Posted at 09:22 PM in Ace Greenberg, Alan Schwartz, Bear Stearns , Bear Stearns collapse, Credit Crisis, Executive Compensation, FCIC, Financial Crisis Inquiry Commission (FCIC), Jimmy Cayne, subprime crisis, subprime meltdown, Warren Spector | Permalink | Comments (1) | TrackBack (0)
Tags: Bear Stearns Collapse, FCIC Testimony, Wall Street Law Blog
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The Facebook page has, and will continue to have, new content - but also additional posts from other sources and some of the best posts from our archives too. Click here to check out the page - Hit the "I like" button to follow...
Introduction (a slight bit of revisionist history is ok now and then...)
1492: The Italian explorer sailed his three ships from island to island, staking claims for the Spanish King and Queen throughout the calm, crystal blue waters of what would later be called the Carribean Sea. His three ships navigated the placid sea for months, and the Italian and his men explored islands we now call Cuba, Puerto Rico, and Jamaica, among many others. March, April, May, June, July, August, and September passed. The weather was perfect. The sea was calm. These were the best sailing waters in the world proclaimed the Italian. He had "discovered" paradise.
Then, in early October, a mild storm came and went. After so many months of perfect weather, some of the crew were uneasy about the sudden turn in the weather. Perhaps this was a bad omen? "Nonsense." Days later, another storm, noticeably stronger than the first. Aberrations, the Italian insisted. Even in the calmest sea there must be an occasional storm. Many of the men, now convinced that their run of good luck was over, urged the Italian to safely anchor the three great ships in one of the many naturally protected harbors on the islands the men had explored. The Italian was stubborn. He refused to listen. He had already compiled an enormous treasure - more gold than he had ever imagined, and he was not about to interrupt his accumulation of treasure because his men were worried about some wind and rain.
Then came a storm unlike any the explorer or his crew had ever witnessed. It sunk one of the three ships, nearly destroyed the other two. Many men drowned. Nearly all of the gold was lost. The Italian was ashamed. He had ignored the warnings of the crew. Now all was lost. All of those months of calm seas - the calmest seas the explorer had ever encountered.
He had seen bad storms in his life. He had seen men die at sea, ships sink, and treasures lost. But it he had rarely seen even a cloud for months and months. Terrible storms had not happened here. Therefore they could not happen here (though he really did not believe his own words).
Although he had sailed the Caribbean for nearly a year, this was his first October. Each October, the hurricanes came to the calm waters. It was a lesson he could have learned from the safety of a protected harbor - had he not been blinded by greed.
As an attorney, I'll be the first to admit that hindsight is 20-20. However, this post (in which I am asking you to imagine that it is December 2006) has nothing whatsoever to do with hindsight. On the contrary, I want you to pretend that you are winding down the year 2006 as Chief Executive Officer of a major Wall Street investment bank. There is something you know at that time (hence no hindsight issue) - something quite important. And you've known it for at least ten years, maybe even two decades.
Here is what you know Mr. or Ms. CEO - financial panics have become a fact of life on Wall Street. The frequency of market bubbles and bursts has increased exponentially during your tenure at or near the pinnacle of your profession. There were exactly zero true market panics between 1929 and Black Monday 1987. However, through December 2006, you've lived through at least six "market panics" in twenty years, including 5 in the preceding decade alone (in 1987, 1996, 1997, two or more in 1998, and 2000).
Maybe not so coincidentally, almost all of Wall Street's investment banks went from private partnership to public corporation during the 1980's, right before the new panic era. Perhaps Wall Street was just a bit less cautious with its money once the risk of loss shifted from the partners to public shareholders. What do you think, Mr. or Madame CEO?
Anyway, all of these panics were unexpected to one degree or another (whether in terms of timing, intensity, or even crises that were completely unforeseen). Each of these panics sent intense shockwaves cascading through markets, sometimes infecting market sectors that were unrelated to the genesis of the panic itself (through the ugly tentacles of "contagion").
