Journalism in the Public Interest

Banks’ Self-Dealing Super-Charged Financial Crisis

As investors left the market in the run-up to the meltdown, Wall Street created fake demand, increasing their bonuses — and ultimately making the crisis worse.

Employees walk past a sign at Merrill Lynch headquarters in New York on Oct. 30, 2007. (Emmanuel Dunand/AFP/Getty Images)

Over the last two years of the housing bubble, Wall Street bankers perpetrated one of the greatest episodes of self-dealing in financial history.

Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses:

They created fake demand.

A ProPublica analysis shows for the first time the extent to which banks -- primarily Merrill Lynch, but also Citigroup, UBS and others -- bought their own products and cranked up an assembly line that otherwise should have flagged.

The products they were buying and selling were at the heart of the 2008 meltdown -- collections of mortgage bonds known as collateralized debt obligations, or CDOs.

As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created -- and ultimately provided most of the money for -- new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those.

Individual instances of these questionable trades have been reported before, but ProPublica's investigation, done in partnership with NPR's Planet Money, shows that by late 2006 they became a common industry practice.

Click to see how frequently the banks turned to their best customers -- their own CDOs.

An analysis by research firm Thetica Systems, commissioned by ProPublica, shows that in the last years of the boom, CDOs had become the dominant purchaser of key, risky parts of other CDOs, largely replacing real investors like pension funds. By 2007, 67 percent of those slices were bought by other CDOs, up from 36 percent just three years earlier. The banks often orchestrated these purchases. In the last two years of the boom, nearly half of all CDOs sponsored by market leader Merrill Lynch bought significant portions of other Merrill CDOs.

ProPublica also found 85 instances during 2006 and 2007 in which two CDOs bought pieces of each other. These trades, which involved $107 billion worth of CDOs, underscore the extent to which the market lacked real buyers. Often the CDOs that swapped purchases closed within days of each other, the analysis shows.

There were supposed to be protections against this sort of abuse. While banks provided the blueprint for the CDOs and marketed them, they typically selected independent managers who chose the specific bonds to go inside them. The managers had a legal obligation to do what was best for the CDO. They were paid by the CDO, not the bank, and were supposed to serve as a bulwark against self-dealing by the banks, which had the fullest understanding of the complex and lightly regulated mortgage bonds.

It rarely worked out that way. The managers were beholden to the banks that sent them the business. On a billion-dollar deal, managers could earn a million dollars in fees, with little risk. Some small firms did several billion dollars of CDOs in a matter of months.

"All these banks for years were spawning trading partners," says a former executive from Financial Guaranty Insurance Company, a major insurer of the CDO market. "You don't have a trading partner? Create one."

The executive, like most of the dozens of people ProPublica spoke with about the inner workings of the market at the time, asked not to be named out of fear of being sucked into ongoing investigations or because they are involved in civil litigation.

Keeping the assembly line going had a wealth of short-term advantages for the banks. Fees rolled in. A typical CDO could net the bank that created it between $5 million and $10 million -- about half of which usually ended up as employee bonuses. Indeed, Wall Street awarded record bonuses in 2006, a hefty chunk of which came from the CDO business.

The self-dealing super-charged the market for CDOs, enticing some less-savvy investors to try their luck. Crucially, such deals maintained the value of mortgage bonds at a time when the lack of buyers should have driven their prices down.

But the strategy of speeding up the assembly line had devastating consequences for homeowners, the banks themselves and, ultimately, the global economy. Because of Wall Street's machinations, more mortgages had been granted to ever-shakier borrowers. The results can now be seen in foreclosed houses across America.

The incestuous trading also made the CDOs more intertwined and thus fragile, accelerating their decline in value that began in the fall of 2007 and deepened over the next year. Most are now worth pennies on the dollar. Nearly half of the nearly trillion dollars in losses to the global banking system came from CDOs, losses ultimately absorbed by taxpayers and investors around the world. The banks' troubles sent the world's economies into a tailspin from which they have yet to recover.

It remains unclear whether any of this violated laws. The SEC has said that it is actively looking at as many as 50 CDO managers as part of its broad examination of the CDO business' role in the financial crisis. In particular, the agency is focusing on the relationship between the banks and the managers. The SEC is exploring how deals were structured, if any quid pro quo arrangements existed, and whether banks pressured managers to take bad assets.

The banks declined to directly address ProPublica's questions. Asked about its relationship with managers and the cross-ownership among its CDOs, Citibank responded with a one-sentence statement:

"It has been widely reported that there are ongoing industry-wide investigations into CDO-related matters and we do not comment on pending investigations."

None of ProPublica's questions had mentioned the SEC or pending investigations.

Posed a similar list of questions, Bank of America, which now owns Merrill Lynch, said:

"These are very specific questions regarding individuals who left Merrill Lynch several years ago and a CDO origination business that, due to market conditions, was discontinued by Merrill before Bank of America acquired the company."

This is the second installment of a ProPublica series about the largely hidden history of the CDO boom and bust. Our first story looked at how one hedge fund helped create at least $40 billion in CDOs as part of a strategy to bet against the market. This story turns the focus on the banks.

Merrill Lynch Pioneers Pervert the Market

By 2004, the housing market was in full swing, and Wall Street bankers flocked to the CDO frenzy. It seemed to be the perfect money machine, and for a time everyone was happy.

