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Failing To Ask Tough Questions
 Are News Investigators Afraid To Call It Criminal?
(opinion/commentary)

One of the most insidious aspects of the reporting on the sub-prime mortgage crisis is the general consensus around certain concepts which tend to sanitize what took place. One of those concepts is the idea that our economic problems are just another down business cycle and that our general problem is to get through it, so we can return to business as usual. As for the sub-prime mortgage meltdown itself, the news media seems content to support the idea that it was caused by "overly optimistic projections", or just plain "bad judgment" by highly compensated executives "who should have known better".

Since most of us in the general public tend to assume that the members of the press are our advocates, we also tend to assume that if something really bad was going on, we would expect them to investigate it and expose it. The most recent (prior) counter-example to that thinking was the near universal acceptance by our representatives in the media of the Bush administration's assertions with regards to "weapons of mass-destruction" in Iraq. Only one major news organization (Knight-Ridder) actually did any serious investigation into those claims, and their reporting on it was largely ignored.

Now, faced with systemic economic problems which have been accumulating over a period of three decades, and a handful of very large financial institutions which appear to be able to force our government to hand over public funds in the hundreds of billions, without any real oversight or transparency as to their ultimate disposition, we are also asked to accept (by omission of it's discussion) the idea that very few (if any) of the people who profited massively from the sale of these toxic assets might be guilty of criminal conduct.

One of the cardinal principles that we all tend to agree upon with respect to the securities industry is that "insider trading" is illegal, and therefore criminal. Typically, insider trading implies that someone who is aware of information which is not public, purchases or sells securities in anticipation of that information being made public. However, if someone offers a security for sale, knowing that the risk associated with that security has been misrepresented, and the seller expects to profit by that sale, is that not a form of insider trading as well?

Of course there's a plausible argument that risk is, by nature, highly subjective. So those who may have engaged in this form of misrepresentation may choose to claim that they promoted these transactions based on faulty judgment, which while reprehensible, does not rise to the level of a crime. However, another way of looking at it involves the objective reality of the compensation systems which were in place, and which drove the entire sub-prime mortgage "industry" from bottom to top: commissions, fees for services, and bonus compensation based on theoretical asset values of large, mortgage-based security portfolios.

In this case, we had large organizations selling securities, the value of which could not be determined with certainty over the short term, taking significant amounts of immediate compensation, most if not all of which accrued within the first year. A case can be made that a compensation system which enables those organizations to extract their 'profits' from the transaction almost entirely 'on the front end', constitutes a structurally fraudulent system, in that it hides the real risks associated with those securities from the buyers.

That structure could easily be compared to what is commonly called a 'pyramid scheme', because the seller takes an immediate profit by persuading the buyer of the theoretical potential of future transactions, which the seller knows to be unsustainable over the long term. In my investigations so far, the chain of transactions relating to sub-prime mortgages follow this model uniformly from beginning to end. And yet, the members of the news media reporting on these events, fail to raise the obvious questions as to motive and intent which some (a grand jury for example), might consider obviously criminal.

Last night (March 2, 2009), on the PBS News Hour, I watched Jeffrey Brown's inteview of two expert commentators on the latest report of losses at AIG, during which this same idea was put forward: that the people selling these securities actually believed the risks were non-existent (in other words: they made 'stupid' mistakes). What Mr. Brown did not ask was this:

"How much money did these securities traders 'earn' (and take home) while making these stupid mistakes?"

Even more to the point, this question:

"How much money in bonuses did top AIG executives get paid for the apparent increase in AIG assets, or stock price appreciation related to those apparent increases?"

Put another way, what part of the legitimate profits made by AIG in it's mainstream insurance business units was siphoned off (at the expense of shareholders) in order to enrich those top executives personally, in return for creating 'assets' which later destroyed the company, and wiped out most of the shareholder equity. Which begs the question: should those executives be held criminally accountable for their conduct?

So I wrote an e-mail to Mr. Brown suggesting that next time, he should consider asking some tougher questions about the legitimacy of these so-called plausible explanations. Here's a (link) to the full story on the News Hour website.

My e-mail, sent (Monday March 2, 2009) to onlineda@newshour.org:

Jeff,

The expert from the New York Times (Mr. Nocera) said, referring to the FP group at AIG:

"They didn't think the (mortgages) would go down in value..."
(editors note: the actual quote from Mr. Nocera was: "...they didn't think there would be any losses. That was the absurdity.")

I don't believe the NYT reporter is lying intentionally, but what he said was incorrect. The traders in the FP group, just as all the executives involved in the sub-prime mortgage racket, did not ever believe that those assets would continue to appreciate. In fact, as evidenced by the compensation systems they had put in place for themselves, they merely believed that the assets would remain fungible long enough for them to receive the (often exorbitant) compensation they anticipated receiving for selling these derivative securities.

The chain of corruption is abundantly clear:

1. Fast buck mortgage-broker boiler rooms sell as many of these flimsy adjustable mortgages as possible, performing the minimum due-diligence to persuade a bank loan officer to approve the loans to under-qualified buyers. (I have personal knowledge of how this business was conducted, as several business associates of mine were involved in it, and casually referred to what they considered "standard operating procedure" in order to push these loan packages through.) As soon as the loans are approved, those brokers and a multitude of other real-estate professionals received commissions, and the bank acquires an 'asset'.

2. Whiz-kids at corporate investment banks cobbled together 'baskets' of mortgages, put them into shell corporations to be traded over-the-counter (unregulated). Lawyers and finance specialists take their fees.

3. Ratings agencies were offered sophisticated 'risk analysis techno-babble' composed by highly qualified mathematicians as justification for rating these securities as carrying an acceptable and manageable risk. As long as they had a plausible explanation for accepting that documentation (the academic credentials of the mathematicians who created it), they were glad to accept the ratings fees they received.

