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Fraud as a Business Model

September 6, 2011

These people knew exactly what they were doing.

“The Wall Street Journal reviewed data showing that a $38 million subprime-mortgage bond created in June 2006 was referenced in more than 30 debt pool causing around$280 million in losses to investors by 2008.”

Of course, Goldman wasn’t the only one.  Great catch by Tom Hickey on a Janet Takavoli article. Note that Janet Takavoli is semi-frequently on CNBC.

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  1. JKH
    September 6, 2011 at 9:50 pm

    Great slide presentation.

    But I’ll play slight devil’s advocate.

    The repetition (30 times in the referenced instrument) is in the nature of the beast for a synthetic CDO (or any synthetic). It’s a bet that can be replicated as desired for anybody who wants to make the bet. Repetition is not the fraud issue. Repetition as a “risk multiplier” is itself a risk that is obvious in the nature of the beast.

    It does amaze me that nobody ever screams about the negligent assholes in the primary financial institutions who wrote protection on these synthetic instruments in order to get yield. They accepted a live grenade because the payoff for not being wrong was huge. The closest thing Tavakoli comes to this in her slides (page 13) is the role of the bond insurer, but that’s not the primary protection writer in most cases. The asset managers weren’t little old ladies mugged for a loaf of marble rye.

    These were trades where both sides were greedy – not just the protection buyers (e.g. Goldman).

    The larger issue is the involvement of investment bankers in the marketing of credit risk, the traditional domain of commercial bankers. Investment bankers are the seediest species of salesmen. What would you expect? It’s their job to be bastards. See slide 43 for scientific analysis.

    And the origination machine for the actual mortgages was just a monumental, stupendous, catastrophic failure of US financial regulatory supervision – regulatory failure as an embedded cultural phenomenon. Compare to Canadian mortgage supervisory authority. (Although I’m constantly told by Americans – we got it coming, kid.)

    The rating agencies are a gargantuan problem. They deserve to be bankrupted by law suits.

    Lots of blame to go around – it’s the entire, interconnected, badly regulated and unsupervised system.

    End of controlled, qualified devil’s advocate rant.

    Hope you don’t suspend my comment privileges.

    But her slides ARE good, indeed.

    🙂

  2. TC
    September 6, 2011 at 11:16 pm

    yeah – lots of blame to go around.

    I suspect this particular protection issue is going to get some investigation. 30 times isn’t the problem as you say. I’d say the problem is that it got sold 22 times, goldman figured it was a certain loser – and then they sold it 8 more times to the same company, AIG.

    One thing about CDS markets – they are very thin. Prices are made by a few market makers, if that.

    I don’t agree these people were all as sophisticated as you might think. I am always surprised how little some people know about anything slightly outside of their daily tasks – even director and MD level people at big banks.

    Just imagine you and me are going in to do this investigation. We would probably find prosecutable fraud at a variety of places on the Goldman side.

    First, the MD’s and D’s that were pushing this stuff in June 2007 as the market was clearly going all wobbly. Then on the trading desks we’d find questionable pricing through Lehman when they knew the markets given were inaccurate.

    Then, at the sales side, we’d find fraudulent misrepresentation because the notes were not transfered to the pool properly, so the reference obligation was not correct, and we might find the reference obligation did not contain the correct kinds of mortgage holders.

    Misrepresenting a security in any context at all is a serious crime. the due diligence is required to be performed by the representing agent.

    If it was a goldman securitization, we’d probably find the CDO wasn’t assigned notes, then the consent to robo signing, then fraudulent foreclosures.

    All of these are goldman prosecutable crimes. Every one.

    On the other side, we’d find greed for a few bps combined with some indifference and some incompetence. But these are not prosecutable crimes.

    To be sure – these are totally offensive, and a gigantic problem with our banking system. There was a good reason why those laws of 33 and 34 were passed and why the definition of security includes the kitchen sink.

    Some of these people must have known they were buying a dog but “everyone was doing it” so they did it too.

    There is plenty of blame to go around. Let’s at least prosecute the crimes we can – maybe it will stop some of the other crimes too.

    This is the biggest pure financial crime in human history. It’s bigger as a % of GDP, impacts more people than anything else.

