Memo to Investigators: Dig Deep
The good news is, there are not one but two major investigations exploring this ground. The House Committee on Oversight and Government Reform, chaired by Edolphus Towns of Brooklyn, New York, broke a hoary taboo this summer--unprecedented in modern times--by issuing two subpoenas to the Federal Reserve, demanding e-mails and other documents on its role in Bank of America's subsidized takeover of Merrill Lynch. The Fed tried to duck and dodge, but given its tarnished reputation, it complied rather than provoke a fight it was bound to lose.
Towns used the evidence from private communications to grill officials with provocative questions. Did Fed chairman Ben Bernanke bully BofA into doing a bad deal? Did BofA CEO Ken Lewis mislead his shareholders on the losses and the outrageous midnight bonuses the bank paid to Merrill Lynch executives? After the hearings, Towns sent a tart letter to Lewis, mocking his double talk and demanding more documents. On September 30 Lewis threw in the towel and announced his retirement. (BofA remains in the cross hairs.)
Bite by bite, Towns is trying to keep alive the aggressive style he inherited from former Oversight Committee chair Henry Waxman. Next he is going after Moody's and other credit-rating agencies that issued triple-A ratings for rotten mortgage securities. The tough-guy approach can produce results, as the example of BofA shows, but also can carry political risks. Right-wing Republicans have blasted back at Towns, accusing him of getting sweetheart mortgages from Countrywide Financial (now owned by BofA). "Congressman Towns did not receive, nor did he seek, any special mortgage benefits," his office responded.
Towns has one crucial advantage over Angelides--the power to issue subpoenas single-handedly. Angelides is required by law to get approval from at least one of the commission Republicans, who are led by former California Congressman Bill Thomas, a brainy and formidable figure. This rule means GOP members (or Democrats, for that matter) could stall or stymie the investigation. If that occurs, Angelides should go public and call them on their tactics.
"We have started off on the right footing," Angelides insists. "Bill Thomas and I are working together. I have reason to believe both Republicans and Democrats on the commission want to and should have an interest in getting to the truth." The chairman, in any case, promises to "pull no punches." Meanwhile, he could develop useful relationships with Towns and with aggressive state attorneys general like Andrew Cuomo of New York, who also targeted Lewis, and Jerry Brown of California. There is plenty of scandal to go around.
Digging deep can begin with uncovering shocking revelations about the bailouts. That would redirect the reform debate toward more fundamental issues. Here are some promising targets for investigators:
Collusion in High Places
. Some Wall Street players suspect that certain bailouts engineered by the Treasury and the Federal Reserve (including Treasury Secretary Timothy Geithner, former head of the New York Fed) were motivated by a logic never revealed to the public. The suspicion goes like this: the strange and costly rescue of AIG, an insurance company facing bankruptcy, was really intended to save Goldman Sachs, the premier investment house. If AIG went down, it would threaten Goldman and other big holders of AIG's collapsing derivative contracts. Goldman CEO Lloyd Blankfein participated in the pre-bailout discussions, an oddity revealed by Gretchen Morgenson of the New York Times. Afterward, Goldman got paid off in full with the public's money--$12.9 billion to erase its exposure.
Something similar is suspected about the Bear Stearns bailout. The intention may have been to protect JPMorgan Chase, the commercial bank with the largest holdings of vulnerable derivatives. Morgan Chase demanded and got full federal financing for any losses it might suffer by taking over Bear Stearns (in effect, the bank was reimbursed for its own rescue). Did Washington decline to rescue Lehman Brothers because the firm was not sponsored by an important club member that felt threatened by Lehman's demise?
Answering these questions can illuminate the overbearing influence on government exercised by the two dozen or so firms at the pinnacle of financial power. Both the Bush and Obama administrations were committed to saving the big boys first, demanding little or nothing in return. The favoritism raises other unexplored questions. Why, for instance, hasn't the Treasury bought up rotten assets from the troubled banks after demanding Congress put up $700 billion for that purpose? One possibility is that officials may have devised a back-door way to clean up bank balance sheets without provoking more anger in Congress. It appears that toxic assets are gradually being offloaded through three discreet channels the government now controls--AIG, Fannie Mae and the Federal Reserve. Look, no hands. If people can't see it happening, they can't get mad.
. Beyond Ponzi schemes and deceitful mortgage lending, a far larger crime may lurk at the center of the crisis--wholesale securities fraud. "Risk models" reassured unwitting investors who bought millions of bundled mortgage securities and derivatives like credit-default swaps. But as Christopher Whalen of Institutional Risk Analytics has testified, many of the models lacked real-life markets where they could be tested and verified. "Clearly, we have now many examples where a model or the pretense of a model was used as a vehicle for creating risk and hiding it," Whalen said. "More important, however, is the role of financial models for creating opportunities for deliberate acts of securities fraud." That's what investigators can examine. What did the Wall Street firms know about the reliability of these models when they sold the securities? And what did they tell the buyers?