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Whistleblower: Wall Street Has Engaged in Widespread Tampering of Mortgage Funds

287 points by catacombs 6y ago

denzil_correa 6y ago
> The historical profits reported for some buildings were listed as much as 30% higher than the profits previously reported for the same buildings and same years when the property was part of an earlier CMBS. As a rough analogy, imagine a homeowner having stated in a mortgage application that his 2017 income was $100,000 only to claim during a later refinancing that his 2017 income was $130,000 — without acknowledging or explaining the change. TL;DR
bantunes 6y ago
Am I the only one not surprised at all by this report?
- ganstyles 6y ago
  No one on the comments so far seems surprised. So, no, I don't think you're the only one not surprised.
themark 6y ago
Combine this with the fact that many business no longer exist and the new normal of the restaurant industry, I would expect to see the commercial market crash pretty hard.
cdubzzz 6y ago
> Flynn has amassed “materials identifying about $150 billion in inflated CMBS issued between 2013 and today,” according to the complaint. [...] > The SEC has the power to fine companies and their executives if fraud is established. If the SEC recovers more than $1 million based on Flynn’s claim, he could be entitled to a portion of it. Hope he got a good lawyer!
jl2718 6y ago
It’s sort of amazing how easy and widely accepted it is to submit, under oath, completely different corporate financial attestations depending on whether you are dealing with the IRS, the SEC, or FINRA. I can imagine 50 years ago, when they all got the ability to check electronically, and knew that everybody was cheating, but they couldn’t do anything because it would it would crash the economy, and also these computers were taking their jobs, so the agencies decided to be willfully ignorant and inefficient and setting rules according to whatever people were doing already. So now it’s like, “OMG we never saw this coming!”
- larrydag 6y ago
  50 years ago banking was a very personal business. A business would work locally with their own bank. The bank knew the owners and since they banked with them knew their cash flows. Now banks are national conglomerates. There is a lot of cost in banking and many of the large banks have moved to automated systems to reduce overhead and labor. This doesn't excuse the bank but they are permitting credit for all sorts of things they probably don't want on their books. It's a bit of a mess right now in the banking industry. You may ask are they knowingly allowing these loose standards? Perhaps, but I'm willing to bet it's more in the line of ignorance is bliss.
  - zentiggr 6y ago
    How about greed? How many decades of repeated patterns of cooking figures, "losing" paperwork, and outright fraud does it take to see that a sizeable percentage of people running the largest financial companies just want to rake in whatever they can. Since so many products are so arcane and/or never disclosed in detail, there's ample opportunity to mess with and profit from just about anything that isn't prima facie simple. I don't know how to rein in the seemingly endless stream of schemers... and the thought that "everybody does it" (think LIBOR), and that shining the proverbial sunlight into the back rooms will cripple what financial system we have just makes me want to burn it all down anyway. Lots of frustration, little action. No answers.
    - 6y ago
bitxbit 6y ago
Every MD running a trading desk comes to work and asks “who’s stealing from me today?” That’s the Wall Street mentality.
- metalliqaz 6y ago
  sorry, I don't know Wall Street lingo, what is "MD" here?
  - cbames89 6y ago
    Managing director I believe
    - metalliqaz 6y ago
      thanks
- paulryanrogers 6y ago
  Managing Director?
vmception 6y ago
Instead we just assume this is happening and extend 0% credit to all the investment banks so that they don't blow up on their fraudulent bets and shady accounting Since we'll never prove anybody had the necessary knowledge of breaking the law and ignorance is an excuse when you write the law specifically that way
code4tee 6y ago
This makes complete sense and there’s no question commercial restate is turning into a bit of a house of cards. In some big cities you have many large buildings where their primary tenant was WeWork, which appears to be imploding, and now adding onto that the whole covid WFM shift where companies are starting to cancel and downsize future leases. When you start to dig into the revenue streams behind these buildings and the owners ability to pay the mortgage back it starts to look really shady in some cases. Most buildings need a fairly high percentage of the floors to be leased out for the building rent to cover the mortgage and moving forward it seems a lot of buildings will struggle to hit that number. It’s going to be an interesting time for commercial office real estate. On the plus side if you’re looking for office space there are going to be some amazing deals!
- wnmurphy 6y ago
  Commercial real estate is going to be really interesting to watch. For a lot of mid-size companies, the building lease is 15% of your total operating expenses.
  - jiveturkey 6y ago
    Especially in CA, where it's propped up by umm prop 13! Every default should trigger a re-assessment when the property changes hands. CA recently put into place a rule (law?) where a change of control of the ownership entity also triggers re-assessment, thereby ending the long running scheme of selling the LLC owner rather than the property itself. If enough of these bad (metric-wise) loans default, there could be a very far reaching negative valuation impact, ie well beyond just the defaulted properties. I expect rents will go up, even as property values go down.
- malandrew 6y ago
  What would be interesting is if those holding commercial property in high rent cities start converting commercial properties to residential. It may not be easy or cheap, but I reckon it's mostly rezoning and just putting up walls and adding plumbing. If this happens, I wonder what happens to cities afterwards where the ratio between residential to commercial in a city shifts permanently. I reckon we could end up with more WFH or flexible work arrangements because commercial real estate becomes scarcer and more expensive.
hhs 6y ago
> Investors don’t comb through financial statements, added Riordan, who used to manage the CMBS portfolio for retirement fund giant TIAA-CREF. Instead, he said, they rely on summaries from investment banks and the credit ratings agencies that analyze the securities. To make wise decisions, investors’ information “out of the gate has to be pretty close to being right,” he said. “Otherwise you’re dealing with garbage. Garbage in, garbage out.” Is there a way to add incentives so investors don’t analyze information from summaries?
