Justice Department eyes possible fraud on Wall Street

WASHINGTON — Turning its scrutiny to bigger fish in the subprime mortgage scandal, the Justice Department is investigating whether lenders or Wall Street firms defrauded investors in the sale of risky mortgage securities, its Criminal Division chief disclosed Thursday.

"We absolutely are looking at the conduct of the securitizers themselves, and what did they say to those who purchased the (securities)," Assistant Attorney General Lanny Breuer told a commission created by Congress to investigate causes of the nation's economic collapse.

"Candidly, (we) have been looking at that for awhile and are looking at that right now in a very key matter."

Breuer didn't identify any company under scrutiny, but Wall Street's biggest investment banks bought many of the $2 trillion in home mortgages issued to shaky borrowers, converted them to high-yield bonds and sold the bonds to investors including pension funds, insurers and foreign banks. Many of the securities have since defaulted, and investors have lost billions of dollars.

Attorney General Eric Holder, who also appeared before the commission, said the economic crisis has brought concern about financial fraud "to the forefront." Holder, who recently announced the creation of a financial fraud task force, said that the Justice Department "is using every tool at our disposal, including new resources, advanced technologies and communications capabilities" to catch perpetrators.

According to Breuer, the FBI received upwards of 70,000 "suspicious activity reports" relating to possible mortgage fraud in 2009 and has 2,800 investigations under way nationwide.

The Justice Department disclosures came on the second day of Financial Crisis Inquiry Commission hearings, as federal and state enforcement officials laid bare the regulatory holes, blunders and lack of foresight that enabled the subprime mortgage industry to churn out millions of ill-fated loans that sank the economy.

Those lapses included:

_ Failing to rein in what Chairwoman Sheila Bair of the Federal Deposit Insurance Corp. called a "shadow banking system" in which major banks ramped up their risks by making hundreds of billions of dollars in exotic, off-the-books bets.

_ Deciding to scale back the FBI's resources for tracking white-collar crime after Sept. 11, and assigning scant personnel at the Securities and Exchange Commission to monitor major investment banks after they were given new freedom in 2004 to take on added risks.

_ Adopting rules in 2004 that restricted state regulators from policing predatory lending and other mortgage abuses, prompting some major lenders to seek federal charters to avoid tough scrutiny.

_ Relying too much on the credit ratings of Wall Street agencies, which had financial incentives to bestow high ratings on dubious mortgage-backed securities.

_ Failing to monitor major banks' compensation arrangements that gave bonuses for completing mortgage securities sales, regardless of the risks of default.

_ Ignoring a warning to Congress by the FBI's investigation chief in 2004 that widespread subprime-related mortgage fraud would lead to a financial crisis.

"I mean, everybody missed everything," said the panel's vice chairman, Bill Thomas, a retired Republican congressman from California.

Bair and SEC Chairwoman Mary Schapiro described a series of fixes under way, including some to address the widespread losses incurred by investors around the world in subprime-related mortgage securities.

Schapiro said her agency is conducting a "broad review" of the regulation of these securities backed by bundles of mortgages and consumer loans. The SEC is looking at Wall Street firms' disclosures in offering circulars, their public reporting and "considering several proposed changes designed to enhance investor protection in this market."

Schapiro and Bair described multiple ways in which they propose to narrow the roles of major Wall Street credit ratings agencies: Moody's Investors Service, McGraw Hill-owned Standard & Poor's and Fitch Ratings.

While the ratings agencies have to date been shielded from liability, largely via the First Amendment's protections of free speech, the SEC is weighing the idea of making them subject to experts' legal exposure, just as are lawyers and accountants, Schapiro said.

That approach, she said, "might impose some additional discipline on how they conduct their business and . . . be an effective check on their enthusiasm for highly rating everything."

Bair said she sees "major advantages" to tying the rating agencies' compensation to the longer-term performance of securities that they give triple-A ratings, the highest investment grade, parceling out their fees over time.

Both women urged creation of a systemic risk council in which financial regulatory agencies would share information so they could identify major risks across the financial system.

Also testifying were four state regulators, including attorneys general Lisa Madigan of Illinois and John Suthers of Colorado. Madigan said that, years before the subprime market exploded, state investigators uncovered "a pattern of predatory lending practices that would eventually permeate and destroy much of the mortgage industry and our economy," including higher payments to mortgage brokers for loans with the most punishing terms for borrowers.

Federal regulators, she said, showed little interest and pushed to curtail state authority, while lenders shifted to federal charters. A major lesson, she said, is that federal charters "must not be mistakenly viewed as giving lenders a blanket exemption" from state laws.

Meanwhile, Goldman Sachs issued what it called a clarification of statements by its chairman and chief executive officer, Lloyd Blankfein, at Wednesday's opening hearing.

Asked about Goldman's secret bets against the housing market while it sold $40 billion in risky mortgage securities in 2006 and 2007, Blankfein said he thought "that the behavior is improper, and we regret the result — the consequence that people have lost money in it."

On Thursday, Goldman said that Blankfein had "said no such thing" and that the question was "predicated on the assumption that a firm was selling a product that it thought was going to default" and in that case, "the practice would be improper."

Mr. Blankfein does not believe, nor did he say, that Goldman Sachs had behaved improperly in any way," the firm said.

A commission spokesman said: "The hearing was Webcast, which is available on our Web site, and a transcript will be available shortly."


The website of the Financial Crisis Inquiry Commission


Goldman Sachs: Low Road to High Finance

Goldman admits 'improper' actions in sales of securities

Goldman: Blankfein didn't say firm's practices were 'improper'

How Moody's sold its ratings - and sold out investors

Goldman's chief executive apologizes for part in fiscal crisis

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