FBI Investigates Victims of the Financial Fallout

As the political push for the Paulson/Bernanke plan geared up in earnest, suddenly news releases appeared telling us the FBI is investigating financial firms – with Fannie Mae (FNM), Freddie Mac (FRE), AIG (AIG) and Lehman (LEHMQ.PK) high on the list. The FBI, we learn, has always done a wonderful job investigating mortgage fraud. This is part of a big cover-up, intended to find some evidence to support the confiscation of shareholder property. Later, clarifying rumors emerged to the effect that the investigations will focus on asset quality – the FBI is attempting to find that assets were over-stated on the books of these companies.

FNM and FRE both had capital in excess of their statutory requirements as of their last financial statements before the confiscation. However, if a way can be found to assert that they over-stated the value of their MBS assets, Paulson's actions can be retroactively justified. For AIG, the terms for the bridge loan were confiscatory – the company was hit by a sudden liquidity crisis due to market conditions that would not have occurred if regulators had been doing their job. Nevertheless, their punishment included the forfeiture of an 80% stake in the company and 8.5% interest on the unused portions of the line of credit. After getting security in the form of a lien on all the company's assets, Paulson determined he needed an 80% ownership on top of that. Again, some finding of wrongdoing on AIG's part would be supportive of the goal of retroactively justifying Paulson's arrogant abuse of regulatory discretion.

At a time when credit markets have totally seized up, the FBI determines it needs to investigate over-stated asset values. Probably they will use the lowest market value of illiquid assets as a starting point. Sounds like a witch-hunt to me.

There are a number of more constructive directions the FBI could take:

Subsequent to the NY State Insurance Department claiming jurisdiction over credit default swaps that are supported by an insurable interest, it develops that 80% of the credit default swaps will still be unregulated. That is to say, 80% of this 62 trillion dollar market exists only for purposes of speculation and manipulation. The hallmark of the crisis was a sudden increase of credit default swaps premiums on the next victim. The huge potential for fraudulent manipulation in this arena needs to be thoroughly investigated for criminal wrongdoing.

Similarly, shares of numerous financial companies are permanently listed on the SEC mandated Threshold List for fail to delivers on naked short-selling. While the short-selling ban is in effect, now would be a very good time to follow up on each and every fail to deliver until all have been resolved. In the process of doing so, any criminal manipulation uncovered should be prosecuted.

The rating agencies, to judge by Mario Cuomo's findings, failed to do their job when they rated the whole parade of MBS products to begin with. The original mis-statement of asset values is directly attributable to their improper rating activities. Cuomo found wrong-doing and let them off with a slap on the wrist. Maybe the FBI should take a look at it. The SEC has oversight of the credit rating agencies, but did nothing to prevent their role in creating this debacle.

As a shareholder of Ambac (ABK), I have listened to conference calls indicating that a very large percentage of the mortgages in some troubled books were fraudulent. My guess is that when these have been thoroughly reviewed about 30% will prove to be based on overstated income, overstated property values, or mis-stated occupancy status. These originated with the mortgage applicants but were systematically overlooked if not encouraged by those in the mortgage origination and packaging business. Proper regulatory oversight of their business practices and operations would have prevented the problem.

Current chaotic market conditions were created by a total lack of regulatory oversight in the areas of mortgage origination and packaging, credit rating, credit default swaps, and short-selling. Having resolved the most pressing crises by confiscating the property of the victims, the administration now seeks to justify Paulson's abuse of regulatory discretion by conducting criminal investigations into the victims.

It would be far more constructive to establish a new and more effective regulatory system. There will be plenty of time to investigate criminal activity by all market participants as we sort out responsibility for the financial crisis in years to come.

Disclosure: Long ABK, AIG.

Comments

[turkeyeyes:]

All the heat needs to be focused on the appropriate target: the lying, scheming, thieving hedgefunds and shorts who singlehandedly, and in collusion, did more damage to this economy via poisonous rumors than Al Qaeda ever could.