- toomuchtodo 6y ago
  Make fund managers partially liable financially for failure to do due diligence on the assets they’re investing in, versus relying on abridged information and credit rating agencies. You can’t fix people, only incentives.
- sailfast 6y ago
  Came here to post this quote. I don't understand how you would base your decisions on ratings agencies after what happened in 2008 and the fact that the incentives are still totally misaligned. The person quoted seems to indicate "investors" in this case means institutional funds as well, which is just frightening. Hope they can do their job otherwise this will go from big loss-causing mistake to contagion.
- cm2187 6y ago
  If the summaries were false or misleading, the bank may be liable for any loss occurred , as for the bankers this may be characterised as securities fraud. So the incentives are for the summaries to be accurate.
  - toomuchtodo 6y ago
    It should be noted that only one person was incarcerated from the fraud that occurred leading up to the 2008 GFC.
    - cm2187 6y ago
cm2187 6y ago
I find that a bit surprising. I used to structure CMBS transactions before the financial crisis and even then all income from properties would be ticked back against the leases and the dataset verified by an independent auditor. In fact the CMBS market blew massive holes in banks balance sheets in 2008 but not because of fraud, but because the commercial property market tanked so much (and will likely not do much better after covid). So it is always possible that underwriting standards drifted downward, and there are perhaps different standards in the US than Europe. But I find this story surprising and unlikely and would like to see more before forming an opinion.
- deleted 6y ago
  [deleted]
PEJOE 6y ago
Wait until Propublica learns that lenders are underwriting based on pro-forma forward Adjusted EBITDA net leverage, not past EBITDA leverage. The whole idea of Adjusted EBITDA is insane to me. We add back "one-time," expenses and other items, but the underlying business ends up seeing similar "one-time," costs every year. The result is that companies often borrow at a leverage ratio that looks 30% smaller than it actually is. This year we are doing "COVID-19," addbacks. What the fuck? You lost money because of COVID, so add it back to EBITDA so that you are still meeting your loan covenants? Lenders are in on it too, because they don't want to see their clients default and deal with bankruptcy or taking control of the assets.
- lotsofpulp 6y ago
  That’s the beauty of working in finance, it’s all subjective. A janitor can’t fudge a dirty bathroom, a mechanic can’t fudge a broken car, a plumber can’t fudge cold water into hot water. But in finance, you can make whatever results you want come true for a long time. And if you have the government’s back who can print funds, that long time could be until the country blows up.
  - Enginerrrd 6y ago
    >And if you have the government’s back who can print funds, that long time could be until the country blows up. I wonder about this. I suspect that if the fed keeps buying junk corporate bonds to prop up share prices, there's got to be a reckoning somewhere. For one, it incentivizes stupid & risky behavior among corporations. I wonder if even the fed can absorb the scope of real contractions in GDP with tricks like this. Color me extremely skeptical. Seems like something will have to give.
  - nickpinkston 6y ago
    Disagree - every job has bad work that doesn't appear so until later. The mechanic who just uses a cheap fix to get you out of there, the plumber whose work results in a frozen pipe that leaks behind a wall, etc. Finance is no different. The only issue is that in a capitalist society, bankers hold a lot of political/economic influence, and this results in bad incentives for the rest of us.
zentiggr 6y ago
What if Flynn publishes a list of the companies involved and the timeframes, we construct a list of the executives, directors, and mangers involved, and blacklist them? No business with any company that employs even one of them, ever again. Starting today. Damn the chaos, signal that this kind of profiteering and crash-building is not tolerated.
atomi 6y ago
I love how the SEC's own lease is possibly mired in the scandal. What a mess. We need another Teddy to clean it all up.
LatteLazy 6y ago
Why do people keep expecting other people to act against their best interests? Why are buyers relying on sellers’ valuations? And given these are billion plus dollar products transacted between professionals, why does Buyer Beware apply?
blueboo 6y ago
Rating agencies - S&P, Moodys, Fitch - are in bed with those they rate. It was a time bomb. It blew up in 2008. It’s a time bomb again.
JoeAltmaier 6y ago
This will continue as long as human beings are in the loop. If it were automated, code-reviewed and made secure we might have a system that could follow the rules.
- huac 6y ago
  I agree. We need real estate that is only inhabited by data centers or automated pizza machines, no humans in the loop at all, not even paying rent.
  - JoeAltmaier 6y ago
    Huh? I meant of course, the issuing of loans and bonds could be codified and enforced. Instead of this house-of-cards involving fallible humans.
- runawaybottle 6y ago
  These people bet on bets. They will abstract the automation in some way as a financial instrument. Or make automation that abstracts on top of the automation. Finance is just dirty.
alexpetralia 6y ago
This is in part due to a search for yield (same as we saw with the housing crisis). There is such a glut of capital that it will invest in anything - even risky CMBS - without performing adequate due diligence. If you don't invest, someone else will. Unfettered "quantitative easing" distorts the price of risk. This is the not-so-surprising consequence.
ordinaryradical 6y ago
This reads like 2008 all over again. How bad is this?
- Red_Leaves_Flyy 6y ago
  Somewhere between a nothing burger and covid19 stimulus big.
creativipy 6y ago
Carl Icahn's short of the CMBX is looking more and more clever. https://www.wsj.com/articles/carl-icahn-placing-a-big-bet-against-mall-owners-11574201244 https://www.wsj.com/articles/carl-icahn-placing-a-big-bet-ag...
lowdose 6y ago
The difference with the other capitalistic system is that the guys from Deutsche Bank are going to jail when this kind of shenanigans is going on. Bankers in the west do not have skin in the game.

