subprime

Hedge Fund Manager Reportedly Brought In $5 Billion Last Year

by on January 28, 2011

BOSTON (By Svea Herbst-Bayliss) – Billionaire hedge fund manager John Paulson, whose bet against the overheated housing market made him one of the world’s wealthiest people, became a lot richer last year. By earning an estimated $5 billion in 2010 thanks to bets the economy would recover, the 55-year old investor likely set a new record for the $1.9 trillion hedge fund industry’s biggest-ever annual payday. He beat his own record, which he set in 2007 with a $4 billion haul made off the subprime bet. The Wall Street Journal first reported Paulson’s payout in its Friday edition, and investors familiar with Paulson’s portfolios said the number is likely correct given the manager’s asset size and his recent profitable bets on Citigroup and gold. For Paulson, the payday comes after he reversed deep losses in his funds halfway through the year, and it may put to rest lingering talk that his investing prowess was limited to a lucky bet during the subprime era, investors said. “He did it on the short side and on the long side,” said Brad Alford, founder of Alpha Capital Management, which invests with hedge funds. “He proved that he can really do it all.” Other prominent managers like Appaloosa Management’s David Tepper and Bridgewater Associates’ Ray Dalio likely also earned 10-figure paychecks, the Journal reported. EYEBROWS RAISED But Paulson and other managers’ eye-popping earnings are sure to raise new questions about how managers are paid in an industry known for charging hefty fees that often guarantee generous payouts even if returns were merely average. Last year, the average hedge fund gained 10.5 percent, lagging the Standard & Poor’s 500 index by 15 percent and falling short of their own 19 percent return in 2009, data from Hedge Fund Research show. But managers will collect 2 percent management fees and about a 20 percent cut of their gains. By definition, this raises the payouts for managers at the industry’s biggest firms. In Paulson’s case, the fact that his 17-year old firm Paulson & Co oversees about $35 billion fattened up his payout. To be fair, Paulson also invests his entire fortune in his funds and since his gold fund gained 35 percent, his investment gains added billions to his payout. For other managers, including ones who lost money, however, the industry’ payouts may seem less fair, investors and analysts said. “People are fine with hedge fund fee structures as long as they are making great returns,” said Stewart Massey, who invests with hedge funds at Massey, Quick & Co. “But where they get antsy is where managers have middling returns and the managers are still making a lot of money.” As hedge funds look for new investors, experts say that investors’ demands on pay will hold more sway. A push from some investors to set a so-called hurdle rate, or minimum accepted rate of return, for manager pay, or to reward them only if they exceed certain benchmarks may gain traction. ROAD TO BIG PAYDAYS The big paydays at hedge funds are likely to confirm that hedge funds can be modern-day gold mines on Wall Street and spark even more movement from the world of banking and mutual fund management into this asset class. “Many of these big hedge fund managers are now earning more than professional athletes,” said Kenneth Murray, president of Mercury Partners, which recruits staff for hedge funds. “And they can do this for the rest of their lives, unlike sports stars who have to find another job after the age of 35…. 100 percent, hedge funds are the places where everyone wants to be.” But he and other recruiters agreed that the hedge fund industry’s biggest payouts really will be limited to its biggest stars, noting that working at a hedge fund is no longer a sure way to easy riches. As the industry matures, these people said that it is becoming harder for newcomers to break in and that portfolio managers need to bring long records of top performance before getting a job. Also with investors becoming pickier, it is harder to raise a lot of money. “If you’ve been in the game and successful, you may be set for life, but for everyone else it is becoming tougher,” Murray said. (Editing by Robert MacMillan) Copyright 2010 Thomson Reuters. Click for Restrictions .

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Mortgage Giants Leave Legal Bills To The Taxpayers

by Adam J. Rose on January 24, 2011

Since the government took over Fannie Mae and Freddie Mac, taxpayers have spent more than $160 million defending the mortgage finance companies and their former top executives in civil lawsuits accusing them of fraud. The cost was a closely guarded secret until last week, when the companies and their regulator produced an accounting at the request of Congress. The bulk of those expenditures — $132 million — went to defend Fannie Mae and its officials in various securities suits and government investigations into accounting irregularities that occurred years before the subprime lending crisis erupted. The legal payments show no sign of abating.

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The year In Wall Street Investigations

December 27, 2010

It’s been over three years since credit markets started shaking with the early tremors of the subprime crisis, and two years since that spread into a marketwide collapse. Prosecutors, regulators, Congress and journalists have spent the year uncovering the financial shenanigans that brought the market to its knees. It’s been marked by a few blockbuster settlements and more revealing investigations — as well as by some no

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To Small To Save: How The Fed Let Community Banks Fail

December 23, 2010

WASHINGTON — The Federal Reserve Board, chastised for regulatory inaction that contributed to the subprime mortgage meltdown, also missed a chance to prevent much of the financial chaos ravaging hundreds of small- and mid-sized banks.

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Preeti Vissa: The Film You Must See — or, We Told You So

November 18, 2010

A few days ago I joined a group of my colleagues from The Greenlining Institute to see the new documentary, Inside Job . I don’t normally go around telling people what to do, but seriously: Step away from the computer and go see this film. We had a special motivation for seeing Inside Job , which lays out in painful detail how the subprime mortgage meltdown happened and how it tanked the economy: Greenlining’s co-founder, Robert Gnaizda, is featured prominently. In a film that will leave any sane person furious and frustrated, he’s highlighted one of precious few who saw the crisis coming and tried to sound a warning. What filmmaker Charles Ferguson does — better than just about anyone else thus far — is connect the dots in a way that makes this very complex material understandable. He shows how a deregulated environment separated lenders from the consequences of their actions, producing a massive housing bubble that was built on a foundation of wishful thinking, speculation, inflated appraisals, bogus bond ratings and outright fraud. The result was a speculative frenzy in which lenders could make a fast buck (hundreds of millions of fast bucks, actually) by making subprime loans, often misleadingly marketed to gloss over hidden time bombs like exploding interest rates, quickly bundling them into securities called collateralized debt obligations (CDOs) and selling them to investors. Without any sort of meaningful oversight to ensure that increasingly complex financial instruments bore some connection to reality, financial operators simply made stuff up — from appraisals phonied up to make a loan seem viable when it really wasn’t to AAA ratings given to securities that close examination would have shown to be nearly worthless. Much of what happened was utterly mad: For example, borrowers were allowed to borrow 99.3 percent of value of their homes, meaning they had basically no investment in the house, and yet two thirds of the securities backed by these loans were rated AAA, as safe as government bonds. It was insane, but while home prices kept skyrocketing it was easy to ignore that the whole boom was built on air. Enter Greenlining’s Bob Gnaizda, one of the few who dared to say that trouble was brewing. In meetings with then Federal Reserve Board Chair Alan Greenspan and other officials, he warned of dangerous and dishonest marketing of subprime loans that was bound to lead to waves of foreclosures and trouble for the whole housing market. But regulators like Greenspan, ideologically opposed to regulation, refused to believe the market wouldn’t correct itself. And everyone in the jungle of lenders and speculators was too busy making piles of money to be interested in the long-term consequences. As we survey the ongoing wreckage — massive unemployment and millions more foreclosures coming if nothing is done — it’s tempting to say, we told you so . And we did, literally. But instead of gloating about predicting the last disaster, it may be more useful to talk about how to stop the next one, and that’s what I’ll be spending the next several weeks doing. More troubles are coming, but like the subprime crash, they’re preventable — if we chose to put aside the conventional wisdom. NEXT WEEK: What Inside Job didn’t show, and what it means.

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Michael Hudson: 16 Cents on the Dollar: Doing the Math on Angelo Mozilo’s Big Settlement

October 19, 2010

In the end, Angelo Mozilo settled for pennies on the dollar. The former Countrywide Financial Corp. chief agreed Friday to a settlement that requires him to pay 16 cents out of his own pocket for every dollar federal authorities claimed he had taken out of the company in ill-gotten personal gains. Let’s do the math: ■ The government alleged that he added $141.7 million (before taxes) to his personal fortune through corporate misconduct. ■ Mozillo agreed to personally pay a $22.5 million fine — 16 percent of the alleged ill-gotten gains. ■ In addition, Mozillo agreed to turn over another $45 million to former Countrywide shareholders, who lost billions when the company’s stock price plummeted as loan defaults soared. But the $45 million won’t come out of Mozilo’s pocket. Under the terms of his employment contract, it will be paid instead by Countrywide’s insurers and by Bank of America, which bought Countrywide in 2008. The government settled the civil fraud and insider trading allegations against Mozilo for less than it wanted because, one legal analyst said, it would have been a challenge to prove its case. “This is not a slam dunk,” Duke University law professor James D. Cox told The New York Times . “It’s a risky case and it’s got a lot of complexities to it.” Mozilo admitted no wrongdoing, and his lawyers were sure to have mounted a ferocious defense. The Securities and Exchange Commission said the $22.5 million fine will be the largest penalty ever paid by a senior executive of a public company in an SEC settlement. Too Easy? But some observers wonder whether Mozilo got off easy. David Callahan, author of the book, The Cheating Culture: Why More Americans Are Doing Wrong to Get Ahead , writes : It is hard to see how the Mozilo settlement — coming on the heels of another weak SEC settlement with financier Steve Rattner — will deter future wrongdoing. . . . Indeed, it could have the contrary effect. If you can make a great fortune behaving badly, get busted, and still end up with most of that [fortune], then you’ve come out way ahead. At least in financial terms. Countywide reaped huge profits — and, eventually, produced huge losses for its shareholders — through a high-wire strategy that focused on selling huge volumes of subprime loans and other risky products. One of the ironies of Countrywide’s fall was that Mozilo had been hesitant, at first, to jump into the subprime market. As I write in my new book about the subprime debacle, The Monster , Mozilo and Countrywide eventually succumbed to the temptation to follow the example of Ameriquest Mortgage Co. and its billionaire owner, Roland Arnall, an entrepreneur who was in many ways the founding father of subprime. The inventive mortgage products emerging in the home-loan market were watched closely by the heaviest of the industry’s heavyweights: Countrywide Financial’s Angelo R. Mozilo. Mozilo’s company had established itself as the largest mortgage lender in America by providing loans to home owners with good credit. Mozilo called his company “my baby.” For much of his career, he had been cautious about the kinds of loans his company made. Countrywide had mostly steered clear of subprime as other lenders dived into the market throughout the 1990s. Mozilo worried that subprime loans were too risky, in some cases even “toxic.” … While Ameriquest’s methods may have made Mozilo uneasy, he wasn’t so troubled that he kept Countrywide from joining the subprime gold rush. His company had survived decades of real-estate booms and busts, and he thought it had the brains and brawn to handle the risks of subprime better than the upstarts. Mozilo’s competitive instincts beat out his caution. He couldn’t accept being second or third. “It’s a question of dominance,” he told investors. He didn’t like that Countrywide trailed Ameriquest in the subprime lending rankings. By 2003 Arnall’s companies had captured nearly 12 percent of the subprime market; Countrywide did barely half as much subprime volume, with a market share of just 6 percent. Besides, the real money in the mortgage business was now in subprime, not in prime loans. When Countrywide sold prime loans to investors, its average profit margin was 0.93 percent; when it sold subprime loans to investors, the company’s profit margin nearly quadrupled, to 3.64 percent. The fees, interest rates, and prepayment penalties embedded in subprime loans made them much more seductive to investors. Countrywide’s Size, Clout Though Mozilo’s company came late to the party, once it was there, its size and clout deepened the pain that subprime visited upon home owners and the financial system. Countrywide did little to pull back on its subprime push, even in 2006, when there were signs of an impending crash. “You have to make a choice: to get out or not. And they stayed,” a longtime mortgage industry watcher told the Los Angeles Times . “It’s hard when you’re following someone off a cliff to know when to stop.” In early 2008, Bank of America purchased Countrywide, once worth as much as $26 billion, for a fire-sale price of $4 billion. Countrywide might have survived if its founder hadn’t become fixated on competing with Ameriquest, Muolo, the National Mortgage News editor, said. “If he hadn’t followed Roland Arnall down the subprime path this would never have happened,” Muolo said. “It’s ego and ambition that sunk him.” Michael Hudson is a staff writer with the Center for Public Integrity and author of The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America — and Spawned a Global Crisis (Times Books, October 2010).