    • JKH
      September 7, 2011 at 7:12 am

      I wasn’t thinking of AIG, but it’s an interesting example. “Financial Products” as in “AIG Financial Products” was an ostensibly “sophisticated” operation – disastrously wrong, but sophisticated – on the long side of mortgage exposure. It used all the “right” Value at Risk type analytics – a mega-disaster in itself, broadly speaking. “Patient Zero” Joe Cassano remained defiant in his risk analysis to the end. AIGFP was sort of a rogue dealer operation within AIG, separate from investment management. I was thinking more of the regular “buy-side” investment management operations of large financial institutions, who would be yield hungry writers of protection, and many of whom dealt head on with Goldman and other designated “fraudsters”.

      Anyway, points taken; just venting for a bit more balance in the overview fraud meme in general; thx.

    • beowulf
      September 7, 2011 at 1:01 pm

      I’ve heard secondhand accounts that career prosecutors and agents tend to be on the side of Bill Black and are pissed off the politicians are tying their hands. It sounds like a Zen koan but financial fraud cases aren’t difficult to prosecute once you realize you’ll never get a conviction on the underlying fraud. The trick is require regular filings (or failing that, secure an FBI interview) and then prosecute any false statements in those.
      The thing is, there’s no way you can get a jury of 12 ordinary citizens to wrap their head around the details of even the simplest white collar crime, a confused jury will have, almost by definition, reasonable doubt. What a jury CAN understand is that lying to the Federales is wrong, so Congress made that a felony too. So, a Martha Stewart will be found not guilty on even a plain vanilla insider trading charge but found guilty (and sent to prison) on a false statements charge.

      The Martha Stewart law has a 5 year maximum sentence, but since mortgage fraud ultimately comes back on the taxpayers, Congress set a much stiffer 30 year maximum sentence on each count. So what qualifies as mortgage fraud?
      Title 18, Sections 1005, 1006 and 1007, (Martha Stewart law is Sect. 1001). I’ll copy the shortest (Sect. 1007) below, but Sect. 1005 “Bank entries, reports and transactions” has an interesting wrinkle-
      http://www.law.cornell.edu/uscode/18/usc_sup_01_18_10_I_20_47.html
      “Whoever makes any false entry in any book, report, or statement of such bank, company, branch, agency, or organization with intent to injure or defraud such bank, company, branch, agency, or organization, or any other company, body politic or corporate, or any individual person, or to deceive any officer of such bank, company, branch, agency, or organization…”
      The key word there is “body politic or corporate”– which means local government. So each instance of submitting knowingly false documents with a local judge (or deed recorder) is a separate felony county with a 30 year sentence.

      1007. Federal Deposit Insurance Corporation transactions
      Whoever, for the purpose of influencing in any way the action of the Federal Deposit Insurance Corporation, knowingly makes or invites reliance on a false, forged, or counterfeit statement, document, or thing shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.

  3. wh10
    September 8, 2011 at 9:55 pm

    Obviously curious to get your perspective on AJA. What’s the best way to understand how big the fiscal stimulus needs to be?

    If we say the output gap is $1T, does that mean stimulus above and beyond the deficit should be around $1T (perhaps w/ multiplier included), or does the overall deficit just need to be around that value? My sense is it’s more of the former? In which case, $450B, assuming it’s even passed anywhere near that value, is the same size as the original fiscal stimulus on an annual basis (I think), and so this is just more of the same. Thus this doesn’t change the pace of the recovery much?

    I like a lot of the ideas in the package (many straight from Mosler), I just don’t think it’s big enough.

    And so more fuel for Republicans to claim fiscal stimulus doesn’t work (when Dems do it, of course).

  4. beowulf
    September 14, 2011 at 3:02 pm

    I wonder if “currency trader” is only a cover for TC’s real job as a NASA assassin (like Ron Silver who, of course, only pretended to be an actor). At any rate, hope he’s back soon.

    Ron Silver, the main villain. He works for NASA, and will stop at nothing to capture or kill Jack Austin, but he also dabbles in acting, perhaps as a diversion, perhaps as a cover. He appears to be invulnerable, shrugging off the threat of being shot and later displaying great annoyance but no injury or pain when he actually is shot. Played by himself.
    http://en.wikipedia.org/wiki/Heat_Vision_and_Jack

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