287 points by catacombs 6y ago

> The historical profits reported for some buildings were listed as much as 30% higher than the profits previously reported for the same buildings and same years when the property was part of an earlier CMBS. As a rough analogy, imagine a homeowner having stated in a mortgage application that his 2017 income was $100,000 only to claim during a later refinancing that his 2017 income was $130,000 — without acknowledging or explaining the change. TL;DR

bantunes 6y ago

Am I the only one not surprised at all by this report?

ganstyles 6y ago
No one on the comments so far seems surprised. So, no, I don't think you're the only one not surprised.

themark 6y ago

Combine this with the fact that many business no longer exist and the new normal of the restaurant industry, I would expect to see the commercial market crash pretty hard.

cdubzzz 6y ago

> Flynn has amassed “materials identifying about $150 billion in inflated CMBS issued between 2013 and today,” according to the complaint. [...] > The SEC has the power to fine companies and their executives if fraud is established. If the SEC recovers more than $1 million based on Flynn’s claim, he could be entitled to a portion of it. Hope he got a good lawyer!

jl2718 6y ago

It’s sort of amazing how easy and widely accepted it is to submit, under oath, completely different corporate financial attestations depending on whether you are dealing with the IRS, the SEC, or FINRA. I can imagine 50 years ago, when they all got the ability to check electronically, and knew that everybody was cheating, but they couldn’t do anything because it would it would crash the economy, and also these computers were taking their jobs, so the agencies decided to be willfully ignorant and inefficient and setting rules according to whatever people were doing already. So now it’s like, “OMG we never saw this coming!”

