Last March, Scott Coren and Michael Nannizzi, analysts at Bear Stearns, issued a report upgrading the stock of New Century Financial, a company that provides sub-prime mortgages to low-income homebuyers, from "underperform" to "peer-perform."
California-based New Century's stock rallied on Coren and Nannizzi's research note to investors, rising 3% in afternoon trading on Thursday March 1, 2007, to close at $15.78.
In April 2007, a month after the analysts issued their somewhat upbeat report, New Century filed for bankruptcy protection due in large part to the massive number of borrowers who were defaulting on their loans.
The move by Coren and Nannizzi, as well as an analyst at UBS who, in February 2007, also upgraded the mortgage company's stock, to lead investors into believing that New Century was undervalued and on solid footing underscores how little Wall Street has learned since Enron imploded in a wave of accounting scandals in 2001.
The historic, unprecedented federal bailout of Bear Stearns over the weekend came as the company engaged in questionable trading practices and allegations that it failed to inform investors the true financial condition of its subprime investment business.
Bear’s collapse represents the failure of federal regulators to enact reforms in the $6.5 trillion mortgage securities market, an industry far bigger than the United States treasury market.
“The regulators are trying to figure out how to work around it, but the Hill is going to be in for one big surprise,” said Josh Rosner, a managing director at Graham-Fisher & Company, an independent investment research firm in New York, and an expert on mortgage securities, in an interview click here with The New York Times in November. “This is far more dramatic than what led to Sarbanes-Oxley,” he added, referring to the legislation that followed the WorldCom and Enron scandals, “both in conflicts and in terms of absolute economic impact.”
Federal regulators have been slow to act, despite the obvious warning signs (an increase in foreclosures and loan defaults), because the housing market drove the economy over the past five years and Bear Stearns led the pack as one of Wall Street's top underwriters of mortgage backed securities. That meant that Bear's financial stability was tied directly to the repayment of loans at the mortgage firms it was underwriting.
Indeed, what Coren and Nannizzi's research note on New Century didn't say was that Bear Stearns was one of the Wall Street banks that financed New Century's mortgage operation. Their positive report on the company seemed to be about protecting Bear's investment and the bank's bottom line than it was about providing investors with sound financial advice.
As with Enron and WorldCom, sell-side firms such as Bear Stearns issued biased stock recommendations during the housing boom in the hopes that they would win investment-banking business. And when the bubble burst the banks continued to reassure investors until dozens of mortgage companies such as New Century closed their doors or ceased making loans available, which lead to a massive sell-off of banking stocks.
William Galvin, Massachusetts' secretary of the commonwealth, subpoenaed Bear Stearns and UBS just two weeks after Coren and Nannizzi issued their report on New Century in March 2007, demanding the firms turn over their research documents into New Century. Galvin alleged that Bear and UBS violated a 2003 global research settlement following the Nasdaq crash of 2000 in which Wall Street firms paid hefty fines and promised to keep their sell-side away from the investment banking side after regulators accused analysts of writing biased research reports in order to win lucrative investment deals from the companies the analysts covered.
"Recent revelations that research analysts issued positive reports on mortgage lenders...even as those companies faced more and more defaults suggests that the commitment of 2003 has not been met," Galvin said in a prepared statement at the time. Glavin had worked closely with then New York Attorney General Eliot Spitzer on the settlement. Spitzer resigned as governor of New York last week after he was alleged to have been a customer of an escort service.
Still, at least one savvy trader saw through Coren and Nannizzi's overly optimistic report on New Century and acted accordingly. Last March, the trader commented on a popular financial message board click here last year that Bear Stearns was "trying to cover its own behind with that upgrade."
"The question on everyone's mind should be, "How much are they on the hook for?" the commenter asked, before signaling that he intended to short Bear's stock. No doubt that the savvy trader is a very rich person today. Bear was sold to JPMorgan Chase for $2 a share last weekend in a deal brokered by the Bush administration.
In November, Glavin reemerged accusing Bear Stearns of an inherent conflict-of-interest when it engaged in trading with two hedge funds the firm managed that specialized in mortgage securities that suffered $1.6 billion in losses and eventually filed for bankruptcy.
Glavin filed a civil complaint against the bank saying it violated securities laws and its own internal regulations by failing to inform the hedge funds' independent directors that it had traded mortgage securities from its own accounts with hedge funds that it also advised. Glavin claims Bear Stearns violated the US Investment Advisers Act of 1940, which bars such transactions unless hedge fund clients receive prior notification in writing about self-dealing and agree to the transaction. That case is still pending.
Jason Leopold is editor of the online investigative news magazine The Public Record, http://www.pubrecord.org, and the author of the National Bestseller, "News Junkie," a memoir. Visit www.newsjunkiebook.com for a preview. He is also a two-time winner of the Project Censored award, most recently, in 2007, for an investigative story related to Halliburton's work in Iran. He was recently named the recipient of the Military Religious Freedom Foundation's Thomas Jefferson Award for a series of stories he wrote that exposed how soldiers in Iraq and Afghanistan have been pressured to accept fundamentalist Christianity.
This final act is part of a play that has been getting rave reviews on Wall Street for thirty years, kicked into a high-kicking finale by the unregulated and financially dominant hedge-fund industry.
Bush is certainly guilty of many things, but this meltdown was seeded when he was a dope-smoking kid. Now he's all grown up and gave up the smoking part.
by
Jim Freeman (108 articles, 43 quicklinks, 195 diaries, 364 comments)
on Wednesday, March 19, 2008 at 7:36:42 AM
"How little Wall Street has learned"? You're kidding!
