Wall Street Law Blog

Bear Stearns Report: Relative to Income, Home Prices "About as stretched as [they have] ever been!"

Another in an occasional series in which Wall Street Law Blog posts excerpts from primary source documents that flat out contradict Wall Street's revisionist history of the financial crisis...

Top executives at Bear Stearns - as we like to point out - have repeatedly insisted (including in sworn testimony) that they did not have any inkling that there might be a massive national housing bubble.  

The truth, however, (as we also like to point out) is that Bear Stearns knew there was a really big housing bubble, and that the end of the housing bubble era would not be pretty.  

Our excerpts today are from a September 13, 2006 Bear Stearns research report.  

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Any questions?

Brett Sherman, Wall Street Law Blog

Bear Stearns, Merrill Lynch Expected Housing Disaster (our all-time most viewed post; first published Oct. 2010)

"These aren't simply the comments of some junior level analysts" Lee Sherman, securities litigation consultant

the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them.

the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial.

UPDATE: Because Bear Stearns Execs' FCIC testimony largely focused on allegedly unforeseeable, "unprecedented" market forces to defend their lack of competent management, Wall Street Law Blog decided to re-post one of our favorites. 

Long before their respective employers ceased to exist as independent companies, former Merrill Lynch Top North American Economist David A. Rosenberg and former Bear Stearns Chief Equities Investment Strategist Francois Trahan published research reports with explicit warnings about asset and credit bubbles in the U.S. housing and mortgage markets.

As early as August 2004, Mr. Rosenberg, Chief Economist at Merrill Lynch for North America, published a detailed analysis regarding the precarious state of the American housing market. Rosenberg warned that there could serious problems ahead in an Economic Commentary entitled: "Housing: If not a Bubble Then an Oversized Sud."

Former Bear Stearns Chief Equities Investment Strategist Francois Trahan first published a report that raised serious questions about housing and real estate investments in a May 2005 report called "REIT all About it." Trahan and his team at Bear Stearns followed their 2005 report with publications in 2006 that explicitly warned about the difficult future facing the U.S. housing market and even raised the possibility of a global credit crisis. The 2006 Bear Stearns reports definitively described the housing market as an unsustainable "bubble" and further cautioned that the term bubble was not one the Bear team used lightly.

It was not until 2008 that overcommitments to mortgage-backed securities (a byproduct of the housing boom), CDO's and related products tied to residential and commercial mortgages caused Merrill Lynch and Bear Stearns to suffer backbreaking losses so severe that Merrill sold itself to Bank of America and Bear Stearns narrowly avoided bankruptcy with a Fed-assisted fire sale to JP Morgan.

--Background

Along with a number of other Wall Street firms, Merrill Lynch and Bear Stearns lost tens of billions of dollars because of their firms' respective commitments to securities backed by mortgages in the "subprime" and "Alt-A" categories. Subprime and Alt-A residential mortgages are considered risky loans because they carry higher default rates than "conforming" mortgages (also called prime mortgages, or agency-quality mortgages). Typical subprime or Alt-A borrowers cannot qualify for a conforming mortgage due to factors that include, but are not limited to, bad credit histories, personal bankruptcies, insufficient income, and the inability to make sufficiently large down-payments.

--Significance of the Merrill Lynch and Bear Stearns reports

While the ultimate import of the reports remains to be seen, The Sherman Law Firm says there is no doubt that the documents are crucial to the touchstone litigation element of foreseeability. "In a litigation sense," said Managing Attorney Brett Sherman, "the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them."

According to The Sherman Law Firm, the reports at issue may show that senior management at Merrill Lynch and Bear Stearns should have foreseen the liklihood of a looming financial crisis with ample time to permit business model shifts that may have prevented crippling losses and, ultimately, the end of these former pillars of Wall Street as independent companies.

