As the great credit crisis of 2007-2008 finally begins to lose steam, most people still don’t understand what the heck happened. For good reason. It’s confusing stuff. The terminology is complicated. The people aren’t well known. The pieces move around quickly.

To the rescue comes Roger Lowenstein, author of When Genius Failed and, significantly, a fine article in this past weekend’s New York Times Magazine. In a nutshell, Lowenstein explains methodically, and in some of the simplest declarative sentences you’ll find written in business journalism, how conflicts of interest at the credit-rating agencies — Moody’s (MCO), S&P (MHP) and Fitch — misled investors in mortgage-backed securities.

The conflict is straightforward, and I’ve written about it here before: The agencies make most of their money from fees paid by bond issuers and their banks rather than from the investors who rely on the ratings. Lowenstein neatly dismisses the credit agencies’ explanation that they did the best they could with the information they had at their disposal. In a pivotal passage, Moody’s walks readers through an actual portfolio of subprime mortgages that was packaged by an investment bank and rated by Moody’s. The actual names are obscured as “Subprime XYZ,” which is how Moody’s was willing to share the illustrative example with Lowenstein. Consider this passage:

The loans in Subprime XYZ were issued in early spring 2006 — what would turn out to be the peak of the boom. They were originated by a West Coast company that Moody’s identified as a “nonbank lender.” Traditionally, people have gotten their mortgages from banks, but in recent years, new types of lenders peddling sexier products grabbed an increasing share of the market. This particular lender took the loans it made to a New York investment bank; the bank designed an investment vehicle and brought the package to Moody’s.

Moody’s assigned an analyst to evaluate the package, subject to review by a committee. The investment bank provided an enormous spreadsheet chock with data on the borrowers’ credit histories and much else that might, at very least, have given Moody’s pause. Three-quarters of the borrowers had adjustable-rate mortgages, or ARMs — “teaser” loans on which the interest rate could be raised in short order. Since subprime borrowers cannot afford higher rates, they would need to refinance soon. This is a classic sign of a bubble — lending on the belief, or the hope, that new money will bail out the old.

Moody’s learned that almost half of these borrowers — 43 percent — did not provide written verification of their incomes. The data also showed that 12 percent of the mortgages were for properties in Southern California, including a half-percent in a single ZIP code, in Riverside. That suggested a risky degree of concentration.

On the plus side, Moody’s noted, 94 percent of those borrowers with adjustable-rate loans said their mortgages were for primary residences. “That was a comfort feeling,” Robinson said. Historically, people have been slow to abandon their primary homes. When you get into a crunch, she added, “You’ll give up your ski chalet first.”

This shows Moody’s understood full well that the mortgages were all subprime. This means
that, by definition, the mortgage holders had inferior credit, and that a giant percentage didn’t supply documentation to back up their income claims on their mortgage applications. Moody’s and others say they were victims of fraud. Yet they’ve admitted to Lowenstein that they were willing victims of fraud. A final note to Claire Robinson, the veteran Moody’s executive quoted at the end of that passage: People who can’t afford prime mortgages typically don’t have ski chalets.

It’s worth taking a step back here and asking what can be done about the conflict. I met Monday with Bill Hambrecht, the founder of the old Hambrecht & Quist [now part of JPMorgan Chase (JPM)] as well as his current firm, the dutch-auction promoter WR Hambrecht + Co. He told me it’s not simply that the ratings agencies curry favor with the banks. It’s also that the analysts at the agencies, who might make in the neighborhood of $100,000 a year, cozy up to the bankers they meet with because they’re interested in going to work for the banks, where they can earn a lot more money. Hambrecht’s solution: Empower the government to rate bonds, especially if the government requires certain kinds of fund managers to own only officially-rated bonds. Lowenstein, by the way, comes to essentially the same conclusion, though he doesn’t directly advocate a government-run ratings regime.