The FBI is starting to scratch the surface and guys like Einhorn will wind up living lavishly within a federal pen.

www.bloomberg.com/apps...

2008 Sep 25 07:02 AM

[Ishortyou:]

Well the real thing for the insurers is that now they can terminate contracts with fraud, so expect many terminations in the quarters to come.

2008 Sep 25 07:14 AM

[apppro:]

Even the FBI misses the point. True, the crisis comes from the destruction of the CDO/mortgage market, but what was the cause of that market’s collapse.
Yes, there is plenty of blame to pass around, but until short sellers attacked the CDO market so they could take down the monolines backing those CDO’s, there was no crisis.
The FBI, SEC, DOJ would be better off investigating Pershing Capital and Bill Ackman to find out the true cause of this current market melt-down.

It should be side-noted that NOW everyone is saying that all those mortgages and CDO’s will make the Government a profit when they buy them. Gee whiz, I thought Ackman and others has made us all believe that they were worthless. And I mean worthless – not worth less.

#4. Implement a WindFall Capital Gains Tax of 65% on ALL SHORT SALES retroactive to 01/01/08.

2008 Sep 25 07:19 AM

[glassbox:]

Tom, thank you for putting everything into perspective so eloquently and in language people can understand. It amazes me that no one has dared say the things you are saying now. Perhaps part of the problem is that no regulator would like to say that they were wrong to start with. Certainly hope that a few good men are still around to stand up for what is right!

2008 Sep 25 07:24 AM

[madasiwannabe:]

The whole GSE takeover was a smoke screen to divert attention away from the other 50% of the mortgage market. The reason the banks are holding to maturity is because they couldn't get them past Fannie and Freddie screeners. That's why their default rates are 1/5th of the industry average. The whole MBS market is exactly what took down the S&L's. We learned nothing.

I'm sure the originators wrote BS contracts so they could get their commissions, but the banks are not totally victims either. They never took the time to look at the loans or provide any oversight to the LLC trusts that sprang up to get into the cash stream. Many of these guys are now gone and we the taxpayers are getting stiffed with the bill.

2008 Sep 25 07:36 AM

[Trish Wilds:]

Great article! Please write another on the other reasons our economy is in the toilet. Not only were bad loans given, about the same time these mortgage arms started coming due and causing higher interest payments, our government passed the law that we now have to start paying approximately a minimum payment of 2% monthly on our credit cards and also gas prices started to increase along with groceries starting to increase. All of these bad loans are not only due to misguided and manipulated underwriters. It was all of this put together at once that started it. Can you imagine having your house payment increase from $1000 to $1500, gas is now costing you $200 more a month and groceries are now costing you $200 more a month when you are on a fixed income? What's more important, food and toilet paper or your house payment?

2008 Sep 25 07:43 AM

[madasiwannabe:]

apppro is correct about Pershing, but they were not alone. When the backstop was announced, the risk went to zero and rewards through the roof for another group; bond and securities brokers like PIMCO. Drive down credibility, drive down ratings, drive up returns. Pure Ponzi; get the markets addicted to credit and then milk them for all the interest they can get. Gross and Ackman announced they made $10 Billion when Paulson stepped in. The biggest one day profit for both companies.

The common thread is Greenspan. He created the mess through policy and then gets a job as a consultant with both Pershing and PIMCO. PIMCO sponsors CNBC programming and for their investment, they get all the airtime they want. Sounds like the perfect place for the FBI to start looking.

PIMCO is drooling right now because they know the bailout will adversly effect the government's ability to attract additional investors (someone has to buy the bonds to pay for the plan). That means even more money. Seen this coming from miles away.

2008 Sep 25 07:49 AM

[Ishortyou:]

now that Frannie is on government hands you would have spect they would buy all these MBS but guess what they are buying the good ones not the bad ones that means some Banks will get in trouble and some small regionals will go belly up...sad...

