This story by Bloomberg is huge. With both the SEC and the US Attorney in San Francisco asking who knew what and when, this is not bean-bag.

It is especially serious when you understand US Attorney Joseph Russoniello’s career record. He is a former FBI agent and Reagan appointee who has never backed down, especially in the face of white collar crime. In fact, he is something of an expert in prosecuting this type of fraud. And, in an odd twist of fate, Russoniello also was the prosecutor in the Jonestown Massacre, specifically the murder of Congressman Leo Ryan.

In short, this is not a man who made his name jamming up 7-11 cashiers for selling too much Sudafed.

Bloomberg reports:

Prosecutors are examining whether Golden West Financial, the lender Wachovia bought for $24 billion in 2006, fraudulently pushed borrowers into expensive loans or altered paperwork to get them approved, Russoniello said in an interview yesterday. His office and the SEC are scrutinizing statements the banks made to investors about Golden West’s loans, he said.

In other words, Russoniello is working both ends of the problem. And something may have to give. Ken Thompson and crew bought Golden West because of the tremendous margins Golden was getting out of mortgage lending. This means they knew borrowers were being charged a lot for loans. What they denied knowing — and continue to — is the level of risk inherent in that Golden West portfolio. Thompson et al have used the stupidity defense.

But there is big problem with the stupidity defense that dogged prosecutors always dig out. You have to be stupid all the time not just when it is in your best interest. To wit, how could Thompson and his Wachovia execs be so clever to see that interest-only, Pick-A-Payment mortgages could be sold to customers who otherwise could NOT afford to borrow, yet so dumb not to see the higher risk inherent in lending money to people with little means to pay it back?

If Ken Thompson has not lawyered up already, he really is not too bright.