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Jeffrey Rubin: Will the Fed’s Zero Rate Policy Bring Another Speculative Bubble?

September 28, 2010

At the recent Federal Open Market Committee meeting, Federal Reserve Board Chairman Ben Bernanke signalled that he plans to keep interest rates effectively at zero for as long as possible, and that he’s ready to stand by with more quantitative easing (i.e. printing money) if necessary. But if the Fed’s blaming the last recession on the financial meltdown from the subprime mortgage market, why is it so committed to recreating those same credit conditions that spawned Wall Street’s worst-ever post-Depression crash? There is no shortage of people to blame for the subprime mortgage fiasco: wayward rating agencies that ranked the risk of mortgage default as comparable to the risk of a US Treasury default; unscrupulous lenders who eagerly approved mortgages and then quickly resold them to financial institutions; over-leveraged banks that used depositors’ money to play Russian roulette in the financial derivatives market; and asleep-at-the-wheel regulators (like the Securities Exchange Commission ), who were either blind or indifferent to Wall Street’s systemic risk to the subprime mortgage market. However, the real culprits behind the subprime mortgage crisis were the incredibly low interest rates that sustained the bubble. All the greed in the world could not have done what the Fed’s easy-money policy made so simple. Was it not the desperate search for yield that threw many an otherwise cautious pension fund into the arms of seemingly safe CDOs (collateralized debt obligations)? Beneath the AAA-rated vanilla wrapping paper were pools of subprime mortgages just waiting to go bust. The measly extra basis points they offered over government-funded AAA bonds may not seem like much when Treasury yields are 5 to 6 per cent, but they meant a lot more to return-starved pension plans when government bond yields fell to near-record lows. Similarly, was it not the ridiculously low cost of credit that allowed banks to become so leveraged–hence exposed–to the subprime mortgage market? And of course, it was the same low cost of capital that allowed interest-free mortgages (negative amortization types) to be given out to anyone who would take them in the first place. Neither the demand for financial products like CDOs that were funded by subprime mortgages, nor the supply of subprime mortgages themselves would have been possible in a world of normal interest rates. When the federal funds rate rose to 5 per cent, an historically average setting, the subprime mortgage market collapsed, creating an insolvency crisis for financial institutions whose vaults were filled with reeking CDOs. Of course it won’t be subprime mortgages and CDOs next time, but if the Fed keeps rates at zero for long enough, you can count on financial markets’ insatiable desire for yield to invent something just as toxic.

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Jonathan B. Mintz: Don’t Bank on Subprime Indictments Anytime Soon

August 16, 2010

In filings this month in federal court in Los Angeles, lawyers for former Countrywide Financial Corp.’s chief executive Angelo Mozilo argued that the Securities and Exchange Commission now admitted that the home lender had fully disclosed to investors the increasingly risky mortgages that Countrywide was originating. They called for the case against him to be dismissed. The SEC has yet to respond. Whether emboldened by the perceived lackluster performance so far from regulators investigating subprime loans or merely a tactical move, Mozilo’s grandstanding in the face of both an SEC complaint and an on-going federal criminal investigation is likely a reaction to the government’s track record — or lack of one — in bringing successful major prosecutions in connection with the subprime mortgage crisis. In fact, three years after the start of the biggest collapse in the home loan market in history and despite the announcement of criminal investigations into Goldman Sachs, Countrywide, AIG and others, investors are still waiting for a conviction of a major player for conduct related to the subprime mortgage crisis. Contrast that with the dotcom collapse in 2000 which led to a string of highly successful, big name prosecutions of CEO’s and CFO’s at companies such as Enron, Tyco, Adelphia and WorldCom to name just a few. It is fair to wonder if these criminal prosecutions are ever coming. The answer is, maybe not, and certainly not in the numbers that the public had expected. If you’re still waiting for a wave of high profile criminal prosecutions to emerge from the haze of the subprime mortgage meltdown, it may be time to readjust your expectations. To be fair to prosecutors, it’s not for lack of desire. In fact, shortly after the implosion of Bear Stearns, DOJ prosecutors obtained indictments of two former Bear Stearns hedge fund managers alleging that they knowingly misled investors about the future prospects of their fund. Armed with a series of seemingly bullet proof, smoking gun emails in which the defendants appeared to be trashing the very investments they were promoting to their investors, prosecutors painted a vivid portrait of Wall Street insiders telling one story to their investors, while privately maintaining an altogether different opinion of the long-term health of the fund. But in the end, prosecutors were unable to convince jurors that the defendants should be held responsible for failing to predict the global economic crisis that swept their funds, along with much of the U.S. economy, into a tailspin. Both defendants were acquitted of all charges. While prosecutors have yet to follow up with any major indictments, SEC regulators have moved ahead, recently announcing settlements with Citigroup and their biggest prize to date — Goldman Sachs. The agency had charged Goldman with intentionally misleading clients by selling a mortgage-security product that they failed to disclose was designed in part by another Goldman client that was betting on the housing market to crash. Despite the record-setting settlement of $550 million, the SEC resolved the matter on terms that suggest that a criminal prosecution is unlikely to follow. Indeed, buried in the Goldman settlement, which was only approved by a federal judge this month, are signs that perhaps their civil case was weaker than originally billed and that federal prosecutors would face an even more daunting task in trying to build a criminal case where the standard of proof is higher. Generally the SEC will demand that a defendant settle on the most serious allegation made in its complaint. Instead, regulators struck a deal that essentially watered down the toughest charge. The SEC complaint contained an allegation that Goldman violated Rule 10b of the securities laws, which includes a broad antifraud provision covering trading in securities. This allegation is one of the most potent weapons in the SEC’s arsenal. Instead, Goldman settled on Rule 17a, which carries a lesser stigma for a financial firm and can involve unintentional fraud as well as negligence. The fact that regulators were willing to back off their claim of intentional wrongdoing is a strong indication that they had doubts as to whether they could ultimately make the charges stick. In addition, while the terms of the Goldman settlement contained an unusual provision which required Goldman to issue a statement that it was “a mistake” to fail to disclose the role of the other Goldman client, that “admission” contrasted incongruously with other language in the settlement in which Goldman expressly denied any wrongdoing. Both the Goldman settlement and the Bear Stearns acquittals show just how difficult it will be to pin criminal intent on the salesmanship that pervades Wall Street. The reality is that this financial meltdown was far more complex and affected by many more external factors than those that followed the dotcom collapse. Cases like Enron and WorldCom were more self-contained. In those prosecutions, since the criminality occurred within the company, cause and effect were easier to demonstrate to jurors. In this case it will be more difficult to draw direct lines of causation between defendants and losses since there are likely going to be many other factors to take into account. While it is still too early to count prosecutors out in the government’s efforts to hold someone accountable for the staggering losses to investors, the presence of lax regulations that clearly contributed to the crisis creates significant difficulties for establishing criminal liability which requires evidence of clear cut wrongdoing. In the wake of a financial crisis it is always tempting to promise that those who are responsible will be brought to justice. But it is one thing to witness a crime and then search for those who committed it. It’s an entirely different matter when prosecutors have to find both the crime and the criminals. In the end, it’s hard to image any outcome in which the victims won’t still far outnumber the villains. Robert A. Mintz is the former Deputy Chief of the Organized Crime Strike Force of the U.S. Attorney’s Office in the District of New Jersey and is currently the head of the Government Investigations and White Collar Criminal Defense practice group at McCarter & English, LLP.

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Robert A. Mintz: Don’t Bank on Subprime Indictments Anytime Soon

August 16, 2010

In filings this month in federal court in Los Angeles, lawyers for former Countrywide Financial Corp.’s chief executive Angelo Mozilo argued that the Securities and Exchange Commission now admitted that the home lender had fully disclosed to investors the increasingly risky mortgages that Countrywide was originating. They called for the case against him to be dismissed. The SEC has yet to respond. Whether emboldened by the perceived lackluster performance so far from regulators investigating subprime loans or merely a tactical move, Mozilo’s grandstanding in the face of both an SEC complaint and an on-going federal criminal investigation is likely a reaction to the government’s track record — or lack of one — in bringing successful major prosecutions in connection with the subprime mortgage crisis. In fact, three years after the start of the biggest collapse in the home loan market in history and despite the announcement of criminal investigations into Goldman Sachs, Countrywide, AIG and others, investors are still waiting for a conviction of a major player for conduct related to the subprime mortgage crisis. Contrast that with the dotcom collapse in 2000 which led to a string of highly successful, big name prosecutions of CEO’s and CFO’s at companies such as Enron, Tyco, Adelphia and WorldCom to name just a few. It is fair to wonder if these criminal prosecutions are ever coming. The answer is, maybe not, and certainly not in the numbers that the public had expected. If you’re still waiting for a wave of high profile criminal prosecutions to emerge from the haze of the subprime mortgage meltdown, it may be time to readjust your expectations. To be fair to prosecutors, it’s not for lack of desire. In fact, shortly after the implosion of Bear Stearns, DOJ prosecutors obtained indictments of two former Bear Stearns hedge fund managers alleging that they knowingly misled investors about the future prospects of their fund. Armed with a series of seemingly bullet proof, smoking gun emails in which the defendants appeared to be trashing the very investments they were promoting to their investors, prosecutors painted a vivid portrait of Wall Street insiders telling one story to their investors, while privately maintaining an altogether different opinion of the long-term health of the fund. But in the end, prosecutors were unable to convince jurors that the defendants should be held responsible for failing to predict the global economic crisis that swept their funds, along with much of the U.S. economy, into a tailspin. Both defendants were acquitted of all charges. While prosecutors have yet to follow up with any major indictments, SEC regulators have moved ahead, recently announcing settlements with Citigroup and their biggest prize to date — Goldman Sachs. The agency had charged Goldman with intentionally misleading clients by selling a mortgage-security product that they failed to disclose was designed in part by another Goldman client that was betting on the housing market to crash. Despite the record-setting settlement of $550 million, the SEC resolved the matter on terms that suggest that a criminal prosecution is unlikely to follow. Indeed, buried in the Goldman settlement, which was only approved by a federal judge this month, are signs that perhaps their civil case was weaker than originally billed and that federal prosecutors would face an even more daunting task in trying to build a criminal case where the standard of proof is higher. Generally the SEC will demand that a defendant settle on the most serious allegation made in its complaint. Instead, regulators struck a deal that essentially watered down the toughest charge. The SEC complaint contained an allegation that Goldman violated Rule 10b of the securities laws, which includes a broad antifraud provision covering trading in securities. This allegation is one of the most potent weapons in the SEC’s arsenal. Instead, Goldman settled on Rule 17a, which carries a lesser stigma for a financial firm and can involve unintentional fraud as well as negligence. The fact that regulators were willing to back off their claim of intentional wrongdoing is a strong indication that they had doubts as to whether they could ultimately make the charges stick. In addition, while the terms of the Goldman settlement contained an unusual provision which required Goldman to issue a statement that it was “a mistake” to fail to disclose the role of the other Goldman client, that “admission” contrasted incongruously with other language in the settlement in which Goldman expressly denied any wrongdoing. Both the Goldman settlement and the Bear Stearns acquittals show just how difficult it will be to pin criminal intent on the salesmanship that pervades Wall Street. The reality is that this financial meltdown was far more complex and affected by many more external factors than those that followed the dotcom collapse. Cases like Enron and WorldCom were more self-contained. In those prosecutions, since the criminality occurred within the company, cause and effect were easier to demonstrate to jurors. In this case it will be more difficult to draw direct lines of causation between defendants and losses since there are likely going to be many other factors to take into account. While it is still too early to count prosecutors out in the government’s efforts to hold someone accountable for the staggering losses to investors, the presence of lax regulations that clearly contributed to the crisis creates significant difficulties for establishing criminal liability which requires evidence of clear cut wrongdoing. In the wake of a financial crisis it is always tempting to promise that those who are responsible will be brought to justice. But it is one thing to witness a crime and then search for those who committed it. It’s an entirely different matter when prosecutors have to find both the crime and the criminals. In the end, it’s hard to image any outcome in which the victims won’t still far outnumber the villains. Robert A. Mintz is the former Deputy Chief of the Organized Crime Strike Force of the U.S. Attorney’s Office in the District of New Jersey and is currently the head of the Government Investigations and White Collar Criminal Defense practice group at McCarter & English, LLP.

