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

Posted on February 6, 2013 by Neil Garfield

“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, http://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

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Zillow Raises Estimate Again: 16 Million Homes Underwater

Posted on June 1, 2012 by Neil Garfield

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Editor’s Comment:

This is why I am re-starting my seminar tours. The information out there is disinformation and in this case sellers don’t realize how badly they have been screwed until they are walking toward the closing table. The “underwater” phenomenon represents a vast market inventory shadow that is not being counted by anyone — which is why my estimates of market activity and prices are so much lower than what you hear from everyone else. So far I have been right every year.

Zillow is at least making an effort. It is sharpening the definition of “underwater.” We have been saying for years that the number of homes “underwater” is both rising and vastly underestimated. The reason I knew was that just by putting pencil to paper and using all the factors that measure the amount of money one might get as proceeds from the sale of a home, the average PROCEEDS from the sale of residential property was substantially below the average VALUES that were being used. Zillow has now entered the world of reality by adding all the relevant mortgages and not just the last one allocated to that property.

Once upon a time when you sold a house you received a check for the proceeds of the sale. It was always lower than what you expected because of expenses and charges that you incurred and after you deducted the expenses that didn’t appear on the HUD 1 Settlement Statement (money that you spent preparing the house for sale).

Now the situation is different. Instead of getting a check, many if not most homeowners must bring a check if they want to sell their home. Most homeowners, in other words, must pay money out of their pocket if they want to sell their home. In some cases, the bank will allow a short-sale where they will accept a payoff less than the amount they say is owed, but even then, the hapless homeowner will still be unable to recover his down payment, all the money he put into the house in furnishings and improvements, and all the principal payments made on a house that was intentionally overvalued, using inflated appraisals that would  leave the homeowner screwed.  

When they start looking at “Seller’s Proceeds” from the standpoint of a real HUD 1 settlement sttements, the figure will be even lower than the current Zillow estimate. The disconnect between “prices”, “home values” and “proceeds” has never been greater. The question of whether or not a home is underwater is determined by proceeds of sale — without regard to price or value. Being underwater means to answer a question: “How much money will the seller need to spend in order to sell the property with free and clear title.”

Forgetting the whole issue of title corruption caused by the use of MERS which further affects prices, values and proceeds, the amount of money required from the seller in order to sell his/her home is nothing short of sticker shock and the fact remains that a majority of the people affected do not know what has happened to their wealth. They do not understand the extent to which they suffered damage by Wall Street schemes. And of course they don’t know that there is something they can do about it — like any rational businessman instead of the deadbeat bottom-feeders  portrayed by bank mythology.

Once all factors (other than MERS) are taken into consideration, the Zillow numbers will change again to more than 20 million homes and will probably reach 25 million homes that are really underwater, most of which are hopeless because values and prices will never get enough lift, even with inflation, to make up the difference between what they must pay as sellers to get out of the deal and what they can get from buyers who are willing to buy the home. Add the MERS’ factors in, now that title questions we raised 4 years ago are being considered, and it is possible that many homes cannot ever be sold at any price. Where the levels of “securitization” are limited to only 1, then perhaps it is possible to sell the property but not without spending more money to clear title. 

Nearly 16M Homes Are Now Underwater

by THE KCM CREW

Zillow just reported that their data shows nearly 16 million homes in this country are now in a negative equity position where the house is worth less than the mortgages on the home. This number is dramatically higher than the approximate 11 million reported by other entities. Why the huge difference? Zillow professes to take into consideration ALL loans on the property not just the most recent loan (purchase or refinance).

The key findings in the study:

▪       Nearly one-third (31.4 percent) of U.S. homeowners with mortgages – or 15.7 million – were underwater on their mortgage.

▪       A slower pace of foreclosures after the robo-signing issues of 2010 contributed to slower progress in working down negative equity. Foreclosures cause homes to come out of negative equity when a bank or third party takes ownership.

