Before the dot com crash, investment banks promoted companies they knew would fail. In December, 2002 ten investment banks settled a suit against them for $1.4 billion, and they vowed to change their ways. The guilty companies were:
• Bear Stearns – $80 million
• Citigroup – $400 million
• Credit Suisse – $200 million
• Deutsche Bank – $80 million
• Goldman Sachs – $110 million
• J.P. Morgan – $80 million
• Lehman Brothers – $80 million
• Merrill Lynch – $200 million
• Morgan Stanley – $125 million
• UBS – $80 million
The Great Depression caused Congress to pass laws regulating the financial industry. Most people who bought a home applied for a mortgage loan. Any institution that made a mortgage loan, made sure the borrower could repay the loan or the institution would lose money. These laws insured our financial stability. They were struck down during the Reagan Administration, freeing financial institutions to invent new high-risk money-making schemes.
Risky investments called ‘derivatives’ appeared. In December, 2000 H.R. 5660, the Commodity Futures Modernization Act passed. It banned the regulation of ‘derivatives’. It was written by financial industry lobbyists.
Lenders sold mortgages to investment banks, who packaged them with car loans, student loans and credit card debt and sold them to investors, calling them Collateralized Debt Obligations or CDOs. Subprime loans are loans to people who may not be able to repay the loans. Investment banks preferred subprime loans, because they charged higher interest rates, and the banks sold the loans, so they risked nothing.
From 2000-2003 the number of mortgage loans made each year nearly quadrupled. Subprime lending went from $30 billion/year to $600 billion/year over a ten year period.
• Countrywide Financial issued $97 billion and made $11 billion profit in 2005-6.
• Countrywide Securities $74 billion
• Credit Suisse First Boston $73 billion.
• Lehman Brothers $106 billion, CEO Richard Fuld made $485 million profit.
• Morgan Stanley $74 billion.
• RBS Greenwich Capital $99 billion.
The Home Ownership & Equity Protection Act gave the Federal Reserve the authority to regulate the mortgage industry, but Alan Greenspan refused to enforce it.
A Credit Default Swap is an insurance policy for a CDO. It pays off if the CDO fails, and speculators could buy ‘swaps’ to bet against CDOs that they didn’t even own. AIG sold vast amounts of swaps, and since derivatives were not regulated, AIG was not required to have the money to cover potential losses. AIG London – Financial Products Division issued $500 billion worth of Swaps from 2001-2007.
Investment banks borrowed heavily to buy more loans and create more CDOs. Goldman Sachs sold $3.1 billion of toxic CDOs in the first six months of 2006. Later in 2006 Goldman Sachs started buying Credit Default Swaps, betting against the very CDOs it was selling to its investors. GS bought $22 billion worth of ‘swaps’ from AIG. Realizing they could cause AIG’s collapse, they spent $150 million insuring themselves against an AIG bankruptcy.
In 2007 Goldman Sachs started selling CDOs specifically designed so that the more money their customers lost, the more money Goldman Sachs made.
When AIG was bailed out at a cost to taxpayers of $150 billion, owners of Credit Default Swaps got $61 billion. Goldman Sachs got $14 billion of the AIG bailout money when Henry Paulson, George W. Bush’s Treasury Secretary and former CEO of Goldman Sachs, Timothy Geithner, head of the New York Federal Reserve, and Ben Bernanke forced AIG to pay Goldman Sachs 100 cents on the dollar. Paulsen and Geithner also forced AIG to surrender its right to sue Goldman Sachs and other banks for fraud.
On October 4, 2008 Bush signed the $700 billion bailout bill, forcing taxpayers to pay for the financial industry’s money making schemes.
• John Paulson, hedge fund manager, made $12 billion betting against the mortgage market, and when he ran out of CDOs to bet against, he worked with Goldman Sachs and Deutsche Bank to create more.
• The top five executives at Lehman Brothers made over $1 billion from 2000-2007.
• Angelo Mozilo, CEO Countrywide made $470 million from 2003-2008, $140 million by dumping his company stock in the twelve months before Countrywide collapsed.
• Dan O’Neal, CEO Merrill Lynch made $90 million in 2006-2007. After ruining Merrill Lynch, its board let him resign and collect $161 million in severance.
• John Thane, CEO after O’Neal resigned, made $87 million in 2007, and in December 2008, two months after Merrill Lynch was bailed out by U.S. taxpayers, Thane and the Merrill Lynch board of directors gave out billions of dollars in bonuses.
• In March 2008 AIG’s Financial Products Division lost $11 billion. Instead of being fired, Joseph Casano, its head, was made a consultant and paid $1 million a month for the next year or so.
Morgan Stanley was also selling securities and betting against them. Hedge funds Tricadia and Magnetar made billions betting against CDOs they had designed with Merrill Lynch, J.P. Morgan, and Lehman Brothers.
Investors use Credit Rating Agencies to determine the relative risk of an investment. The three main CRAs in the U.S. are Moody’s, Standard & Poor’s, and Fitch. The top rating is AAA, which is a very low risk investment. These agencies are paid by the institutions whose products they rate. Moody’s rated Freddie Mac preferred stock at the highest level until Warren Buffett raised concerns on CNBC. The next day the stock was lowered to one grade above ‘junk bond’ status. Although the Credit Rating Agencies had been aware of Enron’s problems for months, it retained an investment grade rating until four days before it collapsed. Despite being rated AAA or Aaa by all three agencies, CDOs issued by Credit Suisse Group lost about $125 million. Moody’s quadrupled its profit from 2000 – 2007.
The financial industry employs 3000 lobbyists, more than 5 lobbyists for every member of Congress. From 1998-2008 the financial sector spent more than $5 billion on ‘lobbying’ and campaign ‘contributions’, and since the collapse they are spending even more.
Other Financial institution behavior since deregulation began:
• Credit Suisse laundered money for Iran, violating U.S. sanctions – fined $536 million.
• Fannie Mae overstated earnings by more than $10 billion – fined $400 million.
• Freddie Mac accounting fraud – fined $125 million.
• UBS was caught helping wealthy Americans evade taxes – fined $780 million.
• Citibank, J.P. Morgan and Merrill Lynch conspired to help Enron conceal fraud – fined $385 million.