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Martin Ford: Gordon Gekko on Steriods: How Wall Street Computers Amplify Risk

August 16, 2010

Nouriel Roubini recently wrote an article at Project Syndicate called ” Gordon Gekko Reborn ” in which he argues that it’s pointless and naive to expect that people on Wall Street won’t be driven by greed. Gordon Gekko, of course, was the now legendary character (loosely based on inside trader Ivan Bosky) in the 1987 film Wall Street . Roubini points out that financial markets have always had a “greed is good” mentality: But were the traders and bankers of the sub-prime saga more greedy, arrogant, and immoral than the Gekkos of the 1980′s? Not really, because greed and amorality in financial markets have been common throughout the ages. While it is certainly true that human nature–and the propensity toward excessive greed–has not changed, there is something that most definitely has changed. The technology that can be wielded by Wall Street players has accelerated dramatically. The computers that sit on Wall Street desks today are at least 2000 (yes, two thousand) times faster than the machines that were in use in 1987 when the film was released. That dramatic increase in computational speed, and also in memory capacity, has been accompanied by similar advances in communications technology and by significant progress in software. To see the role that technology now plays on Wall Street, it’s necessary to look no further than the subprime meltdown and the ensuring global crisis. If subprime loan programs had existed twenty or thirty years ago, it would, of course, have been possible for those borrowers to default in large numbers, just as they began to do in 2007. In earlier years, however, there would have been little or no danger that a mortgage crisis localized in the United States would have grown into the global financial calamity that befell us in 2008. The reason that disaster did occur has a great deal to do with computer technology. The derivatives and securities, such as collatorized debt obligations (CDOs), that nearly brought the global financial system down would have been impossible to create without the use of advanced computers. And if these exotic financial instruments had not been created and distributed to banks and other institutions throughout the world, the subprime meltdown might have been a relatively minor crisis without the disastrous consequences that we continue to endure. Even the relatively primitive computer technology available in 1987 was already beginning to have a significant impact on markets. As Wall Street begins, the date “1985″ appears on the screen; that was necessary because the stock market crashed a staggering 20 percent on October 19, 1987–just before the movie was released. There was really no specific news event or other factor that might have explained the sudden market plunge. Many of the people involved in quantitative technologies on Wall Street at the time believe that the crash may have been precipitated by computer programs that traded autonomously in the hope of providing “portfolio insurance” for big investors. In recent months, a lot of attention has been focused on “flash trading,” a technique that uses extraordinarily fast computers to execute trades in tiny fractions of a second. There is also evidence to suggest that Wall Street firms are increasingly using software algorithms incorporating artificial intelligence to trade at speeds incomprehensible to any human being. The point of all this is not that we should somehow try to halt technical progress, but that we have to recognize the implications of accelerating information technology. As Roubini points out, human nature doesn’t change. But technology does change–and it will continue to advance at an accelerating rate. The people on Wall Street will not hesitate to use that technology to exploit new opportunities. The overall effect will be to amplify risk and potentially introduce new–and quite possibility completely unanticipated–systemic threats. The pace of technical progress on Wall Street makes it critical that regulations are flexible and enforce the spirit of the law, rather than attempting to anticipate the details of the next crisis. As Roubini says, the only effective counterweight to excessive greed is genuine fear of loss–and I think that probably has to be not just corporate loss but personal financial loss for top executives. One effective way to make a future crisis less likely would be to impose an automatic special tax (in addition to normal corporate taxes) on any institution that receives a bailout from the government. The tax should capture a substantial fraction of profits and should be imposed automatically upon the institution’s return to profitability. If the taxpayers step in and rescue a private firm from an existential threat, then I think it is entirely reasonable that the taxpayers should share in the future profitability of that firm–perhaps for many years to come. One can argue, for example, that firms like Goldman Sachs exist today only because the government intervened. In other words, all the future profits that will accrue to both shareholders and executives would not have existed without that taxpayer assistance. If you doubt that, check out the profits currently being generated by Lehman Brothers. In addition to a special, supplementary tax on firms that receive bailouts, I would suggest that the CEO and top executives of the firm also be subject to a substantial and automatic retroactive tax on compensation received during the time leading up to the crisis. This would dissuade executives from allowing their firms to assume excessive risks in order to generate huge bonuses for themselves. The Federal Reserve could be given the authority to impose a bailout–and the associated special taxes–unilaterally on firms in cases where a significant risk to the entire financial system exists. That would prevent firms from holding the system hostage in the event of a crisis. My guess is that these two new taxes would dramatically change the way Wall Street firms are run. If a CEO knows in advance that his or her compensation could be subject to an onerous retroactive tax, I think we can be reasonably certain that the firm would do everything in its power to properly evaluate and minimize risk. The CEO and other executives would have a very personal interest in making that happen. Would that result in more caution on Wall Street and perhaps less financial innovation? Perhaps it would, and that might well be a very good thing. What we need is not exotic new securities but innovation in areas like clean energy or in ways to control health care costs. The role of the financial system should be to maintain relative stability and to support investment and innovation in the real economy–and government regulation should reflect that. For more thoughts on how advancing technology may have contributed to the financial crisis, please also see this post . ——- Martin Ford is the author of The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future (available from Amazon or as a FREE PDF download ) and has a blog at econfuture.wordpress.com .

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Fannie’s & Freddie’s Roles In The Financial Crisis And Their Pursuit Of Countrywide

August 7, 2010

Outwardly, Fannie and Freddie wrapped themselves in the American flag and the dream of homeownership. But internally, they were relentless in their pursuit of profits from partners in the mortgage boom. One of their biggest and most steadfast collaborators was Countrywide, the subprime lending machine run by Angelo R. Mozilo.

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Zach Carter: Where Are The Prosecutions? SEC Lets Citi Execs Go Free After $40 Billion Subprime Lie

July 30, 2010

What is the penalty for bankers who tell $40 billion lies? Somewhere between nothing and a rounding-error on your bonus. The SEC just hit two Citigroup executives with fines for concealing $40 billion in subprime mortgage debt from investors back in 2007. The biggest fine is going to Citi CFO Gary Crittenden, who will pay $100,000 to settle allegations that he screwed over his own investors. The year of the alleged wrongdoing, Crittenden took home $19.4 million. That’s right. Crittenden will lose one-half of one percent of his income from the year he hid a quagmire of bailout-inducing insanity from his own investors. That’s it. No indictment. No prison time. Crittenden doesn’t even have to formally acknowledge any wrongdoing. In 2007, as financial markets were freaking out about the subprime situation, Citi repeatedly told its investors that it owned just $13 billion in subprime mortgage debt. It was true–if you didn’t count an additional $40 billion in subprime debt that the company was also holding onto. Citi’s CEO at the time, Chuck Prince, has not been charged with anything. As Yves Smith emphasizes , all of the top financial officers of every major corporation are responsible for the accuracy of their quarterly financial statements. Lying on those statements is a federal crime. This is the sort of thing that securities fraud cases are built around. The SEC’s own statements about what went on at Citi are damning. If the agency can make this kind of information public, they ought to be pursuing criminal prosecutions. The SEC says that senior Citi management had been collecting information about the company’s subprime situation as early as April 2007, but repeatedly cited the $13 billion figure to investors over the next six months, waiting to acknowledge the additional $40 billion in subprime debt until November 2007. The SEC also says that Crittenden knew the “full extent” of Citi’s subprime situation by September at the latest , but the company continued to cite $13 billion in earnings reports through October. Citi’s subprime shenanigans had consequences for taxpayers, pushing the company to the brink of total collapse and prompting one of the biggest bailouts of 2008. Phil Angelides and the Financial Crisis Inquiry Commission deserve a lot of credit for highlighting the absurdity of Citi’s actions in a hearing on April 7 of this year (the key passage starts on page 368 of this pdf transcript ). Angelides’ line of questioning revealed that even Citi’s board knew that the subprime exposure was much greater than what the company was claiming in public. Citi’s board at the time included Robert Rubin, former Treasury Secretary and architect of much of the deregulation that lead to the current crisis who took home $120 million for his work at Citi. Either the SEC or the Justice Department could be pursuing criminal cases against Citi executives. What does it take to get the Justice Department’s attention on a financial fraud case? You have to launder $380 billion in drug money, and even then, DOJ lets you off with a slap on the wrist . The DOJ caught Wachovia doing just that, and the bank is getting off with a minor fine that won’t even make a dent in it’s second-quarter profits. The Citi settlement is worse than a get-out-of-jail free card for Crittenden, Prince and their cohorts. The SEC actually fined Citi’s shareholders $75 million for the alleged wrongdoing of their executives. For some varieties of corporate misconduct, like Wachovia’s drug money laundering, hitting shareholders with the fine is appropriate. Wachovia’s money laundering operations directly enriched the company and its shareholders. This was not the case with Citi’s subprime scandal. Citi’s executives were hurting their own shareholders . Instead of meting out serious punishment to those executives, the SEC is fining Citi’s shareholders , the very people wronged in the incident. This deference to the elites who wrecked the economy just keeps playing out. When Bank of America lied to its shareholders about billions of dollars in bonus payments it was about to make, the SEC decided to fine BofA shareholders and let the firm’s executives off the hook. The decision-makers at Wachovia who allowed the firm to funnel drug money despite repeated warnings by whistleblowers have not been indicted. Nobody at Washington Mutual has been indicted despite clear evidence of rampant mortgage fraud at the firm . Lehman Brothers’ repo 105 accounting scam is going unpunished, as are similar schemes at other banks including Bank of America. After much public relations flogging, the SEC let Goldman Sachs off easy. More than 1,100 bankers went to jail in the aftermath of the savings and loan crisis. Massive financial crises simply do not occur without widespread fraud. The failure to prosecute that fraud poses systemic risks for the global economy. With too-big-to-fail behemoths dominating the financial landscape, the prospect of prison is the only serious check on executives interested in cannibalizing the economy for personal gain. If the SEC and the Department of Justice continue to let executives get away with outrageous acts without even taking the case to court, our financial system is doomed to repeat the same excesses and abuses we’ve seen over the past decade. If Crittenden did what the SEC claims he did, he screwed over his own investors and scored a huge bonus in the process. Everybody on Wall Street understands the implications: breaking the law is a great way to make a lot of money. When a class of elites can thumb its nose at the law with impunity, the result is not only a threat to the efficiency of our economy, but a threat to the basic functioning of our democracy.

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Investor Steve Eisman RAILS On For-Profit Colleges

May 27, 2010

Steve Eisman, the outspoken investor whose huge wager against the subprime mortgage market was chronicled by author Michael Lewis in his bestselling book The Big Short, has set sights on a new target: for-profit colleges of the kind of you might see advertised on daytime TV and at bus stops. Think ITT Educational Services, Corinthian Colleges, or Education Management Corporation. In a speech titled “Subprime Goes to College,” delivered Wednesday at the Ira Sohn Investment Research Conference, Eisman blasted the for-profit education industry, likening these companies to the seamy mortgage brokers who peddled explosive subprime loans over the past two decades.

