eventual disposal and putting them into a separate division, Citi Holdings, with other businesses deemed “non-core.”

TO BE NOTED: From Bloomberg:

"Citigroup Profit Exceeds Estimates on Trading Gains (Update2)

Share | Email | Print | A A A

By Bradley Keoun

April 17 (Bloomberg) -- Citigroup Inc., the U.S. bank rescued by $45 billion in U.S. taxpayer funds, ended a five- quarter losing streak with a $1.6 billion profit on trading gains and an accounting benefit for companies in distress.

The first-quarter profit compared with a net loss of $5.11 billion, or 34 cents, a year earlier, the New York-based bank said. On a per-share basis, the bank reported an 18-cent loss because of costs related to preferred dividends. The average estimate of 13 analysts surveyed by Bloomberg was a loss of 32 cents.

Citigroup investors hadn’t seen a profit since before Chief Executive Officer Vikram Pandit took over in 2007. While the bank cut compensation costs and took fewer writedowns, it couldn’t halt rising delinquencies on home and credit-card loans. Citigroup benefited from higher fixed-income trading revenue that also bolstered earnings at Goldman Sachs Group Inc. and JPMorgan Chase & Co.

“We’ve seen good trading results from JPMorgan, from Goldman Sachs and now from Citi,” said Gary Townsend, chief executive officer of Hill-Townsend Capital LLC. “There is a question about sustainability, but it’s clearly a good sign for the sector.”

Not a ‘One-Off’

The industry’s first-quarter profits aren’t a “one-off” phenomenon, Barclays Plc President Robert Diamond said in an April 15 interview. “It has been quite a while since we’ve seen analysts talk about revenue as opposed to writedowns and balance-sheet risks,” he said.

Citigroup rose 2 percent to $4.09 as of 9:32 a.m. At its peak in late 2006, the stock was worth $56.41, valuing the company at $277 billion. At the current price, the market value stands at about $22 billion.

The bank reported $4.69 billion of fixed-income trading revenue in the quarter, compared with a trading loss of $7.02 billion a year earlier. Stock-trading revenue was $1.9 billion, a 94 percent increase.

The company took $5.62 billion of writedowns on subprime- mortgage-related securities and other investments in its trading division, reflecting a further erosion in their market value. That compared with $14.1 billion of writedowns in the first quarter of 2008, giving the company a positive $8.47 billion revenue swing.

Stress Tests

Citigroup posted a $2.5 billion gain from accounting rules that allow companies to profit when their own creditworthiness declines. The rules reflect the possibility that a company could buy back its own liabilities at a discount, which under traditional accounting methods would result in a profit.

Citigroup, one of 19 U.S. banks gearing up for the release of so-called stress tests run by the Federal Reserve, has quadrupled on the New York Stock Exchange since falling to an all-time low of $1.02 on March 5, in the wake of the company’s announcement that as much as $52.5 billion of preferred stock would be exchanged for common shares to bolster the bank’s equity base.

Under that plan, as much as $25 billion of the government’s investment in the bank will be converted into regular shares, giving it a 36 percent voting stake. Citigroup’s tangible common equity -- a cushion against losses that many investors and analysts study -- will increase to $81 billion from about $30 billion, the bank says. Existing shareholders will be left with about a fourth of their original stakes. The bank said it plans to complete its exchange offer with the government after industry stress tests have been completed.

‘High Risk’

The government support and additional capital probably are enough “for now” to spare existing shareholders from being wiped out completely, David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, wrote in an April 9 note to investors.

“For prospective new investors, it may be too early to dive in, given continued high-risk exposures that may well require more dilutive actions,” Trone wrote.

In November, Pandit, 52, pledged to cut 52,000 jobs from the company’s 352,000-employee workforce, including 26,000 through business divestitures.

In January Pandit reorganized Citigroup, tagging the CitiFinancial consumer-finance and Primerica insurance units for eventual disposal and putting them into a separate division, Citi Holdings, with other businesses deemed “non-core.” The move, he said, would help investors focus on the earnings power of the company’s “core” retail, corporate and investment- banking businesses.

Credit Swaps

He also shifted some of Citigroup’s distressed trading securities into a long-term “held-to-maturity” investment status, sheltering them from further writedowns while betting the debt instruments will eventually pay off.

The bank still faces speculation about its survival prospects, as reflected in the elevated prices for its credit- default swaps, a type of instrument that investors use to insure against a debt default.

Citigroup’s credit-default swaps as of yesterday were trading at 557, up from 193 at the end of last year. By comparison, rival New York-based bank JPMorgan Chase & Co.’s swaps are trading at 174. Lehman Brothers Holdings Inc.’s swaps were at 322 a week before the U.S. securities firm filed for bankruptcy last September.

Retaining top employees may be a challenge for Pandit, Oppenheimer & Co. analyst Chris Kotowski wrote in an April 8 report.

Vulnerable to Flight

“With Citi’s stock permanently diluted and the company deeply dependent on government assistance, we think it is among the most vulnerable to a flight of revenue-producing talent,” Kotowski wrote.

The receipt of taxpayer money has forced Pandit to endure congressional scrutiny of line-item expenses, including a $10 million executive-suite renovation and a 20-year, $400 million sponsorship of the New York Mets’ stadium in the New York City borough of Queens.

He vowed to cut his salary to $1 until the bank returns to profitability.

The earnings report follows earnings announcements by U.S. banks whose results have surpassed analysts’ forecasts.

Goldman Sachs on April 13 reported better-than-expected earnings as a surge in trading revenue outweighed asset writedowns. Wells Fargo & Co., the second-biggest U.S. home lender, said last week it had about $3 billion in first-quarter net income, up from $2 billion a year earlier. Profit of about 55 cents a share was more than double the average estimate of analysts in a Bloomberg survey.

To contact the reporter on this story: Bradley Keoun in New York at bkeoun@bloomberg.net."

New rules on financial fraud “will help us deal in the future with threats like the practices in subprime lending that kicked off the current crisis,”

TO BE NOTED: From Bloomberg:

"Obama Plans to Propose Stronger Financial-Fraud Rules (Update1)

Share | Email | Print | A A A

By Rebecca Christie

March 25 (Bloomberg) -- The Obama administration plans to unveil new rules to protect consumers and investors against financial fraud, aiming to stamp out practices that helped cause the mortgage-market crisis.

The administration will also release this week proposed legislation to give powers to the Treasury and Federal Deposit Insurance Corp. to take over failing financial institutions and wind them down.

Treasury Secretary Timothy Geithner said in prepared remarks to a conference in New York today that the plan for a so-called resolution authority would include a mechanism for raising funds to cover related losses.

The U.S. also will coordinate internationally to press for stronger global standards for financial companies, Geithner said in a speech to the Council on Foreign Relations in New York.

New rules on financial fraud “will help us deal in the future with threats like the practices in subprime lending that kicked off the current crisis,” Geithner said.

Banks and other financial institutions need stricter oversight that reins in their ability to damage the overall financial system, Geithner said. He said regulators need new tools to prevent “cascading damage” when financial companies run into trouble, such as higher capital standards and restrictions on the amount of risk they can take on.

‘Extraordinary Actions’

To get through the crisis, the U.S. must continue “extraordinary actions” to prop up the financial system and also seek changes to prevent a recurrence, Geithner said. He is scheduled to lay out the administration’s regulatory strategy tomorrow at a House Financial Services Committee hearing.

“This framework will significantly raise the prudential requirements, once we get through the crisis, that our largest and most interconnected financial firms must meet,” Geithner said.

The Treasury chief called yesterday for new authority to seize and wind down failing financial companies in the aftermath of the rescue of American International Group Inc., which has ballooned to $182.5 billion from an initial $85 billion in September. Obama said in a news conference yesterday that he expects the proposal to gain “strong support.”

In details released today, the Treasury said it and the FDIC should be the agencies to trigger either a wind-down of, or financial assistance to, a struggling financial company that isn’t a bank. The plan uses procedures similar to the way the FDIC handles bank failures, without tapping the Deposit Insurance Fund used to safeguard bank deposits.

Instead, the administration will seek new funding mechanisms. This could take the form of a “mandatory appropriation” to the FDIC or a special assessment on financial institutions, the Treasury said."

show just how complex relations between servicers and investors can be

TO BE NOTED: From Housingwire:

"After finding itself dragged into court by hedge fund manager Bruce Rose of Greenwich-based Carrington Capital, Irving, Tex.-based mortgage servicer American Home Mortgage Servicing, Inc. fired its own volley back at both Rose and Carrington on Thursday, suing for alleged acts of racketeering and a scheme to profit illegally from holding REO hostage at the servicing firm. American Home is owned by legendary investor Wilbur Ross’ WL Ross & Co., and is the nation’s largest independent residential mortgage servicer.

The allegations made in the complaint by AHMSI against Rose and Carrington show just how complex relations between servicers and investors can be, amid increasing pressure from lawmakers and regulators to find solutions to the nation’s housing mess.

At the heart of the case are allegations by AHMSI that claim Carrington intentionally delayed recognition of losses by not allowing American Home to sell REO properties at market prices. The case brings civil RICO charges against Rose and Carrington because both sent, continue to send, interstate wire communications with allegedly false statements about the actual value of the REO properties in question.

It’s a move that American Home says has cost the servicer millions in interest lost as it has been forced to advance principal and interest to investors, while the REO remains unsold and on its books; while AHMSI is eventually reimbursed for P&I advanced to investors, it does not recover the interest that must be paid on its credit facilities to fund the advances. By keeping REO on its books, too, AHMSI alleges that Carrington was effectively siphoning funds that should have otherwise gone to senior bondholders into its own junior bond position.

