Kickbacks at Fannie, Freddie Explain a Lot

13 Questions Before You Can Foreclose

foreclosure_standards_42013 — this one works for sure

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EDITOR’S COMMENT AND ANALYSIS:  The criminality of the Wall Street banks for the last 15 years has been so widespread and pervasive that it is difficult to imagine a scenario under which such behavior could have gone undetected.  The questions are unending. One particular answer to those questions stands out far above all the other possible answers, to wit: the actions of Wall Street did not go undetected.

The banks and Wall Street in general practically invented the process of due diligence, which is an examination of a proposed deal to determine whether the representations of each side are true, exaggerated or just plain false.

The government-sponsored entities of Fannie and Freddie clearly had the resources to perform extensive due diligence before they put their stamp of approval and guarantee on loans and investments that were clearly not originated or issued in accordance with government guidelines or industry standards.

The same thing may be said for the rating agencies that “got it wrong” or the insurers who presumably evaluated the risk that they were undertaking, and of course the counterparties to the hedge products including but not limited to credit default swaps.

The Wall Street Journal published a number of articles about the close relationship and economic pressure existing between the banks that were underwriting the bogus mortgage bonds and the rating agencies, insurance companies, and counterparties to credit default swaps.  these articles in the Wall Street Journal and other periodicals in mainstream media started back in 2007.

Similar articles appeared in the blogosphere  before that time warning of the coming catastrophe. Anyone with a background similar to mine on Wall Street could easily see that the underwriting of loans to consumers (especially mortgage loans) did not and could not conform to any known standards for risk assessment.

Why would a bank loan money in the knowledge (and indeed the hope) that the money would never be repaid? Why did government-sponsored entities, insurance companies, rating agencies, securities regulators, and counterparties to exotic hedge instruments turn their heads the other way, with full knowledge of the impending disaster? The answer is as old and simple as the history of commerce —  kickbacks, payoffs, bribes and promises of lucrative employment.

The Wall Street Journal told the stories where individuals working for rating agencies and insurance companies were taken on fishing trips and other junkets following which they received threats from the Wall Street banks that if the rating and insurance contracts were not to the liking of the Wall Street banks, the banks would go elsewhere.

Considering the creation of such entities as mortgage electronic registration systems (MERS)  and the financial strength of the banks, it was easy to see that if the banks didn’t get what they want from existing rating agencies and insurance companies they would create their own. Thus in addition to direct payoffs to individuals the management of old established institutions was put under pressure to play ball with Wall Street or go out of business.

The same playbook was used with appraisers who were promised higher fees if they continue to raise the stated value of the real property as they were instructed to do. In 2005 8000 appraisers warned Congress that this would happen. They were ignored. All the information that was needed for due diligence was easily accessible to the institutions that ignored red flags and eventually became part of the largest case of criminal fraud in human history.

If you look at the history of organized crime in this country you will see substantial similarities between the crime syndicates and the behavior of Wall Street. Payoffs and kickbacks to law enforcement, agencies, government officials, and legislators in the governing body of states and Congress became the ultimate protection and immunity from prosecution regardless of the severity of the crime or the damage caused to society.

While it is true that most such syndicates and eventually fail we cannot wait for time to run its course. That is why the demonstrations by occupy Wall Street and others are so important to bring pressure on those who are protecting multinational banks and the people who run them. It is not going to be easy because the amount of money is staggering. Trillions of dollars have been siphoned out of our own economy and the economy of dozens of other countries. With that kind of money you can pay off a lot of people with more money than they ever dreamed of having.

So it should come as no surprise that a “foreclosure specialist” at Fannie Mae was caught picking up $11,200 in cash in a sting operation. The problem here is that we are catching the smallest fish in the pond instead of removing those who control the action. It is interesting that the case reported below involved steering foreclosure listings to particular brokers. By focusing attention on activities far from the core of evil emanating from Wall Street many of us are distracted from looking at the real cause and the real problem not only still exists, but is being renewed as we speak in new schemes not very different from the old schemes.

The arrogance of Wall Street is either well-founded or stupid. At the present time it appears to be well founded. It remains to be seen whether we the people force our representatives, regulators and law enforcement to reject the carrot and stick from Wall Street and return to a nation of laws.

Kickbacks as ‘a natural part of business’ at Fannie Mae alleged
http://www.latimes.com/business/la-fi-fannie-mae-kickbacks-20130525,0,6280041.story

Rating Agencies Finally Drawing Fire They Richly Deserve — But Will They be Prosecuted?

“The Justice Department claims that the faulty projections were not simply naïveté, but rather a deliberate effort to produce inflated, fraudulent ratings. “The complaint asserts that S.& P. staff chose not to update computer programs because the changes would have led to harsher ratings, and a potential loss of business,” (e.s.)

“I was there. It is not possible that companies like S&P, Fitch and other rating agencies didn’t know how to do securities analysis — they invented it. The S&P Book was widely used as a shorthand method of evaluating a stock or bond for decades before I arrived on Wall Street. They were known and trusted for their data and their crunching of data. It isn’t possible that they wouldn’t know that the ratings were artificially inflated. They were only concerned with collecting fees and covering their behinds with “plausible deniability.”What they gave up was the their reputation for truth and clarity. Now they can’t be trusted.

And the same goes triple for the investment banks who brought those bogus mortgage bonds to market. Wall Street is a small place. Everyone but the customers and borrowers knew what was going on and everyone knew a huge bust was coming. If they knew and the regulators knew, why did they allow it play out when the warning signs were already clear in the early 2000’s.” Neil F Garfield, www.livinglies.me

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Editor’s Analysis: When you see movies like Too Big to Fail and read any of the hundreds of books published on the great recession, you must be left with a sense of outrage  and/or disappointment that our government and our major banks tacitly approved of the illegal activities undertaken by all the participants in what turned out to be a PONZI scheme covered over by a fraudulent scheme they called “Securitization.”

Despite some people raising the concern that the homeowners were hit hardest by the criminal enterprise, any concern for them vanished in the face of an invalid assumption by Hank Paulson and Ben Bernanke that the economy would fail and society would fall apart if they didn’t bail out the banks. If anything, the behavior of the banks was the equivalent of NOT bailing them out because they never honored their part of the bargain — increasing the flow of capital into the economy through loans and investments. While that understanding should have been reduced to writing, it was obvious that the banks would lend out money with extra capital infused into their balance sheet. Except they didn’t.