Homeowners got easy mortgages. Banks and mortgage companies felt secure lending the money because they could sell the mortgages almost immediately to Wall Street and get back all their cash plus a little extra for their trouble. The investment banks charged massive fees for repackaging the mortgages into fancy financial products. Investors all around the world got to play in the then-phenomenal American housing market.

Click to see how the CDO daisy chain worked.

The mortgages were bundled into bonds, which were in turn combined into CDOs offering varying interest rates and levels of risk.

Investors holding the top tier of a CDO were first in line to get money coming from mortgages. By 2006, some banks often kept this layer, which credit agencies blessed with their highest rating of Triple A.

Buyers of the lower tiers took on more risk and got higher returns. They would be the first to take the hit if homeowners funding the CDO stopped paying their mortgages. (Here's a video explaining how CDOs worked.)

Over time, these risky slices became increasingly hard to sell, posing a problem for the banks. If they remained unsold, the sketchy assets stayed on their books, like rotting inventory. That would require the banks to set aside money to cover any losses. Banks hate doing that because it means the money can't be loaned out or put to other uses.

Being stuck with the risky portions of CDOs would ultimately lower profits and endanger the whole assembly line.

The banks, notably Merrill and Citibank, solved this problem by greatly expanding what had been a common and accepted practice: CDOs buying small pieces of other CDOs.

Architects of CDOs typically included what they called a "bucket" -- which held bits of other CDOs paying higher rates of interest. The idea was to boost overall returns of deals primarily composed of safer assets. In the early days, the bucket was a small portion of an overall CDO.

One pioneer of pushing CDOs to buy CDOs was Merrill Lynch's Chris Ricciardi, who had been brought to the firm in 2003 to take Merrill to the top of the CDO business. According to former colleagues, Ricciardi's team cultivated managers, especially smaller firms.

Merrill exercised its leverage over the managers. A strong relationship with Merrill could be the difference between a business that thrived and one that didn't. The more deals the banks gave a manager, the more money the manager got paid.

As the head of Merrill's CDO business, Ricciardi also wooed managers with golf outings and dinners. One Merrill executive summed up the overall arrangement: "I'm going to make you rich. You just have to be my bitch."

But not all managers went for it.

An executive from Trainer Wortham, a CDO manager, recalls a 2005 conversation with Ricciardi. "I wasn't going to buy other CDOs. Chris said: 'You don't get it. You have got to buy other guys' CDOs to get your deal done. That's how it works.'" When the manager refused, Ricciardi told him, "'That's it. You are not going to get another deal done.'" Trainer Wortham largely withdrew from the market, concerned about the practice and the overheated prices for CDOs.

Ricciardi declined multiple requests to comment.

Merrill CDOs often bought slices of other Merrill deals. This seems to have happened more in the second half of any given year, according to ProPublica's analysis, though the purchases were still a small portion compared to what would come later. Annual bonuses are based on the deals bankers completed by yearend.

Ricciardi left Merrill Lynch in February 2006. But the machine he put into place not only survived his departure, it became a model for competitors.

As Housing Market Wanes, Self-Dealing Takes Off

By mid-2006, the housing market was on the wane. This was particularly true for subprime mortgages, which were given to borrowers with spotty credit at higher interest rates. Subprime lenders began to fold, in what would become a mass extinction. In the first half of the year, the percentage of subprime borrowers who didn't even make the first month's mortgage payment tripled from the previous year.

That made CDO investors like pension funds and insurance companies increasingly nervous. If homeowners couldn't make their mortgage payments, then the stream of cash to CDOs would dry up. Real "buyers began to shrivel and shrivel," says Fiachra O'Driscoll, who co-ran Credit Suisse's CDO business from 2003 to 2008.

Faced with disappearing investor demand, bankers could have wound down the lucrative business and moved on. That's the way a market is supposed to work. Demand disappears; supply follows. But bankers were making lots of money. And they had amassed warehouses full of CDOs and other mortgage-based assets whose value was going down.

Rather than stop, bankers at Merrill, Citi, UBS and elsewhere kept making CDOs.

The question was: Who would buy them?

The top 80 percent, the less risky layers or so-called "super senior," were held by the banks themselves. The beauty of owning that supposedly safe top portion was that it required hardly any money be held in reserve.

That left 20 percent, which the banks did not want to keep because it was riskier and required them to set aside reserves to cover any losses. Banks often sold the bottom, riskiest part to hedge funds. That left the middle layer, known on Wall Street as the "mezzanine," which was sold to new CDOs whose top 80 percent was ultimately owned by ... the banks.

"As we got further into 2006, the mezzanine was going into other CDOs," says Credit Suisse's O'Driscoll.

This was the daisy chain. On paper, the risky stuff was gone, held by new independent CDOs. In reality, however, the banks were buying their own otherwise unsellable assets.

How could something so seemingly short-sighted have happened?

It's one of the great mysteries of the crash. Banks have fleets of risk managers to defend against just such reckless behavior. Top executives have maintained that while they suspected that the housing market was cooling, they never imagined the crash. For those doing the deals, the payoff was immediate. The dangers seemed abstract and remote.

The CDO managers played a crucial role. CDOs were so complex that even buyers had a hard time seeing exactly what was in them -- making a neutral third party that much more essential.

"When you're investing in a CDO you are very much putting your faith in the manager," says Peter Nowell, a former London-based investor for the Royal Bank of Scotland. "The manager is choosing all the bonds that go into the CDO." (RBS suffered mightily in the global financial meltdown, posting the largest loss in United Kingdom history, and was de facto nationalized by the British government.)

