Ben Protess stories from The Center for Public Integrity

Dodd’s departure could endanger potential consumer agency

2011-10-12T16:23:27-04:00

It’s the question buzzing around Washington and Wall Street this week: Will Sen. Christopher Dodd’s sudden retirement announcement further jeopardize his already thorny task of overhauling the nation’s financial regulatory system?

At risk in particular, some Capitol Hill observers say, may be a proposal to create a new consumer protection agency that President Obama has characterized as a must for financial reform.

Dodd, a Connecticut Democrat who announced Wednesday that he will not seek re-election in November after 35 years in Congress, is chairman of the Senate Banking Committee. As chair, Dodd is in position to rewrite the rules for Wall Street in the wake of the most debilitating financial crisis since the Great Depression. The U.S. House passed its own sweeping financial package last month with the consumer agency as the centerpiece.

There are two schools of thought on how Dodd’s planned departure will impact legislation. Financial industry insiders surmise that Dodd, short on political capital, will run out the clock on his last year in office or look for a quick bipartisan compromise. On the other hand, consumer advocates believe that Dodd, now free from the constraints of fundraising and campaigning, will want to burnish a legacy as the man who set the bankers straight.

In a press conference Wednesday, Dodd did not directly address the future of his reform package. But amidst staunch Republican opposition, some aspects of his broad effort, such as the proposed consumer agency, have seemed endangered for weeks. The new independent body would regulate financial products such as mortgages and credit cards.

Days after the House approved a consumer agency, Dodd’s counterpart in the House, Rep. Barney Frank, expressed concern that the provision would not survive the Senate.

“The one [provision] that I am most worried about is the consumer agency,” Frank said in an interview with the Huffington Post Investigative Fund last month. “We have been talking to Senator Dodd,” Frank said, “but I am worried that he’s not going to be able to get Republican support or 60 Democrats for a vigorous consumer agency.”

Frank should know. He spent much of last year fighting Republicans, pro-business Democrats and industry lobbyists over the agency. (The Chamber of Commerce remains the fiercest opponent of the agency and has vowed to turn up the heat in the Senate battle.) Ultimately, no Republicans supported Frank’s plan even though it exempted some key sources of consumer loans--auto dealers, smaller banks and student lenders — from the agency’s oversight.

When Dodd first formally proposed the consumer agency in an 1,136-page draft bill last fall, the banking committee’s ranking Republican, Richard Shelby, lambasted the idea.

“An agency that requires financial firms to provide products to consumers repeats the same dangerous practices that led to unqualified consumers receiving mortgages they couldn’t afford,” Shelby said at a Nov. 19 committee hearing. The Alabama Republican added that he would be opposing Dodd’s bill, which he said needed a “complete rewrite.”

But on Dec. 23, in the spirit of the season, Dodd and Shelby released a joint statement saying they had made "meaningful progress" toward resolving their differences. A compromise, they said, might be reached by the end of January.

The sooner the better, reform advocates believe. If the Senate fails to pass a bill this year, Sen. Tim Johnson, a business-friendly Democrat from South Dakota would replace Dodd at the helm of the banking committee. Johnson was the only Senate Democrat last year to oppose new regulations of the credit card industry, which is largely headquartered in his state.

Whatever the end result, Frank said in a statement Wednesday that he anticipated Dodd would push ahead with the challenging political battle. “I will miss his leadership in future Congresses, but I do look forward to working closely with him for the rest of this year on finishing the job of significant financial regulatory reform, to which he is committed, and to which he has already worked to advance," Frank said.

How Wall Street can still win

2011-10-13T11:10:20-04:00

As the battle over Wall Street reform shifts venues — from Capitol Hill to federal agencies — industry lobbyists who oppose some new regulations outnumber consumer advocates 50 to 1, an analysis of lobbying disclosure data shows.

Although Congress passed and President Obama signed the Wall Street Reform and Consumer Protection Act last month, Congress did not iron out many of the law’s details. Lawmakers instead left that task up to regulators such as the Securities and Exchange Commission, FDIC and Federal Reserve.

Over the next two years, the regulators must conduct more than 60 studies and write some 250 rules. This process is well suited to seasoned industry lawyers and lobbyists who are skilled at analyzing the nitty gritty of proposed regulations.

Even before the battle moved to the regulatory agencies, “the corporate onslaught was breathtaking,” said Heather Booth, a top lobbyist for a coalition of consumer groups pushing for new restrictions on Wall Street.

Since 2009, more than 3,000 lobbyists for banks, Wall Street trade groups and financial firms have lobbied Congress and the regulators about financial reform, according to Senate lobbying data assembled by the Center for Public Integrity, a nonpartisan journalism organization.

Consumer advocates are largely limited to Booth’s coalition, Americans for Financial Reform, which tapped about 60 lobbyists from consumer groups such as the Center for Responsible Lending, Consumer Federation of America and major labor unions.

The U.S. Chamber of Commerce alone has 85 lobbyists fighting various aspects of financial reform.

Trade groups and law firms specializing in financial services are still hiring, lobbyists told the Huffington Post Investigative Fund. This year, megabank Goldman Sachs added a member to its team of persuaders, bringing the total to 45, some of whom once worked on Capitol Hill or at the SEC.

At first, lobbyists for Booth’s consumer coalition were less schooled or connected. The “rag-tag band,” as Booth called them, met every Friday for a year to learn about such arcane topics as derivatives. They had a budget of $1.4 million, a tiny fraction of what the industry so far has spent on lobbying.

Yet in the limelight of Capitol Hill, Booth was able to press her case with lawmakers over several months and eventually won key victories in the financial reform law, including the creation of an independent consumer financial protection bureau.

Her team faces greater challenges in the little-noticed labyrinth of the federal bureaucracy.The financial industry’s lopsided advantage is more pronounced there because federal bureaucrats rely on data, research and elaborate reports that typically only well-funded groups produce.

Once regulators propose a new rule lobbyists and lawyers spend weeks crafting response letters, which routinely exceed 30 pages.

Whereas in congressional lobbying, "you have a minute or 30 seconds to make your case, with the regulatory process you have pages and pages,” said Scott Talbott, a senior vice president and top lobbyist for the Financial Services Roundtable, a trade group that represents some of the nation’s largest financial services companies. “The lawyers are enjoying this; it sounds sort of morbid but this is a lot of work for the lawyers.”

Booth isn't slowing down either. Her team is meeting with Obama administration officials this week to discuss the next steps for financial reform.

Still, some policy experts worry that the industry’s competitive advantage drowns out consumers’ viewpoints.

Take, for instance, recent rules that international bank regulators proposed to address a main cause of the financial crisis — a banking industry that didn’t set aside enough for a rainy day. During a four-month comment period, the Basel Committee on Banking Supervision received 273 letters on its proposal to increase capital requirements for banks. Most all comments came from an array of industry groups and banks, while only 27 came from consumers.

“The industry reps are highly organized and well funded,” said Gary J. Edles, a former senior official at regulatory agencies overseeing aviation, the courts and the nuclear industry.

“If my mother-in-law has a serious problem over something, it’s kind of tough for her to marshal all the data to demonstrate that this is a nationwide problem,” said Edles, now a professor of administrative law at American University. “It is far less difficult if the Chamber of Commerce of the United States thinks it is a big problem.”

How Wall Street can still win

2011-10-13T11:10:20-04:00

As the battle over Wall Street reform shifts venues — from Capitol Hill to federal agencies — industry lobbyists fighting a regulatory overhaul outnumber consumer advocates 50 to 1, an analysis of lobbying disclosure data shows.

Many Americans are familiar with the notion that Congress passed and President Obama signed the Wall Street Reform and Consumer Protection Act last month. But Congress did not iron out many of the law's details. Lawmakers instead left that task up to regulators such as the Securities and Exchange Commission, FDIC and Federal Reserve.

Over the next two years, the regulators must conduct more than 60 studies and write some 250 rules. This process is well suited to seasoned industry lawyers and lobbyists who are skilled at analyzing the nitty gritty of proposed regulations.

Details of deals between banks and colleges spur reaction

BANK OF AMERICA CORPORATION — 2011-10-13T10:53:12-04:00

For nearly two decades, Princeton University has been able to count on Donna Riley — and her money.

Every year since she graduated, Riley has donated to her school’s annual alumni fundraising drive.

“I happen to have a perfect giving record 17 years out from graduation,” she said.

This year, she’s thinking differently. “I told them I won't give again until they stop this practice of making money off of student credit card debt.”

Riley was reacting to a report by the Huffington Post Investigative Fund, which identified some 800 colleges that stand to gain millions of dollars from selling the names and addresses of students and alumni to credit card companies such as Bank of America. The schools, including Princeton, are entitled to receive “royalty” payments that multiply the more students use their cards. Some colleges can receive bonuses when students incur debt.

The story touched a nerve, and readers responded. “It changes my whole image of the institution,” Riley said.

Princeton boosters repeatedly implored her to reconsider. They called her twice and sent at least four e-mails. “The scale of Princeton’s business operations (employer, purchaser, investor, etc.) involves enough complexity that there are almost sure to be practices each of us would like to see changed in some way,” one booster told Riley in an e-mail she shared with the Investigative Fund.

But such pleas failed to sway her. “I am sad to let you know that I cannot give money to Princeton until it terminates its agreement with Bank of America,” she wrote to a fundraising official last month. “I find it unconscionable that Princeton has apparently chosen to try to make money off of my personal information and off of the personal information and debts/credit activities of my fellow Tigers.”

Citizen journalists like Riley have volunteered to carry on our investigation of college credit card deals. We’re hearing from readers willing to track down credit card agreements at their alma maters, and from others who have sent tips or personal stories.

Samuel Franklin volunteered to track down Georgetown University’s contract. “Reading your article today about the substantial kick-backs colleges receive and how they sell my information to credit card companies really set me off,” Franklin said in an e-mail. “I won't ever update my contact information again with any school that turns around and sells it to a third-party, thereby pushing more junk mail to my home and e-mail.”

At least one member of Congress also might renew his attempts to crack down on such practices. “Disclosure of these credit card agreements was a first step,” said Rep. Patrick Murphy, D-Pa., who in 2009 successfully sponsored legislation requiring colleges to disclose agreements with banks. Now he indicated a desire to do more than simply require disclosure so that “strong consumer protections are in place for students and their families.”

Some news outlets, meanwhile, have gone beyond our work as they dig into college credit card contracts we hadn’t obtained. Last month, the Iowa Independent took up our investigation and found that The University of Northern Iowa never amended its agreement with Bank of America to prohibit marketing to students, even though the school told state officials in 2007 that the practice was discontinued. We’ve also received inquires from newspapers across the country that want to investigate whether their local colleges have credit card agreements.

Now we want to build on this initial reaction.

Riley wants other alumni donors to follow her lead. “I think this could be over very quickly if other people withhold giving,” she said.

Although Riley estimates that her checks to Princeton have totaled less than $400 over 17 years, the school relies on small donations from a large volume of alumni.

Other than Riley, the school has not received many complaints from alumni about its credit card contract, a spokeswoman said. “Many alumni appreciate the value that the program brings to the Alumni Association in helping to support alumni activities,” said school spokeswoman Emily Aronson. “We have approximately 84,000 living Princeton alumni, and have received only a few responses from individuals expressing concern.”

The school also posted an online statement about the deal this year. “We know that students’ accounts must be handled with particular care and we hold Bank of America accountable for doing so.” The notice went on to specify, “safeguards,” that Princeton had implemented, including “limits on marketing to students” and “providing credit education materials.”

The notice said that Princeton would remove potential customers from the contact list, if requested.

Princeton boosters also defended the credit card deal to Riley.

They directed Riley to page three of the contract, which says the bank “will not directly market this program to student members.”

Riley noted, however, that the contract also says the bank “may directly market to student members” through the campus store.

The contract, Riley observed, “is contradictory at best.”

The contract also states that Princeton “shall provide” to Bank of America “the initial mailing list, containing at least 4,000 nonduplicate names of student members (who are at least 18 years of age) with corresponding valid postal addresses as soon as possible.”

Yet Princeton boosters told Riley that the school no longer allows credit cards marketing to students.

She’s not buying it.

“Everything they tried to do to reassure me, just didn’t add up,” she said. “Even if they aren’t doing it now, they can do it at anytime.”

Columbia University, the Iowa State University alumni association and Michigan State University all recently amended their credit card contracts to prohibit any marketing to students. They did so within a week of receiving phone and e-mail inquires from the Investigative Fund. School officials said they had been working on the amendments for months.

Princeton’s contract is scheduled to end next March.

Follow-up: Baltimore lawmakers seek overhaul of tax lien sale

Baltimore,Maryland,United States — 2011-10-12T23:57:23-04:00

It’s too late to help Vicki Valentine — the Baltimore woman who lost her family’s mortgage-free home over an unpaid water bill of $362—but city officials are trying to prevent others from suffering the same fate.

The Huffington Post Investigative Fund first told Valentine’s story in May as part of an ongoing examination of tax lien sales nationwide. Counties in Maryland, like many other states, sell investors the right to collect unpaid property taxes and other municipal debts of $250 or more. The law allows lien holders to charge double-digit interest rates and in some cases thousands of dollars in fees. Homeowners must either pay or face foreclosure on their property.

Twelve of 15 Baltimore council members now are backing a resolution that asks state legislators to restrict the sale of liens for debts of less than $750 — triple what’s now allowed under state law. Evicting people over small debts "is simply not in Baltimore's long-term interests," the resolution says.

"It's a terrible thing to lose your home over a water bill — particularly a small water bill. This has been a problem with the tax sale," Councilwoman Belinda Conaway, the measure's chief sponsor, told the Investigative Fund in an interview.

City officials said Valentine’s story, published jointly with The Baltimore Sun, helped spur them to action. She was evicted in February from the west Baltimore home her family had owned for decades after a judge ordered her to pay more than $3,600 in legal fees and other costs—nearly ten times her original debt. Valentine, an unemployed former mental health counselor with four children, admitted she failed to pay the water bill, and later some taxes on the property. But she argued the fees were excessive and she couldn’t afford them.

Valentine told the Investigative Fund that the proposed change in state law would have helped her keep the family home, which she returned to about a decade ago to care for her ailing father who had Alzheimer’s disease. “If it gives someone else a chance that makes me happy,” Valentine said.

Since her eviction, Valentine has been staying with family. She said she had not been able to find a job or an apartment. “I still feel anxious about my situation, but it makes me feel good that my story may prevent others from going through what I have been through,” she said.

The call for action in Baltimore comes about two months after the city held what is believed to be a record tax sale, selling more than 12,000 liens to investors. That's more than twice the number sold in 2006 in the midst of Baltimore's housing bubble, an increase some city officials blamed on the poor economy. About 13 percent of the liens sold in May were for unpaid bills of less than $750, records show.

Lester Davis, a spokesman for Council President Bernard C. "Jack" Young, said he believes the council "will grant serious consideration to Ms. Conaway's bill because of its potential positive impact on Baltimore families."

But a spokesman for Mayor Stephanie Rawlings-Blake said city officials are studying other options, noting that the mayor objects to a plan that would allow homeowners to escape obligations.

"The administration does not support an amnesty for property owners that failed to pay taxes and fees," spokesman Ian Brennan said.

Maryland’s tax sale system has drawn controversy in recent years. The U. S. Justice Department's anti-trust division is investigating bid-rigging by some investors at as many as two dozen of the annual sales in Baltimore and other parts of the state. Three men have pleaded guilty to criminal charges in the probe, including two longtime Baltimore tax-sale investors who made more than $10 million from fees and other costs collected over a six-year period from the owners of more than 6,000 properties.

Yet tax collectors argue that nothing short of threatening foreclosure will compel some people to pay taxes and other municipal bills. Losing that leverage could aggravate budgetary problems in Baltimore and other parts of the state, they argue. That view prevailed in the Maryland General Assembly earlier this year when it failed to pass a bill limiting the sale of liens to under $750 by a single vote.

