Investment Fraud Lawyer Blog

In her March 30 “Fair Game” column in the New York Times Business Section, veteran reporter and columnist Gretchen Morgenson reviewed the latest developments in the plight of thousands of individual investors stuck with auction-rate securities that their brokers had told them were “as good as cash.”

As we now know, auction-rate securities are debt obligations of an issuer – usually a municipality, non-profit or closed end mutual fund – whose interest rates are set at regular auctions, typically held every seven to thirty five days. With the gridlock in $330 billion auction-rate securities market, investors cannot get out of these investments while the auctions continue to fail. They have limited choices: They can hope that the issuers of the auction-rate securities offer to buy them back, they can hope to sell them in the secondary market, they can hope the market unfreezes or they can sue the brokers who sold them the securities, often with a promise that they could be cashed in weekly.

Investors in auction rate securities issued by municipalities or non-profits are probably best positioned. Most such auction rate securities provide for much higher default rates when auctions fail. Accordingly, the issuers have strong incentives to seek refinancing to redeem their auction rate securities. Already various such issuers have announced their intent to refinance.

Continue reading " Auction Rate Securities:"Liquid Assets" That You Can't Sell " »

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Posted In: Auction Rate Securities , Subprime Mortgage & Collateralized Debt Obligation Problems

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If you own auction rate securities, you may wind up holding on to them a lot longer than first envisioned. Auction rate securities, which were generally sold as liquid money market or cash equivalents, may now be long-term investments. Most of the auction rate securities market has been frozen since mid-February. To compound the problem, municipalities, non-profits, mutual fund companies, and other issuers have no obligation to redeem the auction rate securities, even though these were sold as safe and liquid as money market funds, according to Bloomberg.com.

Prior to late last summer auctions had rarely failed during the past twenty years. The auction rate market grew rapidly to the point where Bank of America Corp. estimates it is currently worth $330 billion. Of that amount, approximately $60 billion was sold by closed-end funds and most of the remainder by municipalities and non-profit organizations.

The auction rate freeze has far-reaching implications for thousands of small companies and individuals. As reported by Rebecca Buckman in the Wall Street Journal, Silicon Valley start-up companies are starting to feel the pinch. Many of these closely held companies had placed their cash into auction-rate instruments believing that these securities were safe and nearly the same as cash. Then when they needed the money to make payroll or fund operations they found they couldn’t get it. Similarly, many individual investors have placed tax monies, retirement funds and “rainy day” funds in auction rate securities only to find these funds frozen. In many cases, this can result in serious financial hardship to such individuals.

Continue reading " Auction Rate Securities Update " »

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Posted In: Auction Rate Securities , Subprime Mortgage & Collateralized Debt Obligation Problems

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The $330 billion auction-rate securities market is still frozen solid. Since February 13, hundreds of auction failures have occurred each day. The results can be devastating: The issuers are forced to pay high penalty interest rates. The investors are unable to extricate themselves from these investments, even though their brokers sold the securities as if they were as liquid as cash or cash equivalents. To add insult to injury, the brokerage firms continue to get paid by the issuers to hold the auctions that fail.

As many have recently – and painfully – learned, auction-rate securities are long-term bonds intended to behave like short-term debt. They have been sold by brokers as liquid investments and categorized as cash and cash equivalents. The rates are set through a bidding process managed by investment banks and are usually held every seven, 28 or 35 days.

In mid-February, the auction rate market collapsed as investors stopped buying these securities based on fears about the creditworthiness of the bond insurers who guaranteed the debt. At that time, the investment banks ceased stepping in and covering the shortfalls in demand by purchasing the auction rate securities for their own accounts.

Continue reading " $330 Billion Market for Auction Rate Securities Frozen, Yet Brokers Still Get Paid: Regulators Investigate " »

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Posted In: Auction Rate Securities , Bank of America , Citigroup/Smith Barney , Goldman Sachs , Merrill Lynch , Regulatory Developments , Subprime Mortgage & Collateralized Debt Obligation Problems , UBS

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Is the commercial mortgage-backed securities market the next shoe to drop? The U.S. economy is suffering serious financial stress as a result of complex derivative credit securities and inadequate risk analysis. While the federal government seems aggressively intent on providing enough liquidity to the banking system to avoid a financial meltdown and eventually regain control of the markets, can they accomplish it in time?

According to a March 19, 2008 article in the Co-Star Group Real Estate Newsletter, Wall Street’s wild swings and the turmoil in the credit markets are confounding the commercial real estate industry. In recent weeks, the CMBX indexes that follow commercial mortgage-backed securities suggests that such securities have lost roughly 20% of their value.

