Subprime and punishment

June 21st, 2008, 12:01 am · 15 Comments · posted by Mathew Padilla

Is this just the beginning?

On Thursday, former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin were indicted for securities fraud and conspiracy — and Cioffi for insider trading too.

Their indictment is the first subprime-related charge by federal investigators since the mortgage meltdown began more than a year ago.

Attorneys for Cioffi and Tannin say they will be vindicated at trial.

The pair managed two funds that collapsed in June 2007, costing investors $1.6 billion, after bets on subprime related investments soured.

Mortgage Insider quizzed Kurt Eggert (photo above), a law professor at Chapman University who has been following the mortgage industry, about the news – what it means and what comes next. He has criticized Wall Street before.

Q. Many subprime-related investments have lost money. Are the guys from Bear Stearns being unfairly singled out?

A. If the indictment is true, then they are not being singled out just because they lost money. The indictment focused on whether they made misrepresentations about their hedge funds. That is the central question. If they lost money honestly, then they should be acquitted.

Q. But it seems like everyone involved in getting a home loan could be blamed. Critics say consumers exaggerated their income, mortgage brokers pushed higher-cost loans, lenders didn’t double check income and made loans people couldn’t afford, Wall Street firms packaged kinky deals, and rating agencies gave investment-grade ratings on subprime junk. Again, why single out Bear Stearns?

A. I think Bear Stearns was intimately involved in several aspects of the subprime industry. They were not only major players but in ways led the Wall Street attitude on how to handle subprime: what kind of due diligence should be made etc. They were leaders in this, so I think focusing on them is appropriate.

Q. Do you think Wall Street misleading investors on subprime was widespread?

A. I think Wall Street did not do a good job across the board in advising investors of all the risk that Wall Street participants knew about. Much of their description of risk was kind of vague and it was hard for investors to really figure out what the pitfalls were. I think on top of that you had individual Wall Street actors making affirmative misrepresentations, and that’s what these indictments allege. When you make affirmative misrepresentations that is a lot worse than vague disclosure.

To add to that, I think we are just now getting an idea of how widespread affirmative misrepresentations were. And to figure out when people were lying about the securities they were selling, you really have to dig into emails and internal documents of the companies to see how often they were saying things that they either knew or suspected of being untrue.

Q. When will the market to sell loans, known as the secondary market, come back?

A. I think the secondary market as we saw it in 2006 will not come back for subprime loans. I think what happened is investors realized that subprime loans have greater risks than they realized and that securitization did not effectively eliminate those risks. So I think investors will in the long term be fairly wary of investing in subprime.

We will see more than we are seeing now, but I think it will be a long time before it comes back to anything resembling what we saw in 2006.

And for it to come back we are going to need to see effective measures in place to make sure we don’t have borrowers getting loans they can’t afford.

Q. How do you rate government’s response so far? And is government doing the right things to bring back the secondary market?

A. There are two aspects that the government has to work on. One is to fix the subprime market going forward so a lot of abuses we saw up to last year don’t reoccur. I think the Federal Reserve has taken some good steps toward tightening rules and installing consumer protections. The other problem is what to do about all the bad loans made in 2007 and before, figuring out a way to resolve them so we don’t have a wave of foreclosures that could swamp the country. I think government so far has not done a good job of preventing foreclosures, and I think at this point they are not really sure what to do.

Overall, Wall Street has been woefully unregulated in how it treats subprime and mortgage loans and we haven’t seen a willingness to step up and say if you are going to be a major part of the mortgage industry what you should do is be regulated as well, and I think that is one change that is needed.

Q. Additional thoughts?

A. This is just the start. The big question is how deep and how far are the investigators willing to dig. There is a lot more out there that hasn’t come out yet, in my opinion.

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ihatelasner&gwbush says:

June 22, 2008 at 7:10 am

All Republicans in office for the last 25yrs should be prosecuted for de-regulation…Look at the industries in the past 25yrs that suffered from de-regulation!!!

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Carlos says:

June 22, 2008 at 12:22 pm

Fed should look into some News Reporters, National Association of Realtors, etc. They are part of the toxic mortgage frauds.

Thomas says:

June 22, 2008 at 1:24 pm

“ihatelasner” is just screeching for effect, but it bears noting that what he’s half-seriously advocating — basically, the crimininalization of political differences — is what kills democracies. When a public official has reason to believe that to lose power is to get thrown in jail, that creates a pretty strong incentive not to allow yourself to lose power. Which is how you get coups, civil wars, etc.

If the Angry Left ever came remotely close to satisfying its fantasies about throwing the hated opposition in jail, there would be bloodshed. Not a criticism, just an observation of what happens *every time* that kind of thinking gets out of hand.

Buy Houses Now! says:

June 22, 2008 at 2:23 pm

RealtorDaveE,
It’s true that all of those parties looked the other way while they collected their fees, but fundamentally this market was created by Wall Street players like BSC selling fraudulent AAA securities. Without them jamming these to mislead investors, none of the rest would have been enabled.