Since you are (for purposes of our exercise) the leader of one of the most important financial institutions in the entire world, you really can't credibly deny that you understand some seriously important concepts from the six major panics that seized markets starting on Black Monday 1987.
Having been in the thick of the action and privy to lessons learned in the aftermath of these crises, you would have had to have been incompetent for years to miss out on the following wisdom: Panic in the financial sense means pretty much what panic means in every other sense. Some event (it could be a major occurrence or a series of smaller tremors that eventually build to a critical mass), triggers a crisis of confidence in a given sector of the world economy (perhaps doubts about a booming U.S. housing market?). Once a crisis of confidence is triggered, animal instinct - herd mentality - takes over and truly frightened human beings (investors and investment professionals) stampede in a bloody fight for self-preservation. A run on financial markets ensues, feeding on itself in a vicious cycle until hearts stop thumping, collective blood pressure levels out, and panic begins to subside.
You also know - based on your experiences with recent panics - thatalthough the timing of triggering events, and even the severity of panics themselves, may have been unforeseen, the strong probability of similar events occurring again - especially during economic "booms" - is entirely foreseeable. You also know that it is only a matter of time until a company that surfs the biggest wave, wipes out and drowns.
Something is going to happen to derail the gravy train eventually. You know this. After all, you run a major investment bank. Since 1987, you know you can only to limit the downside to your company from the next crash is live by one guiding precept - Expect the Unexpected. Translation - Fail to truly stress the importance of effective risk management at your peril.
The more experience you gained with panics, you realized, the more you knew you should not play games with trying to predict when the next one might come. You only knew that it would come. Therefore, the only protection against disaster - the only true hedge - was to keep an even keel. You had to manage risk prudently, avoid temptation of easy money, resist the pull of greed. Even the most prudent risk management, of course, can fail. But easing up on the reigns of risk management could be truly deadly to any company at any time. This was the lesson you learned from the panics you lived through. But you ignored it anyway.
PART TWO: Wall Street CEO Do's and don'ts (since your are the CEO, feel free to disagree)
By Brett D. Sherman
Posted at 11:16 AM in Black Swans, CEO windfalls, Foreseeability of housing crisis, Greatest Hits Volume 2, Mortgage Backed Securities, risk frequency, risk magnitude, Risk Management, risk-return principle, Risk-return tradeoff | Permalink | Comments (1) | TrackBack (0)
Tags: bailout, black swan events, CEO's, hindsight, market panics, risk management
Quick pull from Reuters (WSLB will update as information is available)
Note/disclaimer - The Sherman Law Firm (WSLB publisher) has been handling subprime and financial crisis fraud litigation since the crisis began
Reprinted from REUTERS NEWS
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By Jonathan Stempel and Steve Eder
NEW YORK (Reuters) - Goldman Sachs Group Inc was charged with fraud by the U.S. Securities and Exchange Commission over its marketing of a subprime mortgage product, igniting a battle between Wall Street's most powerful bank and the nation's top securities regulator.
The civil lawsuit is the biggest crisis in years for a company that faced criticism over its pay and business practices after emerging from the global financial meltdown as Wall Street's most influential bank.
It may also make it more difficult for the industry to beat back calls for reform as lawmakers in Washington debate an overhaul of financial regulations.
Goldman called the lawsuit "completely unfounded," adding, "We did not structure a portfolio that was designed to lose money."
The lawsuit puts Goldman Chief Executive Lloyd Blankfein further on the defensive after he told the federal Financial Crisis Inquiry Commission in January that the bank packaged complex debt, while also betting against the debt, because clients had the appetite.
"We are not a fiduciary," he said.
The case also involves John Paulson, a hedge fund investor whose firm Paulson & Co made billions of dollars by betting the nation's housing market would crash. This included an estimated $1 billion from the transaction detailed in the lawsuit, which the SEC said cost other investors more than $1 billion. Paulson was not charged.
