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A ‘Flawed’ SEC Program [A Retrospective “April Fool’s Day” Analysis]

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SEC Failed to Rein in Investment Banks [April Fool’s Day – 2015]

By Ben Protess, ProPublica – October 1, 2008 5:01 pm EDT

Editor’s Note: This investigative report was first published ten years ago. And so, we ask you to consider – on this April Fool’s Day 2019 – how [if] things have changed since then?  

***

Flag MOney

***

The Securities and Exchange Commission [SEC] last week abolished the special regulatory program that it applied to Wall Street’s largest investment banks. Known as the “consolidated supervised entities” program, it relaxed the minimum capital requirements for firms that submitted to the commission’s oversight, and thus, in the view of some experts, helped create the current global financial crisis.

But, the SEC’s decision to ax the program currently affects no one, since three of the five firms that voluntarily joined the program previously collapsed and the other two reorganized.

The Decision – 18 Months Ago

The decision came last Friday, one day after the commission’s inspector general released a report [1] (PDF) detailing the program’s failed oversight of Bear Stearns before the firm collapsed in March. The commission’s chairman, Christopher Cox, a longtime opponent of industry regulation, said in a statement [2] that the report “validates and echoes the concerns” he had about the program, which had been voluntary for the five Wall Street titans since 2004.

The report found that the SEC division that oversees trading and markets was “not fulfilling its obligations. “These reports are another indictment of failed leadership,” said Sen. Charles Grassley (R-Iowa) who requested the inspector general’s investigation.

The SEC program, approved by the commission in 2004 under Cox’s predecessor, William Donaldson, allowed investment banks to increase their amount of leveraged debt. But, there was a tradeoff: Banks that participated allowed their broker-dealer operations and holding companies to be subject to SEC oversight. Previous to 2004, the SEC only had authority to oversee the banks’ broker dealers.

Longstanding SEC rules required the broker dealers to limit their debt-to-net-capital ratio and issue an early warning if they began to approach the limit. The limit was about 15-to-1, according to the inspector general report, meaning that for every $15 of debt, the banks were required to have $1 of equity.

But the 2004 “consolidated supervised entities” program revoked these limits. The new program also eliminated the requirement that firms keep a certain amount of capital as a cushion in case an asset defaults.

Bear Sterns

As a result, the oversight program created the conditions that helped cause the collapse of Bear Stearns. Bear had a gross debt ratio of about 33-to-1 prior to its demise, the inspector general found. The inspector general also found that Bear was fully compliant with the programs’ requirements when it collapsed, which raised “serious questions about whether the capital requirement amounts were adequate,” the report said.

The report quoted Lee Pickard, a former SEC official who helped write the original debt-limit requirements in 1975 and now argues the 2004 program is largely to blame for the current Wall Street crisis.

“The SEC gave up the very protections that caused these firms to go under,” Pickard said in an interview with ProPublica. “The SEC in 2004 thought it gained something in oversight, but in turn it gave up too much public protection. You don’t bargain in a way that causes you to give up serious protections.”

Pickard, now a senior partner at a Washington, D.C.-based law firm, estimated that prior to the 2004 program most firms never exceeded an 8-to-1 debt-to-net capital ratio.

The previous program “had an excellent track record in preserving the securities markets’ financial integrity and protecting customer assets,” Pickard wrote [3] in American Banker this August. The new program required “substantial SEC resources for complex oversight, which apparently are not always available.”

Asked if he believes the 2004 program was a direct cause of the current crisis, Pickard told ProPublica, “I’m afraid I do.”

The New York Times reported Saturday that the SEC created the program after “heavy lobbying” for the plan from the investment banks. The banks favored the SEC as their regulator, the Times reported, because that let them avoid regulation of their fast-growing European operations by the European Union, which has been threatening to impose its own rules since 2002.

SEC Spokesman

A SEC spokesman declined to comment for this article, referring inquires to Chairman Cox’s statement. In the statement, Cox admitted the program “was fundamentally flawed from the beginning.” But Cox, a former Republican congressman from California, offered mild support for the program as recently as July when he testified before the House Committee on Financial Services. The program, among other oversight efforts, Cox said, had “gone far to adapt the existing regulatory structure to today’s exigencies.” He added that legislative improvements were necessary as well, and has since told Congress that the program failed.

More Questions

So why did the commission not end the program sooner? Some say that the program’s flaws only recently became apparent. “As late as 2005, the program seemed to make a lot of sense,” said Charles Morris, a former banker who predicted the current financial crisis in his book written last year, The Trillion Dollar Meltdown [4]. The SEC “didn’t know it didn’t work until we had this stress.”