Someone I respect a lot thought my article in the current issue of Fortune about Gil Amelio’s latest venture was “a bit heavy-handed and gossipy.” The article, “A SPAC That Went Splat,” is about a special purpose acquisition company, also known as a blank-check company, organized by some prominent Apple (AAPL) alumni from yesteryear, including Amelio, longtime IBMer (IBM) Ellen Hancock and co-founder Steve Wozniak.

You can read my piece and judge for yourself its relative heavy-handedness, which I interpret to mean my having been unkind to Amelio, as well as whether or not the article is merely gossipy, again, which I suppose is a way of saying it is titillating yet trivial or irrelevant.

I’ve already mentioned that I respect my critic quite a bit, so I thought about the criticism. Unsurprisingly, I respectuflly disagree. This story is important because it’s one of managerial hubris and investor naivete. Amelio and his crew spun a tale of newfangled convergence and then went out and bought a plain-vanilla dog of a semiconductor company. Investors, wowed by big names and their association with an unqualified success — that would be Apple — forked over $176 million for Amelio’s SPAC. (It’s worth about $14 million today.) Never mind that Amelio hadn’t been at Apple for 10 years, that Wozniak had been gone longer and that Hancock’s last big effort was a Web hosting company that went kaplooey.

SPAC’s have an alarming level of respectability these days. Yet all they are is a bet on a management team. (My colleague Jennifer Reingold explained last year how they work here.) They’ve been called poor-man’s private equity firms, but even the worst private-equity shop makes numerous bets, not one, as a SPAC does.

Andrew Ross Sorkin recently wrote an entertaining column in the New York Times about one prominent SPAC. He ended with the observation that only one prominent investment bank, Goldman Sachs (GS), so far had stayed away from underwriting SPACs.

Exactly a month later The Wall Street Journal reported that Goldman will enter the field , though with a slight twist. It will allow management to own only 10% of the purchased company, rather than the typical 20%. As if that makes the whole thing virtuous.

Is it heavy-handed and gossipy to expose how management enriches itself, generates fees for investment bankers (including, potentially, the high and mighty Goldman Sachs), and pulls one over on investors?

I think not.

Frank is back.

Frank Quattrone, Silicon Valley’s most powerful investment banker in the 1980s and 1990s, picked a moment of maximum market turmoil to announce that he’s back in business. Yet despite predictions he’d start a private-equity firm, Quattrone instead is returning to his first love, straight-on investment-banking services to high-technology firms. His new outfit, Qatalyst Group, will start as a six-partner boutique in the mold of Greenhill & Co. (GHL), Evercore Partners and Moelis & Co., all firms started by former bankers at high-profile firms.

Another prediction that didn’t pan out: Quattrone’s new firm won’t include his former partners, George Boutros and Bill Brady, who together with Quattrone dominated the tech banking world for more than a decade as the team traveled from Morgan Stanley to Deutsche Bank to Credit Suisse, where Boutros and Brady remain. His five founding partners at Qatalyst are a group of 20- and 30-somethings, each of whom worked with Quattrone at Credit Suisse, though none was there immediately before joining Quattrone. The five are Jonathan Turner, 34, a former Internet banker and most recently a biz-dev executive at the online marketing company QuinStreet; Adrian Dollard, 38, the firm’s general counsel; Neil Chalasani, 29, who did a stint at Evercore; Brain Slingerland, 30, who decamped to Goldman Sachs after Credit Suisse; and Brian Cayne, 26, who came from Vista Equity Partners.

For a while, it looked like Quattrone’s name would be linked with the likes of Dennis Kozlowski and Jeffrey Skilling, both of whom are doing time in jail for crimes committed during the market mania that surrounded the dot-com craze. Yet Quattrone’s conviction on obstruction of justice was overturned and he was fully exonerated in 2006. He says he’d been thinking about starting a private-equity firm but decided instead to focus on what he knows best. “I’m more of a growth guy and a strategy guy,” he said, during a Tuesday-morning interview from his firm’s temporary offices in San Francisco.

