Back on August 11, in "Climateer Quote of the Day: Hot Money and Emerging Markets Edition" I said:
...One of these days I'll get around to telling the story of National City Bank and their early adventures in securitizing sub-prime loans back in the 1920's.Well, it appears that Michael Perino beat me to it and that Felix Salmon recognized the relevant bits in Perino's new book.
National City is now Citigroup.
What was old is new again.
What did Wall Street used to be like, before the Securities Act of 1933? Michael Perino’s new book on Ferdiand Pecora, which I reviewed here, reminds us. For instance, there was National City Bank’s Peru deal.It appears that in the fast-paced world of arcane securities law history, "Ya snooze, ya lose".
National City’s South American experts had reported that the government’s finances were “positively distressing”, with the treasury “flat on its back and gasping for breath” and the president surrounded by “rascals”. Yet, inevitably, National City decided to underwrite a series of bonds from Peru. Nowhere in the prospectus was there any indication of National City’s view on the country; meanwhile, National City’s ads stated that “when you buy a bond recommended by The National City Company, you may be sure that all the essential facts which justify the Company’s own confidence in that investment are readily available to you”.
National City kept right on offering Peruvian bonds in 1927 and 1928, even though one of its own South American experts continued to conclude that he had “no great faith in any material betterment of Peru’s economic condition in the near future”. The political situation, he wrote, was “equally uncertain,” with “revolution” a distinct possibility. Would the public have purchased these bonds, Pecora asked, if that information had been included in the prospectus? “I doubt if they would,” Baker replied.Pecora did something similar with a bond offering for the Brazilian state of Minas Gerais. National City used much of the proceeds to pay off a loan due to itself, without telling telling investors that it was using their money to exit the very credit they were buying into. And that’s not all:
How Minas Gerais would use the proceeds of the bond offering was not the only misrepresentation in the prospectus. Pecora put George Train, the man who originally urged National City to underwrite these bonds, on the stand. Train, it seemed, was willing to play fast and loose with other crucial facts in order to get the deal done. In 1927, analyzing Minas Gerais’s history of bond offerings in Europe, Train was amazed at the shoddy way the government had handled its obligations. The “laxness of the State authorities,” he wrote in an internal company memorandum, “borders on the fantastic”. His review of Minas Gerais’s history “showws the complete ignorance, carelessness and negligence of the former State officials in respect to external long-term borrowing.” It would, he wrote, “be hard to find anywhere a sadder confession of inefficiency and ineptitude than that displayed by various State officials.” Despite those conclusions, Train wrote in the prospectuses for the bond offerings, “Prudent and careful management of the State’s finances has been characteristic of successive administrations in Minas Gerais.”I’m quoting Perino at length, here, because I’m getting a lot of pushback from various commenters to my assertion that pretty much every major investment bank in the world withheld material nonpublic information when they failed to pass on to investors the results of the due diligence tests that Clayton did on mortgage loan pools....MORE