Representatives at Carrington Capital did not immediately return a call asking about the charges in the suit.

Carrington’s MBS investing scheme, where it sought to carve out a junior MBS class with so-called ‘special rights’ that gave it unique rights to direct the servicer’s actions, were first reported by HousingWire two weeks ago. [1] See previous story.

According to the complaint filed by American Home, Rose and employees in his hedge funds used a variety of tactics to keep REO on the servicer’s books: some of the alleged schemes included forcing AHMSI to list REO properties at prices well above market appraisals, as well as taking weeks to respond to good-faith offers on properties and even firing certain REO brokers mid-stream in the sales process as part of what AHSMI alleges was part of a scheme to “impede the process of selling a property.”

AHMSI also alleges that Rose and Carrington went so far as to attempt to wrest servicing away from American Home — Carrington has its own servicing shop, after purchasing the business from failed subprime lender New Century Mortgage — as part of an attempt to keep the scheme under wraps. Had Carrington been successful, AMSHI alleges that the hedge fund “would then have had no need to send fraudulent pricing advice to the servicer, for Carrington Mortgage Servicing would have been able directly to establish pricing that would delay the recognition of defendants’ losses in the mortgage pools.”

In addition to Rose personally, Carrington Capital and its inter-linking group of mortgage businesses are also named for conspiracy and by acting in cahoots to establish a so-called ‘RICO enterprise’ – civil RICO charges will allow American Home to ask for three times damages.

American Home was first sued by Carrington Capital on Feb. 9 for breach of contract and fiduciary duty, with the investor alleging the REO sales hoisted $100 million in losses on the hedge fund. Sources familiar with the case at American Home say that the servicer will shortly file a notice to dismiss the original suit, citing a clause in the original pooling & servicing agreements that stipulates at least 25 percent of the mortgage certificate holders must agree to sue a servicer before any such suit can be effected. Carrington doesn’t own 25 percent of the interest in the mortgage investments they are suing over, the sources said.

– Paul Jackson contributed to this story.

Editor’s note: Teri Buhl is an investigative journalist covering Wall Street who has written for the New York Post Sunday Business and Trader Monthly. Contact her at [2] teribuhl@yahoo.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments."

"He recommends using interest rate spreads instead of credit ratings as a proxy for losses. "

From the WSJ:

"By ROBERT ROSENKRANZ

The rating agencies have been widely criticized for their role in the financial crisis. It is said that they wrongly assessed the risks on trillions of dollars worth of bonds backed by residential mortgages. And indeed they did. But this is hardly surprising.

Rating agencies employ quite ordinary mortals to analyze the credit risk of bonds, just as firms like Goldman Sachs and Merrill Lynch employ quite ordinary mortals to analyze the outlook for stocks. No one is shocked when equity analysts' recommendations don't pan out. Why should we expect any more of the rating agencies? ( IT DEPENDS. UNDER A VERY STRICT SET OF AGREED UPON GUIDELINES, ALL THE CREDIT RATINGS AGENCIES ARE SUPPOSED TO DO IS PROVIDE A THIRD PARTY CONFIRMATION OF THE COMPANY'S FINANCES. STOCK PICKING INVOLVES A LOT MORE THAN THAT. )

We should not, but the regulators have, and that is the problem. Regulators of banks, insurance companies and broker dealers have all incorporated the work of the ratings agencies into their regulations in myriad ways. Most importantly, bond ratings determine -- as a matter of law -- how much capital regulated institutions need in order to own the bonds.( A BAD IDEA )

For every dollar of equity that insurance companies are required to hold for bonds rated AAA, $3 is needed for bonds rated BBB, and $11 is needed for bonds rated just below investment grade (BB). For banks, the sensitivity of capital requirements to ratings is generally even more extreme. ( OK )

The Bank for International Settlements also uses ratings to drive capital requirements, so the rating agencies have the same role in global capital markets that they have in the U.S.

For money market funds, ratings are equally critical: They are typically barred altogether from investments rated lower than AAA. In short, the ratings agencies are like a Consumer Reports for financial instruments -- but with the force of law behind their ratings( TRUE ). It is as if you were forbidden by law from buying an iron or a toaster unless it is rated "Excellent."

Since the ratings determine required capital, they have a profound influence on how financial institutions invest their assets -- in effect, the regulatory reliance on ratings makes the rating agencies the de facto allocators of capital in our system( TRUE ). And every actor in the financial system has every incentive to group and slice assets in ways that maximize not their fundamental soundness but their rating( THEY DID ).

Indeed, that is the entire raison d'être of the $6 trillion structured-finance business, which serves little economic function other than as a rating-agency arbitrage( TO INCREASE LEVERAGE. YES. ). Subprime mortgages (and all manner of other risky loans) held directly by financial institutions are questionable assets( I AGREE ) with high associated capital charges( YES ). Each one alone would deserve a "junk" rating. Structured finance simply piles such risky assets into bundles and slices the bundles into tranches. The rating agencies deemed some 85% of the tranches by value as AAA, and nearly 99% as investment grade -- thus turning dross into gold by a sort of ratings alchemy( NOT QUITE. THE TRANCHES CAN REPLICATE BOND RATINGS BY WHO GETS PAID FIRST. ).

This ratings alchemy( IT WAS MORE LIKE COLLUSION. THE TRANCHES, IN AND OF THEMSELVES, ARE NOT THE PROBLEM. IT WAS THE ASSESSMENT OF RISK AND UNDERLYING ASSETS THAT CAUSED THE PROBLEM. ) created enormous demand for dross -- in this case, dodgy mortgages( POOR LENDING PRACTICES ). Credit was extended to countless dubiously qualified purchasers of homes, which in turn drove dramatic increases in house prices. The housing bubble has now burst, with average house prices in America down some 20% to 25% from the peak. This led( STARTED ) to the current crisis.

The problem was not the erroneous ratings per se; everyone misgauges risk and ratings agencies are no different. The problem is that these erroneous ratings were incorporated into law. Regulators should not have relied on ratings agencies to asses the risk of bond holdings. Instead, they should have relied on markets( HOW? ).

When they come to design new regulations to govern capital requirements and investment parameters for financial institutions, Barack Obama and Congress should write ratings agencies out of the regulation of financial institutions. The market is a far better judge of risk and value than any individual analyst, team or firm( HOW? ).

The amount of capital required to hold a fixed-income security should be determined not by a rating but by its yield, expressed as a spread over Treasurys( WAIT A SECOND. HE BELIEVES THAT CURRENT SPREADS MAKE SENSE BECAUSE THE MARKET SAYS SO? THAT'S SILLY. ). The higher the spread, the riskier the market has determined the asset to be, and more capital should be required to hold it.( THIS IS A TERRIBLE IDEA. IT WOULD MAKE CRISES FAR WORSE BY GUARANTEEING A CALLING RUN IF THE MARKET GETS SPOOKED AND SPREADS GET LARGER. COME ON. )

Similarly, financial institutions should be required to set aside a percentage of their interest income every year as reserves for credit losses; the higher the spread, the higher the reserve percentage. Should spreads widen, the share of the return set aside for reserves should increase, thus gradually increasing reserves commensurate with the market's perception of increased risk.

A requirement that financial institutions set aside reserves for ultimate credit losses sounds obvious, but does not currently apply to holdings of bonds. Using market data to drive reserves, as well as to drive capital requirements, ensures that market perceptions of risk are continuously, but gradually, taken into account. In contrast, rating-agency downgrades are discreet events that often lag the data reflected in market prices.

Rating agencies would continue to have a useful role. Their assessment of credit risk, and their marshalling of pertinent data, would help investors make their decisions. And whether issuers or bond buyers pay for their services, rating agencies will want their ratings to be as predictive as possible. They will still be the "Consumer Reports" of the bond markets, simply without the force of law behind their recommendations. Buyers of toasters can decide for themselves, and so can buyers of bonds. Our economy would be stronger for it.

Mr. Rosenkranz is chairman and CEO of Delphi Financial Group."

Now, Arnold Kling:

"Robert Rosenkranz writes,

in effect, the regulatory reliance on ratings makes the rating agencies the de facto allocators of capital in our system. And every actor in the financial system has every incentive to group and slice assets in ways that maximize not their fundamental soundness but their rating.

Indeed, that is the entire raison d'être of the $6 trillion structured-finance business, which serves little economic function other than as a rating-agency arbitrage. Subprime mortgages (and all manner of other risky loans) held directly by financial institutions are questionable assets with high associated capital charges. Each one alone would deserve a "junk" rating. Structured finance simply piles such risky assets into bundles and slices the bundles into tranches. The rating agencies deemed some 85% of the tranches by value as AAA, and nearly 99% as investment grade -- thus turning dross into gold by a sort of ratings alchemy.

Read the whole thing. He recommends using interest rate spreads instead of credit ratings as a proxy for losses. The logic is that the market is likely to be better at assessing risk than the rating agencies.

I think his view has merit. Still, I believe that any attempt to regulate financial institutions using rules and formulas will be gamed. I think that letter-of-law regulation has to be supplemented by spirit-of-law rules( I AGREE ). If the CEO's of government-backed institution act in ways that are imprudent even though their actions are within boundaries of regulatory requirements, those CEO's ought to face the risk of imprisonment( I AGREE COMPLETELY )."

At least Mark-to-Market is intended to prevent a Calling run. This idea would encourage them.

"one of the biggest flights to safety the industry has seen."

