DYLAN: Welcome to episode 27 of Radio Free Dylan. If you’ve been paying attention to recent developments in our economic system, you know that joblessness continues to be pervasive, that a third of all the homes in our country are worth less than the mortgage that is on them, that foreclosures this year are expected to be at a record, that the federal government continues to literally manufacture hundreds of billions of dollars of new currency at the Federal Reserve in order to prop up the mega banking system. By-products of that include things like commodity price inflation among other things.

So we’re watching the global ripple play out before our eyes in places like Egypt where again doubling the price of wheat for instance. While it may be an aggravation to most people in America, if you are among the 40 percent of Egyptians who live on $2 a day who are forced to spend 80 percent of your income on food, a doubling of your food cost is an exquisite pressure that we are seeing play out.

So if you think that the cover-up and the money printing that is going in our country in order to avoid resolving the inherently corrupt and fraudulent nature of our banking system, one that we subsidized by the trillion with the intention to ideally have a system that invests and lends capital into the development of our own country. It’s the reason why we give banks special status and instead, that special status is being exploited for record payouts for the people in charge of the banks while harvesting trillions in value both directly from the taxpayer and through the dilution of our currency and in the process, sending the sorts of ripples we’re seeing around the world including that playing out in Egypt.

A reporter who I am an admirer of and a fan of and you should be very familiar with. If you’re not already, has been doing among the best works specifically to the intersection of fraud. There’s a lot of things that happened in our – and still happen in our financial system. Our legal and stunningly so – again, 40 percent of the money from our politicians comes from the financial industry so rule making tends to go in their favor.

However, there are aspects of this that are clearly grounds for further investigation if not open prosecution. I welcome Shahien Nasiripour to the conversation. Shahien, a business reporter at The Huffington Post, previously at the Center for Investigative Reporting. And Shahien, how would you describe the current state of the justice system in America, the Department of Justice, the federal bank regulators, the state attorneys general, the SEC, the entire complex that is theoretically there to supervise relative to the activity that did happen and still in some cases is happening in our banking sector.

SHAHIEN: Well, thanks for having me on, Dylan. You know, I would say – well, you’ve got – the state regulators can go after folks who broke state laws. You’ve got – DOJ can go after folks who, you know, make criminal – have criminal investigations and go after folks who just committed fraud and you’ve got – the SEC can do – go after securities fraud. The problem is you just haven’t really seen the number of prosecutions and civil investigations that folks have been hoping to see given the fact that this is the worst financial crisis, The Great Depression.

After the S&L banking crisis in the late 80s, early 90s, some 3800 bankers were sentenced to jail in the five years after – you know – you know, during the middle of the crisis from 1990 to 1995. You’re just not seeing that with respect to this financial crisis and given the fact that so many folks are saying that there was pervasive fraud both on the origination side of mortgages as well as on the securitization side in terms of packaging them up into securities and selling them to investors. You know, a lot of folks are asking serious questions about where are the prosecutions. Where is the justice?

DYLAN: Yes. So let’s – there’s two very distinct categories. One is evidence of fraud and corruption between the borrower and the lender and the other is after all the loans have been made to borrowers, they get packed up and then sold to American pension funds and ultimately the American government. And there are laws that regulate the types of loans, the quality if you will, the probability of repayment having been assessed by theoretically independent third parties like ratings agencies that protect pension managers and for that matter, the government from buying a bundle of loans that doesn’t conform to a predetermined set of standards.

And obviously violation of those conforming standards would theoretically be a crime and also, the lending agreement between the bank itself, the lender and the borrower has a tremendous amount of opportunity for fraud. I would like to spend a little bit of time in each of those areas starting with the [0:05:00] borrower and the lender. Walk us through where fraud could occur in that relationship.

SHAHIEN: Well, in that relationship, you could see fraud – I mean basically from the broker who’s, you know, selling the mortgage to – you know, to a prospective home owner. You – you know, you’re – think about it. You’re at the height of the boom. They’re handing out mortgages left and right. Anyone with a pulse can pretty much get one and so – but the fact of the matter is that if you wanted to – if you didn’t want to keep that mortgage on your balance sheet, let’s say you’re a bank, and you want to just simply process it, reap the fees and then sell it off, you know, into a security on Wall Street, you’re going to try to get that mortgage to conform to these basic standards so investors have, you know, some level of – there’s some level of comfortability with …

DYLAN: And who sets those standards?

