First, remember, this was about the fees earned from CDO-creation and the compensation (worth the click) earned from the fees.
Keeping the assembly line going had a wealth of short-term advantages for the banks. Fees rolled in. A typical CDO could net the bank that created it between $5 million and $10 million — about half of which usually ended up as employee bonuses. Indeed, Wall Street awarded record bonuses in 2006, a hefty chunk of which came from the CDO business.
Second, without the fake CDO market, there is no demand for junk mortgages generated by boiler rooms. Remember, the fake CDO market was created not to serve the housing market, but because it was slowing down. The renewed demand for CDOs gave new life to the boiler rooms and pushed mortgages to increasingly marginal borrowers.
But the strategy of speeding up the assembly line had devastating consequences for homeowners, the banks themselves and, ultimately, the global economy. Because of Wall Street’s machinations, more mortgages had been granted to ever-shakier borrowers. The results can now be seen in foreclosed houses across America.
Third, we are getting closer to an accountability moment. Names are named. Here’s how an “independent” CDO manager was forced to buy Merrill’s junk:
An executive from Trainer Wortham, a CDO manager, recalls a 2005 conversation with [Merrill CDO chief Chris] Ricciardi. “I wasn’t going to buy other CDOs. Chris said: ‘You don’t get it. You have got to buy other guys’ CDOs to get your deal done. That’s how it works.’” When the manager refused, Ricciardi told him, “‘That’s it. You are not going to get another deal done.’” Trainer Wortham largely withdrew from the market, concerned about the practice and the overheated prices for CDOs.
Ricciardi declined multiple requests to comment.
And that’s not the only name.
Fourth, this story is well-documented and includes, remarkably, on-the-record quotes from the likes of Fiachra O’Driscoll, the co-head of Credit Suisse’s CDO business from 2003 to 2008, the whole time.
Here’s what O’Driscoll says about the supposedly independent CDO managers:
“[T]hey were indentured slaves.”
Fifth, Goldman was not above it:
A little-noticed document released this year during a congressional investigation into Goldman Sachs’ CDO business reveals that bank’s thinking. The firm wrote a November 2006 internal memorandum [10] about a CDO called Timberwolf, managed by Greywolf, a small manager headed by ex-Goldman bankers. In a section headed “Reasons To Pursue,” the authors touted that “Goldman is approving every asset” that will end up in the CDO. What the bank intended to do with that approval power is clear from the memo: “We expect that a significant portion of the portfolio by closing will come from Goldman’s offerings.”
Goldman (formerly an Audit funder) told ProPublica/Planet Money that the CDO manager was independent and the deals were fully disclosed.
Finally, the CDO daisy chain here is shown to have started incredibly early, 2005, and accelerated as the housing market began to fall in mid-2006. In a properly working market, the opposite would be the case.
By March 2007, the housing market’s signals were flashing red. Existing home sales plunged at the fastest rate in almost 20 years. Foreclosures were on the rise. And yet, to CDO buyer Peter Nowell’s surprise, banks continued to churn out CDOs.
“We were pulling back. We couldn’t find anything safe enough,” says Nowell. “We were amazed that April through June they were still printing deals. We thought things were over.”
Instead, the CDO machine was in overdrive. Wall Street produced $70 billion in mortgage CDOs in the first quarter of the year.
Stories like this will help to end once and for all the great and false debate about whether the financial crisis was caused by unpreventable systemic imbalances or whether institutions and individuals can and should be called to account.
The answer of course is both. In the end, as this story shows, it’s not that complicated.
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