March 26, 2017

Evidence Builds Against Big Banks in Financial Crisis

Over two years after the sudden fallout of the financial markets in late 2008, the government still has not brought a criminal charge against any individual or business for a role in the crisis. Some argue the financial system itself collapsed and no individual or business committed any crimes, but a bipartisan Senate subcommittee report released on Thursday contrarily argues several major institutions became aware of the inevitable crisis and deceived customers to “massage” the numbers.

After a two-year investigation, the Permanent Subcommittee on Investigations, led by Senators Carl Levin (D-MI) and Tom Coburn (R-OK), released the 635-page report [.pdf] along with over 5,000 internal documents from relevant institutions. This comprehensive report details high-risk lending amid weak markets, inflated credit ratings, conflicts of interest within investment banks, and even regulatory failures that led to the financial crisis.

High-Risk Lending: The report details how Washington Mutual, whose September 2008 collapse was the largest bank failure in US history, strategically sold higher risk loans and mortgage backed securities on Wall Street because they garnered higher prices, due to the high-risk nature eventually leading to higher interest rates and profit.

Washington Mutual and its subprime lender Long Beach Mortgage Corporation continued to accept high-risk loans and sell these on Wall Street, despite internal reviews “describing extensive fraud by employees who willfully circumvented bank policies.” These practices include accepting loan applications without verifying income, steering borrowers to higher risk loans they could not afford, and using teaser rates that could lead to payment shock when higher interest rates took effect.

Washington Mutual President Steve Rotella even went as far as to describe Long Beach as a “mess” that was among the “worst managed businesses” he had seen in his career. The report concludes Washington Mutual was far from the only institution that partook in shoddy practices and it is merely emblematic of all the high-risk loans that polluted the financial system and eventually ignited the financial crisis.

Inflated Credit Ratings: Perhaps the most significant event at the outset of the financial crisis was the beginning of mass downgrades in credit ratings in July 2007, which had never occurred before because credit ratings are generally designed to maintain the same rating throughout its lifetime. Major credit rating businesses, including Moody’s, S&P, and Fitch, each downgraded hundreds of billions worth of securities throughout 2007 and 2008.

These unprecedented downgrades created significant impact because financial firms around the world were suddenly left with billions of unmarketable securities. By 2010, analysts had determined 90% of AAA loans issued in 2006 and 2007 were downgraded to junk status, including all 75 of the AAA securities Long Beach issued in 2006. Since issuers and investment banks pay credit rating businesses for ratings, the report points to an inherent conflict of interest for credit rating businesses to provide ratings favorable to its clients and therefore attract business. Correspondingly, revenue among the three major credit ratings agencies soared from $3 billion in 2002 to $6 billion in 2007.

More Conflicts of Interest in Investment Banks: The report also details how Goldman Sachs and Deutsche Bank both became aware of the declining mortgage market, yet told clients conflicting information that led to these banks profiting from their clients’ losses. For instance, Goldman Sachs took positions that created profit only when its clients suffered losses. Despite suffering losses of $2.5 billion in its mortgage department in 2007, Goldman Sachs still managed to make $1.2 billion in profit from its mortgage department in 2007.

The report details four specific products known as Hudson, Anderson, Abacus, and Timberwolf that Goldman Sachs sold to clients without disclosing its interest of the deal. As a result, the report suggests this potentially violates the precedent from SEC v. Czuckzko (2007), which found that disclosing a potential adverse interest when that adverse interest already exists can constitute a material misstatement to investors.

Regulatory Failures: Despite the Office of Thrift and Supervision (OTS) filing over 500 complaints against Washington Mutual from 2003 to 2008, the agency failed to require the bank to improve its practices. In fact, when the Federal Deposit Insurance Corporation (FDIC) advocated oversight of the bank, the OTS even impeded the FDIC’s actions. The report provides new information showing the OTS’s “deference to bank management and how it used the bank’s short term profits to excuse high risk activities.”

On November 1, 2007, the New York Attorney General filed a lawsuit against two appraisers for colluding with Washington Mutual, but it took more than a year for OTS to begin its own investigation. More specifically, OTS did not initiate this investigation until one week after the closure of Washington Mutual. The Attorney General who filed this lawsuit, Eliot Spitzer, recently discussed the Levin-Coburn Report and suggested US Attorney General Eric Holder file charges against responsible entities or else resign.

Senators Levin and Coburn assumed similar stances, albeit not quite as drastic. Senator Levin told reporters he would refer officials from Goldman Sachs and other organizations to the Justice Department for criminal prosecution, as well as the Securities and Exchange Commission for civil prosecution. Senator Coburn added this report “without a doubt shows the lack of ethics in some of our financial institutions, who embrace known conflicts of interest to accumulate wealth for themselves.”

With a bipartisan field of evidence describing the conflicting practices that led to the financial crisis, whether to proceed with this evidence is now a responsibility of the Obama Administration.

Left and Right News occasionally publishes articles on other websites – this article was originally published at Technorati here.

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