The fraud committed by the banksters was not only ignored by regulators and the courts they were rewarded with tax payer money in the form of TARP. It seems like the scam may be falling apart and the fraud is becoming so obvious that it can no longer be ignored. Ezra Klein interviewed Janet Tavakoli, the founder and president of Tavakoli Structured Finance Inc., to get some perspectives.
Ezra Klein: What’s happening here? Why are we suddenly faced with a crisis that wasn’t apparent two weeks ago?
Janet Tavakoli: This is the biggest fraud in the history of the capital markets. And it’s not something that happened last week. It happened when these loans were originated, in some cases years ago. Loans have representations and warranties that have to be met. In the past, you had a certain period of time, 60 to 90 days, where you sort through these loans and, if they’re bad, you kick them back. If the documentation wasn’t correct, you’d kick it back. If you found the incomes of the buyers had been overstated, or the houses had been appraised at twice their worth, you’d kick it back. But that didn’t happen here. And it turned out there were loan files that were missing required documentation. Part of putting the deal together is that the securitization professional, and in this case that’s banks like Goldman Sachs and JP Morgan, has to watch for this stuff. It’s called perfecting the security interest, and it’s not optional.
She says that the investors that purchased the securities are waking up to the fact that they were the victims of fraud and will go after the banks who sold the securities. This will destabilize the already fragile economy but both the fraud and the loses must be identified. So what will it look like?
EK: It sounds almost like you’re saying we still need to go through the end of our financial crisis.
JT: Yes, but I wouldn’t say crisis. This can be done with a resolution trust corporation, the way we cleaned up the S&Ls. The system got back on its feet faster because we grappled with the problems. The shareholders would be wiped out and the debt holders would have to take a discount on their debt and they’d get a debt-for-equity swap. Instead we poured TARP money into a pit and meanwhile the banks are paying huge bonuses to some people who should be made accountable for fraud. The financial crisis was a product of our irrational reaction, which protected crony capitalism rather than capitalism. In capitalism, the shareholders who took the risk would be wiped out and the debt holders would take a discount but banking would go on.
Most major banks are insolvent and cannot (and should not) be saved. The best approach is something like a banking holiday for the largest 19 banks and shadow banks in which institutions are closed for a relatively brief period. Supervisors move in to assess problems. It is essential that all big banks be examined during the “holiday” to uncover claims on one another. It is highly likely that supervisors will find that several trillions of dollars of bad assets will turn out to be claims big financial institutions have on one another (that is exactly what was found when AIG was examined – which is why the government bail-out of AIG led to side payments to the big banks and shadow banks)…. By taking over and resolving the biggest 19 banks and netting claims, the collateral damage in the form of losses for other banks and shadow banks will be relatively small.
Now the politicians are not going to be too excited about doing something that will increase the pain temporarily but they may not have any choice. Another TARP is not a political possibility.