--Likely Defenses and Response

When confronted with documents like the reports at issue, senior managers may respond that they cannot be expected to read the huge volumes of research produced by their companies. The view of Brett Sherman, securities fraud lawyer and Managing Attorney of The Sherman Law Firm is that "the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial."

Litigation strategist and recently retired attorney Lee Sherman - a frequent consultant to The Sherman Law Firm, former municipal court judge, and founding partner of a top Philadelphia area firm - concurred. "These aren't simply the comments of some junior level analysts," Sherman said. "I mean, we're talking about the Senior North American Economist of Merrill Lynch and the Chief Equities Strategist at Bear Stearns. Any claims by their CEOs and the other senior decision makers at these banks to the effect that they should not have been well-aware of the opinions and outlooks of the top economic and market experts at their companies are simply not credible." 

Lee Sherman continued: "Remember, from mid-2004 until the subprime crisis had clearly arrived, the Fed steadily raised interest rates. For lesser quality borrowers, most of whom had adjustable rate mortgages, higher interest rates meant higher default rates. To say the least, there was great uncertainty as rates were rising about where we were headed. Then, the housing market slowed. I'm talking about 2005 now, before home values really fell off the table. It strikes me as incredible that the kinds of warnings in these reports were out there for years, yet seem to have gone unheeded."

The Sherman Law Firm represents investors in securities fraud / investment loss claims of all types, including claims against investment banks for losses related to mismanagement and other misconduct during the housing and credit bubbles.

Brett Sherman, The Sherman Law Firm

Former Bear Stearns Chief Strategist Trahan Says Sr. Management Ignored His Warnings

In 2005 and 2006, Francois Trahan was...

(a) employed as Chief Investment Strategist at Bear Stearns, and

(b) Wall Street's top-ranked ranked investment strategist according to Institutional Investor Magazine.

Both years, Trahan and his team at Bear Stearns issued detailed and specific warnings about the US housing bubble. Wall Street Law Blog has previously published several posts about Trahan's spot-on warnings about the bubble and his advice to steer clear of investments tied to real estate.

In The Era of Uncertainty, a book published this year and co-authored by the former Bear Stearns strategist,
Mr. Trahan confirms that senior management at Bear Stearns (at the time reporting record profits thanks to its mortgage bond securitization, sales, and trading businesses) was very much aware of his dire prognosis for the housing market and investments linked to real estate.

Indeed, Trahan writes that, before the financial crisis, he had been "pounding the table" about the housing market for "several years."

So why, according to Trahan, did senior management at Bear Stearns ignore all of his warnings? "The answer...," he says in his book, "is that the profits were just too attractive to pass up."

In other words, senior management ignored Trahan because Bear Stearns was raking in the money.

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Francois Trahan left Bear early in 2007. His book has a ton of other great stuff about Bear Stearns and about the state of financial markets in the 21st century.

Disproving the Big Lie - Securities Fraud at Bear Stearns, Part 2 (encore post)

PART 2 - SECURITIES FRAUD AT BEAR STEARNS - A SPECIAL WALL STREET LAW BLOG SERIES

Only a short post is necessary here - A picture, after all, tells a thousand words. 

According to the "official story" from Bear Stearns top executives -- Jimmy Cayne, Alan Schwartz, Warren Spector, Sam Molinaro -- almost no one (and certainly not Bear Stearns) was able to foresee the extent of the housing bubble and/or the possibility of disastrous consequences...

Well, here is the first page of a report Bear Stearns published in May 2006 (nearly two years before the investment bank failed).  

Draw your own conclusions.

 

Feedback invited...

 

Wall Street Law Blog; A Publication of The Sherman Law Firm

Smoking Gun? Mortgage Meltdown Predicted by Bear Stearns in 2005-06.

Updated 9/14/09

THE INTERVIEW THAT FOLLOWS IS SCRIPTED (part of our forthcoming screenplay, or not). NEVERTHELESS, THE UNDERLYING FACTS AND CONCLUSIONS ARE 100% GENUINE. 