And leverage does not always spell trouble. In a strong economy, leverage can also be attractive because it can increase the profitability of banks through lending.

In his recent statement, Cox said the inspector general’s findings reflect a deeper problem: “the lack of specific legal authority for the SEC or any other agency to act as the regulator of these large investment bank holding companies.”

Secretary of the Treasury Henry Paulson has called for a refining of the regulatory structure to reflect the global and interconnected nature of today’s financial system. In any case, the program’s failure can be seen in the disappearance of the participating banks: Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs.

skeleton-jpeg1

***

Assessment

Merrill Lynch’s leverage ratio was possibly as high as 40-to-1 this year and Lehman Brothers faced a ratio of about 30-to-1, according to Bloomberg [5].

The Fed and Treasury Department forced Bear Stearns into a merger with JPMorgan Chase in March. And the last two months, Lehman Brothers went bankrupt and sold their core U.S. business to British bank Barclays PLC, and Merrill Lynch was acquired by Bank of America. Morgan Stanley and Goldman Sachs, the two remaining large independent investment banks, changed their corporate structures to become bank holding companies, which are regulated by the Federal Reserve.

As these banks have folded or reorganized over the last several months, the Federal Reserve has largely assumed the SEC’s oversight responsibilities, though the commission will still have the power to regulate broker dealers.

Original Essay: http://www.propublica.org/article/flawed-sec-program-failed-to-rein-in-investment-banks-101

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Mortgage Investors Join Outcry Against Banks

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Coordinated Strategies Emerging

[By Karen Weise ProPublica: Oct. 18, 2010, 1:18 p.m.]

Homeowners, and at times the government, have long complained that banks and other companies that service mortgages aren’t good at their job of collecting monthly payments, modifying loans and processing foreclosures. Now, a new cast of characters are piling on the criticism: the servicer’s own clients, the investors that actually own the mortgages.

The Servicers

Servicers handle the day-to-day of working with homeowners on behalf of the investors, who bought bundled mortgages from Wall Street. But investors are now threatening servicers with legal action. Just like homeowners, investors are frustrated by the poor job in modifying loans that servicers have been doing. They also say servicers are looking out for themselves, not investors’ interests as their contracts typically require.

For example, Investor Bill Frey, who runs the securities firm Greenwich Financial Services, says servicers view investors as “a Thanksgiving turkey to be carved up and shared among them-selves.” Investors can range from foreign governments and hedge funds to college endowments and pension funds. During the housing bubble, they gobbled up AAA-rated bonds created by pools of mortgages. Now that defaults and foreclosure are mounting, investors argue that flaws in how loans are serviced are costing them billions of dollars.

They say servicers have often dragged out foreclosures to rack up fees and refused to reduce second mortgages to make modifications sustainable. Investors often prefer modifications to foreclosures. But for modifications that won’t ultimately prevent a homeowner from defaulting, investors still prefer quick foreclosures so they can recoup their money and move on.

Of Terminal In-Decision

“Terminal indecision is not good,” says Frey. “If it can be fixed, fix it. If it can’t, nix it.”

Servicers have been slow [1] to modify mortgages—something we’ve written [1] about many times [2] — and when they do modify loans, homeowners are still saddled with other debt from second mortgages and home equity lines. Even after modifications under the government’s program, homeowners typically still must spend almost two-thirds of their income to pay off their mortgage and other loans, like credit cards or second mortgages.

Emerging Paperwork Scandal

The current mortgage paperwork scandal [3] adds more fuel [4] to the fire as major servicers have halted foreclosures because of potential paperwork irregularities around the country. Concerns are also growing that banks may not have properly transferred loans into the mortgage pools in the first place. “This deficient approach undermines the integrity and the operational framework of the housing finance and mortgage system as it exists today,” the Association of Mortgage Investors wrote [5] in a press release.

(For more on the growing scandal, check out our recent explanation of the main players involved.)

The Mortgage Bankers Association, which represents most major servicers, did not respond to ProPublica’s request for comment.

Legal Strategies

Investors from across the country have been coordinating legal strategies for over a year ago, with the effort ramping up in early spring, according to Frey. Since then, more and more investors have formed a loose consortium, gaining momentum “like a snowball going downhill,” he says. In the last month alone, the group added other investors that own an additional $100 billion in mortgage bonds.

They have not filed any suits yet, Frey says, because the group is first trying to grow even more. Also, since each investor group has different, nonmortgage business with the banks, some investors have conflicting interests in how to proceed, he says. The consortium now represents investors that own more than $600 billion in mortgage securities, which is around a third of the entire mortgage securitization market. The group includes 65 major mortgage investors; Bloomberg reported that large investment companies including Black Rock, PIMCO and Fortress are part of the effort, as are the quasi-governmental Fannie Mae and the Federal Home Loan Banks, which both own private securitized loans.