The Aversion To Risk and Accompanying Flight To Safety have been something to behold. All because of an Avalanche Of Foreclosures followed by a Calling Run. Here's proof from the FT:

"Flight to safety hits mutual funds with $320bn outflow

By Deborah Brewster in New York

Published: January 1 2009 23:28 | Last updated: January 1 2009 23:28

Investors pulled a net $320bn from mutual funds in 2008, a record in both dollar terms and as a percentage of assets, in one of the biggest flights to safety the industry has seen.

The move out of what were previously regarded( NO GOVERNMENT GUARANTEES ) as safe and stable investments followed a record year of investor inflows in 2007.

EDITOR’S CHOICE

Money flows out of hedge funds at record rate - Dec-30

Sigh of relief for fund managers - Dec-26

However, it appears that outflows stabilised and even reversed in the final weeks of the year( WE HAVE BEGUN TO SEE SIGNS OF THE DIMINUTION ). Investors put a net $23bn into equity funds during December and withdrew only $3.5bn from bond funds, less than in earlier months.

Equity funds had outflows of $233.5bn in the year to December 29, with bond funds seeing outflows of $58.2bn and balanced funds – which include both securities – having outflows of $28bn, according to Emerging Portfolio Funds Research, which tracks fund flows in most of the world.

The data include both retail and institutional investors. The total outflow of $320bn does not include money market funds.

Almost every money manager has seen a drop in long-term assets this year as a result of net outflows and a decline in performance.

Much of the cash withdrawn went into money market funds, which saw inflows of $422bn during the year, lifting their total assets to a record $3,720bn.

Bank deposits( FDIC INSURED ) also saw increases during the year.

More than 4 per cent of equity fund assets were withdrawn during the year, a record since EPFR began keeping records in 1995.

This is greater than the percentage of assets investors pulled from hedge funds during the year, although hedge fund outflows have been partly halted by managers’ suspending or limiting redemptions. This is not an option available to mutual fund managers, who market their funds as offering daily liquidity.

The main, if not the only, growth for money managers this year has been in money market funds, but these have generated several problems of their own. Earlier in the year many ran into trouble because of exposure to subprime securities.

One fund, the Reserve, “broke the buck”, with the value of assets falling below the level investors paid in.

More recently, as interest rates fell to near zero, the funds have been able to eke out only tiny yields which offer little return to investors and provide no profit to the firms running them."

"prosecutors are investigating alleged "false statements," "market manipulation," and "breach of trust"

From Spiegel Online, a German AIG:

"A Black Hole in the Banking Bailout

By Beat Balzli, Dinah Deckstein and Jörg Schmitt

Prosecutors in Germany are investigating accusations of insider trading( COLLUSION ) at Hypo Real Estate, the Munich-based mortgage lender that has recieved billions of euros in government bailouts -- the most of any company so far -- as a result of risky investments in US subprime loans.

They arrived early in the morning in large teams and they raided numerous offices and private residences at the same time. In November 2006, the Siemens corruption scandal came to light with a major police raid -- an affair whose first chapter ended several days ago with a multibillion dollar settlement with the United States government.

DPA

Former Hypo Real Estate CEO Georg Funke: What will remain of the company will be a shell of its former self.

As news came recently of the Siemens judgment in the US, it almost seemed like deja vu when investigators launched spectacular raids in what could become Germany's next great business scandal.

Yet again, dozens of investigators mounted simultaneous raids on numerous locations. But this time the investigations aren't into corruption. Investigators are looking into charges of speculation, market manipulation, breach of trust and deception, insider trading and incompetence( NEGLIGENCE, FIDUCIARY MISMANAGEMENT, FRAUD, COLLUSION ) among greedy finance managers at the Munich-based Hypo Real Estate, one of the German banks that has been the most deeply entangled in the finance crisis. The sums of money involved in this scandal far exceed those in the Siemens affair.

Just three months ago, the German government, the German central bank (Bundesbank) and several credit institutions agreed to provide HRE with €50 billion ($71.7 billion)( THAT'S MORE THAN THEIR STIMULUS! ) in liquidity to prevent the bank's collapse and a chain reaction( CALLING RUN ) that would have hit other German banks. The government then had to provide an additional €30 billion in credit guarantees to the crippled bank.

The Munich mortgage lender, together with the Irish subsidiary Depfa that it acquired in 2007, had burned massive amounts of money through risky US real estate securities and other reckless business dealings. The company also appears to have covered up the scope of its misdealings. That, at least, is the assumption of public prosecutors who are now investigating HRE executives. According to the search warrant issued, prosecutors are investigating alleged "false statements," "market manipulation," and "breach of trust" by current and former members of HRE's board. In a six-page paper, prosecutors take a tough stance on managers. They claim they made "deliberately false statements" about the company's dramatic situation and that they were guilty of "deliberately concealing" important information and that they had violated their obligation to safeguard company assets.

Prosecutors believe that the company's former board withheld information from the public about the company's true state for more than a year. The Munich public prosecutor's office has also confirmed that it has been investigating the company since February for suspected insider trading among other things. According to several criminal complaints, HRE managers or their relatives and friends are accused of having sold large numbers of HRE shares before the company first warned of its financial woes on January 15. Share prices in HRE have hit rock bottom since the company's financial troubles hit the headlines.

In their search warrant, investigators claim the main reason for the company's current financial misery is that the board failed to take steps( WHAT WERE THESE? ) needed to restructure the company at the necessary time.

Contacted by SPIEGEL, a spokesman refused to comment on the developments. Other executives, however, have defended the company's leadership, saying it had not been given sufficient warning about the true state of HRE.

The former chief excutive, Georg Funke, 53, along with other top executives, has since been fired. The bank's new chief, Axel Wieandt, 42, who was hired in October, has just fired two other members of the management board and announced that by 2011, he will have to lay off more than half of the bank's 1,800 employees. What will remain of the company will be a shell of its former self -- and a raft of unanswered questions.

HRE's holiding company, HRE Holding, was only partially regulated under Germany's Banking Act. The country's banking regulator, BaFin, was in charge of supervising HRE's domestic subsidiaries in Germany and, together with its Irish colleagues, HRE's Depfa unit in Dublin. But it appears that nobody had a complete picture of what was happening at HRE. That led to a disastrous lapse in banking supervision. "So far, we have not been able to comprehensively oversee financial holding companies," a BaFin spokeswoman confirmed.

German lawmakers are now moving to change existing legislation. According to the latest amendment to German securities law, firms can voluntarily subject themselves to the rules and implement systems to reduce their risks. But experts are calling for tougher rules.

"HRE is to Germans what insurance company AIG is to the Americans," said one prominent banker. Both firms were long considered trouble-free, slumbering giants, but in the end, they have emerged as black holes in the industry in which billions in bailout money are rapidly disappearing. The casual approach that had been taken by management should have served as a warning signal long before. As early as May 2007, Michael Thiemann, the manager of HRE subsidiary Collineo, admitted, "You don't have the time to take a close look at each borrower." Shortly afterward, Collineo and Citigroup sold a massive package of highly complex property loan investments, of which almost half were US subprime mortgages.

Recklessness, bravado and greed were the hallmarks of the troop of executives surrounding Gerhard Bruckermann, who ran Depfa -- a company registered under Irish law for the financing of government projects -- before selling it to HRE in the summer of 2007.

Five years earlier he had moved important parts of the company, which was supposedly rock solid but whose management took too many risks, to tax havens in order to save on taxes( GOING OFFSHORE ).

Bruckermann rewarded himself and his management board for such creativity by raising the board's salary by 100 percent in 2003 -- to €20 million. He went on amass an even greater personal fortune: he is believed to have earned €100 million through the HRE deal."

This is clearly illegal behavior. Also, notice the government bailout. Implicit guarantee?

"The company also warned that the downgrades could erode confidence in Financial Products"

Here's the final part to the Washington Post story on AIG:

"Downgrades And Downfall
How could a single unit of AIG cause the giant company's near-ruin and become a fulcrum of the global financial crisis? By straying from its own rules for managing risk and then failing to anticipate the consequences.

By Robert O'Harrow Jr. and Brady Dennis
Washington Post Staff Writers
Wednesday, December 31, 2008; A01

Third of three parts

The contracts were flying out of AIG Financial Products. Hardly anyone outside Wall Street had ever heard of credit-default swaps, but by early 2005, investment banks were snapping them up to insure all kinds of deals in case of default( A GOOD IDEA ), fueling one of the great financial booms in U.S. history.

During twice-monthly conference calls that originated from the company's headquarters in Wilton, Conn., president Joseph Cassano would listen as marketing executive Alan Frost listed the latest swap transactions for associates in the firm's offices in London, Paris and Tokyo.

Once a small part of the firm's business, the increasingly popular contracts had helped boost the company's profits to record levels. The company's computer models( AGAIN, THAT'S ALL THEY ARE ) continued to show only a minute chance that the firm would ever pay out a dime on the contracts, and it turned down deals that didn't meet its standards. After their reviews, Cassano and his team would consult with AIG executives, sometimes including chairman and chief executive Maurice "Hank" Greenberg. "We rode pretty tight rein on them," Greenberg recalls.

But the swaps also exposed Financial Products and its parent AIG, the global insurance titan, to billions of dollars in possible losses( THAT'S CALLED RISK ). By spring 2005, some Financial Products executives were questioning the surge in volume. Among them was Cassano, an early advocate for the swaps business who ran the firm from its London office.

"How could we possibly be doing so many deals?"( A GOOD QUESTION ) one executive recalls Cassano asking Frost, the firm's liaison with Wall Street dealers, during one conference call.

