In August 2006, Nichols Smith, an investment banker at now-defunct Bear Stearns e-mailed a colleague, Keith Lind, who was busy selling the firm’s mortgage bond deals to clients. Smith was supposed to be the manager supervising these deals, and the e-mail was to tell Lind what he thought of the latest deal Lind was trying to pitch to the firm’s clients. In two words: Not much. Smith called the bond named SACO 2006-8 a “sack of s**t,” and wrote, “I hope your [sic] making a lot of money off this trade.”
For investigators looking for smoking guns that show Wall Street bankers at the height of the bubble knew the mortgage bonds they were pushing on clients were worthless junk, these e-mails seem about as good as you can get. And yet, nearly five years later after these e-mails were written, and months after they became public this year as part of case brought by mortgage insurer Ambac against Bear and J.P. Morgan Chase nothing has happened. Neither Lind nor Smith have been charged with any wrong-doing over the deal, nor has anyone else at Bear. Other Wall Street firms did similar deals, with similar risky bonds. No one has been prosecuted there either. What’s going on?
Earlier this week, the New York Times reported that the New York Attorney General’s office has been requesting information from Bank of America, Goldman Sachs and Morgan Stanley on how they created and structured mortgage bonds at the height of the credit boom. That investigation has reignited questions about why, nearly three years after the financial crisis, no Wall Streeter has yet to face criminal charges directly related to the mortgage bonds and other toxic deals that lead to the financial crisis. No one really knows the answer, but there are a number of theories out there. Here are the best ones:
Theory No. 1: Prosecutors have been told to back off. In mid-April, the New York Times did a large investigative piece that found a number of instances where prosecutors were told not to pursue Wall Street. Financial regulators, in the wake of the crisis, were worried about the health of the banks. What’s more, the federal government had just shelled out hundreds of billions of dollars to bail out financial firms. Top government officials were worried that banks would be forced to use taxpayer money to defend themselves against prosecution. Worse, they were concerned that large settlements against the banks would send them back into financial distress, hurting their ability to repay the government. So essentially the theory is that the bank bailout shielded Wall Street from being prosecuted for the very acts that necessitated the bailout. Another reason to hate bailouts? Perhaps.
The problem with that theory is that doesn’t explain why prosecutors haven’t been going after more banks and bankers today. Most of the bailout money has been repaid, and Wall Street is back to minting money. But I guess you could argue that since prosecutors were thrown off at the beginning they have yet to get back on the trail.
Theory No. 2: Wall Street is innocent. It may seem like the most bizarre answer, but it is getting some traction. No one is really saying that Wall Street didn’t do anything wrong. It’s clear that setting up risky mortgage bonds to sell to investors and then betting against them yourself is wrong. But is it illegal? It’s not quite clear. This is essentially the argument that long-time Wall Street columnist Roger Lowenstein made in a recent story in Businessweek.
To some people this theory seems impossible. Inside Job filmmaker Chris Ferguson used his time on stage to question why three years after the crisis no Wall Streeter has been sent to prison. Yet, Ferguson spent over a year detailing the financial crisis, and there’s nothing in his movie that really proves anyone on Wall Street broke the law. Ferguson does a nice job of nailing some economists, but that’s really the only gotcha moment in the movie. So if Ferguson couldn’t find a smoking gun, why does he think prosecutors will.
Theory No. 3: The cases are still in the works. Blogger and lawyer Isaac Gradman recently wrote a piece about the top 5 reasons we are about to see a flood of cases against Wall Street. And there seems to be some evidence that prosecutors are starting to be more aggressive in pursuing cases. One example is the recent Department of Justice case against Deutsche Bank, which alleged that its mortgage unit duped a government program into approving questionable home loans. The other piece of evidence is the fact that the New York State Attorney General’s office, despite efforts by other AGs to get a large settlement and put the matter behind them, is reopening an investigation into how Wall Street created and sold mortgage bonds.
It’s not clear what part of the mortgage process, or what potential wrong doing, the NY AG Eric Schneiderman is investigating. One good guess has to do with the vetting of mortgages. Back in 2008, then NY AG Andrew Cuomo granted immunity to a firm Clayton Holdings that was regularly hired by Wall Street firms to check the quality of the loans that the investment banks were buying and packaging into bonds. Turns out the quality was pretty low. But investment bankers bought the mortgages anyway, and passed them along to investors without telling them about the third-party reviews. The Financial Crisis Inquiry Commission made a big deal about Clayton and the fact that Wall Street firms didn’t disclose the vetting firm’s findings to investors. A lot of people have called this a smoking gun. The excellent financial blogger Felix Salmon has called this the “enormous mortgage bond scandal.” But again, Cuomo and others have known about this since at least late 2008. So I’m not sure what else there is to uncover that would lead to criminal indictments that hasn’t already.
The truth is that Wall Streeters rarely go to jail. Yes, other bubbles and financial crises have resulted in numerous convictions, but generally not of Wall Streeters. In the 1990s, it was the heads of the Savings and Loans that went to jail. In the bust of the early 2000s, it was chief executives like Enron’s Jeffrey Skilling that ended up doing the perp walk. Wall Street analyst Henry Blodget was caught red-handed by then NY AG Eliot Spitzer recommending stocks he didn’t believe in, but again that didn’t lead to jail time. He and the firm he worked for Merrill Lynch ended up paying a fine, as did other firms. And it was less than the fine that Goldman Sachs had to pay this time around.
Nonetheless, if someone should be investigated for wrong doing, you might want to start with the Bear Stearns bankers that come up in the Ambac suit. Clayton plays a part in that case as well. Like other banks, Bear’s bankers had reports from Clayton that should have, and potentially at least in the case of Smith, who sent the e-mail, let them know that the mortgages they were selling were likely to be bad investments. What’s more, when the mortgages did go bad, the trader Lind and others at Bear collected payments to compensate investors for the fact that the loans had defaulted. But they didn’t pass those payments along to bond holders who they had sold the bonds to, and actually took the lose when the borrowers stopped paying. This all seems wrong. Prosecutable? I guess we’ll see.