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Index
I. EXECUTIVE SUMMARY
A. Subcommittee Investigation
B. Overview
(1) High Risk Lending: Case Study of Washington Mutual Bank
(2) Regulatory Failures: Case Study of the Office of Thrift Supervision
(3) Inflated Credit Ratings: Case Study of Moody’s and Standard & Poor’s
(4) Investment Bank Abuses: Case Study of Goldman Sachs and Deutsche Bank
C. Recommendations
II. BACKGROUND
A. Rise of Too-Big-To-Fail U.S. Financial Institutions
B. High Risk Mortgage Lending
C. Credit Ratings and Structured Finance
D. Investment Banks
E. Market Oversight
F. Government Sponsored Enterprises
G. Administrative and Legislative Actions
H. Financial Crisis Timeline
III. HIGH RISK LENDING: CASE STUDY OF WASHINGTON MUTUAL BANK
A. Subcommittee Investigation and Findings of Fact
B. Background
(1) Major Business Lines and Key Personnel
(2) Loan Origination Channels
(3) Long Beach
(4) Securitization
(5) Overview of WaMu’s Rise and Fall
C. High Risk Lending Strategy
(1) Strategic Direction
(2) Approval of Strategy
(3) Definition of High Risk Lending
(4) Gain on Sale
(5) Acknowledging Unsustainable Housing Price Increases
(6) Execution of the High Risk Lending Strategy
D. Shoddy Lending Practices
(1) Long Beach
(2) WaMu Retail Lending
(a) Inadequate Systems and Weak Oversight
(b) Risk Layering
(c) Loan Fraud
(d) Steering Borrowers to High Risk Option ARMs
(e) Marginalization of WaMu Risk Managers
E. Polluting the Financial System
(1) Long Beach and WaMu Securitizations
(2) Deficient Securitization Practices
(3) Securitizing Delinquency-Prone Loans
(4) WaMu Loan Sales to Fannie Mae and Freddie Mac
F. Destructive Compensation Practices
(1) Sales Culture
(2) Paying for Speed and Volume
(a) Long Beach Account Executives
(b) WaMu Loan Consultants
(c) Loan Processors and Quality Assurance Controllers
(3) WaMu Executive Compensation
G. Preventing High Risk Lending
(1) New Developments
(2) Recommendations
1. Ensure “Qualified Mortgages” Are Low Risk
2. Require Meaningful Risk Retention
3. Safeguard Against High Risk Products
4. Require Greater Reserves for Negative Amortization Loans
5. Safeguard Bank Investment Portfolios
IV. REGULATORY FAILURE: CASE STUDY OF THE OFFICE OF THRIFT SUPERVISION
A. Subcommittee Investigation and Findings of Fact
B. Background
(1) Office of Thrift Supervision
(2) Federal Deposit Insurance Corporation
(3) Examination Process
C. Washington Mutual Examination History
(1) Regulatory Challenges Related to Washington Mutual
(2) Overview of Washington Mutual’s Ratings History and Closure
(3) OTS Identification of WaMu Deficiencies
(a) Deficiencies in Lending Standards
(b) Deficiencies in Risk Management
(c) Deficiencies in Home Appraisals
(d) Deficiencies Related to Long Beach
(e) Over 500 Deficiencies in 5 Years
(4) OTS Turf War Against the FDIC
D. Regulatory Failures
(1) OTS’ Failed Oversight of WaMu
(a) Deference to Management
(b) Demoralized Examiners
(c) Narrow Regulatory Focus
(d) Inflated CAMELS Ratings
(e) Fee Issues
(2) Other Regulatory Failures
(a) Countrywide
(b) IndyMac
(c) New Century
(d) Fremont
E. Preventing Regulatory Failures
(1) New Developments
(2) Recommendations
1. Complete OTS Dismantling
2. Strengthen Enforcement
3. Strengthen CAMELS Ratings
4. Evaluate Impacts of High Risk Lending
V. INFLATED CREDIT RATINGS: CASE STUDY OF MOODY’S AND STANDARD & POOR’S
A. Subcommittee Investigation and Findings of Fact
B. Background
(1) Credit Ratings Generally
(2) The Rating Process