"Dealers know we can close and close quickly," Frost said. "That's why we're the go-to."

Efficiency wasn't the only reason. Frost didn't have to say aloud what everyone at the firm already appreciated. Financial Products had become the "go-to" for credit-default swaps in part because of its knowledge and reliability, but also because it had AIG's backing. The parent company's top-drawer, Triple A credit rating and its deep pockets assured customers that they could rest easy( GOOD POINT ).

Their comfort turned out to be illusory. The credit-default swaps became a primary force in the disintegration of AIG as a private enterprise and a massive government rescue aimed at preventing catastrophic damage to the world's financial system. Never in U.S. history has the government invested so much money trying to save a private company( IMPLICITLY GUARANTEED ).

Even as Frost spoke, trouble was brewing for AIG. On March 14, 2005, Greenberg stepped down amid allegations about his involvement in a questionable deal and accounting practices at AIG( IT WAS A CRIME ). The next day, the Fitch Ratings service downgraded AIG's credit rating to AA. The two other major rating services, Moody's and Standard & Poor's, soon followed suit( THE BEGINNING OF A CALLING RUN ).

The initial fallout came swiftly, as AIG's annual report to federal regulators disclosed. The downgrades had triggered provisions in Financial Products' existing transaction, the report said, requiring its parent company to post $1.16 billion in collateral for the deals( A CALLING RUN ).

The company also warned that the downgrades could erode confidence in Financial Products, a crucial element in the unit's phenomenal success. "Historically, AIG's triple-A ratings provided AIGFP a competitive advantage. The downgrades will reduce this advantage and [some] counterparties may be unwilling to transact business with AIGFP except on a secured basis," AIG reported to the Securities and Exchange Commission in May 2005.

The swaps business had bound Financial Products to hundreds of counterparties in New York and Europe. Wall Street firms such as Goldman Sachs and Merrill Lynch favored the credit-default swaps as an extra layer of protection for mortgage-backed securities, one of the many investment by-products helping to fuel the overheated housing boom. European banks liked them because they could treat the swaps as a form of collateral( A VERY BAD IDEA ), which freed up cash( AGAIN, THAT'S THE WHOLE GAME ) that the banks would ordinarily have to set aside as protection against losses( CAN YOU SAY "INHERENTLY RISKIER? " ).

The interlocking, complex nature of these contracts would speed their downfall( IT'S A CALLING RUN. THAT'S WHAT CAUSED THE SPEED. IT IS NOT COMPLEXITY. BELIEVE ME, THE PEOPLE ON THE OTHER END OF THESE INVESTMENTS COULD SEE WHAT THE SITUATION WAS. THERE WAS NO COMPLEXITY. OTHERWISE, THERE WOULDN'T HAVE BEEN ENOUGH INFORMATION FOR THE CALLING RUN. ). When the housing market began to unravel in 2007, it set off a chain of events that would prove disastrous: downgrades in the ratings of securities that Financial Products had insured; demands by Financial Products' counterparties for billions of dollars in collateral( A CALLING RUN ); AIG's desperate search for cash to meet the collateral calls( A CALLING RUN ); a panicky weekend of negotiations in New York and Washington; and, finally, Treasury Secretary Henry M. Paulson's conclusion that AIG could not be allowed to collapse.( IMPLICIT GOVERNENT GUARANTEE GOING BACK TO THE S & L CRISIS. ALSO, LTCM FIGURED IN THIS BECAUSE IT SHOWED, THROUGH ITS INTERVENTION, WHATEVER GOVERNMENT MONEY WAS USED AT THE TIME, THAT THE GOVERNMENT COULD NOT ALLOW A CALLING RUN. THAT WAS EXTREMELY IMPORTANT INFORMATION THAT LED TO A BELIEF IN MORE IMPLICIT GOVERNMENT GUARANTEES TO INTERVENE IN A FINANCIAL CRISIS. )

The taxpayer rescue of AIG stands at $152 billion, including $60 billion in loans, a $40 billion investment in AIG preferred stock and a $52 billion purchase of troubled AIG assets that the government hopes to sell off to recoup its investment( THAT'S THE PLAN. ).

Meanwhile, federal investigators are examining statements made last year by the company and its executives to determine whether shareholders received misleading information( FRAUD ). Several investors have filed civil lawsuits, alleging that executives at AIG and Financial Products hid the extent of their credit-default swap troubles( FRAUD ).

Whether that turns out to be the case, there's no doubt that Cassano's concern in spring 2005 did not slow the firm's mounting involvement in the credit-default swap business for several months. The deals mounted and the risks grew( TRUE ).

Even after Financial Products stopped writing the credit-default swaps at the end of 2005, it maintained a public veneer( FRAUD ) of confidence that the contracts it had on its books were fine and that their computer models were sound. As Cassano told investors in a December 2007 webcast, "Our fundamental analysis says this is a money-good asset. We would not be doing the shareholders any benefit by exiting this right now and taking that loss."

2: Playing Catch-Up

By 2005, the world of debt had changed dramatically since Financial Products wrote its first credit-default swap in 1998. Back then, the swaps involved corporate debt, essentially the bonds that corporations use to finance their operations. There was a wealth of historical data about corporate debt( AND CALLING RUNS? ), which gave Financial Products' executives a high degree of confidence in consultant Gary Gorton's computer models.

Gorton, a Yale business professor with a PhD in economics, had written scores of intricate papers about corporate finance, banking and the history of financial panics. Cassano saw Gorton as a valuable asset. "Gary has helped us tremendously in helping us organize our procedures, organize our modeling effort, developing the intuition," Cassano said during the December 2007 webcast for investors.

By then, Gorton had worked as a consultant for Financial Products for nearly a decade. At that same investor conference, Gorton explained how he saw the analysis that he and his colleagues had been doing. "These models are guided by a few very basic principles, which are designed to make them very robust and to introduce as little model risk as possible," he said. "No transaction is approved by Joe if it's not based on a model that we built."

Financial Products had built itself on data, analysis and a culture of healthy skepticism. Even as the firm grew to about 400 in 2005 from 13 employees in 1987, it sought to maintain its discipline. At Financial Products, God had always been in the details, and the details were always rooted in the math( THE MATH IS COMPLEX. NOTHING ELSE IS. ).

Over the years, the firm had stayed ahead of competitors by finding innovative ways to manage and minimize the risks it took on for clients. Financial Products executives made fortunes, some taking home tens of millions of dollars a year, as the firm created markets in untapped areas -- such as buying synthetic coal equipment to capitalize on energy tax breaks.

On credit-default swaps, the firm adapted as the market evolved. By 2004, Wall Street investment banks were discovering how to turn consumer debt into a moneymaker, churning out bond-like securities backed by mortgages and other assets. Credit-default swaps helped attract institutional investors to these mind-bendingly complex deals( COME ON. IT'S NOT GODEL'S PROOF. THAT'S MIND BENDING. ), known in Wall Street jargon as collateralized debt obligations, or CDOs."

Here's a simple explanation:

(((Collateralized debt obligations (CDOs) are a type of asset-backed security and structured credit product. CDOs are constructed from a portfolio( A BUNDLE OF DIFFERENT ) of fixed-income assets. CDOs are divided by the issuer into different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates)( PAYMENTS ) to compensate for the added default risk( AS ALL BONDS DO ). Since 1987, CDOs have become an important funding vehicle for fixed-income assets.)))

"CDOs defined a revolution in corporate finance called "securitization." Wall Street saw any income stream as a candidate for securitizing: mortgages, credit card payments, car loans, even student loans. The investment banks would bundle these loans, and the monthly payments that came with them, into a new security for investors looking for steady but higher yields than Treasurys or corporate bonds.

CDOs had been around for years, but the real estate boom suddenly made mortgages one of the hottest investments on Wall Street. The mortgage industry turned into the equivalent of a giant assembly line, lubricated by fees from one end to the other. New lenders sprung up by the month, offering loans to first-time buyers as well as existing homeowners who wanted to move up to more square footage. For people with shaky credit( NO CREDIT. NOTHING JUSTIFIES THESE POOR LOANS. AT THE VERY LEAST, IT'S NEGLIGENCE AND FIDUCIARY MISMANAGEMENT ), the industry provided subprime loans, with higher rates that some homebuyers now cannot repay.

Banks packaged and resold the mortgages in pools, which became the basis for mortgage-backed securities. Wall Street scooped them up. The CDO market took off, ballooning to $551 billion issued in 2006 from $157 billion in 2004.

The CDO structure depended on the concept of layered risk. The securities in the "super senior" top tier were considered low risk and attracted the highest ratings. In return for their safety, these bonds paid the lowest interest rate. The reverse was true at the other end: The lower tiers absorbed the first losses in the case of loan defaults. For accepting extra risk, investors in these tiers earned a higher interest rate.( THIS IS JUST AS IF YOU BOUGHT BONDS AT DIFFERENT CREDIT RATINGS )

Financial Products made its money by selling credit-default swaps only on the super-senior tier. It seemed a safe bet: Cassano once defined super senior as the portion of the deal that was safe even "under worst-case stresses and worst-case stress" assumptions.

The mortgage-backed CDOs were also thought to be safe because of the geographic diversity of the underlying loans. Surely, investment bankers reasoned, people in different parts of the country would not default on their home loans at the same time( AS IF IT WERE HURRICANE INSURANCE ). The real estate market was strong and showed no sign of faltering( A BAD SIGN TO A VALUE INVESTOR ).

Financial Products executives said the swaps contracts were like catastrophe insurance( THIS ANALOGY IS THE REAL MODELING ERROR ) for events that would never happen.

