The Year in Wall Street Investigations - ProPublica Page 1 of 3

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The Year in Wall Street Investigations

by Karen Weise
ProPublica, Dec. 27, 2010, 11:30 a.m.

It's been over three years since credit markets started

shaking with the early tremors of the subprime crisis, and
two years since that spread into a marketwide collapse.
Prosecutors, regulators, Congress and journalists have
spent the year uncovering the financial shenanigans that
brought the market to its knees. It's been marked by a few
blockbuster settlements and more revealing investigations
-- as well as by some noticeable inaction in the reckoning.

Let's start at the ground level, with selling risky mortgages

to homeowners. Nobody symbolized the subprime market
-- from its growth to its downfall -- better than former (Michael Loccisano/Getty Images)
Countrywide CEO Angelo Mozilo. This fall, the Securities
and Exchange Commission reached a $67.5 million settlement [1] with Mozilo in its only major case against
a financial executive. The SEC charged Mozilo with praising Countrywide to investors while internally
doubting its lending standards. As part of the settlement, Mozilo admitted no wrongdoing.

Moving up the finance chain, we come to the banks that sold mortgage deals to investors. Much of the
scrutiny focuses on a type of mortgage deal called collateralized debt obligations, or CDOs, which are
essentially bundles of other mortgage bonds that were sold off to investors.

Though nearly every bank [2] is rumored to be under investigation, the year was marked by one major case
looking at the CDO business. In April, the SEC accused Goldman Sachs of creating a mortgage deal [3] that
was designed to fail. The SEC's argument was that Goldman's hedge-fund client helped design the deal
specifically to bet against it -- without Goldman explaining the relationship to investors. In July, Goldman
settled for $550 million (or about two weeks' worth of profit [4]), admitting a "mistake" but no wrongdoing.

The idea of betting against deals lies at the center of a number of other investigations as well. The SEC is
looking into [5] whether JPMorgan Chase allowed a hedge fund named Magnetar to choose assets for a
mortgage deal without disclosing Magnetar's role in selecting what went into the deal. As ProPublica
reported in April with the radio programs This American Life and NPR's Planet Money, Magnetar

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encouraged banks to put together riskier deals [6] and bought the riskiest bond slices that otherwise may
have been unsold. Magnetar then bet against some of those deals [7], standing to make far more by shorting
its losses on those risky slices if the housing market went south.

U.S. prosecutors are also looking into whether Morgan Stanley created a series of CDOs that its own trading
desks bet against [8], the Wall Street Journal reported in May. A few months later it reported on how
Deutsche Bank also bet against the souring housing market at the same time [9] it was marketing new
mortgage deals.

The SEC is also looking into whether Citigroup improperly encouraged an independent manager to stuff a
deal with leftover pieces [10] of other deals that it couldn't sell in the market. In September, ProPublica and
NPR's Planet Money reported on self-dealing [11] among CDOs, showing how banks structured deals to buy
portions of each others' [12] often leftover inventory of hard-to-sell pieces. This created a daisy-chain of
investments [13] that manufactured demand, thereby prolonging the housing bubble. The SEC has said it is
investigating [14] one independent management firm and looking into about 50 others.

The year ended with rumors of mass settlements [15], where banks and the SEC settle broadly over their
CDO practices rather than battling over individual deals, according to the Wall Street Journal.

Deal-by-deal fights may flame up in courts, however, with investors pushing banks to buy back sour deals,
egged on by new evidence [16] that banks may have known the mortgages underlying the deals were flawed.
With such complicated shenanigans going on behind the scenes, investigators also want to know how banks
hid their exposure to these risky securities from investors. The investigations are looking into various tactics,
from general misstatements, like the Citigroup's $75 million settlement [17] with the SEC for not disclosing
$40 billion in subprime risk, to accounting maneuvers that moved certain deals off bank balance sheets.

In the spring, a court-appointed examiner in the bankruptcy of failed investment bank Lehman Brothers
shined a light on a practice known as "Repo 105," where Lehman moved $50 billion in assets off its books
right before it had to submit investor reports. Last week, the New York attorney general filed civil charges
against the accounting firm Ernst & Young [18], saying it had "substantially assisted" Lehman's "house-of-
cards business model" that misled investors. Executives from the now-bankrupt Lehman have not been
charged.

Despite revelations coming up and down the financial spectrum, there have been no major criminal charges
and almost no civil charges against executives. And while the SEC and some government prosecutors have
been active, federal bank regulators have so far been quiet [19].

This all comes as Congress passed the Dodd-Frank financial reform bill this summer, seeking to overhaul the
oversight of everything from mortgage securities to how banks make bets with their own money. As
regulators hammer out the rules of the reforms, the devil may lie in the hotly contested [20] details.

1. http://www.nytimes.com/2010/10/16/business/16countrywide.html
2. http://online.wsj.com/article/SB10001424052748704247904575240783937399958.html
3. http://www.nytimes.com/2009/12/24/business/24trading.html
4. http://www.propublica.org/blog/item/what-the-goldman-sachs-settlement-means-in-context
5. http://www.propublica.org/article/sec-investigating-deal-between-jpmorgan-and-hedge-fund-magnetar
6. http://www.propublica.org/article/all-the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble

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The Year in Wall Street Investigations - ProPublica Page 3 of 3

7. http://vimeo.com/10815824
8. http://online.wsj.com/article/SB10001424052748704250104575238680672738838.html
9. http://online.wsj.com/article/SB10001424052748703900004575325232441982598.html
10.http://www.propublica.org/article/sec-investigating-citigroup-mortgage-deal
11. http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis
12.http://www.propublica.org/special/interactive-cdos-interlocking-ownership#cdo/356w1p
13.http://www.propublica.org/special/the-cdo-daisy-chain
14.http://www.nytimes.com/2010/06/22/business/22sec.html
15. http://online.wsj.com/article/SB10001424052748704594804575649170454587534.html
16.http://blogs.reuters.com/felix-salmon/2010/10/13/the-enormous-mortgage-bond-scandal/
17. http://online.wsj.com/article/SB10001424052748703578104575397302459792766.html
18.http://online.wsj.com/article/SB10001424052748704259704576033540546160536.html
19.http://online.wsj.com/article/SB10001424052748704610904576032062171661374.html?
mod=ITP_moneyandinvesting_0
20.http://www.latimes.com/business/la-fi-financial-lobbying-20101115,0,6793987.story

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http://www.propublica.org/blog/item/the-year-in-wall-street-investigations 12/29/2010