Michael Lewis "The Big Short"

[Winstonm]

FWIW, there is an interesting paper being presented at the American Economic Association this Saturday. You can read a summary at:

 

http://www.bloomberg.com/news/2012-01-06/goldman-citigroup-cdos-were-tip-of-iceberg-the-ticker.html

 

Here's the relevent quote from the Bloomberg article:

 

 

 

The lawyers are going to have a field day...

 

Between the CDOs and the fraudulent robosigning foreclosures, there must be millions of jail years available for the losers.

[y66]

Interesting development in this long running story: From Anonymity to Scourge of Wall Street

 

The architect of a recent legal crackdown on Wall Street’s dubious mortgage practices was not the attorney general, a United States attorney or a rising star in the Justice Department. Instead, it was Leon W. Weidman, an unassuming 69-year-old career prosecutor, toiling away in anonymity 3,000 miles from Washington.

 

For much of his 43 years as a government lawyer, Mr. Weidman led a small group of federal prosecutors in Los Angeles. In the 1990s and 2000s, he and his team brought nearly 200 civil fraud lawsuits against two-bit mortgage crooks and small-business cheats, using an obscure federal law created in the aftermath of the savings and loan crisis a quarter century ago.

 

Now the work of Mr. Weidman, a onetime engineer who earned his law degree at night, has leapt to a bigger stage: the government’s campaign to punish Wall Street for the financial crisis.

 

His pioneering use of the law — the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, or Firrea — underpinned the Justice Department’s tentative $13 billion settlement with JPMorgan Chase. The United States attorney in Manhattan, Preet Bharara, has deployed the statute most often, filing civil fraud actions against Wells Fargo, BNY Mellon and Bank of America, among others. A jury found Bank of America liable in that case last week.

 

The wave of cases has ignited a legal controversy, raising the question of whether federal prosecutors, in dusting off an old statute, are misapplying the law. So far, judges have blessed the government’s tactics.

 

“It’s been an extremely effective tool,” said Mr. Weidman, who lives in West Los Angeles with his wife, an artist, and their 95-pound Labradoodle.

[mike777]

1) yes lawyers run banks...not bankers

 

 

2) Yes the AG is very very powerful you prove that.

 

3)"Now the work of Mr. Weidman, a onetime engineer who earned his law degree at night, has leapt to a bigger stage: the government’s campaign to punish Wall Street for the financial crisis" Your comment says it better than I could ever.

 

4) the fact that ownership did not stop this is most important or even try to stop this as far as I can see is most important.

--------------

 

 

side note as someone who worked there I can attest to all of this and more idiot leading idiot is kind. At some point we throw up our hands and stop caring.

 

If your reaction is throw the rascals out and start over...ok...cannot be worse.

[FM75]

Between the CDOs and the fraudulent robosigning foreclosures, there must be millions of jail years available for the losers.

Given that tens of millions of homebuyers were gambling on the real estate market with somebody else's money, you might expect that. But nearly none of those fraudster's has ever been prosecuted, and likely never will be. They are immune from civil suits, since they have no assets. They are semi-immune from criminal suits because there are so many of them. So the lenders got stuck, and when they failed, the honest taxpayers got the shaft. Too big to fail - ever since The Great Depression. All of the government programs since then have bolstered the behavior that causes the problem. Bailouts = moral hazard. Eliminated them and the system changes profoundly.

 

If the country changed the banking laws and allowed for banks to go bankrupt like any other corporations, things might change. But that means that people placing deposits in a lending institution would be expected to make intelligent decisions about those institutions' credit quality (ability to repay the money that they "deposited"). It also means that you (the depositor) are taking the risk and not transferring it to your taxpaying buddies.

 

What can you take away from this? If you have really sound analytical capabilities, you could correctly arrive at the answer that the system has weaknesses - that the system is the problem.

 

If you do not have that, then you will take the easy road and search for a single culprit, most likely the one that by your upbringing, you have been biased against since early youth. If you can only find a small number of culpable players, you do not understand the market at all.