Hedging, the firm's hallmark, seemed largely unnecessary( COME ON ). "Given the conservatism in that we've built these portfolios, we haven't had to do a huge amount of hedging over the years," Andy Forster, the firm's global head of credit trading, said at a May 2007 presentation to investors in New York.

Cassano also emphasized that both Financial Products and AIG had a review role. "Each and every one of our transactions," he told investors listening to the December 2007 webcast, "passes through the same careful process. We don't have any short-cuts. . . . So there's always two eyes, two teams reviewing our business. There is not one dollar of this business that's been done that hasn't gone through that double-review check( IF THE EYES HAVE THE SAME BIASES, YOU'RE NOT GETTING A LOT OF DIFFERENT POINTS OF VIEW. )."

But there were provisions in the swap contracts that the computer simulations hadn't adequately addressed( GEE ), as later events showed. There were also tremors( HERE WE GO WITH WEATHER WORDS. FROM HERE ON IN IT GETS BAD ) in the mortgage industry that would convince one Financial Products executive that the company should get out of the credit-default swap business -- fast.

3: The Subprime Threat

In fall 2005, Eugene Park was asked to take over Alan Frost's responsibilities at Financial Products. Frost had done exceedingly well in marketing the credit-default swaps to Wall Street, and was getting a promotion. He would now report to Cassano directly on other strategic projects.

Park had been at the firm for six years and ran the North American corporate credit derivative portfolio. Taking on that swaps business would boost his already handsome compensation.

But he wanted no part of it. He was worried about the subprime component( THERE IS NO EXCUSE FOR ANYONE BUYING INTO SUBPRIME LOANS. ) of the CDO market. He had examined the annual report of a company involved in the subprime business. He was stunned, he told his colleagues at the time.

The subprime loans underlying many CDOs formed too large a part of the packaged debt, increasing the risk to unacceptable levels( YOU THINK? ). Those loans could default at any time, anywhere across the country because the underwriting processes had been so shoddy( FRAUD ). The diversification was a myth -- if the housing market went bust, the subprimes would collapse, like a house of cards( A CALLING RUN WOULD BE TRIGGERED BY DOWNGRADES, EVEN IF YOU MANAGED TO PAY OFF AT FIRST THE INVESTMENTS THEMSELVES. ).

Park spelled out his reasoning in meetings and conversations with colleagues over the next several weeks. It was as if he had scratched the needle across an old record album at full volume.

Cassano agreed the firm should dig deeper. Over the next few weeks, Financial Products executives worked with researchers from investment banks to examine the subprime threat( SCAM ).

They discovered that the subprime exposure had been growing since early 2004, when the composition of the CDOs were increasingly dominated by mortgages rather than other kinds of consumer debt.( NEGLIGENCE )

Cassano decided it was time to stop. Gorton explained the decision to investors during the December 2007 webcast: "We stopped writing this business in late 2005 based on fundamental analysis and based on concerns that the model( DID IT INCLUDE A CALLING RUN OF ANY KIND? ) was not going to be able to handle declining underwriting standards."

By then, the firm had $80 billion worth of existing CDOs that included subprime mortgages as underlying assets. About half had been issued before Greenberg's ouster, Nicholas J. Ashooh, an AIG spokesman, said this week. Greenberg said in a recent interview that his research shows only $7 billion in swaps were issued on CDOs with subprime assets during his tenure( CYA ).

Either way, the exposure would prove significant. If additional downgrades occurred, either in AIG's credit rating or in the CDO ratings, Financial Products would have to come up with tens of billions of dollars in collateral it did not have.( A CALLING RUN )

4: 'Not a Lot Of Risk'

In May 2007, Cassano stepped before a crowd of entrepreneurs in Manhattan.

Financial Products was itself an entrepreneurial success story, with the numbers to prove it: an investment portfolio in excess of $50 billion; a trading operation that dealt in dozens of currencies, 18 commodities and a host of credit and equity services; a reputation for finding innovative ways to assess and manage the risks in interest rates, equities and other deals for its clients.

"And who are our clients?" Cassano asked. "It's a broad global swath of mostly high-grade institutions, mostly high-grade entities around the world and it includes banks and investment banks, pension funds, endowments, foundations, insurance companies, hedge funds, money managers, high-net-worth individuals, municipalities and sovereigns and supranationals."( THE INVESTOR CLASS )

Cassano went on. "My colleagues and myself have $500 million invested in the company," he said. "And so we've become very, very good caretakers of the value of the company."( I KNOW SOME PEOPLE CREDIT THIS EXCUSE, BUT, GIVEN THEIR COMPENSATION, I DON'T )

As a company with billions of dollars riding on arcane( PLEASE. USING AN ABACUS WOULD BE ARCANE. ) financial transactions such as derivatives, Financial Products certainly faced challenges, Cassano said. He then alluded to the debate within the firm over credit-default swaps.

"Credit risk is the biggest risk our group has. It's the single biggest risk that we manage," he said. "But with a AA plus/AA credit portfolio, there's not a lot of risk sitting in there. And so while it is the largest risk, it's not by any stretch a risky business( WHAT'S HIS JOB? )."

Three months later, in a conference call with investors, AIG chief executive Martin Sullivan struck a different note, acknowledging the growing unrest over defaults in the U.S. mortgage market.

The 52-year-old Sullivan had taken the reins at AIG after Greenberg's ouster in March 2005. He was an AIG veteran, with more than 35 years at the company, primarily on the insurance side. His rise to the top was an exclamation point on a career that began at 17, when he joined AIG's London office as a clerk.

Cassano joined Sullivan on the call. Asked by a Goldman Sachs analyst about the stability of Financial Products' huge portfolio of credit derivatives, Cassano responded with calm and confidence.

"It is hard for us, without being flippant( IF SOMEONE USES THIS WORD, GET OUT FAST ), to even see a scenario within any kind of realm of reason( WHAT'S THAT? ) that would see us losing $1( HE'S CORRECT ABOUT THAT. THEY DIDN'T JUST LOSE A DOLLAR ) in any of those transactions," Cassano said.

Sullivan added: "That's why I am sleeping a little bit easier at night."( NOW HE NEEDS XANAX )

5: Collateral Calls

After Sullivan's comment to investors, a wave of collateral calls( A CALLING RUN ) would begin, swamping AIG.

The first came from Goldman Sachs, the venerable Wall Street investment bank and one of Financial Products' biggest counterparties. Citing the plummeting value of some subprime assets underlying securities that Financial Products had insured, Goldman demanded $1.5 billion to help cover its exposure.

The 2005 downgrade of AIG to a AA company now came into play. Under the swaps contracts, AIG had to post more collateral than in its Triple A days.( A CALLING RUN )

AIG disputed the amount but had no choice but to negotiate. It agreed to post $450 million.

As if AIG didn't have enough problems, the rapidly crumbling real estate market was causing the ratings services to downgrade the securities in CDOs, including the top layers that investors had been led to believe were safe. Those downgrades also made AIG more vulnerable under the swaps contracts.

In October, Goldman came calling again, demanding $3 billion. AIG balked once more, but agreed to provide another $1.5 billion.

These and other events sent AIG's stock price tumbling. In six weeks, between early October and mid-November, it fell more than 25 percent, contributing to the perception that AIG was in trouble.

The collateral calls( CALLING RUN ) also set off alarms at PricewaterhouseCoopers, AIG's outside auditing firm. The auditors told Sullivan on Nov. 29 that they had found serious oversight problems( NEGLIGENCE ) and "that AIG could have a material weakness" relating to risk management( A CALLING RUN ). More ominously, they said, no one knew whether the value that Financial Products placed on its portfolio of derivatives was accurate( NEGLIGENCE ). That meant the losses in market value could be much worse.

About the same time, the SEC required companies like AIG to adopt an accounting standard known as "mark-to-market," designed to give investors a better sense of the current values of a company's assets( HERE'S WHERE SOME PEOPLE BELIEVE FAIR VALUE ACCOUNTING WOULD HAVE HELPED. UNLIKE MTM, WHICH IS TIED TO THE CURRENT PRICE, WHICH WAS PLUMMETING IN THIS, CAUSING THE CALLING RUN, FVA MIGHT HAVE LESSENED THE NEED FOR MORE CAPITAL, AVOIDING THE CALLING RUN. IT COULD ALSO HAVE BEEN WISHFUL THINKING SINCE IT INVOLVES ASSESSING FUTURE WORTH OF ASSETS, WHICH IS IN PART SUBJECTIVE. OF COURSE, ALL OF THIS IS. ). As the housing market declined, and the rate of defaults increased, the swaps looked at greater risk. That allowed counterparties to ask for more collateral.( A CALLING RUN )

Greenberg questioned the merits of the rule. "Mark-to-market accounting, I would argue, probably caused a great deal of the trauma that the financial industry is in today," he said.

On paper, the value of the credit-default swaps was sliding. In November, the company reported the portfolio had lost $352 million. At the December 2007 webcast for investors, Cassano reported a higher number, $1.1 billion.

Sullivan, Cassano and others at the company remained bullish on their ability to weather the calls, and in the long run( TRUE OR WISHFUL THINKING? ), even recover the collateral they had posted. "But because this business is carefully underwritten," Sullivan said, "we believe the probability that it will sustain an economic loss is close to zero."

AIG's chief risk management officer, Robert E. Lewis, reminded investors of the company's culture. "If you look at AIG's history," Lewis said, "I think you can realize that AIG in its culture does not have an appetite( THE STOMACH ) for undue concentrations of risk."

Cassano made the case that Financial Products would survive the storm because it had one of the world's best companies behind it.