I’d call these indictments a start, but for the most part the government seems more concerned with shoveling taxpayer money at these perpetrators than prosecuting them. This has been a bipartisan activity, too–the Democrats have been cheering deregulation just as much as the Republicans.

mortgagemaker says:

June 22, 2008 at 4:56 pm

I’d like to point out one more time that its not the kind of loan that is the problem, its the colateral thats the problem. Banks should not have continued to over valuate the collateral. A Paper, full doc loans are foreclosing at a rate we have never seen before in our Nations history, why doesnt anyone mention that????? Its bad valuation turns into a foreclosure, regardless of the credit rating of the owner.

OC Appraiser says:

June 23, 2008 at 10:17 am

It is no secret that 90% of all appraisers in So Cal are either incompetent or just flat out crooks. The scary part is that most of the incompetents actually think that its good customer service to give a mortgage broker client the value that he/she needs to close a deal.
These “appraisers” actually think that its legal to promise a client a certain value or range of value prior to accepting the assignment.
On the other side, the brokers actually think that they are helping out the borrower by making sure that the value comes in or at least getting a “heads-up” if the value is not going to come in. After all, they say, we dont want to waste the borrwers money paying for an appraisal that will not fund the loan.
Nevermind, the appraisal is supposed to be tool that an underwriter uses to asses risk. Collateral risk at that. You got a house worth 100k, and you want to borrower 80k from us, better prove the house really is worth 100k.
And that my friends is where the system broke down.
Appraisers keep pumping value, and keep getting more orders. Mortgage brokers make borrowers happy, because who wouldnt want new granite counter tops and stainless steel appliances. Brokers make their rip, and the thing keeps repeating itself, over and over again, like some fantasy game of monopoly. Nobody ever stops to ask the important question: How is a single mother of 3, working as a waitress ever going to pay off that 600k house she just bought with zero down, interest only, no doc, and all the other poison needed to fund this loan. One thing that these guys never needed to worry about, was the value, because as is well known in the industry: An appraisal with ANY value you need, is just one or two phone calls away. Personally, now I work for a bank as an appraiser, after spending many years competing with all the slime. I still get free time, company car etc, I just dont have to deal will loan people pushing for value. threatening not to pay or send more oders if I dont hit the value. The bank I work for just wants good quality collateral valuation. Imagine that. They actually want to know what the thing is worth. If they can fund the loan great. If not, sorry, they move on to the next one. I guess it makes a huge difference when you are loaning out your own money.
The system is still broken, and until the feds look into “comp check” violations, they will not get to the root of the problem. I do love the stings they are doing now. My appraiser friends in other states tell me that the feds have begun cold calling appraisers and point blank asking if they do comp checks.
Those that say yes, a file is opened and they are further investigated. Sure hope these shmucks got work-files for all those comp checks, or as I call them, “promises to hit value”.

NewToTheArea says:

June 23, 2008 at 1:21 pm

Ihatelasner&gwbush,

Just so you know, the most deregulation for banks came under the watch of Bill Clinton.

CitiBank was created by a phone call from Sandy Weill to Clinton letting him know that if his wife, who was running for congress in New York, wanted Wall Street’s support, he would have to deregulate banks and let them become unregulated behemoths. Just read the book “Tearing Down the Walls” about the life of Sandy Weill. If not for this behind closed doors favor, all of these banks would not have been allowed to have a hand in all different types of financial products. People really do need to question things a lot deeper and start reading more. Both Democrats and Republicans are crooked. It makes me sick as a young mid 20’s American to know that these people represent our country to the rest of the world,

Louis says:

June 24, 2008 at 11:47 am

listen it is pretty simple:
the borrowers knew they were sub prime
the Realtors knew they buyers were sub prime
the loan officers knew the borrowers were sub prime
the mortgage company knew the loans were selling were sub prime
the secondary market knew the loans they were buying sub prime
the rating companies knew they were sub prime, but told the world it was AAA……..

Greenspan knew despite the AAA ratings the sub prime could not possible continue to perform

America basically took a big crap on the world…….maybe next time when we want a war they will be a part of the alliance

TsSunami says:

June 25, 2008 at 10:15 am

“All Republicans in office for the last 25yrs should be prosecuted for de-regulation…Look at the industries in the past 25yrs that suffered from de-regulation!!!”

Ah..emm….
It was the DEMOCRATIC agenda to increase homeownership to lower income & minority households that lead to de-regulation and lower credit standards.

Everyone loves to blame the current administration for current problems. Truth is, the problems of the current administration are usually the result of the previous administration’s policies.

Examples:
NAFTA
Subprime
Bin Laden allowed to survive

All of these began or happened during the Clinton administration.

ColoradoKid says:

June 30, 2008 at 9:49 am

A mere 150 years ago, if you stole a man’s horse, you could end up on the end of a rope dangling from a tree. You don’t EVEN want to know what I think should be done to the scumbag politicians and business elite who are ruining our Country! Oh, and it would be a non-partisan hangin’ at that.

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