▪       Nine in 10 homeowners continue to make their mortgage and home loan payments on time, with just 10.1 percent of underwater homeowners more than 90 days delinquent.

▪       Nearly 40 percent of underwater homeowners, or 12.4 percent of all homeowners with a mortgage, owe between 1 and 20 percent more than their home is worth.

▪       An additional 21 percent of underwater homeowners, or 6.6 percent of all homeowners with a mortgage, owe between 21 and 40 percent more than their home is worth.

▪       About 2.4 million, or 4.7 percent of all homeowners with mortgages owe more than double what their home is worth.

How can negative equity impact the housing market? In the report, Zillow Chief Economist Stan Humphries explains:

“Not only does negative equity tie many to their homes, by making homeowners unable to move when they may want to, but if economic growth slows and unemployment rises, more homeowners will be unable to make timely mortgage payments, increasing delinquency rates and eventually foreclosures.”

Case Shiller: House Prices fall to new post-bubble lows in March NSA

by CalculatedRisk

S&P/Case-Shiller released the monthly Home Price Indices for March (a 3 month average of January, February and March).

This release includes prices for 20 individual cities, two composite indices (for 10 cities and 20 cities) and the National index.

Note: Case-Shiller reports NSA, I use the SA data.

From S&P: Pace of Decline in Home Prices Moderates as the First Quarter of 2012 Ends, According to the S&P/Case-Shiller Home Price Indices

Data through March 2012, released today by S&P Indices for its S&P/CaseShiller Home Price Indices … showed that all three headline composites ended the first quarter of 2012 at new post-crisis lows. The national composite fell by 2.0% in the first quarter of 2012 and was down 1.9% versus the first quarter of 2011. The 10- and 20-City Composites posted respective annual returns of -2.8% and -2.6% in March 2012. Month-over-month, their changes were minimal; average home prices in the 10-City Composite fell by 0.1% compared to February and the 20-City remained basically unchanged in March over February. However, with these latest data, all three composites still posted their lowest levels since the housing crisis began in mid-2006.
…
“While there has been improvement in some regions, housing prices have not turned,” says David M. Blitzer, Chairman of the Index Committee at S&P Indices. “This month’s report saw all three composites and five cities hit new lows. However, with last month’s report nine cities hit new lows. Further, about half as many cities, seven, experienced falling prices this month compared to 16 last time.”

Case-Shiller House Prices Indices

Click on graph for larger image.

The first graph shows the nominal seasonally adjusted Composite 10 and Composite 20 indices (the Composite 20 was started in January 2000).

The Composite 10 index is off 34.1% from the peak, and up 0.2% in March (SA). The Composite 10 is at a new post bubble low Not Seasonally Adjusted.

The Composite 20 index is off 33.8% from the peak, and up 0.2% (SA) from March. The Composite 20 is also at a new post-bubble low NSA.

Case-Shiller House Prices Indices

The second graph shows the Year over year change in both indices.

The Composite 10 SA is down 2.8% compared to March 2011.

The Composite 20 SA is down 2.6% compared to March 2011. This was a smaller year-over-year decline for both indexes than in February.

The third graph shows the price declines from the peak for each city included in S&P/Case-Shiller indices.

Case-Shiller Price Declines

Prices increased (SA) in 15 of the 20 Case-Shiller cities in March seasonally adjusted (12 cities increased NSA). Prices in Las Vegas are off 61.5% from the peak, and prices in Dallas only off 6.7% from the peak.

The NSA indexes are at new post-bubble lows – and the NSA indexes will continue to decline in March (this report was for the three months ending in February). I’ll have more on prices later

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Hiding Behind Advice of Counsel No Better Than Ratings

Posted on May 4, 2012 by Neil Garfield

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Editor’s Comment:

In an article entitled “Legal Beagles in Cross Hairs” WSJ reports that the SEC and many others in law enforcement have on-going investigations into the role of attorneys not misconduct of their clients. For the most part it is an attorney’s solemn duty to represent and advocate the position of his or her client to the utmost of their ability without violating the law. Everyone is entitled to a lawyer no matter how reprehensible their conduct might have been when they committed the act.