"Clearly this is a time where it's a huge benefit to be part of the AIG family," he told the investors( YIKES ). "It's these crises and these points in time that give us the wherewithal right now to stand here with you and say on the back of giants, on the back of everybody at AIG who has built the capital that AIG has, the AIGFP unit is able to withstand this aberrant period."

Federal investigators are examining the December 2007 webcast as part of their effort to determine whether Cassano, Sullivan and others at the company misled investors about how dire the situation had become.( IT'S OBVIOUS THEY DID. IT'S AT LEAST NEGLIGENCE AND FIDUCIARY MISMANAGEMENT.)

Two months later, on Feb. 11, AIG disclosed that its auditors had found the company "had a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation( WHAT ABOUT MTM? ) of the AIGFP super-senior credit-default swap portfolio." On Feb. 28, AIG announced that its estimate of paper losses had spiraled to $11.5 billion. The company also acknowledged that its collateral postings had reached $5.3 billion.

The next day, Sullivan announced that the Cassano era was over. The Financial Products president had resigned, effective March 31. Sullivan did not reveal that Cassano would get $1 million a month as a consultant( CYA MONEY ). That fact came out months later during congressional hearings on AIG's near-collapse. AIG had also provided a record of Cassano's compensation history to the committee, showing that he received $43.6 million in salary and bonuses in 2006, and $24.2 million in 2007.

"Joe has been a very valuable member of the AIGFP senior management team for over 20 years," Sullivan said in making the announcement. "He has had a great career with us, and we wish him the very best in the future."

The worst was still to come.

6: A Deep Hole

The urgent phone call that alerted Eric Dinallo to the extent of the financial meltdown came Friday, Sept. 12, as he drove to his family's weekend home in the Hudson Valley, north of Manhattan.

Dinallo, head of New York state's insurance department, got a briefing about AIG, where panicked executives were desperately trying to come up with a huge infusion of cash. They had heard the bond-rating agencies were going to downgrade the company's already ailing credit grade, which would trigger more collateral calls( A CALLING RUN ). "And if downgraded -- even like one notch -- they didn't have sufficient liquidity" to meet the calls, Dinallo said recently.

Dinallo recognized the danger. AIG had operated for so long at the center of the world's financial web, with so many counterparties, that its collapse would be felt in every corner of the globe. As insurance superintendent, Dinallo was aware of the previous calls. But he was still taken by surprise. "I never realized things were as bad as they were," he said. "I didn't realize how deep the hole was they had created."

AIG was going to try selling some of its life insurance affiliates. AIG officials also made a pitch for a $20 billion loan from the state insurance department. "They said, 'We will pay this loan quickly,' " Dinallo recalled.

Dinallo cut short his weekend plans and headed back to Manhattan early Saturday. By noon he had assembled a small team at AIG headquarters. Working on the 18th floor, not far from where Greenberg once reigned, Dinallo and his crew pored through AIG's books, looking for ways to raise money.

Meanwhile, Goldman Sachs and J.P. Morgan set to work on a $75 billion bridge loan from a syndicate of major financial institutions, which was intended to give AIG cash until it could sell enough assets to bail itself out.

The urgency and tension were palpable. New York's governor, David A. Paterson, called in. So did Timothy Geithner, head of the New York Federal Reserve. Geithner was swamped that day with the imminent collapse of Lehman Brothers, but he wanted constant updates.

By Sunday night, no solution emerged, and AIG executives were worried that the company's stock price would take another hit when the market opened on Monday.

On Monday morning, Paterson announced he would relax insurance regulations( OF COURSE ) so that AIG could borrow up to $20 billion from its subsidiaries to cover operating expenses. Meanwhile, the Goldman-J.P. Morgan effort on the bridge loan wasn't coming together.

Hour by hour, it became clear that AIG was far more exposed by Financial Products' commitments than anyone realized. The next day, sensing disaster, the Federal Reserve Board, with the backing of the Treasury Department, stepped in and took control of what had been one of the most successful private enterprises ever.

"The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance," the Federal Reserve said.( TOO LATE. WITH LEHMAN, THE CALLING RUN WAS JUST BEGINNING TO GET UP TO SPEED. )

7: 'An Unacceptable Situation'

In October, SEC chairman Christopher Cox appeared at a roundtable discussion that the agency was hosting at its Washington headquarters. He delivered a tough, grim message: The federal government had failed taxpayers by not regulating the swaps market( THIS DOES SUPPORT THOMA AND OTHERS. I WANT TO KNOW WHAT THEY WOULD HAVE DONE. ).

"The regulatory black hole for credit-default swaps is one of the most significant issues we are confronting in the current credit crisis," Cox said, "and it requires immediate legislative action."

He tried to put the regulatory failure into context. "The market for CDS is barely 10 years old. It has doubled in size since just two years ago," he said. "It has grown between the gaps and seams of the current regulatory system( THAT'S WHY IT GREW. WOULD INVESTORS HAVE FOUND SOMETHING ELSE? ), where neither the commission nor any other government agency can reach it. No one has regulatory authority over credit-default swaps -- not even to require basic reporting or disclosure."

He went on: "The over-the-counter credit-default swaps market has drawn the world's major financial institutions and others into a tangled web of interconnections where the failure of any one institution might jeopardize the entire financial system. This is an unacceptable situation for a free-market economy( WHAT'S THAT? WE DON'T HAVE ONE. WE HAVE A HYBRID ECONOMY. THAT'S WHY THERE'S AN SEC. )."

8: Recriminations

The question of what went wrong at AIG and its Financial Products unit provoked some finger-pointing in recent interviews with former executives.( CYA )

Greenberg, the ousted AIG chairman, says that the responsibility rests with the people who ran the company after his forced resignation in 2005. He said that Cassano, the man he appointed to run Financial Products in 2001, never would have been allowed to do anything untoward under his leadership. "No. No," Greenberg said. "Because he was controlled."( HE WAS A ROBOT. )

His longtime deputy, former AIG vice chairman Edward Matthews, also blamed their successors. "When Hank and I left," he said, "those chains that bound Joe Cassano were off."( PROMETHEUS? )

Cassano doesn't agree. Through his lawyer, F. Joseph Warin, he maintained that "every single super-senior CDS investment was authorized by AIG corporate."

Warin said, in a statement: "Regardless of what Mr. Greenberg says today, the facts speak for themselves: Mr. Cassano decided on his own, after Mr. Greenberg left AIG, to stop writing CDS [credit-default swap] protection. Mr. Cassano instructed his team to analyze the mortgage underwriting standards and then made the decision to exit the business in late 2005, all within months of Mr. Greenberg leaving the company."

As for the allegations that Cassano and others made misleading statements in December 2007, Warin has said, in a statement, his client acted lawfully and is cooperating with investigators. "He provided full and complete information to investors, his supervisors and auditors," Warin said.

Howard Sosin and Randy Rackson, two of Financial Products' founders, left the company in 1993 after a bitter dispute with Greenberg. Sosin lives in Connecticut, not far from Financial Products' headquarters. He traces the roots of the firm's demise to Greenberg's decision to force him out.

"We did really well with it. AIG did really well with it," Sosin said, adding that recent events could have been avoided with more attention to the firm's "core values." "It did not have to be this total failure of control."

In his brownstone on Manhattan's Upper West Side, Rackson said, "You put something together that was good, and then somebody takes the controls and drives it into the ground."

9: Epilogue

On Nov. 11, Gerry Pasciucco pulled open the front door of AIG Financial Products headquarters in Wilton, Conn. For much of Pasciucco's career on Wall Street, Financial Products had drawn some of the smartest, most ambitious people in the business, while doing pioneering work.

Now, it was in ruins.

Just weeks before, the 48-year-old Pasciucco, a vice chairman at Morgan Stanley, had heard from colleagues working with federal authorities that AIG was looking for someone to end Financial Products. He spoke with current AIG chief executive, Edward Liddy, who invited him to the Manhattan headquarters of the hemorrhaging insurance giant. Sullivan was gone; he had resigned as of July 1 with a $47 million severance package.

As Liddy and Pasciucco sat in the office once occupied by Greenberg, Liddy spelled out what he needed from Pasciucco: To identify Financial Products' outstanding obligations, resolve those transactions as profitably and quickly as possible, and then close the doors and turn out the lights.

Pasciucco had worked at Morgan Stanley for 24 years in capital markets and risk assessment. He had once been filmed by Harvard Business School for a case study on how to manage in a fast-paced financial market. But even with that background, he wondered whether he had the chops to sort out Financial Products' problems.

"How solvable is it?" Pasciucco recalled asking Liddy. "I'm up for a challenge, but there has to be a chance."( I LIKE HIM )

Liddy told Pasciucco to think about it. Back in his Morgan Stanley office, overlooking Times Square, Pasciucco did more homework. The organization was in desperate need of leadership and a game plan for unwinding its enormous book of transactions. Pasciucco came to believe that he could make a difference and decided to take the job, in part because he saw it as a chance to pitch in on the great economic crisis of his time.

Now, in Wilton for his first day on the job, Pasciucco knew from the demeanor of new colleagues that it was going to be even rougher than he thought. Their faces looked glum, their arms were crossed, and they seemed unsure of what to do.

He dove into the company's books. The story he found in the numbers was fascinating and daunting: Financial Products had $2.7 trillion worth of swap contracts and positions; 50,000 outstanding trades; 2,000 firms involved on the other side of those trades; and 450 employees in six offices around the world. The majority of the firm's trades had been hedged, essentially along the lines that Sosin, Rackson and others had laid out two decades before.