Coordinating investors is no easy task, since the mortgage bonds were sliced and diced to be sold off to investors around the world. To assert legal rights, investors must coordinate to prove that they collectively represent a certain percentage of each mortgage pool, or in some cases, a certain percentage of each slice of each mortgage pool. (The Wall Street Journal [6] and Bloomberg [7] both describe how Texas-based attorney Talcott Franklin is coordinating a clearinghouse to keep track of the various investments.)

Once investors have standing in each pool, they have the legal right to pressure servicers and trustees to improve or face litigation. The group says they have the legal authority to act in over 2,300 deals.

Investors say servicers must reduce or cancel second mortgages entirely before adjusting the primary loan, since that follows the legal pecking order of how loans should be paid off. But investors say servicers have are dragging their feet in reducing second mortgages to protect their own books, since the largest servicers — Bank of America, Citigroup, JPMorgan Chase and Wells Fargo — also own almost 60 percent of the $1 trillion second lien market.

Bank

Congressional Oversight Panel

A Congressional Oversight Panel concluded in April that there is “tension” between Treasury’s goal of supporting reductions to second mortgages and Treasury’s interest in ensuring that writing down second liens doesn’t severely weaken banks’ balance sheets. The panel wrote than when a servicer owns the second lien, the “inexorable conflict of interest” will more likely lead to modifications on the first loan, “as it benefits the bank at the expense of the mortgage-backed security investors.”

We’ve previously reported [8] that mortgages servicers frequently tell homeowners that investors are the roadblock to loan modifications, even though few mortgage deals actually restrict modifications.

Servicers are also supposed to act like watchdogs and report back to investors when they identify loans they suspect didn’t meet the lending standards promised when the bonds were initially sold to investors. If the banks did misrepresent the quality of the loans initially, the banks would have to buy back the invalid mortgages from the investors. But in many cases, the servicers are subsidiaries of the banks that sold the bonds, which investors say helps explain why servicers have been dragging their feet. Bloomberg noted [7] an analyst’s report that said mortgage repurchases could total over $179 billion.

Original Link: http://www.propublica.org/article/investors-join-outcry-against-mortgage-servicers

Assessment

According to an investor letter cited [6] in the Wall Street Journal, in some mortgage pools that have high default rates, the banks have not repurchased any loans when the servicers are subsidiaries of the banks that sold the bonds. Investors say this is all no small matter. Since the country’s mortgage market is heavily dependent on government support right now, they insist servicers make good on their contracts before start buying loans and supporting the mortgage market again.

Related Articles:

  1. http://www.propublica.org/article/mod-program-falling-short-of-govts-vague-goals
  2. http://www.propublica.org/article/loan-mod-profiles-runaround
  3. http://www.propublica.org/blog/item/biggest-banks-ensnared-as-foreclosure-paperwork-problem-broadens
  4. http://www.businessweek.com/news/2010-10-13/document-flaws-may-lead-investors-to-fight-mbs-deals.html
  5. http://www.propublica.org/documents/item/association-of-mortgage-investors-press-release-oct.-1-2010
  6. http://online.wsj.com/article/SB10001424052748704814204575508143329644732.html
  7. http://www.bloomberg.com/news/2010-09-23/mortgage-investors-target-banks-using-texas-lawyer-s-novel-clearing-house.html
  8. http://www.propublica.org/article/when-denying-loan-mods-loan-servicers-often-blame-investors-wrongly

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Disorganization at Banks

Causing Mistaken Foreclosures

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By Paul Kiel, ProPublica – May 4, 2010 9:20 pm EDT

Millions of people face losing their homes in the continuing foreclosure crisis, but homeowners often have more than the struggling economy and slumping house prices to worry about: Disorganization within the big banks that service mortgages has made a bad problem worse.

ProPublica is matching local journalists with homeowners having trouble getting loan mods.

Are you a homeowner with a story to tell?
Are you a reporter and want to cover it?

Sometimes the communication breakdown within the banks is so complete that it leads to premature or mistaken foreclosures. Some homeowners, with the help of an attorney or housing counselor, have eventually been able to reverse a foreclosure. Others have lost their homes.

“We believe in many cases people are losing their homes when they should not have,” said Kevin Stein, associate director of the California Reinvestment Coalition, which counts dozens of nonprofits that work with homeowners among its members.

In the worst breakdowns, banks — and other companies that service loans — actually work at cross-purposes, with one arm of the company foreclosing on the home while the other offers help. Servicers say such mistakes are rare and result from the high volume of defaults and foreclosures.