Fabrice Tourre, a Goldman vice president whom the SEC said was mainly responsible for creating the questionable mortgage product, known as ABACUS, was charged with fraud.
Goldman shares slid 12.8 percent on Friday, closing down $23.57 at $160.70 on the New York Stock Exchange. The decline wiped out more than $12 billion of market value, and trading volume topped 100 million shares, Reuters data show.
The news dragged down broad U.S. equity indexes, which fell more than 1 percent. The perceived risk of owning Goldman debt, as measured by credit default swaps, increased. Treasury prices rose as investors sought safe-haven government debt.
MORE SEVERE THAN EXPECTED
"These charges are far more severe than anyone had imagined," and suggest Goldman teamed with "the leading short-seller in the industry to design a portfolio of securities that would crash," said John Coffee, a securities law professor at Columbia Law School in New York.
"The greatest penalty for Goldman is not the financial damages -- Goldman is enormously wealthy -- but the reputational damage," he said, adding that "it's not impossible" to contemplate that the case could lead to criminal charges. Coffee spoke on Reuters Insider.
Goldman vowed to defend itself.
"The SEC's charges are completely unfounded in law and fact," it said. "We will vigorously contest them and defend the firm and its reputation."
E-mails from former Washington Mutual Inc CEO Kerry Killinger read aloud during a congressional hearing this week illustrated clients' concerns about working with Goldman.
In 2007, Killinger discussed hiring Goldman or another investment bank to help Washington Mutual find ways to reduce its credit risk or raise new capital, according to one of the e-mails, which Michigan Democratic Sen Carl Levin read during the hearing.
"I don't trust Goldie on this," Levin quoted one of Killinger's e-mails as saying. "They are smart, but this is swimming with the sharks. They were shorting mortgages big-time while they were giving (Countrywide Financial Corp) advice."
The SEC lawsuit announced on Friday concerns ABACUS, a synthetic collateralized debt obligation that hinged on the performance of subprime residential mortgage-backed securities, and which the regulator said Goldman structured and marketed.
According to the SEC, Goldman did not tell investors "vital information" about ABACUS, including that Paulson & Co was involved in choosing which securities would be part of the portfolio.
The SEC also alleged that Paulson took a short position against the CDO in a bet that its value would fall.
In a statement, Paulson & Co said it did buy credit protection from Goldman on securities issued in the ABACUS program, but did not market the product.
Tourre was not immediately available for comment.
Goldman had not disclosed that the SEC was considering a lawsuit but had known charges were possible and had urged the SEC not to file them, people familiar with the situation said on Friday. The sources requested anonymity because the probe was not public.
To better understand CDOs, the SEC in 2008 approached some hedge funds, including Paulson & Co, whose investment Paulo Pellegrini was among those to talk with the regulator.
By betting against subprime mortgage-related debt, Pellegrini helped Paulson's firm earn an estimated $15 billion in 2007. Pellegrini last year left to start his own firm.
COMING OUT SWINGING
The lawsuit is a regulatory and public relations nightmare for Blankfein, who has spent 18 months fending off complaints that Goldman has been an unfair beneficiary of taxpayer bailouts of Wall Street.
Blankfein became chief executive less than a year before the product challenged by the SEC was created.
"This could be the beginning of a period where you have a regulatory cloud over Goldman Sachs, and perhaps even the entire investment banking industry," said Hank Smith, chief investment officer at Haverford Trust Co in Philadelphia.
John Paulson is not related to Henry "Hank" Paulson, who was Blankfein's predecessor as Goldman chief executive and later become U.S. Treasury secretary.
The SEC lawsuit represents an aggressive expansion of regulatory efforts to hold people and companies responsible for the nation's financial crises.
It could help the regulator rehabilitate its reputation after missing other high-profile cases, including Bernard Madoff's Ponzi scheme.
"The SEC has come out swinging," said Cary Leahey, senior managing director of Decision Economics in New York.
Robert Khuzami, head of the SEC's enforcement division, said John Paulson was not charged because it was Goldman that made misrepresentations to investors, not Paulson.