For all the negative press Quattrone got during his trials, his support base in Silicon Valley remained remarkably strong. It showed in the big hitters he lined up for his firm’s inaugural news announcement. Google (GOOG) CEO Eric Schmidt, Intuit (INTU) Chairman and Valley consigliere Bill Campbell, Facebook investor and venture capitalist Jim Breyer, and Facebook CFO and former Yahoo (YHOO) treasurer Gideon Yu each lent their names to enthusiastic testimonials.

Quattrone says the new firm has no clients yet as it awaits approval of its broker-dealer registration, a process that could take up to six months. In the meantime, Qatalyst will operate as a division of JMP Securities (JMP), much the same way former UBS banker Ken Moelis operated initially as part of Mercanti Securities. Indeed, Moelis is more than a role model for Quattrone. He’s an example the kind of business Qatalyst hopes to win. Moelis currently is advising Yahoo on its defense of a Microsoft (MSFT) takeover bid, precisely the kind of assignment Quattrone wants to be in the position to take on. Qatalyst also will raise a fund for investing alongside its clients, though Quattrone says that initially the money will come from himself and his partners.

Quattone says that after some “soul searching” he realized that he doesn’t miss the empire-building and “liasing” with New York, Germany and Switzerland that went along with running outposts of major banks during the years he and his team backed iconic companies like Cisco (CSCO), Netscape and Amazon.com (AMZN). What he misses, he says, is giving “good, old-fashioned, honest advice.”

While Quattrone has been taking time to reflect, of course, his former minions have sprinkled themselves throughout Wall Street. Watching him and his new young recruits compete against them will provide some good, old-fashioned fun in Silicon Valley.

VMware (VMW) today joins the pantheon of Silicon Valley companies with the audacity to go public not only in the supposed doldrums of summer but in a rotten market to boot. Past honorees: Dearly departed Netscape from 1995 and Google (GOOG), in 2004.

The Palo Alto software shop, a unit of EMC (EMC) burst onto the public markets this morning by trading at $52 after being priced Monday evening at $29. Things have all gone very much as planned for VMware. As I noted in June, anlaysts expected VMware to go public at about $27.  Intel (INTC) and Cisco (CSCO) managed to get in before the IPO, buying sizeable stakes at $23 and $25 per share, respectively.

What’s so great about VMware and August IPOs? Let’s take those questions one at a time.

For all the hoo-hah about new this and new that — read: overhyped Web 2.0 companies you’ll never hear about a year from now — VMware actually solves a problem that matters to big technology buyers. Its virtualization approach allows companies with massive server farms to more efficiently use their server capacity. That simultaneously threatens the big server companies like IBM (IBM), Sun (SUNW) and HP (HPQ) and strengthens the market by making servers more valuable. VMware is the “it” company of Silicon Valley right now, again, among real companies that sell real products. Everyone wants to work with them. The company’s growth has been impressive, far better than that of its parent, whose best move of the past half decade turns out to have been buying VMware. (For the numbers on the growth, see the article I did in the print edition of Fortune; It was called “The next big Silicon Valley IPO.” Sometimes we get it right.)

As for August IPOs, is there some kind of magic? Netscape’s bankers told the company it was folly to go public in the heat of the summer. The company was confident. Google never worried about the month it went public. It fretted more over its auction method. Did VMware plan to do its IPO in August and in the midst of a market meltdown? Certainly not the latter. Still, its success today — and let’s remember, to continue to be a success it needs to keep rising, as Google did, not shrivel like Netscape — is a reminder that 1) there is plenty of capital for quality companies and 2) the markets don’t move in lockstep at all times.

I shuddered when I read the Wall Street Journal’s backward-looking but fascinating look at Lehman Brothers’ (LEH) role in the subprime mortgage debacle on Wednesday. Here’s a snippet:

Critics say Wall Street firms helped create the mess by throwing so much money at the market that lenders had a growing incentive to push through shaky loans and mislead borrowers.