The problems happen even among servicers participating in the administration’s $75 billion foreclosure-prevention program [1]. Servicers operating under the year-old program are forbidden from auctioning someone’s home while a modification decision is pending. It happens anyway.

Consumer advocates say the lapses continue because they go unpunished. “We’ve had too much of the carrot, and we need a stick,” Stein says. The Treasury Department has yet to penalize a servicer for breaking the program’s rules. The program provides federal subsidies to encourage modifications.

Treasury officials overseeing the program say they’re aware of the problems and have moved to fix them. But some states are going further to protect homeowners, with recent rules that stop the foreclosure process if the homeowner requests a modification.

Many homeowners, seeing no other option, have gone to court to reclaim their homes. At least 50 homeowners have recently filed lawsuits alleging the servicer foreclosed with a loan mod request pending or even while they were on a payment plan.

Homeowners have long waits for help

In good times, banks and other servicers — Bank of America is the biggest, followed by Chase and Wells Fargo — were known mainly to homeowners simply as where they sent their monthly mortgage payments. But the companies have been deluged over the past couple of years by requests for help from millions of struggling homeowners.

Homeowners commonly wait six months for an answer on a loan mod application. The federal program for encouraging loan mods includes a three-month trial period, after which servicers are supposed to decide whether to make the modifications permanent. But some homeowners have waited as long as 10 months [2] for a final answer.

Communication breakdowns occur because of the way the servicers are structured. One division typically deals with modifications and another with foreclosures. Servicers also hire a local trustee or attorney to actually pursue foreclosure.

“Often they just simply don’t communicate with each other,” said Laurie Maggiano, the Treasury official in charge of setting policy for the modification program. Such problems were particularly bad last summer, in the first few months of the program, she said. “Basically, you have the right hand at the mortgage company not knowing what the left hand is doing,” said Mark Pearce, North Carolina’s deputy commissioner of banks. Communication glitches and mistakes are “systemic, more than anecdotal” among mortgage servicers, he said.

“We’ve had cases where we’ve informed the mortgage company that they’re about to foreclose on someone.” The experience for the homeowner, he said, can be “Kafkaesque.”

“We’re all human, and the servicers are overworked and trying their best,” said Vicki Vidal, of the Mortgage Bankers Association. She said foreclosure errors are rare, particularly if struggling homeowners are prompt in contacting their servicer.

The Human Face

Frances Gomez, of Tempe, Ariz., lived in her house for over 30 years. Three years ago, she refinanced it with Countrywide, now part of Bank of America, for nearly $300,000. The home’s value has declined dramatically, said Gomez, who put some of the money from the refinancing into her hair salon.

Last year, the recession forced her to close her shop. Gomez fell behind on her mortgage, and after striking out with a company that promised to work with Bank of America to get her a loan mod, she learned in December that her home was scheduled for foreclosure.

So Gomez applied herself. She twice succeeded in getting Bank of America to postpone the sale date and said she was assured it would not happen until her application was reviewed. Gomez had opened a smaller salon and understood there was a good chance she would qualify.

She was still waiting in March when a Realtor, representing the new owner of her home, showed up. Her house had sold at auction — for less than half of what Gomez owed. “They don’t give you an opportunity,” she said. “They just go and do it with no warning.”

It’s not supposed to work that way.

Federal Programs

Under the federal program, which requires servicers to follow a set of guidelines for modifications, servicers must give borrowers a written denial before foreclosing. When Gomez called Bank of America about the sale, she said she was told there was a mistake but nothing could be done. She did get a denial notice [3] — some three weeks after the house was sold and just days before she was evicted.

“I just want people to know what they’re doing,” Gomez, now living with family members, said.

After being contacted by ProPublica, Bank of America reviewed Gomez’s case. Bank spokesman Rick Simon acknowledged that Gomez might not have been told her house would be sold and that the bank made a mistake in denying Gomez, because it did not take into account the income from her new salon business. Simon said a Bank of America representative would seek to negotiate with the new owner of Gomez’s house to see if the sale could be unwound.

Simon said the bank regrets when such mistakes happen due to the “very high volume” of cases and that any errors in Gomez’s case were “inadvertent.”

Timeline: How Michael Hill Almost Lost His Home [4]

Even avoiding a mistaken sale can also be a stressful process.

One day in February, a man approached Ron Bermudez of Emeryville, Calif., in front of his house and told him his home would be sold in a few hours. This came as a shock to Bermudez; Bank of America had told him weeks prior that he’d been approved for a trial modification and the papers would soon arrive. He made a panicked phone call to an attorney, who was able to make sure there was no auction.