"The place made sense when I got here," Pasciucco said last week. "They were very, very smart."

But Pasciucco soon found evidence of a fatal miscalculation. It seems that as Financial Products ramped up its credit-default swap business, its leaders assumed that its parent, AIG, would always be as strong as it was the day it backed the firm's first big trade in 1987. He said they had failed to prepare for the possibility of a downgrade in AIG's credit rating( A CALLING RUN ).

The executives who had pushed or approved the credit-default swap business had placed too much faith in the math that told them the worst would never happen, that AIG and its deep pockets would be there to usher them through the trouble.

"When the unexpected happens and you have the biggest credit crisis since 1929, you have to be prepared to deal with it, and they weren't," Pasciucco said. "There was no system in place to account for the fact that the company might not be a Triple A forever."

It's an intersting story, but it fails on many fronts:

1) It doesn't even try to deal with the issue of how complex these investments really are. As I've said, the investments and risk aren't that complicated, but the math used to compute the risk is.

2) It doesn't examine how intelligent it is to believe in math models for investing.

3) It doesn't adequately examine the stupidity of the weather insurance analogy.

4) It doesn't examine the fact that LTCM showed the possibility of a calling run.

5) It doesn't examine the implicit government guarantees underpinning these investments.

6) The story is full of crimes and fraud, but that seems to have no explanatory power to them.

7) They credit CYA from people who are likely going to be litigated to death. They aren't going to publicly say anything incriminating if they speak.

8) They don't go into the role of the Credit Ratings Agencies being paid by the people being graded.

9) They don't explain how Fair Value Accounting would have helped, if at all.

10) They don't explain how regulations would have helped with these regulators.

I could go on. It's a very good story, but only if read with an eye for BS and CYA, which are evident throughout.

"insiders described as a system of dubious legality that enabled real estate agents to collect fees of more than $10,000 for bringing in borrowers"

From The NY TIMES, a post by PETER S. GOODMAN and GRETCHEN MORGENSON:


“We hope to do to this industry what Wal-Mart did to theirs, Starbucks did to theirs, Costco did to theirs and Lowe’s-Home Depot did to their industry. And I think if we’ve done our job, five years from now you’re not going to call us a bank.”

Skip to next paragraph

Enlarge This Image

Sandy Huffaker for The New York Times

“It was just disheartening,” said Sherri Zaback, a mortgage screener for Washington Mutual. “Just spit it out and get it done. That’s they wanted us to do. Garbage in, garbage out.”

The Reckoning

Mortgage Factory

Articles in this series have explored the causes of the financial crisis.

Previous Articles in the Series »

Multimedia

Video

Washington Mutual ‘Power of Yes’ Ad via YouTube

Graphic

Rise and Fall

PUSH TO GROW Former employees say that with Kerry Killinger in charge, WaMu became a loan factory, ignoring borrowers’ incomes.

— Kerry K. Killinger, chief executive of Washington Mutual, 2003

SAN DIEGO — As a supervisor at a Washington Mutual mortgage processing center, John D. Parsons was accustomed to seeing baby sitters claiming salaries worthy of college presidents, and schoolteachers with incomes rivaling stockbrokers’. He rarely questioned them( NEGLIGENCE ). A real estate frenzy was under way and WaMu, as his bank was known, was all about saying yes.

Yet even by WaMu’s relaxed standards, one mortgage four years ago raised eyebrows. The borrower was claiming a six-figure income and an unusual profession: mariachi singer.

Mr. Parsons could not verify the singer’s income, so he had him photographed in front of his home dressed in his mariachi outfit. The photo went into a WaMu file. Approved( NEGLIGENCE ).

“I’d lie if I said every piece of documentation was properly signed and dated,” said Mr. Parsons, speaking through wire-reinforced glass at a California prison near here, where he is serving 16 months for theft after his fourth arrest — all involving drugs( NOT THIS ).

While Mr. Parsons, whose incarceration is not related to his work for WaMu, oversaw a team screening mortgage applications, he was snorting methamphetamine daily, he said.

“In our world, it was tolerated,” said Sherri Zaback, who worked for Mr. Parsons and recalls seeing drug paraphernalia on his desk. “Everybody said, ‘He gets the job done.’ ”

At WaMu, getting the job done meant lending money to nearly anyone who asked for it( NEGLIGENCE ) — the force behind the bank’s meteoric rise and its precipitous collapse this year in the biggest bank failure in American history.

On a financial landscape littered with wreckage, WaMu, a Seattle-based bank that opened branches at a clip worthy of a fast-food chain, stands out as a singularly brazen case of lax lending( HUMAN AGENCY EXPLANATION ). By the first half of this year, the value of its bad loans had reached $11.5 billion, nearly tripling from $4.2 billion a year earlier.

Interviews with two dozen former employees, mortgage brokers, real estate agents and appraisers reveal the relentless pressure to churn out loans that produced such results. While that sample may not fully represent a bank with tens of thousands of people, it does reflect the views of employees in WaMu mortgage operations in California, Florida, Illinois and Texas.

Their accounts are consistent with those of 89 other former employees who are confidential witnesses in a class action filed against WaMu in federal court in Seattle by former shareholders( GOOD ).

According to these accounts, pressure to keep lending emanated from the top, where executives profited from the swift expansion( FIDUCIARY MISMANAGEMENT ) — not least, Kerry K. Killinger, who was WaMu’s chief executive from 1990 until he was forced out in September.

Between 2001 and 2007, Mr. Killinger received compensation of $88 million, according to the Corporate Library, a research firm. He declined to respond to a list of questions, and his spokesman said he was unavailable for an interview.

During Mr. Killinger’s tenure, WaMu pressed sales agents to pump out loans while disregarding borrowers’ incomes and assets( NEGLIGENCE ), according to former employees. The bank set up what insiders described as a system of dubious legality( ILLEGALITY ) that enabled real estate agents to collect fees of more than $10,000 for bringing in borrowers, sometimes making the agents more beholden to WaMu than they were to their clients( FIDUCIARY MISMANAGEMENT ).

WaMu gave mortgage brokers handsome commissions( COLLUSION ) for selling the riskiest loans, which carried higher fees, bolstering profits and ultimately the compensation of the bank’s executives. WaMu pressured( FRAUD ) appraisers to provide inflated property values( FRAUD ) that made loans appear less risky, enabling Wall Street to bundle them more easily for sale to investors( FRAUD ).

“It was the Wild West,” said Steven M. Knobel, a founder of an appraisal company, Mitchell, Maxwell & Jackson, that did business with WaMu until 2007. “If you were alive, they would give you a loan. Actually, I think if you were dead, they would still give you a loan( FRAUD ).”

JPMorgan Chase, which bought WaMu for $1.9 billion in September and received $25 billion a few weeks later as part of the taxpayer bailout( GREAT ) of the financial services industry, declined to make former WaMu executives available for interviews.

JPMorgan also declined to comment on WaMu’s operations before it bought the company. “It is a different era for our customers and for the company,” a spokesman said.

For those who placed their faith and money in WaMu, the bank’s implosion came as a shock( YES IT DID ).

“I never had a clue about the amount of off-the-cliff activity that was going on at Washington Mutual, and I was in constant contact with the company( OF COURSE AVERAGE CITIZENS CAN DETERMINE A BANK'S SOLVENCY. RIGHT. ),” said Vincent Au, president of Avalon Partners, an investment firm. “There were people at WaMu that orchestrated nothing more than a sham or charade( FRAUD ). These people broke every fundamental rule of running a company( FIDUCIARY MISMANAGEMENT ).”

‘Like a Sweatshop’

Some WaMu employees who worked for the bank during the boom now have regrets.

“It was a disgrace,” said Dana Zweibel, a former financial representative at a WaMu branch in Tampa, Fla. “We were giving loans to people that never should have had loans( NEGLIGENCE ).”

If Ms. Zweibel doubted whether customers could pay, supervisors directed her to keep selling( NEGLIGENCE ), she said.

“We were told from up above that that’s not our concern,” she said. “Our concern is just to write the loan( FIDUCIARY MISMANAGEMENT ).”

The ultimate supervisor at WaMu was Mr. Killinger, who joined the company in 1983 and became chief executive in 1990. He inherited a bank that was founded in 1889 and had survived the Depression and the savings and loan scandal of the 1980s.

An investment analyst by training, he was attuned to Wall Street’s hunger for growth. Between late 1996 and early 2002, he transformed WaMu into the nation’s sixth-largest bank through a series of acquisitions.

A crucial deal came in 1999, with the purchase of Long Beach Financial, a California lender specializing in subprime mortgages( HERE WE GO ), loans extended to borrowers with troubled credit.

WaMu underscored its eagerness to lend with an advertising campaign introduced during the 2003 Academy Awards: “The Power of Yes.” No mere advertising pitch, this was also the mantra inside the bank, underwriters said.

“WaMu came out with that slogan, and that was what we had to live by,” Ms. Zaback said. “We joked about it a lot.” A file would get marked problematic and then somehow get approved. “We’d say: ‘O.K.! The power of yes.’ ”( HIGHLY COMICAL FOR YOUR SHAREHOLDERS )

Revenue at WaMu’s home-lending unit swelled from $707 million in 2002 to almost $2 billion the following year, when the “The Power of Yes” campaign started.

Between 2000 and 2003, WaMu’s retail branches grew 70 percent, reaching 2,200 across 38 states, as the bank used an image of cheeky irreverence to attract new customers. In offbeat television ads, casually dressed WaMu employees ridiculed staid bankers in suits( WITH ETHICS ).