2008 Sep 25 07:56 AM

[PhinT:]

The situation is beyond scary. We have a Sec of Treasury who was in the thick of this mess back 2006 (and reassured the public that FNM was a solid company before the gov’t took it over) and is making decisions that from my perspective will make the same people $billions more while folks like me have lost large percentages of their 401k over the last 8 years and individual stock trades (FRE/BS/LEH/FNM etc…)…. Who are we really bailing out and will this bill actually benefit those placed in the middle of this criminal manipulation of the market benefiting the few…

If the FBI real does something (which I doubt because it is to far reaching and would be bigger than the Nuremburg trails after WWII) we will be reading about government, Private Equity, Wall Street and Corporate Executive involvement … I hope the FBI does do something and if so, these guys should really be treated as “War” criminals…

2008 Sep 25 08:23 AM

[apppro:]

All I know is, is that it makes me vomit to see everyone bashing the CEO's (and I'm not thrilled with them either) and companies, when the true villians here are getting away scott free.
Criminal - just criminal.

#4. Implement a WindFall Capital Gains Tax of 65% on ALL SHORT SALES retroactive to 01/01/08.

2008 Sep 25 08:33 AM

[MAKORisk:]

I agree completely with succinct litany of the blameworthy. However, I can't agree that the shareholders are innocent victims. Unfortunately, in our system, the shareholders are deemed to be in control of the corporation through their representatives on the board. Anyone with any smarts/sophistication knew long ago that housing was bubbling, that underwriting & documentation were getting sketchy, that appraisal fraud was rampany, that "Alt-A" was a black hole . . . and that credit quality spreads would inevitably gap back out. The boards of AIG, ABK are chargeable with that knowledge, yet they allowed their managers to load the boat with highly leveraged exposures to mortgage risk via synthetic multi-sector CDOs. And in AIG's case inexplicably also promoted the boat-loading by permitting the trades to be supported with collateral obligations. The results should not be surprising, but still the shareholders have not thrown the rascals out.

2008 Sep 25 09:00 AM

[blondino:]

FBI, SEC, all just puppet show for the masses...

2008 Sep 25 09:53 AM

[monday1929:]

Fine, jail crooked shorts. But blaming honest speculators who saw what the Wall Street terrorists (bankers/Fed/Treasury) had done and understood that all credit bubbles burst, and this was the biggest bubble in history, is misguided. Blame the regulators and politicians from both parties who were bought off. Do not be jealous of people who knew a ponzi scheme when they saw one- the honest shorts who did try to warn you and others and were scoffed at. "house prices always go up" I was told. When I showed you in blackand white that that was not true, you said, " well, they won't go down this time".

2008 Sep 25 10:39 AM

[jum92:]

I think it is extraordinary that we have the ability to read articles written by well informed honest investors who are willing to share their insights and frustrations with others! I'm stunned at the realization that the credit default swaps can bring down a good company...Tom's other article explained it precisely why GE could be in trouble because of these CDS's! I'm not close to being as insightful and sophisticated as some of the respondents on this sight, but it's apparent to me that short selling along with CDS or taking the prime brokerage from a firm and letting the "club" know you were doing so along with short selling is not only unethical but also the most crass, self absorbed way of making money. It's a bit depressing when you are past 60 and thinking you are somewhat informed re' the markets, to realize you are so naive in your thinking!

2008 Sep 25 10:23 PM

[glassbox:]

jum92, I feel exactly like you. I've been in this capital markets for the last 18 years and gone thru a couple of other crisis - one of which is the Asian Financial crisis. The extend of unethical trading taking place these days is amazing, its even more depressing to hear that many of these traders (perhaps like monday1929 who posted before you) think that they are just being 'honest speculators'. Frankly, many of these 'honest speculators' who think they are contributing to market efficiency are just being used as pawns by those in the know to bring down a company. Its saddens mean to hear of people saying that they are 'investing' when they are shorting a stock. How can anyone use that word 'investing' and think they are building themselves a future - its complete fallacy.

2008 Sep 26 09:32 AM

[zink99:]

well said.

2008 Sep 26 11:18 AM

[zink99:]

well said.

2008 Sep 26 11:18 AM