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EDITOR’S NOTE: I might as well take this opportunity to suggest a potential cause of action on behalf of homeowners and borrowers, whether or not they are in litigation or foreclosure. It might sound a little far out to say that the rating agencies have any liability to mortgage borrowers, taxpayers or governmental agencies that collect revenue. I maintain that such liability does in fact exist and that in addition the auditing firms that certified the statements of the large banks that faked the securitization of mortgages may have the same liability.

 The reason why there has been so much  legislation, both federal and state, on the subject of disclosure to consumer buyers and borrowers is the attempt by the Congress and the state legislatures to level the playing field. It is public policy in the country and in each state that borrowers should know as much as possible about both the identity of their lender and the terms of the transaction. It is the public policy of the federal government as well as every state government that consumers have a viable right to choose between alternatives in order to ensure healthy competition in the marketplace.

 The fact that the identity of the actual lenders was intentionally hidden from the borrowers and the fact that the terms of repayment to the actual lenders was also hidden from the borrowers is obviously a violation of many pieces of legislation that announced a public policy of the federal government and each state. We often write about and talk about the liability of the participants in the great securitization scam, but we never talk about the people who helped them withhold vital information from borrowers, taxpayers, investors and government agencies.

 Borrowers made several reasonable presumptions based upon prior history in the lending industry regarding the quality of their lender and the quality of the long product that was being offered to them as the best possible alternative. All of these presumptions were based on false information and led to the current mortgage crisis which in turn has led to the current economic crisis which in turn is leading the world into a double dip recession.

 Most theories of liability under the law are based upon the premise of a “reasonable man.” I doubt if anyone would argue that virtually none of the loans would have been consummated in the event that the borrowers and the investors actually had been provided with full disclosure. Many investors and many borrowers would have been alerted to the possibility that they were being misled in the event that the rating agencies had used independent judgment under the guise of a quasi-government agency. It doesn’t take a great deal of research to discover that there were people inside the rating agencies who wanted to use independent judgment but who were overruled by management in order to justify the rising fees they were charging to the originators of the bogus mortgage bonds and the bogus credit derivatives that were supposedly backed by the bogus mortgage bonds.

 My theory is that borrowers would have been alerted that something was wrong if they knew that the source of funding was coming from a Wall Street scheme that was rated at toxic levels. The media would have been alerted that something was wrong. Regulatory agencies would have been alerted that something was wrong. Warnings would have been issued about both the quality of the loan and the potential negative impact on the title to real property or personal property that was supposedly the subject of a perfected lien.

It is more than obvious that the investors certainly would not have advanced any funds if they had known the truth. While I can expand this theory, I believe I have made my point. If the world had  known the truth, the mortgage mess could never have taken place. It did take place because the ratings from the rating agencies created a misleading impression that the loans were subject to underwriting standards common to the industry.

 It would be interesting to see some enterprising law firm bring an action on behalf of borrowers, or on behalf of both borrowers and investors, against the rating agencies and the auditing companies that all made it possible. Without them, the great securitization scam would never have occurred and would simply be a theory rumbling around in the back of the mind of some Wall Street executive who was thinking “wouldn’t it be great if I could get trillions of dollars from investors without ever paying it back, get trillions of dollars in real estate without ever paying for it, and declare a loss that threatened the financial system enabling me to also get trillions of dollars in bailout money for a loss that never occurred?”

You Get What You Pay For

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

Standard & Poor’s downgrade of United States government debt last month has been much debated, but not enough attention has been devoted to the fact, reported last week by Bloomberg News, that it continues to rate securities based on subprime mortgages as AAA.

Today’s Economist

Perspectives from expert contributors.

In short, S.&P. is suggesting that these mortgages are more creditworthy than the United States government — a striking proposition. Leave aside for a moment that S.&P. made a big mistake in its analysis of the federal budget (as explained by James Kwak in our blog). Just focus on all the things that can go wrong with subprime mortgages: housing prices can fall, people can lose jobs, the economy may fall into recession and so on.

Now weigh those risks against the possibility that the United States government will default. As we learned this summer, that is not a zero-probability event — but it would take either an act of Congress, in the sense of passing legislation, or a determination by members of Congress that they could not act. S.&P. finds this more likely to happen than some subprime mortgages’ going bad.

Now S.&P. might be right, of course. Or its assessment might be influenced by the fact that it is paid by the issuer of those mortgage-backed securities — which presumably wants a higher rating. The rating agency’s employees may want to do an accurate assessment; management can reasonably expect to make higher profits if its ratings please the paying customers.

Perhaps we should just disregard what S.&P. and its competitors say. But this is not so easy, because many investors are guided by rules — either self-imposed or created by regulators — that tie investment decisions, and thus these investors’ holdings, to ratings. Ratings changes undeniably can move markets.

How can we take seriously a rating agency that is compensated by the issuers of securities? This system has long outlived its usefulness and should be discontinued.

In a similar vein, let me ask why we should take seriously economic analysis offered up by a financial-sector lobbying group on behalf of its members — if, for example, it says that regulation of its members will slow economic growth? Surely, we should check the numbers in the analysis carefully and be skeptical of the policy recommendations.

A timely example comes from the Institute of International Finance, which calls itself “the Global Association of Financial Institutions” and whose board members are all from big banks. (Indeed, the institute is more than a mere lobbying group; in the recent Greek debt negotiations, it was in charge of coordinating the terms proposed by private-sector banks for their involvement in the debt restructuring.)

So what do we make of its policy recommendations? In a report released this week, “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework,” for example, the institute asserts that additional capital requirements for its members could result in “3.2 percent lower output by 2015 in these economies than would otherwise be the case” (see Paragraph 5 of its news release accompanying the report).

In recent conversations with some policy makers from the Group of 7 nations, I was told that the institute’s previous, interim report on this same topic was largely without value (some said completely without value).

I hope these policy makers and others react the same way in this instance, because the institute refuses to acknowledge the vast cost imposed on society by the combination of big banks, high leverage and low capital that it endorsed through 2008 and that it defends today, with only minor modifications. (James Kwak and I wrote directly about these issues in “13 Bankers” — and we’re now hard at work on the sequel.)

The institute’s report is nothing more than lobbying masquerading as economic analysis. And just as S.&P. is paid for its ratings by the issuers, the institute is paid to represent the views of big banks. We would be wise to suspect that in both cases, the paying customer would prefer a particular outcome — irrespective of what the evidence says.

Filed under: bubble, CDO, CORRUPTION, currency, Eviction, foreclosure, GTC | Honor, Investor, Mortgage, securities fraud | Tagged: bankruptcy, borrower, countrywide, disclosure, Fitch, foreclosure, foreclosure defense, foreclosure offense, foreclosures, fraud, LOAN MODIFICATION, modification, Moody's, quiet title, rating agencies, rescission, RESPA, securitization, Standard and Poor's, TILA audit, trustee, WEISBAND |