Source: Asset-Backed Alert

Source: Asset-Backed Alert

By persuading managers to pick the unsold slices of CDOs, the banks helped keep the market going. "It guaranteed distribution when, quite frankly, there was not a huge market for them," says Nowell.

The counterintuitive result was that even as investors began to vanish, the mortgage CDO market more than doubled from 2005 to 2006, reaching $226 billion, according to the trade publication Asset-Backed Alert.

Citi and Merrill Hand Out Sweetheart Deals

As the CDO market grew, so did the number of CDO management firms, including many small shops that relied on a single bank for most of their business. According to Fitch, the number of CDO managers it rated rose from 89 in July 2006 to 140 in September 2007.

One CDO manager epitomized the devolution of the business, according to numerous industry insiders: a Wall Street veteran named Wing Chau.

Earlier in the decade, Chau had run the CDO department for Maxim Group, a boutique investment firm in New York. Chau had built a profitable business for Maxim based largely on his relationship with Merrill Lynch. In just a few years, Maxim had corralled more than $4 billion worth of assets under management just from Merrill CDOs.

In August 2006, Chau bolted from Maxim to start his own CDO management business, taking several colleagues with him. Chau's departure gave Merrill, the biggest CDO producer, one more avenue for unsold inventory.

Chau named the firm Harding, after the town in New Jersey where he lived. The CDO market was starting its most profitable stretch ever, and Harding would play a big part. In an eleven-month period, ending in August 2007, Harding managed $13 billion of CDOs, including more than $5 billion from Merrill, and another nearly $5 billion from Citigroup. (Chau would later earn a measure of notoriety for a cameo appearance in Michael Lewis' bestseller "The Big Short," where he is depicted as a cheerfully feckless "go-to buyer" for Merrill Lynch's CDO machine.)

Chau had a long-standing friendship with Ken Margolis, who was Merrill's top CDO salesman under Ricciardi. When Ricciardi left Merrill in 2006, Margolis became a co-head of Merrill's CDO group. He carried a genial, let's-just-get-the-deal-done demeanor into his new position. An avid poker player, Margolis told a friend that in a previous job he had stood down a casino owner during a foreclosure negotiation after the owner had threatened to put a fork through his eye.

Chau's close relationship with Merrill continued. In late 2006, Merrill sublet office space to Chau's startup in the Merrill tower in Lower Manhattan's financial district. A Merrill banker, David Moffitt, scheduled visits to Harding for prospective investors in the bank's CDOs. "It was a nice office," overlooking New York Harbor, recalls a CDO buyer. "But it did feel a little weird that it was Merrill's building," he said.

Moffitt did not respond to requests for comment.

Under Margolis, other small managers with meager track records were also suddenly handling CDOs valued at as much as $2 billion. Margolis declined to answer any questions about his own involvement in these matters.

A Wall Street Journal article ($) from late 2007, one of the first of its kind, described how Margolis worked with one inexperienced CDO manager called NIR on a CDO named Norma, in the spring of that year. The Long Island-based NIR made about $1.5 million a year for managing Norma, a CDO that imploded.

"NIR's collateral management business had arisen from efforts by Merrill Lynch to assemble a stable of captive small firms to manage its CDOs that would be beholden to Merrill Lynch on account of the business it funneled to them," alleged a lawsuit filed in New York state court against Merrill over Norma that was settled quietly after the plaintiffs received internal Merrill documents.

NIR declined to comment.

Banks had a variety of ways to influence managers' behavior.

Some of the few outside investors remaining in the market believed that the manager would do a better job if he owned a small slice of the CDO he was managing. That way, the manager would have more incentive to manage the investment well, since he, too, was an investor. But small management firms rarely had money to invest. Some banks solved this problem by advancing money to managers such as Harding.

Chau's group managed two Citigroup CDOs -- 888 Tactical Fund and Jupiter High-Grade VII -- in which the bank loaned Harding money to buy risky pieces of the deal. The loans would be paid back out of the fees the managers took from the CDO and its investors. The loans were disclosed to investors in a few sentences among the hundreds of pages of legalese accompanying the deals.

In response to ProPublica's questions, Chau's lawyer said, "Harding Advisory's dealings with investment banks were proper and fully disclosed."

Citigroup made similar deals with other managers. The bank lent money to a manager called Vanderbilt Capital Advisors for its Armitage CDO, completed in March 2007.

Vanderbilt declined to comment. It couldn't be learned how much money Citigroup loaned or whether it was ever repaid.

Yet again banks had masked their true stakes in CDO. Banks were lending money to CDO managers so they could buy the banks' dodgy assets. If the managers couldn't pay the loans back -- and most were thinly capitalized -- the banks were on the hook for even more losses when the CDO business collapsed.

Goldman, Merrill and Others Get Tough

When the housing market deteriorated, banks took advantage of a little-used power they had over managers.

Source: Thetica Systems

Source: Thetica Systems

The way CDOs are put together, there is a brief period when the bonds picked by managers sit on the banks' balance sheets. Because the value of such assets can fall, banks reserved the right to overrule managers' selections.

According to numerous bankers, managers and investors, banks rarely wielded that veto until late 2006, after which it became common. Merrill was in the lead.

"I would go to Merrill and tell them that I wanted to buy, say, a Citi bond," recalls a CDO manager. "They would say 'no.' I would suggest a UBS bond, they would say 'no.' Eventually, you got the joke." Managers could choose assets to put into their CDOs but they had to come from Merrill CDOs. One rival investment banker says Merrill treated CDO managers the way Henry Ford treated his Model T customers: You can have any color you want, as long as it's black.