(3) Record Revenues
C. Mass Credit Rating Downgrades
(1) Increasing High Risk Loans and Unaffordable Housing
(2) Mass Downgrades
D. Ratings Deficiencies
(1) Awareness of Increasing Credit Risks
(2) CRA Conflicts of Interest
(a) Drive for Market Share
(b) Investment Bank Pressure
(3) Inaccurate Models
(a) Inadequate Data
(b) Unclear and Subjective Ratings Process
(4) Failure to Retest After Model Changes
(5) Inadequate Resources
(6) Mortgage Fraud
E. Preventing Inflated Credit Ratings
(1) Past Credit Rating Agency Oversight
(2) New Developments
(3) Recommendations
1. Rank Credit Rating Agencies by Accuracy
2. Help Investors Hold CRAs Accountable
3. Strengthen CRA Operations
4. Ensure CRAs Recognize Risk
5. Strengthen Disclosure
6. Reduce Ratings Reliance
VI. INVESTMENT BANK ABUSES: CASE STUDY OF GOLDMAN SACHS AND DEUTSCHE BANK
A. Background
(1) Investment Banks In General
(2) Roles and Duties of an Investment Bank: Market Maker, Underwriter, Placement Agent, Broker-Dealer
(3) Structured Finance Products
B. Running the CDO Machine: Case Study of Deutsche Bank
(1) Subcommittee Investigation and Findings of Fact
(2) Deutsche Bank Background
(3) Deutsche Bank’s $5 Billion Short
(a) Lippmann’s Negative Views of Mortgage Related Assets
(b) Building and Cashing in the $5 Billion Short
(4) The “CDO Machine”
(5) Gemstone
(a) Background on Gemstone
(b) Gemstone Asset Selection
(c) Gemstone Risks and Poor Quality Assets
(d) Gemstone Sales Effort
(e) Gemstone Losses
(6) Other Deutsche Bank CDOs
(7) Analysis
C. Failing to Manage Conflicts of Interest: Case Study of Goldman Sachs
(1) Subcommittee Investigation and Findings of Fact
(2) Goldman Sachs Background
(3) Overview of Goldman Sachs Case Study
(a) Overview of How Goldman Shorted the Subprime Mortgage Market
(b) Overview of Goldman’s CDO Activities
(4) How Goldman Shorted the Subprime Mortgage Market
(a) Starting $6 Billion Net Long
(b) Going Past Home: Goldman’s First Net Short
(c) Attempted Short Squeeze
(d) Building the Big Short
(e) “Get Down Now”
(f) Profiting from the Big Short: Making “Serious Money”
(g) Goldman’s Records Confirm Large Short Position
(i) TopSheets
(ii)Risk Reports
(h) Profiting From the Big Short
(5) How Goldman Created and Failed to Manage Conflicts of Interest in its Securitization Activities
(a) Background
(i) Goldman’s Securitization Business
(ii) Goldman’s Negative Market View
(iii) Goldman’s Securitization Sell Off
AA. RMBS Sell Off
BB. CDO Sell Off
CC. CDO Marks
DD. Customer Losses
(b) Goldman’s Conflicts of Interest
(i) Conflicts of Interest Involving RMBS Securities
(ii) Conflicts of Interest Involving Sales of CDO Securities
AA. Hudson Mezzanine Funding 2006-1
BB. Anderson Mezzanine Funding 2007-1
CC. Timberwolf I
DD. Abacus 2007-AC1
(iii) Additional CDO Conflicts of Interest
AA. Liquidation Agent in Hudson 1
BB. Collateral Put Provider in Timberwolf
(6) Analysis of Goldman’s Conflicts of Interest
(a) Securities Laws
(b) Analysis
(i) Claiming Market Maker Status
(ii) Soliciting Clients and Recommending Investments
(iii) Failing to Disclose Material Adverse Information
(iv) Making Unsuitable Investment Recommendations
(7) Goldman’s Proprietary Investments
D. Preventing Investment Bank Abuses
(1) New Developments
(2) Recommendations
1. Review Structured Finance Transactions
2. Narrow Proprietary Trading Exceptions
3. Design Strong Conflict of Interest Prohibitions
4. Study Bank Use of Structured Finance
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