Branches were pushed to increase lending. “It was just disgusting,” said Ms. Zweibel, the Tampa representative. “They wanted you to spend time, while you’re running teller transactions and opening checking accounts, selling people loans.”

Employees in Tampa who fell short were ordered to drive to a WaMu office in Sarasota, an hour away. There, they sat in a phone bank with 20 other people, calling customers to push home equity loans.

“The regional manager would be over your shoulder, listening to every word,” Ms. Zweibel recalled. “They treated us like we were in a sweatshop( YOU WERE ).”

On the other end of the country, at WaMu’s San Diego processing office, Ms. Zaback’s job was to take loan applications from branches in Southern California and make sure they passed muster. Most of the loans she said she handled merely required borrowers( NEGLIGENCE ) to provide an address and Social Security number, and to state their income and assets.

She ran applications through WaMu’s computer system for approval. If she needed more information, she had to consult with a loan officer — which she described as an unpleasant experience. “They would be furious,” Ms. Zaback said. “They would put it on you, that they weren’t going to get paid if you stood in the way( NEGLIGENCE ).”

On one loan application in 2005, a borrower identified himself as a gardener and listed his monthly income at $12,000, Ms. Zaback recalled. She could not verify his business license, so she took the file to her boss, Mr. Parsons.

He used the mariachi singer as inspiration: a photo of the borrower’s truck emblazoned with the name of his landscaping business went into the file. Approved.

Mr. Parsons, who worked for WaMu in San Diego from about 2002 through 2005, said his supervisors constantly praised his performance. “My numbers were through the roof,” he said.

On another occasion, Ms. Zaback asked a loan officer for verification of an applicant’s assets. The officer sent a letter from a bank showing a balance of about $150,000 in the borrower’s account, she recalled. But when Ms. Zaback called the bank to confirm, she was told the balance was only $5,000.

The loan officer yelled at her, Ms. Zaback recalled. “She said, ‘We don’t call the bank to verify( FRAUD ).’ ” Ms. Zaback said she told Mr. Parsons that she no longer wanted to work with that loan officer, but he replied: “Too bad.”

Shortly thereafter, Mr. Parsons disappeared from the office. Ms. Zaback later learned of his arrest for burglary and drug possession( NOT FOR THIS ).

The sheer workload at WaMu ensured that loan reviews were limited. Ms. Zaback’s office had 108 people, and several hundred new files a day. She was required to process at least 10 files daily.

“I’d typically spend a maximum of 35 minutes per file,” she said. “It was just disheartening. Just spit it out and get it done. That’s what they wanted us to do. Garbage in, and garbage out.”

Referral Fees for Loans

WaMu’s boiler room culture flourished in Southern California, where housing prices rose so rapidly during the bubble that creative financing( FRAUD ) was needed to attract buyers.

To that end, WaMu embraced so-called option ARMs, adjustable rate mortgages that enticed borrowers with a selection of low initial rates and allowed them to decide how much to pay each month( FRAUD ). But people who opted for minimum payments were underpaying the interest due and adding to their principal, eventually causing loan payments to balloon( FIDUCIARY MISMANAGEMENT ).

Customers were often left with the impression( LIED TO ) that low payments would continue long term, according to former WaMu sales agents( IT'S THEIR JOB TO MAKE THE INVESTMENT CLEAR TO THE CLIENT ).

For WaMu, variable-rate loans — option ARMs, in particular — were especially attractive because they carried higher fees( YES ) than other loans, and allowed WaMu to book profits( LIE ) on interest payments that borrowers deferred. Because WaMu was selling many of its loans to investors( FRAUD ), it did not worry about defaults: by the time loans went bad, they were often in other hands.

WaMu’s adjustable-rate mortgages expanded from about one-fourth of new home loans in 2003 to 70 percent by 2006. In 2005 and 2006 — when WaMu pushed option ARMs most aggressively — Mr. Killinger received pay of $19 million and $24 million respectively.

The ARM Loan Niche

WaMu’s retail mortgage office in Downey, Calif., specialized in selling option ARMs to Latino customers who spoke little English and depended on advice from real estate brokers( FRAUD ), according to a former sales agent who requested anonymity because he was still in the mortgage business.

According to that agent, WaMu turned real estate agents into a pipeline for loan applications by enabling them to collect “referral fees”( YES ) for clients who became WaMu borrowers.

Buyers were typically oblivious( NEGLIGENCE ) to agents’ fees, the agent said, and agents rarely explained the loan terms( FRAUD ).

“Their Realtor was their trusted friend,” the agent said. “The Realtors would sell them on a minimum payment, and that was an outright lie( FINALLY ).”

According to the agent, the strategy was the brainchild of Thomas Ramirez, who oversaw a sales team of about 20 agents at the Downey branch during the first half of this decade, and now works for Wells Fargo.

Mr. Ramirez confirmed that he and his team enabled real estate agents to collect commissions, but he maintained that the fees were fully disclosed.

“I don’t think the bank would have let us do the program if it was bad( IT OBVIOUSLY WAS ),” Mr. Ramirez said.

Mr. Ramirez’s team sold nearly $1 billion worth of loans in 2004, he said. His performance made him a perennial member of WaMu’s President’s Club, which brought big bonuses and recognition at an awards ceremony typically hosted by Mr. Killinger in tropical venues like Hawaii.

Mr. Ramirez’s success prompted WaMu to populate a neighboring building in Downey with loan processors, underwriters and appraisers who worked for him. The fees proved so enticing that real estate agents arrived in Downey from all over Southern California, bearing six and seven loan applications at a time, the former agent said.

WaMu banned referral fees in 2006, fearing they could be construed as illegal payments( THEY WERE ) from the bank to agents. But the bank allowed Mr. Ramirez’s team to continue using the referral fees, the agent said.

Forced Out With Millions

By 2005, the word was out that WaMu would accept applications with a mere statement of the borrower’s income and assets — often with no documentation required — so long as credit scores were adequate, according to Ms. Zaback and other underwriters.

“We had a flier that said, ‘A thin file is a good file( FRAUD ),’ ” recalled Michele Culbertson, a wholesale sales agent with WaMu.

Martine Lado, an agent in the Irvine, Calif., office, said she coached brokers to leave parts of applications blank( FRAUD ) to avoid prompting verification if the borrower’s job or income was sketchy.

“We were looking for people who understood how to do loans at WaMu,” Ms. Lado said.

Top producers became heroes. Craig Clark, called the “king of the option ARM” by colleagues, closed loans totaling about $1 billion in 2005, according to four of his former coworkers, a tally he amassed in part by challenging anyone who doubted him.

“He was a bulldozer when it came to getting his stuff done,” said Lisa Alvarez, who worked in the Irvine office from 2003 to 2006.

Christine Crocker, who managed WaMu’s wholesale underwriting division in Irvine, recalled one mortgage to an elderly couple from a broker on Mr. Clark’s team.

With a fixed income of about $3,200 a month, the couple needed a fixed-rate loan. But their broker earned a commission of three percentage points by arranging an option ARM for them, and did so by listing their income as $7,000 a month( FRAUD ). Soon, their payment jumped from roughly $1,000 a month to about $3,000, causing them to fall behind.

Mr. Clark, who now works for JPMorgan, referred calls to a company spokesman, who provided no further details.

In 2006, WaMu slowed option ARM lending. But earlier, ill-considered loans had already begun hurting its results. In 2007, it recorded a $67 million loss and shut down its subprime lending unit( GOOD WORK ).

By the time shareholders joined WaMu for its annual meeting in Seattle last April, WaMu had posted a first-quarter loss of $1.14 billion and increased its loan loss reserve to $3.5 billion. Its stock had lost more than half its value in the previous two months. Anger was in the air.

Some shareholders were irate that Mr. Killinger and other executives were excluding mortgage losses from the computation of their bonuses. Others were enraged that WaMu turned down an $8-a-share takeover bid from JPMorgan.

“Calm down and have a little faith,” Mr. Killinger told the crowd. “We will get through this.”

WaMu asked shareholders to approve a $7 billion investment by Texas Pacific Group, a private equity firm, and other unnamed investors. David Bonderman, a founder of Texas Pacific and a former WaMu director, declined to comment.

Hostile shareholders argued that the deal would dilute their holdings, but Mr. Killinger forced it through, saying WaMu desperately needed new capital.

Weeks later, with WaMu in tatters, directors stripped Mr. Killinger of his board chairmanship. And the bank began including mortgage losses when calculating executive bonuses.

In September, Mr. Killinger was forced to retire. Later that month, with WaMu buckling under roughly $180 billion in mortgage-related loans, regulators seized the bank and sold it to JPMorgan for $1.9 billion, a fraction of the $40 billion valuation the stock market gave WaMu at its peak.

Billions that investors had plowed into WaMu were wiped out, as were prospects for many of the bank’s 50,000 employees. But Mr. Killinger still had his millions, rankling laid-off workers and shareholders alike.

“Kerry has made over $100 million over his tenure based on the aggressiveness that sunk the company,” said Mr. Au, the money manager. “How does he justify taking that money?”

In June, Mr. Au sent an e-mail message to the company asking executives to return some of their pay. He says he has not heard back."

Maybe now my number two cause of this crisis, namely Fraud, Negligence, Fiduciary Misconduct, and Collusion, will start becoming apparent to people. We need to investigate and prosecute and sue the perpetrators of these crimes. In the S & L Crisis, far too many people were let off the hook, and that became a lesson for financial criminals, who populate this crisis from top to bottom. We can't afford another round of letting people avoid the penalties for what they've done. Stop blaming the investments, and start blaming the people involved.