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WSJ: SEC in Talks With Banks to End Probe

December 2, 2010
By

60 Wall Street; J.P. Morgan HQ

The Wall Street Journal floats a story today that the Securities and Exchange Commission is “in talks” with several big banks on a possible settlement to the regulators’ investigation of banks selling doomed-to-fail collateralized debt obligations (CDOs). Those are those mortgage bonds—aka “toxic assets”—that devastated the world’s economy by the end of 2008. From the article:

. . . the move to try to work out deals with each bank is a sign of interest by all sides in ending the probe without a rerun of the public fight between the SEC and Goldman Sachs Group Inc.

You may recall Goldman paid a “record” $550 million to settle SEC claims in July. Didn’t even get to deny any wrongdoing. I was hopeful that someone might run with this, one of the biggest parts of the biggest heist in world history. As the WSJ sums:

Banks churned out more than $1 trillion of CDOs. They often created them at the request of investors who made bets against the deals. Some banks made their own bearish bets. Such bets paid off when the mortgage market crashed, though financial firms also suffered steep losses from CDOs stuck on their books.

Perhaps it wasn’t illegal after all. Here’s what I think happened.

The scene: Conference Room, 57th floor of Megabank Intl., Dec. 3, 2006:

Megabank CEO (looking over draft financial report): Oh shit! You idiots! You fucked up! We’re fucked. We’re idiots!

Head of Bond Unit (sardonically): Jamie, a lot of other people are also idiots. . . . What if they’re dumber than we are? They must be. They don’t have access to our financial reports—not the precleaned ones, anyway . . . so they don’t know yet.

Megabank CEO: Keep talkin’ . . .

Head of Bond Unit: What if we can keep them from realizing how stupid and doomed all this is for a while longer? Could we make money on that?

Megabank CEO: Well, could we?

Head of Bond Unit: What if we make more of this crap and sell it to them as if nothing bad is happening in the housing market?

Megabank CEO: I like what I’m hearing. Let’s do that!

Head of Bond Unit: Yes, boss, we’ll do that. But it won’t make up for all the losses we’re about to take on the crap we’re holding.

Megabank President: Oh no! Can’t we sell that too? What do I pay you all $60 million a year for?

Head of Bond Unit (calmly): Sir, you pay me to be smarter than you are in certain esoteric fields of play. Allow me to earn my meager keep.

Megabank CEO: Please continue.

Head of Bond Unit: We’re gonna take the crappy mortgages we have on our books now—the ones that are failing, the ones that are about to fail, and remix them into new bonds, which we will tranche up and sell to stupid Germans and Midwestern pension funds and Iceland as triple-A rated investment-grade stuff.

Megabank CEO: I like it. But don’t we need to hold the bonds we have, for legal and tax reasons?

Hedge Fund Manager (stepping forward): If I may. Of course. You’re just going to make copies of those shittiest mortgages and bundle them up into synthetic bonds. And we’re going to bet against them using credit default swaps.

Megabank CEO: And you are?

Hedge Fund Manager: My name is immaterial. Suffice it to say that, without me, your Bond Unit Chief here would be nowhere near as valuable to you as he is. Also, I made 10 times his meager salary last year.

Head of Bond Unit (to Megabank CEO): We can’t do this all by ourselves. When the bonds crater and we make a bunch of money while police and fire pension funds fail it will look too cynical.

Megabank CEO: You may have a point. What is your solution?

Head of Bond Unit: Hedge Funds. We cut them in on it. Everyone hates them already. They pick the bad mortgages we bundle, they buy the first insurance, we come in behind them and make the deal work—for a reasonable fee, of course—and we also place our own bets. Spread the responsibility around. Plausible deniability, etc.

Megabank CEO: So crazy it just might work! But wait, but what happens when the SEC gets wind of this?

(All in room burst out laughing.)

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