larrydag 6y ago
50 years ago banking was a very personal business. A business would work locally with their own bank. The bank knew the owners and since they banked with them knew their cash flows. Now banks are national conglomerates. There is a lot of cost in banking and many of the large banks have moved to automated systems to reduce overhead and labor. This doesn't excuse the bank but they are permitting credit for all sorts of things they probably don't want on their books. It's a bit of a mess right now in the banking industry. You may ask are they knowingly allowing these loose standards? Perhaps, but I'm willing to bet it's more in the line of ignorance is bliss.
- zentiggr 6y ago
  How about greed? How many decades of repeated patterns of cooking figures, "losing" paperwork, and outright fraud does it take to see that a sizeable percentage of people running the largest financial companies just want to rake in whatever they can. Since so many products are so arcane and/or never disclosed in detail, there's ample opportunity to mess with and profit from just about anything that isn't prima facie simple. I don't know how to rein in the seemingly endless stream of schemers... and the thought that "everybody does it" (think LIBOR), and that shining the proverbial sunlight into the back rooms will cripple what financial system we have just makes me want to burn it all down anyway. Lots of frustration, little action. No answers.
  - 6y ago

bitxbit 6y ago

Every MD running a trading desk comes to work and asks “who’s stealing from me today?” That’s the Wall Street mentality.

metalliqaz 6y ago
sorry, I don't know Wall Street lingo, what is "MD" here?
- cbames89 6y ago
  Managing director I believe
  - metalliqaz 6y ago
    thanks
paulryanrogers 6y ago
Managing Director?

vmception 6y ago

Instead we just assume this is happening and extend 0% credit to all the investment banks so that they don't blow up on their fraudulent bets and shady accounting Since we'll never prove anybody had the necessary knowledge of breaking the law and ignorance is an excuse when you write the law specifically that way

code4tee 6y ago

This makes complete sense and there’s no question commercial restate is turning into a bit of a house of cards. In some big cities you have many large buildings where their primary tenant was WeWork, which appears to be imploding, and now adding onto that the whole covid WFM shift where companies are starting to cancel and downsize future leases. When you start to dig into the revenue streams behind these buildings and the owners ability to pay the mortgage back it starts to look really shady in some cases. Most buildings need a fairly high percentage of the floors to be leased out for the building rent to cover the mortgage and moving forward it seems a lot of buildings will struggle to hit that number. It’s going to be an interesting time for commercial office real estate. On the plus side if you’re looking for office space there are going to be some amazing deals!

wnmurphy 6y ago
Commercial real estate is going to be really interesting to watch. For a lot of mid-size companies, the building lease is 15% of your total operating expenses.
- jiveturkey 6y ago
  Especially in CA, where it's propped up by umm prop 13! Every default should trigger a re-assessment when the property changes hands. CA recently put into place a rule (law?) where a change of control of the ownership entity also triggers re-assessment, thereby ending the long running scheme of selling the LLC owner rather than the property itself. If enough of these bad (metric-wise) loans default, there could be a very far reaching negative valuation impact, ie well beyond just the defaulted properties. I expect rents will go up, even as property values go down.
malandrew 6y ago
What would be interesting is if those holding commercial property in high rent cities start converting commercial properties to residential. It may not be easy or cheap, but I reckon it's mostly rezoning and just putting up walls and adding plumbing. If this happens, I wonder what happens to cities afterwards where the ratio between residential to commercial in a city shifts permanently. I reckon we could end up with more WFH or flexible work arrangements because commercial real estate becomes scarcer and more expensive.

hhs 6y ago

> Investors don’t comb through financial statements, added Riordan, who used to manage the CMBS portfolio for retirement fund giant TIAA-CREF. Instead, he said, they rely on summaries from investment banks and the credit ratings agencies that analyze the securities. To make wise decisions, investors’ information “out of the gate has to be pretty close to being right,” he said. “Otherwise you’re dealing with garbage. Garbage in, garbage out.” Is there a way to add incentives so investors don’t analyze information from summaries?

toomuchtodo 6y ago
Make fund managers partially liable financially for failure to do due diligence on the assets they’re investing in, versus relying on abridged information and credit rating agencies. You can’t fix people, only incentives.
sailfast 6y ago
Came here to post this quote. I don't understand how you would base your decisions on ratings agencies after what happened in 2008 and the fact that the incentives are still totally misaligned. The person quoted seems to indicate "investors" in this case means institutional funds as well, which is just frightening. Hope they can do their job otherwise this will go from big loss-causing mistake to contagion.
cm2187 6y ago
If the summaries were false or misleading, the bank may be liable for any loss occurred , as for the bankers this may be characterised as securities fraud. So the incentives are for the summaries to be accurate.
- toomuchtodo 6y ago
  It should be noted that only one person was incarcerated from the fraud that occurred leading up to the 2008 GFC.
  - cm2187 6y ago

cm2187 6y ago

I find that a bit surprising. I used to structure CMBS transactions before the financial crisis and even then all income from properties would be ticked back against the leases and the dataset verified by an independent auditor. In fact the CMBS market blew massive holes in banks balance sheets in 2008 but not because of fraud, but because the commercial property market tanked so much (and will likely not do much better after covid). So it is always possible that underwriting standards drifted downward, and there are perhaps different standards in the US than Europe. But I find this story surprising and unlikely and would like to see more before forming an opinion.

