Questionable Trading Practices May Have Led to Bear Stearns' Collapse

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By Jason Leopold (about the author) Page 1 of 2 page(s)

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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.

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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 (more...)

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