense. Then it publishes information that purports to represent the actual market price of that CDS. This process is certainly unscientific. And it is ripe for abuse.

  • Consider, for example, the Markit Groupprice” for CDSs insuring the debt of company X. The Markit Group price strongly suggests that company X is going to default on its debt in the immediate future. Short sellers eagerly point to the Markit Group CDS price” as evidence that company X is doomed. Panic ensues, and suddenly, company X really is doomed. But the fact is, nobody ever bought a company X CDS at the price quoted by Markit Group. Rather, that panic-inducingprice” was, in effect, pulled out of a hat. Who pulled it out of a hat? That is matter of immense importance. There are two possible scenarios:

  • The first possible scenario is that the 22contributorsreport their quotations in good faith. They should be sending the actual traded price, not just a quotation, but assume they are just doing what was asked of them. From these quotations, Markit Group somehow decides what the “priceshould be. It is possible that this decision is based on some secret formula (which would be worrisome); or it is possible that Markit Group executives sit around a table debating what the price should be and take a shot in the dark (which would be even more worrisome); or it is possible that Markit Group deliberately chooses the most horrifying price possible in order to assist the short sellers who are affiliated with its owners (which would be a matter for the authorities).

  • The second possible scenario is that Markit Group acts in good faith (if not scientifically), but one or more of the 22 contributors” or their affiliates has an interest in seeing company X fail. If just one of those contributorssends in an astronomically high quotation, that could be enough. Markit Group factors the absurd quotation into its postedprice” and it suddenly becomes possible to convince the world that company X is about to default on its debt. Panic ensues, the firm’s layer of debt dries up, the stock price plunges, and perhaps the “contributor” or its affiliate make a lot of money.

  • As Deep Capture understands it, CDS quotations suggested by the 22contributors” also help determine the movement of the CMBX and ABX indexes. The movement of these indexes did serious damage to the American economy in multiple ways. The indexes prompted write downs at most of the major banks and mortgage companies. They were ammunition for short sellers, like David Einhorn, who claimed that companies had cooked their books by not writing down to the rock bottom prices suggested by the Markit Group indexes. They helped precipitate the decline in prices of mortgage securities, and contributed mightily to the panic that spread across the markets. A lot of people made a lot of money as result of those indexes moving downward. So, it is rather important to know more about how those indexes are formulated, and if they can be driven by the same people who are making directional bets on their movements.

Conclusion: Ten years ago, there was no such thing as a credit default swap. Six years ago, a very small number of investors traded credit default swaps as hedges against the long-shot possibility of corporate defaults. Nobody looked to credit default swaps as reliable indicators of corporate well-being.

Then, suddenly, there were over $60 trillion in credit default swaps outstanding. That is, over the course of a few years, somebody had made over $60 trillion (many times the gross domestic product) in long shot bets that borrowers would default on their debt. As this derivative risk marbled through the system, the trading in credit default swaps was completely opaque. Nobody knew who bought them, who sold them, or at what price.


These “prices” were not prices in any meaningful sense of the term. But, suddenly, these “prices” became perhaps the single most important indicator of corporate well-being. Assuming that those four hedge funds and the 22 contributors” (or hedge funds affiliated with them) bet against public companies, it seems more than possible that short-sellers got to run the craps table, call the dice, and place bets, all at the same time.

So perhaps it is not surprising that a lot of long-shot rolls paid off quite nicely.

Bottom line: Jamie Dimon's "tempest in a teapot" just became a fully-formed, perfect storm which suddenly threatens his very position, and could potentially lead to billions more in losses for his firm.