And the world didn’t end, but there was chaos all over the world because the banks were and continue sitting on a bounty that has not been subject to any audit or accounting.

As I expected, the rating agencies are now being sued not for negligence but for intentionally skewing the ratings knowing that stable managed funds were restricted from investing in anything but the safest securities (meaning the highest rating from a qualified rating agency). It is the same story as the appraisers of real property who were pressured into inflating and then re-inflating the prices of property whose value was left far behind. Both the rating agencies and the appraisers who participated in this illicit scheme caved in to threats from Wall Street that they would never see any business again if they didn’t “play ball.”

The very structure and the actual movement of money and documents would tip off an amateur securities analyst. Starting with the premise of securitization and an understanding of how it works (easily obtained from numerous sources) any analysis would have revealed that something was wrong. Securities analysis is not just sitting at a desk crunching numbers. It is investigation.

Any investigation at random picking apart the loan deals, the diversion of title from the REMIC trusts, the diversion of money from the investors to a mega-account in which the investors’ money was indiscriminately commingled, thus avoiding the REMICs entirely, would lead to the inevitable conclusion that even the highest rated tranches and the highest rated bonds, were a complete sham. Indeed internal memos at S&P shows that it was well understood by all — they even made up a song about it.

The analysis by the people at S&P omitted key steps so they wouldn’t be accused of knowing what was going on. It is the same as the underwriting of the loans themselves where the underwriting process was reduced to a computer platform in which the aggregator approved the loan — not he originator — and the investment banker wired the funds for the loan on behalf of the Investors, but the documents showed that it was the originator, who was not allowed to touch any of the money funded for loans, whose name was placed on the note and mortgage. Why?

Any good analyst would have and several did ask why this was done. They got back a double-speak answer that would have resulted in an unrated or low-rated mortgage bond, with a footnote that the REMICs may never have been funded and that therefore without other sources of capital they could not possibly have purchased the loans. Which means of course that the REMICs named in foreclosures over the past 5-6 years.

Some of the best analysts on Wall Street saw at a glance that this was a PONZI scheme and a fraudulent play on the word “Securitization.” Simply tracing the parties to their real function would and still will reveal that all of them were acting in nominee capacities and not as true agents of the investors or participants in the securitization scheme.

And the nominees include but are not limited to the REMIC itself, the Trustee for the REMIC, the subservicer, the Master Servicer, the Depositor, the aggregator, the originator, and the law firms, foreclosure mills and companies like LPS and DOCX who sprung up with published price sheets on fabrication of documents and forgeries of of those documents to convince a court that the foreclosure was real and valid. The whole thing was a sham.

If I saw it at a glance after being out of Wall STreet for many years, you can bet that the new financial and securities analysts at the rating agencies also saw it. Instead they buried their true analysis behind a mountain of fabricated data that in itself was a nominee for the real data and then crunched the numbers in the way that the Wall Street firms dictated.

The fact that there were algorithms that took the world’s fastest computers a full weekend to process without the ability to audit the results should have and did in fact alert many people that the bogus mortgage bonds were unratable because there was no way to confirm their assumptions or their outcome.

The government is very close, now that it is moving in on the ratings companies. They are close to revealing that this was not excessive risk taking it was excessive taking — theft — and that the rating companies should lose their status as rating companies, the officers and analysts who signed off should be prosecuted, and the receiver appointed over the assets should claw back the excessive fees paid to the ratings companies from officers of the ratings companies and, following the yellow brick road, the CEO’s of the investment banks.

We have found out, thanks to the greed and deception practiced by the banks on officers at the highest level of your government what will happen if the credit markets free up without the TARP money being used to free up those markets. It isn’t pretty but it isn’t apocalypse either. The proof is in. The mega banks should be taken down piece by piece and their function should be spread out over a wide swath of more than 7,000 community banks, credit unions and savings and loan associations — all of whom have access to the utilities at SWIFT, VISA, MasterCard, check 21, and other forms of interbank electronic funds transfer.

If the administration really wants a correction and really wants to increase confidence in the marketplaces around the world and the financial system supporting those markets, then it MUST take the harshest action possible against the people and companies who engineered this world-wide crisis. Eventually the truth will all be out for everyone to see. Which side of history do we mean to be aligned — the bank oligopoly or a capitalist, free, democratic society.

BY WILLIAM ALDEN, DealBook NY TIMES

DOCUMENTS IN S.&P. CASE SHOW ALARM Documents included in the Justice Department’s lawsuit against Standard & Poor’s provide a glimpse at the company’s inner working in the run-up to the financial crisis. “Tensions appeared to be escalating inside the firm’s headquarters in Lower Manhattan as it publicly professed that its ratings were valid, even as the home loans bundled into mortgage-backed securities, or M.B.S., were failing at accelerating rates,” Mary Williams Walsh and Ron Nixon write in DealBook. “Together, the documents show a portrait of some executives pushing to water down the firm’s rating models in the hope of preserving market share and profits, while others expressed deep concerns about the poor performance of the securities and what they saw as a lowering of standards.”

Some of the documents also showed some of the snark among the rank-and-file over the impending crisis. One analyst in March 2007 borrowed from the Talking Heads, creating new lyrics to “Burning Down the House,” according to the complaint: “Subprime is boi-ling o-ver. Bringing down the house.” In a confidential memo reproduced in the complaint, one executive said: “This market is a wildly spinning top which is going to end badly.”

At the heart of the civil case are the computer models S.&P. used to rate complex mortgage securities. The Justice Department claims that the faulty projections were not simply naïveté, but rather a deliberate effort to produce inflated, fraudulent ratings. “The complaint asserts that S.& P. staff chose not to update computer programs because the changes would have led to harsher ratings, and a potential loss of business,” Peter Eavis writes. But S.&P., which says the lawsuit is without merit, disagrees with the government’s characterization of the models. Catherine J. Mathis, an S.& P. spokeswoman, said the Justice Department had not “shown actual adjustment to the models or other changes that were not analytically justified.”

