"The Only Thing You Can't Hedge is Fraud"

Despite my many years in the financial industry I am still amazed at the amount of fraud that permeated the US markets, especially when it came to accounting-thank you Mr Lay, Mr Kozlowski and Mr Ebbers.

So when I reflect that one of the biggest con men, Bernie Madoff was elevated at one point to be Chairman of the NASDAQ and was the third largest OTC stock trader in the United States I am dumbfounded by anyone who still promotes the idea that self-regulation works.

So it was with total disbelief this morning that I read that only now are California mortgage brokers coming under closer scrutiny as the state adopts a federal law in an attempt to halt the fraud and abuse that helped destroy the housing market. And get this, the federal law was only enacted on July 30, 2008-after the horse had bolted!

So the guys providing sub-prime mortgages will now be required to pass criminal background checks, credit checks, and oh horror, licensing exams. As of January 1, 2010.

Now these rules were developed after investigators learned that there was rampant lending to people who either couldn't afford to repay their loans, or never intended to. Now there will even be Broker ID's so that authorities and borrowers will be able to track their lending histories.

All of this makes sense. What I don't understand is what the regulators were thinking before all this happened. It is nice that Senator Dianne Feinstein, (D) California, a co-sponsor of the federal legislation has recognised that the federal and state rules were essentially non-existent. But why does it always take a crisis to put in simple rules?

I also wonder what Ms Feinstein and her co-sponsors were thinking when they decided that federally regulated lenders i.e. banks won't require testing for mortgage brokers? Her answer was that brokers at banks are exempt because they are "already regulated and overseen by a number of federal agencies". Well now I can sleep at night given the record of the federal regulators.

The regulator overseeing the federal regulations would also like to impose licensing requirements for employees handling loan modifications for homeowners struggling with their loan burden. Not surprisingly the Mortgage Bankers Association and banks in general oppose this legislation-"it would slow hiring...."

When the CDO's of ABS-basically pools of mortgages sliced and diced into the CDO structure were all the rage the equity or first-loss piece of a pool of AAA mortgages engineered into a CDO yielded over 20%. It seemed like shooting fish in a barrel so I asked the head of CDO origination what the real risk was. "Fraud" he said. "We can look at all the loans, even the documentation, but if fraud is involved, we're screwed".

I didn't buy the equity piece.