As student credit card debt rises, banks quietly reward schools

BANK OF AMERICA CORPORATION — 2011-10-12T23:37:50-04:00

A version of this story was published in the San Francisco Chronicle. The story is one in a series of articles on student debt produced by the Investigative Fund.

Some of the nation’s largest and most elite universities stand to gain millions of dollars from selling the names and addresses of students and alumni to credit card companies while granting the companies special access to school events, the Huffington Post Investigative Fund has found.

The schools and their alumni associations are entitled to receive payments that multiply as students use their cards. Some colleges can receive bonuses when students incur debt.

The little-known agreements have enriched schools and some banks at a time when young women and men already are borrowing at record levels, raising questions about whether such collegiate and corporate alliances are in the best interests of students.

“The fact that schools are getting paid for students to rack up debt is a disgrace,” said congressman Patrick Murphy, a Pennsylvania Democrat and former professor at the U.S. Military Academy at West Point. He said that banks’ payments to schools amount to “kickbacks.”

Landmark credit card legislation signed by President Obama one year ago curbed some marketing tactics on campuses but didn’t prohibit the arrangements between colleges and banks, known as “affinity” agreements.

The substance of these deals had been secret. A provision in the law, authored by Murphy, requires their disclosure. But even now, few schools post the contracts online or publicize their existence. Obtaining a copy can take two weeks or more.

Thus it’s unclear how many of the nation’s 2,700 four-year colleges have such agreements, or how many allow credit card companies to target students in addition to graduates. Bank of America, which dominates the market, said it has affinity contracts with some 700 schools and alumni associations, where marketing practices vary. At least 100 schools are believed to have affinity agreements with other financial institutions.

Seventeen contracts obtained by the Investigative Fund from schools and their alumni associations detail the special access granted to banks, such as allowing them to set up booths at football games. All of the agreements call for colleges to provide students’ names, phone numbers and addresses.

For granting such access and information, schools can receive royalty payments based on the number of students opening accounts and the amount they spend, the contracts show.

Most of the schools are entitled to earn more whenever a student carries a balance from year to year.

Some consumer advocates question whether colleges participating in affinity agreements are failing to safeguard the young people in their care.

“Universities should place the welfare of their students as their highest priority and shouldn’t sell them off for profit,” said Ed Mierzwinski, consumer program director for the federation of state Public Interest Research Groups, or PIRG.

Three schools, after being contacted by the Investigative Fund, stopped allowing banks to market to students. Seven other schools and alumni associations, including alumni organizations at Brown University and the University of Michigan, said they have abandoned the practice, even though their contracts appear to require it.

The contracts call for a range of minimum payments by banks. At Brown, Bank of America agreed in 2006 to pay $2.3 million over seven years. At Michigan, the bank in 2003 agreed to pay $25.5 million over 11 years.

The bank says it’s not taking advantage of students; it’s amassing new customers whose loyalties can span a decade or more.

“Our objective in serving the student market is to create the foundation for a long-term banking relationship,” Bank of America spokeswoman Betty Riess said in an e-mail, adding that the bank offers reasonable rates and low credit limits on student cards, and that it primarily solicits graduates and sports fans.

Many schools have renegotiated contracts with the bank to limit marketing to students, she said.

Schools still engaging in the practice defend selling access to students and their contact information. Colleges say the money helps them plug holes in budget shortfalls and shrinking endowments. Some say they use the money to grant more scholarships to students.

Some colleges and alumni organizations also argue that students need to learn fiscal responsibility—and how better to do that than by having a credit card?

The University of Michigan alumni association, facing growing scrutiny from consumer groups, says it reached an agreement with Bank of America to stop marketing to students in early 2008. Jerry Sigler, chief financial officer of the alumni association, said he made the decision begrudgingly.

“Managing credit is as much a part of education and maturation as anything else going on campus," he said. “Credit isn’t bad, it’s a reality.”

The benefits are not always so obvious for students whose families already face soaring tuition costs and hefty loan payments. College seniors graduated in 2008 with average credit card debt of more than $4,100, up from $2,900 four years earlier, according to data compiled by student lending company Sallie Mae.

On their own for the first time, young credit card users can quickly fall behind on payments.

Despite not having a full-time job or much in savings, Lisa Smith easily found her first credit card on campus—from bank marketers stationed outside her freshman dormitory. Once she racked up charges, new card applications poured in from other companies.

By the time she graduated in 2005, she had the average number of credit cards for a college student – four – as well as $15,000 in credit card debt. Now 28, Smith is still paying $500 monthly in credit card bills, some dating back to purchases from her college days.

"I know that I brought it on myself," said Smith, who attended High Point University in North Carolina, which says it now prohibits on-campus marketing. "But I really felt like I was preyed on. I didn’t understand how long it was really going to take to pay them back.”

Students ‘Hugely Important’

On May 22, 2009, President Obama signed sweeping new consumer credit card protections into law. All too often, Obama noted at the time, Americans used credit cards as an anchor rather than a lifeline. Students were no exception.

The Credit Card Accountability, Responsibility and Disclosure Act prohibited banks from using some of their most aggressive marketing practices on students. For instance, banks can no longer require students to apply for a card to receive promotional gifts such as pizza or sweatshirts.

Nor can banks supply credit cards to anyone under age 21—most college underclassmen—unless the customer has a cosigner. The law requires only that the co-signer be over 21. The co-signer needn’t be a parent or guardian.

The law does not prevent credit card companies from paying schools for special access to students.

Chase Card Services, a division of JPMorgan Chase & Co., has a handful of such agreements, but Bank of America dominates. It became the market leader in 2006 when it acquired credit card giant MBNA, a pioneer in affinity agreements that often involved pro sports teams and professional associations.

Soon after the acquisition, Bank of America set its sights on colleges. At a March 2006 conference hosted by Goldman Sachs, Bank of America executive John Cochran described students as “an emerging market that we could really capitalize on,” according to a transcript.

From a bank’s perspective, students represent an important demographic: Not only do many first-time cardholders hunger for credit; they are likely to stay customers for quite some time – up to 15 years, according to a 2005 study by Ohio State University researchers.

“Student credit cards are hugely important to a bank,” said Kerry Policy Groth, who negotiated collegiate affinity agreements as an MBNA account executive from 1998 to 2005. “Your first credit card is usually the one you keep.”

Although Bank of America does not disclose how many student accounts it has or what it earns from student credit cards, Cochran, at the 2006 conference, characterized the collegiate affinity market – students, faculty, alumni and sports fans – as “an over $6 billion portfolio.” The portfolio may have declined in recent months as the bank’s entire credit card business has suffered from rising default rates.

Bank of America spokeswoman Riess emphasized that the bank primarily targets alumni and fans as prospective customers, with students accounting for about 2 percent of all open collegiate accounts – likely representing thousands of young consumers.

‘Students as Commodities’

Affinity agreements vary from school to school.

The University of Pennsylvania’s agreement with Bank of America required the school to compile an initial list of 233,000 potential customers, including students, alumni, faculty and staff, to offer the bank. If requested, the school removes potential customers from the contact list.

When Princeton University signed its affinity agreement with Bank of America in 2004, it agreed to provide the names of at least 4,000 students and 75,000 graduates.

After a bank obtains the information, it can send an agreed-upon number of solicitation letters and e-mails. A 2008 PIRG survey of more than 1,500 undergraduate students found that about 80 percent received mailings from credit card companies.

Some affinity agreements also permit banks to advertise at school sporting events. Banks often have booths at football and basketball games where students 21 or older, alumni and fans can sign up for a card.

Colleges and alumni associations are entitled to rewards for providing special access and information. Bank of America typically pays schools $1 for each student who opens a credit card account and keeps it open for 90 days, according to contracts reviewed by the Investigative Fund.

Some schools also can earn more as students rack up charges—and debt. The University of Oklahoma, among other schools, is entitled to receive 0.4 percent of all retail purchases made with student cards. Most of the 17 contracts obtained by the Investigative Fund entitle schools to extra compensation—up to $3 a card--when students carry a balance from year to year.

“Essentially, contracts with credit card companies are using students as commodities to earn revenue for the universities from companies who don’t necessarily have the students’ best interest in mind,” said PIRG’s Mierzwinski.

As part of many agreements, banks also pay for rights to use school trademarks –mascots, logos and emblems – on their advertisements.

Banks often brand their cards with the familiar images. This marketing tool, known as co-branding, has its critics. Irene Leech, associate professor of consumer studies at Virginia Tech, said the practice leads some to believe that universities have negotiated favorable credit card rates for their students.

"Alumni and students both think that it’s the best deal out there that [the school] could get for me," an assumption that is not always correct, she said.

Nor do students necessarily get the lowest rates. At Princeton, alumni cards carry an annual percentage rate of 11.9 percent, compared to 14.9 percent for student cards, according to the school’s seven-year affinity agreement, signed in 2004. Rates may have changed since then.

Bank of America currently charges a 14.24 annual percentage rate on its Student Visa Platinum Card, the primary product it markets to students. Students are not locked in; the rate varies depending on the market’s prime rate. The bank said it doesn’t increase rates on students for reasons such as falling behind on their payments. Nor does it impose an annual fee.

“We take a conservative approach to lending to young adults,” Bank of America’s Riess said, noting that the bank limits a student’s exposure to debt. The bank offers credit lines for students that “typically” start at $500 and are capped at $2,500, she said.

The bank, Riess said, also seeks to educate students. “We also provide a number of tools to help young adults better manage their finances,” she added, including free identity theft protection, a student financial handbook and an online educational brochure about building good credit, called “The Essentials.”

“Building a future customer—that was really the goal” of affinity agreements, said former MBNA executive Groth. “You’re not out to gouge them; you want a positive experience.”

Shifting Practices

This spring, Columbia University, the Iowa State University alumni association and Michigan State University all amended their affinity agreements to prohibit any marketing to students. They did so within a week of receiving phone and e-mail inquires from the Investigative Fund. School officials said they had been working on the amendments for months.

The Investigative Fund requested Columbia’s contract on March 22. Columbia officials signed the school’s amended agreement two days later. The timing was “mostly coincidental,” according to Michael Griffin, executive director of Columbia's alumni association. He said that the school had never allowed marketing directly to students.

Seven other schools contacted by the Investigative Fund said they no longer allow marketing to students, even though their affinity contracts would appear to obligate them to. School officials said they had no documentation backing up their assertions.

“A lot of schools have student access in their agreements” – but don’t necessarily allow it anymore, said Peter Osborne, who managed the collegiate credit card business at Bank of America through 2008. Schools sometimes informally “just request that marketing stop rather than reopening their entire contract.”

For instance, according to an affinity agreement between the University of Texas alumni association and Bank of America, the association is expected to provide the bank with students' names and addresses. But the alumni association says it has abandoned that practice.

“We are not marketing to students at this time and we haven't for some time,” said Bill McCausland, chief operating officer for Texas Exes, the ex-students' association. “Whether the contract allows us to or not, we are not doing so."

He acknowledged that students could still sign up for credit cards without the school’s involvement. Bank of America, he said, is “still marketing our card and they are doing a very good job of it."

At Harvard, the alumni association is supposed to provide a subsidiary of Barclays PLC with “as complete a list as possible of all Harvard alumni and students,” according to the association’s affinity contract. But Harvard spokesman Kevin Galvin said the card was never marketed to students. “We view this card as a service to alumni,” he said.

Other schools acknowledged to the Investigative Fund that they release students’ contact information. These schools staunchly defend their affinity agreements as important sources of revenue. And some royalties benefit students, according to school and bank officials.

“The revenues from this go to vital services that otherwise might not be free and otherwise might not be offered,” said Osborne, the former bank official who now advises universities as they negotiate affinity agreements. Osborne said the revenues “support alumni programs, student scholarships and preserve jobs within alumni associations.”

Some of the royalties from Penn's contract go to scholarships and helped pay for the development of Campus Express, an online system where students can order textbooks and manage their dining plans, according to university spokesman Ron Ozio.

Princeton uses its profits "to support alumni activities," school spokeswoman Emily Aronson wrote in an e-mail.

Catherine Bishop, vice president of public affairs at the University of Oklahoma, said affinity agreements are beneficial because they limit the amount of marketing that goes on. "The contract that we have in place,” she said, “is designed to keep multiple companies from soliciting on campus.”

This story was reported in partnership with the Stabile Center for Investigative Journalism at Columbia University. Protess is a staff reporter with the Investigative Fund. Neumann graduated from the Stabile program in May. Amanda Zamora, Lauryn Smith, Joseph Frye and Michael Ono also contributed to this story.

The other foreclosure menace

Baltimore,Maryland,United States — 2013-01-18T12:11:45-05:00

A version of this story appeared in The Baltimore Sun.

One raw day in early February, Vicki Valentine stood by helplessly as real estate investors snatched her West Baltimore home over what began with an unpaid city water bill of $362.

As snow threatened to fall, she watched a work crew hired by the new owners punch out the lock on her front door. A sheriff’s deputy was on the scene while Valentine and her teenage son piled whatever they could into a borrowed car.

Running out of time, Valentine scrambled topack up clothing and mementos. The home had been her family’s for nearly three decades, and her father had paid off the mortgage in 1984. “It’s hard to say goodbye to this house,” she said. “It’s like someone forcing you out of something that belongs to you. I don’t get it.”

Valentine lost the two-story brick row home after the city sold her debt to investors through a contentious and byzantine legal process called a “tax sale.” This little-known type of foreclosure can enrich investors as growing numbers of property owners struggle to pay their bills.

These foreclosed homeowners are not the families making headlines for taking on mortgages they could ill afford. Families ensnared in the tax sale sometimes are unable to overcome relatively small debts owed to local tax collectors.

Rather than collect the overdue money they are owed, many local governments are selling tax liens. Buyers range from behemoths such as JPMorgan Chase & Co, and some regional banks and law firms, to small-fry investors lured by late-night television commercials promising quick riches. Investors generally bid in an auction for the right to collect delinquent taxes and other municipal debts on property owners, sometimes by paying only a few hundred dollars. When owners can’t pay, investors can pick up property at bargain prices.

It can be a good deal for everyone except the property owner. Selling the debts to investors can help governments efficiently ease budget woes without having the added expenses of debt collection, foreclosing and being a landlord.

Investors, meanwhile, can rake in hefty profits. That’s because they can tack on fees and steep interest rates, which can amount to 18 percent annually in Baltimore.

In Valentine’s case, legal fees and other charges climbed past $3,600 — nearly 10 times her original bill.

Investors purchased an estimated $30 billion of real estate tax debt held by governments across the country in 2009, double the amount a year earlier, according to the Florida-based National Tax Lien Association. Altogether, 29 states and the District of Columbia can sell tax lien debt to investors.

Lien sales in Baltimore have nearly doubled since the housing bubble of 2006. On Monday, the city sold 12,689 liens — a probable record. Properties ranged from boarded-up shells and vacant lots to row homes in gentrified neighborhoods and some commercial buildings.

City records show that one in five of these liens on properties is for unpaid taxes or other municipal bills amounting to $1,000 or less. If Baltimore’s 2009 tax sale is any indication, hundreds will stem from delinquent water bills; there were 666 such liens last year.

Although the brisk tax lien trade thrives beneath the radar, largely unnoticed, it has occasionally drawn scrutiny from law enforcement authorities.

Some of Maryland’s most prominent tax sale investors have been swept up in a criminal investigation into bid rigging at the sales. Federal prosecutors allege that those investors agreed in advance which properties to bid at some auctions, improperly reducing the money earned bymunicipalities.

So far, Justice Department prosecutors have secured three convictions in the ongoing investigation. At a May 4 sentencing hearing for two of the defendants, a witness for the government was lawyer John Reiff, part-owner of the company that currently owns Valentine’s lien. He was not charged in the case.

Investing in liens can be risky, with profit on a particular property anything but certain. Investors generally compensate for such uncertainty by buying in large volumes, sometimes at a clip of thousands of liens each year.