Indeed, the government faces an uphill battle in making its case that S.&P. intentionally inflated ratings. “The government will have to prove that ratings were in fact faulty, and published intentionally so as to deceive investors in the securities. In response, S.& P. could simply argue that the company was just as blinded by the financial crisis as anyone else, and that questionable e-mails are simply the work of lower-level employees who were not involved in the decision-making,” Peter J. Henning and Steven M. Davidoff write. “Even if the Justice Department can prove the agency acted to deceive investors, it still has to deal with something lawyers call reliance. In other words, did investors rely on these ratings to make their decisions?”

R.B.S APPROACHES SETTLEMENT OVER RATE-RIGGING The Royal Bank of Scotland said on Wednesday that it was in advanced discussions with authorities on both side of the Atlantic over settling accusations that it manipulated Libor. “Although the settlements remain to be agreed, R.B.S. expects they will include the payment of significant penalties as well as certain other sanctions,” the bank said.

A settlement, which could be announced as soon as Wednesday, is expected to include a penalty of about 400 million pounds, or $626 million, according to several news reports. “As part of the anticipated deal, R.B.S.’s Japanese unit is expected to plead guilty to a crime in the U.S., although the Justice Department isn’t expected to charge any individuals, according to one of the people briefed on the talks,” The Wall Street Journal writes. John Hourican, the head of R.B.S.’s investment bank, is also expected to resign, the reports said.

S&P Analyst Joked of ‘Bringing Down the House’ Ahead of Collapse
http://www.bloomberg.com/news/2013-02-05/s-p-analyst-joked-of-bringing-down-the-house-ahead-of-collapse.html

Case Details Internal Tension at S.&P. Amid Subprime Problems
http://dealbook.nytimes.com/2013/02/05/case-details-internal-tension-at-s-p-amid-subprime-problems/

Justice Sues S&P, But What Purpose are Ratings Agencies Serving Anyway?
http://business.time.com/2013/02/06/justice-sues-sp-but-what-purpose-are-ratings-agencies-serving-anyway/

S&P charged with fraud in mortgage ratings
http://www.wsws.org/en/articles/2013/02/06/rate-f06.html

RATING AGENCIES: MARKETING TOOLS FOR WALL STREET

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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

By SIMON JOHNSON
DESCRIPTION

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.

Berating the Raters and Appraisers

“of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent — 93 percent! — have now been downgraded to junk status.”

Editor’s Note: What homeowners and their lawyers, forensic analysts, and experts need to realize is that the ratings scam on Wall street was only one-half of the equation in a scheme to defraud homeowners. If you don’t understand how an appraisal of a home is the same thing as the rating of the security that was sold to fund the home, then you are missing the point and the opportunity to do something meaningful for borrowers.

TILA and Reg Z make it clear that the LENDER is responsible for verification of the appraisal. The LENDER is responsible for viability of the loan, NOT THE BORROWER. IT’S THE LAW! Instead the media and Wall Street PR and lobbyists are drumming a myth into our heads — that 20 million homeowners with securitized loans cooked up a scheme to get a free house. Where did they meet?

We have ample evidence that the entire scheme depended upon reasonable reliance upon those who were in fact not reliable and who were lying to us. If you bought a house for $600,000, the odds are:

  • the house was actually worth less than $400,000
  • the appraiser put the value at $620,000
  • the rating agency called it a triple AAA loan
  • you thought the house was worth what you were paying
  • the house is now worth $300,000
  • your mortgage is at least $500,000
  • Even if you can afford the payments, you will not be able to sell your home for more than the amount owed on it until at least 15-18 years have passed.
  • You will not be able to sell your home for what you paid for at least another 25-30 years, and that is only with the help of inflation
  • Counting inflation, you will never sell your home for what you paid for it or the amount you thought it was worth when you refinanced it

Besides obvious violations of federal and state lending statutes it is pure common law fraud. You are now faced with options that go from bad to worse, UNLESS you sue the people who caused this and your lawyer understands the basic economics of securitization. Your opposition knows all of this. That is why the cases, for the most part ,never get to trial. These cases are won or lost in demanding discovery, enforcing your demands, and relentless pursuit of the truth.

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April 26, 2010
Op-Ed Columnist

Berating the Raters

Let’s hear it for the Senate’s Permanent Subcommittee on Investigations. Its work on the financial crisis is increasingly looking like the 21st-century version of the Pecora hearings, which helped usher in New Deal-era financial regulation. In the past few days scandalous Wall Street e-mail messages released by the subcommittee have made headlines.

That’s the good news. The bad news is that most of the headlines were about the wrong e-mails. When Goldman Sachs employees bragged about the money they had made by shorting the housing market, it was ugly, but that didn’t amount to wrongdoing.

No, the e-mail messages you should be focusing on are the ones from employees at the credit rating agencies, which bestowed AAA ratings on hundreds of billions of dollars’ worth of dubious assets, nearly all of which have since turned out to be toxic waste. And no, that’s not hyperbole: of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent — 93 percent! — have now been downgraded to junk status.

What those e-mails reveal is a deeply corrupt system. And it’s a system that financial reform, as currently proposed, wouldn’t fix.

The rating agencies began as market researchers, selling assessments of corporate debt to people considering whether to buy that debt. Eventually, however, they morphed into something quite different: companies that were hired by the people selling debt to give that debt a seal of approval.

Those seals of approval came to play a central role in our whole financial system, especially for institutional investors like pension funds, which would buy your bonds if and only if they received that coveted AAA rating.

It was a system that looked dignified and respectable on the surface. Yet it produced huge conflicts of interest. Issuers of debt — which increasingly meant Wall Street firms selling securities they created by slicing and dicing claims on things like subprime mortgages — could choose among several rating agencies. So they could direct their business to whichever agency was most likely to give a favorable verdict, and threaten to pull business from an agency that tried too hard to do its job. It’s all too obvious, in retrospect, how this could have corrupted the process.

And it did. The Senate subcommittee has focused its investigations on the two biggest credit rating agencies, Moody’s and Standard & Poor’s; what it has found confirms our worst suspicions. In one e-mail message, an S.& P. employee explains that a meeting is necessary to “discuss adjusting criteria” for assessing housing-backed securities “because of the ongoing threat of losing deals.” Another message complains of having to use resources “to massage the sub-prime and alt-A numbers to preserve market share.” Clearly, the rating agencies skewed their assessments to please their clients.

