Eyes On Wall Street : Executive Compensation Lawyers & Attorneys : Labaton Sucharow Law Firm : Class Action Litigation, Shareholder Rights

Investment banks have long disclaimed their culpability for the subprime crisis by arguing that they had been bamboozled by the AAA ratings that credit rating agencies had bestowed on instruments that were in fact very risky. That alibi is looking increasingly unlikely.

On September 23, 2010, D. Keith Johnson, the former president of Clayton Holdings, testified before the Financial Crisis Inquiry Commission  that the rating agencies routinely ignored evidence that the loans they were rating “did not meet lending criteria promised to investors”.

More importantly, he suggested that investment banks were well aware of the infirmity of the ratings. Clayton Holdings was hired by investment banks to analyze the mortgage pools they were bundling into securities. Johnson testified that an analysis of a sampling of the loans revealed that almost half of these mortgages failed to meet the underwriting standards laid out by the banks themselves. These findings were provided to the same investment banks that have been pleading ignorance of the risk associated with the loans they securitized and sold.

Worse, Johnson testified that Wall Street investment firms capitalized on Clayton’s findings. Instead of informing the public about the risky loans, the investment banks used the information provided by Clayton to obtain the bad loans at a lower price from the issuing lenders. And, instead of passing these savings on to the public, the investment banks sold these mortgage pools at the same prices as the loans that actually met underwriting standards.

Contributed by Carol Villegas

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On Sunday, the Basel Group reached agreement on a controversial new set of banking requirements that will put an end to the heady days when financial institutions could take huge gambles using investors’ cash. The new rules, called Basel III, will ultimately require that banks raise their Tier 1 capital, the kind of funds most important to have in the event of disaster, from 2% to 7%. These higher capital requirements will go a long way towards reining in the risk-taking that fueled the financial collapse of 2007 and 2008. 

Not all the news was good for investors, however, as banks have been given until 2019 to reach the 7% level. The new Basel requirements will also force banks to set aside extra cash in times of growth as a buffer for financial crises—a “countercyclical buffer.” These changes will go a long way to helping stem the volatility in the financial sector that has had investors spooked.

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In a September 7 speech before the Economic Club of New York, SEC Chairwoman Mary Schapiro hinted that there may be some surprises in the Commission’s upcoming report on the infamous “Flash Crash” of May 6, 2010. 

In her remarks, Chairwoman Schapiro suggested that any effort to understand the crash must be seen against the larger background of structural changes that have reshaped the equities market in the last decade. Schapiro pointed out that nearly a third of all equities trading is now conducted in non-public venues such as dark pools and “internalizing” broker dealers, and that automated stop loss orders and algorithmic trading may be multiplying market volatility. 

Contributed by Michael Stocker

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On September 2, Ben Bernanke, the chairman of the Federal Reserve System, and Sheila Bair, the Chairwoman of the Federal Deposit Insurance Corporation, told the Financial Crisis Inquiry Commission that increased capital requirements are an important weapon in the fight against systemic risk. Their comments are not likely to be well-received by the international banking community. 

Bernanke and Bair stressed that is was imperative that the Basel Committee on Banking Supervision, an international coordinating body of regulators, impose stricter standards on how much and what kind of capital banks should be required to hold. Bernanke explained that it was important that the increased capital requirements work in a countercyclical manner to better aligned with risk and to ensure that losses can be absorbed more effectively. This view has been met with considerable resistance from several E.U. members, and it remains to be seen whether the Basel Committee will have sufficient resolve to support meaningful reform.

Contributed by Yoko Goto

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