 

 

[Winstonm]

Given that tens of millions of homebuyers were gambling on the real estate market with somebody else's money, you might expect that. But nearly none of those fraudster's has ever been prosecuted, and likely never will be. They are immune from civil suits, since they have no assets. They are semi-immune from criminal suits because there are so many of them. So the lenders got stuck, and when they failed, the honest taxpayers got the shaft. Too big to fail - ever since The Great Depression. All of the government programs since then have bolstered the behavior that causes the problem. Bailouts = moral hazard. Eliminated them and the system changes profoundly.

 

If the country changed the banking laws and allowed for banks to go bankrupt like any other corporations, things might change. But that means that people placing deposits in a lending institution would be expected to make intelligent decisions about those institutions' credit quality (ability to repay the money that they "deposited"). It also means that you (the depositor) are taking the risk and not transferring it to your taxpaying buddies.

 

What can you take away from this? If you have really sound analytical capabilities, you could correctly arrive at the answer that the system has weaknesses - that the system is the problem.

 

If you do not have that, then you will take the easy road and search for a single culprit, most likely the one that by your upbringing, you have been biased against since early youth. If you can only find a small number of culpable players, you do not understand the market at all.

 

What a bunch of hogwash. It was not the purchasers who pulled the wool over the eyes of the hardworking but naive Wall Street bankers. The history is fairly simply. Phil Gramm and many others lobbied heavily for free markets and deregulation, which they got. Alan Greenspan dropped interest rates to 1% when the markets collaped in 2000 or so. This led to a clamor for yield from institutional investors, which led to inventive loans and loan products, which led to Wall Street brokering those products and making millions and millions of dollars, so much money that no one could be bothered to check if the underlying loans were any good, and with no minding the store and no regulatory agency to prevent it, mortgage companies, which were outside the scope of normal banking practices, make liar loans and no doc loans not to hold but to sell to Wall Street for a fee.

 

As for picking a bank, Glass-Steagall used to guarantee that banks that took deposits did not also gamble with that money - but when GS was repealed, it became a free-for-all again, and all banks - investment and deposit - began to speculate.

[FM75]

What a bunch of hogwash. It was not the purchasers who pulled the wool over the eyes of the hardworking but naive Wall Street bankers. The history is fairly simply. Phil Gramm and many others lobbied heavily for free markets and deregulation, which they got. Alan Greenspan dropped interest rates to 1% when the markets collaped in 2000 or so. This led to a clamor for yield from institutional investors, which led to inventive loans and loan products, which led to Wall Street brokering those products and making millions and millions of dollars, so much money that no one could be bothered to check if the underlying loans were any good, and with no minding the store and no regulatory agency to prevent it, mortgage companies, which were outside the scope of normal banking practices, make liar loans and no doc loans not to hold but to sell to Wall Street for a fee.

 

As for picking a bank, Glass-Steagall used to guarantee that banks that took deposits did not also gamble with that money - but when GS was repealed, it became a free-for-all again, and all banks - investment and deposit - began to speculate.

 

Q.E.D. Thanks for playing.

[mycroft]

Okay, I fit in my "I can see the problem, therefore I'm blind" bubble as much as at least two of the previous two posters, but how many of those "gamblers in the real estate market" were buying the homes they lived in, that the professionals told them (because they got paid by the sale, and *their company sold off all the risk, so there was no reason for the company to care*) were affordable? For the first time?

 

I can't be the only one - the only two differences being that in Canada, the banks can't do a lot of the stuff that happened in the U.S. and the U.K. so the minefield wasn't as thickly strewn, and I actually *could* afford the mortgage given me (and I knew enough to make sure I got a straight-up fixed-rate, not anything I couldn't understand).

 

So much of the world operates on keeping the consumers uneducated, and then claiming it's their fault that they did something that (with the correct education, like they have) was obviously stupid. If there's one thing you can credit lawyers as a profession for (and there may only be one thing), it's that having set up the world so that lawyer "always" beats no-lawyer, they at least really push for you to *get one* if you even think you need one.

[FM75]

Okay, I fit in my "I can see the problem, therefore I'm blind" bubble as much as at least two of the previous two posters, but how many of those "gamblers in the real estate market" were buying the homes they lived in, that the professionals told them (because they got paid by the sale, and *their company sold off all the risk, so there was no reason for the company to care*) were affordable? For the first time?