But the SEC seems to be leading the way, starting with indictments and convictions of attorneys that kicks aside the clients’ defense of “I did it on advice of counsel.” in wide ranging probes law enforcement agencies are after the attorneys who said it was OK — upon receiving lavish payments, that what the Banks did in setting the securitization structure for the cash trail and setting up the securitization procedure for the document trail and then setting up the contents of the documents that would provide coverage for intentional acts of theft, forgery, fabrication and a variety of other acts.

The attorneys who gave letters of opinion to the investment banks blessing securitization of home and commercial mortgages as they were presented and launched are in deep hot water. This is especially true since the law firms that engaged in these “blessings” had lawyers quitting their jobs leaving behind memorandums to the partners that the law firm itself was committing crimes. The similarity between the blessing of the law firm and the ratings of Moody’s, S&P, Fitch is surprising to some people.

And the attorneys who suggested severance settlements conditioned on employed lawyers or other witnesses on a sudden onset of amnesia are also in the cross-hairs, getting stiff long-term sentences. These are all potential witnesses in what could be come nationwide probes that were blocked by “advice of counsel” claims and brings to mind those many cases where the lawyer for Wells, US Bank, or BOA was fined and sanctioned for lying to the court about facts which they most certainly knew or should have known — like the name of their client.

As these probes continue it may be seen as scapegoating the attorneys or as chilling the confidentiality of the relationship between lawyer and client. But that rule of confidentiality and the defines of advice of counsel vanishes when the conduct of the attorney or indeed a whole law firm is that of a co-conspirator. It is especially unavailable when you have a foreclosure mill that is forging, fabricating and filing documents on behalf of extremely well paying clients.

It would therefore seem to be an appropriate time to file complaints with law enforcement including police and regulatory authorities that are well-written, honed down to a sharp point and which attach at least some evidence beyond the mere allegation of wrong-doing on the part of the attorney or law firm. If appropriate lay people can file the same complaints as grievances with the state Bar Association that is required to regulate and discipline the behavior of lawyers. And attorneys for homeowners and judges who hear these cases are under an obligation to report evidence of wrongdoing or else face disciplinary charges of their own resulting in suspension or disbarment.

Legal Eagles in Cross Hairs

By JEAN EAGLESHAM

The Securities and Exchange Commission is intensifying its scrutiny of lawyers who gave a green light to certain mortgage-bond deals before the financial crisis or have tried to thwart investigations by the agency, according to people familiar with the matter.

The move is at an early stage and might not result in any enforcement action by the SEC because of the difficulty proving lawyers went beyond their legal duty to clients, these people cautioned. In the past, SEC officials generally have gone after lawyers only when accusing them of active involvement in securities fraud or serious misconduct, such as faking documents in a probe.

In recent months, though, some SEC officials have grown frustrated by what they claim is direct obstruction of a few investigations and a larger number of probes where lawyers coach clients in the art of resisting and rebuffing. The tactics include witnesses “forgetting” what happened and companies conducting internal investigations that scapegoat junior employees and let senior managers off the hook, agency officials say. “The problem of less-than-candid testimony … is a serious one,” Robert Khuzami, the SEC’s director of enforcement, said at a conference last month. The stepped-up scrutiny is aimed at both internal and outside lawyers.

Claudius Modesti, enforcement chief at the Public Company Accounting Oversight Board, an accounting watchdog created by the Sarbanes-Oxley Act, said at the same event: “We’re encountering lawyers who frankly should know better.”

The SEC enforcement staff has recently reported more lawyers to the agency’s general counsel, who can take administrative action against lawyers for alleged professional misconduct.

The SEC hasn’t disclosed the number of referrals. Only one lawyer has ever been banned for life from representing clients before the agency because of professional misconduct.

