The decimation of mortgage underwriting standards was one of the core causes of the financial crisis as the Wall Street banks recklessly assembled, packaged and sold bonds backed by fraud-riddled mortgages.
After the crisis, the private market for such mortgage-related bonds understandably vaporized as once-bitten, twice-shy investors steered clear of the financial products that had caused such mayhem.
Alas, years of zero-interest-rate policy by the Federal Reserve has yet again triggered a chase for yield, and in response the banks are gingerly dipping their toes back into the private mortgage-securitization pool. History won’t repeat itself, right?
Well, not so fast. As with all things related to Wall Street, it’s all about the incentives. And the individuals behind the securitization machine before the crisis made a lot of money. Like buy-your-own-island type of money. And when everything collapsed, they largely kept that money. No indictments, no handcuffs, no jail time and no significant financial penalties for the architects of a crisis built on a foundation of fraud (they were called liar loans for a reason).
Although the government has brought some civil cases, they have been settled on terms that can only be compared to the proverbial slap on the wrist, and we are reminded almost daily that there remain banks that are both too big to fail and too big to jail.
The one silver lining to this very dark cloud is that the banks haven’t yet proved to be too big to nail, as the wronged purchasers and insurers of their toxic bonds have been waging an occasionally successful multiyear legal battle against the banks and, indirectly, actually punishing them financially for their misconduct. It, therefore, shouldn’t be surprising that, as the banks re-enter the securitization market, their biggest concern seemingly isn’t to ensure that they aren’t once again peddling fraudulent products that might bring government scrutiny, but rather to deal with private civil litigation.
So, as reported in the Wall Street Journal, they have proposed stripping away investors’ ability to later sue them by putting an expiration date on the representations and warranties in the bonds and altering some of the presumptions when a borrower defaults.
Put simply, the old bonds contained legal clauses in the contracts that essentially said: “Hey, we promise that what we say are in these bonds are actually in the bonds. And if not, you can sue us.” The new bonds? “Good luck with that.”
As the Journal reports, however, the banks are facing a most unusual obstacle in their plan to unleash what may prove to be the next wave of ticking time bombs: the credit-rating companies. Yes, the same ones that demonstrated before the crisis that the only thing standing between a mortgage-related bond and a AAA rating was a pile of bank money. They are now apparently refusing to bestow such a rating on bonds whose representations and warranties will expire like stale milk.
This is a problem for the banks because they need that stamp of approval in order to persuade large-scale investors to jump back into the mortgage-bond pool with them.
JPMorgan Chase & Co., apparently outraged that a lowly credit-rating company would dare to question one of its elastic economic models, has publicly whined about the stance of one such unidentified rating company. As a result, we are told, credit will be restricted, the economy won’t recover, and countless Americans will be deprived of the opportunity to help inflate the next real-estate bubble.
My response? Well, for the first time in my almost 43 years on this planet, let me say this: Good for you, unidentified credit-rating company.
Whether this is the result of some residual pride in your work (unlikely), a deep sense of shame for your role in the crisis (difficult to fathom), or fear now that the Justice Department has filed a $5 billion lawsuit against Standard & Poor’s for fraud (almost certainly), it’s nice to see someone stand up to the bullies. Now let’s see how long it takes for a rival rating company, fees in hand, to swoop to the banks’ rescue.
(Neil Barofsky served as the special inspector general in charge of oversight of the Troubled Asset Relief Program and is currently a senior fellow at New York University’s School of Law. He is the author of “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street.” The opinions expressed are his own.)
To contact the writer of this article: Neil Barofsky at email@example.com.
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