Wall Street Has Ruled….Because of the Wall Street Rule

An edited version of this post originally appeared on Yahoo! Homes and is being republished on South Florida Law Blog with their permission.

I am often asked how Wall Street has managed to be so reckless, with little to no regard for its customers and its investors, yet avoid any real consequence for its actions.

The easy answer, if there is one, is that no one has really tried to change the very culture of the banking industry. Corrections have been at the micro level, yes, but these granular solutions have merely chipped away at the problems with mortgage securitization.

No one until this point has been bold or audacious enough to stand up to the banks. Maybe it’s because of fear of blowback from the bankers and their powerful allies, maybe it’s that the regulators and legislators actually don’t know how take them on.

Wall Street has always managed to have a defense that it always seems to fall back on whenever its motives are questioned.

Banks have used it so often there is actually a name for it. It’s called the Wall Street Rule.

Two Brooklyn Law School professors recently, and succinctly, brought attention to the Wall Street Rule and how it applies to the mortgage securitization engine. Bradley Borden and David Reiss correctly argue mortgage backed securities were flawed from the start.

By convincing Congress to ease certain tax restrictions back in 1986, these securities called REMICS were created and became a loophole to allow the banks to avoid paying income tax on millions upon millions of mortgages, which I alluded to back in August.

The banks defense to their over-bundling of REMICs, in their pursuit of endless profits, is pretty simple.

It doesn’t matter what we have done, the banks have argued, even if it’s illegal or unethical, because everyone else has done the exact same thing, The securitization engine has grown so large that if you change the game, you threaten the very fabric of the economy.

And most regulators have bought into the Wall Street rule, and have allowed the banks to dictate their own terms.

Which is why the news of Eric Schneiderman, the man behind the mortgage fraud task force, filing a lawsuit against JPMorgan Chase is such a shot across the bow to the status quo.

Now this lawsuit may not make headlines as much as seeing a banker in handcuffs would. The reality is that we as a society have not figured out how to hold a corporation in jail yet.

But Schneiderman’s lawsuit, the first major action for the Residential Mortgage Backed Securities Fraud Working Group is an action that many of us in the legal field have been waiting for some time.

Because here is a lawsuit that gives the proper weight to the systemic fraud and misconduct that has robbed Wall Street of its core purpose and good people of their homes.

Rather than looking at individual instances of fraud, Schneiderman has attacked the way Wall Street has been allowed to operate the securitized trust market.

Bear Stearns, which is now owned by JPMorgan Chase, lied to its investors and committed systemic fraudulent acts by promoting bad mortgages as ones of value.

Lured by the endless profits these securitized trusts provided, Bear Stearns dropped any pretense of standards in the way it processed these home loans, as the lawsuit states:

“Evidence demonstrates that, through their singular focus on increasing loan volume, Defendants sacrificed thorough due diligence – that is, the rigorous review of the loans that they told investors they undertook – and thus acquired and securitized loans without ensuring loan quality or adequately assessing the borrowers’ ability to repay”.

Schneiderman has finally acknowledged what I have been saying for years, that the rules of Wall Street are different than the rules for the rest of us.

It may not be the perp walk we were hoping for, but this might lead to the banks changing their business practices.

I expect that after months of speculation about how the RMBS Working Group would act, or if it would even act at all, that we will see more lawsuits that deal with the systemic fraudulent conduct that has been commonplace on Wall Street, up to and including the way the trusts were originally structured.

Banks have ripped off the government for hundreds of billions of dollars, if not trillions, by failing to pay taxes on REMICs, and as Borden and Reiss so elegantly state, the Wall Street rule has allowed Wall Street to continue to literally rule.

Maybe Schneiderman’s lawsuit will get us on the path to that long overdue perp walk and resetting the culture of Wall Street.

From The Trenches,

Roy Oppenheim