Streetwise

Lauren Rudd

Sunday, July 10, 2011

Wall Street Plays Fast and Loose

Wall Street has played fast and loose with the investing public, amateur and professional. While there are antidotes for exaggeration, ignorance, and even misinformation, it is when the Street’s behavior morphs into a more fraudulent domain designed to deliberately mislead some of their own that lines are quickly drawn in the sand.

The latest cat fight involves Bank of America, who on June 29 announced an $8.5 billion settlement with 22 institutional holders of soured mortgage-backed securities, including the New York Fed. That accord was part of a $20 billion mortgage-related settlement and write-off that the bank said it would take in an effort to resolve much of the liability resulting from its $2.5 billion purchase in 2008 of Countrywide Financial.

BofA also indicated it was taking $6.4 billion in other mortgage related charges, along with a record a $5.5 billion reserve for liabilities related to claims from Fannie Mae and Freddie Mac. As a result, BofA will likely report a second-quarter net loss of between $8.6 billion and $9.1 billion, or between 88 and 93 cents per share. Excluding the mortgage settlement costs, the Bank would have reported second-quarter income of 28 cents to 33 cents per share.

But wait, not so fast says one group of bondholders, that settlement is unfair to certain groups, such as themselves. Court papers filed recently show that 11 companies sharing the name Walnut Place indicated that they had "serious concerns about the secret, non-adversarial, and conflicted way in which the proposed settlement was negotiated and about the fairness of the terms."

Walnut Place had previously alleged in a lawsuit filed last February that Countrywide had made false representations about 1,432, or nearly 66 percent, of the 2,166 loans it investigated. Walnut Place called the settlement "inadequate." It said it plans to ask the court to excuse it from the accord, or else to compel greater disclosures about the pact.

So what we have is a number of large sophisticated Wall Street investment houses who were hoisted on their own petards when they purchased bonds that were misrepresented by their brethren as being investment grade when they were really much closer to junk rating.

It reminds one of the scorpion crossing the river on the back of a frog. The scorpion stings the frog, meaning they will both drown. “Why did you do that," the frog says. To which the scorpion replies, "I could not help myself, it is my nature."

The question is not whether some fat cats will be made whole at the expense of some other fat cats. The real issue is the lack of attention being paid to the folks on Main Street who were victimized to create the securities that are being fought over.

While at one time a bank worthy of analysis in this column, BofA became embroiled in this seemingly bottomless quagmire because of its purchase of Countrywide. Nonetheless, it is no angel. Last year I wrote how BofA "mistakenly" used Repo 105-type transactions on $10.7 billion in assets, which it had misclassified as sales rather than borrowings. A repo is a repurchase agreement whereby securities are used as collateral for a short-term loan with the transaction to be reversed on a specified future date.

A repo is in no way illegal or even improper, on the contrary. However, failing to disclose the action and booking it as a sale is more than “inadvertent error,” it could easily pass for fraud.

Why is it that we continually let Wall Street take advantage of us, or at least try to at every turn, even when we should know better? Kermit Long answered the question well when he told the story of the two men who were walking along a crowded sidewalk. Suddenly one exclaimed, listen to the lovely sound of that cricket. The other commented he heard nothing. Furthermore, he asked his companion, how was it possible to detect the sound of a cricket amid the din of the city?