SHAHIEN: Well, you’ve got Fannie Mae and Freddie Mac, the two, you know, now – taxpayer-owned mortgage entities to …

DYLAN: And give me an example of what – some of the requirements and those standards would be.

SHAHIEN: Well, some of the requirements would be – I mean, just, you know, you have to have a certain credit score. The mortgage would have to be of a certain size. You would have to be able to document your income. You would have to have – you know, you would have to be able to actually afford your home, put down a – you know, put down a good-sized down payment. Just essentially, you know, your …

DYLAN: And that’s what’s called conforming. So theoretically, Fannie and Freddie shouldn’t be writing checks. The American government shouldn’t be writing checks to help fund home loans unless they know that there’s evidence that the buyer has the income to pay the loan, that there’s a meaningful down payment as you just described. Is that fair?

SHAHIEN: Right. Essentially, they meet standards set by Fannie Mae and Freddie Mac …

DYLAN: … is to say we’ve made this loan. It meets these standards. Will you please buy it from us? We’ll keep the fees for making it.

SHAHIEN: Exactly, exactly. They’ll say to the investor, you know, this meets these standards. It’s safe to buy. This borrower will repay the loan. You will get this guaranteed income for the next however many years you own the security. That’s basically how it’s supposed to work.

DYLAN: And they are selling not just to Fannie and Freddie but also to pension funds for judges, teachers and cops in every state in America.

SHAHIEN: Right, right. Fannie and Freddie set the standards. They then guarantee the loans in case they go bad and then pension funds and the rest would buy these because it was guaranteed income.

DYLAN: And is the bank legally attached to the opinion that they represent? In other words, when the bank shows up at the government or at the pension fund and says we hereby verify that this bundle of mortgages complies with the standards of income down payment and repayability and then they sell that or the ratings agencies say we validate the bank’s opinion on this group of loans, is the bank legally bound to that opinion?

SHAHIEN: They’re bound to their own opinion, not necessarily to the rating agencies. But everyone was bound to the opinion. The broker to the lender, the lender to the Wall Street firm that securitized it and the Wall Street firm that securitized it to the eventual investor. It’s one long chain. Everyone making promises to the next person up the chain.

DYLAN: And that is legally bound.

SHAHIEN: Yes.

DYLAN: In other words, the pension manager and the federal government is theoretically protected by a law from being sold an investment that claims to have certain conforming qualities and standards. And in the event that it turns out that it doesn’t conform with those standards, what is the traditional recourse?

SHAHIEN: Well, the term of art that they use is called reps and warranties which is just short for representations and warranties. So when – you know, let’s say Countrywide would originate a mortgage and they would sell it to, let’s say, Goldman Sachs. They would make representations and warranties that these mortgages met these standards and then Goldman Sachs would make the same deal with the investors who would buy it. That …

DYLAN: The pension manager, whoever it is.

SHAHIEN: The pension manager, right, who – if you’re going to buy these securitized mortgages, they meet – we are making representations and warranties that they meet certain standards.

DYLAN: So now I’m the pension manager who is trying to keep up with my free spending state government, one way or the other. I’m being told by Goldman Sachs or whoever, Deutsche Bank, Morgan Stanley. I don’t want to just pick on Goldman.

SHAHIEN: Right.

DYLAN: That this investment conforms with this legally-determined set of standards. Goldman has been told that it conforms with this legally-determined set of standards by Countrywide.

SHAHIEN: Right, and it …

DYLAN: And everybody is legally obliged. Where is the liability theoretically in that agreement if it turns out that the representations and warranties from Countrywide to Goldman or Goldman or whatever – the bank to the pension fund is in fact – turns out to be untrue?

SHAHIEN: Well, if it’s outright fraud, you would have – you can have, you know, potential criminal prosecution …

DYLAN: Where?

