I will start out with an analogy that will illustrate exactly what took place in a way that everyone can understand.
John Doe had a $70 billion-dollar home mortgage. John was having trouble making the payments and was running short on money for home repairs. John knew that he couldn’t qualify for a larger mortgage based on his real income or the home’s value. But that didn’t stop John.
John decided to have his CPA prepare a misleading and fraudulent tax return along with a financial statement and use that information to lie on his application for a new mortgage. John applied for a $71 billion-dollar mortgage refinance. The banker reviewed the application and immediately saw through the misleading tax returns and financial statements. The banker knew that John could not make the payments on this loan and that the dollar amount of the loan far exceeded the value of the house.
The banker was frustrated. He really wants to make the 2% in loan fees on the $71,000,000,000 mortgage. After all, 2% of $71 billion is roughly $142 million dollars. The banker decided to make the loan anyway hoping that John the borrower would refinance the loan with some other sucker down the road and pay him off. But just to make sure he would be okay, the banker hired a rating agency to give the loan a good rating so he could sell it to another bank and get it off his banks books.
Upon quick inspection, the rating agency saw that the loan was no good. The borrower did not really have enough money to pay the monthly payments and the home or collateral was not worth enough. The rating agency was frustrated, they wanted to make the tens of millions in fees by certifying this as a good mortgage. After some thought the rating agency figured out that the mortgage would likely be refinanced before it goes bad and decided to take the risk to earn those healthy fees. They issued a fraudulent rating.
The loan was sold and shortly thereafter defaulted. John the borrower stopped making payments and refused to cooperate with the new mortgage holder. When the mortgage holder started to investigate the loan, they found out that the income stated on the application did not exist and the value of the collateral, John’s home, was grossly overstated. Further investigation found that John stole much of the extra $1 billion of loan proceeds to fund his high flying personal lifestyle rather than make improvements to the property, as promised.
As the new mortgage holder started to take legal steps to recover their money, the borrower, the bank and the rating agency started to panic. They could go to jail for this.
Well, as we heard earlier, John the borrower stole the extra $1 billion from the refinance, the bank made $142 million in fees and the rating agency made tens of millions. Given the overwhelming evidence of fraud and dozens of other criminal charges they knew they had to act quickly.
John, the borrower, the bank and the rating agencies started to share some of the stolen money with Washington’s politicians. In return the politicians passed a new law stripping the current mortgage holder’s legal rights and prevented anyone from suing John the borrower. In addition, the politicians confiscated whatever value was left in the fraudulent mortgage and will determine later who they will give that money to.
That ladies and gentleman is the Puerto Rico financial crisis. Instead of a mortgage loan it was all done with municipal bonds.
All this information is widely available and the sworn testimony and documentary evidence is overwhelming. The FBI and the SEC have had all this information for almost two years and will not act against anyone. The politicians have made it clear that Wall Street and municipal agencies are off limits.
Richard Lawless is a former senior banker who has specialized in evaluating and granting debt for over 25 years. He has a Master’s Degree in Finance from the University of San Diego and Bachelor’s Degree from Pepperdine University. He sits on several Corporate Boards and actively writes for several finance publications.