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Investor Steve Eisman RAILS On For-Profit Colleges

May 27, 2010

Steve Eisman, the outspoken investor whose huge wager against the subprime mortgage market was chronicled by author Michael Lewis in his bestselling book The Big Short, has set sights on a new target: for-profit colleges of the kind of you might see advertised on daytime TV and at bus stops. Think ITT Educational Services, Corinthian Colleges, or Education Management Corporation. In a speech titled “Subprime Goes to College,” delivered Wednesday at the Ira Sohn Investment Research Conference, Eisman blasted the for-profit education industry, likening these companies to the seamy mortgage brokers who peddled explosive subprime loans over the past two decades.

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Hedge Funds Bet Europe’s $1 Trillion Rescue Package Won’t Cure Debt Crisis

May 19, 2010

By Katherine Burton and Tom Cahill May 19 (Bloomberg) — Kyle Bass , who made $500 million in 2007 on the U.S. subprime collapse, is betting Europe’s debt crisis won’t be solved by the $1 trillion loan package the International Monetary Fund and European Union agreed on last week. “The EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world,” wrote Bass, head of Dallas-based Hayman Advisors LP, in a letter to clients sent after the bailout was announced. Bass bought gold last week and took other steps to position the fund for hyperinflation and a “competitive devaluation” by Europe, Japan and the U.S. that he is forecasting, according to the letter. Christopher Kirkpatrick, general counsel for Hayman, declined to elaborate on the comments. Managers who made short bets on U.S. subprime securities as the housing market was imploding in 2007 and 2008 see similar opportunities in Europe, said Nick Swenson , who manages Minneapolis-based Groveland Capital LLC and profited as mortgages tumbled. In March, he started buying credit-default swaps on Spanish, Italian and Irish government bonds, a sort of insurance that pays off in the event of a default or restructuring. “It’s asymmetric — it reminds me of the subprime trade,” he said in a telephone interview. Yesterday, Germany said it was temporarily prohibiting naked short-selling and speculating on European government bonds with credit-default swaps. Naked short sellers bet against a security without first borrowing it. Euro Decline The euro tumbled to as low as $1.2159 after the pronouncement. In February, as some investors forecast that Greece might not be able to pay its debts, French Finance Minister Christine Lagarde said she wanted politicians to take a united approach against “speculators” betting on government bond defaults. Swenson decided to buy the sovereign CDS after looking at the external-debt-to-exports ratios of the 26 countries that have defaulted on their debt since 1970. The average ratio for those countries was 2.3. As of the third quarter of 2009, Spain’s was about 6.9 and Italy’s was about 5.1, he said. While the CDS on these bonds rose in April and have since dropped nearer to levels where he bought them, Swenson isn’t selling. He believes the chance that one of the three countries will default or restructure is greater than the 9 percent currently priced into the CDS. Paulson Stays Out John Paulson , who made $15 billion betting on the subprime trade, is one manager who may not be replicating the CDS trade he used three years ago. Earlier this month, in a conference call with investors, he called Europe’s debt problems “manageable.” A weaker euro will benefit French and German exporters, he told clients. Like Bass, he’s been forecasting a jump in inflation, which is why he’s been a buyer of gold and gold producers since at least last year. For other managers, the potential profits from betting against Europe still outweigh the costs. Swenson pays 1.3 percent annually to put on his bet against Irish, Spanish and Italian debt. Mark Hart , who runs Fort Worth, Texas-based Corriente Advisors LLC, returned $320 million of the $424 million European Divergence Master Fund LP in February, after betting that some European governments will default on their bonds. ‘Asymmetric’ “The European divergence theme offers an asymmetric risk/reward profile,” Hart told clients at the time. “The sovereign debt problem in Europe is widespread and is not isolated to a single issuer.” Hart, who also profited from bets against subprime mortgages, didn’t return a call seeking a comment. Matrix PVE Global Credit Fund, a 110 million-euro ($133.9 million) fund run by Gennaro Pucci based in London, gained 19 percent in April because of bets that Europe’s credit crisis would worsen. “The ECB is buying debt at artificial levels, but that won’t solve structural problems,” Pucci said in a telephone interview. Matrix Group Ltd. manages about 3 billion pounds ($4.3 billion) including a half-dozen hedge funds. The credit fund sold most of its CDS positions in the recent jump in prices, and then put some back on at current levels. “We’re in the aftermath of a financial crisis,” Pucci said. “It’s not unusual for sovereign debt to explode.” To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net ; Tom Cahill in London at tcahill@bloomberg.net .

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Michael Pento: The Subprime Rhyme with U.S. Debt Debacle

May 5, 2010

The similarities between the subprime mortgage crisis and that of the coming collapse of the U.S. bond market are uncanny. In fact, Mark Twain may have had the U.S. debt market and the previous debt-fueled real estate crisis in mind when he said that “History does not repeat itself — but it does rhyme.” The housing and credit crisis first became evident to most in 2007 with the distress in the subprime mortgage market. The foundation for the housing bubble was low interest rates, which were provided by the Fed, and passed along to consumers via commercial banks and the shadow banking system. Those low “teaser rates” from the Fed compelled consumers to take on too much debt and for banks to become over-leveraged. Excessive lending in the real estate sector of the economy caused home prices to skyrocket out of reach of most consumers. Home prices subsequently fell and the assets on banks’ balance sheets tumbled in value. The result was the biggest economic contraction since the Great Depression. Similarly, rock bottom interest rates provided by the Fed and from foreign central banks recycling our trade deficit are misleading the government into believing it can take on a tremendous amount of debt by spending significantly more money than it collects in revenue. Those low rates have also duped the Treasury into believing it can sell a virtual unlimited amount of debt without ever incurring a substantial increase in debt service expense. Of course, this is not unlike homeowners who took on onerous mortgage payments, believing home prices would always increase. And just like those homeowners who took on adjustable rate loans, our Treasury has set itself up for a bout with intractable mortgage rate resets. Interest rates are currently at historic lows, but instead of choosing to take advantage of those rates by locking them in for decades, the U.S. Treasury has chosen to follow the lead of subprime borrowers. The government should be taking on the equivalent of a thirty year fixed-rate mortgage by issuing only 30 year bonds. However, they have chosen the path of what amounts to a short term adjustable rate mortgage by moving their debt duration to the short end of the yield curve. Today the Treasury has an average maturity on its debt of just about 5 years. Compare that with the U.K. which is about 14 years and even to Greece which is about 8 years in duration. That means the U.S. must roll over its debt much more frequently and is much more susceptible to rising rates. The only logical explanation for this practice is that the U.S. doesn’t feel it can issue long term debt and still afford to service its interest rate expenses. Another similarity between the housing and bond market bubbles is that the housing market of circa 2006 and the U.S. bond market of today contain all three elements of a classic asset bubble; massive oversupply, an unsustainably high price level and over-ownership of the asset class in question. In the early part of the last decade, home builders began to increase construction volume to twice the intrinsic demand for home ownership. Home price to income ratios eventually reached unsustainable levels. And levels of home ownership reached a record high percentage of the population. Likewise, the U.S. Treasury is dramatically increasing the supply of debt each year to fund our $1 trillion deficits. The public has plowed their savings into the U.S. debt market as commercial bank holdings of Treasuries have reached an all-time high. And bond prices have soared, pushing the yield on the 10 year note to 3.6%, which is less than half the average yield of 7.3% going back to 1969. Therefore, all the elements of a bubble in the bond market are in place, just as they were for the real estate market in the middle of the last decade. And now, if we do not cut aggressively cut spending on the federal level, the bond market may be ready to enter a multi-decade bear market in prices. The trigger for this secular move higher in yields will be the resurgence of inflation and the overwhelming effect supply has on bond prices. However, a temporary reprieve from significantly higher yields has been given courtesy of Europe. Investors are fleeing Greek debt and the Euro currency in favor of the U.S. dollar and our bond market. But this is a temporary phenomenon and in no way bails out America from its own fiscal transgressions. In just a few years our publicly traded debt will reach nearly $15 trillion. If interest rates just rise to their historic averages, the interest on our debt (depending on the level of economic growth and tax receipts) will absorb anywhere from 30-50% of total Federal revenue. If we indeed reach that point, massive monetization of the debt may be deployed by the Fed in a vain effort to keep rates from spiraling out of control. One last similarity between to the two bubbles is that the prevailing consensus of not too long ago was that home prices could never decline on a national level. Today we are being told that the U.S. dollar will always be the world’s reserve currency and that Treasuries will always be viewed as a safe haven by global investors. Remember how those in Washington and on Wall St. also assured investors that the subprime mortgage problem was well contained and would not bring down the housing market — much less the entire global financial system. Well, regardless of what those same people are saying now, these record low yields on U.S. Treasuries are unsustainable and cannot last given our massive $13 trillion national debt, $108 trillion in unfunded liabilities and the record-high $2.3 trillion Fed balance sheet. Astute investors should prepare now for the likelihood of much higher interest rates in the not too distant future. Michael Pento is the Senior Market Strategist for Delta Global Advisors and a contributor to greenfaucet.com

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Fed Puzzled by `Hard to Explain’ Home-Price Boom in 2004 Before Tightening

April 30, 2010

By Joshua Zumbrun April 30 (Bloomberg) — Federal Reserve officials were perplexed by speculation in housing and rising home prices in the course of discussions that resulted in an increase in borrowing costs in June 2004, according to transcripts of their meeting. Stephen Oliner, then Fed associate research director, told the Federal Open Market Committee on June 30, 2004, that the ratio between rents and prices deviated from historical trends and wasn’t explained by “fundamentals,” according to transcripts of FOMC meetings released today by the central bank. “I don’t want to leave the impression that we think there’s a huge housing bubble,” Oliner said. “We believe a lot of the rise in house prices is rooted in fundamentals. But even after you account for the fundamentals, there’s a part of the increase that is hard to explain.” While the Fed held interest rates low from June 2003 until June 2004, the boom in home prices accelerated, eventually leading to the crash in valuations that preceded the financial crisis. The annual increase in home prices reached a record 20 percent in July 2004, according to the Standard & Poor’s Case- Shiller 10 City Composite Home Price Index. Policy makers in June 2004 raised the federal funds target to 1.25 percent from 1 percent, the first of 17 consecutive quarter-point increases over two years, stopping at 5.25 percent. The Fed releases FOMC transcripts after five years. Speculative Excess In March 2004, then-Atlanta Fed President Jack Guynn warned of speculative excess in housing. “A number of folks are expressing growing concern about potential overbuilding and worrisome speculation in the real estate markets, especially in Florida,” Guynn said. “Entire condo projects and upscale residential lots are being pre-sold before any construction, with buyers freely admitting that they have no intention of occupying the units or building on the land but rather are counting on ‘flipping’ the properties–selling them quickly at higher prices,” he said. Minutes of the FOMC meeting in March 2004 showed policy makers discussed speculation in housing markets in some parts of the country. That speculative activity suggested “the possibility that house prices might be moving into the high end of the range that could be consistent with fundamentals,” minutes of the meeting said. Subprime Loans During 2004, the share of subprime originations in the mortgage market more than doubled. In 2004, 18.5 percent of mortgages were subprime compared to 7.9 percent in 2003, according to Harvard University’s “State of the Nation’s Housing” report , citing data from Inside Mortgage Finance. Fed Governor Edward Gramlich in May of 2004 said in a speech about “Benefits, Costs and Challenges” of subprime mortgage lending that “while the basic developments in the subprime mortgage market seem positive, the relatively high delinquency rates in the subprime market do raise issues.” Issuance of mortgage-related securities, another cause of the financial crisis, reached a peak of $3.07 trillion in 2003, up from less than $500 billion in 1996, according to data from the Securities Industry and Financial Markets Association. Fed Chairman Alan Greenspan in an Oct. 19, 2004 speech raised the risks of a collapse in home prices, saying “these concerns cannot be readily dismissed.” “Should home prices fall, we would have reason to be concerned about mortgage debt; but measures of household financial stress do not, at least to date, appear overly worrisome,” Greenspan said. To contact the reporter on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

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Goldman Sachs `Armed’ Salespeople to Discard Mortgage Assets, E-Mails Show

