Facts are stubborn things but ideologues are immune. Extreme right wing rhetoric concerning the role of Fannie and Freddie in the subprime debacle, is an example. As readers of this blog already know, nine out of 10 commissioners of the bi-partisan Financial Crisis Inquiry Commission rejected the thesis that Fannie Mae and Freddie Mac (the "GSEs") operated as the primary cause of the financial debacle. No matter the facts, the right twists some new tale about how the GSEs caused it all (as opposed to being essentially bit players or one of many causes).
Therefore, I anxiously await the response to the following: the real culprits have already fessed up to (or at least paid for) monumental frauds of unprecedented audacity and scale in the subprime market. And, Fannie and Freddie played zero role in this story. A massive number of real estate loans were made with the specific intent of default (i.e. the ultimate in predatory lending) so that Wall Street could make a killing (killing American capitalism for their enrichment) on undisclosed short positions on subprime assets they selected for portfolios that they then foisted on investors across the globe. THEY DEMANDED LOAN DEFAULTS! Wall Street literally loaded up mortgage backed securities (in the form of collateralized debt obligations or CDOs) with the riskiest loans possible so they could cash in on their secret short positions on the very securities they were selling to firm clients.
So, Goldman Sachs paid an all time record $550 million to settle charges that it marketed securities based upon subprime loans without disclosing that a hedge fund was short those very same securities and that the hedge fund played a role in selecting the underlying mortgages for inclusion in the portfolio. In Goldman's own words: "it was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors." This rare admission, betrays a brazen fraud and explains why so many senseless loans were made at the height of the subprime frenzy. In short, the great Wall Street derivatives machine demanded subprime loans that would default.
Citigroup also settled similar charges, on Oct. 19, 2011, with the SEC, for $285 million. Here, Citigroup held an undisclosed short position in the very securities they were selling to investors. Citigroup also allegedly exercised "significant influence" in selecting the underlying portfolio. According to the SEC complaint: "One experienced CDO trader characterized the . . . portfolio in an e-mail as 'dogsh!t' and 'possibly the best short EVER!' An experienced collateral manager commented that “the portfolio is horrible.'” Again, Citi sold securities that it wanted to default, and therefore demanded the riskiest loans possible. Perhaps this explains why private subprime loans failed at over twice the rate of even the riskiest Fannie loans as shown on the chart at right. Banks like Citi wanted loans that would default and default fast. In fact, the portfolio at issue in the SEC action closed in February of 2007, and defaulted by November, in synch with the subprime collapse. Citi made $160 million on this sordid deal.
JP Morgan Chase paid the SEC $153.6 million for its misconduct in subprime lending. According to an SEC official: “What J.P. Morgan failed to tell investors was that a prominent hedge fund that would financially profit from the failure of CDO portfolio assets heavily influenced the CDO portfolio selection. With today’s settlement, harmed investors receive a full return of the losses they suffered.” The SEC also alleged that when the deal closed in May 2007, the hedge fund--called Magnetar--held a $600 million short position that dwarfed its $8.9 million long position in the portfolio. "In an internal e-mail, a J.P. Morgan employee noted, 'We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart.'" The SEC further found that Chase frantically sold interests in the portfolio because it knew how bad the portfolio and it knew the market was starting to come unglued.
The SEC continues this line of enforcement actions. Still, we probably will never know the full scale of these predatory frauds. The FCIC found that more than half of all CDOs generated in the second half of 2006 appeared infected with this so-called "Magnetar Trade." (FCIC Report, p. 192). Notably, all the deals underlying the SEC securities fraud actions hail from 2007. The three settlements above already total in excess of $1 billion. Thus, billions and billions worth of subprime mortgages resulted from this demand for loans that would default.
This newfangled source of predatory lending adds to the predatory loans generated for fees, or to grab collateral, or other old-fashioned predatory lending. Thus, Illinois Attorney General Lisa Madigan (Loyola University Chicago, Law Alum) spearheaded a multistate predatory lending action against Countrywide leading to an $8.7 billion dollar settlement (affecting over 400,000 homeowners nationwide) and currently is again suing Countrywide as well as Wells Fargo for steering racial minorities into high-cost, subprime loans. And, even the Fed took action against Wells Fargo for predatory lending and steering involving 10,000 home mortgages, as noted on this blog, by dre cummings. The bottom line is that massive predatory lending occurred, by any measure, and formed a core cause of the subprime debacle. According to the Wall Street Journal, 61% of all subprime loans in 2006 went to prime borrowers. An LA Times expose' found that 32 former Ameriquest employees "across the country say they witnessed or participated in improper practices, mostly in 2003 and 2004. This behavior was said to have included deceiving borrowers about the terms of their loans, forging documents, falsifying appraisals and fabricating borrowers' income to qualify them for loans they couldn't afford."
So, my question to the right is simply this: given the indisputable evidence of massive predatory lending, how can you ignore this as one (of many) cause? Do you really want to continue to maintain that it was all the GSEs in the face of overwhelming evidence of this massive predatory lending and fraud?
Professor Steven A. Ramirez
Loyola University Chicago