These skewed assessments, in turn, helped the financial system take on far more risk than it could safely handle. Paul McCulley of Pimco, the bond investor (who coined the term “shadow banks” for the unregulated institutions at the heart of the crisis), recently described it this way: “explosive growth of shadow banking was about the invisible hand having a party, a non-regulated drinking party, with rating agencies handing out fake IDs.”

So what can be done to keep it from happening again?

The bill now before the Senate tries to do something about the rating agencies, but all in all it’s pretty weak on the subject. The only provision that might have teeth is one that would make it easier to sue rating agencies if they engaged in “knowing or reckless failure” to do the right thing. But that surely isn’t enough, given the money at stake — and the fact that Wall Street can afford to hire very, very good lawyers.

What we really need is a fundamental change in the raters’ incentives. We can’t go back to the days when rating agencies made their money by selling big books of statistics; information flows too freely in the Internet age, so nobody would buy the books. Yet something must be done to end the fundamentally corrupt nature of the the issuer-pays system.

An example of what might work is a proposal by Matthew Richardson and Lawrence White of New York University. They suggest a system in which firms issuing bonds continue paying rating agencies to assess those bonds — but in which the Securities and Exchange Commission, not the issuing firm, determines which rating agency gets the business.

I’m not wedded to that particular proposal. But doing nothing isn’t an option. It’s comforting to pretend that the financial crisis was caused by nothing more than honest errors. But it wasn’t; it was, in large part, the result of a corrupt system. And the rating agencies were a big part of that corruption.

Tourre: The CDO’s I Create Are “Pure Intellectual Masturbation”

“a ‘thing’ which has no purpose, which is absolutely conceptual and highly theoretical and which nobody knows how to price.”

Editor’s Note: Think about it. The foundation of the supply of money that was pressure pumped into our economic housing system resulted in inflation of home appraisals.

  • It was so large that everyone thought the “market” was going up, when in fact it was going nowhere.

  • Everyone knew it except the homeowners who were tricked into relying upon “lenders” who had no stake in the transaction except to close it and collect their fee.

  • Under intense pressure from Wall Street consisting of the carrot of higher fees and the whip of unemployment if they didn’t comply, nearly everyone in the real industry on up to the securities industry was corrupted by this scheme.

  • And it was all based upon creating a scheme that was so complex, nobody could understand it or assess the value of what they were buying.
  • So front and center, the rating agencies and appraisers, both performing the same task, both violating the most basic standards of their “professions” gave credence to this intellectual exercise that far from pleasurable, brought the worst pain to the American soil since the Great Depression.
  • The supreme Irony is that they still have us under their spell. We have good people pointing the finger at other good people raising hell about how nobody should get a free house, while the fight itself is allowing just that — a free house to anyone who walks away with title or proceeds from a foreclosure sale of property “secured” by a securitized loan.
  • I have yet to see a single foreclosure sale where the party foreclosing had one dime at risk in the loan.

Fabulous Fab Tourre: The CDO’s I Create Are “Pure Intellectual Masturbation”

Gregory White | Apr. 25, 2010, 1:49 PM | 2,242 | comment 33

fabrice toureFabrice “Fabulous Fab” Tourre has bitten his tongue again, after it was revealed in an e-mail that he likened the debt instruments he created to, “pure intellectual masturbation,” according to the Times of London.

Other e-mails also revealed his distrust for the index many of his derivatives products were based on, the ABX, comparing it to “Frankenstein“, who famously turned on his inventor.

He also said that his creation was “a ‘thing’ which has no purpose, which is absolutely conceptual and highly theoretical and which nobody knows how to price.”

While the SEC’s release of a full e-mail between Fabrice Tourre and his girlfriend did much to make the man look more sincere, these latest revelations will heap pressure on the Goldman Sachs market-maker as his Senate hearing looms.

Check out our top 20 winners and losers from the Goldman Sachs Case >

Discovery and Motion Practice: Watch Those Committee Hearings on Rating Agencies

Editor’s Note: As these hearings progress, you will see more and more admissible evidence and more clues to what you should be asking for  in discovery. You are getting enhanced credibility from these government inquiries and the results are already coming out as you can see below.The article below is a shortened version of the New York Times Paper version. I strongly recommend that you get the paper today and read the entire article. Some of the emails quoted are extremely revealing, clear and to the point. They knew they were creating the CDO market and that it was going to explode. One of them even said he hoped they were rich and retired when the mortgage mess blew up.
Remember that a rating is just word used on Wall Street for an appraisal So Rating=Appraisal.
  • The practices used to corrupt the rating system for mortgage backed securities  were identical in style to the practices used to corrupt the appraisals of the homes.
  • The appraisals on the homes were the foundation for the viability of the loan product sold to the borrower.
  • In the case of securities the buyers were investors.
  • In the case of appraisals the buyers were homeowners or borrowers.
  • In BOTH cases the “buyer” reasonably relied on an “outside” or “objective” third party who whose opinion was corrupted by money from the seller of the financial product (a mortgage backed security or some sort of loan, respectively).
  • In the case of the loan product the ultimate responsibility for verification of the viability of the loan, including verification of the appraisal is laid squarely on the LENDER.
  • Whoever originated the loan was either passing itself off as the lender using other people’s money in a table funded loan or they were the agent for the lender who either disclosed or not disclosed (nearly always non-disclosed).
  • A pattern of table funded loans is presumptively predatory.
  • The appraisal fraud is a key element of the foundation of your case. If the appraisal had not been inflated, the contract price would have been reduced or there would have been no deal because the buyer didn’t have the money.
  • The inflation of the appraisals over a period of time over a widening geographical area made the reliance on the appraiser and the “lender” even more reasonable.
  • Don’t let them use that as proof that it was market forces at work. Use their argument of market forces against them to establish the pattern of illegal conduct.
April 22, 2010

Documents Show Internal Qualms at Rating Agencies

By SEWELL CHAN

WASHINGTON — In 2004, well before the risks embedded in Wall Street’s bets on subprime mortgages became widely known, employees at Standard & Poor’s, the credit rating agency, were feeling pressure to expand the business.

One employee warned in internal e-mail that the company would lose business if it failed to give high enough ratings to collateralized debt obligations, the investments that later emerged at the heart of the financial crisis.

