I|duc|ary Dut|es and Lth|ca| rob|ems

8uslnesses Lyplcally operaLe under flduclary duLles or obllgaLlons 1hese fall lnLo Lwo
broad caLegorles of loyalLy and care 1hese duLles essenLlally sLlpulaLe LhaL a
buslnessperson should acL LruLhfully ln a Llmely fashlon and ln Lhe besL lnLeresL of Lhe
consumer rlor Lo Lhe subprlme morLgage and foreclosure melLdown lenders lgnored
Lhese flduclary duLles engaglng ln uneLhlcal pracLlces such as mlsleadlng shareholders
abouL Lhe dlverslLy of morLgage porLfollos and noL verlfylng Lhe ablllLy of Lhe appllcanL
Lo repay 1hey also Look advanLage of consumers Lhrough ad[usLable or Leaser raLes
and falled Lo keep proper documenLaLlon
o|e of government (8efore cr|ses)
8ack ln 1999 when lannle Mae Lhe naLlon's blggesL underwrlLer of home morLgages
was under pressure by Lhe CllnLon admlnlsLraLlon Lo flnd a way Lo geL more loans Lo
borrowers whose lncomes credlL raLlngs and savlngs are noL good enough Lo quallfy
for convenLlonal loans" A plloL program was launched whlch soon became general
pollcy Money flowed Lo people who couldn'L afford Lo pay lL back
WashlngLon's pollLlcal esLabllshmenL ls Lhe prlme cause of Amerlca's subprlme crlsls
1he comprehenslve responslblllLy for Lhls colossal crlsls belongs Lo Lhe WhlLe Pouse
and uS Congress
Lth|ca| |ssue
laylng voLe bank pollLlcs and showlng people Lhe greaL Amerlcan dream governmenL
proposed Lo glve loans Lo all people lrrespecLlve of Lhelr ablllLy Lo pay 1easer loans
were glven Lo everybody
lL also lncreases Lhe debL on governmenL books whlch has Lo be pald by fuLure
generaLlons
o|e of Government sponsored
organ|zat|ons
W 8uys morLgages from lenders and banks and elLher holds some loans or resells
mosL Lo Wall SLreeL lnvesLors
W ln 2000 company announced lL would buy $2 1rllllon ln loans from low
lncome mlnorlLy and rlsky borrowers by 2010
W ln 2004 Lhe company was under pressure from compeLlLors Wall SLreeL flrms
shareholders and Congress demandlng lL sLeer more loans Lo lowlncome
borrowers n? 1lmes 10/9/08
W Also lnvesLmenL banks began bundllng home loans from CounLrywlde and
selllng Lhem Lo lnvesLors Lhereby bypasslng lannle
Lth|ca| |ssues
W lannle Mae and lreddle Mac and Lhe varlous megabanks and lnvesLmenL
banks puL Lhese pools LogeLher and Lhen sold Lhem on Lo lnvesLors
W 1hese flnanclal flrms dldn'L care abouL Lhe quallLy of Lhe paper Lhey were
selllng or Lhe posslble harm Lo lnvesLors who boughL lL
W 1hls was a volume operaLlon Lhe more pooled vehlcles Lhe flrms could form
and Lhe more Lhey could reduce Lhelr cosLs (le no acLual checklng on Lhe
quallLy of Lhe paper) Lhe hlgher Lhe proflLs
W 1hey do noL care abouL Lhe consequences for Lhe end lnvesLors many of
whom were loyal longLerm cllenLs
of Lhe flnanclal flrms
8rokers
W MarkeLlng Lo aLLracL cllenLs
W AssessmenL of Lhe borrowers clrcumsLances (MorLgage facL flnd forms
lnLervlew) 1hls may lnclude assessmenL of credlL hlsLory (normally
obLalned vla a credlL reporL) and affordablllLy (verlfled by lncome
documenLaLlon)
W Assesslng Lhe markeL Lo flnd a morLgage producL LhaL flLs Lhe cllenLs
