Criminal activity may be behind financial crisis

Brunei News.Net Thursday 18th September, 2008

U.S. authorities have launched a series of investigations into market practises in relation to events that have led to the current global financial and economic crisis.

The sudden collapse of previously sound investment banks on both sides of the Atlantic has puzzled sections of the financial community. While the subprime mortgage crisis, and the overleveraged state of the banking industry have played a part authorities are now investigating the source of rumors that have led to the collapse of Bear Stearns and Lehman Brothers in particular.

Even the Chairman of the SEC, as detailed later in this article, attributes the demise of Bearn Stearns to rumors, and not a lack of capital.

Morgan Stanley has also been subject to market rumors this week driving down the company’s stock price. Short sellers and rumors are also believed to have been at play in the collapsing share price of British banking conglomerate HBOS, a well-capitalised global bank, forcing it into a merger with Lloyds TSB

Short-selling is a practise where traders can sell “short” a stock, that is sell stocks they don’t own, taking a view that the price of the stock will fall. When the stock falls the short traders then buy the stock back at a lesser price and pocket the difference. What is concerning authorities is that huge short-sell orders relating to particular stocks have been placed at the same time as, or ahead of, the emergence of rumors concerning those stocks.

Short-selling is a legitimate practise however when it precedes, accompanies or follows a deliberate placement of false information in the market, it amounts to securities fraud. When more than one individual or party is involved it becomes a conspiracy. There are many in financial markets that say Bear Searns was brought down by such an event. On Monday March 10 this year the bank became the target of a rumor sweeping Wall Street that the firm had a liquidity problem. That was false. In fact Bear Stearns had cash reserves of $18 billion.

Nonetheless CNBC, which has monitors all over the trading floors in New York picked up on the rumor referring to an "unnamed Wall Street firm" that might be having liquidity problems. Bear Steans had opened at $70 that day but at 11am began falling sharply. An hour later when CNBC picked up the rumor the stock was already down 10%. Shorly after a CNBC commentator said, "There is speculation the firm is Bear Stearns." The rumors persisted and Bears' share price kept falling.

On Wednesday March 12 Bear Stearns CEO Alan Schwartz appeared on CNBC to scotch the rumors. He was to be interviewed by anchor David Faber. In an article last month in Vanity Fair Byan Burrough wrote, "Faber’s first question was a bombshell. He told Schwartz he had direct knowledge of a trader — a single trader — whose credit department had held up a trade with Bear Stearns, citing concerns about its health. At Bear, many executives gasped. It was a killer statement: Faber was saying, in essence, that Bear’s status as a trader, the basis of its business, was in question. Schwartz answered as best he could, saying everything was fine; only later did Faber say on-air the trade in question had finally gone through. But the damage had been done."

"You knew right at that moment that Bear Stearns was dead, right at the moment he asked that question,” a Wall Street trader of 40 years told Burrough. “Once you raise that idea, that the firm can’t follow through on a trade, it’s over. Faber killed him. He just killed him,” the veteran trader said.

The persistent rumors made it difficult for the bank, which had been founded in 1923, to continue, and over the weekend a deal was put together where JPMorgan Chase would buy Bear Stearns for $236 million, or $2 per share. The price should have been much higher, in the range of $4 to $4.50 a share but, as Burrough reported, U.S. Treasury Secretary Henry Paulson wanted to "punish" Bear and encouraged JP Morgan Chase to lower the price. Bear Stearns shares had previously traded at a 52 week high of $133.20.

(Because of the outcry that followed the JP Morgan deal from Bear shareholders, and the potential for legal action, the price was later revised to $1.1 billion, or $10 a share).

Three days after the sale of Bear Stearns, the Chairman of the SEC, Christopher Cox, wrote to the Basel Committee on Banking Supervision concluding that the fate of Bear Stearns was not a lack of capial, but a lack of confidence. "When the tumult began last week, and at all times until its agreement to be acquired by JP Morgan Chase, the firm had a capital cushion well above what is required to meet supervisory standards calculated using the Basel II standards," Cox wrote. He added later in his submission, "The market rumors about Bear Stearns liquidity problems became self full-filling."

"Even among the circle of top executives who lived through that frantic week, no two people see the crisis at Bear the same way," Burrough wrote in his article. "Many, though, agree with some version of the scenario Alan Schwartz has come to believe. Yes, Schwartz tells friends, mistakes were made. Yes, the firm was financially weakened. But the more he learned about what had happened behind the scenes that week, the more Schwartz came to believe that Bear’s collapse was a pre-meditated attack orchestrated by market speculators who stood to profit from its demise. According to those Schwartz has briefed, these unnamed speculators—several now being investigated by the S.E.C.—employed a complex scheme to force a handful of major Wall Street firms to hold up trades with Bear, then leaked the news to the media, creating an artificial panic."

