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How Bear Stearns Really Screwed Investors

Posted by Larry Doyle on November 12, 2012 8:57 AM |

The Wall Street Journal reports this morning that JP Morgan will merely pay a fine for transgressions that occurred at Bear Stearns prior to the large money-center bank’s life-saving takeover of the former Wall Street broker.

With merely a fine to be paid, global investors and American taxpayers are once again left scratching their heads wondering if the transgressions involved happened without any sort of meaningful human involvement. I mean, how is that JP Morgan will pay a fine likely in the hundreds of millions of dollars and not one single individual is likely to face the music? More on that in a second. What today’s WSJ report and many other reports fail to identify is what really happened at Bear Stearns. Let’s navigate.

Investors got screwed by the actions at Bear Stearns in two ways: 

1. Bear, much like every other firm on the street, was involved in packaging and distributing mortgages that had been fraudulently underwritten. Regulators not only failed to protect investors beforehand but have failed to protect them after the fact as well.

2. In the case where mortgages identified by the trustee as not meeting well defined standards, those mortgages were taken out of the deal and sold back to the originator. The funds derived by these repurchases should have gone back to the trustee for the benefit of the investors. In the case brought against JP Morgan (that is, Bear Stearns, ex post facto), investigators make the strong and compelling argument that some percentage of these funds was retained by the firm and not delivered back to the trust for the benefit of investors. If this activity is not the definition of theft, I do not know what is.

You can rest assured that the diversion of these funds did not occur based on a computer model. Human beings made these calls. Given the size of the deals and the fact that Bear was one of the largest dealers in the mortgage sector, the funds inappropriately diverted likely ran well into the hundreds of millions of dollars if not more than that.

Which investors were hurt the most? Those who typically purchase the lower credit tranches of the deals. Who are they? Typically insurance companies. Make no mistake, insurance companies invest their own funds on behalf of their own customers, those being tens of millions of individuals.

The question begs as to why the individuals involved in these alleged activities at Bear Stearns are not being held to accout and brought to justice. It would not be difficult to identify the individuals involved. So why aren’t they being prosecuted? I believe there are three reasons:

1. These individuals would certainly possess a wealth of information about the entire fraud involved in the securitization and distribution of  improperly originated mortgages.

2. These individuals could point the finger at the senior executives at Bear Stearns who were charged with supervising this business. A failure to properly supervise is a very serious charge.

3. If this activity of improperly diverting funds from a trust into the coffers of the firm occurred at Bear Stearns, then I strongly believe it probably occurred elsewhere as well. Why do I make that statement? Wall Street may seem like a large industry but when one zeroes in on specific business units, it gets very small very quickly. People talk. I would find it VERY hard to believe that given the size of the dollars involved, other firms and other individuals were not similarly engaged in improperly diverting funds that justifiably belonged to investors.

By not targeting specific individuals, regulators and judicial officials do not choose to take the risk of having the entire scheme come crashing down.

Meanwhile how do investors react to the injustice of it all?

They choose not to invest their funds. The failure to perform by regulators and judicial officials compels investors to believe that they are not properly protected. How do investors respond? They fail to commit further capital to the market. Those declining capital commitments are reflected in a lack of capital flowing into and through our economy. Little wonder why our economy is so slow to recover.

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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