“We are meeting with your group this week to discuss adjusting criteria for rating C.D.O.s of real estate assets this week because of the ongoing threat of losing deals,” the e-mail said. “Lose the C.D.O. and lose the base business — a self reinforcing loop.”

In June 2005, an S.& P. employee warned that tampering “with criteria to ‘get the deal’ is putting the entire S.& P. franchise at risk — it’s a bad idea.” A Senate panel will release 550 pages of exhibits on Friday — including these and other internal messages — at a hearing scrutinizing the role S.& P. and the ratings agency Moody’s Investors Service played in the 2008 financial crisis. The panel, the Permanent Subcommittee on Investigations, released excerpts of the messages Thursday.

“I don’t think either of these companies have served their shareholders or the nation well,” said Senator Carl Levin, Democrat of Michigan, the subcommittee’s chairman.

In response to the Senate findings, Moody’s said it had “rigorous and transparent methodologies, policies and processes,” and S.& P. said it had “learned some important lessons from the recent crisis” and taken steps “to increase the transparency, governance, and quality of our ratings.”

The investigation, which began in November 2008, found that S.& P. and Moody’s used inaccurate rating models in 2004-7 that failed to predict how high-risk residential mortgages would perform; allowed competitive pressures to affect their ratings; and failed to reassess past ratings after improving their models in 2006.

The companies failed to assign adequate staff to examine new and exotic investments, and neglected to take mortgage fraud, lax underwriting and “unsustainable home price appreciation” into account in their models, the inquiry found.

By 2007, when the companies, under pressure, admitted their failures and downgraded the ratings to reflect the true risks, it was too late.

Large-scale downgrades over the summer and fall of that year “shocked the financial markets, helped cause the collapse of the subprime secondary market, triggered sales of assets that had lost investment-grade status and damaged holdings of financial firms worldwide,” according to a memo summarizing the panel’s findings.

While many of the rating agencies’ failures have been documented, the Senate investigation provides perhaps the most thorough and vivid accounting of the failures to date.

A sweeping financial overhaul being debated in the Senate would subject the credit rating agencies to comprehensive regulation and examination by the Securities and Exchange Commission for the first time. The legislation also contains provisions that would open the agencies to private lawsuits charging securities fraud, giving investors a chance to hold the companies accountable.

Mr. Levin said he supported those measures, but said the Senate bill, and a companion measure the House adopted in December, did not go far enough.

“What they don’t do, and I think they should do, is find a way where we can avoid this inherent conflict of interest where the rating companies are paid by the people they are rating,” he said. “We’ve got to either find a way — or direct the regulatory bodies to find a way — to end that inherent conflict of interest.”

Although the agencies were supposed to offer objective and independent analysis of the securities they rated, the documents by Mr. Levin’s panel showed the pressures the companies faced from their clients, the same banks that were assembling and selling the investments.

“I am getting serious pushback from Goldman on a deal that they want to go to market with today,” a Moody’s employee wrote in an internal e-mail message in April 2006.

In an August 2006 message, an S.& P. employee likened the unit rating residential mortgage-backed securities to hostages who have internalized the ideology of their kidnappers.

“They’ve become so beholden to their top issuers for revenue they have all developed a kind of Stockholm syndrome which they mistakenly tag as Customer Value creation,” the employee wrote.

Lawrence J. White, an economist at the Stern School of Business at New York University, said he feared that the government’s own reliance on the rating agencies had “endowed them with some special aura.”

The House bill calls for removing references to the rating agencies in federal law, and both bills would require a study of how existing laws and regulations refer to the companies.

The addition of new regulations might inadvertently serve to empower the agencies, Mr. White said. “Making the incumbent guys even more important can’t be good, and yet that’s the track that we’re on right now,” he said.

David A. Skeel, a law professor at the University of Pennsylvania, said the Senate bill “basically just tinkers with the internal governance of the credit rating agencies themselves.”

Ending the inherent conflicts of interest is “more ambitious, but if you’re ever going to talk about it, then this is the time,” Mr. Skeel said.

Binyamin Appelbaum contributed reporting.

Ohio Sues Rating Firms for Losses in Funds: Fraud Catching Up with Swindlers

NOW AVAILABLE ON KINDLE/AMAZON
WHY THIS IS IMPORTANT TO FORECLOSURE DEFENSE AND OFFENSE: OK I know the last thing you want to hear is how complex this scheme was. But if you can get over the intimidation factor, you will see how the lawsuits filed by individual homeowners, attorney generals, and class actions are picking apart the whole scheme, coming up with the inconvenient answers that Wall Street is working to avoid and that many government officials are too lazy or paid off or whatever to get involved.
So here we focus on the rating agencies and you might be asking why do I care if I wasn’t an investor who bought those empty bonds that funded my loan? The reason is that others with far greater resources than you are doing your work for you.
The SINGLE transaction, starting with the sale of the bond to the investor and then to the sale of the financial loan product to the homeowner and then ending with the false foreclosures and unconscionable proceeds of credit default swaps could ONLY have been achieved with the active participation from the rating agencies.
By selling their reputation for objectivity to the highest bidder, by misusing their skill in assessing credit risk,  the rating agencies enabled those bonds to be sold under the pretense that they were AAA sound investments. But for that the mortgage meltdown would never have occurred. But for that, you would not be in the upside down position, or delinquency, default or foreclosure in which you find yourself.
But for the free flow of free money there would have been no pressure to get rid of it in order to make Wall Street’s unconscionable profits. And without that pressure, housing prices would have remained relatively stable instead of shooting up to unprecedented (by any measure) unsustainable levels that were not reflective of what the homeowner would get when Wall Street’s scheme was over.
Your home loan was rated by these rating agencies. They looked the other way and changed underwriting standards from common sense to common fraud. The ONLY way the bonds sold to investors could have been rated so high was by rating the underlying mortgages and notes. No REAL analysis would have done anything except raise red flags bringing the rating down to junk. Just starting with the appraisal” on the house which was also a form of rating, no reasonable person could possible look at the history of housing prices and believe that the 30% jump in 4 months was sustainable. Nobody using their own money would fund a deal based on that. It is only because the originating “lenders” (i.e, straw-men, conduits) were not using their own capital that these loans were made.
We were all duped by the appraisers and the rating agencies who sold their integrity to the highest bidder. And in the process of tragedy of astonishing severity is unfolding, getting worse and fooling the American public — until it reaches each and every one of us, which it will.
At some point the homeowners should be suing the rating agencies and appraisers for their part in all this. The counterclaim is both fraud in the inducement and fraud in the execution. Fraud in the execution because you thought you were just taking out a loan when in fact you were purchasing a financial loan product that was a security promising you passive returns whose value was intentionally misrepresented. Fraud in the inducement because had you known the true value of the property you would never have assumed that you could cover the loan terms, which were also illegal and predatory.
The game is on. If you reach the truth before Goldman et al are done, you can stop it, reverse it, and set the country back on the path of confidence in an economy that is based upon something other than $500 trillion in derivative vapor.
November 21, 2009