April 28, 2010

By Joshua Gallu and Jesse Westbrook April 28 (Bloomberg) — Goldman Sachs Group Inc. , seeking to reduce assets tied to the declining U.S. housing market, urged its sales force in 2006 and 2007 to sell those products to clients, newly disclosed internal e-mails show. The e-mails, including communications from Chief Executive Officer Lloyd Blankfein , show that employees discussed how to “arm” salespeople to shed bonds the firm found too risky to hold. The e-mails were released yesterday by Senator Carl Levin in connection with a hearing where current and former managers testified about the firm’s role in the financial crisis. Levin, the Michigan Democrat who heads the Senate’s Permanent Subcommittee on Investigations , grilled the executives about the firm’s bets against the housing market and its disclosure to clients. In one of the e-mails, Blankfein asked whether employees were doing enough to sell bonds backed by home loans including subprime mortgages. “Could/should we have cleaned up these books before and are we doing enough right now to sell off cats and dogs in other books throughout the division,” Blankfein, 55, wrote in an e- mail dated Feb. 11, 2007. Questioned about the e-mail at yesterday’s hearing, Blankfein told senators that his comment didn’t represent an opinion of the bonds. “When I use the expression ‘cats and dogs’ I mean miscellaneous stuff,” he said. “This is part of my normal point about aged inventory. Part of the discipline of our business is to manage risk and sell inventory.” Clients’ Questions The e-mails show that as early as the fall of 2006 clients were questioning products tied to the mortgage market. On Oct. 19, 2006, Mitchell Resnick sent an e-mail to two colleagues asking whether the firm had material about “how great” BBB bonds tied to home loans were. BBB is a credit rating from Moody’s Investors Service and Fitch Ratings that indicates an asset is two levels above junk. “A common response I am hearing” from potential investors is “a concern about the housing market and BBB in particular,” Resnick wrote. “We need to arm sales with a bit more. Do we have anything?” Goldman Sachs Chief Financial Officer David Viniar convened a meeting of mortgage traders and risk managers on Dec. 14, 2006, according to a document prepared by the firm that the Senate panel released yesterday. ‘Net Long’ At the time, Goldman Sachs had a “net long exposure” to the subprime-mortgage market, meaning the bank was betting the market would continue to rise. At the meeting, executives agreed that the firm should “reduce its overall exposure to the subprime mortgage market,” the document said. Goldman Sachs’s Stacey Bash-Polley sent an e-mail to colleagues six days later with the subject line “Mezz Risk,” a reference to lower tranches of collateralized debt obligations linked to mortgages. Investors in mezzanine tranches are among the first to lose money when the asset starts souring. “We have been thinking collectively about how to help people move some of the risk,” wrote Bash-Polley, an executive in the Goldman Sachs division that sold bonds. “We need to make sure we arm” salespeople “with our pricing and have them focus on the more difficult positions.” Targeting Clients In targeting clients, Bash-Polley wrote that Goldman Sachs should focus on those that “can possibly do larger size at a level that would be attractive when you take into consideration the size of risk we could move.” “Makes sense to me,” responded Kevin Gasvoda , a Goldman Sachs colleague. Goldman Sachs spokesman Samuel Robinson declined to comment on the e-mails. The Senate hearing comes less than two weeks after the U.S. Securities and Exchange Commission sued the firm and employee Fabrice Tourre , 31, on claims they withheld material information from investors in a CDO. Goldman Sachs said it will vigorously contest the case, and Tourre told the senators yesterday, “I deny categorically the SEC’s allegations.” Levin said at the hearing that Goldman Sachs “profited by taking advantage of its clients’ reasonable expectation that it would not sell products that it didn’t want to succeed, and that there was no conflict of economic interest between the firm and the customers it had pledged to serve.” Making Money In a Sept. 26, 2007, e-mail released by the committee, Peter Kraus , Goldman Sachs’s then co-head of investment management, told Blankfein that some clients were expressing concern that the firm was making money for itself but not its customers. Goldman Sachs had reported six days earlier that third- quarter net income rose 79 percent to $2.85 billion after the bank bet against mortgage bonds. Kraus told Blankfein he had met with more than 10 clients and “individual prospects” since the earnings announcement. “The institutions don’t and I wouldn’t expect them to, make any comments like ur good at making money for urself but not us,” wrote Kraus, who left Goldman Sachs in September 2008 after working at the company for 22 years. “The individuals do sometimes, but while it requires the utmost humility from us in response, I feel very strongly it binds clients even closer to the firm. The alternative of take ur money to a firm who is an under performer and not the best, just isn’t reasonable. Clients ultimately believe association with the best is good for them in the long run,” he wrote. To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net ; Jesse Westbrook in Washington at jwestbrook1@bloomberg.net

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Goldman Armed Salespeople to Dump Bonds, E-mails Show

April 28, 2010

By Joshua Gallu and Jesse Westbrook April 28 (Bloomberg) — Goldman Sachs Group Inc. , seeking to reduce assets tied to the declining U.S. housing market, urged its sales force in 2006 and 2007 to sell those products to clients, newly disclosed internal e-mails show. The e-mails, including communications from Chief Executive Officer Lloyd Blankfein , show that employees discussed how to “arm” salespeople to shed bonds the firm found too risky to hold. The e-mails were released yesterday by Senator Carl Levin in connection with a hearing where current and former managers testified about the firm’s role in the financial crisis. Levin, the Michigan Democrat who heads the Senate’s Permanent Subcommittee on Investigations , grilled the executives about the firm’s bets against the housing market and its disclosure to clients. In one of the e-mails, Blankfein asked whether employees were doing enough to sell bonds backed by home loans including subprime mortgages. “Could/should we have cleaned up these books before and are we doing enough right now to sell off cats and dogs in other books throughout the division,” Blankfein, 55, wrote in an e- mail dated Feb. 11, 2007. Questioned about the e-mail at yesterday’s hearing, Blankfein told senators that his comment didn’t represent an opinion of the bonds. “When I use the expression ‘cats and dogs’ I mean miscellaneous stuff,” he said. “This is part of my normal point about aged inventory. Part of the discipline of our business is to manage risk and sell inventory.” Clients’ Questions The e-mails show that as early as the fall of 2006 clients were questioning products tied to the mortgage market. On Oct. 19, 2006, Mitchell Resnick sent an e-mail to two colleagues asking whether the firm had material about “how great” BBB bonds tied to home loans were. BBB is a credit rating from Moody’s Investors Service and Fitch Ratings that indicates an asset is two levels above junk. “A common response I am hearing” from potential investors is “a concern about the housing market and BBB in particular,” Resnick wrote. “We need to arm sales with a bit more. Do we have anything?” Goldman Sachs Chief Financial Officer David Viniar convened a meeting of mortgage traders and risk managers on Dec. 14, 2006, according to a document prepared by the firm that the Senate panel released yesterday. ‘Net Long’ At the time, Goldman Sachs had a “net long exposure” to the subprime-mortgage market, meaning the bank was betting the market would continue to rise. At the meeting, executives agreed that the firm should “reduce its overall exposure to the subprime mortgage market,” the document said. Goldman Sachs’s Stacey Bash-Polley sent an e-mail to colleagues six days later with the subject line “Mezz Risk,” a reference to lower tranches of collateralized debt obligations linked to mortgages. Investors in mezzanine tranches are among the first to lose money when the asset starts souring. “We have been thinking collectively about how to help people move some of the risk,” wrote Bash-Polley, an executive in the Goldman Sachs division that sold bonds. “We need to make sure we arm” salespeople “with our pricing and have them focus on the more difficult positions.” Targeting Clients In targeting clients, Bash-Polley wrote that Goldman Sachs should focus on those that “can possibly do larger size at a level that would be attractive when you take into consideration the size of risk we could move.” “Makes sense to me,” responded Kevin Gasvoda , a Goldman Sachs colleague. Goldman Sachs spokesman Samuel Robinson declined to comment on the e-mails. The Senate hearing comes less than two weeks after the U.S. Securities and Exchange Commission sued the firm and employee Fabrice Tourre , 31, on claims they withheld material information from investors in a CDO. Goldman Sachs said it will vigorously contest the case, and Tourre told the senators yesterday, “I deny categorically the SEC’s allegations.” Levin said at the hearing that Goldman Sachs “profited by taking advantage of its clients’ reasonable expectation that it would not sell products that it didn’t want to succeed, and that there was no conflict of economic interest between the firm and the customers it had pledged to serve.” Making Money In a Sept. 26, 2007, e-mail released by the committee, Peter Kraus , Goldman Sachs’s then co-head of investment management, told Blankfein that some clients were expressing concern that the firm was making money for itself but not its customers. Goldman Sachs had reported six days earlier that third- quarter net income rose 79 percent to $2.85 billion after the bank bet against mortgage bonds. Kraus told Blankfein he had met with more than 10 clients and “individual prospects” since the earnings announcement. “The institutions don’t and I wouldn’t expect them to, make any comments like ur good at making money for urself but not us,” wrote Kraus, who left Goldman Sachs in September 2008 after working at the company for 22 years. “The individuals do sometimes, but while it requires the utmost humility from us in response, I feel very strongly it binds clients even closer to the firm. The alternative of take ur money to a firm who is an under performer and not the best, just isn’t reasonable. Clients ultimately believe association with the best is good for them in the long run,” he wrote. To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net ; Jesse Westbrook in Washington at jwestbrook1@bloomberg.net

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Goldman Sachs `Armed’ Salespeople to Dump Mortgage Assets, E-mails Show

April 27, 2010

By Joshua Gallu and Jesse Westbrook April 28 (Bloomberg) — Goldman Sachs Group Inc. , seeking to reduce assets tied to the declining U.S. housing market, urged its sales force in 2006 and 2007 to sell those products to clients, newly disclosed internal e-mails show. The e-mails, including communications from Chief Executive Officer Lloyd Blankfein , show that employees discussed how to “arm” salespeople to shed bonds the firm found too risky to hold. The e-mails were released yesterday by Senator Carl Levin in connection with a hearing where current and former managers testified about the firm’s role in the financial crisis. Levin, the Michigan Democrat who heads the Senate’s Permanent Subcommittee on Investigations , grilled the executives about the firm’s bets against the housing market and its disclosure to clients. In one of the e-mails, Blankfein asked whether employees were doing enough to sell bonds backed by home loans including subprime mortgages. “Could/should we have cleaned up these books before and are we doing enough right now to sell off cats and dogs in other books throughout the division,” Blankfein, 55, wrote in an e- mail dated Feb. 11, 2007. The e-mails show that as early as the fall of 2006 clients were questioning products tied to the mortgage market. On Oct. 19, 2006, Mitchell Resnick sent an e-mail to two colleagues asking whether the firm had material about “how great” BBB bonds tied to home loans were. BBB is a credit rating from Moody’s Investors Service and Fitch Ratings that indicates an asset is two levels above junk. ‘Common Response’ “A common response I am hearing” from potential investors is “a concern about the housing market and BBB in particular,” Resnick wrote. “We need to arm sales with a bit more. Do we have anything?” Goldman Sachs Chief Financial Officer David Viniar convened a meeting of mortgage traders and risk managers on Dec. 14, 2006, according to a document prepared by the firm that the Senate panel released yesterday. At the time, Goldman Sachs had a “net long exposure” to the subprime-mortgage market, meaning the bank was betting the market would continue to rise. At the meeting, executives agreed that the firm should “reduce its overall exposure to the subprime mortgage market,” the document said. Goldman Sachs’s Stacey Bash-Polley sent an e-mail to colleagues six days later with the subject line “Mezz Risk,” a reference to lower tranches of collateralized debt obligations linked to mortgages. Investors in mezzanine tranches are among the first to lose money when the asset starts souring. ‘Thinking Collectively’ “We have been thinking collectively about how to help people move some of the risk,” wrote Bash-Polley, an executive in the Goldman Sachs division that sold bonds. “We need to make sure we arm” salespeople “with our pricing and have them focus on the more difficult positions.” In targeting clients, Bash-Polley wrote that Goldman Sachs should focus on those that “can possibly do larger size at a level that would be attractive when you take into consideration the size of risk we could move.” “Makes sense to me,” responded Kevin Gasvoda , a Goldman Sachs colleague. Goldman Sachs spokesman Samuel Robinson declined to comment on the e-mails. The Senate hearing comes less than two weeks after the U.S. Securities and Exchange Commission sued the firm and employee Fabrice Tourre , 31, on claims they withheld material information from investors in a CDO. Goldman Sachs said it will vigorously contest the case, and Tourre told the senators yesterday, “I deny categorically the SEC’s allegations.” Reasonable Expectation Levin said at the hearing that Goldman Sachs “profited by taking advantage of its clients’ reasonable expectation that it would not sell products that it didn’t want to succeed, and that there was no conflict of economic interest between the firm and the customers it had pledged to serve.” In a Sept. 26, 2007, e-mail released by the committee, Peter Kraus , Goldman Sachs’s then co-head of investment management, told Blankfein that some clients were expressing concern that the firm was making money for itself but not its customers. Goldman Sachs had reported six days earlier that third- quarter net income rose 79 percent to $2.85 billion after the bank bet against mortgage bonds. Kraus told Blankfein he had met with more than 10 clients and “individual prospects” since the earnings announcement. “The institutions don’t and I wouldn’t expect them to, make any comments like ur good at making money for urself but not us,” wrote Kraus, who left Goldman Sachs in September 2008 after working at the company for 22 years. “The individuals do sometimes, but while it requires the utmost humility from us in response, I feel very strongly it binds clients even closer to the firm. The alternative of take ur money to a firm who is an under performer and not the best, just isn’t reasonable. Clients ultimately believe association with the best is good for them in the long run,” he wrote. To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net ; Jesse Westbrook in Washington at jwestbrook1@bloomberg.net