Once, Merrill's Ken Margolis pushed a manager to buy a CDO slice for a Merrill-produced CDO called Port Jackson that was completed in the beginning of 2007: "'You don't have to buy the deal but you are crazy if you don't because of your business,'" an executive at the management firm recalls Margolis telling him. "'We have a big pipeline and only so many more mandates to give you.' You got the message." In other words: Take our stuff and we'll send you more business. If not, forget it.

Margolis declined to comment on the incident.

"All the managers complained about it," recalls O'Driscoll, the former Credit Suisse banker who competed with other investment banks to put deals together and market them. But "they were indentured slaves." O'Driscoll recalls managers grumbling that Merrill in particular told them "what to buy and when to buy it."

Other big CDO-producing banks quickly adopted the practice.

A little-noticed document released this year during a congressional investigation into Goldman Sachs' CDO business reveals that bank's thinking. The firm wrote a November 2006 internal memorandum about a CDO called Timberwolf, managed by Greywolf, a small manager headed by ex-Goldman bankers. In a section headed "Reasons To Pursue," the authors touted that "Goldman is approving every asset" that will end up in the CDO. What the bank intended to do with that approval power is clear from the memo: "We expect that a significant portion of the portfolio by closing will come from Goldman's offerings."

When asked to comment whether Goldman's memo demonstrates that it had effective control over the asset selection process and that Greywolf was not in fact an independent manager, the bank responded: "Greywolf was an experienced, independent manager and made its own decisions about what reference assets to include. The securities included in Timberwolf were fully disclosed to the professional investors who invested in the transaction."

Greywolf declined to comment. One of the investors, Basis Capital of Australia, filed a civil lawsuit in federal court in Manhattan against Goldman over the deal. The bank maintains the lawsuit is without merit.

By March 2007, the housing market's signals were flashing red. Existing home sales plunged at the fastest rate in almost 20 years. Foreclosures were on the rise. And yet, to CDO buyer Peter Nowell's surprise, banks continued to churn out CDOs.

"We were pulling back. We couldn't find anything safe enough," says Nowell. "We were amazed that April through June they were still printing deals. We thought things were over."

Instead, the CDO machine was in overdrive. Wall Street produced $70 billion in mortgage CDOs in the first quarter of the year.

Many shareholder lawsuits battling their way through the court system today focus on this period of the CDO market. They allege that the banks were using the sales of CDOs to other CDOs to prop up prices and hide their losses.

"Citi's CDO operations during late 2006 and 2007 functioned largely to sell CDOs to yet newer CDOs created by Citi to house them," charges a pending shareholder lawsuit against the bank that was filed in federal court in Manhattan in February 2009. "Citigroup concocted a scheme whereby it repackaged many of these investments into other freshly-baked vehicles to avoid incurring a loss."

Citigroup described the allegations as "irrational," saying the bank's executives would never knowingly take actions that would lead to "catastrophic losses."

In the Hall of Mirrors, Myopic Rating Agencies

The portion of CDOs owned by other CDOs grew right alongside the market. What had been 5 percent of CDOs (remember the "bucket") now came to constitute as much as 30 or 40 percent of new CDOs. (Wall Street also rolled out CDOs that were almost entirely made up of CDOs, called CDO squareds.)

Source: Thetica Systems

Source: Thetica Systems

The ever-expanding bucket provided new opportunities for incestuous trades.

It worked like this: A CDO would buy a piece of another CDO, which then returned the favor. The transactions moved both CDOs closer to completion, when bankers and managers would receive their fees.

ProPublica's analysis shows that in the final two years of the business, CDOs with cross-ownership amounted to about one-fifth of the market, about $107 billion.

Here's an example from early May 2007:

  • A CDO called Jupiter VI bought a piece of a CDO called Tazlina II.
  • Tazlina II bought a piece of Jupiter VI.

Both Jupiter VI and Tazlina II were created by Merrill and were completed within a week of each other. Both were managed by small firms that did significant business with Merrill: Jupiter by Wing Chau's Harding, and Tazlina by Terwin Advisors. Chau did not respond to questions about this deal. Terwin Advisors could not reached.

Just a few weeks earlier, CDO managers completed a comparable swap between Jupiter VI and another Merrill CDO called Forge 1.

Forge has its own intriguing history. It was the only deal done by a tiny manager of the same name based in Tampa, Fla. The firm was started less than a year earlier by several former Wall Street executives with mortgage experience. It received seed money from Bryan Zwan, who in 2001 settled an SEC civil lawsuit over his company's accounting problems in a federal court in Florida. Zwan and Forge executives didn't respond to requests for comment.

After seemingly coming out of nowhere, Forge won the right to manage a $1.5 billion Merrill CDO. That earned Forge a visit from the rating agency Moody's.

"We just wanted to make sure that they actually existed," says a former Moody's executive. The rating agency saw that the group had an office near the airport and expertise to do the job.

Rating agencies regularly did such research on managers, but failed to ask more fundamental questions. The credit ratings agencies "did heavy, heavy due diligence on managers but they were looking for the wrong things: how you processed a ticket or how your surveillance systems worked," says an executive at a CDO manager. "They didn't check whether you were buying good bonds."

One Forge employee recalled in a recent interview that he was amazed Merrill had been able to find buyers so quickly. "They were able to sell all the tranches" -- slices of the CDO -- "in a fairly rapid period of time," said Rod Jensen, a former research analyst for Forge.