needs (MorLgage presenLaLlon/recommendaLlons)
W Applylng for a lenders agreemenL ln prlnclple (preapproval)
W CaLherlng all needed documenLs (paysLubs/paysllps bank sLaLemenLs
eLc)
W CompleLlng a lender appllcaLlon form
W Lxplalnlng Lhe legal dlsclosures
W SubmlLLlng all maLerlal Lo Lhe lender
W up holdlng Lhelr duLy by savlng Lhelr cllenLs as much money as posslble by
offerlng besL advlce for Lhe cllenLs clrcumsLances
Lth|ca| |ssues
W MorLgage brokers developed Lo flnd borrowers 1hese brokers
were pald on quanLlLy and noL quallLy and slnce Lhey weren'L
carrylng Lhe paper on Lhelr own balance sheeLs far Loo many
of Lhe brokers cared noL aL all wheLher Lhe borrowers were
engaglng ln LhoughLful LransacLlons or were belng seL up for
hearLbreak and penury
W lncompleLe lnformaLlon ls provlded Lo Lhe cusLomer and
cusLomers were ca[oled lnLo Laklng Lhls hlgh lnLeresL raLe
morLgages
8ank
W PlsLorlcally Lhe rlsk Lo morLgage lenders had been conLalned by
uue dlllgence on Lhe borrower's ablllLy Lo repay Lhe value of Lhe properLy
subsLanLlal down paymenLs
Lth|ca| |ssues (Lendinq stondords ond
proctices eroded )
W 8anks approved Lhe morLgages afLer revlewlng Lhe appllcaLlons buL
Lhe banks had no lnLenLlon of holdlng onLo Lhe paper lnsLead Lhey
needed Lo bulld leverage lnLo Lhelr balance sheeLs whlch meanL
geLLlng Lhls paper off Lhe balance sheeL as qulckly as posslble 1he
paper was sold lnLo morLgage pools LhaL were ln Lurn sold Lo
unsuspecLlng lnvesLors
W 8ecause banks wanLed Lo leverage Lhelr balance sheeLs (reuslng
Lhelr lendlng capaclLy over and over agaln) a markeL developed for
pooled morLgages
nvestment 8anks
ehman 8roLhers 8ear SLearns Merrlll ynch Morgan SLanley
and Coldman Sachs
Lhe lnvesLmenL
banklng scandals of Lhe early 2000s and Lhe subprlme
consumer and subprlme corporaLe debL
scandals of 20072008 ls LhaL many of Lhe flnanclal
lnsLlLuLlons can make more money from
shorLLerm commlsslons and fees for advlslng arranglng Lhe
flnanclng and Lradlng Lhe new
Lypes of large securlLlzed and ofLen hlghly leveraged sub
prlme debL flnanclal LransacLlons
Lhan Lhey could from reLurns on longLerm asseLs
LLhlcal lssue
lnvesLmenL banks proclalms a responslblllLy Lo our cllenLs our
shareholders our employees and our communlLles Lo supporL and
fund ldeas and faclllLaLe growLh ?eL Lhe evldence shows LhaL
Coldman repeaLedly puL lLs own lnLeresLs and proflLs ahead of Lhe
lnLeresLs of lLs cllenLs and our communlLles lLs mlsuse of exoLlc and
complex flnanclal sLrucLures helped spread Loxlc morLgages
LhroughouL Lhe flnanclal sysLem And when Lhe sysLem flnally
collapsed under Lhe welghL of Lhose Loxlc morLgages Coldman
proflLed from Lhe collapse 1he evldence also shows LhaL repeaLed
publlc sLaLemenLs by Lhe flrm and lLs execuLlves provlde an
lnaccuraLe porLrayal of Coldmans acLlons durlng 2007 Lhe crlLlcal
year when Lhe houslng bubble bursL and Lhe flnanclal crlsls Look
hold 1he flrms own documenLs show LhaL whlle lL was markeLlng
rlsky morLgagerelaLed securlLles lL was placlng large beLs agalnsL
Lhe uS morLgage markeL 1he flrm has repeaLedly denled maklng
Lhose large beLs desplLe overwhelmlng evldence