Two of the investors who pleaded guilty in the bid rigging case made at least $10 million from fees and other costs collected from owners of some 6,000 property liens they bought over six years, according to federal prosecutors.

Prosecutors said in court filings they suspect bid-rigging occurs in other areas of the country. A JPMorgan subsidiary called Xspand and at least two other companies received grand jury subpoenas last year as part of a Justice Department anti-trust investigation in New Jersey, according to Bloomberg.

‘Unintended Consequences’

Some state lawmakers have questioned the fairness of the tax sale foreclosure process, which often sticks homeowners with thousands of dollars in legal fees and other costs. But cities and counties in Maryland earlier this year fended off an effort to keep water bills out of the tax sale, arguing that without the threat of losing homes many people would fail to pay their bills.

Revenue collectors defend their tax sales as a necessary, if sometimes distasteful, means for feeding the public treasury. In aging cities such as Baltimore, there’s also hope that new owners will rehab decaying or abandoned properties, restoring them to the tax rolls.

Investors say they aren’t the bad guys — they’re providing a service that helps plug holes in municipal budgets. Homeowners should face consequences for failing to pay their bills, they argue, noting that people faced with losing property have many opportunities to redeem it. The mounting fees, they say, reflect the costs involved in navigating complex legal requirements, tracking down property owners and taking them to court to enforce the liens. In Valentine’s case, they noted, a judge approved the fees.

“We are essentially the city’s bill collector,” said lawyer and tax lien investor Reiff.

Critics of tax sales question the morality of government tax collectors acting to enrich private investors at the expense of property owners with low incomes or facing hard times. They ask whether it's the best way to compel people to honor their debts — especially involving relatively paltry public utility bills.

After all, when water bills go unpaid, some cities and counties simply shut off service. In Baltimore, officials often leave it on. Another alternative would be to have private collection agencies track down debtors.

“This is a case where good intentions have led to severe unintended consequences,” said Debra Gardner, of the Public Justice Center in Baltimore, a non-profit advocacy group for minorities and the poor.

Asked about Valentine’s story, David Vladeck, director the Federal Trade Commission's Bureau of Consumer Protection in Washington, said it was “just horrifying to me."

While noting that his comments did not reflect agency policy, Vladeck said he believed more recession-wracked homeowners across the country could face a similar plight. “It’s beyond tragic that this poor woman lost her home.”

Pleas – and More Fees

Valentine was incredulous when the price to keep her property shot past $3,600. Jobless and lacking the savings to pay, she said she could do little to stave off the day of reckoning.

That day arrived on February 3, when a Baltimore City Sheriff’s Department deputy served her with a court-issued “writ of possession” stripping her claim to the home.

Valentine, a former mental health counselor and rehab specialist with four children, said she moved back to her childhood home about a decade ago to care for her ailing father, Charles L. Turner. A retired brewery worker, he had Alzheimer’s disease.

As his condition worsened, he tended to hide bills from the family. (City records confirm that Turner often fell behind in meeting his obligations during the final years of his life and nearly wound up in the tax sale as early as 2000 over unpaid water bills and property taxes.)

When her father died in 2003, Valentine took over the home and stayed there with her son, Dimitrian, now 17. She said she fell into a serious depression in the wake of her father’s deteriorating health and death, and was unable to work or pay her bills on time. She has worked only sporadically since his death. Though she made partial payments on the water and sewer account in 2006, she acknowledges her failure to pay a bill of $462.28 in full. She went down to city hall and paid $100, but never took care of the balance.

When the deadline passed for paying up, the city added 2005-2006 property taxes of $287.92, interest and city tax-sale processing charges. That brought the total she owed to $710.57, according to city records.

The City of Baltimore washed its hands of Valentine’s debt in May 2006 when it sold the lien to Sunrise Atlantic LLC, an arm of the BankAtlantic in Fort Lauderdale. The Florida bank has bid on tax liens in a range of states, from Florida to Illinois, though it has largely sold off its Maryland lien portfolio and is not implicated in the bid-rigging case. BankAtlantic did not return phone calls seeking comment.

Unlike mortgage foreclosures initiated by banks, there’s no appealing a tax sale debt once it is sold off; a property owner has no option other than to abide by the investors’ terms and pay the fees. The lien holders also have little incentive to be flexible about repayment terms.

Maryland law gives property owners six months to redeem a tax lien with only minimal added costs. But if they don’t pay by then, lien holders can sue to seize the property and stick the homeowner with a slew of fees, including legal bills incurred in taking the matter to court. Sunrise Atlantic filed such a case on Valentine’s home in Baltimore City Circuit Court in December 2006, records show.

More than a year later, the court awarded the property to Sunrise Atlantic.

At that point, Valentine sent a handwritten letter to the court, begging for mercy and more time to repay.

In the letter, dated Feb. 9, 2008, Valentine described being unable to work because of depression and other problems. “For now, this is the roof over my son and my head. I am trying to get the money together to catch up on my delinquent bills.” She added: “Please allow more time to pay all bills connected with the foreclosure of said property.”

But the longer she waited and the more she protested, the more legal fees and other charges she incurred.

In 2008, Baltimore attorney Anthony De Laurentis, who represented Sunrise Atlantic, submitted itemized charges to the court: $305.91 in interest on the lien; a $1,500 bill for responding to Valentine’s requests to cut the fees and other legal work; more than $1,000 in assorted expenses, including $325 for a title search of the property and $79 for photocopies, according to court records.

The price list passed muster with a judge, who on Sept. 19, 2008 ordered that Valentine pay $3,603.41 – or forfeit her property.

She asked for another hearing, which delayed the process for more than a year.

While the case dragged on, the Florida bank started divesting its tax lien certificates from Maryland, eventually transferring the lien on Valentine’s home to a firm called Montego Bay Properties. Part of the firm is owned by a trust set up to benefit members of the family of lawyer De Laurentis. Reiff, one of De Laurentis’ law partners, also owns part of the firm.

In an interview in their Baltimore office, De Laurentis and Reiff said 90 percent or more of property owners eventually pay whatever is necessary to keep their homes.

They said most of the properties they take over are vacant and thus nobody is displaced. They also said they had repeatedly tried to settle the matter with Valentine and showed Investigative Fund reporters a thick file of court papers and other records as well as notes of more than a dozen contacts with her to make arrangements to clear the debt.

“We bent over backwards for her,” Reiff said, adding that his staff had tried for more than two years to “work something out” to no avail.

Feds Say Bids Rigged

Though Valentine had no way of knowing it, some investors rigged the 2006 Baltimore tax sale auction that led to her eviction, federal prosecutors alleged in court.

The roots of that conspiracy run deep, prosecutors said. For years, a handful of Baltimore real estate lawyers and their investment partners quietly dominated Maryland tax sale auctions, with few questions asked about their bidding tactics or collection policies.

That changed after The Baltimore Sun used city records and court filings to report in March 2007 that hundreds of mainly low-income city residents had been kicked out of their homes over small unpaid bills, ranging from water and sewer charges to minor environmental citations. Some people were driven from family property because they couldn’t afford to pay thousands of dollars demanded by lien holders.

The Baltimore newspaper also documented for the first time that while dozens of parties bid in Baltimore tax auctions in 2006 and 2007, just three investment groups had won about two-thirds of the liens.

Prosecutors went on to charge three men with conspiring to rig bids at 21 auctions in Baltimore and four other jurisdictions, including Montgomery and Prince George’s counties in the suburbs of Washington D.C. between 2002 and 2007. All three have since pleaded guilty. No other charges have been filed.

Another investment group involved in the conspiracy was DRT Fund, according to court filings by federal prosecutors. DRT is owned in part by De Laurentis and Reiff. DRT participated in a dozen of the 21 fixed auctions, though not the Baltimore City auction in 2006 in which Valentine’s lien was sold, according to court filings.

The Justice Department filed no charges against DRT, which came forward in the fall of 2007 and “fully and truthfully reported their own wrongdoing and that of their co-conspirators and terminated their part in the conspiracy,” prosecutors wrote in court papers filed last month.

DRT went on to sign an amnesty agreement with the Justice Department that commits it to “pay restitution to any person or entity injured as a result of the bid-rigging activity being reported in which it was a participant,” court records state.

Neither De Laurentis nor Reiff would discuss DRT’s settlement with the Justice Department.

Water Bill Woes

Some lawmakers have tried for years, with modest success, to rein in the tax-sale fees that can steamroll low-income homeowners. Maryland legislators passed a bill in 2008 that raised the minimum lien sold from $100 to $250. But a bill to prohibit cities and counties from selling delinquent water bills to investors failed in the state Senate earlier this year by a single vote.

Legislators also rejected a bill that would have prevented the sale of any lien of less than $750, as happens in some other locales outside of the state.

Both bills failed, lawmakers said, largely due to fierce opposition from tax collectors and officials in Baltimore, which conducts the largest tax sale in the state.

Andrea Mansfield, of the Maryland Association of Counties, testified that the tax sale process provides “a much-needed device to ensure that property owners remit payment for their fair share of taxes and charges connected to public services.”

Eliminating water bills from the tax sales would result in more “deficient accounts,” and lead to “increased rates on citizens who properly pay,” she wrote.

Sen. James Brochin, a Democrat from Baltimore County who co-sponsored the legislation that would have banned the sale of delinquent water bills to investors, vehemently disagrees. “It's just disgusting. It's highway robbery. It's dead wrong. It's immoral," he said.

While city officials publicly defend the practice, he said, in reality “they're humiliated and embarrassed by it. Deep down they know how immoral it is."

Baltimore’s mayor, Stephanie Rawlings-Blake, declined requests for an interview on the topic with the Investigative Fund.

City officials were more talkative earlier this year when they sought to block lawmakers from banning the sale of water bill liens. Mary Pat Fannon, a lobbyist for the mayor’s office, said in prepared testimony for a February 5 hearing that the city had begun offering repayment plans for water bills to help homeowners avoid tax sale.

She said that the 666 water bill liens sold by Baltimore City in 2009 was way down from the 1,129 sold to investors the previous year and credited the repayment plans for the reduction.

And she went further, testifying that nobody had lost a home due to an unpaid water bill from either sale in 2008 or 2009. What Fannon neglected to mention: Because of the lengthy transfer process in the courts, it was too early for those groups of property owners to begin losing their homes. Most tax sale lawsuits have taken longer than two years to resolve through the courts.

Fannon also said that without the tax sale, the city would need to file debt collection lawsuits against each delinquent property owner, which she said “would be very expensive, time consuming and flood the courts.”

Two days before Fannon’s testimony at the state capital, Valentine stood watching as her belongings piled up on the sidewalk in Baltimore.

A Neighborhood’s Decline

More than three years after Valentine’s small debt drew her into the tax sale, neither the city nor the investors seem to have won much.

The property is unlikely to be fixed up any time soon. Instead, it adds to a sense of decay that permeates some parts of urban Baltimore. On Valentine’s old block in the Sandtown neighborhood, all but a handful of houses, abandoned long ago, are boarded up.

Such decline has summoned other ills. “Drugs moved in and replaced the good with the bad,” said Valentine, who is living temporarily with her mother. Many of her possessions are in storage.

De Laurentis and Reiff now hold a “writ of possession” for a property that’s in need of substantial repair. Though the home is assessed at $46,000, in such dilapidated condition the investors said they probably would have trouble selling it for more than $16,000.

In addition, investors could be on the hook for a $7,000 water bill of their own. Just how that happened is unclear; there may have been an undetected leak in Valentine’s home. Last month, the city finally turned off the water.

If the investors take the final step to secure a deed to the property, they would have to pay the city roughly $6,300, which the city is then supposed to turn over to Valentine. The law entitles original property owners to receive at least some compensation.

De Laurentis and Reiff say they’re still willing to work with Valentine to resolve the matter. Reiff said he gave her a key to the new lock so she could have more time to remove her belongings as a good faith gesture.

“We'll definitely work something out with her,” Reiff said.

Yielding to Wall Street, raters 'drink the Kool-Aid'

2011-10-12T22:50:58-04:00

In the lead up to the financial meltdown, Wall Street firms routinely exerted influence on the nation’s largest credit rating companies — which judge the quality and safety of bonds — and the companies often surrendered to the pressure, a Senate panel has found.

The rating companies, Standard & Poor’s and Moody’s, regularly awarded generous grades to thousands of mortgage-related investments that later collapsed and precipitated the financial crisis. Investors rely on the raters’ assessments in deciding what to buy and sell.

But an examination, conducted by the Senate's Permanent Subcommittee on Investigations, uncovered internal e-mails and documents that describe the raters as “beholden” to investment banks — firms the raters referred to as their “clients.”

In an October 2007 e-mail, Moody’s chief risk officer warned the company’s chief executive, Raymond McDaniel, that Moody’s employees are “continually 'pitched' by bankers,” a process that can “color credit judgment, sometimes improving it, other times degrading it (we 'drink the Kool-Aid').” The risk officer said such influence “does constitute a 'risk' to ratings quality."

The subcommittee on Thursday released this e-mail and excerpts from some 500 other documents collected during its probe of the rating companies. In response, Moody’s spokesman Michael Adler said the company has "rigorous and transparent methodologies." S&P spokesman Chris Atkins said the company has "learned some important lessons from the recent crisis" and made "significant enhancements to increase the transparency, governance, and quality of our ratings." In the past, the raters have said their critics are wrong to characterize ordinary discussions about a rating as any kind of collusion.

The subcommittee found that both companies eased their standards as they battled for control over the credit rating business. The raters, internal e-mails suggest, knew that some mortgage investments were flawed but gave them good grades anyway.

"I'm not surprised; there has been rampant appraisal and underwriting fraud in the [mortgage] industry for quite some time as pressure has mounted to feed the origination machine," an S&P managing director wrote in a 2006 e-mail.

That year was crucial for the raters. Between 2006 and 2007, S&P and Moody’s each rated 10,000 mortgage securities, according to the subcommitee. Their revenues soared, peaking in 2007 at nearly $3 billion. But the raters later had to downgrade 90 percent of the risky mortgage securities they awarded top ratings to between 2004 and 2007, according to an analysis by BlackRock Solutions provided by the subcommittee.

Such downgrades have been blamed for triggering the financial meltdown.

“I don’t think either of these companies have served their shareholders or the country well,” said Sen. Carl Levin (D-MI), chairman of the subcommittee. “They were excessively influenced by investment bankers.”

The Huffington Post Investigative Fund reported last year that rating analysts worked closely with financial institutions as they created mortgage investments. Banks often structured the financial products and then sold them to pension funds and other investors.

In the most recent lawsuit filed against the raters, Ohio’s Attorney General Richard Cordray accused the companies of being “intimately involved in structuring” investments that caused retirement funds for police officers, firefighters and teachers to lose $457 million.

Internal e-mails of Moody's and S&P, released by the subcommittee, provide a window into Wall Street’s influence over the raters, said Levin.

S&P's residential mortgage rating group has “become so beholden to their top issuers [investment banks] for revenue they have all developed a kind of Stockholm Syndrome,” an S&P employee wrote in 2006.

A June 2007 e-mail exchange between a Moody’s analyst and an investment banker highlights how fees seeped into rating discussions. The analyst told the banker that a particular rating likely could not be finalized until the “fee issue” was resolved.

The banker, who worked for Merrill Lynch, responded: “We are agreeing to this under the assumption that this will not be a precedent for any future deals and that you will work with us further on this transaction to try to get to some middle ground with respect to the ratings.”

According to an e-mail Moody's provided to the Investigative Fund late Thursday, there was more to the conversation. The Moody's analyst replied to the Merrill Lynch banker later that day: "We will certainly continue working with you on this transaction, but analytical discussions/outcomes should be independent of any fee discussions."

Levin, however, said that competitive pressures affected the ratings process.

In a 2004 e-mail, an S&P employee discussed “adjusting” rating procedures “because of the ongoing threat of losing deals.”