 

I can't be the only one - the only two differences being that in Canada, the banks can't do a lot of the stuff that happened in the U.S. and the U.K. so the minefield wasn't as thickly strewn, and I actually *could* afford the mortgage given me (and I knew enough to make sure I got a straight-up fixed-rate, not anything I couldn't understand).

 

So much of the world operates on keeping the consumers uneducated, and then claiming it's their fault that they did something that (with the correct education, like they have) was obviously stupid. If there's one thing you can credit lawyers as a profession for (and there may only be one thing), it's that having set up the world so that lawyer "always" beats no-lawyer, they at least really push for you to *get one* if you even think you need one.

So one thing you should know - You sold a mortgage when you bought a house. That sale becomes a liability for you and an asset to the buyer - who typically resells it to another buyer, sometimes retaining the obligation to "service" the loan, which means collecting payments and passing them on to the new owner, as well as other related obligations. So you were not "given" a mortgage.

 

You are also right about another key perception of the market. Lenders (direct lenders, such as banks) in the US became obligated to lend where they might not otherwise have lent - to buyers who they deemed not good credits, because of an act of Congress (well meaning, of course, but with unexpected consequences). That is where things like the mortgage insurance industry comes into the picture - think of them as credit reinsurers. Once the assets are sold, they get repackaged into packages more suitable to the ultimate investors - some of whom have long term liabilities, such as pension funds, life insurance companies. They typically have credit quality requirements to meet which may be either regulatory or investor imposed. So step in rating agencies, who have models based upon nearly 100 years of the performance of the mortgage market. (One nasty wrinkle - there was no history to back liar loans. They did include modelling to handle loss of market value, which for the most part was based on the loss of home values in the great depression when loan to value ratios where much lower, and some recent housing recessions that were not even close to as severe as the 2006+ recession.)

 

The mortgage finance system is way too complex to explain here, but fundamentally you could pull out any single component and the crash could not have happened. That is why it is important to understand that the problem is systematic. Blaming a single culprit would only be done by someone who does not understand what really happened. Remove the ratings agencies, or the law that Congress passed, or "liar" borrowing, or long term buyers of mortgages - pension funds, etc., or the intermediaries - investment banks, or even the law preventing banks from going bankrupt, and the entire problem becomes far less likely. I have left out a number of other less direct problems that contributed to the CREDIT CRISIS, because explaining them has nothing to do with mortgages.

[y66]

JPMorgan Settlement Offers Look Into Mortgage Machine

 

JPMorgan Chase and the Justice Department reached a record $13 billion settlement on Tuesday, wrapping up a series of state and federal investigations that offer a rare glimpse into Wall Street’s mortgage machine before the financial crisis, when it churned out billions of dollars in securities that later imploded.

 

At the heart of the civil settlement, which materialized after months of wrangling, is a statement of facts negotiated with the government that provides details into how JPMorgan assembled mortgage securities sold from 2005 through 2008. While the bank did not admit any violations of law, its decision to approve the statement was one of a few critical concessions it made in order to strike the deal.

 

The statement shows that as JPMorgan packaged the residential mortgages into complex securities, the bank promised to alert investors to any flaws that might raise questions about the loans, according to the statement.

 

Investors relied on the bank to vet the underlying loans, which mortgage lenders across the country originated with varying degrees of quality. Still, investors were kept in the dark, the government’s statement found.

 

They were told, the statement of fact says, that the lenders originating the mortgages had “solid underwriting platforms” and that JPMorgan itself would provide another level of assurance by ensuring that the loans were independently scrutinized.

 

To do that, the bank hired Clayton Holdings and other third-party firms to examine the loans before they were packed into investments. Poring through the mortgages, the firms scoured them for potential red flags like borrowers who had vastly overstated their incomes or appraisals that inflated property values, the statement of fact shows.

