By Elizabeth MacDonald, Foxbusiness.com 5 February 2009
Law enforcement officials say arrests on Wall Street will be made not just by those who hawked predatory loans, but those who sold predatory securities built on those as loans well, interviews with Justice Dept. officials denote.
Namely, the bonds and derivatives compulsively minted by Wall Street’s financial engineering factory, where bad mortgages, bad credit card payments, bad auto loans, bad student loans, you name it, were sluiced through the underwriting pipeline and magically emerged as Triple A rated securities, safe as a US Treasury.
Bonds and derivatives that were sold by companies purposely set up offshore in places like the Cayman Islands or Guernsey, away from the prying eyes of regulators.
The credit rating agencies are under scrutiny, too, as the push was on to get these radioactive securities gold plated Triple A, meaning safe and virtually risk-free, because both Wall Street and the credit rating agencies knew full well that investment portfolios around the world, notably pension funds, by the very dint of their own regulations were only allowed to invest in safe, Triple-A rated securities.
It’s clear Wall Street went wild. It manufactured trillions of dollars in asset-backed bonds and derivatives that dwarfed the value of the underlying mortgages, auto loans, and student loans on which they were based, investment experts say.
The mayhem was notable inside the offices of the Wall Street underwriters of what are called collateralized debt obligations (CDOs), pools of bonds which are backed by pools of mortgages, and so on.
Bucket Shop Bonds
When you invest your money, you expect a competent money manager who will protect your investment, right?
However, too many investors in these mortgage-backed and other asset-backed bonds invested on autopilot, without checking who was watching their money.
Specifically, the securities and derivatives under scrutiny were supposed to be overseen by competent investment managers to ensure investors money was protected and returns were being paid.
Anything less is a breach of fiduciary duty, and potentially securities laws, says Janet Tavakoli, derivatives expert and author of “Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street” (John Wiley & Sons, 2009).
So who were these guys who oversaw these jerry rigged bonds?
Executives you wouldn’t want managing your local McDonald’s, notes Fox Business’s Joanne Ossinger.
And the deals were filled with so many rotten heads of lettuce.
An Unregulated Bond Factory
Derivatives expert Tavakoli says that in November 2006, she warned a Wall Street shop that “their CDO managers are unregulated,” that “most do not have the expertise or the resources to perform CDO management or surveillance,” and that “many cannot build a CDO model.”
She also noted that “rating agencies rarely ask for background checks on CDO managers.”
Many prospectuses for these securities offerings read like “finance comic books,” Tavakoli says she wrote in a letter to legendary investor Warren Buffett in December 2007.
A Rotten Deal
Tavakoli says one notably rotten deal came across her radar screen. In late 2006, she read the prospectus for a mortgage-backed security that took hundreds of mortgage loans, shoved them into a portfolio, and sold the risk to investors.
The portfolio included negative amortization loans and interest-only loans, the most combustible mortgages bought from some of the worst mortgage mills that have since flopped.
In these mortgages, because principal is not being paid down, the loan amount steadily increases and then the interest rate shoots up, with a massive balloon payment that is similar to the levees breaking in New Orleans, Tavakoli says.
More than 60% of the loans backing this security were purchased form New Century Capital, which in turn bought them from New Century Mortgage Corp., a unit of New Century Financial Corporation, an incestuous stew of a company that restated its financials in February 2007 and then filed for bankruptcy on April 2, 2007, under a cloud of fraud allegations, Tavakoli says.
Merrill Lynch Goes Full-Bore
Merrill Lynch was Wall Street’s biggest underwriter of CDO deals built on loans such as these, derivatives built on loans from places that were essentially mortgage mills.
For example, Merrill Lynch was a part owner of California-based Ownit Mortgage Solutions, a mortgage mill that eventually collapsed in December 2006, Tavakoli points out.
Ownit issued crazy 45-year ARMs and no-income-verifications loans. In the words of William D. Dallas, its founder and CEO: “The market is paying me to do a no-income-verification loan more than it is paying me to do the full documentation loans.”
Michael Blum, Merrill Lynch’s head of global asset-backed finance, sat on the board of Ownit Mortgage Solutions. When Ownit imploded in December 2006, Blum faxed in his resignation, Tavakoli says.
Full Steam Ahead
But Merrill continued to sell derivatives based on Ownit’s loans well into 2007, Tavakoli says.
For example, in early 2007, Merril created a package of securities deals including loans issued by Ownit, Tavakoli says.
However, around 70% of the borrowers of the loans had not provided full documentation of either their income or assets, Tavakoli says. Most of the loans were for the full appraised value, meaning they were no down payment loans, loans given at a time when home prices were already starting to crumble.
In the deal documents, says Tavakoli, Merrill disclosed that Ownit went bankrupt, but did not mention it was Ownit’s largest creditor.
Can Merrill say it did an “arms-length” transaction with Ownit when a Merrill officer sat on the Ownit’s board, Tavakoli asks?
In early 2007, both Moody’s Investors Service and Standard and Poor’s, the credit rating agencies, downgraded the Triple-A rated tranche of the deal, “an investment they had previously rated as ‘super safe’ with almost no possibility of loss) to B (junk status meaning you are likely to lose your shirt),” Tavakoli says.
Moody’s later forecast that 60% of the original portfolio value could eventually be lost, Tavakoli says.
However, the SEC as a regulator of the investment banks had the power to stop this nonsense, but it did nothing to halt this securitization activity. “Instead, investment banks accelerated securitization activity in the first part of 2007,” Tavakoli says.