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Goldman Sachs Emails: Firm Had ‘The Big Short’ As Economy Fell

April 24, 2010

As homeowners were falling behind on their subprime mortgages, wreaking havoc for investors that owned slices of their mortgages in securities peddled by Wall Street, Goldman Sachs was “well positioned,” according to internal company emails from top executives. The firm had “the big short,” declared chief financial officer David Viniar — Goldman Sachs was making money off the souring of the very securities they had peddled to the market. The internal emails released Saturday by the Senate Permanent Subcommittee on Investigations paint a picture long known by most of the country, yet never before so vividly and explicitly articulated by Goldman officials. (Scroll down to see the full text of the emails.) As early as May 2007, as homeowners were being crushed under the weight of subprime mortgages, the most profitable firm on Wall Street had long taken out a form of insurance on those delinquencies. The firm made money on the upside — originating, securitizing and selling subprime mortgage-based securities to investors — and on the downside, thanks to the insurance. “Bad news,” a May 17, 2007, email began from one Goldman employee to another. A security the firm had underwritten and sold had just lost value, costing Goldman about $2.5 million. Further down in the email, the employee, Deeb Salem, wrote “Good news…we own 10mm protection…we make $5mm.” The firm made $5 million betting against the very securities it had underwritten and sold. In a July 25 email that year, Gary Cohn, the firm’s chief operating officer, wrote Viniar to update him on the firm’s mortgage market activities. The firm lost about $322 million on residential mortgages — but it made $373 million on its bets against the market, bets that increased in value as the market tanked. About 25 minutes later, Viniar wrote back, “Tells you what might be happening to people who don’t have the big short.” The firm made $51 million that day. “There it is, in their own words: Goldman Sachs taking ‘the big short’ against the mortgage market,” subcommittee chairman Sen. Carl Levin (D-Mich.) said in a statement accompanying the release of the internal emails. “Investment banks such as Goldman Sachs were not simply market-makers, they were self-interested promoters of risky and complicated financial schemes that helped trigger the crisis,” Levin said. “They bundled toxic mortgages into complex financial instruments, got the credit rating agencies to label them as AAA securities, and sold them to investors, magnifying and spreading risk throughout the financial system, and all too often betting against the instruments they sold and profiting at the expense of their clients.” Levin’s panel points out that in the firm’s 2009 annual report, Goldman Sachs stated that the firm “did not generate enormous net revenues by betting against residential related products.” “These e-mails show that, in fact, Goldman made a lot of money by betting against the mortgage market,” Levin said. Top Goldman Sachs executives will testify before Levin’s panel on Tuesday to answer for their subprime activities. The panel is using the firm as a case study to focus on the role played by investment banks in contributing to the worst financial crisis and economic downturn since the Great Depression. The nearly 18-month-long investigation has already netted impressive results. The panel exposed the subprime shenanigans at failed lender Washington Mutual, and how lax federal supervision allowed it to become the biggest bank failure in U.S. history, and this week it showed how the major credit rating agencies essentially worked with Wall Street in allowing the firms to peddle AAA-rated securities that had no business ever earning top ratings. That lulled investors into buying what they were told was gold but was really just lead. Goldman Sachs is under a particularly harsh glare, as its profits have engendered the kind of enmity normally reserved for swindlers. The Securities and Exchange Commission filed charges against the firm April 16 for defrauding investors. Goldman vigorously denies that it did anything wrong. In a Nov. 17, 2007, email, Goldman’s chief executive officer, Lloyd Blankfein, wrote to his top lieutenants in response to an upcoming New York Times story about how the firm had profited off the souring subprime market: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost because of shorts.” Blankfein is one of the top executives to be questioned Tuesday by Levin. In an Oct. 11 email that year, one Goldman employee, reacting to news that Moody’s Investors Service had downgraded $32 billion in mortgage-related securities, wrote to a colleague: “Sounds like we will make some serious money.” “Yes, we are well positioned,” the colleague responded. Most investors lost money off that downgrade. But Goldman had been shorting the market. As of November 2007, Goldman had about $2.1 billion worth of long positions in subprime mortgage products, meaning it was betting that those securities would increase in value, according to the firm’s 2008 annual filing with the SEC . But in a cautionary note to investors and regulators, the firm also noted that “At any point in time, we may use cash instruments as well as derivatives to manage our long or short risk position in the subprime mortgage market.” See the full emails: Goldman Sachs Emails

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Magnetar Says It Didn’t Help Banks on Mortgage-Backed CDOs `Built to Fail’

April 19, 2010

By Katherine Burton and Jody Shenn April 20 (Bloomberg) — Magnetar Capital LLC, the $7 billion hedge-fund firm that profited in 2007 from wagers that subprime-housing debt would tumble, told investors it didn’t help banks create mortgage-linked investments “built to fail.”      The firm offered limited input on the selection of securities in the deals and made bets that would pay off if they soured, as part of a “market neutral” portfolio designed to profit no matter what happened, according to a letter to clients yesterday from Evanston, Illinois-based Magnetar. “There was no embedded view regarding the direction of housing prices , the rate of mortgage defaults or the subprime- mortgage market generally,” the firm said in the letter. Bank of America Corp.’s Merrill Lynch unit, Citigroup Inc. and UBS AG are among at least nine banks that underwrote more than 20 collateralized debt obligations whose riskiest slices were bought by Magnetar, according to data compiled by Bloomberg. Those CDOs, named for constellations, totaled at least $32 billion. Magnetar’s 11-page letter came in response to an April 9 article on the Web site of ProPublica, an independent, nonprofit investigative journalism project based in New York. The article suggested its CDOs were “built to fail,” according to Magnetar’s letter. “The facts in our story should allow readers to reach their own conclusions,” ProPublica said in a statement to Bloomberg News. “We see nothing in the story to correct.” Goldman Sachs Sued The SEC sued Goldman Sachs Group Inc. for fraud on April 16, saying the bank improperly failed to disclose that New York- based Paulson & Co., a hedge-fund firm betting that subprime defaults would climb, had helped choose risky mortgage-based securities to be linked to a so-called synthetic CDO. Paulson then wagered the investment would collapse. Paulson, which wasn’t accused by the SEC of any wrongdoing, said in a statement that ACA Management LLC chose the assets for Abacus 2007-AC1, as Goldman Sachs disclosed to investors. Paulson suggested some individual holdings, according to the SEC’s complaint. Goldman Sachs, based in New York, has said the SEC’s allegations are unfounded. Magnetar said in its letter that it didn’t select specific securities to be included in its CDOs. Collateral managers for the firm’s CDOs included State Street Corp., Marsh & McLennan Cos.’s Putnam Investment Management LLC, GSC Partners and Harding Advisory LLC, Bloomberg data show. John Nester , an SEC spokesman in Washington, and Steve Lipin , a spokesman for Magnetar, declined to comment. Magnetar said in the letter it bought the riskiest piece of CDOs, known as the equity, which it expected to return 20 percent annually over six to eight years if mortgage defaults remained low. It also hedged those positions with bets against its CDOs and others at a cost of less than 6 percent annually, the firm said. Use of Swaps The credit-default swaps that the company used to make those bets represented on average no more than 7 percent of the collateral of its CDO, the letter said. The banks serving as underwriters would know whether its CDOs included those bets, the firm said. The purchase of a CDO’s equity class is usually taken as “an expression of confidence in the structure,” said Thomas Adams , a partner at New York-based law firm Paykin Krieg & Adams LLP who worked in the CDO groups for two bond insurers. “It would definitively have been relevant” to other investors that Magnetar wasn’t simply making a bullish bet, Adams said in a telephone interview. Although Magnetar said its portfolio was designed to make money no matter what happened to the value of subprime mortgages, its executives have expressed views on the market. “Magnetar has been concerned about the excesses in the subprime-housing market since early 2006,” David Snyderman , Magnetar’s head of global fixed income, said in an interview with Bloomberg News in March 2007. “As a result, we have positioned our structured-credit portfolio such that we are profiting from the recent volatility.” Magnetar was started in late 2005 by Alec Litowitz , who previously worked at Ken Griffin ’s Citadel Investment Group LLC. He specialized in trading the stocks of merging companies. Snyderman also worked at Citadel before joining Magnetar. To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net ; Jody Shenn in New York at jshenn@bloomberg.net

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Magnetar Says It Didn’t Help Banks on Mortgage-Backed CDOs `Built to Fail’