 

But even when problems were found, JPMorgan sometimes ignored the warnings. According to the statement of facts, an analysis for JPMorgan performed from the first quarter of 2006 through the second quarter of 2007 on 23,668 loans found that 27 percent — about 6,238 loans — should have been categorized as “event 3,” meaning they did not meet underwriting standards. Still, JPMorgan ultimately decided to accept the loans anyway or altered their classification to a higher rating.

[Winstonm]

It always sucks when facts do not fit ideological fantasies:

The Community Reinvestment Act of 1977 seeks to address discrimination in loans made to individuals and businesses from low and moderate-income neighborhoods.[7] The Act mandates that all banking institutions that receive Federal Deposit Insurance Corporation (FDIC) insurance be evaluated by Federal banking agencies to determine if the bank offers credit (in a manner consistent with safe and sound operation as per Section 802(b) and Section 804(1)) in all communities in which they are chartered to do business.[3] The law does not list specific criteria for evaluating the performance of financial institutions. Rather, it directs that the evaluation process should accommodate the situation and context of each individual institution. Federal regulations dictate agency conduct in evaluating a bank's compliance in five performance areas, comprising twelve assessment factors. This examination culminates in a rating and a written report that becomes part of the supervisory record for that bank.[8]

 

The law, however, emphasizes that an institution's CRA activities should be undertaken in a safe and sound manner, and does not require institutions to make high-risk loans that may bring losses to the institution.[3][4] An institution's CRA compliance record is taken into account by the banking regulatory agencies when the institution seeks to expand through merger, acquisition or branching. The law does not mandate any other penalties for non-compliance with the CRA.

[PassedOut]

Lenders (direct lenders, such as banks) in the US became obligated to lend where they might not otherwise have lent - to buyers who they deemed not good credits, because of an act of Congress (well meaning, of course, but with unexpected consequences).

Surely not. Where did you get that idea?

[Winstonm]

Surely not. Where did you get that idea?

 

 

There has been a claim that the Community Reinvestment Act was the catalyst for the bad loans - but as my post above shows, the CRA did not require bad loans, and it only applied to banks that received FDIC insurance, i.e., at the time of the credit crisis non-investment banks - the bad loans that led to the credit crisis were not bank loans at all, but loans made by and large by mortgage lending businesses - companies that comprised the so-called "shadow banking system" - that fell outside of the scope of CRA and other normal banking regulations. The non-bank entities making those loans could have been regulated by the Federal Reserve, but the Fed chose not to take on that responsibility.

[mike777]

Clearly there was little to no due diligence. No one bothered to check on these loans as they are sold and resold.

 

It reminds me of a true story regarding H-bombs.

 

1) step one keep H-bombs in same bunker as standard bombs.

2) step two: Some H- bombs were plucked out of storage, no one checked to see which ones they were.

3) step three: a different crew carries the bombs to the plane, no one checks on the bombs.

4) step four: yet another crew loads the bombs onto plane and leaves plane unguarded, yep again no one checks the bombs.

5) step five: the pilot and crew fly bombs across country, leaves the plane alone upon arrival, yes pilot did not check out bombs.

 

In this case H-bomb loans were kept in same place as standard loans and no one bothered to check until they blew up.

------------------------

 

 

To be fair due diligence is hard, really hard to do and so many just assume others have done it. One simple example, when I bought this home we paid a guy come out and check out the house. This guy did this for a living and our real estate agent recommended him.

 

It turns out the guy only checks out about half the house. In fact later we find out this is pretty common. Even then the half he checked out he did wrong and we got a few thousand from the guy to keep us from suing him and the local real estate company put pressure on him to pay up.

[Winstonm]

Mike,

 

I think your h-bomb analogy is good. The odd thing about the crisis is how rapidly it developed - the majority of the really bad loans were made between 2005 and 2008. During that period, loans were originated by many non-banks, unregulated entities who were able to quickly sell those loans to Wall Street Banks. The key ingredient was time - fast loans, fast processing, and fast turnover left the mortgage brokers without risk.

 

But no one talks about motivations - what was the underlying cause of the willingness to bundle and sell mortgages without due diligence enforced? As always seems the case, it was the chase for yield that created the demand for the MBS. The chase for yield occurred because the yield curve was flattened artificially by the Greenspan Fed in response to the collapse of the NASDAQ bubble, and then those historically low rates (at that time) were kept low for too long.