SHAHIEN: … if it …

DYLAN: At Goldman? At Countrywide? Both? At the pension?

SHAHIEN: All of them. I mean …

DYLAN: Okay. So everybody has legal liability in that chain.

SHAHIEN: Right. If – well, I mean, you know, criminal fraud is a high bar to clear. If there is criminality involved, the Department of Justice could get involved or like your state attorney general. If it’s just civil fraud, you’ve got – well, first of all, the parties could litigate between themselves. So let’s say Goldman lies to the pension manager. The pension …

DYLAN: About representations and warranties for this investment.

SHAHIEN: Right. The pension manager can then force Goldman to buy back that mortgage and to make him whole. So …

DYLAN: Say, listen, what you told me this was isn’t what it turned out to be and as a result, I’m returning it. It’s no different than if you ordered a pair of pants from J. Crew and they sent you a sweater. You ordered pants. You’re not – you send them back the sweater.

SHAHIEN: Right. Essentially, you’re giving them back their product and they are giving you back your money.

DYLAN: Got it.

SHAHIEN: And if it’s – let’s say – and then let’s say Goldman said, well, you know, Countrywide lied to us then they do the same thing to Countrywide.

DYLAN: Got it.

SHAHIEN: And so that’s how the private parties can litigate amongst themselves …

DYLAN: And that’s actually happening.

SHAHIEN: That is happening. Correct. It’s not happening as much as pension fund managers, investors would like but it is happening. And then Fannie and Freddie are doing it too as well. But again …

DYLAN: And Fannie and Freddie, so people understand, is another buyer of these mortgages from the banks and they have their own representations and warranties.

SHAHIEN: Right.

DYLAN: And pension funds could either buy directly from the bank like Goldman Sachs and suffer the fraud there or Goldman could sell it to Fannie and Freddie and then the pension fund could buy it from them. Is that correct?

SHAHIEN: Exactly. Exactly. And so, between – you know, between those parties, if they can figure it out for themselves, great. But if there’s fraud, whether criminal or if it’s just, you know, securities fraud, you could have authorities getting involved. And so …

DYLAN: And who would those authorities be in this case?

SHAHIEN: Well, if it’s criminal, DOJ, Department of Justice.

DYLAN: So it’s a federal offense.

SHAHIEN: Right. If it’s – you know, if it’s civil fraud, if it’s securities fraud, then the Securities and Exchange Commission would get involved. And so …

DYLAN: I want to do a brief history lesson because the idea of selling a piece of paper that promises a high return to an investor in exchange for cash now is an age old way of stealing money. Specifically, there are a set of laws that were put in place after the crash in 1929 that are called blue sky laws that specifically were put in place because there was a culture, a practice on Wall Street in the 1920s in which individuals – so let’s say Shahien and I formed Shahien Corporation which produces nothing, owns nothing and has nothing but we go to our printer and we print a bunch of pieces of paper that say Shahien Corporation, $10 a share and then we come up with a story about all the wonderful things Shahien Corporation is going to do, our spaceship and our navy and whatever we’ve got which doesn’t exist.

And then we sell that piece of paper, that stock to hungry, greedy investors in the 1920s. It turns out that it’s nothing. Shahien and I collect all the money from selling the shares and we – you know, we head to Mexico or whatever we want to do with the money. To prohibit that, after the depression – or excuse me, after the crash, before the depression, all the legislation that was passed between 1929 and the early 1930s included the set of laws called blue sky laws. And those blue sky laws were explicitly put in place to prevent people who would sell investments of questionable character, shall we say, from approaching an investor pool and selling them “a piece of blue sky”. And those laws were actually very effective when it came to the stock market, selling equity shares in an American corporation from that point forward where you had to draft all these prospectuses and there’s all this compliance research as to does the company actually exist, where is it’s headquarters, where – do they – can – what money are they making? What money are they spending? Those blue sky laws were fairly effective, were they not, Shahien?

