One on One with John Coffee, Law Professor, Columbia University
Wednesday, December 05, 2007
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SUSIE GHARIB: Several powerful Wall Street firms have received subpoenas from the New York State attorney general's office over their role in packaging and selling debt tied to high-risk mortgages. Merrill Lynch, Bear Stearns and Deutsche Bank have been targeted, according to "The Wall Street Journal" today. The subpoenas are reportedly part of an overall investigation into the sub-prime mortgage mess. Specifically at issue, how well investment banks reviewed the quality of the loans they bought and packaged. The attorney general's office did not comment on the report. Joining us now for more analysis of this development, John Coffee, securities law professor at Columbia University law school. Hi Jack.
JOHN COFFEE, LAW PROFESSOR, COLUMBIA UNIVERSITY: Good evening.
GHARIB: Let's first talk a little bit about how well New York State Attorney General Andrew Cuomo go about this investigation and fact-finding mission. What's the process?
COFFEE: Well, he sent out subpoenas and you want to see what you get. I suspect one thing he'll look at are the e-mails. E-mails are really the greatest advance in law enforcement since the two-way radio, because all kinds of casual off-the-cuff statements may be made in e-mails. I think he'll have two focal points. Was there real due diligence being performed by the underwriters? Was there really high standards to the underwriting process or was this just in effect farming this out to third parties for a token look? That's question one. Was there any kind of real due diligence?
Question two is what is the relationship between the underwriters and the debt rating agencies? Structured finance and securitizations cannot be sold without an investment-grade rating and was there pressure placed on the debt-rating agencies? Were inducements offered to them? In that respect, this investigation could be quite reminiscent of the 2002 investigation that Eliot Spitzer undertook of the security analysts. They played the same role in the equity market the debt rating agencies play in the debt market. We found there that there were a lot of inflated recommendations because of pressure placed on them.
GHARIB: Well, it's all about relations (ph) and that investigation you're talking about is between the analysts and the investment bank. In this case, what is your thought about the credit rating agencies? Right now they have not been subpoenaed. But do you think that S&P and Moody's, for example, at some point will be investigated and look into how they analyze these security packages?
COFFEE: You should understand that the SEC is also looking at the relationship between underwriters and debt-rating agencies. I'm assuming nothing. You have to have evidence. You have to find the smoking gun. But if you were to find e-mails in which pressure was being brought to bear in which the agency was saying, we can't give this an investment-grade rating and they were gradually pushed to just move it over the end zone into the world of investment grade, that's the kind of process that I think the attorney general would have to act if he found that evidence.
GHARIB: How do you think that this is going to play out a year from now? Will there be enforcement action, penalties, fines? What do you think?
COFFEE: Well of course, you can't assume guilt. You have to find evidence. But if you were to find that pressure was being brought on the debt-rating agencies, then I think we're in exactly the same posture that Eliot Spitzer found himself in 2002 with respect to security analysts. And there, he wanted institutional reform. He wanted to reduce the conflicts of interest. There are all kinds of proposals that are out there. The strongest critics do not want the underwriters or the issuer paying the debt rating agency, saying that's a conflict of interest. I think that's a rather radical reform. But there are all kinds of other proposals to try to reduce conflicts of interest and if you find evidence that there was pressure and there were inducements offered, then I think we're going to see a demand for structural reform.
GHARIB: Real quickly, right now, Merrill Lynch, Bear Sterns and Deutsche Bank have been targeted. Do you think this is going to grow beyond those three banks?
COFFEE: Again, I think it depends on the evidence you find. Eliot Spitzer in effect ran into a treasure trove of evidence and smoking guns. You find that and this will balloon very rapidly.
GHARIB: We'll have to leave it there. Thank you so much Jack.
COFFEE: OK.
GHARIB: My guest tonight, John Coffee, securities law professor at Columbia University law school.
