Some Wall Street lawyers want the SEC to have a bigger budget, because of its expanded responsibilities under Dodd-Frank. Yes, the investigation and enforcement agency for Wall Street is getting encouragement for a bigger budget from the lawyers of the firms they investigate. This is made doubly odd by the fact that the SEC’s budget, while set by Congress, comes directly from transaction fees on Wall Street firms. So how could this be? Well, many of those lawyers once worked for the SEC and may have some residual loyalty.

But I have a better explanation. The SEC’s current conception of “enforcement,” with the occasional splashy headline on relatively minor crimes, while relieving the perpetrators of the really large crimes of the need to admit wrongdoing, or outright failing to prosecute the most massive and obvious crimes around, really works well for Wall Street. Why wouldn’t they go to bat for an organization that goes to bat for them? They probably think it will help them over the long term in the form of a lighter hand for regulation and enforcement.

Now, this has to be balanced with a pretty major front-page story in the Financial Times about the SEC targeting fraud in the securitization markets:

US securities regulators investigating the role of banks in the mortgage crisis are homing in on the question of whether investors were misled about the home loans used to back securities […]

Kenneth Lench, chief of the SEC’s structured products unit, said at a conference in Washington on Friday that issues of interest to the commission include whether investors were properly informed about underwriting and foreclosure practices and the quality of mortgages used to back securities […]

Mr Lench highlighted areas that could be of concern: “Were representations relating to the transfer or documentation of mortgages into the loan pools accurate? Did activities such as ‘robo-signing’ contradict those representations? Were disclosures to investors regarding the quality of the loans in the pools accurate?”

This is precisely the fraud described in the FCIC report at great lengths. The trustees knew about the bad loans in their pools and never mentioned it to the investors, who thought they were getting AAA securities that could never default. In fact, the trustees – namely, the big banks – used the data on the loan pools to secure discounts from the originators, clearly understanding that the originators committed mortgage fraud and faulty underwriting and essentially using that information to shake them down. In addition, the SEC is picking up on the fact that the industry has lost several cases in court showing they did not properly convey the mortgages to the trusts, making the securities essentially worthless and canceling out the standing to foreclose. In effect, they were sold non-mortgage backed securities, and that’s pure fraud.

The way that the banks have been trying to hide these errors in securitization is through foreclosure fraud, but they keep losing those cases as well.

Citigroup Inc., the third-largest U.S. bank, settled or lost at least five claims in 2010 brought by borrowers who accused the bank of filing fraudulent mortgage documents provided by a Texas firm.

In the most recent settlement in December, a bankrupt homeowner in Wappingers Falls, New York, challenged Citigroup’s use of a mortgage “assignment,” which shows the transfer of ownership of a mortgage. It was signed by an employee at Orion Financial Group Inc., a Southlake, Texas, firm that provides document services to lenders.

The document was “of fraudulent nature and questionable origin,” the borrower’s attorney, Linda Tirelli, wrote in an August objection to the bank’s claim at U.S. Bankruptcy Court in New York. Citigroup created and filed the assignment after proceedings began because it otherwise couldn’t prove its right to collect the debt, she wrote in an e-mail. The bank denied the allegations and didn’t admit liability in the settlement.

These faulty assignments are everywhere, and while that’s not necessarily the purview of the SEC, it is still fraud, in this case fraud upon state courts and the defendants in the cases. These settlements are designed so that Citi or other banks doesn’t end up with a precedent on a case that proves they lied to the courts and created a false assignment.

Everything that’s being done – the settlements, the playing nice with the SEC – has sought to keep a lid on this boiling kettle of fraud that could explode at any moment. There are plenty of ways to blow that lid off. The 50 state AG investigation could find criminal fraud, as could the SEC, the foreclosure task force out of the Financial Stability Oversight Council, the Justice Department, and state and federal regulatory bodies across the government.

I’m sure there’s a lot of internal pressure to keep that lid firmly sealed. The banks are surely telling the regulators that exposure would cause another major crisis. But that assumes the crisis doesn’t already exist. In cities where the housing bubble has popped, the misery index has risen, with attendant unemployment, crime and suffering. Housing, with the lead weight of foreclosures still propped atop it, has not yet recovered, and the expected price drop could lead the country right into a double dip recession. This problem is spreading, and one reason is the failure to cure the market by addressing the fraud and using that as the lever to get a solution. Without the threat of actual prosecution, it won’t happen. Just take a look at this amazing case:

Marc Sanders, who lost his job as a radiology consultant in October, was thrilled to find out he qualified for a federally funded program that will make up to $3,000 a month in mortgage payments on behalf of unemployed homeowners in California.

Sanders was eligible for the maximum assistance – $3,000 a month for six months – from the Keep Your Home California program, but he was shut out for an astonishing reason.

His mortgage payment is $3,180 a month and his loan servicer, Bank of America, will not accept a $3,000 payment from the program and a separate payment from Sanders for $180.

BofA – like most banks participating in the state-run program – will accept only a single, full payment.

Sanders can’t combine the $3,000 with his own funds and make a full payment to BofA because the program will only send money to loan servicers, not homeowners.

The program can’t make a combined payment either because it is not set up to accept money from homeowners, says Diane Richardson, director of legislation with the California Housing Finance Agency, which administers the program.

So you have servicers who refuse to even be given $3,000 a month because their system won’t let them accept two checks. This is but a sample of the kind of abuse borrowers have received. I can assure you that if BofA’s CFO had to go to jail because of authorizing faulty mortgage bonds, suddenly the whole system would be much more willing to make accommodations.

Perhaps the SEC will do its job, or any number of the other alphabet soup agencies. But I’m not hopeful. And without that possibility, this crisis will just linger.

David Dayen

David Dayen

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