SHAHIEN: They were. They were. I mean up until this most recent …

DYLAN: Of course. Well, they were really designed to deal with selling fraudulent stock as – this is a whole new thing which is selling fraudulent debt effectively. So I want to fast forward if I can – well, before, I fast forward, how important is our laws, like those blue sky laws, to prevent people selling worthless pieces of paper to investors?

SHAHIEN: I mean, that’s – it’s hard to say. I mean it’s a basic standard. You can’t make, you know, false promises and so, you would think that it would have – it would serve as some kind of deterrent to fraudulent activity. I think it’s a basic standard. I would imagine that it would – it should be acting as a basic deterrent but I think where it gets – runs into trouble is when you’re dealing with these complex transactions where maybe the investor doesn’t know what’s going on or the transactions have been gamed to skirt around the letter of the law but maybe it violates the principle of the law.

DYLAN: And let’s talk about that a little bit going – so you’ve got Countrywide in Southern California making a loan to collect the fee to somebody who doesn’t comply or conform to whatever the lending standard is. Countrywide misrepresents the reps and warranties to Goldman. Goldman misrepresents it to the pension or the government. Part of the way they do this is they get outside auditors, outside agencies, whether it’s the rating agencies or other outside auditors, to validate this so that Countrywide can say, listen, this has been audited by X, Y, Z and they say this is conforming. How important is that outside opinion?

SHAHIEN: Well, it’s incredibly important. I mean, you’ll – first of all, you have the ratings agencies and those ratings are public but even more important than them, you had due diligence firms who operated, you know, during the entire – you know, during the boom and the bust and what they – they were brought in by securitizers. So let’s say, you know, you’re Goldman. They would want to buy loans from Countrywide and so, this – you know, due diligence firms like the biggest one the country Clayton Holdings based in Connecticut, they would come in and they would evaluate Countrywide’s loans or Goldman and …

DYLAN: Got it. So …

SHAHIEN: Goldman – go ahead.

DYLAN: So I want to – so let’s get ahead to Clayton Holdings a little bit. You’ve written about them a number of times. Bill Greider over at The Nation turned it up again going through the documents of the financial crisis inquiry report and in his article he writes the following. He says, Clayton Holdings which is one of these – you say it’s the biggest outside auditing firm validating that these mortgages conform was hired to examine some 900,000 mortgages.

SHAHIEN: Right.

DYLAN: Clayton found that 255,000 -- 28 percent were flawed.

SHAHIEN: Right.

DYLAN: And should not have been packaged as mortgage-backed securities. Greider goes on to say, Clayton’s president delicately described the high deficiency rate as a quality control issue but the – and then this is Greider again, according to the FCIC but the banks went ahead and included nearly a hundred thousand of these loans in new securities anyway without informing the buyers.

SHAHIEN: Right.

DYLAN: Greider goes on to say, this smells like old-fashioned fraud. The biggest players were Citigroup, JPMorgan Chase, Bank of America, Morgan Stanley and three European banks. How is knowingly selling non-conforming loans as conforming not a prosecutable offense?

SHAHIEN: That’s actually a good question. I wrote about this in September and, you know, the SEC and the New York – you know, all this data is old. It’s all from 2005, 2006, 2007, early ’08, 2004. The New York state attorney general, the current governor Andrew Cuomo, he had this data in early ’08. The SEC had this data in early ’08. It became public because the Crisis Commission held a hearing in Sacramento that was, you know, barely followed back in September when all this great information came out but, you know, SEC has been sitting on this for three years. You know, it’s – we’re now February of 2011 and I haven’t heard anything …

DYLAN: Right. So we know for a fact that at least a hundred thousand loans that were clearly evaluated by Clayton Holdings as flawed were sold without informing the buyers to pension funds and the government. Classic blue sky, selling something worthless to your – now, we’ve got all the talk about holding – cutting pensions austerity and no one is doing anything about the investor fraud that the – and – or the amount of money that Goldman and the banks paid themselves or collected selling this worthless paper. So let’s cut to the chase.

At the Department of Justice, what could – are they the ones that should be prosecuting this or the SEC? Who’s responsible for not doing this?