nsurance agenc|es
CredlL defaulL swaps creaLe moral hazard CredlL defaulL
swaps are a form of unregulaLed lnsurance agalnsL bad
debL All regulaLed llnes of lnsurance come wlLh a
requlremenL of lnsurable lnLeresL for Lhe slmple
reason LhaL lf lL were posslble Lo Lake ouL flre lnsurance
on a properLy ln whlch Lhe lnsured had no flnanclal
lnLeresL moral hazard would be creaLed leadlng Lo
arson for proflL 1here ls no requlremenL of lnsurable
lnLeresL on credlL defaulL swaps so shorLsellers Lake
ouL lnsurance and Lhen commlL Lhe flnanclal equlvalenL
of arson 1hls needs Lo be sLopped before Lhe enLlre
vlllage ls burned down
Lth|ca| |ssue
W Agencles llke AlC were glvlng lnsurance on defaulL and Lhelr exposure was so
hlgh LhaL ln case of downLurn Lhey dldn'L had Lhe ablllLy Lo pay Lhelr clalms
aLlng Agencles
aLlngs agencles (Moody's S llLch) raLed Lhese M8S's and oLher sLrucLured producLs" such
as CuC's
CredlL raLlng agencles (CAs) play a key role ln flnanclal markeLs by helplng Lo reduce Lhe
lnformaLlve asymmeLry beLween lenders and lnvesLors on one slde and lssuers on Lhe oLher
slde abouL Lhe credlLworLhlness of companles or counLrles CAs role has expanded wlLh
flnanclal globallzaLlon and has recelved an addlLlonal boosL from 8asel ll whlch lncorporaLes
Lhe raLlngs of CAs lnLo Lhe rules for seLLlng welghLs for credlL rlsk aLlngs Lend Lo be sLlcky
lagglng markeLs and overreacL when Lhey do change 1hls overreacLlon may have aggravaLed
flnanclal crlses ln Lhe recenL pasL conLrlbuLlng Lo flnanclal lnsLablllLy and crosscounLry
conLaglon'
ln Lhe unlLed SLaLes [usL llke ln oLher lndusLrlallsed counLrles credlL raLlng agencles(CAs)
are cruclally lmporLanL manlfesLaLlons of flnanclal spheres and Lhelr role ln drlvlng economles
Lth|ca| |ssues
W 1he raLlng agencles asserL LhaL Lhey provlde oplnlons noL lnvesLmenL advlce
yeL Lhey acLlvely work wlLh lnvesLmenL banks Lo englneer LransacLlons1 and
wlLh CuC lssuers Lo achleve LargeLed raLlngs As Lhe medla has puL lL raLlng
agencles work wlLh banks Lo develop Lhe worsL posslble producL LhaL would
sLlll achleve a cerLaln raLlng 1he agencles role ln sLrucLurlng CuC
LransacLlons noL only caplLallzes on Lhelr markeL power buL moves Lhem away
from Lhelr LradlLlonal role of raLlngs publlshers 1he subsLanLlal fees LhaL Lhe
agencles collecL Lo raLe a LransacLlon Lhey charge as much as Lhree Llmes
more Lo raLe a CuC Lhan Lo analyze a bond4 remove Lhe agencles furLher
from Lhelr LradlLlonal role
W 1he raLlng agencles have emerged from Lhe caLasLrophe among Lhe LargeLs for
llablllLy afLer proflLlng lmmensely from Lhelr sLrucLured flnance buslness
durlng Lhe subprlme boom
Area of Concern
W Iau|ty emunerat|on Method 'aLers' were remuneraLed by 'raLed' 1hls resulLed ln Lhe confllcL of
lnLeresLs and Lherefore leadlng Lo blasness Lowards Lhose raLed
W M|smanagement of pr|v|||ged |nformat|on
1he CAs say LhaL nonpubllc lnformaLlon may be used only Lo lnform analysLs' assessmenLs ln Lhe conLexL
of research declslons Agency sLaff wlLh access Lo nonpubllc lnformaLlon along wlLh Lhelr famlly
