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Taibbi on Schneiderman's task force—plus a primer on mortgage fraud

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Matt Taibbi has a very nice piece on Obama's brave new populism: "Is Obama's 'Economic Populism' for Real?".

The title is itself a topic, and I'll leave that for later. Further in the article Taibbi also discusses New York AG Eric Schneiderman and the bank fraud task force proposed by Obama in his State of the Union address.

The Schneiderman appointment raised a lot of questions. Is he selling out? Is he putting himself in better position to push his prosecutions? Is he being "ring-fenced" by a wily Obama? Will the fact that he's only co-chair dilute his effectiveness?

Most of these questions still aren't settled, but Taibbi does make some things clear (my emphasis throughout):

Some people have been confused about Schneiderman’s new role. The new Unit on Mortgage Origination and Securitization Abuses will not be investigating the same abuses covered in the foreclosure settlement. When the public thinks about corruption in the housing markets on the part of the big banks, what it mostly thinks of is robosigning and the other mass-perjury issues, which is the stuff targeted in the foreclosure settlement.

But in fact those problems were a tawdry little sideshow to the more serious crimes of the housing crisis.
Taibbi then quotes Schneiderman himself on this difference:
Schneiderman said Wednesday his dual roles — raising concerns about a multi-state settlement with the major banks and investigating the mortgage problem — wouldn’t be at odds.

“These are abuses in the foreclosure process. Our working group is focusing on the conduct related to the pooling and the creation of mortgage-backed securities and issues relating to the conduct that created the crash, not the abuses that happened after the crash.”
Keep in mind the mortgage business, as it evolved during the housing bubble, had two ends and a middle. Fraud related to the mortgage market crash occurred at each end.

The two ends are — (1) The consumer end. Home-buyers contracted with banks and mortgage sellers like Countrywide for loans. These are debt contracts. (2) The banking end. Banks sold "securities" using bundles of mortgages as the underlying "thing of value" to its largest (and often, most gullible) customers. There's fraud at both ends.

(The middlemen were the people buying mortgages from people like Countrywide, creating the bundles (the so-called "RBMSs"), then selling them wholesale to the banks — for a very fine fee of course. Those guys are SOL these days — that business is dead — but to my knowledge they're not being investigated for fraud.)

In simple terms, here's what happened. It actually started at the banks-selling-to-customers end, with what a brilliant This American Life documentary calls "The Global Pool of Money". (If you've never heard this documentary and its two follow-ups, you should. They are masterpieces of clarity and research.)

The "Global Pool of Money" means all of the big-boy investment money in the world — the sovereign wealth funds, pension funds, massive investment trusts, hedge funds, bank investment funds, the whole lot — all sloshing around looking for a place to park itself at a profit. After the high-tech crash, much of that investment money (a great many trillions) just sat, going nowhere, earning almost nothing.

As you can imagine, the advisers and directors of these investment funds are not strangers to each other. Far from it — they golf together; they ride in each other's jets; they date each other's wives; they hire politicians to strew roses in each other's footpaths. They use the same tailors, bribe the same corrupt officials, hire the same chauffeurs, and tell each other tall tales behind walls of houses in communities you're not even allowed to know the names of.

It doesn't take much for word to get around in this small group. One day, they discovered "securities" backed by RBMSs (mortgage bundles) — all paying tons of money in a nicely booming housing market — and the race was on. All those trillions of dollars suddenly could not buy enough slices of RBMS-backed securities as sold by the banks.

(Who was the first little bird that whispered the first little news into the first global shell-like ear? Likely a man named Greg Lippmann, a senior trader at DeutscheBank; see below.)

The Global Pool became immediately hungry for this stuff, which created a serious problem for the banks. What kind of problem? Imagine you have a hotdog stand, you buy 1000 hotdogs a day, and mostly sell out. One day, one million people line up in front of you looking for a hotdog. Needless to say, you try your best not to disappoint.

In the case of the banks, they "failed to disappoint" by telling the small-time shops (the middlemen who were creating the RBMSs for them) — "Can you speed it up? Like, Now?" The RBMS shops, who were taking a very sweet slice of the pass-through business, said, "No prob." They in turn went to mortgage lenders like Countrywide, creators of the mortgages themselves, and said, "Big prob — the Global Pool is hungry, and the banks want more mortgages than exist in the world right now."

Countrywide smiled and said, "Got you covered." Then they (not Fanny and Freddie) put anyone with a pulse into a mortgage, sold the paper to the RBMS shops, who rebirthed them into "securities" and sold them to the banks, who in their turn, bundled, tranched and sold the result to the real customer — the Global Pool of Money.

The whole thing was made of tulip bulbs, but prices kept going up, the sales and pass-through fees were huge (seriously; that's where much of the money always is), and there was an enormous side business "insuring" these monstrosities, which meant even more fees. Global "wall street" was swimming in cash and bonuses; the Global Pool thought it had found pieces of old King Midas, all by itself.

How good were the mortgages really? A great many weren't even recorded, and a great many people were lied to in the process of getting them sold. That's the consumer-side scandal (under the umbrella terms "robosigning" and "foreclosure") that the AG settlement duel is about. NY AG Schneiderman is a major thorn in the side of that wrist-slap attempt (pushed by the banks, and ultimately, the Obama administration).

Now ask yourself — How good could those "securities" be, which were sold into the frenzied maw of the Global Pool of Money? Only as good as the mortgages themselves. That gigantic hunger, and the underlying shakiness of those RBMS-backed "securities," is what the 2008 crash was all about.

Investors woke up when the housing market finally turned down, a possibility no one in that world thought ever would happen. (Proof that rich doesn't mean smart, I guess.) At that point smart investors realized the bankers (and the ratings agencies) had lied.

In the new declining housing market, most of that "AAA-rated" stuff turned out to be worth far less than the banks had said they were. The Global Pool of Money lost its global shirt, the people insuring the Global Pool lost their shirts as well (that's the AIGs of the world, plus some banks and hedge funds); and everyone who held these things in their portfolio — including lots of banks — were stuck with investments no one wanted to value because no one wanted to know how low the number was.

The party was over, and everyone who bought this stuff knew they were up a creek.

How much fraud was involved at the banking end? It looks like a lot. And that's what Obama's shiny new task force, if it performs true to its purpose, will go after.

That's the big enchilada. How big? Back to Taibbi:
My first thought, when I heard about this deal, was that Schneiderman was deciding to compromise on robosigning and other post-securitization abuses, in exchange for a mandate to go after the much bigger crimes, which took place in the origination/securitization stages.

The securitization offenses were massive criminal conspiracies, identically undertaken by all of the big banks, to defraud investors in mortgage-backed securities. If you’re looking for an appropriate target for a massive federal investigation, one that would get right to the heart of the corruption of the crisis era... well, they picked the right target here.

If they were to do a real clean sweep on securitization, the federal prisons would end up literally teeming with senior executives from the biggest banks. A lot of very big names would end up playing ping-pong and cards in Otisville and Englewood.

The question is, how real of an investigation will we get? The fact that Schneiderman’s co-chairs are Lanny Breuer and Robert Khuzami make me extremely skeptical. I’m actually not sure that both men, in an ideal world, wouldn’t be targets of their own committee’s investigation.
Taibbi goes on to talk about Khuzami and Breuer. Khuzami got on our own radar in this story. As Yves Smith wrote (quoted in that earlier story):
[Khuzami] was General Counsel for the Americas for Deutsche Bank from 2004 to 2009. That means he had oversight responsibility for the arguable patient zero of the CDO business, one Greg Lippmann, a senior trader at Deutsche, who played a major role in the growth of the CDOs, and in particular, synthetic or hybrid CDOs ...
A "CDO" (collateralized debt obligation) is just the banking term for what this whole article is about — the "security" created by the banks, using RBMSs as the underlying thing of value. (Individual mortgages got packaged into RBMSs; RBMSs got bundled, sliced and sold as CDOs.)

What Smith is saying is that Khuzami was the boss of the guy who first created the hunger for mortgage-backed "securities" in the Global Pool of Money.

And as Khuzami's apparent reward, Thank You Street has convinced Barack Obama to make him Schneiderman's co-chair in investigating this mess, where he can perhaps do still more damage.

See why people are scratching their heads over this?

Bottom line — It really is the big enchilada if the Task Force does its job. Every big bank in the country will have execs in jail, and as our Matt Browner Hamlin pointed out recently, the banking industry itself could collapse and need restructuring. Matt argues, along with others, that the restructuring should have happened already, in 2008, so it's long overdue.

This is the biggest story in the country you probably can't wrap your brain around, but we're trying to help out. Please stay tuned. We sure will.

[Update: Corrected for my bad spelling, plus some added links and cleanup.]


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