Earlier this year, Kenneth Lench, head of the SEC’s structured-products enforcement unit, said the agency needed to “seriously consider” charges against lawyers in “appropriate cases.” Mr. Lench said he saw “some factual situations where I seriously question whether the advice that was given was done in good faith.”

In July, the Commodity Futures Trading Commission gained the new power to take civil action against anyone, including lawyers, who makes “any false or misleading statement of a material fact.”

The agency, which oversees the futures and options market, hasn’t taken any action yet under the expanded power, according to a person familiar with the matter. A CFTC spokesman declined to comment.

“Frankly, I wish we had the power the CFTC has,” Mr. Khuzami said.

The SEC’s focus on advice provided by lawyers in mortgage-bond deals is part of the wider push by officials to punish alleged wrongdoing tied to the financial crisis. So far, the SEC has filed crisis-related civil suits against 102 firms and individuals, and more cases are coming, according to people familiar with matter.

Some former government officials say stepping up regulatory scrutiny of lawyers for their work on cases snared in investigations by the SEC could send a chilling message. “The government needs to be careful not to deter lawyers from being zealous advocates for their clients,” says John Wood, a former U.S. Attorney for the Western District of Missouri.

The only lawyer hit with a lifetime ban by the SEC for his work on behalf of a client is Steven Altman of New York. The client was a witness in an SEC investigation, and the agency alleged that Mr. Altman suggested in a recorded phone conversation that the client’s recollection of certain events might “fade” if she got a year of severance pay.

Last year, an appeals court rejected Mr. Altman’s bid to overturn the 2010 ban. Jeffrey Hoffman, a lawyer for Mr. Altman, couldn’t be reached for comment.

In December, a federal grand jury in Los Angeles indicted lawyer David Tamman on 10 criminal counts related to helping a former client cover up an alleged $20 million fraud. Prosecutors claim Mr. Tamman changed and backdating documents, removed incriminating documents from investor files and lied to SEC investigators in sworn testimony.

“The truth is that my client was set up and made a scapegoat,” says Stanley Stone, a lawyer for Mr. Tamman, adding that his client acted under the advice and guidance of senior lawyers at his former law firm, Nixon Peabody LLP. “We’re going to prove at trial that what was done was not criminal,” Mr. Stone says.

A Nixon Peabody spokeswoman says Mr. Tamman was fired in 2009 “as soon as we learned that he was under SEC investigation and he failed to explain his actions to us.” The law firm has asked a judge to throw out a wrongful-termination suit filed by Mr. Tamman.

A criminal trial last year shows how the SEC could face daunting hurdles in bringing enforcement actions against lawyers for providing bad advice.

“A lawyer should never fear prosecution because of advice that he or she has given to a client who consults him or her,” U.S. District Judge Roger Titus in Maryland ruled when dismissing all six charges against Lauren Stevens, a former lawyer at drug maker GlaxoSmithKline PLC. GSK +0.19%

Ms. Stevens was accused by prosecutors of lying to the FDA and concealing and falsifying documents related to an investigation by the U.S. agency. The federal judge refused to let a jury decide the case, saying that would risk a miscarriage of justice.

Reid Weingarten, a lawyer for Ms. Stevens, couldn’t be reached. A spokeswoman for the Justice Department declined to comment.

Despite the government’s defeat, “the mere fact she was charged sends a strong signal to other lawyers about the risks of being seen as less than forthcoming in their representation s to the government,” says Mr. Wood, the former federal prosecutor in Missouri. He now is a partner at law firm Hughes Hubbard & Reed LLP.


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is it one of them or is it all of them? Mr. Cuomo, are you listening?

Posted on May 18, 2010 by Neil Garfield

According to two EMC analysts, they were encouraged to just make up data like FICO scores if the lenders they purchased loans in bulk from wouldn’t get back to them promptly

Editors’ Note: With Bear Stearns “underwater” it is difficult to come up with scenario where there won’t be criminal charges brought against the bankers and traders who worked there. They are low-hanging fruit, easily made the scape goat and easily subject to inquiry since nobody has any allegiance to them. They have no reason to stay silent except for self-incrimination. If some are offered immunity they will sing like birds in the meadow.

