New York vs. Banks?

Welcome to Politics Bites, where every afternoon at It's A Free Country, we bring you the unmissable quotes from the morning's political conversations on WNYC. Today on the Brian Lehrer Show, Gretchen Morgenson, business writer for the New York Times and author of the new book Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, talked about the news that the New York Attorney General is preparing for an investigation into the banks' role in the financial crisis.

Schneiderman makes a move

In an article published on Monday, Gretchen Morgenson reported that New York Attorney General Eric Schneiderman was requesting information and documents from Bank of America, Goldman Sachs, and Morgan Stanley—the first step in determining whether criminal charges could be brought against these banks for misleading investors as they bundled risky mortgage securities.

Comprised mainly of home loans, these securities were then sold to investors like pension funds and insurance companies. But many of these loans were "troubled," according to Morgenson. If the banks knew of their poor quality without informing buyers, that will be the basis of Schneiderman's case.

That's where he's really going to focus on the securitization angle. Did they know, for instance, that many of these loans were in fact not performing, were going to go into default or delinquency? Did they not tell investors? We know investors bought them thinking they were going to perform, then shortly thereafter they started failing in droves. That's a crucial question.

Don't forget also that Wall Street firms funded all these lenders—they didn't have the money to make these loans themselves. They required what are called 'warehouse' lines of credit to keep making loans over and over again. They were a big enabler of this process.

What the Martin Act means

Taking on the nation's largest banks is a tall order for a State Attorney General, but Morgenson pointed out that New York offers Schneiderman a big weapon in the Martin Act. The 1921 piece of legislation extends extraordinary powers to an A.G. fighting financial fraud.

Typically, if you want to bring a criminal case, to win it you have to prove intent to defraud, intent to deceive or mislead. That's very difficult to prove; you have to have that smoking gun e-mail that says, 'I intend to defraud.' The Martin Act allows that you dont have to show intent to defraud in roder to win a case, and that's a huge leg up for Schneiderman.

Domino effect?

Schneiderman's starting with three mortgage giants, but Morgenson predicts that far more people and powers contributed to the crisis. She said that selective investigation and prosecution now could lead to more widespread indictments later, as cases will likely implicate other offenders and establish precedent.

It was not something that one or two banks was doing, so I think you're going to find that the probe will probably expand to all firms that were large in the area of securitizing mortgage loans and selling them to investors...If prosecutors have been holding back on bringing charges, some of these lawsuits and the discovery and material coming out in them can be very helpful in making a case.

The role of rating agencies

Of all the players that could be implicated in wrongdoing, many wonder why credit rating agencies have avoided scrutiny. Indeed, as S&P downgrades the United States' rating, questions linger about how seriously we should take the same people who fudged their assessment of Lehman Brothers. In such cases, are agencies being deceitful, or just plain dumb? Morgenson said that the muddy answer makes levying criminal charges especially difficult.

Rating agencies were central to the process of putting securities together and pooling loans and selling them; investors would never have purchased these securities if rating agencies had not given them their imprimatur. They were central to this disaster, no doubt about it. They were really not keeping up with what was in the securities, but that's not held as being a criminal activity. We might call it perhaps incompetence, and even rating agencies would agree they were not operating up to par, they were asleep at the switch. But as far as holding them as part of any kind of crime, that certainly has not been the case.

'Simply amazing' that we aren't rioting

As is usually the case with on-air segments about big banks, callers were livid at the lack of accountability: the active attempts to deflect blame, the lobbying efforts to avoid inquiries, continued excessive profits while the rest of the country goes lean. Morgenson shared their frustration, saying she was shocked that the frustration hadn't yet come to a head.

I have been super surprised that it hasn't boiled over by now. We have very high unemployment, the foreclosures have been immense, people have been harmed and hurt, families have been destroyed over this. The fact that we don't have people rioting over it I think is simply amazing.