Paul McMorrow

SEC shows how weak it is

The Securities and Exchange Commission said last week it won’t sue Goldman Sachs over an awful subprime deal from 2006. The SEC now looks like it’s writing off any hope of scoring meaningful reprisals against the banks that brought down the American economy. In saying it won’t prosecute, the SEC is revealing the staggering weakness of the laws that are supposed to protect the economy, and the agency that’s supposed to be enforcing them.

Subprime mortgage bonds were rainmakers for Wall Street banks. Wall Street collected fees for supplying the cash that backed subprime loans, for packaging those loans into bonds, and for selling the bonds off to investors. So long as one wasn’t a homeowner stuck holding an exploding mortgage, or a bank with a balance sheet full of them, the subprime game was as lucrative as anything Wall Street had ever dreamed up. Which is why, as the wheels started to come off the subprime bus, big banks hit the gas.

In late 2006, Goldman Sachs put a bow on a $1.3 billion mortgage deal full of loans from the notorious subprime lender Fremont General. Red flags abounded. Fremont was seeing scores of its mortgages go belly-up. Goldman sales reps were sending internal emails dismissing Fremont’s mortgages as “crap.” But Goldman couldn’t get the loans out the door, and into private investors’ hands, quickly enough. The bank sold Freddie Mac, the now-nationalized mortgage giant, a $468 million slice of the Fremont mortgage bond; by the time Freddie sued Goldman last year in a bid to get its money back, 56 percent of the mortgages in the Fremont deal had soured.


The scale of the devastation shouldn’t have been surprising to Goldman. The Fremont loans were built to explode. Goldman wanted it that way, because the risk brought in juicier fees for the bank. And by any measure, the Fremont deal the SEC sniffed around reeked of risk: The bulk of the mortgages Freddie Mac bought were high-interest adjustable-rate loans set to blow out in two years, made to borrowers with marginal credit scores. More than a third of the borrowers hadn’t verified their income.

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Goldman warned its customers that there was some risk in paperwork the bank filed with the SEC. But it faced an SEC investigation because the mortgages Goldman sold off were allegedly in far worse shape than those filings let on. When Goldman sold its Fremont mortgage bonds to investors, it made promises about loan quality. Goldman said more than half the borrowers in the late 2006 Fremont deal had put 20 percent down; according to Freddie Mac’s lawsuit, Goldman oversold that figure by 23 percentage points. The bank also allegedly hid the fact that one-quarter of the Fremont mortgages were upside-down, with borrowers owing more than their homes were worth, from day one.

The story of the housing bubble is the story of a prolonged, deliberate Wall Street racket. Banks enabled reckless mortgage lenders, paying premiums to brokers who made riskier loans. Wall Street knew these loans couldn’t withstand scrutiny, but they sold them anyway. Banks routinely overstated the quality of the mortgage bonds they were selling investors. Bankers derided their deals as “crap” and “pigs,” but pushed them out the door anyway; some, like Goldman, turned around and bet against the very same loans they’d just sold. Banks also cherry-picked the best loans to keep for themselves, passing the junk on to their customers.

There wasn’t anything special about the $1.3 billion Goldman deal the SEC targeted. It could have been any bubble-era mortgage bond from any Wall Street bank. But if the SEC can’t find anything to prosecute in the Goldman-Fremont deal, it’s saying there was nothing wrong with an obviously crooked system that cheated investors and welcomed foreclosures as the price of netting big fees.

Last week, the agency lost a fraud case against a Citigroup banker who had sold investors a $1 billion subprime mortgage instrument that Citi had placed a $500 million bet against. So the SEC may feel it can’t pin specific charges on a pervasively fraudulent system. It’s worth noting, then, that Massachusetts won decisive anti-subprime actions against both Goldman and Fremont because the state’s laws are straightforward. Massachusetts simply bars businesses from ripping off consumers. Federal regulators need to take the same approach. There’s no excuse for letting the financial crisis’s perpetrators slide away unscathed.

Paul McMorrow is an associate editor at CommonWealth magazine. His column appears regularly in the Globe.