On the other hand Cuomo is aiming for the wrong target and could end up losing his cases unless he aims right. If this report is correct, then Cuomo is looking for the the real criminal culprit in the ratings fraud. What is wrong with that approach is that he is attempting to single out ONE defendant out of a group. They ALL knew, as the article goes on to say, what they were doing with ratings, just as they all knew what was going on with property appraisals just as they all knew that there was no underwriting of the loans.

Underwriting, which was the process of verifying the loan data from soup to nuts was abandoned because the party initiating the loan had no dog in the race. They were using investor dollars to fund the loan. Their income was based upon closing the loan without regard to risk. In fact, as has now been acknowledged after three years of me harping on the subject, the more likely it was that the loan would fail, the higher the profit and fees to everyone.

In the world of securities, underwriting was once the product of verifying the facts and risks of an investment through “due diligence”. Like the home loans there was no due diligence underwriting. The object was to sell something that LOOKED good even though they knew the loss was a sure thing — something the investment bankers needed and wanted.

They wanted the investments to fail because they were selling it (securitizing specific loans, parts of loan pools and entire loan pools) into multiple SPV packages, effectively selling the same loans over and over again.

They were taking the yield spread caused by the lower rate the investors were willing to accept because they perceived the investment as being little or no risk. The loan interest charged to borrowers was much higher, sometimes by multiples. This causes a SPREAD, which means that in order to give the investors the dollar income they we re expecting, they could promise, based upon exhibits that were fabricated in part, that the investor would get the desired revenue.  But the income was coming from loans to borrowers at much higher “nominal” rates. In plain language they were able to invest only a portion of the investors money into funding mortgages that were guaranteed to fail. The rest of the money they kept for themselves. Each time they re-sold the security as described above, the entire proceeds were kept by the ivnestment banking house. As long as the pools failed, nobody would demand an accounting.

The investors might make claims for the losses but they were stuck with being tagged as qualified investors who should have known better, even if they were some small credit union who had no person on staff capable of performing verification or due diligence on the investment in mortgage-backed securities.

But fund managers (especially those  who received bonuses due to the higher returns they reported) were highly unlikely candidates to demand an accounting since they either had no clue or cared less as to what was REALLY done with the proceeds of their investment. AND then of course there are the fund managers who may or may not have overlooked, through negligence of intentionally, the quality of these investments. They may have received some sort of perks or kickback for investing in these dog-eared securities. Since the manager is in charge, he or she would be required to ask for things that they really don’t want to hear about.

The ratings companies were put in the exact same position as the the appraisers of the homes subject to mortgage. Play or die. Here is what we assisted you in coming up with a human and computer algorithm to arrive at the value of this investment. In securities, the value was expressed as AAA down to BBB and below. Here are the securities which we reverse engineered to fit that algorithm. Now give us the triple ratings as we agreed, take our fees which are higher now for your cooperation and don’t ask any questions. If someone did ask questions or raised alarms at the ratings agency or appraisal companies they were blacklisted.

So you tell me — is it one of them or is it all of them? Mr. Cuomo, are you listening? Contrary to the report below, this is no grey area. It is really very simple. Just because you have a pile of documentation doesn’t make it theft. Look at the result to determine the intent. That’s what you are supposed to do in Court.

More Corruption: Bear Stearns Falsified Information as Raters Shrugged

MAY 14 2010, 2:25 PM ET |  Comment

Made up FICO scores? Twenty-minute speed ratings to AAA? If government prosecutors like New York Attorney General Andrew Cuomo want answers to why the mortgage-backed securities market was so screwed up, they should talk to Matt Van Leeuwen from Bear Stearn’s servicing arm EMC.

Reports indicated on Thursday that Cuomo is pursuing a criminal investigation surrounding banks supplying bad information to rating agencies about the quality of the mortgages they signed off on. But so far he hasn’t been able to prove where in the chain of blame the due diligence for the ratings broke down.