Ohio Sues Rating Firms for Losses in Funds

Already facing a spate of private lawsuits, the legal troubles of the country’s largest credit rating agencies deepened on Friday when the attorney general of Ohio sued Moody’s Investors Service, Standard & Poor’s and Fitch, claiming that they had cost state retirement and pension funds some $457 million by approving high-risk Wall Street securities that went bust in the financial collapse.

The case could test whether the agencies’ ratings are constitutionally protected as a form of free speech.

The lawsuit asserts that Moody’s, Standard & Poor’s and Fitch were in league with the banks and other issuers, helping to create an assortment of exotic financial instruments that led to a disastrous bubble in the housing market.

“We believe that the credit rating agencies, in exchange for fees, departed from their objective, neutral role as arbiters,” the attorney general, Richard Cordray, said at a news conference. “At minimum, they were aiding and abetting misconduct by issuers.”

He accused the companies of selling their integrity to the highest bidder.

Steven Weiss, a spokesman for McGraw-Hill, which owns S.& P., said that the lawsuit had no merit and that the company would vigorously defend itself.

“A recent Securities and Exchange Commission examination of our business practices found no evidence that decisions about rating methodologies or models were based on attracting market share,” he said.

Michael Adler, a spokesman for Moody’s, also disputed the claims. “It is unfortunate that the state attorney general, rather than engaging in an objective review and constructive dialogue regarding credit ratings, instead appears to be seeking new scapegoats for investment losses incurred during an unprecedented global market disruption,” he said.

A spokesman for Fitch said the company would not comment because it had not seen the lawsuit.

The litigation adds to a growing stack of lawsuits against the three largest credit rating agencies, which together command an 85 percent share of the market. Since the credit crisis began last year, dozens of investors have sought to recover billions of dollars from worthless or nearly worthless bonds on which the rating agencies had conferred their highest grades.

One of those groups is largest pension fund in the country, the California Public Employees Retirement System, which filed a lawsuit in state court in California in July, claiming that “wildly inaccurate ratings” had led to roughly $1 billion in losses.

And more litigation is likely. As part of a broader financial reform, Congress is considering provisions that make it easier for plaintiffs to sue rating agencies. And the Ohio attorney general’s action raises the possibility of similar filings from other states. California’s attorney general, Jerry Brown, said in September that his office was investigating the rating agencies, with an eye toward determining “how these agencies could get it so wrong and whether they violated California law in the process.”

As a group, the attorneys general have proved formidable opponents, most notably in the landmark litigation and multibillion-dollar settlement against tobacco makers in 1998.

To date, however, the rating agencies are undefeated in court, and aside from one modest settlement in a case 10 years ago, no one has forced them to hand over any money. Moody’s, S.& P. and Fitch have successfully argued that their ratings are essentially opinions about the future, and therefore subject to First Amendment protections identical to those of journalists.

But that was before billions of dollars in triple-A rated bonds went bad in the financial crisis that started last year, and before Congress extracted a number of internal e-mail messages from the companies, suggesting that employees were aware they were giving their blessing to bonds that were all but doomed. In one of those messages, an S.& P. analyst said that a deal “could be structured by cows and we’d rate it.”

Recent cases, like the suit filed Friday, are founded on the premise that the companies were aware that investments they said were sturdy were dangerously unsafe. And if analysts knew that they were overstating the quality of the products they rated, and did so because it was a path to profits, the ratings could forfeit First Amendment protections, legal experts say.

“If they hold themselves out to the marketplace as objective when in fact they are influenced by the fees they are receiving, then they are perpetrating a falsehood on the marketplace,” said Rodney A. Smolla, dean of the Washington and Lee University School of Law. “The First Amendment doesn’t extend to the deliberate manipulation of financial markets.”

The 73-page complaint, filed on behalf of Ohio Police and Fire Pension Fund, the Ohio Public Employees Retirement System and other groups, claims that in recent years the rating agencies abandoned their role as impartial referees as they began binging on fees from deals involving mortgage-backed securities.

At the root of the problem, according to the complaint, is the business model of rating agencies, which are paid by the issuers of the securities they are paid to appraise. The lawsuit, and many critics of the companies, have described that arrangement as a glaring conflict of interest.

“Given that the rating agencies did not receive their full fees for a deal unless the deal was completed and the requested rating was provided,” the attorney general’s suit maintains, “they had an acute financial incentive to relax their stated standards of ‘integrity’ and ‘objectivity’ to placate their clients.”

To complicate problems in the system of incentives, the lawsuit states, the methodologies used by the rating agencies were outdated and flawed. By the time those flaws were obvious, nearly half a billion dollars in pension and retirement funds had evaporated in Ohio, revealing the bonds to be “high-risk securities that both issuers and rating agencies knew to be little more than a house of cards,” the complaint states.

Foreclosure Defense and Offense: Rating Agencies and Appraisals

Taking the entire Mortgage Meltdown process as a single transaction starting with the origination of the loan to the borrower and ending with the sale of an asset backed security to an investor, a pattern of deception and confusion emerges — providing the borrower with an arsenal of offensive and defensive strategies to avoid foreclosure, recover damages and even free their property from the mortgage altogether. In foreclosure defense and particularly offense for “lender” liability, keep in mind that there was a chain of entities who all knowingly conspired (under a cloak of what they deemed “plausible deniability”).

This chain was never disclosed to the borrower — thus the disclosure obligations set forth in TILA, state law, RICO, common law and other resources were never met and the right to rescission was blocked by lack of information, to wit: the borrower in most cases does not know who to send the rescission letter to because in all likelihood there are now multiple parties who have an interest in the security instrument, the note and the risk of loss, none of whom were disclosed to the borrower at or after closing. 

