Wall Street feels the heat

Tag : Heat Exchange System


It's that time of the boom-and-bust cycle when the Feds crack outthe handcuffs.
First in front of the cameras this time out, two heretofore obscurehedge fund managers from inside the defunct investment bank BearStearns. Matthew Tannin and his boss Ralph Cioffi, readied fortheir close-up, were taken in cuffs from Manhattan's FBIheadquarters last week and charged in a Brooklyn courthouse with afraud that cost their investors $1.6bn when the value of itsholdings in sub-prime mortgages collapsed.
The two men sat at the end of a chain of connections across themortgage and bond markets that has infected the entire financialsystem and threatens to plunge the United States into recession. Atthe other end, for millions of low-income homeowners unable to keepup payments on unsuitable mortgages, repossession looms.
It is an economic crisis and an election-year issue of such aproportion that the indictments of Messrs Cioffi and Tannin willnot be enough to satisfy public pressure for wrongdoers to bebrought to book. There will be more handcuffs. Bob Mintz, the headof securities litigation at the New Jersey law firm McCarter &English, said federal authorities will be painstakingly trying tobuild cases.
"In theory, the government is not supposed to respond to publicpressure, but clearly when there have been staggering losses onWall Street and investors have lost millions upon millions ofdollars, these cases rise up to the top of the list in terms ofpriority and there is a push to respond with criminal charges," MrMintz said. "Of course, the need to show a rapid response istempered with the need to build a successful case. The last thingthe Department of Justice wants is a high-profile acquittal. Itcould be that this Bear Stearns case becomes a bellwether and willdetermine if we see a wave of future indictments or if theDepartment of Justice decides that the subprime crisis is toocomplex and too systemic to sustain a prosecution."
Certainly the government is keen to show it has put a cop on thebeat. In an announcement timed to get on the same TV news reportsas the Bear Stearns arrests, the deputy Attorney General, MarkFilip, said the FBI was leading a "sweep" of the mortgage industryand had charged more than 400 people already, including 60 in oneday. Those named in the cases include housing developers, mortgagelenders and brokers, lawyers and estate agents, accused of aidingthe submission of fraudulent mortgage applications. Meanwhile, theFBI is investigating about 19 much larger mortgage-relatedcompanies including, according to leaks, the collapsed New CenturyFinancial and the biggest mortgage lender of them all, CountrywideFinancial, led by Angelo Mozilo, who became a favourite whippingboy of politicians on Capitol Hill because he repeatedly sold stockin the months before the company's fortunes deteriorated.
On Wall Street, the Securities and Exchange Commission and theDepartment of Justice are investigating whether banks and otherinvestors, including the insurance giant AIG, mislead investors byoverstating the value of their holdings in sub-prime mortgages andother credit derivatives. Other squalls that might yieldprosecutions include the gumming up of the auction rate securitiesmarket in February, when large brokers including UBS and Citigroupstopped supporting the market and hundreds of thousands ofinvestors who believed the securities were the equivalent of cashfound they could not sell them.
With so much to chew over, federal authorities have banded togetherunder local DoJ attorneys, creating "task forces" pulling inrepresentatives of the FBI, the SEC and even the US secret service,plus a slew of other local and federal agencies.
They need to follow a chain of evidence that might lead from asmall town homeowner whose income was mis-stated on a mortgageapplication, through the broker who encouraged or made themis-statement, via the lenders and up to the Wall Street banks thatbought and packaged mortgages into new securities, and then finallyto the banks and hedge funds which ultimately owned the mortgages.
There are accusations that banks and funds misrepresented the valueof the mortgage derivatives they owned, and the revaluations todate have cost more than $400bn in writedowns and sunk numerousfunds. Many in the finance industry, of course, say it is only inretrospect that it has become clear the securities were mispriced.In other words, we were stupid at worst, not fraudulent. That iscertain to be the defence of Messrs Cioffi and Tannin, who say theyare being made scapegoats for a market crisis that blindsided themin the same way it took others by surprise.
The legal threats to executives come not just from the federalgovernment and from ambitious DoJ attorneys – many of whomuse high-profile prosecutorial careers as a springboard for theirpolitical aspirations – but also from the states.Attorneys-general, the chief prosecutors in the states, arepublicly elected and responsive to popular outrage. Eliot Spitzer,New York's now-disgraced former attorney-general, harried WallStreet during the dot.com bubble, prosecuting conflicts of interestand extracting multi-billion dollar legal settlements that got himelected governor of New York and even talked of as a futurepresidential candidate.
Prosecutors in Connecticut, New York, Illinois, Massachusetts andOhio are among those who said they are looking into aspects of thefinance and mortgage industries. Mr Spitzer's successor in NewYork, Andrew Cuomo, for example, is investigating whether WallStreet banks withheld damaging information about the mortgages theypackaged into derivatives called collateralized debt obligations(CDOs) of the sort that the Bear Stearns hedge fund managersinvested in.
At this stage, there is little to suggest their investigations willtake them all the way to the chief executive's offices of the majorWall Street banks – but there is nervousness all round, andit could be years before all those ousted executives can feelcomfortable spending their pay-offs.
"In the Enron case, despite tremendous public pressure to act, ittook the government a number of years to bring a case," said MrMintz. "In this Bear Stearns case, the government has moved fairlyquickly because, although the sub-prime crisis was fairly complex,the criminal charges here are simple, a garden-variety fraudalleging these managers were telling the investing public one thingwhile really seeing a far gloomier prospect for the success oftheir funds. The question is whether they went beyond permissiblespin to outright fraud, and it remains to be seen whether theindictment will take on a different look once the full pictureemerges."