What Cuomo needs to establish is: whose shoulders does it fall on to verify the information lenders were selling to investment banks about the quality of their loans? And who was ultimately responsible for the due diligence on the loans that created toxic mortgage securities that were at heart of our financial crisis?

False Information and the Grey Area

Employed during the go-go years of 2004-2006, and speaking in an interview taped by BlueChip Films for a documentary in final production called Confidence Game, Van Leeuwen sheds some light onto the shenanigans going on during the mortgage boom that might surprise even Cuomo. As a former mortgage analyst at Dallas-based EMC mortgage, which was wholly owned by Bear Stearns, he had first-hand experience working with Bear’s mortgage-backed securitization factory. EMC was the “third-party” firm Bear was using to vet the quality of loans that would purchase from banks like Countrywide and Wells Fargo.

Van Leeuwen says Bear traders pushed EMC analysts to get loan analysis done in only one to three days. That way, Bear could sell them off fast to eager investors and didn’t have carry the cost of holding these loans on their books.

According to two EMC analysts, they were encouraged to just make up data like FICO scores if the lenders they purchased loans in bulk from wouldn’t get back to them promptly. Every mortgage security Bear Stearns sold emanated out of EMC. The EMC analysts had the nitty-gritty loan-level data and knew better than anyone that the quality of loans began falling off a cliff in 2006. But as the cracks in lending standards were coming more evident the Bear traders in New York were pushing them to just get the data ready for the raters by any means necessary.

In another case, as more exotic loans were being created by lenders, the EMC analyst didn’t even know how to classify the documentation associated with the loan. This was a data point really important to the bonds ratings. When Bear would buy individual loans from lenders the EMC analyst said they couldn’t tell if it should be labeled a no-doc or full doc loan. Van Leeuwen explains, “I wasn’t allowed to make the decision for how to classify the documentation level of the loans. We’d call analysts in Bear’s New York office to get guidance.” Time was of the essence here. “So, a snap decision would be made up there (in NY) to code a documentation type without in-depth research of the lender’s documentation standards,” says Van Leeuwen.

Two EMC analysts said instead of spending time to go back to the lender and demand clarification, like if verification of income actually backed these loans, the executives at Bear would just make the loan type fit. Why? One EMC analyst explains, “from Bear’s perspective, we didn’t want to overpay for the loans, but we don’t want to waste the resources on deep investigation: that’s not how the company makes money. That’s not our competitive advantage — it eats into profits.”

Twenty Minutes for AAA

It’s easy to paint Bear as the only villain here — but what were the rating agencies thinking?

Susan Barnes of Standards and Poor’s testified before Congress last month saying banks like Bear were responsible for due diligence in the transactions described above: “For the system to function properly, the market must rely on participants to fulfill their roles and obligations to verify and validate information before they pass it on to others, including S&P.”

Yet, was it reasonable for agencies to stand behind ratings when due diligence was done by an affiliate of Bear? That’s like buying a car from a guy whose mechanic brother said it was great, and then finding out it was a lemon.

Equally amazing was how responsive the raters were even on the big deals. Van Leeuwen says, “The raters would provide a rating on a $1 billion security in 20-30 minutes.” Describing it as “a rubber stamp,” Van Leeuwen said that the ratings agencies slavish devotion to their computer models “was vital” because it allowed Bear to “cram mortgages through the process.”

The greatest asset Bear had in its quest to squeeze every ounce of profit from the mortgage-backed securities market was the methodology of the big ratings agencies. The bankers knew what kind of loan detail was needed to get that coveted AAA rating. After they prepped the rating agencies for what they ‘thought’ they loans would look like, they would buy loans in bulk, and then spend a day scrubbing them.

Bear’s decision to cut corners and to fail to take the time to make sure the raters got correct information about the quality of loans was big no-no. But rating bonds based on fast reactions, instead of thoughtful analysis and reliable due diligence, also might place some responsibility on the agencies’ shoulders.

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