Feds Are Burying Yet Another Case of Wall Street Fraud

Last Updated Sep 7, 2011 5:33 PM EDT

Anyone out there still think Wall Street banks didn't stomp all over the rule of law in the years leading up to the housing bust? American Banker has details of one scam that's just coming to light:
Many of the country's largest banks received $6 billion in kickbacks from mortgage insurers over the course of a decade, according to a previously undisclosed investigation by the Inspector General of the Department of Housing and Urban Development....
In exchange for the their business, companies such as Citigroup Inc. (C), Wells Fargo & Co. (WFC), SunTrust Banks Inc. (STI) and Countrywide allegedly required reinsurance partnerships on generous terms that violated the Real Estate Settlement Procedures Act, a 1974 law prohibiting abusive home sales practices.
Here's how the scheme worked. Big mortgage lenders required riskier borrowers to buy insurance on their loans. The financial firms also arranged additional protection in the form of reinsurance on the mortgage coverage. In theory, this was aimed at protecting mortgage investors against potential losses.

But the real purpose of these deals was so banks could force mortgage insurers to "cut them in" on their business. How? By making the insurance companies purchase the reinsurance from the banks' own "captive" subsidiaries. HUD investigators also learned that banks and insurers colluded in creating phony financial instruments that looked like reinsurance, but that failed to full transfer the risk to the banks. Insurers got a steady supply of business from the banks, and the latter collected fees on the bogus reinsurance.

Notes AB's Jeff Horwitz:
Some of the deals were designed to return a 400 percent profit on a bank's investment during good years and remain profitable even in the event of a real estate collapse....
Banks considered the insurers to be interchangeable, and companies like Wells Fargo made it clear as early as 2000 that they wanted "deep cede" deals in which their captives would receive as much as 40 percent of the insurance premiums in return for providing reinsurance.
Justice league?
This would be but one more in a series of stings pulled by Wall Street firms in recent years -- if it weren't for the Department of Justice's unusually lax response to HUD's 2009 allegations. At its own request, Justice took over the case from the housing agency. Given the strength of the evidence, HUD expected DOJ to conduct a quick investigation and proceed with a speedy settlement worth hundreds of millions of dollars.

Fat chance. More than 18 months later, the case has gone cold. It isn't even clear if there still is a case. HUD's inspector general, who had helped lead the probe for the agency, is understandably peeved at the lack of progress, telling the Banker that "this thing has been going on for too damn long."

Under Attorney General Eric Holder, the Justice Department has pointedly refused to prosecute bankers implicated in financial fraud. It has repeatedly entered wet-noodle agreements with companies over a range of misdeeds, undermining the agency's own enforcement efforts and encouraging firms to treat such violations as the cost of doing business.

Now Justice is screwing up -- or even deliberately quashing -- investigations that other regulators handed it on a silver platter. As financial pundit Yves Smith puts it:
[W]hy is the Department of Justice's excuse for sitting on its hands? The excuse made is that it lacks the needed accounting skills. If you believe that, I have a bridge I'd like to sell you. Actions speak louder than words, and the evidence is overwhelming that the DoJ has no interest in inconveniencing anyone influential, particularly banks.
The long arm of the law? Good luck.

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  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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