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"[H]ousing activity is only just beginning to cool, and... there is no end in sight for a year or two."

-Francois Trahan (Former) Chief Investment Strategist, Bear Stearns

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Q:  OK, I can't stand the suspense.  So who sounded alarm bells about the end of the housing bubble, credit bubble, the world economy and so on?

A:  What if I told you it was Francois Trahan, Kurt D. Walters, Caroline S. Portney.

Q:  I'd ask you who those people are. [Pauses, gets no response, continues...]  OK, Who are Trahan, Walters, and Portney?

A:  Senior Wall Street Research Analysts.  In fact, Trahan, at the time, was a highly regarded Chief Investment Strategist for a major investment bank.

Q:  [Yawn].  You've told us about your "smoking gun" research reports before.  Deutche Bank.  HSBC.  Even Merill Lynch. 

A: Ah, but this time is different.  This time I've seen the evidence.

Q: OK, ok - enlighten us.

A: BEAR STEARNS.

Q:  Come Again?    

A:  Bear Stearns.  In a September 13, 2006 issue of the Bear Stearns "Investment Strategy" research report called -

"RAMIFICATIONS OF A U.S. HOUSING SLOWDOWN FOR EQUITIES," 

Chief Strategist Trahan and his colleagues emphasized that they had identified a housing bubble in 2005.  That report was called "REIT ALL ABOUT IT."  

Trahan described the growth of the housing bubble in detail, and concluded with conviction that the bubble was deflating.  Finally, Trahan and company predicted possible dire consequences for the global economy.

Q:  And this is important, why?

A:  Because these are BEAR STEARNS RESEARCH REPORTS.  Because they are from 2005 and 2006, when Bear continued to report record profits from selling junk mortgage-backed securities while its own senior people were (no pun intended) very bearish on the housing and mortgage markets.  The 2006 report says, among many other things-

"[H]ousing activity is only just beginning to cool, and... there is no end in sight for a year or two."

That's on page 6, by the way. The report also warns that

(a) rising interest rates have long been an indicator of a coming down-cycle for housing, and 

(b) the expected deflation of the housing bubble would drag down the mortgage market, restrict liquidity, and have serious negative impact on the U.S. economy and the global economy. 

THE BEAR RESEARCH REPORTS ARE FLASHING NEON LIGHTS.  THEY SIGNAL THAT BEAR KNEW IT WAS APPROACHING THE END OF THE LINE FOR ITS MORTGAGE-DRIVEN BUSINESSES. I REPEAT, THE REPORTS PROVE THAT FAILURE OF BEAR'S BUSINESS MODEL WAS FORESEEN BY BEAR STEARNS. 

Q:  OK, I get it.  But aren't the opinions of a few Bear employees just that?  You don't expect the CEO to read every research report, do you?

A:  Not sure.  Maybe.  Maybe not.  But I certainly believe that the senior officers and the Board of Bear Stearns had the obligation to, at the very least, be familiar with the opinions of Bear's Chief Equities Investment Strategist regarding current state of the world economy, and the Chief Strategist's views about the immediate future.  

Q:  That sounds good.  You have me 95% convinced.  But you're missing the one thing that would lock it up for me.

A:  Really?  What's that?

Q:  If you could only show me on the report some sort of adoption and approval by Bear Stearns itself, that would do it.  I mean, that would tell me that the report is the opinion of Bear Stearns and not just Francois Trahan and his team.  You know what I mean?

A:  Sure. I understand.  

The best I can do is here, on page 14, where the report states that it "has been adopted and approved for distribution within the United States by Bear, Stearns & Co. Inc. for its and its affiliates customers."

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By Brett Sherman 

FOR A COPY OF "RAMIFICATIONS OF A US HOUSING SLOWDOWN...", CLICK HERE AND LEAVE YOUR NAME AND A FAX Number OR EMAIL Address, or call The Sherman Law Firm.