Still, Khuzami called Paulson's firm "a hedge fund that had a particular interest in the securities performing poorly."
MORE LAWSUITS TO COME?
It is unlikely that criminal charges will be brought, a person close to the matter said. Representatives for the Justice Department declined to comment.
Yet the lawsuit is widely expected to spur other lawsuits, and is "probably the first of several," according to Doug Kass, president of hedge fund Seabreeze Partners Management.
"Regulators and plaintiffs' lawyers are going to be looking at other deals, to what kind of conflicts Goldman has," said Jacob Zamansky, a lawyer who represents investors in securities fraud lawsuits.
"I've been contacted by Goldman customers to bring lawsuits to recover their losses," he added. "With the SEC bringing fraud charges it's going to expose what's behind the curtain."
According to the SEC, Goldman marketing materials showed that a third party, ACA Management LLC, chose the securities underlying ABACUS, without revealing Paulson's involvement.
The SEC complaint quotes extensively from internal e-mails and memos, noting that in early 2007 it had become difficult to market CDOs tied to mortgage-backed securities.
It quoted a January 23, 2007, e-mail from Tourre to a friend as saying: "The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!"
Another e-mail, to Tourre from the head of Goldman's structured product correlation trading desk, complained: "The CDO biz is dead we don't have a lot of time left."
INDEPENDENCE MATTERS TO CLIENTS
Other communications detail the importance of hiring ACA.
The SEC said Goldman reached out to German bank IKB to buy securities that Paulson was selling, knowing it would buy only securities selected by an independent asset manager.
"We expect the strong brand-name of ACA as well as our market-leading position in synthetic CDOs of structured products to result in a successful offering," a March 12, 2007, Goldman e-mail said.
IKB ultimately took on exposure to ABACUS, as did the Dutch bank ABN Amro Holding NV.
The German government ultimately bailed out IKB in the summer of 2007, in part because of the bank's investments, while lenders that eventually bought much of ABN Amro were also subjected to their own government bailouts.
In a statement after U.S. markets closed, Goldman said it lost more than $90 million on the transaction, six times the $15 million fee it received, and provided "extensive disclosure" on the securities involved.
It also said it never represented to ACA Capital Management, which invested $951 million in the transaction, that Paulson was going to be a "long" investor, meaning that Paulson was betting the securities would gain in value.
Paulson & Co paid Goldman $15 million to structure and market the ABACUS CDO, which closed on April 26, 2007, the SEC said. Little more than nine months later, 99 percent of the portfolio had been downgraded, the SEC said.
Janet Tavakoli, president of Tavakoli Structured Finance Inc in Chicago and author of a book on synthetic CDOs, said it may have been common on Wall Street for hedge funds to play big roles in picking mortgage-backed securities for use in CDOs.
"Many investors were not aware of how disadvantaged they were by these CDO structures," she said.
The charges are expected to fuel anti-Wall Street sentiment on Capitol Hill where sweeping financial industry reforms are expected to soon arrive on the Senate floor for a vote.
A Democratic bill, strongly supported by President Barack Obama, would slap new restraints on major banks, likely curtailing their opportunities for profit and revenue growth.
Similar legislation was approved in the House of Representatives in December. Analysts believe a bill could be signed into law by Obama by mid-year.
"Banks were getting their mojo back, successfully fighting the regulatory reform bill," said James Ellman, president of Seacliff Capital in San Francisco. "Clearly, such malfeasance could help get the bill to go through."
Goldman in 2008 won a $5 billion investment from Warren Buffett's Berkshire Hathaway Inc.
Last month, Buffett praised Goldman as a "very, very strong, well-run business," and said of Blankfein, "You cannot find a better manager."
Buffett had no immediate comment, his assistant Carrie Kizer said.
The SEC lawsuit was assigned to U.S. District Judge Barbara Jones, who was appointed to the bench in 1995 by President Bill Clinton. She presided over the 2005 criminal trial of former WorldCom Inc Chief Executive Bernard Ebbers over an $11 billion accounting fraud at the phone company.
