Perspective

They ought to draw a go-to-jail card

By ROBYN BLUMNER
Published January 27, 2008

It's the perfect crime, so big and so reeking of establishment that few recognize the inherent criminality, but the results are the same as if some street thug held us all up at gunpoint. This country is spiraling toward recession. Huge amounts of wealth have disappeared with upward of 2-million families in danger of losing their homes to foreclosure, all because of the corruption of people in suits.

When someone gets mugged for the few dollars in their wallet, the thief goes to prison for years. But when bankers, mortgage brokers, credit rating agencies and investment firms conspire to scam investors and exploit the naivete of borrowers in order to enrich themselves to the tune of billions of dollars, no one goes to jail.

It's a story as old as the expression "money talks." When the crooks maintain country club memberships, we call their actions misjudgments or "froth," the way someone might get caught up in a pique of enthusiasm.

But there is nothing frothy about purposely putting unsophisticated home buyers into loan instruments that have interest rates that explode over time, with big prepayment penalties and "yield spread premiums" a.k.a. kickbacks to the broker. This is called setting up a pigeon. The broker knows the borrower doesn't have the income to support the loan in the long term, so it's not a matter of if he'll default but when.

Then there are the banks that originated these loans with the full knowledge that care was not taken in determining the borrower's ability to pay. No docs? No matter. The banks weren't left holding the bag; they made a nice profit by selling those loans to Wall Street banks who then spun them into more gold by transforming them into investment instruments.

These securitized loan pools were then sold to unsuspecting investors. Why were the investors unsuspecting? Well, it could be that the bundling firms failed to disclose the extent of risk involved.

There are mortgages considered a worse bet than subprime, known as exception loans. They are given to people who don't meet the lender's most basic standards. According to the New York Times, investment banks buy these loans, sometimes at a discount, then add them to the mix of more conventional mortgages, making the resulting security appear more secure than it is.

Andrew Cuomo, New York's attorney general, is currently investigating a number of Wall Street banks to see the extent to which they packaged these exception loans into their loan pools without providing precise details to investors in their prospectuses. If Cuomo can show that the banks failed to disclose material facts to investors, criminal penalties may attach.

Sic 'em!

Another reason investors in mortgage securities were unsuspecting is that the credit rating companies that investors rely on in determining relative risk were touting these instruments as if they were as safe as government bonds.

Seriously. Securities stuffed with America's worst loans were often given AAA ratings, the same given U.S. Treasury bonds.

The ones handing out these gold stars were the top credit rating companies - Moody's Investors Service, Standard & Poor's and Fitch Ratings. Those inflated ratings helped lure droves of investors to mortgage-backed securities.

And if you want to know why these rating companies would so badly misstep, you might look at the compensation structure. Apparently, the world of the securities issuer and the firms that rate them is a lot chummier and mutually profitable than one would hope. It is not investors who pay for this information but the very Wall Street banks that have their investment instruments evaluated.

"The idea that the rating agencies are impartial in the world of structured finance is a joke," Joshua Rosner, managing director of the New York research firm Graham Fisher & Co., told the New Zealand Herald. He said that investment banks would use available models to structure loan pools and then sit down with rating agencies to tweak them until the desired rating was obtained.

Meanwhile, the smart people who are charged with overseeing lenders and preventing disasters like this for the U.S. economy had self-imposed blinders.

Alan Greenspan, the former revered Federal Reserve chairman, encouraged "financial innovation" even as he received desperate warnings about the abusive practices of the subprime mortgage industry. Greenspan simply refused to take steps to impose standards on lenders.

His indifference and that of other Bush administration officials who could have acted as a protector of little-guy borrowers but didn't, makes them as responsible as the sleazy mortgage broker and rapacious banker.

The people in suits have proven time and again that ethics and conscience take a backseat to profits. The subprime mortgage meltdown and the upending of mortgage-backed securities is just the latest national mugging. Those who got rich off of it know full well it's the perfect crime.

[Last modified January 26, 2008, 22:57:16]