SHAHIEN: Well, you know, the Crisis Commission says that this would appear to violate securities fraud or securities laws. That this would appear to be securities fraud so that would be clearly the jurisdiction of the Securities and Exchange Commission, the SEC.

So, the ball is in the SEC’s court. I mean, the fact of the matter is you had Clayton evaluating nearly million mortgages. Of those, 28 percent fail to [0:20:00] meet the standards set by, you know, the Wall Street firms that bought these mortgages and then sold them as investment and of that 28 percent, about half of them were likely sold to investors anyway. I mean, we don’t know for certain if they were sold to investors but it appears likely so. And it was never – the thing is, they can sell it to investors but they have to tell investors what they’re buying and it’s …

DYLAN: It’s the misrepresentation is where the crime lives.

SHAHIEN: Exactly. And the Crisis Commission looked into it and they never saw one incident. Then there’s one example of Clayton’s findings being disclosed to investors.

DYLAN: Right. It’s a failure to disclose. Now, I want to go down now to the state attorney general level.

SHAHIEN: Sure.

DYLAN: What do the state attorney generals have authority over? What specific people, what specific aspects of this criminal chain could they, should they be prosecuting?

SHAHIEN: Well, when it comes to federal securities law, I mean that’s pretty – that trump [0:21:06] [Phonetic] state law. So the SEC, the ball is essentially in their court. What the state AGs can do is they can look at how specific actions have harmed residents of their state. So, you have the Massachusetts attorney general for example, Martha Coakley. She went to the – you know, she went against Morgan Stanley and Goldman Sachs and got settlements from both of them because of their failure to disclose and their shenanigans and how …

DYLAN: In selling to the Massachusetts pension.

SHAHIEN: Well, I can’t – I don’t recall if it was with respect to the Massachusetts pension but what she did is she tied their activity to loans made in the city of Massachusetts that eventually – that were foreclosed on, those homes that were foreclosed on. And so, that’s how she tied it in.

DYLAN: Got – what about a state like Nevada where there is massive housing boom, massive housing bust? What could the Nevada AG focus on and prosecute?

SHAHIEN: Well, as I understand it, Nevada and Arizona are both – both took an interest in Clayton Holdings and what they had to say, what they told the Crisis Commission back in September and both are investigating. What the status is of those investigations, I don’t know. But if they can tie it in – they can tie in what Clayton did and the lack of disclosure by investment firms to, you know, aggrieved investors in Nevada and Arizona or – you know, aggrieved home owners in Arizona and Nevada, then they could go to bat.

DYLAN: So if the – so if an attorney general can tie the failure to disclose, the selling of the fraudulent investment either to the state pension in a given state or to the failure to disclose and its impact on the home owners in that state. Is that – do I understand that right?

SHAHIEN: I’m – that appears to be the case but I don’t know for certain. I mean, I know for example the state of New York, they’ve got the Martin Act and that gives the attorney general wide latitude to go after, you know, securities firms because they’re all based in New York. And so, where the SEC doesn’t want to – you know, if they don’t want to go to bat against the Goldman or Morgan or any other big firm, the New York attorney general can.

DYLAN: Got it.

SHAHIEN: As far as the western states, to be honest, I’m not entirely certainly.

DYLAN: Understood. Shahien, a pleasure. Keep up the great work. Information is our friend. The more people understand everything that you and I just discussed, the more impossible I think it will become for the federal regulators who are, I believe, under the influence of the political process and the financial dependence of politicians on bank donations, to continue to sit on their guns [Phonetic] as it where. Thank you, Shahien.

SHAHIEN: Thank you, Dylan.

DYLAN: Alright. Shahien Nasiripour, business reporter for The Huffington Post. Do check out also Bill Greider’s article today, needles in a haystack. Again, the FCIC Report Turns a Blind Eye to Wall Street Fraud and specifically look at this data about Clayton Holdings examining mortgages, finding 28 percent of them to be flawed. The FCIC finding that 100,000 of them were sold to investors, perhaps your pension fund without informing the buyer and our government still refuses to conduct any prosecutions on this matter, which is outrageous to say the least.

That does it for this particular episode of Radio Free Dylan. We’ll talk to you next time.