Anxieties over losing deals surfaced in another instance.

"We just lost a huge [mortgage deal] to Moody's due to a huge difference in the required credit support level,” an S&P employee said in another 2004 e-mail. “There's no way we can get back on this one but we need to address this now in preparation for the future deals."

S&P’s concerns cost them precious time, according to an e-mail released by the subcommittee.

A new version of the S&P ratings model, “could've been released months ago and resources assigned elsewhere if we didn't have to massage the sub-prime and Alt-A numbers to preserve market share,” an S&P employee wrote in 2005.

Some rating company employees appear to have objected to the changes.

In a 2005 e-mail, one employee wrote: "Screwing with [the model's] criteria to 'get the deal' is putting the entire S&P franchise at risk — it's a bad idea."

Even with U.S. oversight, AIG keeps secrets

American International Group, Inc. — 2011-10-12T22:29:50-04:00

After taxpayers rescued American International Group from the brink of collapse, the U.S. government moved to protect its investment by appointing directors and special trustees to oversee the company.

Now the government’s appointees, all hailing from Wall Street or the Federal Reserve, are allowing AIG to withhold key records generated during the company's decline. The documents could decode the murky circumstances leading to the second largest bailout of the financial crisis.

The Huffington Post Investigative Fund has learned, in the course of inquiring into oversight of AIG, that the government’s six appointed directors and trustees are resisting calls for AIG to release its internal documents and e-mails from that time.

Those calls have come from several congressmen and former financial prosecutors. They argue the documents could show how executive decisions contributed to AIG’s downfall, which prompted a $182 billion government commitment.

The government, meanwhile, is keeping its own secrets: Despite repeated requests, the Treasury Department hasn’t divulged the criteria it used to select directors of AIG’s board. Nor has Treasury disclosed how much the directors will be paid.

But former New York Gov. Eliot Spitzer, who prosecuted Wall Street fraud during his earlier role as the state's attorney general, speculated that the internal documents could only help the government determine whether AIG committed fraud in the run-up to its bailout. In any examination of corporate behavior, e-mail and internal documents are “the holy grail,” Spitzer told the Investigative Fund. Such records, Spitzer noted, have been pivotal in making cases against executives of corporations such as Enron.

Responsibility for releasing the documents, Spitzer said, falls on AIG’s directors and trustees. AIG has 13 directors, two of whom the Treasury Department appointed this month. Separately, the Federal Reserve Bank of New York appointed three trustees when it created the AIG Credit Facility Trust to oversee taxpayers’ investment in the company.

Congress also could take action. Earlier this year, Rep. Steve Israel (D-N.Y.) introduced legislation that would force AIG to release its e-mails, a move that would “get to the bottom of the AIG collapse,” he said.

Ties to Wall Street

The rise and fall of AIG can be traced to credit default swaps – insurance products the company sold to banks that had large stakes in mortgage investments. When those investments collapsed in the mortgage meltdown, AIG’s insurance policies kicked in. The company, which owed billions to Goldman Sachs and others, lost $110 billion between 2008 and 2009. Taxpayers likely won’t recover their bailout billions for some time.

That hasn’t stopped AIG from rewarding senior managers. An April 12 regulatory filing shows the company approved 2009 compensation packages worth about $30 million for its top five executives. In February, AIG received congressional scrutiny for deciding to pay employees some $100 million in bonuses.

Still, AIG has repeatedly failed to pay the government scheduled dividends on taxpayer-owned stock. As a result, the Treasury Department this month exercised its authority to appoint two directors to AIG’s board. The department, led by Treasury Secretary Timothy Geithner, chose Wall Street veterans Donald H. Layton and Ronald A. Rittenmeyer.

For several years while Geithner was chairman of the Federal Reserve Bank of New York, Layton was a member of the bank’s international markets advisory committee. The New York Fed is AIG’s main regulator.

Layton, a former chairman and chief executive of E* Trade Financial, spent 29 years at JPMorgan Chase & Co., where he most recently was vice chairman.

Treasury touted Layton's executive experience when announcing his appointment in a press release on April 1.

Treasury's announcement did not mention that Layton also worked for a financial industry lobbying powerhouse, the Securities Industry and Financial Markets Association, or SIFMA. The association is one of several trade groups rallying against key elements of President Obama’s effort to crack down on Wall Street. From 2006 to 2008, Layton was a SIFMA senior advisor, according to published reports.

Rittenmeyer, Treasury’s other pick for the board, was the chairman, president and chief executive of Electronic Data Systems, which was bought by Hewlett-Packard in 2008. He also was managing director of the Cypress Group, a private equity firm in New York. Rittenmeyer has served on the board of the national Chamber of Commerce, another industry lobbying group working to derail Wall Street reform.

Layton and Rittenmeyer will be paid for serving on the board, though Treasury and AIG spokeswomen would not disclose details of their compensation. AIG’s current directors receive a $150,000 retainer and $50,000 in deferred stock units annually, according to the recent regulatory filing.

It’s unclear exactly what led Treasury to select Layton and Rittenmeyer for the AIG board. The government used KornFerry, an executive search firm, to aid the process.

Treasury, in response to a request from the Investigative Fund, declined to disclose the search criteria.

“We are confident that these appointees will make significant contributions to AIG’s strategy to de-lever, de-risk and pay back taxpayers," an assistant treasury secretary, Herbert Allison, said at the time of the appointments.

“No comment”

Layton and Rittenmeyer, as board members, theoretically could demand that AIG release its internal e-mail, accounting documents and financial models. The record of AIG’s actions in the lead up to its bailout presumably are contained in those secret records.

Both Layton and Rittenmeyer, through an AIG spokeswoman, declined to speak with the Investigative Fund or explain why they haven’t compelled AIG to release the documents.

If AIG's board does not disclose the documents, some believe that the three government-appointed trustees could force it to do so. The trustees can’t interfere in the company’s day-to-day affairs but can oust AIG's directors.

Rep. Alan Grayson (D-FL), a member of the House Financial Services Committee, has demanded that the trustees force the release of the documents. “It is beyond outrageous that this company, which taxpayers capitalized after Wall Street used it as a slush fund, hides nearly all relevant facts from its owners, the public,” Grayson wrote in a March letter to the trustees.

But the trustees are unwilling to meet such demands. “The trustees have no comment regarding the suggestion that AIG's board release the e-mails of the company, nor will they comment on any views they might have on that issue,” Peter Bakstansky, the Trust’s adviser, said in an e-mail responding to Investigative Fund inquiries in January.

He confirmed Friday that the trustees have not changed their position.

The trustees each receive a $100,000 salary from AIG.

Although the New York Fed considers the trustees independent, most are either current or former Federal Reserve officials.

One trustee, Jill M. Considine, chairs a firm that administers hedge fund portfolios and is a former board member of the New York Fed. Another trustee, Chester B. Feldberg, was an employee of the New York Fed for 36 years. After leaving the Fed, he became chairman of Barclays Americas until 2008. Douglas L. Foshee, chief executive of the El Paso Corporation and former chief operating officer of Halliburton, is the current board chair of the Federal Reserve Bank of Dallas’ Houston branch.

Peter Langerman, president and chief executive officer of the Mutual Series fund group of Franklin Templeton Investments, became a trustee after Foshee resigned in February. The Treasury Department recommended Langerman, who has donated nearly $100,000 to Democratic candidates, including Barack Obama.

Facing crackdown, credit raters bring on heavy hitters

S & P Syndicate Public Company Limited — 2011-10-12T22:01:29-04:00

Credit rating companies have long seemed the Wall Street equivalent of the New York Yankees: Controversial but virtually unbeatable. Again and again, disgruntled investors have taken the raters to court — and lost.

Now facing a crackdown for their role in the financial crisis, the raters worry that Congress will leave them vulnerable to a barrage of lawsuits that are harder to defend. In response, the raters are stepping up their game on Capitol Hill. They are breaking their own spending records as they deploy some of the heaviest hitters in lobbying and lawyerly persuasion.

Financial reform legislation now making its way through Congress includes provisions that would make it easier for investors to sue the companies when they award top marks to bonds that turn out to be toxic. Investors rely on rating companies to judge the quality and safety of bonds by assigning the investments a letter grade. During the financial crisis, people lost billions on highly rated subprime investments.

Recent disclosure reports filed by lobbyists and their clients show that in 2009, the top rating companies —Standard and Poor’s, Moody’s and Fitch — collectively spent almost $4 million on lobbying. That’s a record for the rating industry, and about 56 percent more than in 2008.

Of the big three raters, S&P spent the most last year on lobbying — about $2.2 million — though that amount includes some lobbying for other business units of S&P parent company McGraw-Hill.

And S&P is not missing an opportunity to pitch their cause: Representatives for S&P have had “direct meetings” with most all 23 senators on the Senate banking committee or their staff members, Ted Smyth, a McGraw-Hill vice president, told the Huffington Post Investigative Fund.

Smyth wouldn’t say which, if any, senators have been receptive to S&P’s attempts to kill the increased liability provision. “We’re hearing from Democrats and Republicans who don’t want unnecessary lawsuits” for the ratings companies, he said.

S&P’s lobbyists also have taken their case to the White House, Securities and Exchange Commission, FDIC, Federal Reserve, the Treasury Department, and even the Government Accountability Office, the investigative arm of Congress, records show.

In July 2009, McGraw-Hill hired the Podesta Group and its owner, Tony Podesta, one of Washington’s most influential lobbyists, to tackle “liability provisions in credit rating agency reform,” the group’s lobbying disclosure reports show. Tony’s brother, John Podesta, was President Clinton’s chief-of-staff and co-chairman of President Obama’s transition committee.

S&P also has hired the lobbying firm Nappi and Hoppe, which represents an array of financial interests including the Chamber of Commerce. A principal in the firm, Douglas Nappi, was chief counsel to the Senate banking committee from 2003 to 2005.

For years, the big three credit raters have faced lawsuits from state attorneys general and investors who claim to have lost billions by relying on credit ratings. S&P alone now faces roughly 50 lawsuits. The investors typically accuse the raters of awarding inflated safety grades to dangerous investments. But the raters, who argue that ratings are only an opinion and that investors assume their own risk, remain undefeated in court.

Many congressional Democrats are trying to break that winning streak.

A bill passed late last year in the Democratically controlled House would make it easier to sue the raters. Instead of having to prove that a rating company committed fraud, investors would only have to show the raters were “grossly negligent” – a lower standard.

Floyd Abrams, a renowned First Amendment attorney who has represented Standard & Poor’s for more than 20 years, said in an interview last year that switching to a so-called negligence standard could “be a very major threat to rating agencies being able to go about their business.”

Senate Democrats didn’t go quite as far as their colleagues in the House. The Senate banking committee last month approved a bill allowing investor lawsuits only when the facts strongly infer that a rating company “knowingly or recklessly failed to conduct a reasonable investigation” of the investments before giving them a grade.

S&P’s Smyth objects even to the weaker Senate provision. He said the language is vague and subject to interpretation by the judiciary and juries. “This ill defined provision introduces a degree of uncertainty,” said Smyth. “It’s like in football, they’re punting” to the courts. Raters also complain that other market participants such as accountants face less onerous standards.

The ultimate shape of the legislation won’t be known until later this summer. Meanwhile, McGraw-Hill’s in-house lobbyists are reaching out to key Republican lawmakers on the banking committee.

One McGraw-Hill lobbyist, Cynthia Braddon, met last month with Republican Sens. Bob Corker of Tennessee and Judd Gregg of New Hampshire. Corker joined the committee’s chairman Christopher Dodd (D-Conn.) in writing many of the bill’s provisions. Gregg, along with Democratic Sen. Jack Reed of Rhode Island, helped construct the rating agency provisions.

At the March meeting, Braddon pushed Corker and Gregg to oppose the committee’s provision that would make it easier to sue the raters, according to an e-mail Braddon sent to Hill staffers on March 22, first reported by Bloomberg. That provision “remains a bone of contention,” Braddon’s e-mail said.

Smyth said that Braddon’s e-mail “miscommunicates our bipartisan approach to the Bill.”

According to one congressional source, nothing was agreed to at Braddon’s meeting with Corker and Gregg. The committee approved the bill along party lines, with Corker, Gregg and the committee’s other Republicans voting against it.

In a statement released Wednesday, Reed attacked the March meeting as a “cynical attempt by Wall Street lobbyists to kill Wall Street reform before it has a chance to see the light of day.”

Reed called on Republicans to ignore S&P’s attempts to influence the bill. “I hope these overtures from the banking industry will be resoundingly rejected and that we can get several Republican senators to join us in passing comprehensive Wall Street reform that increases transparency and protects taxpayers,” he said.

Gregg’s office did not return a call requesting comment. Corker’s spokeswoman, Laura Herzog, said in e-mail: “Sen. Corker believes credit rating agencies were a big part of the problem and need to be part of the reforms.”

The rating agencies say they support most proposed reforms, including an SEC office to oversee them.

When faced with previous threats from Capitol Hill, the rating agencies mostly have fended them off. An Investigative Fund review last year of congressional testimony, SEC documents and lobbying reports revealed that the raters frequently have quashed or watered down potential government oversight by arguing that, much like a newspaper editorial, ratings are protected by the constitutional right to free speech.

Why Fannie and Freddie continue to cost taxpayers billions

2011-10-12T21:23:55-04:00

Of all the companies bailed out by the federal government, mortgage finance giants Fannie Mae and Freddie Mac are shaping up as the deepest money pits. A close look at their past and recent financial filings shows why their losses continue to mount.

Fannie and Freddie effectively became wards of the government in 2008. The Obama administration had promised to reveal its plans for the agencies last month, but Washington’s focus on reforming the banking system pushed them to the bottom of the to-do list. Fannie and Freddie aren't mentioned in either the Senate or House financial regulatory reform bills.

Treasury Secretary Timothy Geithner may reveal some of the administration’s ideas on Tuesday when he testifies before Congress about Fannie and Freddie. But in general, the companies’ troubles have drawn less attention than the rest of the financial industry. For example, unlike bonus announcements made on Wall Street, Fannie and Freddie’s recent disclosures of about $40 million in executive compensation and bonuses for 2009 caused little stir on Main Street.

Together the two firms have already tapped $125 billion from government lifelines and the Congressional Budget Office predicts they ultimately will drain $380 billion. That would far exceed the final tabs for rescuing the big banks, the automakers or even insurance behemoth American International Group (AIG).

“These calls on taxpayer funds are troubling to all of us,” Edward J. DeMarco, acting director of the Federal Housing Finance Agency, said in a letter to congressional leaders last month.

DeMarco’s predecessor at the housing finance agency, Fannie and Freddie’s regulator, has acknowledged that taxpayers are unlikely to ever see a full return on their investment.

Why are the two companies in such dire shape, when many large banks have been able to turn a profit even as they take huge losses from their real estate investments?

Fannie and Freddie's losses largely stem from internal decisions made in 2006 and 2007 that sent the companies on a shopping spree for dubious mortgages, according to regulatory filings, congressional testimony and interviews with economists and former Fannie Mae employees. Fannie and Freddie uncharacteristically collected more than $1 trillion in subprime and other risky mortgages---many of which were branded “alternative,” or alt-a, because they did not meet the rules set by Fannie and Freddie.

“It’s ironic because the original definition of alt-a mortgages was that it didn’t meet Fannie and Freddie’s underwriting standards,” said Thomas Lawler, a former senior vice president of Fannie Mae who left in 2006 to start a consulting business. “A disturbingly high share of losses were incurred from loans acquired during those dog years.”

Chasing Market Share

Fannie’s and Freddie’s ill-fated decision to hop on the risky mortgage bandwagon was inevitable given their inherently contradictory missions, housing specialists said in interviews.

For 40 years, they functioned as publicly traded companies controlled by shareholders who demand profits. But they also operate under a congressional charter, as government-sponsored enterprises (GSEs), to keep credit flowing in minority and low-income communities. The charter also carried an implicit guarantee that if the companies got into trouble, the taxpayer would bail them out.