members ls naLurally prohlblLed from uslng such lnformaLlon for personal ends Powever some of Lhe
agencles Lake a sllghLly dlvergenL approach ln applylng Lhls pollcy 1hey say LhaL Lhls Lype of lnformaLlon
may be communlcaLed Lo Lhlrd parLles ouLslde Lhe agency such as consulLanLs or lawyers who may be
lnvolved ln Lhe raLlng process lnvolvemenL of several parLles may lead Lo pllferage of senslLlve lnformaLlon
Lo oLhers for personal galns
W ccountab|||ty of rat|ng compan|es
Complex collaLerallzed debL securlLles many of Lhese were backed by rlsky uS subprlme morLgages were
hlghly raLed aL Lhe LrlpleA level slmllar Lo Lhe debL of Lhe uS CovernmenL When Lhese securlLles
defaulLed raLlng companles clalmed LhaL Lhelr responslblllLy were llmlLed only Lo Lhe assessmenL and Lhey
never guaranLeed Lhe safeLy of Lhe securlLy
SoluLlons
W egulaLlon and audlL of raLlng pracLlces and
Lechnlques
W Cverhaullng of revenue model of raLlng
agency
W oLaLlon of lndependenL dlrecLors from Llme
Lo Llme
W SecurlLy of senslLlve lnformaLlon
W Poldlng securlLy agency more accounLable
over a perlod of Llme
Plgher pay packages of managers
Managers and Lop execuLlves have packages whlch
are on an average 10 Llmes hlgher Lhan Lhe
managers worklng elsewhere
managers of flnanclal lnsLlLuLlons such as Charles
rlnce of ClLlgroup and SLan C'neal of
Merrlll ynch were allowed Lo reslgn wlLh hundred
mllllon dollar reLlremenL" packages whenLhe
subprlme morLgage and subprlme corporaLe debL
lncurred under Lhelr waLch collapsed
LLhlcal lssues
1hese hlgher packages creaLe greed among
managers and Lhere only moLlve remalns Lo make
flnanclal sLaLemenLs looks good ln a shorL Lerm
AfLer flnanclal crlses some managers and Lop
execuLlves were asked Lo reslgn buL companles
could have save money by [usL flrlng Lhem for
Lhelr underperformance
been ellglble Lo collecL unless Lhey had performed
beLLer Merrlll and ClLy have damaged Wall
SLreeL
ay|ng h|gh compensat|on] retent|on bonuses to top
execut|ves us|ng ba||out money
1he Amerlcan lnLernaLlonal Croup whlch has recelved more Lhan $170 bllllon ln
Laxpayer ballouL money from Lhe 1reasury and lederal eserve plans Lo pay abouL
$163 mllllon ln bonuses
8a|||ng out by Government
1he Lmergency Lconomlc SLablllzaLlon AcL of 2008 auLhorlzed Lhe governmenL Lo
use $700 bllllon Lo buy dlsLressed asseLs and make caplLal ln[ecLlons lnLo banks ln
SepLember Lhe governmenL gave abouL $83 bllllon Lo Amerlcan lnLernaLlonal
Croup (AlC) yeL Lhe company reporLed record losses ln Lhe flrsL quarLer of 2009
Cne of Lhe flnanclal secLor's mosL successful ballouL LransacLlons sLlll marked a
loss as Coldman Sachs Lurned $10 bllllon lnLo $77 bllllon
Lth|ca| |ssue
1he governmenL ls behavlng uneLhlcally ln conLlnulng Lo glve money Lo Lhese
banks whlch ln Lurn lose Lhe lnvesLmenLs ln essence Lhe governmenL ls
squanderlng Lax dollars
lL's far from eLhlcal LhaL Lhe governmenL's cholce leads Laxpayers Lo pay Lhe prlce
of Wall SLreeL greed 1he governmenL should puL Lax revenues Lowards welfare
soclal securlLy healLhcare and oLher programs Lo help Lhe growlng numbers
faclng unemploymenL and flnanclal hardshlp