Wall St.: Fraud Exposed as the Regulators turn up the Heat

As I start this post I have noticed that stocks are beginning to roll over again. DOW is now down 73 points. What a shocker....Not!

I wanted to bring a couple of articles to every ones attention that discuss what regulators are starting to find as they turn up the heat on the Wall St.

We all know that the pressure was enormous to keep the profits going as the bull market soared through 2006. Well, we found out today that Moody's has begun a probe looking into a computer bug that falsely issued Aaa ratings to debt that actually should have been rated four notches below. Here is the Moody's article from Bloomberg:

"May 21 (Bloomberg) -- Moody's Investors Service said it's conducting ``a thorough review'' of whether a computer error was responsible for assigning Aaa ratings to debt securities that later fell in value.

Some senior staff at Moody's were aware in early 2007 that constant proportion debt obligations, funds that used borrowed money to bet on credit-default swaps, should have been ranked four levels lower, the Financial Times said, citing internal Moody's documents. Moody's altered some assumptions to avoid having to assign lower grades after it corrected the error, the paper said.

The allegations raise questions about internal controls at credit ratings firms as they face scrutiny from lawmakers and regulators for assigning their top grades to securities derived from loans to people with poor credit."

Quick Take:

Ooops! This sure sounds shady. Its amazing what you will find if you are a regulator and you turn on a flashlight in Moody's closet. I blame the ratings agencies more than anyone for this CDO fraud.

Wall St. essentially paid these ratings agencies to rate debt at AAA when they clearly had no justification to rate it at this level. 27% of subprime loans are now delinquent. These ratings agencies had to know that the risk of borrowing to lifelong renters was high. Yet, they still rated these pieces of garbage at AAA which is the highest rating any securitization can get.

Lets see how many skeleton's are found after this probe is finished.

Fraud # 2

The other piece of fraud in the news today was the lawsuits that are being announced over the auction rate securities market.

Wall St. has already lawyered up and is preparing for a waterfall of lawsuits due to this debacle. Here is the info from The Independent:

"Some of Wall Street's biggest financial institutions are bracing themselves for large fines and legal settlements over the collapsed auction-rate securities market, which is shaping up to be one of the costliest mis-selling scandals of the credit crisis to date.

Thousands of individuals, and many more institutional investors, have been left holding bonds that they cannot sell, despite being told that these investments were the equivalent of cash.

An auction-rate security is a bond whose interest rate is not fixed, but set at a weekly or monthly auction, when existing holders can sell the bonds. For more than 20 years, Wall Street banks acted as "market-makers", stepping in to buy the bonds at auction if demand was weak, so that holders could cash out. But amid the spiralling credit crisis, they stopped acting as buyers of last resort and since then almost 60 per cent of auctions have failed.

Banks created, ran and then ultimately abandoned the auction-rate market, said Jonathan Levine, attorney at Girard Gibbs in San Francisco, one of several law firms launching class action suits against the biggest players.

"We think this is one of the biggest frauds on Wall Street in years," he said. "There is a perception that this is just a temporary liquidity problem for a few rich people, but that is not true. Brokers were selling this stuff to anyone who walked in the door with $25,000 (£12,800), to people who had sold a house and not yet bought a new one, to people who had come into a small inheritance. People can't retire, small business owners cannot pay payrolls, it is affecting people's lives."

Those stories are set to give the auction-rate securities issue a particularly human face as regulators pick through the myriad scandals and market failures revealed by the credit crisis. Wall Street made about $825m a year in fees from handling the regular auctions, on top of a total of $1bn from underwriting the issuance of the bonds in the first place."

Quick Take:

When the money was flowing on Wall St., it wasn't a problem to pick up the tab if an auction failed. Now that the credit crisis has clobbered the banks, they are leaving the little guy stuck with bonds that they cannot sell as the banks have now refused to be the buyer of last resort.

Expect this one to hit a nerve with judges because it hurts the little guy. I said yesterday that many a lawsuit will be filed as this debacle plays out.

Ohhh look at that. The DOW is now down 87 points. I better sign off now before we hit triple digits.