April 19, 2010

By Katherine Burton and Jody Shenn April 20 (Bloomberg) — Magnetar Capital LLC, the $7 billion hedge-fund firm that profited in 2007 from wagers that subprime-housing debt would tumble, told investors it didn’t help banks create mortgage-linked investments “built to fail.”      The firm offered limited input on the selection of securities in the deals and made bets that would pay off if they soured, as part of a “market neutral” portfolio designed to profit no matter what happened, according to a letter to clients yesterday from Evanston, Illinois-based Magnetar. “There was no embedded view regarding the direction of housing prices , the rate of mortgage defaults or the subprime- mortgage market generally,” the firm said in the letter. Bank of America Corp.’s Merrill Lynch unit, Citigroup Inc. and UBS AG are among at least nine banks that underwrote more than 20 collateralized debt obligations whose riskiest slices were bought by Magnetar, according to data compiled by Bloomberg. Those CDOs, named for constellations, totaled at least $32 billion. Magnetar’s 11-page letter came in response to an April 9 article on the Web site of ProPublica, an independent, nonprofit investigative journalism project based in New York. The article suggested its CDOs were “built to fail,” according to Magnetar’s letter. “The facts in our story should allow readers to reach their own conclusions,” ProPublica said in a statement to Bloomberg News. “We see nothing in the story to correct.” Goldman Sachs Sued The SEC sued Goldman Sachs Group Inc. for fraud on April 16, saying the bank improperly failed to disclose that New York- based Paulson & Co., a hedge-fund firm betting that subprime defaults would climb, had helped choose risky mortgage-based securities to be linked to a so-called synthetic CDO. Paulson then wagered the investment would collapse. Paulson, which wasn’t accused by the SEC of any wrongdoing, said in a statement that ACA Management LLC chose the assets for Abacus 2007-AC1, as Goldman Sachs disclosed to investors. Paulson suggested some individual holdings, according to the SEC’s complaint. Goldman Sachs, based in New York, has said the SEC’s allegations are unfounded. Magnetar said in its letter that it didn’t select specific securities to be included in its CDOs. Collateral managers for the firm’s CDOs included State Street Corp., Marsh & McLennan Cos.’s Putnam Investment Management LLC, GSC Partners and Harding Advisory LLC, Bloomberg data show. John Nester , an SEC spokesman in Washington, and Steve Lipin , a spokesman for Magnetar, declined to comment. Magnetar said in the letter it bought the riskiest piece of CDOs, known as the equity, which it expected to return 20 percent annually over six to eight years if mortgage defaults remained low. It also hedged those positions with bets against its CDOs and others at a cost of less than 6 percent annually, the firm said. Use of Swaps The credit-default swaps that the company used to make those bets represented on average no more than 7 percent of the collateral of its CDO, the letter said. The banks serving as underwriters would know whether its CDOs included those bets, the firm said. The purchase of a CDO’s equity class is usually taken as “an expression of confidence in the structure,” said Thomas Adams , a partner at New York-based law firm Paykin Krieg & Adams LLP who worked in the CDO groups for two bond insurers. “It would definitively have been relevant” to other investors that Magnetar wasn’t simply making a bullish bet, Adams said in a telephone interview. Although Magnetar said its portfolio was designed to make money no matter what happened to the value of subprime mortgages, its executives have expressed views on the market. “Magnetar has been concerned about the excesses in the subprime-housing market since early 2006,” David Snyderman , Magnetar’s head of global fixed income, said in an interview with Bloomberg News in March 2007. “As a result, we have positioned our structured-credit portfolio such that we are profiting from the recent volatility.” Magnetar was started in late 2005 by Alec Litowitz , who previously worked at Ken Griffin ’s Citadel Investment Group LLC. He specialized in trading the stocks of merging companies. Snyderman also worked at Citadel before joining Magnetar. To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net ; Jody Shenn in New York at jshenn@bloomberg.net

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Video: Buffett’s Goldman Sachs Warrants Drop on SEC Lawsuit: Video

April 16, 2010

April 16 (Bloomberg) — The value of Warren Buffett’s options to buy Goldman Sachs Group Inc. shares dropped after regulators sued the bank for misleading clients on the sale of securities tied to the subprime mortgage market. The warrants give Buffett’s Berkshire Hathaway Inc. the right to buy New York-based Goldman Sachs common stock for $115 a share. Bloomberg’s Brennan Lothery reports. (Source: Bloomberg)

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Zach Carter: John Dugan: Why It’s So Hard to Hold Wall Street Accountable

April 12, 2010

The Financial Crisis Inquiry Commission hearings continue to be a broad, boring failure, peppered with a few moments of significant insight. Throughout most of yesterday’s hearing featuring the nation’s top bank regulator, Comptroller of the Currency John Dugan, Commissioners treated their witness as a credible expert, rather than a culpable catalyst of the crash. You’d never know it from Dugan’s calm, mousey demeanor before the FCIC, but he spent several years working as a high-powered bank lobbyist before being appointed to his current job by George W. Bush in 2005. Since then, he’s been a major defender of big banks, pushing to defang consumer protection regulations and provide legal cover for subprime predators. Nobody on the Commission ever pressed Dugan on his lobbyist background. Who he lobbied for, what he lobbied for, and how much he got paid were never under discussion. Nobody asked him why he’s been receiving lobbying talking points from major bank executives in secret during the debate over financial reform. Nobody asked him what sort of job he’s likely to take after his term as Comptroller expires in August. This is a tremendous problem: Wall Street’s political influence is so tremendous that they can secure top-level regulatory jobs for their own lobbyists. It’s as if someone appointed Billy Tauzin head of the FDA. And in Dugan’s warped history of the past decade, both he and the banks he regulates never really did anything wrong. “We made very clear that predatory lending . . . was not something we would tolerate,” Dugan said. “Honestly, those practices never really took root.” This astounding claim is impossible to square with any credible account of the explosion in subprime lending over the past decade, an explosion in which Dugan’s banks were some of the top players. In a 2007 speech, FDIC Vice Chairman Martin J. Gruenberg said, “It now appears that the most elementary notion of predatory lending–failure to underwrite based on the borrower’s ability to pay–became prevalent in the subprime mortgage market.” Throughout his testimony, Dugan claimed it was not banks, but independent mortgage companies like New Century and Ameriquest who created the subprime debacle. These other companies that didn’t accept consumer deposits, and thus were not subject to bank regulations, were able to get away with terrible practices, but the banks were generally innocent. Yet according to an analysis by the National Consumer Law Center, Dugan’s banks issued 31.5% of all subprime mortgages in 2006, along with 40.1% of exotic Alt-A mortgages, and 51% of tricky option-ARM loans (Alt-A and option-ARMs were often worse for consumers than subprime). Late in the hearing, FCIC Chairman Phil Angelides hammered home an equally important point: the Ameriquests and the New Centurys were being directly supported by the banks Dugan regulates. In fact, 21 of the 25 largest subprime lenders relied directly on support financing from national banks. The Wall Street behemoths were fueling the subprime machine, even when they weren’t issuing the loans directly. But the gravest sin committed by Dugan’s agency, the Office of the Comptroller of the Currency (OCC), was an aggressive effort to block state regulators from enforcing consumer protection laws against big banks. The OCC regulates federally chartered banks, but until 2004, states still had the right to enforce their own laws against national banks operating within their borders. That meant that for national banks, the OCC’s rules served as a regulatory floor– state regulators couldn’t enforce weaker standards than those imposed by the OCC, but they could enforce stronger rules. That changed when Dugan’s predecessor, John Hawke Jr., asserted sweeping preemption powers, insisting that the states’ authority was invalid. Dugan continued this crusade throughout his time as Comptroller, and at yesterday’s hearing, he defended the move in his opening statement. “If it were true that federal preemption caused the subprime mortgage crisis by preventing states from applying more rigorous lending standards to national banks, one would expect that most subprime lending would have migrated from state regulated lenders to national banks. One would also expect that all bank holding companies engaging in these activities that owned national banks would carry out the business through their national bank subsidiaries subject to federal preemption, rather than their nonbank subsidiaries that were subject to state law . . . neither of these conjectures is accurate.” In fact, preemption spurred a race-to-the-bottom in regulatory standards, and was a major cause of the subprime explosion. But nobody challenged Dugan on the assertion seriously until Angelides took the reins around 3:00 p.m., two-and-a-half hours after the hearing began. “You tied the hands of the states and then you sat on your hands,” Angelides said. Angelides was exactly right. State and federal bank regulators are funded by taxes they levy against the banks they regulate. Banks game this system, flocking to whatever regulator will give them the most leeway. Preemption sent a clear message to the states: if they want to keep their bank tax revenue, they have to go easy on their banks. And so about half of all states in fact lay off after preemption came down. But another half of the states decided at some point or another to go after predatory national banks. Anytime that happened, the OCC would intervene, deploying every legal excuse it could come up with to protect the bank. There are dozens of examples of the OCC engaging in this activity, but the most egregious case is its lawsuit against First Franklin, a bank whose sole raison d’etre was subprime lending. There is no way to construe the OCC’s assault on First Franklin’s state regulator as anything other than an attempt to protect a subprime predator.

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Greenspan Says His ‘Friends’ Got The Financial Crisis Right – And Trades Barbs With Michael Burry (VIDEO)

April 5, 2010

In a New York Times op-ed yesterday, Michael Burry , the reclusive hedge-fund manager profiled in Michael Lewis’s best-selling “The Big Short,” lambasted former Federal Reserve Chair Alan Greenspan and his colleagues, claiming that they “either willfully or ignorantly aided and abetted the bubble.” Burry, who was trained as a medical doctor and suffers from Aspberger’s syndrome, placed huge bets that the subprime market would collapse and helped make his investors many millions. Greenspan responded to Burry’s op-ed in an interview on ABC News’s “This Week,” where he told Jake Tapper that while almost everyone failed to predict the implosion of the subprime market and while some people predicted it by chance, there was a “very small group, most of whom are my friends, who got it right, for the right reasons.” Burry, he said, may well have been one of those people: “I don’t know whether or not he is in that extremely small group… . I know four or five people who are really good. I don’t know six, seven, eight or nine.” In an appearance on Bloomberg Television last week, Greenspan insisted that Burry’s successful prediction of the subprime crisis was a “statistical illusion.” Burry, for his part, says that Greenspan “should have seen what was coming and offered a sober, apolitical warning.” But that’s not what happened. And, peculiarly, in the years since the subprime market imploded, Burry says policymakers have shown little interest in understanding how or why he was able anticipate the timing of the crisis with such accuracy. Rather than a simple dismissal of those who got it right, Burry argues: “Mr. Greenspan should use his substantial intellect and unsurpassed knowledge of government to ascertain and explain exactly how he and other officials missed the boat. If the mistakes were properly outlined, that might both inform Congress’s efforts to improve financial regulation and help keep future Fed chairmen from making the same errors again.” Watch Greenspan discuss Burry in this clip from his appearance on “This Week” yesterday:

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Bill Donius: Credit Crisis: Who Knew What? When? Then a $13 Billion Repayment?

February 17, 2010

Many articles and books have been published about the Subprime Mortgage Crisis, the implosion of CDO’s, CMO’s and CDS’ and the investment banks and banks that dropped in their wake. I wonder if there were individuals within these companies, including the rating agencies, that were aware of the faulty ‘products’ being assembled and sold? If so, did these companies not have ‘whistle blower’ mechanisms to warn the board of directors of the regulatory agency? Many in the industry may have falsely believed the problem would take care of itself in a quasi-free market economy. I suppose no one really knew how much of these products were being sold around the world? A systemic regulator may help prevent the next massive economic crisis. The stakes and the payoffs were very high. Perhaps the huge dollars involved in these deals were enough to muzzle those who may have spoken up otherwise? I, for one, would be interested in knowing what went on inside these firms? It is clear Goldman Sachs for one was in an odd position as they were selling these complex, toxic securities to their clients and then subsequently shorting the entire mortgage market for their own account by purchasing credit default swaps to the tune of $13 billion from AIG. It is no wonder taxpayers were upset when they were reimbursed 100% by the government through AIG on their credit default swaps and then subsequently were paid huge bonuses for the firm’s performance. They get $13 billion + big bonuses, the taxpayers get a firm that sells toxic assets to clients, then buys billions to ensure themselves when the toxic assets explode. Genius. The new gold standard.

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Kevin Connor: What is John Paulson doing in Greece?

