WSJ Flicks on Lights in a Wall Street Corner

A terrific story in the Journal this morning shines a light on what the country’s brightest minds do all day on Wall Street—bicker over paper sold by boiler-room lenders to strapped lower-middle-class borrowers.

The piece, by Greg Zuckerman, Serena Ng and Liz Rappaport, describes a trade between Wall Street banks and small Texas outfit that sold them insurance, credit default swaps, on ailing bonds backed by subprime mortgages in California.

The Texas outfit, Amherst Holdings, then arranges for the bonds to be paid off in full, rendering the CDS worthless. Ta da!

Now JP Morgan Chase, Bank of America, Royal Bank of Scotland are crying foul, the Journal says, because they paid 90 cents expecting to be paid a dollar in insurance for bonds that were certain to go bad had they not been redeemed. Ha ha.

A couple of key details to keep in mind, courtesy of the WSJ

Traders can buy credit-default swaps on securities they don’t own. At one point, at least $130 million of bets had been made on the performance of around $27 million in securities, according to a person familiar with the matter.


So far the latest dust-up has been all words, in part, bankers say, because they are wary of attracting more regulatory scrutiny at a time when lawmakers are planning major reforms in the largely unregulated derivatives markets, long lucrative for banks.

First, there’s no small irony in all this, as many of the commenters on the Journal’s story have noted, including the fact that JP Morgan was beaten at a game it helped to invent.

Second, the story is a great example of straightforward reporting at its best because it places new facts in the public domain, and allows people like me to ponder their implications. My take: this is what our brightest minds do for a living?

What is the economic utility of having $130 million of insurance sold on $27 million worth of bonds, especially bonds backed by mortgages that never should have been made in the first place? Remember, as we now know (and “Giant Pool of Money” remains the best explainer on this), it was the demand for bonds that drove the hard-sell of subprime mortgages to unsuspecting amateurs, in this case in California, not the other way around. Without the bonds, subprime mortgage lending remains the backwater it always was. Remember also, as the Journal reported back in 2007, more than half of subprime mortgages were sold to people who probably qualified for more affordable prime loans:

An analysis for The Wall Street Journal of more than $2.5 trillion in subprime loans made since 2000 shows that as the number of subprime loans mushroomed, an increasing proportion of them went to people with credit scores high enough to often qualify for conventional loans with far better terms.

In 2005, the peak year of the subprime boom, the study says that borrowers with such credit scores got more than half — 55% — of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are.

Why, 2005, that’s the same year as the mortgages in today’s story!

And this is all not to mention the fact that this story deals with the sale of bond insurance that was not defined as insurance, meaning that the seller did not have to follow normal insurance rules and set aside reserves to cover potential losses. That’s why AIG went down, and why taxpayers own it.

And then there are the players. Did you know that RBS this year recorded the biggest loss in British corporate history? And as for BoA, proud owner of Countrywide and Merrill Lynch, what more can one say?

A lot that’s wrong with the financial system can be found in this story. Good job, WSJ.

Has America ever needed a media watchdog more than now? Help us by joining CJR today.

Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.