Last November, Michael Hill of Lexington, S.C., finally got the call he’d been waiting for. Congratulations, a rep from JPMorgan Chase told him, your trial mortgage modification is approved. Hill’s monthly payment, around $900, would be nearly halved.

Except there was a problem. Chase had foreclosed on Hill’s home a month earlier, and his family was just days away from eviction.

“I listened to her and then I just said, ‘Well, that sounds good,’” recalled Hill, who is married and has two children. “‘Tell me how we’re going to do this, seeing as how you sold the house.’” That, he found out, was news to Chase.

Hill was able to avoid eviction — for now. Chase reversed the sale by paying the man who’d bought the home an extra $19,500 on top of the $86,000 [5] he’d paid at the auction.

After the mistaken foreclosure, he began the trial modification last December. He made those payments, but two months after his trial period was supposed to end, Hill is still waiting for a final answer from Chase.

The miscommunications have continued. He received a letter in January saying that he’d been approved for a permanent modification, but he was then told he’d received it in error.

His family remains partially packed, ready to move should the modification not go through. “I’m on pins and needles every time someone’s knocking on the door or calling,” he said.

Christine Holevas, a Chase spokeswoman, said that Chase had “agreed with Hill’s request to rescind the foreclosure” and was “now reviewing his loan for permanent modification.” She said Chase services “more than 10 million mortgages — the vast majority without a hitch.”

HOPE Hotline

To contest a foreclosure under the federal program, Maggiano, the Treasury official, said a homeowner should call the HOPE Hotline, 888-995-HOPE, a Treasury Department-endorsed hotline staffed by housing counselors. Those counselors can escalate the case if the servicer still won’t correct the problem, she said.

That escalation process has saved “a number” of homeowners from being wrongfully booted out of their homes, Maggiano said. Hill, the South Carolina homeowner, is an example of someone helped by the HOPE Hotline.

Of course, the homeowner must know about the hotline to call it. Gomez, the Arizona homeowner who lost her home to foreclosure, said she’d never heard of it.

Many homeowner advocates say the government’s effort has been largely ineffective at resolving problems with servicers.

“I uniformly hear from attorneys and counseling advocates on the ground that the HOPE Hotline simply parrots back what the servicers have said,” said Alys Cohen, an attorney with the National Consumer Law Center. Cohen said she’d voiced her concerns with Treasury officials, who indicated they’d make improvements.

Bank

New rules to offer more protection

Under the current rules for the federal program, servicers have been barred from conducting a foreclosure sale if the homeowner requested a modification, but are allowed to push along the process, even set a sale date. That allows them to foreclose more quickly if they determine the homeowner doesn’t qualify for a modification.

As a result, a homeowner might get a modification offer one day and a foreclosure notice the next. As of March, servicers were pursuing foreclosure on 1.8 million residences, according to LPS Applied Analytics.

Maggiano, the Treasury official, said that’s been confusing for homeowners. Some “just got discouraged and gave up.”

New rules issued by the Treasury in March say the servicer must first give the homeowner a shot at a modification before beginning the process that leads to foreclosure.

They also require the servicer to adopt new policies to prevent mishaps. For instance, the servicer will be required to provide a written certification to its attorney or trustee that the homeowner does not qualify for the federal program before the house can be sold.

Maggiano said the changes resulted from visits to the servicers’ offices last December that allowed Treasury officials to “much better understand (their) inner workings.”

The rules, however, don’t take effect until June. Nor do they apply to hundreds of thousands of homeowners seeking a modification for whom the process leading to foreclosure has already begun. And Treasury has yet to set any penalties for servicers who don’t follow the rules.

Maggiano said Treasury’s new rule struck a balance to help homeowners who were responsive to servicer communications to stay out of foreclosure while not introducing unnecessary delays for servicers. Some borrowers don’t respond at all to offers of help from the servicers until they’re faced with foreclosure, she said.

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States Differ

Some states, such as North Carolina, have recently gone further to delay moving toward foreclosure if a homeowner requests a modification. State regulators there passed a law that requires a servicer to halt the process if a homeowner requests a modification.

Pearce, the North Carolina official, said the rule was prompted by the delays homeowners have been facing and puts the burden on the servicers to expeditiously review the request. “They’re in total control.”

Stopping the process not only removes the possibility of a sudden foreclosure, he said, but also stops the accumulation of fees, which build up and can add thousands to the homeowner’s debt as the servicer moves toward foreclosure.

In California, state Sen. Mark Leno, a Democrat from San Francisco, is pushing a bill that would do something similar. The servicers “should be working a lot harder to keep homeowners in their home,” he said.

