More mortgage chicanery turns up

In a nutshell, Wall Street banks propped up the market for mortgage-backed securities even as investors began to shy away from the complicated financial products, according to an investigation by ProPublica. The banks essentially created demand by buying portions of their own mortgage-backed securities that nobody else wanted. This may help explain why the housing bubble dragged out for as long as it did. ProPublica targets Merrill Lynch, Citigroup, and UBS and as among the primary culprits.

The products they were buying and selling were at the heart of the 2008 meltdown -- collections of mortgage bonds known as collateralized debt obligations, or CDOs. As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created -- and ultimately provided most of the money for -- new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those.

As banks became desperate to keep the money machine flowing, they were much less discerning about loan quality. That's why you started hearing stories about folks with little or no financial standing being approved for loans.

There were supposed to be protections against this sort of abuse. While banks provided the blueprint for the CDOs and marketed them, they typically selected independent managers who chose the specific bonds to go inside them. The managers had a legal obligation to do what was best for the CDO. They were paid by the CDO, not the bank, and were supposed to serve as a bulwark against self-dealing by the banks, which had the fullest understanding of the complex and lightly regulated mortgage bonds. It rarely worked out that way. The managers were beholden to the banks that sent them the business. On a billion-dollar deal, managers could earn a million dollars in fees, with little risk. Some small firms did several billion dollars of CDOs in a matter of months.

Still unclear is whether any of this was illegal. The SEC is looking into how deals were structured and whether banks pressured managers to take bad assets. But it seems like a tough case to prove, even if the circumstantial evidence is pretty damning. NPR's Planet Money worked with ProPublica on this story.