It reminded me EXACTLY of what happened in Silicon Valley in the late 1990s. When I got here, a decade ago this month, I met all the bankers, who told me all about their high standards. If Goldman Sachs (GS) (or insert your other bulge-bracket investment bank here) was going to take a company public, you better believe it would be a high-quality, thoroughly vetted company, they said. Then, when their lesser competitors started taking companies public that the biggies previously wouldn’t have touched, Goldman and Morgan Stanley (MS) and Deutsche Bank and yes, Lehman, jumped right into the game. Standards? Hah. There was money to be made off commissions on IPOs. Reputation? Did I mention there was money to be made?

You get that same feeling reading the Journal’s piece on Lehman, which included, by the way, vigorous defenses by Lehman of its behavior. Fees were fat from assembling packages of subprime loans, and if the loans went bad it was going to be someone else’s problem. The fact that that someone else is the client of the investment bank doesn’t seem to have registered.

A recent Fortune Magazine cover trumpted a story about THE NEXT HOT SOFTWARE IPO. That hot company is VMware, and the banner was about a story I wrote, which I elaborated on in this blog posting.

In my article I sited research from Bernstein Research’s Toni Sacconaghi suggesting that if VMware is worth $10 billion, as many observers think it is, then its stock will price at about $27 per share. VMware itself recently weighed in on the subject of its valuation. According to an amended filing with the SEC, VMware made a gonzo stock-option grant to its employees, 29 million shares, on June 5 at a price of $23 a share. Sacconaghi says that equates to a valuation of about $8.5 billion, and he believes VMware is being conservative. Neither VMware nor its owner, EMC (EMC) – which is carving out a piece of VMware for the public to buy – is commenting on when the IPO will happen.

But it’ll be interesting if the IPO happens at a price significantly above $23 in the near term. If so, then employees would have gotten options at a price much lower than the new valuation. That’s often referred to as cheap stock, though VMware will make the case that, as the June 5 grant was made in consultation with its bankers, it’s a fair price and doesn’t require an additional compensation expense that cheap stock typically would entail.

In the unlikely event VMware prices below $23, not only might the stock be a bargain, but you’d have a lot of at least temporarily unhappy employees there.

It’s tough to be the top dog. Goldman Sachs (GS) probably will learn this over and over. Far and away the leader of the new investment banking/private equity/hedge fund hybrid category, Goldman is an easy mark for anyone who wants to criticize any of the above sub-species of financial animals. I’ve taken my shots, highlighting Goldman’s multiple roles in a entry called No conflict, no interest.

Now short-seller superstar James Chanos has slammed the whole firm with a dig at Goldman over a dispute he’s having with one managing director, Marc Spilker. Chanos is mad at Spilker over some allegedly despoiled shrubbery between their vacation homes in East Hampton, N.Y. Basically accusing Spilker of playing fast and loose with the rules, Chanos wrote in an email published by Conde Nast Portfolio.com: “I hope this is not a harbinger of how other Goldman senior executives may act when the markets become ‘just not lucrative enough for us!’” Ouch. Another account appears in today’s New York Post.

It’s a little amusing how few people know about VMware, the EMC (EMC) unit that’s going to go public some time this summer. I’ve tried very hard over the years not to write next-hot-IPO stories. That’s what the bankers want to see written, but articles like that don’t always help investors. I did write one back in 1998 about a young Internet company called eBay (EBAY). “Believe the hype,” was how I put it. Anyway, VMware is similar. Institutional technology investors already know all about VMware. Retail investors don’t. Because I think the deal — a 10% carve-out of VMware as an independent company, with EMC retaining the rest — will do well doesn’t mean you should buy at any price. Want to learn how to play it? Read my article about it in the new issue of Fortune here.