To follow their mandates, the companies developed two key lines of business. One is to buy mortgages from lenders, which can then use the money to offer new loans to consumers. Fannie and Freddie bundle the loans, guarantee them against default and sell them as securities to investors such as pension funds. The second line of business is management of their own investment portfolios.

Although both sides of the business helped bring the companies down, last year’s losses stemmed largely from the loans they bought and guaranteed in 2006 and 2007. Before 2006, the companies dominated the residential mortgage market, owning or guaranteeing more than half of new mortgages. But after initially resisting the subprime boom, they began losing their control to Wall Street banks. Fannie and Freddie’s market share plummeted to 37 percent in 2006.

They decided to rev up their buying and guaranteeing of risky mortgages. This decision restored their market share but also helped destroy the companies.

The riskiness of the 2006 and 2007 loans handled by Fannie and Freddie can be read in the details of their financial filings. Compared to earlier years, the borrowers had lower credit scores yet higher outstanding balances on their mortgages. Both companies became especially fond of the alt-a mortgage. Fannie acquired $135 billion in alt-a mortgages that were originated in 2006 and 2007 alone, more than twice the total in all years before 2005. Ultimately, alt-a loans caused about 40 percent of Fannie’s credit losses last year.

Ironically, the alt-a name is short for “alternative to agency,” meaning that they were the type of loans that Fannie and Freddie historically refused to buy or guarantee. People who secure alt-a mortgages typically have good credit scores but do not identify their incomes or net worth. Such mortgages are prone to default though technically are not subprime, which allowed Fannie and Freddie to rationalize their purchases.

It’s still unclear exactly what drove Fannie and Freddie to prioritize market share over safety. To be sure, the shift came partly in response to a series of federal rules crafted during the Clinton and Bush administrations. The rules, adopted by the Department of Housing and Urban Development, required the companies to promote affordable housing in low-income and minority communities.

But the companies often failed to meet their housing goals between 2005 and 2008, “and without any significant repercussions from their regulators,” Dwight Jaffee, a professor at the University of California Berkley's Haas School of Business, said in testimony last month before the Financial Crisis Inquiry Commission.

Fannie and Freddie’s drop in standards, Jaffee said, more likely came from a desire to please shareholders. After Fannie got more aggressive in 2007, their stockholders’ equity increased six percent to $44 billion.

“The bottom line is that GSE managers long understood that they and their shareholders would benefit from risk-taking as long as the higher risks created higher expected returns,” Jaffe said.

Christmas Gift

When alt-a and other risky mortgages entered foreclosure in huge numbers in 2007, Fannie and Freddie were on the hook for many of these loans, which they had sold to investors with a guarantee against default. But the companies lacked sufficient funds to cover their pending payouts.

The Bush administration rescued the companies with the promise of big government lifelines. The Treasury Department also purchased an 80 percent ownership stake in Fannie and Freddie, which promptly entered government conservatorship.

Fannie and Freddie agreed to pay the government a 10 percent dividend each year on funds they draw from their lifeline. So far the companies have paid $6.8 billion to the Treasury Department, even as they continue to take in tens of billions of dollars from Treasury. In essence they are paying Treasury’s dividends with money from Treasury, the companies disclosed in regulatory filings last year.

Aside from the bailout, the Federal Reserve has purchased about $1.2 trillion of Fannie and Freddie mortgage securities and corporate bonds. The Treasury Department also has bought about $220 billion of the companies’ mortgage securities.

In total, Fannie and Freddie have received direct and indirect federal support worth more than $1.5 trillion.

Yet the companies’ financial health has not been improving. At first, the companies were each entitled to a $100 billion government lifeline. The Obama administration later raised the limit to $200 billion.

Then on Christmas Eve, the administration quietly lifted the cap altogether, effectively giving the companies a blank check. It was one of several controversial Fannie and Freddie-related announcements made on the holiday. After Dec. 31, the decisions would have required congressional approval.

Some of the announcements were expected. For example, Fannie said it would need another $15 billion from taxpayers to stay afloat. Freddie hasn’t asked for more money since last May, but indicated that it will in “future periods.”

Amidst these statements was an even more controversial disclosure: The Treasury Department approved about $42 million in combined cash compensation and bonuses for Fannie and Freddie’s top executives.

The payouts drew the ire of some lawmakers.

“We are paying these people bonuses to lose tens of billions of dollars,” Rep. Jeb Hensarling (R-Texas) said at a House Financial Services Committee hearing in January. “What people do with their money is their business. What they do with the taxpayer money is our business.”

Awarding compensation in cash also contradicts the Obama administration’s demands that bank executives pay their employees in stock. The administration notes that Fannie and Freddie’s conservatorship agreement prohibits stock-based compensation. The companies’ cash payments, the administration said, will be deferred so they will resemble a stock salary. Fannie and Freddie’s total compensation, on average, dropped 40 percent in 2009, according to a statement released by the federal housing agency.

Still, Fannie and Freddie’s chief executives will each make more than $6 million for their 2009 performance, including a roughly $2.5 million bonus. Lloyd Blankfein, the chief executive of mega bank Goldman Sachs, received a $9 million bonus last year, all in stock. His company turned a record $13.4 billion profit last year.

The latest in a series of Congressional attempts to tax bonuses awarded at bailed out companies targeted Fannie and Freddie’s executive compensation. Like its predecessors, the bill has gone nowhere amidst met fierce opposition in the Senate.

Freddie still has not disclosed its final compensation plan so its exact salaries are unknown. None of Freddie’s current executives were at the company during the bad years.

But Fannie’s chief executive, Michael Williams, served as the company’s chief operating officer from 2005 to 2009. The housing agency says that Williams, who will earn $6.6 million for 2009, did not run or oversee the purchasing of mortgages. He also has taken a pay cut since the bailout.

DeMarco, head of the housing agency, defended the payments in recent congressional testimony.

“These new structures are designed to align with taxpayer interests,” he told the House financial committee last month. “In my judgment, we have achieved the right balance between enough compensation to acquire and retain quality management, while preventing compensation from exceeding appropriate bounds.”

Uncertain Future

While a reform plan for Fannie and Freddie takes a back seat to other government concerns the administration is using the companies to stabilize the housing market, keep credit flowing during tough times and direct its seminal foreclosure rescue initiative. By the end of 2009, Fannie and Freddie have approved more than 40,000 permanent mortgage modifications that lowered interest rates. These actions have drained the companies of precious income.

Restructuring the companies thus poses a dilemma for Washington that so far has proven too thorny to tackle: How to protect taxpayers from Fannie and Freddie’s losses while using the companies to protect homeowners from foreclosure.

Some housing experts want to privatize Fannie and Freddie once the economy settles, forcing the government out of the housing finance business altogether. Others suggest turning them into a public utility, like an electric company. More likely, the government will simply return the companies to their pre-bailout status as public-private entities, said Peter Wallison, who follows housing finance for the American Enterprise Institute, a conservative think-tank.

“There aren’t any real good answers,” said Wallison, though he added that he favors the privatization path because it minimizes the likelihood of future bailouts.

This debate will take center stage Tuesday as the House Financial Services Committee holds a hearing on the future of the companies. Geithner has said that his testimony will offer “broad objectives and principles” for remaking the companies.

In anticipation of the hearing, House Republicans floated a plan last week to phase out the companies over the next few years.

At a hearing in January, Rep. Barney Frank (D-Mass.), chairman of the House committee and a long-time Fannie and Freddie ally, proposed eliminating the companies and starting from scratch. “I believe this committee will be recommending abolishing Fannie Mae and Freddie Mac in their current form," Frank said, "and coming up with a whole new system of housing finance.”

In details of Dodd bill, some loopholes and unanswered questions

2011-10-12T21:18:58-04:00

The fine print in the sweeping overhaul of the U.S. financial system proposed by Sen. Christopher Dodd reveals loopholes, ambiguities and unanswered questions about some key players — among them a new consumer protection bureau, credit-rating companies and payday lenders.

Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, unveiled his draft legislation on Monday. His plan’s details suggest his struggle to balance the conflicting demands of Republicans and the financial industry lobbyists, who oppose an independent new consumer agency, and Democrats, many of whom question whether Dodd has gone far enough.

Dodd has stressed the reach of his blueprint, especially noting the importance of a new independent consumer watchdog to write rules for products such as mortgages and credit cards. “This crisis started when people were given mortgages they didn’t understand and could never afford,” said Dodd. “If there was a watchdog on duty, it didn’t bark.”

Still, the legislation would impose significant limits on the autonomy of the new watchdog. It would establish a Financial Stability Oversight Council of nine members, all but one of whom would be existing financial regulators such as the Treasury Secretary and Comptroller of the Currency, which oversees national banks.

Just one member of the Council would have the power to delay the bureau’s suggested regulations, and six would be needed to override them. Council members could block any bureau recommendation they feel threatens the stability of the banking system.

Even before it crafted a rule, the consumer bureau would be required to consult with other financial regulators about whether the rule would be consistent with the objectives of those existing agencies, some of which have been accused of being lax in the lead-up to the financial crisis. The bureau also would have to consult with the Federal Trade Commission before imposing any regulations.

Nor would the consumer bureau be allowed to examine the books of any lender without first coordinating with other federal and state bank examiners so that they all go on the same day — a measure intended to reduce the regulatory burden on lenders.

In addition, the new bureau would have to rely as much as possible on existing documents of the financial institutions it oversees and could not dictate that they use any specific technology to aid the bureau in monitoring.

The consumer bureau would be housed in the Federal Reserve. While Dodd said the Fed wouldn’t have “one iota” of authority over the bureau — and would basically be renting office space — the bill provides for the presidents of the regional Fed banks to recommend at least six members to the bureau’s advisory board.

Much of the bill addresses what the consumer bureau would not be able to do. For instance, the bureau could not declare a lending practice “unlawful” simply because it is deemed unfair. To be illegal, the practice must be “likely to cause substantial injury to consumers, which is not reasonably avoidable by consumers.”

It’s also unclear exactly which lenders the bureau could regulate. Take, for example, payday lenders, which offer short-term, high interest loans.

Dodd’s bill does not actually mention the word “payday.” Yet Dodd’s 11-page summary of the bill does. The summary says a new consumer protection bureau housed within the Fed will have the authority to examine and enforce regulations for “large payday lenders.” But “large” is not defined.

"It's not clear what 'large' means," states the "Payday Pundit," a blog of the industry trade group, the Community Financial Services Association. "I will try to seek clarification over the next few days."

Another payday industry lobbyist told the Investigative Fund that he believes Dodd intends for the consumer protection bureau to determine what “large” means.

As the Investigative Fund has reported, the industry spent about as much as JP Morgan & Co. last year on lobbying alone, and is engaged in an aggressive campaign to resist being ruled by Washington.

Payday lenders were not explicitly mentioned in the approved House version of financial reform either. Amid uncertainty, the bill's author, financial services committee chair Barney Frank (D-Mass), quickly dispatched a letter to his colleagues saying the new consumer agency would have authority over them.

Separately, Dodd's bill targets the nation's top credit rating companies, such as Standard & Poor's and Moody's.

As the Investigative Fund reported in a three-part series last year, the raters have long dodged regulation using the First Amendment as a shield. But now, the raters are at the center of the financial crisis. They awarded inflated grades to investments — including ones they allegedly helped create — that ultimately unraveled the economy.

Dodd's bill calls for a new credit rating overseer within the Securities and Exchange Commission, which will have the authority to fine — or even de-register — the companies for repeated mistakes. The bill also would require ratings analysts to pass qualifying exams and receive relevant education.

But in certain ways, Dodd doesn't appear to have been as forceful with the raters as Frank was last year. Whereas Frank would remove most, if not all, requirements that investors and banks rely on credit ratings, Dodd called for a Government Accountability Office study of this step. Meanwhile, his bill would direct regulators to remove whatever statutory references to credit ratings that they see as unnecessary. Again, however, it's unclear exactly what that wording means.

Dodd, like Frank, provided investors the first explicit right to sue the rating companies. But Frank's bill set forth a seemingly easier standard for suing the raters.

Ultimately, Dodd's measures, clear and ambiguous alike, face an uncertain future. They are subject to change as the full banking committee takes up amendments to the bill next week.

Another Wall Street bonus tax falters in Congress

2011-10-12T20:51:33-04:00

Editor's Note: The bonus tax failed Tuesday. See full story.

Few topics have generated as much political heat between Main Street and Wall Street as the billions of dollars in bonuses handed out at financial companies that received federal bailouts. But Washington’s efforts to claim some of that money for taxpayers continue to falter.

The latest attempt is a measure authored by Democratic Sens. Jim Webb of Virginia and Barbara Boxer of California. It would impose a one-time 50 percent tax on 2009 bonuses of more than $400,000 paid by the 13 firms receiving the most federal bailout money.

The plan appears to be crumbling amid opposition from two financial industry-lobbying powerhouses and hesitation among moderate Democrats and key New York politicians, including Sen. Charles Schumer. It has little chance of surviving a procedural vote expected late Tuesday, according to legislative aides and industry lobbyists.

The New York State Comptroller recently reported that bonuses paid to New York City securities industry employees jumped 17 percent last year. JPMorgan Chase & Co. awarded its employees about $26 billion in salaries and bonuses; Goldman Sachs employees earned about $16 billion.

Webb and Boxer have pitched their tax as an act of fairness — and a way to reduce the ballooning federal deficit. “As a matter of equity, the reward should be shared with the taxpayers who made it possible,” Webb said on the Senate floor.

Webb and Boxer want the bonus tax attached as an amendment to a roughly $150 billion bill that would extend unemployment benefits and tax credits. Although technically still alive, the bonus tax is likely to be formally abandoned Tuesday after a procedural vote on the larger bill.

Lawmakers and the Obama administration have grappled with the bonus issue for months. Last March, in the wake of AIG’s payout of about $150 million in bonuses, the U.S. House overwhelmingly passed a bill imposing a 90 percent tax on bonuses awarded by bailout recipients. The Senate never passed a comparable bill.

This year, Sen. Sherrod Brown (D-Ohio) proposed a 50 percent tax on executive bonuses above $25,000. A group of House Democrats floated a similar plan. Neither has gained traction.

President Obama has his own $90 billion tax plan, which he said will “recover every single dime the American people are owed.” Rather than tax specific employees, Obama’s “financial crisis responsibility fee” would apply directly to about 50 firms with more than $50 billion in assets. Obama included the tax in his recent budget proposal.

In a letter to Sen. Charles Grassley (R-Iowa), the nonpartisan Congressional Budget Office said Obama’s plan would have a “small” impact on bailed-out firms. “The cost of the proposed fee would ultimately be borne to varying degrees by an institution’s customers, employees, and investors,” the letter said.

Webb and Boxer’s tax would apply only to 13 companies that took more than $5 billion in taxpayer funds. The proceeds would be applied toward reducing the deficit. Regulators in Britain have implemented a similar plan, called a “supertax,” which according to recent reports will reap more than $3 billion for the government.

Last week, the Senate’s number two Democrat, Richard Durbin of Illinois, signed on as a co-sponsor to Webb and Boxer’s bonus tax. Senate Majority leader Harry Reid expressed support for the plan as well.

Webb and Boxer also reached out to Republicans by targeting bonuses paid by mortgage finance giants Fannie Mae and Freddie Mac, which have elicited conservative ire for having unlimited access to taxpayer funds.

But some moderate Democrats opposed the bonus tax and sought to keep it from getting a vote, according to sources in the financial industry and on Capitol Hill. The moderates, according to one source, feared that in an election year the business lobby would target them as being pro-tax.

Some finance committee members, meanwhile, expressed hesitation because the tax didn’t go through the committee’s typical vetting process.

New York’s senators — Schumer and Kirsten Gillibrand — also raised concerns with fellow lawmakers. Their spokesmen say that the New York Democrats haven’t formally opposed the bonus tax, but would face an uncomfortable decision should it ever come to a vote.

