The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?

New York Review of Books ^ | January 9, 2013 | By Jed S. Rakoff

[aquila48]

“What we normally think of with the word ‘banks’. These banks were not the major players in the housing bubble.”

Wamu, Countrywide, BofA, Wells Fargo, Citi, etc etc were not major players in subprime loans?

I got loans from all of them (all subprime) and I definitely don’t fit the mold of a CRA borrower. What happened was all the banks and loan brokers ended up using crappy CRA type of underwriting for everybody not just CRA types. Why? Because, as you mentioned, they didn’t keep them in house, or they were kept in house just long enough to create a pool big enough that they could be bundled and sold, and then they would repeat the process.

But what’s not clear to me is why so many deposit banks (like Wamu, BofA, Citi, etc) got into so much trouble if they didn’t keep the loans in house. Was it because they got stuck with the loans “in progress” (the ones they were temporarily holding for bundling), and when the SHTF, they got stuck holding the bag? I wouldn’t have thought that those “temporary” pools would be big enough to bring down those large banks.

I also think that the fact that Freddie and Fannie got very heavily in the game of purchasing and securitizing subprime loans (to the tune of something like several trillion) and since their paper was insured by the government, (as safe as treasuries but with better yields), that that contributed significantly to the feeding frenzy.

By the way, I’m curious - were you in the banking or mortgage business?

[Pelham]

“Wamu, Countrywide, BofA, Wells Fargo, Citi, etc etc were not major players in subprime loans?”

Ameriquest and Argent were the biggest and they largely invented the business. Countrywide also, it began as a pure mortgage lender until it bought an S&L.

“What happened was all the banks and loan brokers ended up using crappy CRA type of underwriting for everybody not just CRA types.”

Loan brokers were independent operators funded by credit lines from Wall Street firms. Wall Street demanded high yield paper so the brokers gave them what they were paying for. Retail banks had to write conforming paper if they were going to sell it to Fanny and Freddy. Loan brokers by contrast were dealing in exotic high risk lending because it provided the highest yield.

“But what’s not clear to me is why so many deposit banks (like Wamu, BofA, Citi, etc) got into so much trouble if they didn’t keep the loans in house.”

They were buying CDOs and CMOs like everyone else looking for yield. They believed their own story that this paper was safe- after all it was AAA rated- and they all thought that Li’s Gaussian copula function had proven that it was safe. Of course it proved not to be, which they should have suspected if they had been paying attention.

“I also think that the fact that Freddie and Fannie got very heavily in the game of purchasing and securitizing subprime loans (to the tune of something like several trillion) “

Fanny and Freddy were late to the party and they weren’t the big players in subprime lending. They got burned simply because of their size. Their several trillions was dwarfed by rival private securitizers who wrote tens of trillions of paper. F&F dealt in stodgy, low yield conforming paper even in the subprime sector. Their private sector rivals were writing exotic no doc, no down, NINJA loans (No Income No Job no Assets), That was the very high yield paper that ultimately blew up like weapons of mass destruction.

“By the way, I’m curious - were you in the banking or mortgage business?”

Nope. I have a bit of training in finance and economics but actually I was just in the right place at the right time. I had friends and neighbors and clients and coworkers involved in the subprime business as it began and I picked their brains to find out what they were doing. I used what I garnered to search for articles and books and began filling in the blanks for the parts I didn’t know. It became a crusade of sorts. I badgered my friends about there being a real estate bubble, and they thought I was a crank predicting the end of the world until the world did come to an end. Then they thought I could see the future, a perception I encouraged them to believe.

The only real surprise I got from the collapse of the bubble was its sheer size. I didn’t know that the derivatives and swaps market was in the tens of trillions of dollars and I didn’t expect the fallout to go global.