 

This left many investment managers searching for yield. When the (now disproved) models showed almost no risk with MBS, the party started in earnest. More and more innovation became the norm as churning out loans became the profit center for the shadow banks, while the Wall Street appetite for those loans was gluttonous.

 

Instead of making and holding good loans, mortgage profit became a package and sell industry where everyone tried to earn fees for service, and only the last ones in the daisy chain, who ultimately bought the mortgage-backed securities, held any risk.

 

These were not bad people doing bad things. These were normal people making normal decisions based on bad data that arose from artificial circumstances - the Fed's interventions that created an environment that left money managers scrambling for yield.

[mike777]

These were not bad people doing bad things. These were normal people making normal decisions based on bad data that arose from artificial circumstances - the Fed's interventions that created an environment that left money managers scrambling for yield

 

 

 

Winston you say it well, I call it moral hazard.

 

"In economic theory, a moral hazard is a situation where a party will have a tendency to take risks because the costs that could result will not be felt by the party taking the risk. In"

[hrothgar]

These were not bad people doing bad things. These were normal people making normal decisions based on bad data that arose from artificial circumstances

 

Bullshit

 

There was a clear violation of fiduciary responsibility.

The investment banks were deliberately crafting instruments with specific characteristics and failed to disclose this information to buyers or the bond ratings agencies.

 

The fact that you, a so called investment advisor, considers these sorts of actions "normal" is a clear signal that no one in their right mind should consider doing business with you...

[Winstonm]

Bullshit

 

There was a clear violation of fiduciary responsibility.

The investment banks were deliberately crafting instruments with specific characteristics and failed to disclose this information to buyers or the bond ratings agencies.

 

The fact that you, a so called investment advisor, considers these sorts of actions "normal" is a clear signal that no one in their right mind should consider doing business with you...

 

Richard,

 

I need to step in here as the quote was what I wrote, not Mike, and it referenced the people who were responsible for managing huge sums of money like retirement accounts and other fund pools - not the mortgage companies or the Wall Street investment bankers.

 

The basic reason for the systemic nature of the problem was ignoring (or trusting, you might say) risk in search of higher yield - and many of those who ignored risk were not trying hanky panky but simply trying to manage their accounts.

 

If there is one culprit, look to Alan Greenspan. His actions as Fed chair set up the circumstances that created the scramble for yield.

 

 

edit: to be clear, many of the mortgage companies who initiated the loans and the many of the Wall Street investment banks who packaged and sold the loans acted criminally and it is ridiculous that no one is in prison because of the crisis.

[mycroft]

One of the big issues is that everybody, within the rules, did what was best for them. Unfortunately, nobody did what was best for the loan purchaser or the end holder - in fact, it's quite obvious that people deliberately did their best to play pass-the-potato. Why the people who wrapped the damn things didn't make it clear to the purchasers in their company that these things were in fact potatoes I don't understand (but I think boils down to "what's best for themselves", and even loyalty to the company not getting played by their own plays applied, or maybe they just assumed they would always be able to pass).

 

I think this boils down to the fundamental failure of capitalism - it is frequently not in my best interest to consider your best interest - especially if repeat sales is not going to be an issue (or, at least, not my issue). Without something that mandates care for the purchaser (rather than the "completely educated parties" required for "invisible hand" free markets, which clearly doesn't apply for these kinds of "twice-in-a-lifetime" purchases vs. "handle 40 of them a day") rather than "regulations coming from industry" that Adam Smith himself said should be "ought never be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention", this failure will happen again.

 

It's just that this time it happened to business. And, as we expect from government that doesn't, in fact, do the above with suggestions from the industry, they - and the people who with intent hosed both their business and their customers (both the end customers and the rebuyers) for their own personal profit - got away with it. Which of course means that they will never do this again...

[mike777]

Stop

 

many posters want to make selling against the law

 

If you sell you go to jail.

 

follow million and million rules or go to jail if you sell equity or debt

 

My guess is most of you poster never have and want to impose rules on others not you.