These participants are subject to liability for monetary damages and many are insured as well as having deep pockets of their own. They also de-linked several aspects of what had been a single event — the purchase of a home with a first mortgage on residential property using money in part loaned by a lender who took the risk of non-payment, followed underwriting guidelines set by the banking industry and regulators, and therefore had a direct stake in the outcome of the loan and a specific desire to avoid default on the loan. 

The de-linking of teht ransaction and overlapping with other parts of the entire single “mortgage meltdown” chain resulted in separation of the security interest from the the obligation to pay, adding obligors who had liability for payment, and adding receivers of income. Thus the classic and relatively simple foreclosure that involved non-payment by the borrower to the lender, was converted in a complex series of transactions leaving the investor who bought the asset backed security with the right to the income and some rights to the security interests, and others with the the right to the security interest but no right to payment, and still others who made payments to the investor or who were liable for non-payment to the investor who acquired the right to payment from the underlying mortgage and note from which his asset backed security derived its value.

The significance of this in foreclosure defense is that the party alleging non-payment by the borrower is NOT and CANNOT allege non-payment to the entity or person (investor) who is entitled to that payment. The usual person entering the foreclosure process is the trustee posting notice of sale or the originating lender filing foreclosure. But they do not know if the investment bank, an insurer or some other third party, including another borrower was contributing to the flow of payments that the investor received, nor do they know the allocation of those funds which the investor received.

Thus the party entitled to income from the borrower’s note may or may not have been paid by the borrower (through overcharges and other TILA violations in addition to regular monthly payments, or by third parties whose obligation derived in part from the note signed by the borrower and in part by hundreds or thousands of other notes in cross collateralization agreements or cross guarnatees, indemnifications, indentures and covneants between the lender, mortgage agregator, investment banker, seller of teh security and the investor who bought the security. 

You can therefore take the position that if the default alleged is non-payment, the entity or person making the allegation must prove the non-payment and that proving that the borrower did not make one or more payments does not prove that the party (investor) entitled to payment did not get paid in whole or in part. Thus no default has been alleged without alleging that no payment was received by the holder of the original note and mortgage and the party to whom payment was to be received as a result of the income stream from this mortgage combined with thousands of other mortgages.

Production of the original note and mortgage becomes critical and a condition precedent to any action, sale, motion for summary judgment, judgement of foreclosure, sale or rights of redemption. Equally important and perhaps more so is the production of the documents that assigned, sold or otherwise transferred the security interest, the income from the note or the risk of non-payment to one or more parties. You will find that in many cases, those are all different third parties with different interests and agendas.

Perhaps the most important, we are finding in Ohio and other states, that NOBODY can come up with documents that directly link a particular borrower with any of these third parties holding primary or secondary rights to the security instrument, the note, or the risk of loss. In those cases, we are seeing borrowers walk away with their home free and clear of any encumbrances and lawyers getting paid fat bonuses or contingency fees for eliminating the risk of foreclosure, and feeing the borrower from the entanglement in a complex transaction that was never disclosed to him/her/them.

The appraisers, who are usually insured by errors and omissions policies, state the fair market value of real property through supposedly independent analysis of comparable statistics and other factors. The standards are governed by the regulatory board in each state that licenses them, although there might still be some states who do not license appraisers. In states without licensing, they are governed by common law and other applicable law concerning deceptive business practices.

The rating agencies state the quality of a security that is used to determine the fair market value of the security. They too are supposedly using objective means, analysis and due diligence to issue their rating. In the world of the mortgage meltdown, rating agency objectivity broke down y virtue of two main factors: (a) the rating agencies were competing for customers and revenue and (b) in a related factor, the rating agency analysts were receiving gifts, pressure from clients (issuers) and pressure from management to “accommodate” the client (issuer). A Nationally Recognized Statistical Rating Organization (or “NRSRO”) is a credit rating agency which issues credit ratings that the U.S. Securities and Exchange Commission (SEC) permits other financial firms to use for certain regulatory purposes.

The nine organizations currently designated as NRSROs are:

Ratings by NRSRO are used for a variety of regulatory purposes in the United States. In addition to net capital requirements (described in more detail below), the SEC permits certain bond issuers to use a shorter prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimick the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating from an NRSRO. Likewise, insurance regulators use credit ratings from NRSROs to ascertain the strength of the reserves held by insurance companies.

The following article described the efforts of the New York Attorney general to address the break down of objectivity caused by competition for fees.

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Bond-Rating 
Shifts Loom 
In Settlement

N.Y.’s Cuomo Plans 
Overhaul of How 
Firms Get Paid
By AARON LUCCHETTI
June 4, 2008; Page C1

The three major bond-rating firms are set to overhaul the way they collect fees as part of a settlement with New York state’s attorney general, Andrew Cuomo, that could be announced as soon as this week, people familiar with the matter said.

If a deal is reached, it could change the $5 billion-a-year bond-rating industry as fundamentally as Mr. Cuomo’s predecessor Eliot Spitzer did six years ago with his settlement with Wall Street firms over stock-research analysts whose recommendations were compromised by investment-banking ties.

[Andrew Cuomo]

Terms of Mr. Cuomo’s settlement with Moody’s Corp.’s Moody’s Investors Service; McGraw-Hill Cos.’ Standard & Poor’s unit; and Fimalac SA’s Fitch Ratings deal with what many critics claim has been a chronic problem with bond ratings: They are paid for by the entities being rated. That financial dependence has been blamed for the industry’s failure to predict that risky subprime mortgages would crumble, resulting in losses and shaken confidence.

The accord attempts to change the incentive structure for the ratings firms. Now, while more than one ratings firm reviews most deals, not all of them always rate the deal and get paid. That gives the firms an incentive to go easy on their rating in order to win the business.

Under the Cuomo settlement, which would cover the hardest-hit portions of the mortgage market, the firms would get paid for their review, even if they didn’t end up getting hired to rate the deal. This would mean the firms would get paid even if they were tough. The plan, which requires final agreement by Mr. Cuomo’s office and the rating firms, wouldn’t dictate the exact fees rating firms could charge. But the firms would be required to charge more than a nominal fee for their preliminary work.