Continue reading " Commercial Mortgage-Backed Securities Are Losing Value " »

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Posted In: Subprime Mortgage & Collateralized Debt Obligation Problems

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In a somewhat shocking announcement Thursday afternoon, Bloomberg.com reported that, on March 25, 2008, James Cayne, former Chairman of Bear Stearns had sold his entire 5.66 million share stake in the company for $61 million ($10.84/share). The sale surprised many observers who expected competing bids for Bear Stearns. In fact, Cayne and Joseph Lewis, another major shareholder, had tried to drum up competing bids for Bear as late as last week.

The “get out while the getting is good” sale suggests that Cayne himself may have concerns about Bear’s underlying value. The Bear has been notoriously difficult to value because of its intricate involvement in a broad array of complex derivative arrangements, many of which are illiquid. In addition several of Bear’s core business segments have significant exposure to volatile market conditions. Since it would be logical to expect that Cayne would want to maximize the value of his huge holding in the Bear, apparently he concluded that $10.84/share was close to its maximum value.

Continue reading " Former Bear Stearns Chairman Sells All of His Stock: What Does He Know That We Don't? " »

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Posted In: Subprime Mortgage & Collateralized Debt Obligation Problems

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Carrington Capital Management, LLC, a $1 billion hedge fund, is looking for a few good investors. The fund, which specializes in mortgages, is asking investors to lend it as much as $200 million with an 18 percent interest rate on new preferred shares.

Carrington is raising the money to replace bank loans but maintains that its relationship with traditional lenders Citigroup and JP Morgan Chase remains “good.”

How good can the bank relationships be when you have to pay investors 18% interest to borrow money? The hedge fund’s inability to obtain credit from its traditional lenders and the high rate of interest it is being required to offer in its efforts to raise capital indicate a “rocky road ahead.’

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Posted In: Subprime Mortgage & Collateralized Debt Obligation Problems

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Merrill Lynch, which has already written down approximately $24.5 billion on its subprime securities investments, is anticipated to write down additional investments in the first quarter of 2008. Noted stock research firm, Sanford C. Bernstein & Co., estimates that Merrill Lynch will write down an additional $4.5 billion on collateralized debt obligations (“CDOs”). Merrill Lynch reported that it held approximately $30.4 billion in CDOs at the end of 2007 and the values of CDOs have fallen sharply since that time.

Bernstein analyst, Brad Hintz, believes that Merrill’s problems associated with subprime securities and other related derivative instruments will continue to impact the firm for the foreseeable future. Hintz said “It will take at least several years for Merrill to fully divest itself of these troubled assets.”

Continue reading " Merrill Lynch's Subprime Problems to Continue " »

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Posted In: Merrill Lynch , Subprime Mortgage & Collateralized Debt Obligation Problems

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Well-respected banking analyst, Meredith Whitney of Oppenheimer & Co., predicts that Citigroup may be facing additional writedowns of $13.1 billion on collateralized debt obligations and leveraged loans. In addition, Ms. Whitney now anticipates that Citigroup will lose $.15/share during 2008.

Previously, Citigroup had written down approximately $18 billion on its subprime securities investments and was forced to cut its dividends. As a result, the company has been in a serious cost cutting mode, eliminating 4,200 jobs with plans for additional cuts. Previous estimates have suggested that thousands of additional Citigroup employees are at risk of losing their jobs.

Continue reading " Analyst Expects More Big Subprime Losses for Citigroup " »

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Posted In: Citigroup/Smith Barney , Subprime Mortgage & Collateralized Debt Obligation Problems

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Investors across the country with accounts in Charles Schwab Corp. have learned the hard way that their so-called "money market fund" wasn't as safe as they thought it was. The fund in question, Schwab's High Yield Plus Select Fund (SWYSX) has declined twenty-two percent since January 2, 2007 due to excessive investments by the fund in subprime mortgage-related products. Unfortunately, many financial advisors put their clients' short-term money into the fund. Many of the advisors have complained that they believed the fund was essentially a low-risk money-market fund and, indeed, Schwab and other firms have often promoted these funds as cash alternatives since 2003 when money market rates hovered at around one percent. The problem is that neither Schwab nor advisors buying the fund for their clients highlighted the extra risk in the fund, preferring, naturally, to highlight only the extra yield the fund could achieve while simultaneously accepting higher commissions. As Peter Crane, Editor of Money Fund Intelligence of Westboro, Massachusetts, pointed out in a recent article in Investment News, "Nobody gets paid to put investors in cash."

Continue reading " Schwab Fund Sold as Money Market Drops by Twenty-Two Percent " »

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Posted In: Charles Schwab , Schwab YieldPlus Fund , Subprime Mortgage & Collateralized Debt Obligation Problems

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As a result of the subprime securities crisis and the ensuing credit crunch, a “run on the bank” at Bear Stearns forced the company to sellout to J.P. Morgan for just $10 a share, far below its reported book value. Once the country's fifth-largest investment bank, the sudden collapse of Bear is the latest sign that America’s financial system has overheated.