 

I challenge you posters have you sold thousands and more ...if so how?

 

do you risk going to jail?

[blackshoe]

Mike777 apparently wants to abolish the market economy altogether. Interesting thought, though I frankly don't see how it can work, absent worldwide Communism. I could be wrong but I swear I heard somewhere that horse is dead. <_<

[PassedOut]

I challenge you posters have you sold thousands and more ...if so how?

Yes, via honest businesses.

 

do you risk going to jail?

No.

[Winstonm]

Stop

 

many posters want to make selling against the law

 

If you sell you go to jail.

 

follow million and million rules or go to jail if you sell equity or debt

 

My guess is most of you poster never have and want to impose rules on others not you.

 

I challenge you posters have you sold thousands and more ...if so how?

 

do you risk going to jail?

 

If I commit fraud, I risk going to jail. The same should be true of anyone, including sellers of fraudulent mortgage backed securities.

[mycroft]

many posters want to make selling against the law

 

If you sell you go to jail.

If you sell something that is actively harmful to the purchaser, there should be a cost to you.

 

Sell a product that causes a particular kind of cancer to go from 15th most common to absolutely most common? Yeah, we should fine you.

Sell melamine-laced milk or toxic painted toys? Same thing. You didn't make it? Don't care, you sold it. You should be checking; and if you outsource production, you should be *testing*.

Sell a car whose throttle sticks and kills people? BIG fine.

Why should selling an *actively harmful* mortgage to people who you know will likely lead to bankruptcy and foreclosure, or selling that mortgage to a bank as "top rating", or packaging a bunch up and selling them together as "well, there's this 20% that are bad, but most are AAA" be any different?

 

Now, if you do any of these things, *knowing about their toxicity*, there should be an even bigger fine.

If you do any of these things, *actively concealing what you know about their toxicity*, why should that be any different than if you stuck in the knife yourself?

 

As has been said repeatedly here, free markets require an equally educated marketplace to work correctly. The vendor is just by their nature going to be better educated, but when it's a huge difference, especially to the point where the consumer can't be "educated enough", then we need regulations to ensure that there's a little more of a level playing field. When the vendor actively discourages education of the consumer (by suppressing that knowledge, or obfuscating the issue enough to impede education) - and it's toxic - there needs to be *punitive* regulations, *especially* if there's a high risk of seriously damaging consequences.

 

Finally, think of the FDA. I see on channel of choice, 50% of the ads are "did you do this medical procedure and have a major problem? If so, join our class action and get money." This is after all the trials the FDA force medical players to do to put something on the market. Why should the banks be any different?

[mike777]

"If you sell something that is actively harmful to the purchaser, there should be a cost to you"

 

 

 

guys we are talking about selling stocks and bonds in the secondary market (not an ipo). You seem to want to to blame the seller for selling and put them in jail. No one said anything about fraud but many seem to define fraud way too broadly.

 

For example I own GM stock and think the company is toxic....and want to sell in the secondary market. You want to make this illegal or impossible. Somehow I am going to jail unless I somehow find out who the person buying the stock is and telling her I hate the company.

 

Or in this case if I think the country housing market is going to crash I have to tell you first. YOu keep talking about fraud in the mortgages but keep in mind these were sophisticated buyers who often were not lied to,, they just did not bother to check. You guys put way too much blame on the seller and none on the buyer.

 

To use Mycrofts point if I sell you something and you lose money and are harmed it is my fault.

[Winstonm]

No, Mike, we are talking about making misleading, non-factual statements and concealing negative information in order to make a profit: in other words, fraud.

 

Fraud

A false representation of a matter of fact—whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed—that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury

 

The U.S. government on Tuesday filed two civil lawsuits against Bank of America that accuse the bank of investor fraud in its sale of $850 million of residential mortgage-backed securities....The Justice Department and the U.S. Securities and Exchange Commission filed parallel lawsuits in U.S. District Court in Charlotte, North Carolina, accusing Bank of America of making misleading statements and failing to disclose important facts about the pool of mortgages underlying a sale of securities to investors in early 2008.