Forge achieved this feat because Merrill sold the slices to other CDOs, many linked to Merrill.

The ProPublica analysis shows that two Merrill CDOs, Maxim II and West Trade III, each bought pieces of Forge. Small managers oversaw both deals.

Forge, in turn, was filled with detritus from Merrill. Eighty-two percent of the CDO bonds owned by Forge came from other Merrill deals.

Citigroup did its own version of the shuffle, as these three CDOs demonstrate:

  • A CDO called Octonion bought some of Adams Square Funding II.
  • Adams Square II bought a piece of Octonion.
  • A third CDO, Class V Funding III, also bought some of Octonion.
  • Octonion, in turn, bought a piece of Class V Funding III.

All of these Citi deals were completed within days of each other. Wing Chau was once again a central player. His firm managed Octonion. The other two were managed by a unit of Credit Suisse. Credit Suisse declined to comment.

Not all cross-ownership deals were consummated.

In spring 2007, Deutsche Bank was creating a CDO and found a manager that wanted to take a piece of it. The manager was overseeing a CDO that Merrill was assembling. Merrill blocked the manager from putting the Deutsche bonds into the Merrill CDO. A former Deutsche Bank banker says that when Deutsche Bank complained to Andy Phelps, a Merrill CDO executive, Phelps offered a quid pro quo: If Deutsche was willing to have the manager of its CDO buy some Merrill bonds, Merrill would stop blocking the purchase. Phelps declined to comment.

The Deutsche banker, who says its managers were independent, recalls being shocked: "We said we don't control what people buy in their deals." The swap didn't happen.

The Missing Regulators and the Aftermath

In September 2007, as the market finally started to catch up with Merrill Lynch, Ken Margolis left the firm to join Wing Chau at Harding.

Chau and Margolis circulated a marketing plan for a new hedge fund to prospective investors touting their expertise in how CDOs were made and what was in them. The fund proposed to buy failed CDOs -- at bargain basement prices. In the end, Margolis and Chau couldn't make the business work and dropped the idea.

Why didn't regulators intervene during the boom to stop the self-dealing that had permeated the CDO market?

No one agency had authority over the whole business. Since the business came and went in just a few years, it may have been too much to expect even assertive regulators to comprehend what was happening in time to stop it.

While the financial regulatory bill passed by Congress in July creates more oversight powers, it's unclear whether regulators have sufficient tools to prevent a replay of the debacle.

In just two years, the CDO market had cut a swath of destruction. Partly because CDOs had bought so many pieces of each other, they collapsed in unison. Merrill Lynch and Citigroup, the biggest perpetrators of the self-dealing, were among the biggest losers. Merrill lost about $26 billion on mortgage CDOs and Citigroup about $34 billion.

Additional reporting by Kitty Bennett, Krista Kjellman Schmidt, Lisa Schwartz and Karen Weise.

Correction: This story previously reported that there were 85 instances during 2006 and 2007 in which two complex securities known as collateralized debt obligations bought pieces of each others' "unsold" inventory. In fact, there were some instances when this cross-exposure occurred through later transactions. The banks sometimes used such transactions to minimize their own exposure to CDOs they had created.

An interactive graphic we published includes at least one example of cross-exposure that did not involve "unsold" inventory. A CDO called Tourmaline III made a sidebet in 2007 that mirrored the performance of a piece of a CDO called Zais Investment Grade 8; that same year Zais 8 bought a piece of Tourmaline III. Both CDOs were underwritten by Deutsche Bank.

Thank You Propublica for this great story.

Now we know why Henry Paulson was so nervious to get the 800 billion dollar bail out in 2007.

Artificial markets were part of many business flops in the last 15 years, as with Enron. If a market does not exist, create one, like that for generated energy in California. The basic idea of any Ponzi scheme is to create the illusion of a market, and of profits from it.

When instruments being traded are abstracted many levels away from any underlying asset value on which they are purportedly based, the game is transformed into fantasy finance, not unlike fantasy football.

This is the exact same description of a Ponzi scheme. And no one is going to jail? Typical of a government bought and paid for.

Just what will it take to put the perps behind bars?  Perhaps the Justice dept. should just arrest every one, put them in prison, ala Guantanamo Bay, eventually bring them to court, after they disgorge the ill gotten gains. I’m sure they will plead guilty just to get out.

The problem is that Wall Street has an inordinate amount of power in Washington, in fact it appears that they own Washington. With the CEO’s devising “creative” Enronlike accounting “products” schemes that no one else was able to understand, all corrupt, all in their favor at the expense of shareholders, they not only emptied their banks’ reserves, but took “free money” and “cheap money” from the Treasury, money given to them by Paulson, Bernanke, Geithner, and Summers. One of the robber barons even said that he was doing God’s work. Why none of these criminals is in jail beats me.

It is interesting to me that we are not calling this exactly what it is. The previous post had it correct. This is a Ponzi scheme. Any average Joe on the street would be in jail by now for creating a Ponzi that bilked a million out of people. Why is it that Wall Street execs that bilk people for billions walk away rich?

Thhe real tragedy here is that no one has to go to jail for all this misery heaped upon the American people. In a truly just society these people would be punished. Serfdom is right around the corner.

This is what brings on revolutions…....and one can be sure that those who created it, who wanted no regulations, no taxes, no anything, will be the 1st to scream “WHO is going to protect me”. Sadly, many of us “Average Joes” will suffer too as a result, but the brunt of the masses wraith will be towards the very rich…...happened in late 18thC France, in early 20thC Russia…...WE will be no different.