The bond-rating firms also have tentatively agreed to disclose on a quarterly basis the fees they are paid for nonprime-mortgage-backed securities, which include subprime mortgages and so-called Alt-A mortgages that have less documentation or don’t conform with prime-mortgage standards.

Such disclosures are seen as a potential red flag to help investors detect instances where bond issuers or their bankers may have essentially pitted different rating firms against each other in order to get a higher rating.

In an interview late last year, Brian Clarkson, then the president and chief operating officer of Moody’s Investors Service, acknowledged that “there is a lot of rating shopping that goes on…What the market doesn’t know is who’s seen” certain transactions but wasn’t hired to rate those deals. Last month, Mr. Clarkson, who once ran the Moody’s group overseeing mortgages and other structured-finance products, stepped down, effective in July.

The settlement is unlikely to satisfy critics who have urged that bond-rating firms stop being paid altogether by bond issuers or that the firms be permitted to rate any deal they choose, regardless of whether the issuer cooperates. Following the settlement, bond issuers still would get a strong say over which firms published the final rating, as well as those invited to look over a pool of loans in the first place.

For Moody’s, S&P and Fitch, the agreement largely eliminates the possibility of a nasty showdown with Mr. Cuomo, whose office has been investigating the industry for about nine months, poring through thousands of pages in documents and emails and interviewing senior executives at each of the three big rating firms, people familiar with the matter said.

Mr. Cuomo has leverage over the bond-rating industry partly because Moody’s and S&P are based in New York. The attorney general also has one of the most powerful legal tools in the nation: the 1921 Martin Act, which spells out a broad definition of securities fraud without requiring that prosecutors prove intent to defraud.

In a statement, Deven Sharma, S&P’s president, said the firm “is pleased to work with New York Attorney General Andrew M. Cuomo and other rating agencies on these important measures, which we believe will help ensure our ratings process continues to be of the highest quality.”

Rating-company shares rose after The Wall Street Journal reported news of the settlement talks Tuesday afternoon. In 4 p.m. composite trading on the New York Stock Exchange, Moody’s was at $38.45, up $1.80, or 4.9%. McGraw-Hill was up 38 cents at $41.20.

As the probe proceeded, attorneys in Mr. Cuomo’s office concluded that rating firms could be more effective if Wall Street had less control over which ones were paid, these people said. As part of the deal, the firms would cooperate with Mr. Cuomo’s continuing investigation into investment banks and other financial firms that issued mortgage-backed securities later plagued by high levels of defaults. The New York attorney general is trying to determine if banks intentionally overlooked or hid flaws in loans that were securitized and sold to investors.

The decision not to seek fines from the three major bond-rating firms partly reflects Mr. Cuomo’s firm but less-confrontational style than that of Mr. Spitzer. The 50-year-old Mr. Cuomo, elected in 2006, has promised to aggressively pursue financial wrongdoing, and the likely pact shows he believes investor confidence can be shored up without an all-out attack on the bond-rating industry.

Mr. Cuomo’s settlement will likely be structured in a way that doesn’t contradict rules being proposed by the Securities and Exchange Commission. It will take up to six months to implement and may also need to address antitrust concerns at investment banks or among smaller rating firms. “Without knowing all the details, I’m concerned it would entrench the three large rating firms,” said David Schroeder, chief operating officer of DBRS, a Toronto rating firm not included in the settlement talks.

Mortgage Meltdown: Regulation or Re-creation?

It is startling to see how little anyone knows about the mess we are in. First they don’t understand how bad this is going to get. Second they don’t understand how it happened because they don’t understand the financial system. And third, they have no clue how to prevent this from happening again. They don’t even realize that it has happened before several times right here in this country. 

The Country, the States and even the Counties and cities are more or less organized around the concept of bicameral legislatures, with checks and balances from the executive and judicial branches of government.

In all of those governmental entities there is not one person who has the knowledge or the authority or the accountability for the Mortgage Meltdown. It is impossible to imagine any smart regulation coming out of our current approach, so the inevitable conclusion is that the Mortgage Meltdown, the dot com meltdown, etc., will all happen again. The players will change but the game is the same.

So the first thing is to throw out all the proposals for future regulations or simply accept the fact that they won”t perform the basic purpose of government: to preserve society and protect the citizens from harm. 

Let’s get specific about the mortgage meltdown: it happenned because the private sector was able to create the equivalent of money using investor cash under false pretenses. It also happened because the participants were able to do it without perceiving any risks or negative consequences to themselves.

While you might say that the mortgage meltdown has had plenty of negative consequences to the financail institutions and intermediaries who participated in this fraud, the fact is that very few of the decision-makers have suffered any negative outcome. They walked away with bonuses and golden parachutes. People who worked for them suffered loss of jobs and themselves are in difficult financial straits, but not the real decision-makers (the movers and shakers).

If you want this scenario to stop (yes it is still happening) then three things must be true:

1. Full disclosure to government must be filed with a governmental agency on any program that involves a loan. Visa and MasterCard require every card issuance program to be individually approved. If they understand this simple concept, certainly government can learn something from the private sector. No lender should be able to act as a pure conduit for a loan without losing their status as a financial institution. If that is what they want to do, they are a broker not a lender. Every lender should have risk or they should not get paid a dime and the borrower should be told that the lender has no interest in the loan other than getting the borrower’s signature so that the lender can make a profit. If the fair market value of the house is stated incorrectly then all parties who had knowledge, despite plausible deniability, should be accountable for the difference.

2. The risk of imperfect disclosure and failure to perform in accordance with the fiduciary duties of a lender should be substantial and obvious and should be felt by the decision-makers. The same holds true for the seller of securitized products to investors. The simple test is this: if the borrower or investor knew what the lender or securities seller knew, would they have done the deal? If not, the full loss should fall on the companies and individuals who created these flawed programs.

3. Securitization of loans is not a good thing unless the investor fully understands the security he or she is buying. Allowing plausible deniability through reliance on rating agencies and insurers will always leave the investors holding an empty bag. The sellers, the rating agencies and the insurers should be required to file in the public record everything they know about the security and what they did to assure themselves that the facts were true. Later, if the deal falls apart, investors have defendants who are in clear violation of their duties and government has a clear case for prosecution.

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