deleted 6y ago
[deleted]

PEJOE 6y ago

Wait until Propublica learns that lenders are underwriting based on pro-forma forward Adjusted EBITDA net leverage, not past EBITDA leverage. The whole idea of Adjusted EBITDA is insane to me. We add back "one-time," expenses and other items, but the underlying business ends up seeing similar "one-time," costs every year. The result is that companies often borrow at a leverage ratio that looks 30% smaller than it actually is. This year we are doing "COVID-19," addbacks. What the fuck? You lost money because of COVID, so add it back to EBITDA so that you are still meeting your loan covenants? Lenders are in on it too, because they don't want to see their clients default and deal with bankruptcy or taking control of the assets.

lotsofpulp 6y ago
That’s the beauty of working in finance, it’s all subjective. A janitor can’t fudge a dirty bathroom, a mechanic can’t fudge a broken car, a plumber can’t fudge cold water into hot water. But in finance, you can make whatever results you want come true for a long time. And if you have the government’s back who can print funds, that long time could be until the country blows up.
- Enginerrrd 6y ago
  >And if you have the government’s back who can print funds, that long time could be until the country blows up. I wonder about this. I suspect that if the fed keeps buying junk corporate bonds to prop up share prices, there's got to be a reckoning somewhere. For one, it incentivizes stupid & risky behavior among corporations. I wonder if even the fed can absorb the scope of real contractions in GDP with tricks like this. Color me extremely skeptical. Seems like something will have to give.
- nickpinkston 6y ago
  Disagree - every job has bad work that doesn't appear so until later. The mechanic who just uses a cheap fix to get you out of there, the plumber whose work results in a frozen pipe that leaks behind a wall, etc. Finance is no different. The only issue is that in a capitalist society, bankers hold a lot of political/economic influence, and this results in bad incentives for the rest of us.

zentiggr 6y ago

What if Flynn publishes a list of the companies involved and the timeframes, we construct a list of the executives, directors, and mangers involved, and blacklist them? No business with any company that employs even one of them, ever again. Starting today. Damn the chaos, signal that this kind of profiteering and crash-building is not tolerated.

atomi 6y ago

I love how the SEC's own lease is possibly mired in the scandal. What a mess. We need another Teddy to clean it all up.

LatteLazy 6y ago

Why do people keep expecting other people to act against their best interests? Why are buyers relying on sellers’ valuations? And given these are billion plus dollar products transacted between professionals, why does Buyer Beware apply?

blueboo 6y ago

Rating agencies - S&P, Moodys, Fitch - are in bed with those they rate. It was a time bomb. It blew up in 2008. It’s a time bomb again.

JoeAltmaier 6y ago

This will continue as long as human beings are in the loop. If it were automated, code-reviewed and made secure we might have a system that could follow the rules.

huac 6y ago
I agree. We need real estate that is only inhabited by data centers or automated pizza machines, no humans in the loop at all, not even paying rent.
- JoeAltmaier 6y ago
  Huh? I meant of course, the issuing of loans and bonds could be codified and enforced. Instead of this house-of-cards involving fallible humans.
runawaybottle 6y ago
These people bet on bets. They will abstract the automation in some way as a financial instrument. Or make automation that abstracts on top of the automation. Finance is just dirty.

alexpetralia 6y ago

This is in part due to a search for yield (same as we saw with the housing crisis). There is such a glut of capital that it will invest in anything - even risky CMBS - without performing adequate due diligence. If you don't invest, someone else will. Unfettered "quantitative easing" distorts the price of risk. This is the not-so-surprising consequence.

ordinaryradical 6y ago

This reads like 2008 all over again. How bad is this?

Red_Leaves_Flyy 6y ago
Somewhere between a nothing burger and covid19 stimulus big.

creativipy 6y ago

Carl Icahn's short of the CMBX is looking more and more clever. https://www.wsj.com/articles/carl-icahn-placing-a-big-bet-against-mall-owners-11574201244 https://www.wsj.com/articles/carl-icahn-placing-a-big-bet-ag...

lowdose 6y ago

The difference with the other capitalistic system is that the guys from Deutsche Bank are going to jail when this kind of shenanigans is going on. Bankers in the west do not have skin in the game.