The case is SEC v. Goldman Sachs & Co et al, U.S. District Court, Southern District of New York, No. 10-03229. (Reporting by Jennifer Ablan, Maria Aspan, Clare Baldwin, Karen Brettell, Jeffrey Cane, Elinor Comlay, Kevin Drawbaugh, Steve Eder, Ellen Freilich, Burton Frierson, David Gaffen, Joseph A. Giannone, Matthew Goldstein, Svea Herbst-Bayliss, Ed Krudy, Herb Lash, Grant McCool, Jeremy Pelofsky, Christian Plumb, Aaron Pressman, Leah Schnurr, Jonathan Spicer, Jonathan Stempel, Caroline Valetkevitch, Phil Wahba, Dan Wilchins, Rolfe Winkler, Karey Wutkowski and Rachelle Younglai; Editing by Robert MacMillan and John Wallace)
By Brett Sherman,The Sherman Law Firm
THESE ARE NOT THE RISKS YOU'RE LOOKING FOR...
True risk management begins with one fundamental concept: Companies must prepare for the fact that outcomes can and do differ from expectations.
WHAT WOULD HAPPEN TO OUR COMPANY IF HOME PRICES PLUNGED?
No one can predict the future - even the immediate future - with any certainty. Sometimes, events unfold as anticipated, and so we may fool ourselves into believing that we knew what would happen before it happened.
For example: We predict the Patriots will beat the Jets. The Patriots do beat the Jets. We knew it all along. Well... Not quite.
In reality, we made either an educated guess (we watch the teams a lot and we believe the Patriots are better) or a random guess (we know nothing about football, but we like the Patriots uniforms a lot), and our guess turned out to be correct.
The fact that our prediction was right is mostly a matter of luck. The outcome matched our expectation, but that does not mean our prediction was certain to come true. Not even close. What if Tom Brady had broken his leg in the first five minutes of the game? What if half of the Pats defense was struck down with the swine flu the morning of the game? What if Randy Moss caught a long pass and was running free "certain" to score the winning TD and the ball just squirted out of his hands on the ten yard line as he began to celebrate before he reached the end zone?
Maybe the Patriots win despite this seemingly amazing run of bad luck. Maybe they lose.
The main points are these -
Thus, certainty comes only after the fact. Until that point, there is always a chance that your expectations will be wrong.
Put another way, it is impossible to eliminate the risk that things will not turn out as expected.
Some of our favorite variables that can impact outcomes (positively or negatively) include weather, timing, mood, whether or not you accellerate through a yellow light or step on the breaks, sunspots and solar flares, the length of the line at Starbucks, sleeping on a decision or making a snap judgement, whether you run to catch your train to work or walk to the platform, content to wait for the next one, and so on and so on, etc., etc. The point, of course, is that our list of variables could go on for millions of pages and still be nowhere near complete.
* * * *
Even assuming for the sake of argument the very dubious proposition that senior management and the best analysts and economists at Lehman Brothers, Merrill Lynch, and Bear Stearns truly believed the housing boom would continue indefinitely would be a responsible (even competent) risk management policy required these financial institutions to build into their business models the very real chance that the views of their best analysts and economists could be wrong. Because the future is unknowable, preparing for unexpected outcomes needs to be priority one for risk managers and top decision makers.
No amount of risk management can account for every contingency. But effective risk management must account for the fact that unexpected events will happen, and those unexpected events will produce unexpected losses. Losses come with the territory. However, crippling losses can and should be prevented.
Banks can never be too prepared for unforeseen (and unforeseeable) financial shocks. Banks can never have enough capital. Risk managers must be prepared to circle the wagons and withstand a crisis.
Like JP Morgan Chase CEO Jamie Dimon (Wall Street's current Obe Wan Kenobe) preaches - Banks need a "Fortress Balance Sheet."
