Mark Pittman: Where is this demand coming from? How can you guys sell this issue in thirty minutes? Who the hell’s buying this stuff like that? We’re going to come to the answer that it was going off balance sheet, at least temporarily, and then it might be sold to other customers.
The Audit: So they were buying it themselves and…
Pittman: They were buying it themselves. Yeah. And not every deal. But you know what—it happened enough.
—Ryan Chittum’s interview with the Bloomberg investigative reporter in May 2009. Pittman died unexpectedly the following November.
Ah. Finally.
Two years after the Great Crash of 2008, we are now getting a clearer picture of just how bad it was on Wall Street during the mortgage frenzy’s last years, what might be called the Locust Years.
As the housing market slowed, drying up the market for CDOs, Wall Street banks maneuvered to create, on a huge scale, other CDOs—cat’s paw operations—to buy the CDOs they had already created.
This is not a wonky detail. This Wall Street-created false market for CDOs—a clear, honest-to-goodness flimflam—reverberated all the way down the value chain, down through the Countrywides, the New Centurys and other mortgage boiler-room operators, down through the strip-mall mortgage brokers, down to the strapped subprime borrowers at end of the phone hearing all about the wonders of the Pick-A-Pay Option ARM.
ProPublica and NPR’s Planet Money (in partnership with This American Life)posted an important story last night that rings like a church bell. This is one of the special stories that both bring important new information into the public record and clarify a complex problem, all at the same time. Read this:
Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses:
They created fake demand.
You can’t get much clearer than that.
And this wasn’t just on the margins. At one point, two-thirds of all CDOs were being bought by other CDOs. These two paragraphs are well worth reading:
An analysis by research firm Thetica Systems, commissioned by ProPublica, shows that in the last years of the boom, CDOs had become the dominant purchaser of key, risky parts of other CDOs, largely replacing real investors like pension funds. By 2007, 67 percent of those slices were bought by other CDOs, up from 36 percent just three years earlier. The banks often orchestrated these purchases. In the last two years of the boom, nearly half of all CDOs sponsored by market leader Merrill Lynch bought significant portions of other Merrill CDOs [3].
ProPublica also found 85 instances during 2006 and 2007 in which two CDOs bought pieces of each other’s unsold inventory. These trades, which involved $107 billion worth of CDOs, underscore the extent to which the market lacked real buyers. Often the CDOs that swapped purchases closed within days of each other, the analysis shows
ProPublica/Planet Money here build on their own illuminating Magnetar story and on a line work in The Wall Street Journal, the New York Times and elsewhere showing that great financial institutions threw their own standards out the window to keep the bubble going, long after it was clear to bankers that it was headed for a giant crash. This had nothing to do with allocating capital to its most efficient purpose. It was about getting bonuses without regard to consequences, even for their own institutions.
I quote Mark Pittman at the top because he was a financial journalists who surely got the big picture (and he got it very early). The authors of this piece, ProPublica’s Jake Bernstein and Jesse Eisinger can certainly be included on that not-long-enough list.
The culprits in the spotlight here are Merrill Lynch, Citigroup, and Credit Suisse—though Goldman makes a cameo and looks terrible. I’m sure Bear and Lehman will get theirs someday soon. At this point it’s only a matter of time.
The ProPublica/Planet Money story isn’t long—indeed, not a word is wasted—but I can’t resist highlighting a few segments and making a few points:
Everyone has known this since they invented TARP to rescue banks.
The "Troubled Assets" of the banks were the CDO's and that was openly discussed.
This is really silly reporting to anyone who is familiar with the securitization mess.
#1 Posted by Sally, CJR on Fri 27 Aug 2010 at 08:02 PM
But, Sally, it's not "silly reporting" to those of us who are not experts, and not familiar with the securitization mess. I learned a lot from this piece. And I'm left with a big question--why haven't there been any prosecutions?
#2 Posted by Larry, CJR on Fri 27 Aug 2010 at 09:57 PM
The pseudonymous financial blogger Yves Smith investigated the Magnetar hybrid CDO deals, shorting the mortgage market synthetically, as the climax to her book on the financial crisis and its origins "Econned". The book was "put to bed" with the publisher in Oct. 2009 and only published at the beginning of March 2010. A few weeks later Pro Publica came out with its piece on the Magnetar trades without any attribution. (Michael Lewis' pop book on the CDS mortgage shorters, judging by reviews, tended to treat the shorters as eccentric heroes and showed no sign of understanding the systematic implications and damages being done). Smith's account was more technical and complex that Pro Publica's, thus ultimately clearer, more rigorous and trenchant, and as a long time Wall St. "insider", that is, an experienced professional on competitive markets, an analyst rather than a more "balanced" journalist, she was willing perhaps to attribute more cynically dark or murky motives not directly in evidence, for example, surmising that Magnetar's sponsorship of its hybrid CDO deals enabled it to front run the buying and pricing of CDS protection. But the two accounts are broadly similar and convergent.