Wall Street learned from ENRON that a corporation can get away with ripping off the people and the govern,ment will protect them. The private corporation called The Federal Reserve and it's FIAT money being printed out of thin air is being spent by Americans on cheap crap from China to help sustain the UN War for a NWO. That is what this is about. ILLUSION.
by
Jeanette Doney (0 articles, 0 quicklinks, 6 diaries, 304 comments)
on Wednesday, March 19, 2008 at 6:22:56 AM
The UN NWO needs the USA to give up it's constitution and borders to form a North American Union...that is what this is about. The connection to Bush is Bush supports a North American Union
by
Jeanette Doney (0 articles, 0 quicklinks, 6 diaries, 304 comments)
on Wednesday, March 19, 2008 at 6:30:50 AM
the books and financial records of these corporations, yet Bush is doing nothing. This makes him just as guilty as his have more core supporters regardless of how much dope he smoked in the 70's. What is called for here is a bank holiday, just like the one Roosevelt declared in 1932. Then a massive investigation into the enormous wrongdoings that were intentionally implemented by Wall Street.
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Michael Shaw (7 articles, 1 quicklinks, 1 diaries, 310 comments)
on Wednesday, March 19, 2008 at 11:59:27 AM
These crimes are worse then Enron and the guilty parties are free walking the streets with their ill gotten gains.
Why is it that when a petty thief steals something, their lives are ruined and they are thrown in prison. When one of these corporate fat cats pressures our politicians for de-regulation and then preys on the people, they walk away with extraordinary CEO pay and get to keep their mansions.
They ought to be forced to live penniless for the rest of their lives, after serving years in prison.
And Bushco - well, just add another charge to the list of things our Congress will to absolutely nothing about.
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August Adams (10 articles, 0 quicklinks, 1 diaries, 430 comments)
on Wednesday, March 19, 2008 at 5:57:32 PM
There’s little doubt that questionable trading practices contributed to Bear’s demise.But the business may have been doomed earlier by two major strategic mistakes.
The first mistake was in allowing an overconcentration in one asset class.Bear dominated the subprime mortgage securities market.Unfortunately, the subprime mortgage securities market dominated Bear.Bear had too many eggs in that basket when the basket's handle broke.
The second mistake was in failing to understand in a fundamental way where the eggs came from in the first place.Bear may have been trading mortgage securities, but underlying all that paper and information – possibly several layers removed from Bear – were real mortgages taken out by real people to buy real houses with real money.
For a variety of reasons – maybe they lost their jobs, or misunderstood the loan terms, or were swindled, or did not appreciate how much home ownership would really cost – the borrowers began to default.And that was the beginning of the end for Bear Stearns.
From its lofty position, Bear never appreciated that down at the base of that mountain built of paper and promises was a stratum of real people who were not very good credit risks trying to pay off mortgages they could not afford.
Could Bear have seen this coming?I think they could have, if they had looked.For one thing, the economy has been unimpressive the past seven years (despite what Bush says).If you put $100 into a Dow Jones Index Fund on January 22, 2001 and reinvested all the dividends, you would now have $114.38.But, adjusted for inflation, your $114.38 would be worth $98.55 in 2001 dollars.That’s not what an expanding economy looks like.
Second, job growth has been disappointing since May 2003.The economy has added just 4.6 million new jobs over that 59-month period.People need decent, secure jobs if they are going to pay their mortgages.
Third, real wages have been declining for low- and middle-wage workers even as their mortgage payments were ratcheting upward over time.People need wage growth that at least matches the increases in their mortgage payments.
Fourth, those borrowers were classified as “subprime” for a reason.Would you loan money to someone you thought from the get-go may not be able to pay you back? Probably not (a deadbeat brother-in-law excepted maybe).But that’s what subprime mortgagees did.And they made money at that game by getting rid of the paper before they got stuck with it.That’s not a viable business proposition, it’s financial musical chairs.
In short, Bear should have seen this (or some variation of it) coming.And they would have if they had looked.A decent strategist will ask, “Why might this not work?What don’t we see?What is the weakest link in this chain of money that leads to us?If they write our obit next year, what will they say we died from?”
These are not new mistakes.About 20 years ago, Travelers Insurance sold billions of dollars worth of Guaranteed Investment Contract (GICs) to retirement plans, at rates as high as 13%, for terms as long as 10 years.The effect was to guarantee that the firm would more than triple the client’s money in 10 years.
In order to generate the returns that would allow the company to pay such high returns and make money at it, Travelers invested heavily in commercial mortgages, especially in the south and southwest.Before long, the borrowers began to default on their loans, leaving Travelers disintermediated, on the hook for billions of dollars but without the billions-plus-more needed to meet their commitments.It was the end of Travelers as an independent company.
Should Travelers have predicted that outcome?Yes.By peeling back the layers of the original business proposition – commercial mortgage lending in concentrated geographic areas – they might have realized that the local economies in those areas relied heavily on oilfield and oil service businesses.Those were the businesses occupying the office buildings on which Travelers held mortgages.Those were the businesses paying the workers who shopped in the strip malls Travelers financed.
And all those oil-related businesses depended ultimately on the price of foreign oil.As long as domestic oil was cheaper than OPEC oil, times were good.But when OPEC dropped its price to $12 a barrel, the domestic businesses were stuck.So were their employees.So was Travelers.
Like Travelers, Bear Stearns’ failure was ultimately a failure of strategic thinking.They saw eye-popping returns but they did not understand, at ground level, how those returns would be created.There has to be a lesson there for every thinking business owner and investor in the country. It's not enough to engineer high returns; you have to know who is producing them, and how.
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Richard Wise (20 articles, 0 quicklinks, 0 diaries, 45 comments)
on Thursday, March 20, 2008 at 3:37:29 PM