Why uncomfortable? On the one hand, the senators have repeatedly expressed support for reining in Wall Street excess. On the other, Wall Street is a top contributor to the New York economy — and their campaigns.

“Senator Schumer is open to any proposal that will help make taxpayers fully whole after they footed the bill,” said Schumer’s spokesman Brian Falon. Schumer’s preference so far, Falon said, is Obama’s plan because it would tax firms and not employees.

New York City Mayor Michael Bloomberg, a staunch opponent of the bonus tax, added his voice to the debate.

Bloomberg’s spokesman, Marc Lavorgna, wouldn’t confirm or deny that the mayor called senators to lobby against the bonus tax, but argued that the plan “would take billions of dollars out of the City’s economy, money that would otherwise flow to small business and the middle class families who own them and work in them.”

Lobbyists fighting the bonus tax echoed these concerns.

In a letter to senators, The U.S. Chamber of Commerce, a leading business lobby in Washington, warned in a letter to senators that the tax “would hamper efforts to resolve the ongoing financial crisis, restore economic growth, spur job creation and is likely unconstitutional.” The chamber noted that employees received bonuses as part of “contractual obligations.”

The Financial Services Roundtable, a trade group representing banks including JPMorgan Chase & Co., also opposed the plan.

Consumer complaints soar on mortgage 'rescue' schemes

2011-10-12T20:16:32-04:00

As many Americans sank deeper into financial trouble last year, a record number reported that they fell victim to schemes seeking to profit from their misfortune, according to a federal report released Wednesday.

Complaints data collected by the Federal Trade Commission from several U.S. law enforcement agencies show that distressed homeowners became particularly vulnerable to fraudulent practices by individuals or companies promising financial “rescue.” Companies that, for instance, offer mortgage modifications or foreclosure relief programs generated nearly 8,000 complaints in 2009. Only one such complaint was officially recorded in 2008. The numbers are an indication of a much larger problem, since only a fraction of victims file formal complaints.

“These people are desperate and are unfortunately the perfect target for a scammer who has no conscience and is trying to take the last dollar out of these people’s wallets,” said David Vladeck, the FTC’s director of consumer protection.

The Huffington Post Investigative Fund is documenting these schemes in our ongoing series, Hard Times Profiteers. We are compiling your stories of real estate schemes and your photos of come-ons advertised on roadside signs.

The FTC collected more than 1.3 million complaints of all kinds last year, up from 1.2 million in 2008. Consumers reported losing more than $1.7 billion from fraud and various other schemes, with the largest concentration of complaints coming from Nevada and Colorado.

The complaints were not limited to mortgage swindles. This year, the most commonly reported problem was identity theft.

But as people increasingly lost their jobs and fell behind on mortgage payments last year, some of the most striking spikes in complaints related to credit schemes. Between 2008 and 2009, complaints about companies that offer advance-fee loans and promise to repair bad credit more than doubled to 41,448. “Debt management” and “credit counseling” complaints also doubled.

The FTC, the U.S. Justice Department and state attorneys general have accused — and are prosecuting — dozens of companies for fraudulently using the recession to victimize consumers.

Now the FTC is paying particular attention to mortgage schemes. The sudden leap in consumer complaints is in part attributable to hundreds of “rescue” companies that launched last year after the Obama administration created a government-subsidized loan modification program.

Logistical problems have plagued the administration’s Home Affordable Modification Program, which has produced only 116,000 permanent mortgage modifications. In turn, many homeowners have turned to fly-by-night companies for help, analysts say.

“Fundamentally they’re a product of a broken system,” said Ira Rheingold, executive director of the National Association of Consumer Advocates. “As long as people are desperate to save their homes, and don’t have a good alternative, these guys are going to find a way to cheat them.”

Although some businesses offer legitimate loan modification services, the FTC has proposed a new rule that would prohibit companies from charging consumers up-front fees, a move that will probably “drive a lot of these scammers out of this business,” Vladeck said. The agency, which can bring civil but not criminal court cases, has identified about 500 companies that currently charge advance fees.

Through its “Operation Loan Lies,” the agency has sued about 30 companies accused of operating bogus loan modification or foreclosure rescue businesses.

Ultimately, Vladeck hopes these cases will encourage the Justice Department to pursue criminal charges against mortgage schemers.

“I want to shut you down,” Vladeck said of the schemers. “I want to take every penny you have and I want to send you to jail.”

What's still hidden in AIG's files?

American International Group, Inc. — 2011-10-12T16:54:43-04:00

As federal hearings into the cause of the financial crisis got underway this week, attention has focused on one key outstanding question: Whether the giant insurer American International Group committed fraud in the run-up to its $182 billion bailout.

The records of AIG’s actions presumably are contained in company documents and e-mails. Some of those records have been obtained and published by news organizations and congressional investigators. But some lawmakers and former financial prosecutors argue that most details remain unknown and should be made public—an idea resisted so far by congressional Democrats and AIG’s regulators.

The little the public knows about AIG’s bailout pertains to the company’s use of $25 billion in government money to buy back toxic securities from Wall Street’s big banks.

Last week, Rep. Darrell Issa (R-Calif.), ranking member of the Committee on House Oversight and Government Reform, released e-mails showing that the Federal Reserve Bank of New York, AIG’s regulator, kept details of these payouts secret while now-Treasury Secretary Timothy Geithner was in charge of the New York Fed. The Financial Crisis Inquiry Commissionscrutinized the payouts—specifically to Goldman Sachs-- at a hearing Wednesday. Then Rep. Ed Towns (D-N.Y.), chairman of the oversight committee, subpoenaed the New York Fed this week for all documents related to the payouts, including Geithner’s e-mail and phone logs.

AIG was a pioneer and the world’s top player in the trade of credit default swaps – exotic instruments blamed for fueling the cascade of financial disasters in 2007 and 2008. The company ultimately received four separate federal bailouts and, unlike big banks, is unlikely to pay it all back to taxpayers.

AIG’s financial products division, which handled the swaps, is a “black box, the epicenter” of the financial crisis, former New York Governor Eliot Spitzer said in an interview. Given that taxpayers own nearly 80 percent of the company, Spitzer said, the public is entitled to see a decade’s worth of AIG’s e-mail, internal accounting documents and financial models. This information will help prosecutors determine whether AIG employees broke the law, he said.

“It’s the best use of our money,” said Spitzer, who as New York’s attorney general was known as the Sheriff of Wall Street for prosecuting financial titans. Spitzer leveraged his performance as attorney general into the governor's mansion before resigning in a prostitution scandal in 2008.

Spitzer’s call for AIG records has gained traction among some congressional Republicans.

Issa, according to a spokesman, would support expanding the subpoena. “In our pursuit to fully understand what risks led to the financial meltdown, we should access and release as much information as we possibly can,” said the spokesman, Kurt Bardella.

But Issa lacks the power to issue subpoenas. And those who can compel AIG to turn over the documents are so far balking at the idea.

Towns’ staff, for instance, has said the congressman is limiting his investigation to AIG’s payments to banks. This inquiry likely will produce documents from the last year or two.

“The subpoena Chairman Towns will issue to the Federal Reserve Board of New York is a responsible and targeted effort to uncover important facts about important issues,” said Jenny Thalheimer Rosenberg, communications director for Towns’ committee.

If Congress won’t act, Spitzer said, the AIG Credit Facility Trust should. The New York Fed created the Trust last year to hold and oversee the taxpayers’ investment in the company. Although the Trust’s three members are not allowed to interfere in the day-to-day affairs of the company, they have authority to oust AIG’s current board. If the trustees wanted, Spitzer said, this implicit threat could compel the board to release the documents.

The trustees “have the opportunity to be among the most effective and influential investor advocates in history,” Spitzer and two other experienced fraud investigators said in a recent op-ed article in the New York Times. “Before A.I.G. escapes, they should demand the evidence,” wrote Spitzer; Frank Partnoy, a former investment banker; and William K. Black, a former banking regulator who led investigations of fraud during the savings-and-loan scandal.

But the Investigative Fund found that the trustees, who each receive an annual $100,000 salary, are steering clear of the controversy. “The trustees have no comment regarding the suggestion that AIG's board release the e-mails of the company, nor will they comment on any views they might have on that issue,” Peter Bakstansky, the Trust’s adviser, said in an e-mail.

Although the New York Fed says the trustees are independent, each is either a current or former Federal Reserve official.

One trustee, Jill M. Considine, chairs a firm that administers hedge fund portfolios and is a former board member of the New York Fed. Another trustee, Chester B. Feldberg, was an employee of the New York Fed for 36 years. Douglas L. Foshee, chief executive of the El Paso Corporation and former chief operating officer of Halliburton, is the current board chair of the Federal Reserve Bank of Dallas’ Houston branch.

Without the trust’s cooperation, another potential route for obtaining AIG’s documents is the Financial Crisis Inquiry Commission. When Congress created the bipartisan commission, lawmakers gave it subpoena power.

A spokeswoman was unsure whether the commission planned to apply its subpoena power to AIG.

But at the commission’s first hearing on Wednesday, its chairman, Phil Angelidies, probed AIG’s government-subsidized payments to Goldman Sachs and other big banks.

Goldman was one of several banks that bought AIG’s credit default swaps, which insured the banks against losses on their risky mortgage-backed investments. When the investments collapsed, AIG owed billions to Goldman, Bank of America and Citigroup, among others. Instead of honoring the insurance agreements, AIG used $24 billion in taxpayer funds to buy the mortgage investments from the banks at 100 cents on the dollar.

But many of the investments were worth substantially less than their face value, according to a report last year by the special inspector general for the bailout.

At the hearing, Angelides asked Lloyd Blankfein, Goldman’s chair and chief executive officer, whether government regulators ever asked him personally to accept a discount from AIG.

Blankfein’s answer: “Never.”

Barney Frank vs. the credit raters

2011-11-28T11:06:53-05:00

After deftly dodging federal regulation for years, the nation’s top credit rating companies now must get past the formidable Barney Frank.

Last week, as the U.S. House debated the Wall Street reform package crafted largely by Frank, the Massachusetts Democrat quietly slipped regulations into the bill that would force the most significant overhaul of the credit rating industry to date.

The top raters — Standard & Poor’s, Moody’s and Fitch — seemed ripe for regulation ever since they awarded inflated grades to investments that ultimately unraveled the economy.

If the provisions in the bill, passed by the House last Friday, make it through the Senate, investors who lost billions of dollars on those top-rated financial products would likely find it easier to sue the raters for fraud. Also, by no longer mandating that mutual funds buy only top-rated investments, the bill has the potential to squeeze the raters out of their special status in the financial system.

“This really sounds like progress,” said Lawrence J. White, an economics professor at the Stern School of Business at New York University and a specialist in the credit rating industry.

The credit raters have embraced some of Frank’s changes — an indication they’re not exactly frightened by the entire proposal. They are, however, engaged in a yearlong lobbying campaign, which has cost them about $2.7 million so far, a record for the rating industry, documents show.

The plan by Frank, chairman of the House Financial Services Committee, does not eliminate the conflicts of interest in the credit rating industry, an omission he said he regrets. And it does not contain another idea that has been gaining traction among critics of the raters – a ‘public option’ that would create an alternative government-run credit rating agency to compete with the private sector.

“The basic problem with the rating agencies is that they’re paid by the people they’re rating; there’s an inherent conflict of interest,” Frank said in an interview with the Huffington Post Investigative Fund. Curbing these conflicts, he said, is “one thing we’re still trying to get at.”

In the interview, Frank said the raters, on the whole, “hate” his bill. In particular, they have not taken kindly to the prospect of more lawsuits.

But Frank’s legislation faces an uncertain fate in the Senate, where lawmakers have struggled to rewrite rules for Wall Street. Frank’s counterpart in the Senate, banking committee chair Christopher Dodd (D-Conn.), has floated his own reform package. Dodd’s bill lacks some of Frank’s more forceful new regulations of the rating industry.

If Frank’s provisions die in the Senate, it would not be the first time the raters escaped an overhaul.

A three-part Investigative Fund series recently documented how the credit raters have repeatedly defeated government oversight by arguing that their ratings are opinions, protected by the constitutional right to free speech. With help from the First Amendment, the raters also remain undefeated in court against disgruntled investors.

Although Frank said the raters should enjoy some First Amendment cover, he argued “you do not have full First Amendment protections when you’re doing things for money.”

Standard & Poor’s already faces some 50 lawsuits from investors and state attorneys general, who argue that the raters should compensate the people and institutions who bought top-rated toxic securities. “The door has already been opened,” said Daniel Bacine, a partner at Philadelphia law firm that has investigated possible lawsuits against the raters.

But Frank said his bill would, for the first time, provide investors an explicit right to sue the rating companies. It also would change the standard for suing them. Instead of proving a rating company “knowingly or recklessly” issued a bogus rating, also known as committing fraud, investors would only have to show the raters were “grossly negligent.”

“We made it much easier for them to sue,” Frank said, which will “put the rating agencies very much on notice.”

Floyd Abrams, a storied First Amendment attorney who has represented Standard & Poor’s for more than 20 years, said switching to a so-called negligence standard could “be a very major threat to rating agencies being able to go about their business.”

In effect, Abrams said in an interview this fall, investors would need to show the raters merely acted unreasonably.

In a letter published in the New York Times this week, S&P’s president, Deven Sharma, warned that “singling out rating firms for increased and discriminatory liability standards is likely to result in more defensive, less robust ratings.”

Sharma, on the other hand, recently endorsed Frank’s plan to scale back the raters’ entrenchment in the financial system.

S&P and other companies anointed by the government as Nationally Recognized Statistical Rating Organizations, or NRSROs, are chiseled into many rules that regulate the financial industry.

One such rule allows big banks to leverage themselves based on how well their assets are rated by the NRSROs. Another requires mutual funds and other investment managers to buy only top-rated products.

The result: The government is essentially “outsourcing” its regulatory duties to the raters, said White, of New York University.

Frank’s bill would remove the raters from many of these rules, a decision that “could erode their market share,” White said.

Sharma seems to disagree. In a letter to the SEC this month, he said, “We believe investors will continue to view credit ratings as providing analytical insight and transparency even if they are not referred to in the various rules, statutes and forms where they appear today.”

Some rating companies also endorsed a few of Frank’s more modest measures, including one to beef up their compliance departments and another requiring them to follow their own rating methodologies.

Those changes alone don’t go far enough, said James Heintz, associate director of the Political Economy Research Institute at the University of Massachusetts, Amherst.

Heintz has another idea: create a public option. Had there been an unbiased, government-run credit rating agency operating five years ago, “it’s unlikely the crisis would have happened in this magnitude,” he said.

Heintz likens his independent agency to the Food and Drug Administration, which assess the health risks of drugs before the public can buy them. Likewise, before investors can buy a financial product, the public rating agency would have to evaluate its risk to the financial system. Bond issuers, he said, would still be free to get a second opinion from private raters.

Because the agency would not generate profits — any surplus would be transferred to the Treasury — it would be free of conflicts of interest. Without profits, he said, there’s no motive to please bond issuers or investors.

Frank said he has mulled a public option but is “skeptical that you could insulate a government-run rating agency from pressure from the people being rated.”

In that case, some argue, why not at least have an independent watchdog overseeing the rating industry?

The Congressional Oversight Panel, for instance, floated the idea of a Credit Rating Review Board that would audit ratings after the fact. The idea stems from the Public Company Accounting Oversight Board, an independent nonprofit created to oversee auditors of public companies after the Enron scandal.

A similar proposal, articulated by Demos, a liberal think-tank in New York, would have the watchdog act as a middleman between bond issuers and the rating agencies. To minimize conflicts, the watchdog would assign bonds to rating agencies at random. The watchdog would withhold assignments from, or even suspend, the least accurate raters.

This policy would “change these three rating agencies profoundly,” said James Lardner, a senior policy analyst at Demos.