I’m sure the defenders of the gop will not bother to read this article. They don’t want to know the truth as their minds have been poisoned for years by the gop, fnc and right wing media.

to ST.

You know the term “Ponzi scheme” because that’s the one they want you to know, or at least, have allowed you to remember in history. What if I told you there was a man who stole much more then Ponzi did during the same time, but somehow you never heard his name. A man who was the main reason new laws were put into effect to prevent another Wall Street crash in the US after the Great Depression. Laws that were successful up until Ronald Reagan began dismantling them. That mans name was Ivar Kreuger and the reason you don’t know his name is because his games are still in play. His scheme, his invention, is called the derivatives market. There’s an excellent book called “The Match King” about his life.

The sad thing is, this is nothing new.  The key to every one of these schemes is to find easy financial prey to get the money into the “end investor ponzi” system. And sadly, nothing in this story and others like it addresses the real reason these schemes are perpetuated over and over. Here’s a hint.

80 years ago the average American had a 6th grade literacy level. That was right around the time there was any easy credit frenzy that filled Wallstreet with lots of money that was apparently not well invested and presto-whammo we get—The Great Depression.

Interestingly enough, just this year a study showed the average MATH literacy level was that of a 6th grader. These hapless number illiterate consumers were sold some of the most complex mortgage products—Option ARMs, 2/28 ARMs, with prepayment penalties and margins and index disclosures that were in tiny 6 point print ever devised by Wallstreet.  The great irony?—the creators of the Option ARM under the guise of the Center for Responsible Lending have repented of their predatory lending sins, and are now influencing legislation on…wait for it…mortgage lending!!! 

The biggest thing missing from financial reform is a mandate for financial literacy in K-12, despite the findings of back to back Presidential Financial Literacy studies in 2008 & 2009…I wonder why?


And no one is going to jail? Typical of a government bought and paid for. How much more are Americans going to pay, directly and through Banks over charges, before we put them all in front of a Judge on the to the hangman.

I don’t doubt that much of this occurred, but this story is very light on sources. How can your complain about the obscurity of the CDO market and then publish an obscure story?

The ruling class empowered Reagan to begin the avid destruction of the middle class, and GW was even more effective. They want unfettered power, and an educated middle class stands in the way. Beck, Rush, O’Riley - there just paid to distract us.

I find these stories I am reading about the banks horrifying. I used to trust banks, trust their accounting, trust their managers when they promised they were looking after their depositors and clients. But we regular people got stuck with the bills while everyone else took their money and headed for the hills. And we bailed them out?  And, yes, it had to be done right away before these stories came out and the country screamed “over my dead body.” 

Just like I won’t ever go into a BP station ever again, I refuse to deposit one penny in a bank.  If I had put my money under my mattress these past 10 years instead of depositing in banks and investment accounts, I would be a wealthy woman.

We have been totally unprotected in a sea of sharks. No wonder we are broke and unemployed but nonetheless dunned for payments on credit card accounts with usurious rates.

Wow…this was nothing but a Ponzi scheme. Madoff went to jail for it and so should all these bankers, Paulson included.

There will be no revolutions, no Congressional investigations, nothing. The current administration’s financial team is led by people who were suckers for this Ponzi scheming, the Democrats running the financial committees in the Senate (Dodd) and the House are bought and paid for, and the GOP, which is set to sweep strongly supports anything and everything Wall Street did, and wants even LESS regulation. It’s a nightmare for average Americans, which is to say, the majority of us, but we have almost no one advocating on our behalf, and we’re so easily misled by side issues that this, like so much that has come out about the terrible years between 2001-2008, will disappear in the ash heap of history.

Many thanks for your very important story.  It is incumbent upon the public to read these stories and appreciate the issues raised because there is very little being done by our government officials to address the root causes of this behavior.  Instead, banks and other Wall Street interests have amassed lobbyists to confuse the public and to delay any changes to this system. When this fails, they simply buy the politicians and write the laws themselves.  When that fails, they use influence peddling to cause the regulators to turn a blind eye. 
Banks and corporations then create entities to saturate the media with lies about legislation and to pay for think tank scholars to go onto news programs to spread falsehoods that their behavior is not only not wrong, but necessary for our free-market capitalist system to function as our Founding Fathers intended.

But none of this coordinated behavior stops unless we, the Public, read these important stories and refuse to be confused, misled, or lied to.  We cannot simply be angry.  We must be informed and angry. But do not doubt that the power amassed by banks to protect this essentially illegal behavior is vast.  And that the levers which they pull to achieve these ends will be easily stopped. 

I have gladly donated $100 to Pro Publica and hope others will also join.  We have to support investigative journalism as a first step.  Because unless we are fully informed we cannot act in our own best interests, and instead we will continue to be made to pay for the improper actions of the powerful corporate interests.

Thank you to ProPublica and NPR’s Planet Money for caring enough about this issue to invest the time, effort and money. Many Mortgage Servicing Fraud victims have been speculating along lines such as these for years now but none of us have had the means to perform or commission the requisite analyses necessary to confirm such blatant and wide spread megalomania.

The mere fact that humans, of any race, can and obviously do exhibit such incredibly monumental levels of selfishness makes me come eerily close to wanting to lop off my opposable thumbs and return to walking on all fours…

Thinking Person

Aug. 27, 2010, 2:20 a.m.