February 15, 2010

Goldman Sachs’s Greek adventure got an in-depth look from the New York Times yesterday. The article extends on last week’s Spiegel piece, which reported that the bank helped Greece hide the true extent of its debt through the use of specialized derivative products. We first reported on the parallels between AIG and Greece in a post last week, following the lead of Zero Hedge . Entry into the paper of record means the story now has legs this side of the pond, and MIT economist Simon Johnson is arguing that Goldman Sachs is set to be blacklisted in Europe. One question looming over this story: did Goldman position itself to profit from the Greek fiasco? Did it use its special knowledge of Greek’s hidden debt to build profitable bets on its future downfall and rescue? If the bank’s past behavior is any guide, the answer is yes. Ignoring the impending catastrophe (obvious from their vantage point), and failing to properly “hedge” (extract massive profits), would have been “irresponsible” (insufficiently greedy/corrupt) on the part of senior management. Considering this, hedge fund king John Paulson’s role in Greece deserves far more scrutiny. I wrote about this last week, pointing out that they shared the same vulture flight pattern in Greece , but at the time did not realize that Paulson and Goldman actually partnered in executing massive and profitable bets against the subprime market. Are they doing the same with Greece? News of Paulson’s fund taking large positions against Greek debt has barely risen above rumor in the English-language press, despite this article in a Greek daily, which says that Paulson is “orchestrating the pressure on Greek government bonds and the Euro,” and reports that Paulson has a team of 20-30 traders focused on Greece. A research firm is now calling Paulson the George Soros of derivatives markets, where the bulk of speculation against European debt and the Euro is happening; the Telegraph says that so far ” no hedge fund has put its head above the parapet in this destructive trade ,” but the rumor is that Paulson is behind it. If Paulson is the hedge fund king behind the parapet, as rumored in English and reported in Greek, then it would seem fairly likely that Paulson and Goldman partnered — colluded? — to build profitable short positions against Greek debt. That Goldman was shepherding hedge fund client Paulson around Athens in recent weeks would seem to suggest that the bank and hedge fund are working together in Greece. Paulson and Goldman have partnered before — on the subprime short trades that won them enormous profits in the midst of the housing. Those trades have gotten a lot of attention, but the fact that Paulson and Goldman worked together to make it all happen has received much less ink. The story of Paulson’s investments is detailed in Gregory Zuckerman’s book, The Greatest Trade Ever . Goldman plays a prominent role, setting up the CDOs that Paulson would wager against, and then selling them to investors. The star Goldman trader who placed the bank’s winning bets against the subprime market, Josh Birnbaum, was reportedly in frequent contact with Paulson, at one point encouraging him to back off his bets (perhaps to make more room for Goldman). Since Paulson was in the room with Goldman (and several other banks) when these CDOs were first conceived, it would seem that the fund had an unfair edge over the investors that would lose their shirt buying the securities. Zuckerman notes that Deutsche Bank suffered losses because it couldn’t find takers; that famous taker, AIG , may have been Goldman’s convenient solution. These parallels raise obvious questions: was Paulson also in the room with Goldman before it tried to sell Greece on a new way to hide its debt this past November? As a hedge fund client of Goldman’s, did Paulson have special information about Greece’s true debt situation? Are Goldman and Paulson partnering, once again, to profit from the downfall of an entire country/continent? Cross-posted from Eyes on the Ties .

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Goldman Sachs Under Investigation For Its Role In Subprime Mortgage Meltdown

January 22, 2010

WASHINGTON — One of Congress’ premier watchdog panels is investigating Goldman Sachs’ role in the subprime mortgage meltdown, including how the firm sold securities backed by risky home loans while it simultaneously bet that those bonds would lose value, people familiar with the inquiry said Friday.

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AIG Internal Emails: Insurers Correspondence Details Confusion During Crisis

December 30, 2009

The Cassano-Habayeb correspondence, along with thousands of other e-mails obtained by The Washington Post, as well as supporting interviews, reveal a company wracked by more division, doubt and turmoil than anyone on the outside realized during those tense months in 2007, a full year before the federal government undertook one of the largest corporate bailouts in U.S. history to prevent AIG’s collapse. The Financial Products unit had made AIG billions of dollars in the largely unregulated world of financial derivatives, operating primarily from Wilton, Conn., and London. But as the subprime mortgage boom began to deflate in 2007, some e-mails from New York took on an unfamiliar tone of concern.

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Bill Donius: The Next Shoe to Drop in Residential Lending: FHA?

December 7, 2009

With 7 million properties currently either vacant or in foreclosure, the country cannot afford more residential lending mistakes. Caution: former subprime lending superstars have re-emerged as FHA (Federal Housing Adminstration-under HUD) lenders! This development is a major problem for the country. I’ve learned loan officers who previously worked for sub prime loan companies have learned they can work for mortgage brokers and bankers who originate and sell mortgage loans to the federally insured FHA. The FHA was created decades ago to assist lower income individuals purchase homes with lower down payments, more relaxed credit guidelines and easier to qualify loan to income guidelines. FHA has helped many deserving Americans purchase homes. They insured the mortgages creating liquidity for the lending sector so they would not have to carry those mortgages on their books. The system has traditionally worked well due to both the integrity of the originating lenders and adequate oversight by FHA staff of the product being insured. So what went wrong? Since the shady subprime mortgage lenders of the past were put out of business, many discovered they can work for a company that originates and sells FHA insured loans into the market where there are many buyers since the government insures these mortgages through FHA. The problem is FHA has been unable to properly oversee the huge volumes of loans they have insured since the subprime bubble burst! Many lenders have delegated underwriting status with FHA and as such are able to approve loans themselves! They are supposed to be following FHA guidelines, therein lies the rub. FHA is unable to properly audit and review the huge surge in loan volume. As a result, opportunistic lenders have made FHA the new dumping ground for loans they cannot sell anywhere else as today’s buyers of residential loans are very strict about the quality of the loans they are buying. Subprime loans were previously sold through various channels through Wall Street entities. Since this channel is closed, opportunists are looking for another way to make money for themselves and put people into homes they cannot afford or are not ready to purchase. FHA in the past few months began a new QC project to better control the quality of loans they are insuring. But, is it too little, too late? FHA has originated billions of dollars in loans over the past years since subprime mortgages stopped being originated. Most of the countries banks did not make subprime loans, only 6% of the lending industry made them (and some were not banks, but mortgage brokers). The tiny minority obviously caused a disastrous result for the entire banking sector as the number of delinquencies, vacancies and foreclosures skyrocketed depressing properties values nationwide and thereby straining the entire mortgage finance system. Many in the residential lending industry (including me as the CEO of $1.3 billion community bank originating over a billion a year in conforming mortgages) were stunned the subprime lenders could actually find buyers for their products for nearly a dozen years. The bottom ultimately dropped out of the market. However, in retrospect, we should have demanded the regulatory agencies take a closer look at this type of lending. Instead, we stood by, allowed the free market to function and are now suffering with deflated real estate portfolios. I don’t think many of us knew what type of effect ‘liar’s loans’ and disreputable lenders could have on the industry and economy. It is in this spirit that I am writing to send a warning signal to the government! We cannot afford another housing black eye. We must protect FHA for the important institution that it is and not allow lenders to take advantage of the system by enriching themselves making loans to individuals who are not able to pay them back. Note: William A. Donius was appointed to a two year term to the U.S. Federal Reserve’s TIAC Council in 2008. He was invited to speak at the Federal Home Loan Bank of Des Moines Symposium on the Future of Residential Finance last month in St. Paul, Minn. He spoke at the educational sessions for bank board members at the invitation of banking regulator, Office of Thrift Supervision during the spring and summer. He is currently writing a non fiction book. Donius served as the Chairman and CEO of Pulaski Bank in St. Louis until May 2009 and May 2008 respectively. He is a former board member of America’s Community Bankers and the Missouri Bankers Association. He currently serves on a dozen boards and committees in the St. Louis area.

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Bear Stearns Managers Cioffi, Tannin Not Guilty in Biggest Subprime Case

November 10, 2009

By Patricia Hurtado and Thom Weidlich Nov. 10 (Bloomberg) — Former Bear Stearns Cos. hedge-fund managers Ralph Cioffi and Matthew Tannin were found not guilty of misleading investors who lost $1.6 billion, the first major test of a U.S. effort to obtain convictions tied to the subprime mortgage crisis and subsequent recession. A jury of eight women and four men deliberated less than a day before reaching a verdict today. Cioffi, 53, the portfolio manager for the hedge funds, and Tannin, 48, their chief operating officer, went on trial Oct. 13 in federal court in Brooklyn, New York, on charges of conspiracy, securities fraud and wire fraud. Each faced as many as 20 years in prison if convicted. The trial was the first stemming from a federal probe into the collapse of the subprime mortgage-market, which cost investors as much as $396 billion and helped trigger a worldwide recession. The men were indicted by a federal grand jury in June 2008 in a case brought by Brooklyn U.S. Attorney Benton Campbell a year after the hedge funds collapsed. The acquittal may make it more difficult for the U.S. Justice Department to bring additional prosecutions for securities fraud related to the subprime market and the various financial instruments that were based upon it. ‘Major Prosecution’ “Any time the government undertakes a major prosecution in a new area, the outcome certainly influences its thinking about the prosecutability of other potential defendants,” said Jacob Frenkel , a former U.S. Securities and Exchange Commission lawyer now in private practice. “Acquittals force prosecutors to rethink their theories and charges.” U.S. District Judge Frederic Block , who presided over the trial, gave the jury its instructions yesterday afternoon. They deliberated for less than nine hours. Prosecutors said the men still face fraud charges in Manhattan federal court related to the collapse of the funds. Cioffi and Tannin called three witnesses during the trial, including R. Glenn Hubbard, dean of Columbia University’s Graduate School of Business. Hubbard testified the funds failed because lenders stopped extending credit. The investing strategies employed by Cioffi and Tannin during this period could have returned the funds to profitability of as much as $1.35 billion had they continued to operate, he told the jury. The defense also argued that the acts and meetings alleged to be part of the conspiracy occurred in Manhattan and not in the Eastern District of New York where the men were tried. Cioffi and Tannin’s lawyers said the government didn’t bring the case in the right jurisdiction. Subprime Mortgages According to the government, Cioffi and Tannin conspired to defraud their clients by publicly touting the health of the funds, made up mostly of subprime mortgage-backed securities. The hedge funds, which filed for bankruptcy in July 2007, were the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd. and the Bear Stearns High- Grade Structured Credit Strategies Master Fund Ltd. The two hedge funds failed when prices for collateralized debt obligations linked to home loans fell amid rising late payments by borrowers with poor credit or heavy debt. The men claimed in e-mails and conversations to be adding their own money to the funds in the months immediately prior to their collapse, according to the government. Neither man added any money to the funds, once valued at $20 billion, the U.S. alleged. Honestly Optimistic The defense argued Cioffi and Tannin were innocent of any wrongdoing and had remained honestly optimistic about the funds’ health. E-mails which the men sent were more ambiguous than the government alleged, the defense said. Prosecutors claimed that Cioffi moved $2 million — one third of his holdings in the funds — to another Bear fund which he supervised. The U.S. alleged that he moved the money in March to a fund that was still profitable. Prosecutors argued Cioffi committed insider trading when he moved the money ahead of investors who lost money in his funds and while using material, non-public information because of his role as a fund manager. Both men were charged with one count of conspiracy to commit securities fraud, two counts of wire fraud and two counts of securities fraud. Cioffi was charged with one count of insider trading. The case is U.S. v. Cioffi, 08-CR-00415, U.S. District Court, Eastern District of New York (Brooklyn). To contact the reporters on this story: Patricia Hurtado in U.S. District Court for the Eastern District of New York in Brooklyn at pathurtado@bloomberg.net and; Thom Weidlich in U.S. District Court for the Eastern District of New York in Brooklyn at tweidlich@bloomberg.net .

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The Real News Network – Goldman left investors holding its …

November 3, 2009

McClatchy also learned of a second private Goldman deal, in which it sought in May 2007 via another Cayman company to sell $44.6 million in bonds related to subprime loans written by New Century Financial , a mortgage lender that weeks earlier had careened into … Goldman was a latecomer to the subprime game on Wall Street, and it was the first to get out and the only one to get out safely. But in the middle of the height of all this, Goldman was doing a lot of deals. …

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The 10 Worst Calls Of The Financial Crisis (PHOTOS)

August 7, 2009

Oh, how wrong they were. If there’s one overarching truth of the financial crisis, it’s that the world’s most powerful business leaders, investors and politicians were so flat-out, unarguably wrong about the severity of the crash and its causes. The harrowing market plunge of last fall seemed to catch a nearly every prominent public figure off guard. Of course, this created some memorable and ludicrously wrong predictions, prognostications and all too rosy expressions of faith in the American economy (In fact, ” fundamentally sound ” became something of a go-to phrase in 2008.) In the interest of looking back, we’ve compiled some of the worst calls of the financial crisis: Ben Bernanke’s famous dismissal of the subprime problem, a few glaringly bad statements about Fannie Mae and Freddie Mac and, of course, a Jim Cramer classic. Check out our SLIDESHOW and VOTE for the worst prediction. Or…if you’ve got other examples of incredibly off base statements during the crisis, leave them in the comments below. We’ll be compiling a larger list in the coming days. Get HuffPost Business On Facebook and Twitter !

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