Assessment

Original article: http://www.propublica.org/feature/disorganization-at-banks-causing-mistaken-foreclosures-050410

Conclusion

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Product Details  Product Details

Bank Deals Similar to Goldman Sach’s Gone Awry

Other Major Banks Participated, Too?

By Marian Wang, ProPublica – April 16, 2010 1:36 pm EDT

As you may have heard, or read on this ME-P, Goldman Sachs is being sued for fraud [1] by the Securities and Exchange Commission [2] for allegedly misleading investors about a deal that Goldman helped structure and sell. In the civil suit, the SEC specifically faulted Goldman for failing to disclose that a hedge fund was helping create the investment while betting big the deal would fail.

According to the SEC, Goldman Sachs knew about the hedge fund’s bets, knew it played a significant role in choosing the assets in the portfolio, and yet did not tell investors about it. (Goldman Sachs has called the SEC’s accusations “completely unfounded in law and fact.” And in another more detailed statement [3], it said it “did not structure a portfolio that was designed to lose money.”) 

[picapp align=”none” wrap=”false” link=”term=Goldman+Sachs&iid=8541566″ src=”0/4/f/8/The_Goldman_Sachs_7d6f.jpg?adImageId=12513388&imageId=8541566″ width=”380″ height=”568″ /]

In ProPublica

As we reported at ProPublica last week, many other major investment banks were doing a similar thing [4].

Investment banks including JPMorgan Chase [5], Merrill Lynch [6] (now part of Bank of America), Citigroup, Deutsche Bank and UBS also created CDOs that a hedge fund named Magnetar was both helping create and betting would fail. Those investment banks marketed and sold the CDOs to investors without disclosing Magnetar’s role or the hedge fund’s interests.

Here is a list of the banks that were involved [7] in Magnetar deals, along with links to many of the prospectuses on the deals, which skip over Magnetar’s role. In all, investment banks created at least 30 CDOs with Magnetar, worth roughly $40 billion overall. Goldman’s 25 Abacus CDOs — one of which is the basis of the SEC’s lawsuit — amounted to $10.9 billion [8].

One reporter Jake Bernstein explained the investment banks’ disclosure failures on Chicago Public Radio’s This American Life [9]:

On the Magnetar Hedge Fund

The role of Magnetar, both as equity investor and in their bets against the very CDOs they helped create were not disclosed in any way to investors in the written documents about the deals. Not the marketing materials, not the prospectuses, not in the hundreds of pages that an investor could get to see information about the deal was it disclosed that it was in fact Magnetar who’d helped create the deal, and who’d bet against.

That is, of course, along the lines of what the SEC is suing Goldman Sachs for now. The SEC’s suit also says CDOs like the ones Goldman built “contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market.”

Notably, the SEC did not sue the hedge fund [10] involved in Goldman’s Abacus deals — Paulson & Co. — or its manager, John Paulson. Instead, it’s going after Goldman. And as we pointed out in our reporting, there’s no evidence that what Magentar did was illegal [11].

Assessment

We’ve called the major banks involved in Magnetar CDO deals to see if they were concerned about similar lawsuits. Thus far, Bank of America, Citigroup, Deutsche, Wells Fargo (which bought Wachovia) and UBS have responded and have all declined our requests for comment. Here is Magnetar’s response [12] to our original reporting.

Conclusion

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How One Hedge Fund Helped Keep the Bubble Going

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On the Magnetar Trade

By Jesse Eisinger and Jake Bernstein, ProPublica – April 9, 2010 1:00 pm EDT

In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe.

Precise Timing

At just that moment, a few savvy financial engineers at a suburban Chicago hedge fund [1] helped revive the Wall Street money machine, spawning billions of dollars of securities ultimately backed by home mortgages.

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When the crash came, nearly all of these securities became worthless, a loss of an estimated $40 billion paid by investors, the investment banks who helped bring them into the world, and, eventually, American taxpayers.

Yet the hedge fund, named Magnetar for the super-magnetic field created by the last moments of a dying star, earned outsized returns in the year the financial crisis began.

The Magnetar Trade

How Magnetar pulled this off is one of the untold stories of the meltdown. Only a small group of Wall Street insiders was privy to what became known as the Magnetar Trade [2]. Nearly all of those approached by ProPublica declined to talk on the record, fearing their careers would be hurt if they spoke publicly. But interviews with participants, e-mails [3], thousands of pages of documents and details about the securities that until now have not been publicly disclosed shed light on an arcane, secretive corner of Wall Street.

