It’s often the travail of a blogger, and small media generally, to have its story picked up by bigger fry without acknowledgment. But it’s one thing when a writer suspects having made a contribution to another’s story (there is, after all, the possibility of parallel inquiries bearing fruit on different timetables); quite another to have firm grounds for knowing a journalist was aware of your work.
I’m of two minds in writing this post. ProPublica has gone to some lengths to publicize CDO abuses, which we have long considered to be central to the crisis, yet not to have gotten sufficient attention because, well, CDOs are hard. Complexity, opacity and leverage, branded as “innovation,” have served the financIal services industry well, often to the detriment of customers and taxpayers. Yet many accounts of the crisis, in classic drunk under the streetlight fashion, have tended to focus on phenomena that are comparatively easy to understand. So we and ProPublica are on the same side in this process, that of trying to unearth bad practices in the hopes of supporting other efforts to curb them.
But we are puzzled at how chary ProPublica is in giving credit to aligned efforts. This wouldn’t be so troublesome were they not making bold claims about their own work. Their latest release is on CDO managers, a topic which has come under increasing focus. Note the section we have highlighted from their latest piece:
A ProPublica analysis shows for the first time the extent to which banks — primarily Merrill Lynch, but also Citigroup, UBS and others — bought their own products and cranked up an assembly line that otherwise should have flagged.
“First time” is a strong claim. It can be read as referring narrowly to a the particular study commissioned by ProPublica. But the problem is that there are prior efforts, with real analytical underpinnings, that have covered this terrain.
Consider this section from a May 2007 paper by Joe Mason and Josh Rosner, “Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptionsm” an article we have pointed to repeatedly:
Without investors willing to purchase the last classes of securities – typically, about 10 percent of the securities sold – the prior classes bear the risk. If the prior classes are not willing to bear the risk, the other 90 percent of the mortgage pool cannot be funded, that is, the mortgage originator cannot sell the loans. Hence, the last classes of securities are providing about 10:1 leverage for the structure of RMBS, so that every dollar of lower-tranche RMBS supports about $10 of higher-tranche RMBS.
Specific types of CDOs have arisen that specialize in holding such risky classes of securities have become popular in recent years, providing a great deal of funding for lower-tranche RMBS at that 10:1 leverage ratio…. the 90 percent of the RMBS structure above the lower-tier (junior) tranches cannot be sold until those 10 percent lower-tier (junior) tranches are sold. Because the 90 percent of higher-tier (senior) securities in an RMBS cannot be sold without selling the 10 percent of lower-tier (junior) securities first, even a small decline in CDO funding of mezzanine RMBS investments relative to the total RMBS market can have a large effect on RMBS funding, and therefore consumer mortgage funding…
This early work admittedly does not provide a percentage estimate of RMBS sold to CDOs, but the flip side is that Mason and Rosner had found the dead body in the room, that CDOs were keeping the subprime market going and would be a crucial point of failure, BEFORE the CDO market had started to implode.
And in May of this year, Jody Shenn of Bloomberg came up more spadework on the role of CDO managers, focusing on three CDOs, Neo, 888, and Octonian underwritten by Merrill and managed by Harding, headed by Wing Chau. Harding was a de facto captive CDO manager of Merrill but was presented as independent. Note that ProPublica focuses on these same two deals in its account:
Neo CDO Ltd. was a complex construction. More than 40 percent of its holdings were slices of collateralized debt obligations sold by Merrill, according to Moody’s Investors Service and data compiled by Bloomberg. Many of those were CDOs made up of other CDOs backed by bonds linked to home loans. About one-sixth of Neo was invested in junk-rated debt….
Managers such as Chau were at the center of a financial machine that pumped out more than $200 billion of mortgage- linked CDOs in the months before the subprime crisis spread. They picked the securities that went into CDOs and held themselves out as independent agents. Now potential conflicts of interest and questions about what banks disclosed have drawn regulators’ attention….About two-thirds of his [Chau's] business came from Merrill, according to Bloomberg data.
Shenn’s article also discusses, with data, the troubling relationship between Merrill and Citigroup CDOs, in what appears to be mutual backscratching masked by complicit managers like Harding, another focus of the ProPublica story.
As we alluded at the outset, ProPublica cannot claim to be unaware of the work on CDO managers that Tom Adams has published on this blog. He had lunch with Jake Bernstein and Jesse Eisinger in April, the week after publishing a post entitled “The Myth of Insatiable Investor Demand.” The piece was in response to the testimony of Citigroup officials before the FCIC as they tried to excuse their failures by blaming continued investor demand for the CDOs. Despite the common perception in the mainstream media and the insistence of the Citi executives, third party investors were not demanding more CDOs. In reality much of the demand came from other CDOs the banks were creating and from the banks themselves. As a result, the meme of “investor demand” was an illusion, the same one noticed by Mason and Rosner in 2007, and the banks and CDO managers were clearly to blame for failing to police for deflating market well before it ultimately collapsed.
Not surprisingly, the lunch conversation included considerable discussion of the dubious role of CDO managers.
While we are pleased to see the depth of reporting that Pro Publica has dedicated to issues that we have long felt were poorly understood by regulators, law makers and the investing public, we are troubled by not simply a lack of attribution, but an effort to deny (the “first time” claim) the substantial efforts others have made on this topic. We’ve also found evidence of other patterns of collusion and market manipulation not covered in ProPublica’s piece. This matters because those reading ProPublic’s assertion of the definitiveness of its work might be dissuaded from looking for other reports on this topic.
We are hopeful that even though Goldman has settled with the SEC on the Abacus transaction, the ProPublica article, which is detailed and written to engage lay readers, will bring renewed interest among the mainstream media, regulators, lawmakers and even private litigants on the problematic practices of the banks and CDO managers. These are issues near and dear to our hearts. As we wrote,
[R]iskier and riskier loans were being originated at effectively lower costs for issuers with little outside feedback. In one big happy family among the mortgage issuers, CDO managers and CDO investors, there would have been little motivation to worry about increasing risk or wider spreads. They were all keen to keep the great fee machine rolling.
We remain puzzled as to why ProPublica seems loath to acknowledge aligned efforts, particularly when we are working towards the same objective. We commented on it regarding ProPublica’s Magnetar story, where they were presumably in the awkward position of having invested substantial effort in a story, then to have an independent party beat them to the punch by six weeks, and unearth critical details (the structure of the deals and most important, their systemic impact) which were absent from their investigation. We we far from the only parties to notice a repeat; we received sympathetic e-mails from journalists and readers, the funniest being from John C. Halasz, “You’ve been, er, retro-scooped once again.”
Giving credit to people who have made a contribution to your efforts is the norm in academia and blogging. Why are journalists, particularly ones with established reputations, so reluctant to do the same?