A fortress balance sheet - per Mr. Dimon - is a balance sheet strong enough to assure JP Morgan Chase can withstand severe shocks that arise with little or no warning.
The CEO of JP Morgan Chase has become a rock star for many reasons. One of the main reasons surely must be that Jamie Dimon knows what it means to be a Jedi Risk Manager.
*FRAUD BY SILENCE AND COVER-UP*An individual's creditworthiness is highly correlated to mortgage default risk. In other words, the worse a borrower's credit history, the more likely it is that the borrower will default.
Posted at 11:27 PM in 10b-5 Private Right of Action, 10b-5 Securities Fraud, Collapse of Bear Stearns, Correlation of risks, Greatest Hits, Securities Fraud, Subprime Bear Stearns | Permalink | Comments (0) | TrackBack (0)
Tags: Bear Stearns mortgage fraud, Bear Stearns securities fraud, Brett Sherman, material omissions, mortgage lending standards, subprime meltdown, subprime risks, Wall Street Law Blog
Pictured: 1943 Stock Certificate from a Kidder Peabody underwriting
The following excerpt is from an article that originally appeared in the Wall Street Journal in 1995. We found the story in the archives of the Seattle Times.
NEW YORK - Another one bites the dust.
Kidder, Peabody & Co., one of Wall Street's longest-running names, will disappear when the investment bank is dismantled later this month.
PaineWebber Group Inc. agreed to acquire most of Kidder's assets in October but wanted to mull over whether it wanted to acquire the Kidder name.
Now, after a six-week "global study" of its retail, banking and institutional clients, PaineWebber has decided that it's time to make the Kidder Peabody name a Wall Street footnote.
"Our research, as well as other considerations, is showing us that PaineWebber is the name to go forward with," said Jerry Johnston, manager of corporate communications. "Now that we are a bigger force internationally, we want to behave as one company, with one voice and one name."
The demise of Kidder will mean the end of a name that has been kicking around Wall Street for nearly 130 years.
Kidder was founded in Boston on April 1, 1865, by Henry Kidder, Francis Peabody and Oliver Peabody. When the firm first opened, it advertised "banking, brokerage and exchange business."
Unlike other Wall Street names, which have gone through various incarnations, the Kidder Peabody name has remained intact throughout the firm's history.
Kidder, long known for its investment-banking prowess, was acquired by General Electric Co. in 1986 and stumbled in a 1980s insider-trading scandal.
Although the Kidder name had cachet in the late 1970s and early '80s, analysts say today it has little, if any, luster.
"Fifteen or 20 years ago, the Kidder name would have made a difference," said Perrin Long, an independent securities-industry analyst. "Kidder was strong in utility underwriting, it had a crackerjack research department, it had high-net-worth retail clients and a very strong investment-banking franchise."
Kidder is the second Wall Street name to be shelved in less than a year. Last May, Travelers Group, parent of brokerage giant Smith Barney Inc., scrapped the Shearson name after Smith Barney and Shearson's brokerage operations merged.FOR THE FULL ARTICLE, PLEASE VISIT THE SEATTLE TIMES ARCHIVES HERE
Commentary and editing by Brett Sherman, The Sherman Law Firm
Profits were just too big for Bear's Ace Greenberg to stop the "locomotive"Alan "Ace" Greenberg was the man most responsible for the so-called "strong culture of risk management" at Bear Stearns.
Ace Greenberg was Chairman of the Bear Stearns Executive Committee until the firm collapsed.
Ace Greenberg led the Bear Stearns risk committee until at least 2007.
Ace Greenberg was the man who said many times that his number one rule was to take small losses before they turned into big, crippling losses. He also presided over Bear's famously intimidating Monday afternoon risk meetings.
SO- What did super strict risk manager Ace Greenberg tell PBS Frontline in an interview for an episode called "Inside the Meltdown?"
Speaking after Bear collapsed, Greenberg discussed how he felt and what he did (and did not do) about the housing/mortgage bubbles back in the days when Bear was still raking in the profits: