Introduction

As the subprime foreclosure crisis deepens, media sources are parading an endless array of subprime villains before our eyes: mortgage brokers, lenders, ratings agencies, banks, homeowners, regulators. Blame is plentiful, but it is also being spread very thin. Submerged in much of the analysis is the question of who, exactly, wielded power in this market, and who should be the primary focus of the accountability process that will unfold in the coming months and years.

Though there were many passengers on the subprime gravy train - and many others tied to the tracks - Wall Street's major investment banks were at the controls. They had the power to put a halt to the predatory lending rampant in the subprime market, but instead pushed subprime lending full steam ahead in order to reap massive, short-term profits - and record billions in bonuses.

Through their roles as mortgage securitizers, investment banks essentially financed the subprime lending boom. They paid high premiums for subprime loans, and they pushed lenders to deliver massive quantities of the kinds of loans that put borrowers in extremely precarious positions down the road, and are frequently indicators of predatory lending: hybrid adjustable rate mortgages, for instance, which carry a fixed teaser rate that jumps to a much higher adjustable rate after two to three years, or loans with prepayment penalties, which force borrowers to pay large fees in order to re-finance (70% of subprime mortgages carry these penalties, as opposed to 2% of prime mortgages).

These types of loan features were not in demand because homeowners wanted them. They were in demand because Wall Street wanted them.

Subprime mortgage-related securities were some of the most lucrative products on Wall Street over the past several years, and major investment banks did everything they could to pump up the supply of subprime loans in order to create, sell, and trade these securities. Billions in revenues and end-of-year bonuses were at stake, and bankers who worked in mortgage-related areas were rewarded handsomely over the past several years.

Of course, these securities would not have been nearly as lucrative if Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, Bear Stearns and other investment banks had not overvalued them using flawed mathematical models, sold yield-hungry investors on them, and repeatedly re-packaged them into numerous "innovative" and exotic financial structures - thus obscuring the actual value of the underlying mortgages.

The following is a brief summary of each section of the report:

Part I: The Subprime Motive. Investment banks’ subprime motive: billions in revenues and bonuses. Subprime-related bonds were the hottest products in the US financial markets from 2001 to 2006, and bankers who worked in these fields took home some of the largest bonuses on Wall Street.

Part II: Financing Subprime. Investment banks provided subprime lenders with essential funding. Investment banks forged agreements with subprime lenders to buy mortgages and supplied them with lines of credit that were tapped on a daily basis.

Part III: Setting Standards. Pressure from Wall Street caused spike in predatory lending. The investment banks pushed lenders to produce more loans with high rates and prepayment penalties, both of which signal predatory lending practices.

Part IV: "Making" the Market. Investment banks pumped up demand for risk-laden subprime bonds. Since investment banks "make markets" for these subprime mortgage-backed bonds, they were able to set inflated prices for the bonds and encourage investors to purchase the bonds, including financial products that were largely untested.

Part V: After the Binge. As bonus season approaches, investment banks are scrambling to hide losses. There have been large subprime-related writedowns at some banks, but analysts project that billions more are coming.

Part VI: $38 Billion in Bonuses.The big five investment banks are projected to pay out $38 billion in bonuses this year – even more than last year. Because revenues were strong through the first half of the year, the investment
banks are still preparing to pay out record bonuses.