*FRAUD BY SILENCE AND COVER-UP*
A subprime borrower is more likely to default than an individual with strong credit background. Indeed, it cannot be disputed that subprime mortgages have always been riskier for lenders than conforming mortgages. It is specifically because subprime loans have relatively high default rates - and are therefore risky by definition - that subprime borrowers must pay higher interest rates than individuals who qualify for conforming mortgages.
To prevent lenders from taking excessive risks, both prime and nonprime mortgage applicants historically have been subject to a rigorous underwriting process. In the later years of the housing bubble, lending standards simply disappeared for subprime mortgage applicants.
Today, it is well known that subprime lenders (including Bear Stearns' own mortgage subsidiaries) progressively reduced subprime underwriting requirements during the housing bubble. At the time, however, Bear Stearns failed to disclose (a) that lending standards were eroding, or (b) that the reason for lowering underwriting requirements was to preserve the immense profits from sales of mortgage securities.
By 2004-2005, Bear Stearns knew that the supply of "qualified" subprime borrowers was dwindling. To keep the Company's mortgage inventories large enough to maintain and expand its incredibly profitable mortgage securitization and sales platforms, new mortgage origination rates had to stay high. The only way lenders could assure a steady supply of new mortgages for the securitization machines of Bear Stearns and others was to increase the universe of the subprime borrowers. And the only way to increase the number of "qualified" borrowers was to relax, and eventually almost eliminate, subprime lending standards.
Because mortgage default risk grows as credit quality and income shrink, Bear Stearns cannot credibly argue that the firm did not know that new batches of collateralized debt obligations were backed by far more risky loans than in prior years.
Bear Stearns certainly knew that the MBS and CDOs the firm sold to investors in the later years of the bubble were loaded with junk mortgages. Therefore, there is no doubt that Bear Stearns knew that the inevitable disruption of rising home prices could very well produce vast numbers of mortgage defaults by low credit homeowners.
Despite all that it knew about the ever precarious quality of subprime loans, Bear Stearns continued to collude with credit rating agencies to obtain investment grade ratings. Worse, Bear Stearns still publicly insisted that its mortgage securities were extremely safe investments.
Sales of newer "vintage" collateralized debt obligations grew at an incredible rate through early 2007. At the time, Bear Stearns' decision to omit material and specific new risk disclosures (and/or to lie about the prospects of its MBS businesses) allowed the Company's stock price to artificially inflate.
When defaults of low quality MBS and CDOs started to spike in late winter/early spring 2007, the high risk nature of the more recent crop of mortgages became apparent. Soon thereafter, Bear Stearns' stock price began its long slide into oblivion.
Failing to make plain English, honest, accurate and specific risk disclosures about the junk mortgages in the MBS and CDOs the firm created and sold is one way Bear Stearns committed securities fraud during the financial crisis.
There were many others...
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