June 6 addendum:

Since posting this entry I’ve had two questions from readers that are worth adding right here. The first asked who the six investment bankers are on this deal, presumably so the reader can figure out where to buy shares. They are: Citi, JPMorgan, Lehman Brothers, Credit Suisse, Merrill Lynch and Deutsche Bank. The second reader wanted to know if existing EMC shareholders will receive shares in VMware. The answer is no. This is a carve-out, meaning EMC is selling a 10% stake in VMware and retaining a 90% stake. Unless you buy VMware shares, the only investment you will have in VMware is an indirect one, through your investment in EMC.

That’s the joke, anyway, among firms and people with built-in conflicts of interest in their jobs. Lawyers, for example, who know everybody in town — and represent most of them. Labor organizers who have relationships with governors. And investment bankers whose own firms have buyout arms.

As I reported my recent article on Kinder Morgan (KMI), I asked numerous buyout investors not involved in the deal if they were bothered by the role Goldman Sachs (GS) played as advisor, investor and debt financier. The typical response was that there was enough work going around and so it wasn’t such a problem. That may be about to change. A handful of private-equity firms, including Blackstone, Providence, KKR and Carlyle, are complaining that they weren’t treated fairly in the sort-of auction for Alltel (AT) claimed by …. TPG and Goldman Sachs. Goldman’s investment banking unit is advising the buyers in this deal.

It’s a complex deal – aren’t they all? – and some good explanatory stuff can be found in this Wall Street Journal Deal Journal entry as well as in reporting by Andrew Ross Sorkin in The New York Times. (Note Sorkin’s fascinating tidbit about how the winning group exceeded debt-to-equity levels set out by management in the bidding process. Also note the WSJ’s contention that Alltel management wanted to end the process quickly because it was concerned someone else would launch a lowball bid. That doesn’t make a helluva lot of sense.)

The point here is that what passes as business as usual in good times starts to get new scrutiny as deal conditions become stricter and fears begin to rise that we’re seeing a top in the buyout boom.

I have an article in the current issue of Fortune (the full text is here) about the $15.2-billion deal to take private Kinder Morgan Inc., (KMI) a natural-gas pipeline company in Houston. We put it online today. This story has lots of big names on Wall Street: Goldman Sachs (GS), which is the deal’s investment banker, lead investor and debt-syndicate leader; Carlyle Group, another major investor; Blackstone Group and Morgan Stanley (MS), who advised the company’s board of directors; and CEO Richard Kinder himself, a former president of Enron and one of the most brilliant operators and financial engineers in the energy business.

It’s a complex  story because it’s a complex deal. But through this one company you can understand all the cross-currents at play in the world of private equity today. Here’s a snippet:

It’s not just the war chests that are bigger this time; the potential conflicts of interest are too. Wall Street investment banks have plunged full force into the private-equity business, further clouding their already compromised judgment as corporate advisors. “Hostile” takeover bids by buyout firms have become far less common, as corporate managers have learned to share in the lucrative paydays that PE firms promise.

And the temptations have only become greater with the proliferation of so-called club deals, in which multiple private-equity firms team up to make bigger and bigger offers, which typically go unchallenged, for companies previously considered too large to devour. In October the Justice Department said it was beginning a preliminary investigation into potentially anticompetitive behavior by private-equity firms in club deals.

Since we went to press there’s been another interesting development in the story, one that Kinder Morgan hasn’t bothered disclosing yet to shareholders. In late April the California Public Utility Commission issued a preliminary ruling that would allow the deal to move forward by late May. The California regulator is involved because a group of oil companies  –Valero (VLO), Ultramar, BP (BP), ExxonMobil (XOM) and Chevron (CVX) – opposed the merger as part of a longstanding business dispute having to do with rates Kinder Morgan charges to transport oil on its pipelines. This week the oil companies asked the commission to delay its final ruling pending Kinder Morgan’s adherence to certain conditions requested by the oil companies. If the CPUC rules against Kinder Morgan, this deal could get delayed as late as September. If the commission rejects the request, Rich Kinder could get his company by Memorial Day.