According to bankers and others involved, the Magnetar Trade worked this way: The hedge fund bought the riskiest portion of a kind of securities known as collateralized debt obligations — CDOs. If housing prices kept rising, this would provide a solid return for many years. But that’s not what hedge funds are after. They want outsized gains, the sooner the better, and Magnetar set itself up for a huge win: It placed bets that portions of its own deals would fail.

Chance Enhancement

Along the way, it did something to enhance the chances of that happening, according to several people with direct knowledge of the deals. They say Magnetar pressed to include riskier assets in their CDOs that would make the investments more vulnerable to failure. The hedge fund acknowledges it bet against its own deals but says the majority of its short positions, as they are known on Wall Street, involved similar CDOs that it did not own. Magnetar says it never selected the assets that went into its CDOs.

Magnetar says it was “market neutral,” meaning it would make money whether housing rose or fell. (Read their full statement. [4]) Dozens of Wall Street professionals, including many who had direct dealings with Magnetar, are skeptical of that assertion. They understood the Magnetar Trade as a bet against the subprime mortgage securities market. Why else, they ask, would a hedge fund sponsor tens of billions of dollars of new CDOs at a time of rising uncertainty about housing?

Key details of the Magnetar Trade remain shrouded in secrecy and the fund declined to respond to most of our questions. Magnetar invested in 30 CDOs from the spring of 2006 to the summer of 2007, though it declined to name them. ProPublica has identified 26 [5].

Independent Analysis

An independent analysis [6] commissioned by ProPublica shows that these deals defaulted faster and at a higher rate compared to other similar CDOs. According to the analysis, 96 percent of the Magnetar deals were in default by the end of 2008, compared with 68 percent for comparable CDOs. The study [6] was conducted by PF2 Securities Evaluations, a CDO valuation firm. (Magnetar says defaults don’t necessarily indicate the quality of the underlying CDO assets.)

From what we’ve learned, there was nothing illegal in what Magnetar did; it was playing by the rules in place at the time. And the hedge fund didn’t cause the housing bubble or the financial crisis. But the Magnetar Trade does illustrate the perverse incentives and reckless behavior that characterized the last days of the boom.

Major Players

Magnetar worked with major banks, including Merrill Lynch, Citigroup, and UBS. At least nine banks helped Magnetar hatch deals. Merrill Lynch, Citigroup and UBS all did multiple deals with Magnetar. JPMorgan Chase, often lauded for having avoided the worst of the CDO craze, actually ended up doing one of the riskiest deals with Magnetar, in May 2007, nearly a year after housing prices started to decline. According to marketing material and prospectuses [5], the banks didn’t disclose to CDO investors the role Magnetar played.

Many of the bankers who worked on these deals personally benefited, earning millions in annual bonuses. The banks booked profits at the outset. But those gains were fleeting. As it turned out, the banks that assembled and marketed the Magnetar CDOs had trouble selling them. And when the crash came, they were among the biggest losers.

Assessment

Of course, some bankers involved in the Magnetar Trade now regret what they did. We showed one of the many people fired as a result of the CDO collapse a list of unusually risky mortgage bonds included in a Magnetar deal he had worked on. The deal was a disaster. He shook his head at being reminded of the details and said: “After looking at this, I deserved to lose my job.”

Magnetar wasn’t the only market player to come up with clever ways to bet against housing. Many articles and books, including a bestseller by Michael Lewis [7], have recounted how a few investors saw trouble coming and bet big. Such short bets can be helpful; they can serve as a counterweight to manias and keep bubbles from expanding.

Magnetar’s approach had the opposite effect — by helping create investments it also bet against, the hedge fund was actually fueling the market. Magnetar wasn’t alone in that: A few other hedge funds also created CDOs they bet against. And, as the New York Times has reported, Goldman Sachs did too. But Magnetar industrialized the process, creating more and bigger CDOs.

Conclusion

Several journalists have alluded to the Magnetar Trade in recent years, but until now none has assembled a full narrative. Yves Smith, a prominent financial blogger who has reported on aspects of the Magnetar Trade, writes in her new book, “Econned,” [8] that “Magnetar went into the business of creating subprime CDOs on an unheard of scale. If the world had been spared their cunning, the insanity of 2006-2007 would have been less extreme and the unwinding milder.”

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Product Details  Product Details

Why Health Savings Accounts are No Longer a Banking Industry Pariah

The High Deductible Insurance Competition Heats Up

By Dr. David Edward Marcinko; MBA

[Editor-in-Chief]

As ME-P readers are aware, I’ve had a High Deductible Healthcare Plan [HDHP] coupled with a Health Savings Account [HSA] for my family, and consulting firm, for more than a decade. We’ve been very pleased with it thus far. No significant health problems along the way; just a few scares that proved costly, but benign, because of physician over-protection, over-reaction, or liability phobia; i.e., its better to be safe, than sorry!.