I went to business school. Really, we don’t need regulations. This is the most obvious play in the book of fraud. That anyone is wringing their hands over legislation appears futile. Come on, if bankers can’t prevent themselves from acting like thugs, there is no law that will either.

I also can not get over the credit rating agencies, what? you didn’t check the value of the assets?

What irks me so much is that these horrible raters of credit have hatched and perpetuated a Ponzi scam of their own. Now there is this million dollar business by which these poor arbiters of credit cheat hard working Americans with the FICO score scam. So many people are judged by the hair on their back for that FICO score, used to make employment and housing decisions, and these guys couldn’t do credit check 101? 

That these agencies find any face to judge others credit is beyond me.

Excellent research by ProPublica, Thank you.

What do we expect? The seeds were planted for this behavior in the 80’s. The Reagan years, when greed was good and whatever you did to get rich was acceptable.

This debacle to large degree is caused by the soulless QANTs that streamed out of the IVY League universities..These high end univesities educated and created these soulless and heartless souls who have no conciences,,,They have created far more damage to our country than any enemy today or in the past!!  Obvious they have no shame or remorse..They are the soulless QANTS..Why do we expect them to feel any thing..They absolutely can’t.. They are robots and can’t feel shame!!!! Hello!!.

OK, so now what? Do we just sit back and let this play out or can we do anything to set things right again?

I don’t see that either party has the ability to change the status quo. What action can ordinary citizens take to effect a change?

We need a vision of what a fair economy would look like and a path forward.

I wonder how many pension funds got suckered into these scams.Their advisors, accountants, attorneys, consultants,etc., may have been very lax in their fiduciary duties.  Mary Shapiro and her staff should have a field day going after these sob’s.

I’m guessing that these are some of the people that the Congressional Republicans are trying to protect with a continuation of the Bush tax cuts.

what’s scary, is that all the guys are still in the business.  check out who runs MorganStanley (bunch of guys responsible for blowing up merrill).  UBS hired DBs CDO head and he now co-runs Fixed Income after nearly blowing up DB.  UBS and MS could be future train wrecks, if the past is an indication of the future…..UBS and other Merrill dudes are at all kinds of small broker-dealers like BTIG, Cantor, Stifel…is the system better?

Thanks, ProPublica, for doing the homework, excellent article.  this egregious behavior by the banks caused inflated home prices, precipitated the loss of my job, and they want ME to pay for the losses on their ill-gotten gains?  I’m not paying my mortgage and neither should anyone else who got one in the last five years, at least.  2008: record bailouts for banks,  2009: record profits at banks, 2010: they take our houses?  For real?  Is this North Korea?  It is as crazy as previous post referencing past revolutions.  Banks (banking class) thinks they can do this?  We gonna let them?

Jennifer Connors

Aug. 27, 2010, 5:35 a.m.

I loved this article!  I hope that our justice system does its slow and methodical job.

The article and none of the comments touched on the borrowers fault.  We all speculated!  We used our home’s obviously inflated value/phantom equity to increase our standard of living.

There will be no change until WE take responsibility for our roles.  How can we expect the business community or our government to act appropriately, if we won’t?

I agree with those comments that sited Ronald Reagan and his banker backers as the start of all this blatant greed.  The problem is we all bought into it as well.  If we don’t take control of our lives, do the due diligence, then nothing will ever change!

Thanks to Reagan, we always always always find a way to blame someone else.  It’s his historical claim to fame.

Thank you, ProPublica

I’m a real estate agent in a small town working with foreclosures and banks and I can tell you there is still funny stuff going on. In 10 years the biggest property owners will be the united state goverment and or banks



This is actually NOT a ponzi scheme.  A ponzi scheme pays old investors with new investors money.  In this case, the unsold CDO tranches never found its first investor.  In terms of dollars, the bank owns the unsold asset, so when the CDO tranche finally finds a home inside another CDO, that’s when the bank is off the hook.  But you are not generating NEW external investment through this process.  All you are doing is degrading the seniority of the new deals by stuffing it with mezz tranches.

What is the statute of limitations on these crimes? Are they even crimes? If it’s seven years all the perps have to do is stall until that expires. Also why not go back to the old school terms: these were SWINDLES; There was a CRASH: We are in a DEPRESSION.

Excellent article. Just baffled as to how we move forward now?  Everyday working individuals trust these financial institutions with their hard earned money so that they can take it and play games, but earn million dollar bonuses when they lose or make money! How do earn bonuses when you lose money? Let a homeowner miss one or two payments on a mortgage, car loan, or even a credit card and see how fast they come to collect. It’s sad, but I truly smell revolution coming. What’s even more sad is that Fox News and Republicans are calling for less regulation, and privatization of government social security and other basic government entitlements.  While yes Democrats have the right ideas and agenda, they do not fight hard enough to get them, i.e. Public Option.This article was informative and depressing at the same time because it really shows that these financial institutions cannot help themselves. How much money is enough money????? I mean come one you are destroying people’s lives and blaming them for taking housing they can’t afford when you’ve cheated them from the start. I sincerely hope that there is a future for America, because the principles for which the country was based on was great.

Great story!! This is exactly the reason why we need rules and regulations as well as greater oversight of Wall Street and the banking industry.

The temptation to deceive and scheme to make an easy buck is too overpowering for the average man to resist! There is too much money circulating out.

We need greater oversight and the Feds need to pay the money necessary to make sure an economic meltdown down like this one never happens again…if it does, we as a country will not survive it!!

