Think Twice Finance

The Subprime Mortgage Crisis-related Legal Investigations Will Discover Fraud and then Go Away Quietly.

The SEC, FBI, Justice  Department, and New York State Attorney General’s Office, and French and German government regulatory authorities are all “looking into” the Subprime Mortgage Crisis. These agencies are investigating Citibank, Merrill Lynch, Bank of America, Bear Stearns, UBS, Barclays, HSBC, Standard and Poors, Moody’s, Fitch, Countrywide, and The Bond Insurers. (Yes, I know. I’ve left several entities off both lists. And there are sub rosa investigations as well.) The agencies expect to find evidence of criminal activities, of course, since responsible authorities wouldn’t otherwise spend the tens of millions these investigations will require, would they?

Well, in an otherwise uncertain world, those of us with Wall Street experience (Hell, those of us with chicken farm experience) know that you cannot send that many ambitious people off to investigate that many greedy people without finding quite a number of foul deeds.

Yet I am going to make what may seem to be the most outrageous forecast of my career. Perhaps the most outrageous forecast of any career! These investigations are all going to come to nothing. There will be no significant actions brought against these firms.

There are four reasons – three bad reasons and one good one.

First, the actual process by which mortgages were made, sold, sold again, securitized, and sold again to create our current circumstances is well known, in the public  domain, and had the support of prominent government officials and law-makers until the day it all fell apart.

Second, the whole process was computerized. At several points during the process equations blessed by prominent academics were used by the computers to facilitate valuation decisions.

Third, the process itself was an attempt to deceive investors and stockholders about the risks the involved institutions were assuming. The phase “attempt to deceive” is critical here. Everyone was attempting to deceive. It means all the investigated entities are guilty as sin of fraud. The deception was to move the subprime-mortgage-like risks off the balance sheet, disguising the size of the associated risk and permitting the banks who are now bearing the brunt of the losses from setting aside capital  for risk protection purposes. So the whole process is fraudulent and anybody paying attention knows that.

Fourth, The Federal Reserve knows that too. And that means there will be no legal action. The accounting profession tried to do away with the off-balance-sheet entities that are causing us so much grief. After Enron, rules meant to do away with such things as mortgage conduits, called FAS 46, were promulgated that actually declared these vehicles illegal. But the Federal Reserve knowingly forced a “compromise” upon the accountants that brought the mortgage conduits back to life, FAS 46R. OK, then. All those ambitious prosecutors who want to sue the Federal Reserve, raise your hands. What? Nobody?