Since CJR functions as a kind of public ombudsman for the press in the public interest, shouldn't you be drawing attention to Smith prior contribution and appropriately attributing it. (Perhaps you could contact her; she might even send you a free copy of her book to examine). Smith and Pro Publica no doubt have somewhat different "proprietary" interests in this story and there is an element of petty rivalry involved, but they are broadly on the same side of the public interest in exposing this matter of momentous public consequence, the systemic and structural mechanisms behind the genesis and unfolding of the housing and general credit bubble on Wall St. and beyond which ended "inevitably" in such a massive financial crisis and economic melt-down. Bringing the two accounts together with proper and fair attribution can only strengthen the case in imprinting it on public attention and awareness.
There are two basic systemic/structural points that should be emphasized. (Yes, there was much self-dealing, corruption and outright fraud involved, but, alas!, it's not clear that any of it was exactly illegal, and certainly it occurred with an astonishing lack of regulatory oversight or even awareness, indeed, with active regulatory acquiescence ). 1) The whole machinery of structured securitization with derivative credit "insurance" required a chain of resecuritizations to "work". The only way to take a pool of BBB mortgages and create a structure with 80% "AAA" tranches is to concentrate the risk in the lower rated tranches, for which there was little market demand. So to continue the build-up of securitizations, the lower rated tranches were placed in re-securitizations called CDOs, consisting largely of BBB tranches of BBB mortgages, i.e. further concentrations of risk, which, in turn, needed to be disposed of through further securitizations, etc. (There were some other mechanisms for unloading structured "product", such as off-balance-sheet SIVs or the creation of "super-senior" tranches which remained on the IBs' books as supposedly risk-free, but the chain of securitizations with "credit enhancements" was the key to maintaining the myth of "AAA"). This was Ponzi finance, in Hyman Minsky's sense, not a secret, privately narrow scheme, but an open, public Ponzi market. 2) At the end of the credit bubble, the formation of hybrid or synthetic CDOs consisting primarily of CDS contracts not only artificially maintained the demand for increasingly dubious mortgages, even after the housing bubble had ended and started to slowly deflate, by artificially propping up the prices of securitization tranches, (or, otherwise put, maintaining the underpricing of eventual risk), but they actually engendered something of a financial/econom
#3 Posted by john c. halasz, CJR on Fri 27 Aug 2010 at 10:11 PM
How is this story different from Michael Lewis' 'The Big Short,' which was published in January?
I agree that it was well-presented for an unsophisticated radio audience. But it wasn't news.
If CJR thinks this is news, then CJR hasn't been paying attention.
#4 Posted by Harry Eagar, CJR on Sat 28 Aug 2010 at 06:25 PM
It certainly doesn't hurt anyone if Propublica revisits this story. But for the past three years or so, the fact that banks owned the high-risk equity tranches was discussed on the front pages of all the major newspapers. It's been covered just as extensively as can be, in papers, and in best-selling books.
Still, there are apparently some people who didn't read anything about collateralized debt obligations though until now.
In terms of prosecutions, there have been precious few because investigators haven't been able to establish criminal conduct (although they may be missing something of course.) It has been widely reported that there are various task forces investigating, so that is nothing new. The indictment of Bear Stearns Ralph Cioffi was well publicized as was his acquittal.
#5 Posted by Sally, CJR on Sat 28 Aug 2010 at 10:06 PM
Thanks Sally, Larry, John, and Harry:
I think John hit on my view with this sentence: "There is an element of petty rivalry involved, but they are broadly on the same side of the public interest in exposing this matter of momentous public consequence," etc.
PP doesn't claim to be the first to report on the creation of fake CDO markets. Its claim is specific enough; it's about the *extent* to which specific institutions bought their own product, a point Yves acknowledges in her post on this. And a breathtaking extent it is.
Whether PP could have done more to acknowledge previous work on the subject is a fair question, though it does nod to the WSJ work as well as Lewis's.
I hope everyone doesn't get bogged down in fights about credit and just keeps digging.
Sally, far from hurting anybody, it's an important advance in the public's understanding. And in the end, readers come first.
#6 Posted by Dean Starkman, CJR on Mon 30 Aug 2010 at 12:22 PM
I read the PP story with interest as I'm not a that sophisticated financially. I found it to be new information for me, at least in the scope of the fraud. Of course the commentary above would have been a bit more amicable if the PP piece had included full citations for cited work.
#7 Posted by Timothywmurray, CJR on Mon 30 Aug 2010 at 04:22 PM
Dean,
To characterize the lack of attribution as an issue of petty rivalry diminishes both efforts and distracts from the more significant fact that there is a body of research previously published and available at Naked Capitalism , and in Econned ,on a topic that is exceedingly difficult to describe in layman's terms. Ideally ProPublicas piece will draw eyeballs to the story, which should lead directly to the extensive research previouslly published by the team at Naked Capitalism.
I'm not a layman in this space. It makes experts brains hurt as they try to unravel the intricacies of the structures and connect the dots.
I am thrilled more people are finally willing to help tell it. But it seems unjust that a truly independent tiny shop of experts is put in the position of defending their claims to fine work on a difficult topic, especially here.
#8 Posted by MichaelC, CJR on Mon 30 Aug 2010 at 05:29 PM