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Inside Wall Street’s Factory of Fakery
Third in the Crackdown on Wall Street series
By Elizabeth MacDonald, Foxbusiness.com
5 February 2009
Law enforcement officials say arrests on Wall Street will be made not just by those who hawked predatory loans, but those who sold predatory securities built on those as loans well, interviews with Justice Dept. officials denote.
Namely, the bonds and derivatives compulsively minted by Wall Street’s financial engineering factory, where bad mortgages, bad credit card payments, bad auto loans, bad student loans, you name it, were sluiced through the underwriting pipeline and magically emerged as Triple A rated securities, safe as a US Treasury.
Bonds and derivatives that were sold by companies purposely set up offshore in places like the Cayman Islands or Guernsey, away from the prying eyes of regulators.
The credit rating agencies are under scrutiny, too, as the push was on to get these radioactive securities gold plated Triple A, meaning safe and virtually risk-free, because both Wall Street and the credit rating agencies knew full well that investment portfolios around the world, notably pension funds, by the very dint of their own regulations were only allowed to invest in safe, Triple-A rated securities.
It’s clear Wall Street went wild. It manufactured trillions of dollars in asset-backed bonds and derivatives that dwarfed the value of the underlying mortgages, auto loans, and student loans on which they were based, investment experts say.
The mayhem was notable inside the offices of the Wall Street underwriters of what are called collateralized debt obligations (CDOs), pools of bonds which are backed by pools of mortgages, and so on.
Bucket Shop Bonds
When you invest your money, you expect a competent money manager who will protect your investment, right?
However, too many investors in these mortgage-backed and other asset-backed bonds invested on autopilot, without checking who was watching their money.
Specifically, the securities and derivatives under scrutiny were supposed to be overseen by competent investment managers to ensure investors money was protected and returns were being paid.
Anything less is a breach of fiduciary duty, and potentially securities laws, says Janet Tavakoli, derivatives expert and author of “Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street” (John Wiley & Sons, 2009).
So who were these guys who oversaw these jerry rigged bonds?
Executives you wouldn’t want managing your local McDonald’s, notes Fox Business’s Joanne Ossinger.
And the deals were filled with so many rotten heads of lettuce.
An Unregulated Bond Factory
Derivatives expert Tavakoli says that in November 2006, she warned a Wall Street shop that “their CDO managers are unregulated,” that “most do not have the expertise or the resources to perform CDO management or surveillance,” and that “many cannot build a CDO model.”
She also noted that “rating agencies rarely ask for background checks on CDO managers.”
Many prospectuses for these securities offerings read like “finance comic books,” Tavakoli says she wrote in a letter to legendary investor Warren Buffett in December 2007.
A Rotten Deal
Tavakoli says one notably rotten deal came across her radar screen. In late 2006, she read the prospectus for a mortgage-backed security that took hundreds of mortgage loans, shoved them into a portfolio, and sold the risk to investors.
The portfolio included negative amortization loans and interest-only loans, the most combustible mortgages bought from some of the worst mortgage mills that have since flopped.
In these mortgages, because principal is not being paid down, the loan amount steadily increases and then the interest rate shoots up, with a massive balloon payment that is similar to the levees breaking in New Orleans, Tavakoli says.
More than 60% of the loans backing this security were purchased form New Century Capital, which in turn bought them from New Century Mortgage Corp., a unit of New Century Financial Corporation, an incestuous stew of a company that restated its financials in February 2007 and then filed for bankruptcy on April 2, 2007, under a cloud of fraud allegations, Tavakoli says.
Merrill Lynch Goes Full-Bore
Merrill Lynch was Wall Street’s biggest underwriter of CDO deals built on loans such as these, derivatives built on loans from places that were essentially mortgage mills.
For example, Merrill Lynch was a part owner of California-based Ownit Mortgage Solutions, a mortgage mill that eventually collapsed in December 2006, Tavakoli points out.
Ownit issued crazy 45-year ARMs and no-income-verifications loans. In the words of William D. Dallas, its founder and CEO: “The market is paying me to do a no-income-verification loan more than it is paying me to do the full documentation loans.”
Michael Blum, Merrill Lynch’s head of global asset-backed finance, sat on the board of Ownit Mortgage Solutions. When Ownit imploded in December 2006, Blum faxed in his resignation, Tavakoli says.
Full Steam Ahead
But Merrill continued to sell derivatives based on Ownit’s loans well into 2007, Tavakoli says.
For example, in early 2007, Merril created a package of securities deals including loans issued by Ownit, Tavakoli says.
However, around 70% of the borrowers of the loans had not provided full documentation of either their income or assets, Tavakoli says. Most of the loans were for the full appraised value, meaning they were no down payment loans, loans given at a time when home prices were already starting to crumble.
In the deal documents, says Tavakoli, Merrill disclosed that Ownit went bankrupt, but did not mention it was Ownit’s largest creditor.
Can Merrill say it did an “arms-length” transaction with Ownit when a Merrill officer sat on the Ownit’s board, Tavakoli asks?
In early 2007, both Moody’s Investors Service and Standard and Poor’s, the credit rating agencies, downgraded the Triple-A rated tranche of the deal, “an investment they had previously rated as ‘super safe’ with almost no possibility of loss) to B (junk status meaning you are likely to lose your shirt),” Tavakoli says.
Moody’s later forecast that 60% of the original portfolio value could eventually be lost, Tavakoli says.
However, the SEC as a regulator of the investment banks had the power to stop this nonsense, but it did nothing to halt this securitization activity. “Instead, investment banks accelerated securitization activity in the first part of 2007,” Tavakoli says.
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