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U.S. Attorney General Eric Holder leads a news conference to announced that the United States is bringing a civil lawsuit against the ratings agency Standards & Poor's and its parent company, McGraw-Hill Companies, over its pre-fiscal crisis bond ratings.

That's what Matt Nesto and Jeff Macke at Yahoo Finance think, and you can watch them talk about it here.

The timing of the Justice Department's lawsuit against the credit rating agency — alleging that S&P fradulently overrated numerous mortgage-backed securites in the lead-up to the financial crisis — is a tad suspicious, surfacing as Washington is about to enter what could be a fractious debate over sequestration. 

Those automatic cuts could begin March 1 if Congress doesn't resolve or delay them. And hanging over the process, like Damocles' sword, is the threat that S&P in particular will downgrade U.S. debt again,  repeating an action that it took after the debt ceiling debate in 2011.

The Justice Department filed its 124-page complaint — which contains enough securities-market abbreviations (RMBS, CDO, SVP...) to thrill even the most jaded of finance geeks — in Los Angeles late Monday. Various reports suggest that state attorneys general will follow suit, with California's Kamala Harris and New York's Eric Schneiderman leading the charge. 

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Check out the above video, one of the series, of Michael Lewis in conversation with Jacob Weisberg of the Slate Group. It's a quickie but a goodie. Lewis covers a lot of ground. The young guns of Wall Street shouldn't have been getting paid $2 million! Credit default swaps (a) shouldn't have been invented — "innovation" in finance is not necessarily a good thing — and (b) were bound to lead to people betting against the securities, mainy home mortgages, they were based on.

But things really get interesting when Lewis starts sounding exactly like L. Randall Wray, an increasingly prominent economist from the University of Missouri, Kansas City, and a proponent of an increasingly popular new school of economics thinking called "Modern Monetary Theory" (some call it Neo-Chartalism). Wray also says the big banks need to be broken up. I've embedded a video below in which he discusses this idea. He's not exactly Michael Lewis. But the message is quite similar.

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A recent ProPublica/NPR report on Freddie May refusing to refinance mortgages for struggling homeowners shows that the market is still coming to terms with new ways of measuring risk.

There's a battle looming between Congress and the Federal Housing Finance Agency, the entity that's been responsible for mortgage giants Freddie Mac and Fannie Mae since the two were taken over by the government during the financial crisis. California and New York are also in the fray, given that those states' attorneys general have been resisting a mortgage settlement with big banks. But that resistance may be collapsing, now that principal writedowns are on the table. Meanwhile, the FHFA remains opposed to writedowns.

So what would principal writedowns entail? Well, the problem many homeowners are up against is that they owe more than their homes are worth. If they paid $300,000, with a 10 percent downpayment, the principal is $270,000. That's what they financed through the mortgage at whatever interest rate they were able to obtain. The monthly expense is made up of a payment that applies to the principal, the interest, and in may cases, insurance and property taxes. (And my example is boilerplate — in some regions, much higher loans, so-called "jumbo loans," make the situation more difficult.)

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Refinancing is a key way for homeowners to improve their bottom lines. But did Freddie Mac prevent borrowers from pursuing refis so it could make more money?

Yesterday's NPR/ProPublica story about Freddie Mac's refusal to refinance mortgages so that it can make more money on some high-risk parts of its investment portfolio has divided the blogosphere. As I noted yesterday, Matt Levine at Dealbreaker thinks that Freddie was absorbing a refinancing risk that it would find difficult to pass on to investors. Felix Salmon at Reuters disagrees and disagrees profoundly, basically saying that we should call a duck a duck and conclude the Freddie was putting its own returns above the needs of homeowners.

Arnold Kling thinks not, dismissing the idea that Freddie was engaged in pure speculation:

The authors describe this as only being bad. It is bad for homeowners because it reduces Freddie's incentive to refinance loans. It is bad for Freddie Mac because it means taking on more risk from these instruments. 

There is another possibility. In its normal course of business, Freddie Mac buys mortgages and issues debt, giving it a duration mismatch. These inverse floaters seem to have negative duration, which helps to offset that mismatch.

The article does not discuss the duration issue at all. Instead, it acts as if inverse floaters were a pure speculative play by Freddie Mac, which I think is unlikely to be the motivation.

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A recent ProPublica/NPR report on Freddie May refusing to refinance mortgages for struggling homeowners shows that the market is still coming to terms with new ways of measuring risk.

This morning, NPR and ProPublica fired a broadside at the government side of the embattled mortgage market, with a report on how Freddie Mac is refusing to refinance loans, reportedly because Freddie has developed a financial derivative that would suffer if interest rates on loans were lowered. Here's a sampling, and please note that there's something called an "inverse floater" at the core of the alleged problem. The Silversteins are a couple who have been unable to refinance their mortgage after doing a short sale on another property:

Here's how Freddie Mac’s trades profit from the Silversteins staying in “financial jail.” The couple’s mortgage is sitting in a big pile of other mortgages, most of which are also guaranteed by Freddie and have high interest rates. Those mortgages underpin securities that get divided into two basic categories.

One portion is backed mainly by principal, pays a low return, and was sold to investors who wanted a safe place to park their money. The other part, the inverse floater, is backed mainly by the interest payments on the mortgages, such as the high rate that the Silversteins pay. So this portion of the security can pay a much higher return, and this is what Freddie retained.

In 2010 and '11, Freddie purchased $3.4 billion worth of inverse floater portions — their value based mostly on interest payments on $19.5 billion in mortgage-backed securities, according to prospectuses for the deals. They covered tens of thousands of homeowners. Most of the mortgages backing these transactions have high rates of about 6.5 percent to 7 percent, according to the deal documents.

Between late 2010 and early 2011, Freddie Mac’s purchases of inverse floater securities rose dramatically. Freddie purchased inverse floater portions of 29 deals in 2010 and 2011, with 26 bought between October 2010 and April 2011. That compares with seven for all of 2009 and five in 2008.

In these transactions, Freddie has sold off most of the principal, but it hasn’t reduced its risk.

First, if borrowers default, Freddie pays the entire value of the mortgages underpinning the securities, because it insures the loans.

It’s also a big problem if people like the Silversteins refinance their mortgages. That’s because a refi is a new loan; the borrower pays off the first loan early, stopping the interest payments. Since the security Freddie owns is backed mainly by those interest payments, Freddie loses.

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