“There was a reason this was leaked, and the reason is simple: someone wanted us to go down, and go down hard,” a former Bear Stearns executive told Burrough. Faber says his reporting was accurate, and arose from talks with a source he has known for 20 years.

"But who? According to one vague tale, initially picked up at Lehman Brothers, a group of hedge-fund managers actually celebrated Bear’s collapse at a breakfast that following Sunday morning and planned a similar assault on Lehman the next week. True or not, Bear executives repeated the story to the S.E.C., along with the names of the three firms it suspects were behind its demise. Two are hedge funds, Chicago-based Citadel, run by a trader named Ken Griffin, and SAC Capital Partners of Stamford, Connecticut, run by Steven Cohen. (A spokesman for SAC Capital said the firm “vehemently denies” any suggestion that it played a role in Bear’s demise. A Citadel spokeswoman said, “These claims have no merit.”) The third suspect, at least in Bear executives’ minds, is one of its main competitors, Goldman Sachs. (“Goldman Sachs was supportive of Bear Stearns,” says a Goldman Sachs spokeswoman. “There is no foundation to rumors that we behaved otherwise.”), reported Burrough.

Such is the concern at the role short-selling has been playing in market gyrations, the British regulator, the Financial Services Authority, or FSA as it is known, announced on Thursday it would ban short-selling, at least for the next four months. 'We have been much concerned, as have many, at the volatility and what I would describe as incoherence in the trading of equities, particularly for financial institutions,” Callum McCarthy, Chairman of the Financial Services Authority said late Thursday night.

“There is a danger in a trading system which allows financial institutions to be targeted and subject to extreme short-selling pressures, because movements in equity prices can be translated into uncertainty in the minds of those who place deposits with those institutions with consequent financial stability issues. We have seen acute examples of this phenomenon in both London and New York this week,” he said.

Early Friday, before markets opened in New York, the SEC announced it too was prohibiting short-selling. SEC Chairman Christopher Cox said, “The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets."

New York State Attorney General Andrew Cuomo co- incidently has announced a probe into short-selling practices, his office announced Thursday.

Cuomo said short-selling itself is legal but what is illegal is if you are spreading false information, rumors, and you join a conspiracy to purposely drive down the price of a stock, and you are profiting from the decline,' he said in an interview.

Cuomo said manipulation of the price of a stock with false information is securities fraud.

'Companies like Lehman, companies like Morgan Stanley, companies like Goldman Sachs who are seeing the rapid share declines, we have complaints that there are episodes of illegal short-selling, and that is what we are investigating,' he said.

On Wednesday Securities and Exchange Commission Chairman Christopher Cox and SEC Enforcement Division Director Linda Chatman Thomsen issued statements concerning ongoing and forthcoming Commission actions to investigate fraud and manipulation in the nation's securities markets.

'In order to ensure that hidden manipulation, illegal naked short-selling, or illegitimate trading tactics do not drive market behavior and undermine confidence, the SEC today took several actions to address short-selling abuses,' Cox said. 'In addition to these initiatives, which will take effect from Thursday, I am asking the Commission to consider on an emergency basis a new disclosure rule that will require hedge funds and other large investors to disclose their short positions.”

Managers with more than $100 million invested in securities will be required to begin public reporting of their daily short positions.

'Director Thomsen and the Division of Enforcement will also expand their ongoing investigations by undertaking a series of additional enforcement measures against market manipulation,” the SEC chairman said . “The Enforcement Division will obtain disclosure from significant hedge funds and other institutional traders of their past trading positions in specific securities. Those institutions will also be required immediately to secure all of their communication records in anticipation of subpoenas for these records.'

SEC Director of Enforcement Linda Chatman Thomsen said, 'The Enforcement Division has been investigating and will continue to investigate any suggestion of manipulative trading. We are committed to using every weapon in our arsenal to combat market manipulation that threatens investors and capital markets.'

The SEC has already sent subpoenas to more than fifty hedge funds, and is preparing to issue many more, in relation to conspiracy and market manipulation concerns.

“Even with subpoena power, I’m not sure the SEC will get to the bottom of this, because the standard of proof is just so difficult,” a vice-chairman at a major investment firm told Vanity Fair's Bryan Burrough. “But I hope they do. Because you can look at this as just another run on a bank or as a seminal point in the financial history of this country that could bring about a change, perhaps a drastic change, in the way we govern financial markets. If there is a solution to this kind of thing, it must be found in the roots of what happened at Bear Stearns. Because otherwise, I can guarantee you, it will happen again somewhere else.”