Banks' Self-Dealing Super-Charged Financial Crisis
by Jake Bernstein and Jesse Eisinger
ProPublica
August 26, 2010
http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis

Over the last two years of the housing bubble, Wall
Street bankers perpetrated one of the greatest episodes
of self-dealing in financial history.

Faced with increasing difficulty in selling the
mortgage-backed securities that had been among their
most lucrative products, the banks hit on a solution
that preserved their quarterly earnings and huge
bonuses:

They created fake demand.

A ProPublica analysis shows for the first time the
extent to which banks -- primarily Merrill Lynch, but
also Citigroup, UBS and others -- bought their own
products and cranked up an assembly line that otherwise
should have flagged.

The products they were buying and selling were at the
heart of the 2008 meltdown -- collections of mortgage
bonds known as collateralized debt obligations, or CDOs.

As the housing boom began to slow in mid-2006, investors
became skittish about the riskier parts of those
investments. So the banks created -- and ultimately
provided most of the money for -- new CDOs. Those new
CDOs bought the hard-to-sell pieces of the original
CDOs. The result was a daisy chain [1] that solved one
problem but created another: Each new CDO had its own
risky pieces. Banks created yet other CDOs to buy those.

Individual instances of these questionable trades have
been reported before, but ProPublica's investigation,
done in partnership with NPR's Planet Money [2], shows
that by late 2006 they became a common industry
practice.

An analysis by research firm Thetica Systems,
commissioned by ProPublica, shows that in the last years
of the boom, CDOs had become the dominant purchaser of
key, risky parts of other CDOs, largely replacing real
investors like pension funds. By 2007, 67 percent of
those slices were bought by other CDOs, up from 36
percent just three years earlier. The banks often
orchestrated these purchases. In the last two years of
the boom, nearly half of all CDOs sponsored by market
leader Merrill Lynch bought significant portions of
other Merrill CDOs [3].

ProPublica also found 85 instances during 2006 and 2007
in which two CDOs bought pieces of each other's unsold
inventory. These trades, which involved $107 billion
worth of CDOs, underscore the extent to which the market
lacked real buyers. Often the CDOs that swapped
purchases closed within days of each other, the analysis
shows.

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