Preet Bharara is sending a message to Wall Street with his latest insider trading conviction, that he will use “aggressive prosecutorial methods and unprecedented tactics” to root out insider trading. The message I hear is that the only thing Bharara cares about is making the world safe for hedge fund traders.
As far as Bharara is concerned, no one else on Wall Street has done anything that even merits an investigation. Those garbage-filled sacks of mortgages banksters peddled around the globe were just fine. The offering materials disclosed everything and more, and if you bought them you were just unlucky. You see, it turned out there was a housing bubble! Who could have known? The bubble burst, the economy crashed, and those perfectly good mortgages just couldn’t be paid. No crime here.
The financial press agrees. Roger Lowenstein has an article in Bloomberg’s Businessweek explaining that there was no criminal fraud, and that any other position is ignorant, based on foolish human emotions instead of the cold logic of the law. Andrew Leonard sadly writes in Salon that Lowenstein is right: “The crooks rigged the system so that they weren’t, technically speaking, crooks.”
These are just two of the recent reports from financial writers buying into the big lie: no one is guilty because everyone is guilty. As Lowenstein explains to the emotional and ignorant:
The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors, and regulators were all blind to risk. More broadly, the crash was the result of a tendency in our financial culture, especially after a period of buoyancy, to push leverage and risk-taking to the extreme.
Wall Street Bankers weren’t blind. They knew what they were selling was garbage. The FCIC explains how the dirty deed was done. It wasn’t some grand scheme, some Bernie Madoff manipulation, some foul act worthy of universal condemnation.
Instead, it was active concealment, the willful refusal of Wall Street to disclose exactly what was in those bags of mortgage loans that were being sliced and diced into real estate mortgage-backed securities. The offering materials for each RMBS state the underwriting guidelines used in generation of the mortgages in the pool. No doubt those were the underwriting guidelines. But that is a half-truth.
The FCIC Final Report (large .pdf) at 165 says that the underwriters of the pools did due diligence on the pools of mortgages. They hired companies like Clayton Holdings to examine the loan files. Clayton Holdings filed a report as an exhibit (.pdf) to its testimony, showing that many of the mortgages it examined did not meet those guidelines. That report says that on average, about 15% of the mortgages in pools set up in the third quarter of 2006 did not meet the underwriting guidelines. That information is not disclosed. As the FCIC says:
Nonetheless, many prospectuses indicated that the loans in the pools either met guidelines outright or had compensating factors, even though Clayton’s records show that only a portion of the loans were sampled, and that of those that were sampled, a substantial percentage of [loans that didn’t meet guidelines] were waived in.
SEC Regulation AB requires the offeror to state the underwriting guidelines used to generate mortgages in the pool. Failure to disclose that a substantial number of loans did not meet the underwriting guidelines violates securities laws, such as Rule 10b-5. It isn’t hard to prove intent. Lots of people knew about those due diligence reports, knew that the offering materials didn’t include the qualifying statement that the offeror waived the underwriting guidelines for a substantial number of loans and sold anyway. Someone intentionally concealed material information about the mortgages. You don’t have to prove intent to defraud directly. You prove it with circumstantial evidence, in this case, that information necessary to a full understanding of the securities was deliberately concealed.
There is no explanation from Lowenstein, Leonard, or any of the other apologists for Wall Street as to why this isn’t a crime, or at least worthy of detailed investigation. Preet Bharara has the staff to do this investigation. But, he has shown that his goal is to make the world safe for hedge fund traders, not to hold Wall Street accountable for the Great Crash.