The idea, first mentioned in an oversight panel report published in January, was initially well received on Capitol Hill. Two Democratic congressmen on Frank’s committee sought to include it in the bill, an effort that ultimately failed.

Courts examine credit raters' 'intimate' relationship with bankers

2011-10-12T15:16:30-04:00

Editor’s Note: This is the last of three articles by the Investigative Fund on the credit rating companies.

A decade ago, the nation’s largest credit-rating companies developed a new line of business that boosted their profits and sent them on a hiring spree. They began rating complex investments that featured large packages of bonds sometimes based on subprime mortgages.

Now the raters are reaping the consequences of their embrace of Wall Street’s so-called structured financial products. For one thing, they are facing a flood of about 50 lawsuits — including one filed last month by the state of Ohio — for handing out inflated grades to many such investments that defaulted and cost investors billions of dollars.

But the more ominous development for the raters is that structured finance may have opened a crack in their long-standing shield for warding off investors’ lawsuits — the First Amendment defense.

For years, the companies — Standard & Poor’s, Moody’s and Fitch — have argued that they are analogous to journalists. They say their ratings are independent opinions, protected by the constitutional right to free speech. The defense works: Even when their ratings have turned out to be wrong, as in the collapse of Enron, the companies remain undefeated in court.

Many of those currently suing the credit raters, however, contend that they did not just offer opinions but worked with bankers to help create financial products and then, in effect, graded their own work. The raters “no longer played a passive role but would help the arrangers structure their deals so that they could rate them as highly as possible,” the California Public Employees' Retirement System, known as Calpers, alleges in a lawsuit. Calpers is the largest state pension fund in the country.

Several former rating company employees confirmed in interviews with the Huffington Post Investigative Fund that rating analysts worked closely with financial institutions as they created structured investments. Research documents produced by the raters and obtained by the Investigative Fund, as well as Securities and Exchange Commission reports, also provide a window into the raters’ role in the structuring process.

The lawsuits against the credit raters further allege that the ratings on these products were only distributed to a select audience. As a result, plaintiffs argue, the credit raters cannot receive First Amendment protection and should be forced to compensate investors who trusted their ratings.

This argument recently gained some traction in federal court.

"It's one thing to come in after the fact and say, ‘What a beautiful building.’ But it’s another if they first helped build the building." — Frank Partnoy, former investment banker

In September, a U.S. District Court judge in New York refused to throw out an investor’s lawsuit even in the face of a First Amendment claim. The investor, Washington state’s King County, lost about $100 million on products highly rated by Standard & Poor’s and Moody’s, their lawyers said.

King County’s lawsuit also highlights potential conflicts of interest plaguing the credit-rating business. Since the 1970s, corporations that issue bonds have paid the rating companies for their work. Critics claim this payment arrangement gives the rating companies the incentive to please bond issuers rather than investors.

Structured finance magnified the conflict — and the raters’ bottom line. In its lawsuit, Calpers said that fees for rating structured investments ranged from $300,000 to $1 million per deal — about three times higher than for rating corporate bonds. Consequently, as a 2008 SEC report to Congress pointed out, issuers of structured investments “have the potential to exert greater influence” on a credit rater than a company that issues traditional bonds.

According to the SEC report, the raters generally did not get paid for their work until a structured product was formally offered to investors. And the product often wasn’t offered unless it received a Triple-A rating.

To ensure this top grade was achieved, the rating companies and the bond issuers would be in “constant contact,” Frank Raiter, a former managing director for Standard & Poor’s, said in an interview. The financial institutions “would sit down with a rating analyst and they’d tell you what you need to do to get as many of the senior bonds rated triple-A,” Raiter said.

Occasionally, while profits were soaring, rating officials acknowledged publicly how the system worked. In 2007, Moody’s then-chief operating officer and president Brian Clarkson told a business magazine: "You start with a rating and build a deal around a rating.”

Now under fire, the credit rating companies say their critics are wrong to characterize ordinary discussions about a rating as any kind of collusion.

Floyd Abrams, a renowned First Amendment lawyer who has represented Standard & Poor’s for more than 20 years and has never lost one of their cases, said his clients “don’t structure” financial products.

“But they do engage in an iterative process — a give and take, a discussion with the entities that they’re rating,” Abrams said in an interview.

'Attractive Returns'

One such discussion began in early 2005 for the structured investment where King County and Calpers put their money.

Cheyne Capital Management Ltd., a London-based hedge fund, assembled an estimated $8 billion portfolio of securities, mostly backed by mortgages, to offer to investors. The product was a so-called structured investment vehicle, or SIV. In the last decade, hedge funds and banks popularized the creation of SIVs—spin-off companies that would raise money from investors and use the proceeds to buy securities with more lucrative returns.

Cheyne turned to S&P and Moody’s to rate its SIV, named Cheyne Finance, so it could start selling slices of the package. To attract big investors, the hedge fund wanted the slice that contained the highest-quality — or “senior” — assets to be rated triple-A, according to King County’s lawsuit.

A Standard & Poor’s research document obtained by the Investigative Fund suggests that — a few months before the Cheyne SIV was available to investors — the rating company helped the hedge fund figure out how to qualify for certain ratings.

The document, labeled “presale” and dated May 17, 2005, assigned a “preliminary” triple-A rating to Cheyne’s senior slice. It also described the steps Cheyne would take to maintain sufficient capital on its books, and in turn, its top rating. Keeping a cushion of capital theoretically protects a company from going bust.

“A variety of different scenarios were analyzed to determine the required level of capital for Cheyne Finance,” the document said. “Standard & Poor’s is comfortable that the minimum capital requirements ensure that under the tested scenarios the senior liabilities will be repaid in full.”

S&P also set forth particular “capital adequacy tests” that Cheyne “is subject to.”

The document does not make clear which party designed those tests. A July 2008 SEC report, which was based on in-depth examinations of several rating companies, described in general how the process worked. If a rating company concluded a structured product had insufficient capital to “support the desired ratings,” this conclusion “would be conveyed” to the issuer, who could then adjust the structure “to get the desired highest rating,” the report said.

In the Cheyne deal, discussion was not limited to the highest-rated slice of the SIV. For the lower-rated parts, Cheyne “will use the methodology described” by Standard & Poor’s, the presale document said.

S&P declined to discuss the document, citing ongoing litigation involving the Cheyne case.

Before Cheyne was even available for purchase, potential investors received the presale document as well as a prospectus advertising the unofficial ratings. The credit raters also had telephone conferences with Cheyne’s issuers “to help draft the language” in the prospectuses, according to the Calpers lawsuit.

The prospectuses made Cheyne’s SIV appear ideal for pension funds and other large groups hoping to protect their nest eggs. In one prospectus, Cheyne was pitched as “ground breaking”; the “First SIV to achieve two public ratings” on its lower-quality slices. Another advertisement, circulated in spring 2005 before the SIV became available, promised “attractive returns.” On a slice rated triple-B by S&P, the document predicted “hypothetical returns” of about 5 percent for the first couple years.

King County was sold on the deal. In 2007, the county invested about $50 million of a $4 billion fund that manages, among other things, school lunch programs. “They wanted the least risky space they could find,” said Patrick Daniels, an attorney for the county. Calpers invested $1.3 billion of its nearly $200 billion fund in three SIVs, including Cheyne.

'Oasis of Calm'

Within months, the housing market began to implode. Yet the credit raters assured investors that the ripples from the subprime mortgage collapse were not reaching Cheyne and other SIVs.

On July 20, 2007 — 10 days after it downgraded $5.2 billion worth of investments backed by subprime mortgages — Moody’s published a report titled “SIVs: An Oasis of Calm in the Subprime Maelstrom.”

The ”inherent diversity” of SIVs and their focus on highly-rated assets led Moody’s to expect SIV ratings “to remain stable.”

On Aug 15, 2007, S&P issued a similar report that said SIVs were “weathering the current market.”

Two weeks later, Cheyne’s issuers sent S&P and Moody’s a letter saying it was winding down the SIV because it was no longer meeting capital requirements. S&P quickly downgraded Cheyne’s rating.

Moody’s, on the other hand, put it on “review” for a “possible downgrade” but didn’t reduce some ratings to “junk” status until July 2008, Calpers alleged in its lawsuit.

Spokesmen for Moody’s and S&P argue that the reports are examples of their many well-researched publications on market trends and were not meant to encourage anyone to invest in SIVs.

Moody’s and S&P say that, for transparency’s sake, their general methods for grading structured products are publicly available online. But in some structured deals, their specific rating methods were not as transparent as the raters suggest. The July 2008 SEC report said: “Significant aspects of the ratings process were not always disclosed.”

The raters also say that any detailed discussions they hold with issuers are akin to a teacher providing students with grading criteria. Issuers are free to disagree with the raters’ opinions and take their business elsewhere.

Gary Witt, a former managing director for Moody’s, explained that as banks tinkered with their structured products, they would regularly seek feedback from the raters. The raters would evaluate the investments, and if necessary, explain why it didn’t qualify for a high rating.

“Because of the complexity of deals being done, and because the deals are changing a lot over the course of several weeks, a detailed back-and-forth was necessary,” said Witt, now a professor at Temple University.

However, Witt said he believes that SEC should step in to change the relationship. The agency, he said, could prohibit banks or hedge funds from advertising their preliminary ratings in prospectuses.

“The SEC should do away with this,” he said. “Then there wouldn’t be so much pressure to have this detailed back-and-forth.”

A Moody’s spokesman declined to comment for this article. Fitch did not respond to a request for comment.

'Intimately Involved'

In the most recent lawsuit filed against the raters, Ohio’s Attorney General accused the companies of being “intimately involved in structuring” investments that caused retirement funds for police officers, firefighters and teachers to lose $457 million.

Because the raters’ “fingerprints are all over” the investment documents, “the free speech claim is on much less sturdy grounds,” said Frank Partnoy, a former investment banker and current professor at the University of San Diego Law School.

“It’s one thing to come in after the fact and say, ‘What a beautiful building.’ But it’s another if they first helped build the building,” said Partnoy, who also is an expert consultant for the government, defense attorneys and plaintiffs, including investors who sue the raters.

In the King County case, U.S. District Court Judge Shira Scheindlin threw another potential wrench in the raters’ First Amendment defense. While tossing out almost all of the county’s claims, she said she was rejecting the raters’ request to dismiss the case on free speech grounds because Cheyne Finance’s ratings allegedly “were never widely disseminated” and were offered instead “to a select group of investors.”

A Moody’s spokesman disputes that allegation, noting that Cheyne’s ratings are published on the company’s Web site. But a check of the Web site shows that those ratings are inaccessible without a paid subscription.

Abrams, the Standard & Poor’s attorney, said he doubts Scheindlin’s ruling will be “truly harmful.”

“This case is atypical,” Abrams said, noting how Scheindlin reaffirmed that “under typical circumstances, the First Amendment protects rating agencies.”

But Todd Seaver, an attorney for Calpers, said he was encouraged by Scheindlin’s ruling. He said while it is arguable whether some ratings should be entitled to free-speech protections, when it comes to structured finance, the rating companies “are basically whispering in the ear of a select few people.”

This allegation poses the greatest threat to the raters’ free-speech protections, said Eric Talley, a professor at the University of California-Berkeley law school and a specialist in the credit-rating industry.

“If I got a case in front of me that says the ratings had a small dissemination,” Talley said, “I start to think, ‘Exactly what are the democratic ideals that we need to protect here?’ It doesn’t strike me as a place where we need constitutional protections.”

Maria Zilberman contributed research for this report.

Federal regulator gets derivatives advice from industry insiders

2011-10-12T14:39:11-04:00

Like many federal agencies contemplating reform these days, the Commodities Futures Trading Commission is hearing a lot from the industry it regulates.

But executives and lobbyists don’t always have to knock on the commission’s door. Some are already inside.

They belong to the Global Markets Advisory Committee, which was set up by the CFTC to provide it with private-sector expertise. All of the committee’s 19 members are representatives of financial exchanges, investment banks or other industry groups – an imbalance that is coming under fire from a key senator, farm and consumer organizations, and businesses such as airlines that are sensitive to commodity prices.

The committee, which operates below the general public’s radar, is one of hundreds of similar advisory panels throughout government. It is emblematic of the way industry players or technical experts with a vested interest in agency decisions can gain unfettered access to regulators and a platform to advance arguments in Congress.

A 1972 federal law, the Federal Advisory Committee Act, requires advisory committees to be “fairly balanced.”

The global markets committee has the ear of decision-makers at the CFTC, a government agency long viewed as permissive and now at the crux of a crackdown on the obscure world of privately traded derivatives. Those often-speculative insurance contracts wreaked havoc on the ailing financial system.

When the advising group gathers in December it will focus on derivatives reform. The meeting comes as CFTC Chairman Gary Gensler tries to impose oversight on trillions of dollars in bets on future prices of commodities such as oil and wheat, as well as more exotic mortgage debts. Advancing bills in Congress would impose more capital requirements on derivative dealers and move some trades onto open exchanges.

Such efforts don’t appear to mesh with one of the advisory committee’s formal purposes, described in its 2009 annual report, as “avoiding unnecessary regulatory and operational impediments to conducting global business.”

Jill E. Sommers, one of the CFTC’s five commissioners, chairs the advisory committee and chooses its members. A former industry lobbyist herself, Sommers is a Republican recently reappointed by President Obama.

Big banks and investment houses are using the committee “to protect their profits and their dark market activity. They want to have carte blanche – and they look at Jill Sommers as an ally,” said Jim Collura, a lobbyist for the New England Fuel Institute, one of the groups that has complained to Sommers about being excluded from the process.

Sommers did not reply to requests for comment.

The global markets committee, established more than a decade ago, is only one of some 900 formal advisory groups scattered across the government. Altogether, 65,000 committee members counsel more than 55 agencies, the Government Accountability Office said last year. By advising agencies such as the EPA, FDA and Energy Department, they influence standards for food safety, environmental protection and energy use.

Advisory committees can afford their members – often industry players or technical experts with a vested interest in agency decisions – unfettered access to regulators and a platform to advance arguments in Congress. In some cases, agencies have faced legal challenges for ignoring advisory committee recommendations.

“These committees can be really important and have a lot of influence,” said Wake Forest University law professor Sidney Shapiro, a specialist in administrative procedure and regulatory policy. “It’s hard to generalize, but this is cause for worry, and the public interest is disadvantaged.”

The global market committee’s charter requires it to “serve as a channel of communication” that includes “end users most directly involved in and affected by market globalization.” The charter further specifies that “market users” must be members.

But none of the committee’s members represent ordinary consumers, who may face hardships from the effects of speculative commodities trading, whether at the gas pump or from fluctuating prices of electricity. Even so-called end users – major industries such as airlines or power companies that use derivatives to hedge their risk— have no seat at the table.

That soon may change. Last week, the Huffington Post Investigative Fund contacted the CTFC about the committee’s membership. In an e-mail Monday, a spokesman said the agency is “in the process of expanding the committee membership to include end users.” The spokesman declined to specify who may join.

Seeking More Balance

Sommers, the CFTC commissioner and chair of the advisory group, was a top lobbyist for the International Swaps and Derivatives Association, the main trade group representing those working in the $600 trillion-a-year privately negotiated derivatives markets. Sommers’ former boss and current chief executive officer of the swaps trade group, Robert Pickel, is on Sommers’ committee.

Sommers also was a lobbyist for the Chicago Mercantile Exchange, now CME Group, where some derivatives are traded. The exchange’s chief executive and one of its board members also are on Sommers’ committee.

Among the committee’s other members: Richard Berliand, JP Morgan’s worldwide head of futures and options; Bonnie Litt, a managing director of Goldman Sachs; and Robert Klein, managing director and associate general counsel of Citigroup Global Markets. The committee also includes a registered lobbyist, Joanne Medero, who heads government relations and public policy for Barclays Global Investors.

Transcripts from the most recent committee meeting on July 15, 2008 indicate some preference for the status quo. Among other things, the members were discussing how tighter U.S. rules could affect the global market.

