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Mortgages may soon tempt Spitzer

Where will Eliot Spitzer strike next? Follow the money.

Other than mutual funds, the greatest store of wealth in the United States is mortgages. Fannie Mae, the biggest source of home mortgage financing, says the industry is worth $7.4-trillion (U.S.), or about $400-billion more than the mutual fund industry. Mr. Spitzer, the New York State Attorney-General who, depending on the rumour, wants to be mayor, governor, president or God, has given no hint he'll pry open garbage can lids in the mortgage market. But the smart people on Wall Street wouldn't be surprised if he did.

Mr. Spitzer is moving down-market. He first lunged at the Wall Street investment firms for tainted research. Merrill Lynch and its colleagues paid $1.4-billion to settle the charges. The probe made headlines but was, for the average American, little more than entertainment laced with schadenfreude. Henry Blodget, Jack Grubman and the other all-star analysts who used sugar-coated "research" reports to attract investment banking deals, weren't part of their world. Analysts didn't have a fiduciary duty to give investors the best advice and build their wealth.

Mr. Spitzer's next big investigation underwent a personality change. His targets were mutual funds (the most popular way to play the stock market), fund managers (who did have a fiduciary duty to their investors), and the owners of the fund companies (some of whom used sleazy trading techniques to put their own wealth creation ahead of the fund holders').

Last week, the scandal cost Lawrence Lasser, the CEO of Putnam Investments, the fifth-largest mutual fund company, his job. Yesterday, Alliance Capital Management, the biggest publicly traded U.S. money manager, ousted John Carifa, its president and chief operating officer, and Michael Laughlin, the chairman of mutual fund distribution, for "inappropriate market-timing transactions."

Almost every day, Mr. Spitzer's crew or the U.S. Securities and Exchange Commission expose more dubious dealings. The latest came from the SEC, which wants to know whether money managers funnelled shares in hot initial public offerings to their hedge funds, rather than to funds, like mutual funds, with lower fees. New regulations and corporate governance standards --a mutual fund equivalent of Sarbanes-Oxley-- seem inevitable.

The mutual fund investigation is moving quickly and will probably reach its apex before Christmas, when certain fund companies, as Mr. Spitzer has promised, will get whacked with civil and criminal charges. Then what?

Mr. Spitzer may take a breather. Or he may return to Wall Street, the scene of his first big kill. The message from Wall Street is: Go away, you've done enough damage, we're on something of a roll after three years in the tank, so don't ruin it for us. Taking a breather seems unlikely, if only because it's not Mr. Spitzer's style. If he continues to go down-market, that is, goes after targets that affect Middle America, the mortgage industry might be on his short list.

A taste of what might come happened earlier this year when both Fannie Mae and Freddie Mac, the two government-sponsored companies that buy mortgages from lenders to boost the efficiency of the mortgage market, stepped into the muck and sacrificed decades of goodwill. It was hard not to like the twins. By working with lenders to make sure they don't run out of mortgage funds, Fannie and Freddie helped millions of Americans from all income levels buy homes. Home ownership rates in the United States are at record-high levels and the housing boom made a good number of homeowners rich.

Freddie Mac got caught up in an accounting scandal, which, earlier this year, resulted in a $4.5-billion earnings restatement, a plunge in the company's share price and the loss of five senior executives. Fannie Mae, for its part, reported a $1.3-billion accounting mistake last month, after finding errors related to a derivatives accounting rule. For their sins, the Bush administration wants to move oversight of Freddie and Fannie from the Department of Housing and Urban Development to the U.S. Treasury Department, where financial scrutiny is bound to be more rigorous.

The direct mortgage market itself -- the world of banks and other mortgage lenders, mortgage brokers, real estate agents and other intermediaries -- was left untouched by the Freddie and Fannie fiascoes. What might an ambitious truth warrior like Mr. Spitzer go after were he to pounce?

Fees might be one area, just as fees made a guest appearance in the mutual fund scandal (Mr. Spitzer said mutual fund investors would save $10-billion a year if the fee structure were similar to that of pension funds). The relationship between mortgage providers and real estate agents might be another. Are they working in concert? Are banks involved in tied selling? For example, might they offer better terms if the prospective mortgage holder transfers other assets, such as investment funds, to the bank? Investigators might look at whether mortgage rates are as low as they can be, given prevailing bond or Treasury rates, or whether there's an undue lag time between falling interest rates and falling mortgage rates.

All this is just a guess, but the mortgage market might prove tempting. Like the mutual fund industry, it houses trillions in wealth, is full of trusting and perhaps gullible customers who can be tempting targets, and represents a lot of votes should Mr. Spitzer move into politics. The word on Wall Street is that Mr. Spitzer is just waiting for the right mortgage complaint to land on his desk.

ereguly@globeandmail.ca

© 2007 The Globe and Mail. All rights reserved.

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