Investment banks have long disclaimed their culpability for the subprime crisis by arguing that they had been bamboozled by the AAA ratings that credit rating agencies had bestowed on instruments that were in fact very risky. That alibi is looking increasingly unlikely.
On September 23, 2010, D. Keith Johnson, the former president of Clayton Holdings, testified before the Financial Crisis Inquiry Commission that the rating agencies routinely ignored evidence that the loans they were rating "did not meet lending criteria promised to investors."
More importantly, he suggested that investment banks were well aware of the infirmity of the ratings. Clayton Holdings was hired by investment banks to analyze the mortgage pools they were bundling into securities. Johnson testified that an analysis of a sampling of the loans revealed that almost half of these mortgages failed to meet the underwriting standards laid out by the banks themselves. These findings were provided to the same investment banks that have been pleading ignorance of the risk associated with the loans they securitized and sold.
Worse, Johnson testified that Wall Street investment firms capitalized on Clayton's findings. Instead of informing the public about the risky loans, the investment banks used the information provided by Clayton to obtain the bad loans at a lower price from the issuing lenders. And, instead of passing these savings on to the public, the investment banks sold these mortgage pools at the same prices as the loans that actually met underwriting standards.