“It’s not helpful to have legislation that encumbers the good decision making of the CFTC,” said Craig Donohue, chief executive of the CME Group. Arthur Hahn, a lawyer representing Euronext Liffe, an international derivatives exchange, said “rulemaking tends to be hard and fast.”

Sommers was named to the CFTC in 2007 by George W. Bush and reappointed this summer by President Obama. She has chaired the global advisory committee since February 2008.

Shortly after Sommers’ reappointment, a coalition of multiple interests not represented on her committee – from consumer organizations to ranchers, power companies, and airlines – wrote her a letter complaining that the group was unbalanced. “Our organizations have an interest in seeing its membership diversified to include commodity end-users and consumers,” wrote Collura on behalf of the coalition.

Sen. Maria Cantwell (D-Wash.), agreed that the committee should expand its membership. During Sommers’ most recent confirmation last month, Cantwell extracted a promise from Sommers to include end users before scheduling the advisory panel’s next meeting.

But on Nov. 6, when the CFTC announced the next scheduled meeting for December, there were no additional members.

Pickel, of the International Swaps and Derivatives Association, downplays the committee’s influence. The CFTC “can decide to listen to us or not,” he said. “It’s really just a forum that allows the commission to cast a net to take in views across the marketplace.”

Still, he said, “I wouldn’t be surprised” if the committee added new members.

Serving Out Their Terms

Despite White House rhetoric about minimizing the direct influence of registered lobbyists, efforts at a crackdown have been soft. On Sept. 23, Obama appeared to call for an end to the membership of lobbyists on advisory committees – in the form of an announcement on a White House blog by Norm Eisen, the president’s special ethics counsel. Lobbyists and executives from Boeing, International Paper Co., IBM and 13 other companies and trade organizations quickly complained - and threatened to circumvent the requirement by having their lobbyists simply stop registering.

Obama hasn’t required immediate changes on the advisory committees. He has not issued an executive order, or dispatched an official memorandum to the heads of his agencies – other options available to the nation’s chief executive.

The result is that lobbyists, executives, scientists and others who have a stake in decisions made by the agencies they advise can hold their positions until their terms expire.

“It is the president’s desire that registered lobbyists not be appointed to federal boards and commissions, and that those registered lobbyists currently serving…be allowed to serve out their terms but that they not be reappointed,” noted Robert Flaak, an overseer of the advisory committees at the General Services Administration, in an Oct. 1 “guidance” letter to federal agencies.

Attempts to remedy imbalances in committee membership have foundered in Congress. Among others, Rep. Henry Waxman, the California Democrat who until recently chaired the House government oversight committee, repeatedly has proposed amendments to the 37-year-old advisory committee law. One measure passed the House last year only to fail in the Senate. This year, Waxman is trying again.

The composition and occasional secrecy of advisory committees has weakened the agencies they counsel, argued law professor Shapiro. “You either get bad advice or you’re just cooking the books – allowing special interests to game the process,” he said. Congress, presidents and the courts, he added, “have made it virtually impossible for these agencies to be hard-charging, effective protectors of the public.”

How credit raters fended off oversight from Congress and SEC

2011-10-12T14:16:45-04:00

Editor’s Note: This is the second of three articles by the Investigative Fund on the credit rating companies. Read the others here and here.

When the nation’s top credit rating companies came under attack in Washington in recent years, Charles E. Schumer often emerged as their strongest ally.

As recently as 2006, the senior senator from New York questioned whether new oversight legislation was necessary given that the companies, “located in the great city of New York,” were already “making good-faith efforts to improve the transparency of their ratings.” At a Senate hearing that spring, he encouraged the chairman of the Securities and Exchange Commission not to ignore the raters’ central argument against government interference — that their ratings of bonds are just opinions, protected by the First Amendment.

But a year later, as the nation reeled from an economic meltdown, the Democratic senator changed his mind. He lashed out at the companies for awarding top grades to bonds comprised of high-risk mortgages. When the bonds defaulted, investors lost billions.

“My particular bugaboo here are the credit agencies,” Schumer told a press conference in December 2007. “The investors who bought this can't be expected to know all the nooks and crannies.”

Schumer’s turnabout is at once a symbol of the credit rating industry’s past success on Capitol Hill and its more precarious future. Some of the same politicians who used to go to bat for the companies are supporting bills in the House and Senate that would mandate stricter oversight.

Yet passage of either bill is far from assured, and in the meantime the three big raters — Standard & Poor’s, Moody’s and Fitch — are spending record amounts to lobby lawmakers and regulators.

For years, the credit raters have stated that they are open to stronger supervision from Congress and the SEC. But behind the scenes they repeatedly have quashed or watered down potential government rules by arguing that, much like a newspaper editorial, ratings are protected by the constitutional right to free speech, according to a Huffington Post Investigative Fund review of congressional testimony, SEC documents and lobbying reports.

The companies say they gather facts to form educated opinions about the safety of bonds. Ratings are not, the companies say, guarantees that the bonds will or will not default.

So far the courts have agreed with the credit raters, but some specialists in constitutional and securities law find fault with the argument that a bond rater is akin to a journalist.

“To the extent that they are successful in claiming protections under the First Amendment, this could have rather dangerous consequences and seriously undermine the sense of transparency in the U.S. capital markets,” said Michael Siebecker, a University of Florida law professor and former arbitrator for the National Association of Securities Dealers.

Pushing Back the SEC

Investors rely on credit rating companies to be their eyes and ears in the bond markets.

The companies have been around for a century, growing increasingly important to the U.S. and global financial systems. When corporations, banks or local governments want to borrow money from investors, they issue debt in the form of bonds. The rating companies determine the likelihood of default by assigning bonds a letter grade — ranging from the safest triple-A to the “junk” bond status of C or lower.

Until the 1970s, the raters charged investors for their work. Then they shifted, assigning fees to the corporations that issue the bonds. Critics have claimed that the switch caused an inherent conflict of interest, giving the rating companies the incentive to please the bond issuers rather than the investors.

The idea that the companies needed more accountability gained traction at the SEC in the mid-1990s. But nearly every time the SEC has proposed credit rating regulation over the last 15 years, the companies have filed comments with the commission invoking the First Amendment defense, records show. In response, the SEC has often either abandoned or modified its attempts.

In 1997, when the SEC aimed to define the job of a credit rating agency, the general counsel for Moody’s filed a comment objecting that among other things new regulation would “Erode the First Amendment rights of all publishers of credit opinion.” The SEC eventually abandoned the plan.

In 2000, the SEC was pondering a crackdown on insider trading. If financial players selectively disclosed information to an interested party, the SEC wanted them to share the information publicly.

Moody’s spoke up and asked for an exemption for the credit raters. “The rating agency's role is analogous to that of a newspaper or magazine publisher, not to the role of a legal or financial advisor,” the company’s vice president said in a comment filed with the SEC.

The SEC approved the rule — and the exemption for rating companies.

‘On a Pedestal’

In the wake of the Enron scandal, the raters finally braced for a change. The companies had left high grades on Enron’s bonds just four days before it filed for bankruptcy in 2001.

At an SEC hearing in 2002, the commission's chief economist challenged the rating companies to voluntarily drop their free-speech claims. Leo C. O'Neill, then president of S&P, declined. “I don't think that we should be asked to waive our rights under the First Amendment,” he said.

No new rules arose from the hearings.

In 2003, the SEC did float the idea of having its staff inspect the companies’ rating procedures. O’Neill again rebuffed the SEC, this time in a comment filed with the commission. The plan “would likely run afoul of fundamental First Amendment principles,” his comment said.

The SEC’s plan never materialized.

Failing to impose rules on the credit raters, the SEC instead turned to a voluntary oversight plan. Jerome Fons, a Moody’s managing director, recalled in a recent interview that he was on vacation in March 2004 when the SEC called to pitch the idea.

Fons jumped at the plan, he said, and his bosses were receptive. “We thought it was great,” Fons said. The voluntary plan balanced the First Amendment protections with concerns that the companies were unregulated, Fons said.

Eventually, though, the credit raters learned that as part of the plan the SEC’s enforcement officers wanted access to some of their records. “That’s when the lawyers said, ‘No, that’s not going to happen,’” said Fons, who now consults on credit issues.

In an interview, Richard Y. Roberts, who was an SEC commissioner from 1990 to 1995, said the SEC “put the rating agencies on a pedestal.”

Roberts said he first warned the commission 15 years ago about the danger of lax oversight. “They did not use the authority they had, even though it wasn’t much,” he said.

An SEC spokesman declined to discuss decisions made under past SEC chairmen or the commission’s current regulatory proposals.

’That Would Be Pleasant’

On the wall of his Langhorne, Pa., law office, former congressman Michael Fitzpatrick hangs a framed copy of the bill that he had hoped would rein in the rating companies. It reminds him of both a legislative victory and a lost opportunity.

In 2005, as a freshman Republican on Capitol Hill, Fitzpatrick was alarmed that the rating companies were players in virtually every recent financial mishap yet had little oversight from the SEC.

“We believed that the rating agencies had consistently failed to perform their basic mission, which is to provide timely and accurate ratings,” he said. Meanwhile, the companies were enjoying record profits in 2005. Moody’s saw net income of $560 million and Standard & Poor’s reported $1 billion, including earnings from its S&P stock index.

So Fitzpatrick proposed a bill to allow the SEC to “take action against” the companies if they issued ratings that violated their own internal procedures. He met resistance. At a 2005 hearing, Rep. Paul E. Kanjorski (D-Pa.,) warned that Congress must be “very sensitive to the First Amendment issue posed in these debates.”

The legislation nonetheless passed the House in 2006, the first time either chamber of Congress had approved new oversight of the raters. (Kanjorski was one of the 165 Democrats who voted against Fitzpatrick’s bill. Kanjorski is now chairman of the House subcommittee on capital markets and the author of the pending credit rating oversight legislation.)

When the Senate took up Fitzpatrick’s measure, the rating companies brandished the free-speech defense. Standard & Poor’s submitted a memo to Congress that said the bill had “fatal constitutional defects.”

“Courts have repeatedly held that rating agencies are entitled to similar constitutional protections as, say, The Wall Street Journal or BusinessWeek,” Vickie Tillman, then executive vice president of Standard & Poor’s, told a Senate committee in March 2006. “This is so because the activities of rating agencies are fundamentally journalistic.”

At another Senate hearing in April 2006, Schumer, the New York Democrat, questioned then-SEC Chairman Christopher Cox about showing “sensitivity” to the companies’ First Amendment rights. Without those rights, Schumer said, investors might “threaten to sue” the rating companies or “bamboozle them, push them around.”

Schumer encouraged Cox to revive the voluntary oversight plan. "You might come up with something that makes everybody happy, and we won't have to legislate,” Schumer told Cox.

"That would be pleasant all around," Cox responded.

Schumer agreed: "Yes, it would,” adding that the companies still “need to be strictly regulated.”

Weakening the Bill

Despite Schumer’s efforts, Fitzpatrick’s bill advanced. But it carried an amendment — which records show was introduced by Sen. Mitch McConnell (R-Ky.) — forbidding the SEC from regulating “the substance of credit ratings or the procedures and methodologies.”

That echoed language in the Standard & Poor’s memo previously submitted to Congress, which had warned that SEC regulation of rating “procedures and methodologies” would “affect the substance of those ratings.”

The Senate’s amendment also parroted Schumer’s words at a hearing the year before: “The regulation of these entities should not mean dictating the content of their businesses.” The bill passed and was signed by President Bush in September 2006.

Fitzpatrick, who lost his seat in the 2006 midterm election, blames Schumer for weakening the law. “Mr. Schumer from New York became involved with doing their bidding,” he said. “A bill was passed that was much less reforming than what I shepherded in.”

In 2007, following the dictates of the new legislation, the SEC adopted rules requiring the companies to publicly disclose their rating methodologies, performance of their ratings and potential conflicts of interest. The SEC also aimed to prohibit credit raters from the “coercive or abusive” practice of slashing a company’s bond rating when the company refuses to buy additional ratings.

Schumer again intervened.

He and three other senators — Michael Enzi, a Wyoming Republican; John Sununu, a New Hampshire Republican; and Robert Menendez, Democrat of New Jersey — wrote Cox a letter in May 2007 to “express our concern” over the plan. The senators reminded Cox that the 2006 law required the SEC to enforce “narrowly tailored” regulations.

Four months later, it was clear the housing bubble was bursting, and the raters were vilified for misjudging mortgage-backed bonds. Schumer did an about-face. He announced at a September 2007 Senate hearing: “I will tell all of the representatives of [rating] companies that I have worked with and defended in the past — they're good New York companies — to say nothing went wrong, that ain't going to fly.”

He also has urged the SEC to sanction Moody’s if the commission verified allegations that the firm issued inflated ratings and covered up the error.

Asked to comment on the senator’s change in position about the rating companies, Schumer’s spokesman, Brian Fallon, said in an e-mail that the rating companies “treated their ratings as negotiable to please their clients, and ended up as one of the main culprits behind the economic crisis. As a result, Senator Schumer has been one of the lead proponents in Congress for drastically overhauling this industry’s business model in order to root out inherent conflicts of interest once and for all.”

Turning to Lobbyists

In the wake of the financial crisis, the credit raters say they have tightened internal controls and made it harder for products such as mortgage-backed bonds to receive rosy ratings.

All three big raters also have filed comments with the SEC encouraging some additional regulation. In September, the SEC approved rules that require the companies to make public all of their ratings, beginning with those issued in 2007.

Floyd Abrams, the renowned First Amendment lawyer who has defended Standard & Poor’s for more than 20 years, said that the SEC already has “significant oversight powers.” He said that another check on the companies is the market itself, because if the ratings aren’t credible the companies won’t be able to sell them.

Still, Abrams said, “I think that, in light of the events of recent years, more regulation by the commission is in the interest not only of the public but of the rating agencies.”

Moody's and Fitch declined to comment for this article.

Some aspects of Kanjorski's bill, now making its way through the House, concern the credit raters. They object, in particular, to a provision that would allow investors to sue the companies if it later turned out that they had failed to follow their own internal rules in assigning a rating.

Even stronger provisions emerged in the Senate on Tuesday, when Democrat Christopher Dodd of Connecticut unveiled his financial reform plan. Dodd’s plan would make it easier for investors to sue the credit rating companies if they could show the raters "knowingly or recklessly" failed to fully investigate a bond.

Facing the new pressure from Congress, the credit raters have stepped up their lobbying. In the first nine months of 2009, records show, the companies collectively spent almost $2.7 million, already $180,000 more than they spent in all of 2008 and the most they have ever spent in a year. Of the big three raters, Standard & Poor’s has spent the most so far this year on lobbying — about $1.5 million — though that amount includes some lobbying for its parent company, McGraw Hill. Standard & Poor’s lobbyists also have cast the widest net — taking their case to the White House, SEC, FDIC, Federal Reserve and Treasury Department, records show.

Recently joining the company’s campaign is the influential Podesta Group and its owner, Tony Podesta. His brother, John Podesta, was co-chairman of President Obama’s transition committee. The Podesta group also has Israel Klein, Schumer’s former communications director, lobbying for the rating company.

An S&P spokesman noted that the rating industry’s lobbying expenses are paltry relative to that of banks and other financial players.

Moody’s has spent $820,000 this year on lobbyists that include former Sen. Lauch Faircloth (R-N.C,) and former Rep. Vic Fazio (D-Calif.) The company also has hired a new lawyer--constitutional heavyweight and Harvard professor Laurence Tribe. Tribe was a law-school mentor to then-student Barack Obama and later became an adviser to Obama’s presidential campaign.

Tribe recently wrote a white paper for Moody’s about the rating companies and the First Amendment, which the company offered to share with Kanjorski. Moody’s declined to release the white paper to the Investigative Fund.

Maria Zilberman and Rachel Leven contributed research to this report.