4. Armed with those ratings from Standard & Poors/Moodys, and the theoretical returns they were able to project, these large investment banks (which were rapidly becoming too big to fail), marketed these securities to anyone who was willing to risk their money, or more often, someone else's money, buying the derivatives. Once again, fees were paid.

5. When potential buyers of these securities raised reasonable questions about the 'real risk' associated with them, they were offered 'insurance' in the form of Credit Default Swap contracts. This provided one layer of (unregulated) security for the investor. If the investor was a fiduciary agent, the CDS contract provided a way of demonstrating that they had "gone the extra mile" to protect their client's interests.

At every stage, the compensation was being paid as each transaction took place. Even though the underlying assets implied and depended upon 20-30 year terms of performance in order to fully realize the value they supposedly represented, all of the parties through which these transactions passed cashed in their compensation within a year of closing, based on their best-case, most optimistic future performance. And now, reporters ask: "Why would they do that?"

To ask "Why", given these facts, is an oxymoron. The individuals actively involved in this racket made sure they got their compensation out as quickly as possible, knowing that regardless of the intermediate or long term disposition of those mortgages, they would have captured their slice of the pie. So the real answer to the original question is not that they believed the mortgage asset values would never go down, the answer is: they didn't care whether asset values went down, because they were being paid simply to close the deals.

If we take a look at Richard Fuld of Lehman Brothers as a prime example, the same analysis applies: Mr. Fuld expected to receive in the neighborhood of $400-million in bonus compensation in 2008. Was it in his interest to exercise a critical analysis of the true financial condition of his own firm? Absolutely not. It was in his interest to continue to insist that "he believed" Lehman Brothers was on sound financial footing for as long as possible.

I would also ask this question: so what if the people who sold the CDS contracts don't get paid? They were trading in an unregulated market, with no explicit guarantee that the counter-parties would be able to respond to the 'triggers'. Who are these shadowy individuals who claimed to have assets sufficient to cover hundreds of trillions in 'bets' on sub-prime mortgages? Why are their financial interests superior to the good credit of the United States? One of your experts said that AIG considers the names of these people a "trade secret". It begs the question: if you want government funds, why not require them to divulge the names and the amounts of the CDS contracts?

As long as the news media continues to accept these euphemistic answers and outright omissions of fact, these "plausible explanations" as to the motives of the thousands of financial executives who did and are continuing to feed off of this tacit pattern of corruption by consensus, they will get away with it. Their co-conspirators in Congress will continue to criticize them for their "bad judgment" and selfish motives, anything but utter the truth, which is that these people were engaged in inexcusable fiduciary misconduct at just about every level. It was a "racket by consensus of interests". For many of them, the actual conduct should be treated as criminal, and the gains they took home should be recovered.

As for the members of Congress who first repealed the inconvenient regulatory hurdles necessary for them to create this racket, and then looked the other way while they exploited the opportunities that had been created, the details of their relationships with these criminal operatives on Wall Street should be fully disclosed.

However, none of that will happen until the members of the Fourth Estate step up and fulfill their obligation to report the truth.

Of course my allegations as to what they knew and why they did nothing about it are subjective opinions, since it's impossible to know for sure what anyone is thinking. On the other hand, given the often astronomical amounts of compensation paid to these individuals, one could make the case that in accepting that compensation, they in effect stipulated as to sufficient competency in the field to know exactly what they were doing, and should therefore be held accountable.

That is the larger principle which the perpetrators themselves, and the media who report on their activities, are doing everything possible to sweep under the rug. Why? I can only conclude that the number of very influential people, some of them elected officials in Congress, who might be found culpable is simply too large to allow it to happen. And unless our new President chooses to order the Department of Justice to start down that path, they never will be.

Here is an excerpt from Jeffrey Brown's interview containing the exchange I referenced in my e-mail:

Credit default swaps harmed AIG

JEFFREY BROWN: And now to more on the AIG story. And for that, we turn to Frank Partnoy, director of the Center on Corporate and Securities Law at the University of San Diego, and Joe Nocera, a business columnist for the New York Times. He also writes the paper's online "Executive Suite" blog.

Well, Frank Partnoy, first, remind us what AIG did to get into so much trouble.

FRANK PARTNOY, University of San Diego: The key thing AIG did was to abandon its traditional insurance business in favor of a second business in derivatives, the credit default swaps that were referred to earlier.

AIG was the world's largest insurance company. It was a safe company. It was trusted. It had roughly $1 trillion of value, in terms of assets. And it shifted about a decade ago towards a much riskier business.

Its subsidiary, AIGFP, its AIG Financial Products subsidiary, began writing large numbers of credit default swaps. And that business was largely opaque. It was undisclosed. People didn't know about it. And that's the business that carried the seeds of disaster that we're seeing now and over the recent few months.

JEFFREY BROWN: So, Joe Nocera, what would you add to that? I mean, we keep referring to this as a insurance company. Is that just wrong?

JOE NOCERA, business columnist, New York Times: Well, there's a couple of things I would add to that. First of all, Frank's description is really a good one.

You know, the F.P. unit in London was 350 people out of, you know, 100,000 employees. And, you know, this is typical throughout this crisis. Very small numbers of people have essentially brought down the financial system.

Secondly, you know, credit default swaps are a form of insurance when you really get down to it, because they're basically saying, "I accept the risk of loss in your portfolio." But they were not regulated like insurance products, and AIG was not responsible for having reserves in case there were losses, because they didn't think there would be any losses. That was the absurdity.

So they thought this was free money. And now, of course, it's turned out to be anything but free money. And the reason you have to keep AIG propped up is because, if they were to default, all of the banks on the other sides of those trades would be in even worse trouble than they're in today.

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