Still, having some economic skin in the insurance game because of the high-deductible feature, makes one an informed consumer. It also provides a sense of empowerment which, while ultimately illusionary for mortals, does offer a bit of self-control. After all, while we can’t mitigate against drunk-drivers and catastrophic diseases, we can live a healthy lifestyle and pay out of pocket for true health “maintenance” … much as we self-pay to maintain our cars and homes, etc. We can do our best … and hope for the rest.

Of course, the savings portion [HSA] has always been a secondary after-thought relative to the actual re-insurance coverage terms, exclusions and conditions. I personally remain focused on the indemnity or PPO type with full coverage, no co-payments and few restrictions. After all, if I use up my high-deductible for an adverse health incident, I figure I have far more problems to worry about than economic. My health, well-being and probably life are significantly in peril.

Nevertheless, as a health economist, I have always appreciated the above market rates given to my cash HSA account; 5% to 4.0% historically; and now 2.5% even after the domestic implosion thru 2010. Compared to the paltry 0.19% in my FDIC protected Wachovia money market deposit account, or the 0.5% in my non-FDIC protected money market mutual fund [brokerage] account; this is a great deal. And, it is tax exempt.

Oh the Irony! 

So, it comes as some surprise that after more than a decade, and the recent health insurance reform political debacle, that there is a surge of interest in the HSA companion. This time however, interest comes not from the insured’s – but the insurers. And, not from the health insurance industry, but rather from the affiliated [and desperate] banking industry.

How so – and why?

Well, it now seems some insurance companies actually desire the business of folks like me who are willing to bear a higher deductible in return for lower premiums, or who are willing to research CPT® code prices and question the efficacy of the procedures they negotiate with physicians in a collaborative fashion; or who are willing to watch their weights and abstain from over-indulgences for their own good. How novel; and again, why?

It’s the HSA pot-o-gold; Duh!

The Proof

Below, is a copy of an email I personally received from eHealthInsurance soliciting my separate health savings account [HSA] business; not my health insurance coverage business:

Dear David,

Did you know that your health insurance plan can be complemented by a Health Savings Account (HSA)? If you haven’t opened an HSA yet, it’s not too late! An HSA allows you to:

  • Use funds to pay for copays, deductibles, prescription drugs, dental services, vision care and more
  • Save money by deducting 100% of your HSA contributions from your taxable income
  • Earn tax-free interest on the funds that accrue in your account over time
  • Grow your account from year to year – the money you contribute won’t expire; you can even use an HSA as a secondary retirement savings account

There are no penalties or taxes when you use your HSA funds to pay for qualified medical expenses. Take advantage of your health plan’s benefits and open an HSA today! eHealthInsurance has partnered with nationally recognized, highly-rated HSA banks to offer you industry leading choices:

  • The Bancorp Bank
  • HSA Bank
  • JPMorgan Chase Bank
  • OptumHealth Bank
  • Sovereign Bank
  • Wells Fargo Bank

We’re with you every step of the way

Our representatives are also available for online chat 24 hours day.

Gary Matalucci
Vice President of Customer Care

The Question Is?

Such the deal; NOT!

So, any thinking HDHP participant [like me] must logically ask why such “nationally recognized, highly-rated HSA banks” would offer above market rates during these times of essentially zero interest rate levels.  Why the interest at all? Are they trying to loose money; or are they just befriending me?

As tennis player John McEnroe might say: are you serious!

Assessment

Yes John, the high rates are a serious loss-leader for more expensive products.

These banks want to make money; not from the non-existent interest rate spread on your HSA cash, but by enticing us to place this growing cash horde into their “investment vehicles.”  In the recent past, some of us mortgaged our homes chasing the stock market or were goaded into flipping houses. And now, these same bankers are encouraging us to mortgage our health insurance on whatever high-priced, low-quality, fee-ridden, load bearing, snarky “investment vehicles” they can pawn off on us.

Of course, the health insurance companies get a fat sales commission or percentage cut, as well. A win-win situation for all but us – the insured.

Think AARP.

My Personal Advice

Do not do it. Do not take the bait.

The HSA portion of your HDHP is for paying premiums and future medical care in the event of a health catastrophe. It is for savings, not for investing in a risk-bearing vehicle. Far too many of us realized too late that a home is a place to live – not an investment. Likewise, a health savings account is for your health, and health insurance – not risky investing.

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Assessment

Well, that’s my opinion as a retired surgeon, former insurance agent and financial advisor.

Conclusion

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