I question whether Merrill and Citi actually lost any money. They had their credit default swaps from AIG and I wouldn’t be surprised that they collected $3 on every actual dollar lost. All paid for by the taxpayers and the destruction of the largest insurance company in the world.

This was a Ponzi scheme with insurance and a bailout.

Matt Stutterheim

Aug. 27, 2010, 7:49 a.m.

Financial crimes are treason, they must be punished.

But, sadly, I think we will be in a violent revolution in this country before any prosecutions takes place.

How sad that a cadre of greedy SOBs have decimated our fair land. A lot of people will hang (figuratively) before it’s all over, but our ability to survive as a nation is dependent on a top-to-bottom cleansing.

If one stands back and looks at the goings-on in Washington and Wall Street, they are running scared, really scared. That’s frightening because we little people will pay the price.

The ghost of Lenny Bruce

Aug. 27, 2010, 8:04 a.m.

There is no statute of limitations on fraud, and if the actions by these bankers are not fraudulent, then the word has no meaning.

“They created fake demand.”

Maybe—but the article doesn’t demonstrate that, at all.  The CDO is nothing but an idea until it’s sold to an investor and money changes hands.  The demand of those ultimate investors is “real” not “fake.”  CDOs trading parts of themselves between each other is not “demand”—that is, nobody has paid anything and nobody’s been financially hurt.

Now, if the writers showed that the banks held MBSs (bonds backed by mortgages), put these bonds into CDOs, and then, bought the CDOs they’d just constructed, then, that would be creating a “fake demand.”  The CDOs being nothing but a means to hide the poor quality of the underlying MBSs the banks already held—that is, nothing but a name change.

Where in the article do the writers make that charge?

So what are we supposed to do? Not use banks at all I am sorry but I wouldn’t know where else to store my money. If I knew I would def not store there; any suggestions?  The last thing I want to do is give these jerks more business!!

As I believe Matt Taibi of Rolling Stone said.  We live in a gangster state.  The banks are gangster banks.

JPNashville says—“when the CDO tranche finally finds a home inside another CDO, that’s when the bank is off the hook.”

But only if the CDO can be sold to an outside/unrelated investor!  If the bank sells it to a SIV (special investment vehicle) it owns or to a hedge fund it is loaning money to, then, the bank is creating “fake demand”—that is, buying back (or lending against) its own product.

Captain Renault is shocked.





It is clear that the IQ of the authorities (and for that matter the politicians behind) only reach the level where they can deal with parking tickets, petty thieves and murderers.  In such environment it’s easy for the ruling class to get away with not millions, not billions but trillions without any going to prison. The sad thing is that about 290 million average Americans (approximately the 95%) can’t do anything about it because they are so totally un-organized against the 5% who are organized in so many great ways such as only two ruling parties controlled 100% by the 5% class (the rich), the FED cartel where they print 1.25 Trillion out of thin air when their buddies need to be covered (banks loss on CDO’s etc.) and in many other ways all the way down to the 100K+ Golf Club membership where the next attack is in the making. The average American citizen (being lead to believe that the Democrats or Conservative will take care of their interest) is in effect Chess-Mate while being brought to the slaughter house. Sad but true.

Life is Good when you are deemed Too Big To Jail.
Expect more to be safe.

When asked why he robbed banks, veteran bank robber The Yellow Kid replied “that’s where they keep the money.”

This behavior had nothing to do with legitimate business, it was sophisticated bank robbery by individuals and corporations.

For all the background history and CDO information on what happened, read the book “The Big Short” by Michael Lewis.  Outstanding and you love the book because it covers this event thoroughly.  It then tells you how some VERY smart people saw it coming and bet against the CDO’s by purchasing credit default swaps and made millions.  Read the book

Maybe—but the article doesn’t demonstrate that, at all.  The CDO is nothing but an idea until it’s sold to an investor and money changes hands.  The demand of those ultimate investors is “real” not “fake.”  CDOs trading parts of themselves between each other is not “demand”—that is, nobody has paid anything and nobody’s been financially hurt.

They become a way to hide junk investments and are “fake” investments when they are created to do so. CDOs by themselves do have some sort of asset backing them so they are legitimate investments. When they take low rated junk bonds and stick them in CDOs and sell them off as a higher rated bond, thats when they become trash

Great work on this story—I’ll be contributing to ProPublica today in the hope that you can continue the good fight where the other “main stream media” have clearly been co-opted and failed.

That said, I’m not sure that there’s any hope for changing the ethos of unproductive, non-producing Wall Street… or much of the rest of our faltering country.  Yes, as commenters have mentioned, the govt at most levels is bought & paid for, not always in any blatant sense, but definitely as captives of revenue sources and rich folks’ contributions. 

If this enormous economic crisis (it IS a depression by any standard) hasn’t changed minds and sufficiently awakened people, then there really isn’t much chance to change our very ill system.  I guess we’ll see after the coming “lost decade” here in America…  (sigh)

This article is part of an ongoing investigation:
The Wall Street Money Machine

The Wall Street Money Machine

Enticed by profits and bonuses, Wall Street took advantage of complicated mortgage-based instruments to reap billions, only to exacerbate the eventual crash.

The Story So Far

As the housing market started to fade, bankers and hedge funds scrambled for ways to maintain the lavish bonuses and profits they had become so accustomed to, repackaging mortgages in complex securities called collateralized debt obligations. The booming CDO market masked how weak the housing market was, and exacerbated its collapse.

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