In a desperate attempt to get the financial markets humming again, the Federal Reserve is trying to stabilize the credit market before a failure of confidence contaminates the entire financial system. Otherwise, further economic decline could spread to other banks and beyond.

Steve East, chief economist for FBR Capital Markets says, "As far as Wall Street securities houses go, Bear Stearns wasn't too big to fail. It was too interconnected to fail."

Continue reading " Bear Stearns' Collapse Affects Main Street America " »

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Posted In: Bear Stearns , Subprime Mortgage & Collateralized Debt Obligation Problems

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Experts fear that Wall Street firms will cut thousands of additional jobs in the coming months as liquidity concerns spread. Jo Bennett, an executive search firm specialist in New York, estimated that job cuts by Wall Street firms “could be more than 100,000 in a few years.” Similarly, USA Today reported that New York City, alone, could lose over 20,000 jobs in the financial sector during the next 2 years.

Already, Wall Street firms have aggressively cut jobs in an effort to get costs under control. Bloomberg.com reports that more than 34,000 jobs have been cut in the last nine months as a result of the subprime crisis and ensuing credit crunch. The job cuts have impacted a wide array of firms with at least eleven firms having eliminated over 1,500 jobs. The largest job cuts have taken place at Citigroup, Lehman Brothers, Bank of America, Morgan Stanley, and Merrill Lynch.

Continue reading " Wall Street Expected to Pare More Jobs as Liquidity Concerns Spread " »

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Posted In: Subprime Mortgage & Collateralized Debt Obligation Problems

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Over recent months, the list of major hedge funds that have halted investor withdrawals and/or appear to be on the brink of collapse has been growing rapidly. These developments underscore the liquidity problems being experienced by the major hedge funds. This poses a major threat to the financial markets. Hedge funds are typically among the biggest and most active players in the financial markets and further deterioration of these funds could be disastrous. Moreover, many hedge funds are intricately involved in the explosion of derivative investments that have bonded various firms and hedge funds together in ways impossible to predict. Thus, the ramifications of major hedge funds imploding presents far reaching risks to other market participants.

This impending problem was summarized in an article in The Wall Street Journal by Liz Rappaport and Justin Lahart entitled “Debt Reckoning: U.S. Receives a Margin Call.” In pertinent point, the article concludes “The resulting blow to confidence threatens to further weaken lending, borrowing, spending and investment in the U.S. economy. ‘Hedge fund blow-ups have so far been one-off situation. One worry is that we’ll cross some line and there’ll be a systemic wave of fund failures. It’s a reason why the market is so nervous’ says John Tierny, credit derivatives strategist at Deutsche Bank.”

Continue reading " Faltering Hedge Funds Threaten Financial Markets " »

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Posted In: Subprime Mortgage & Collateralized Debt Obligation Problems

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Investors in conservative U.S. Bond Funds should be on the alert for possible risks in such funds due to the existence of so-called "credit default swaps" in the fund's portfolio. These investments - essentially a futures contract tied to whether a bond issuer's credit rating will get better or worse - are not strictly regulated by the Securities and Exchange Commission and details regarding their risks are not typically explained in the fund's prospectus.

Many bond fund managers use these swaps as a way to achieve a slightly higher yield for the fund. Unfortunately, there are various significant risks associated with these types of arrangements. For example, if the bond issuer defaults, the fund, which has essentially agreed to insure against default, is required to pay for the loss. This could result in the fund manager having to sell other fund assets, thereby dragging the fund's performance. Additionally, credit default swaps are carried at values that are unreliable and may result in overstatement of the fund’s Net Asset Value. The price of credit default swaps is based on a "fair value estimate" that may or may not be realized when it comes time to have to sell it. Thus, the valuation of these instruments is inherently unreliable. Finally, fund managers are exposed to the risk that the institution on the opposite side of the transaction, "the counter party" may experience financial problems that would interfere with its ability to pay the premium for insuring the bonds.

Continue reading " Credit Default Swaps Pose a Risk to U.S. Bond Funds " »

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Posted In: Subprime Mortgage & Collateralized Debt Obligation Problems

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Not surprisingly, some financial advisers are more inclined to exploit a client’s fear during a bear market than during a bull market. In periods of turmoil, such advisors encourage so called “safety net” investment vehicles.

The term “safety net” is used to describe an investment that promises the upside of a market with little or no risk. In some cases, guarantees such as a minimum income or principal protection are offered. Sometimes a bonus of at least 7% of the account value is also promised when an agreement is signed.

When an advisor pitches a safety net investment, it usually involves an insurance product, e.g. equity indexed annuity or variable annuity with living benefit guarantees. The downside of safety net investments is that while agent commissions are high, returns are low - averaging about 2% to 3% annually. Also, a surrender charge or exit fee of 6% is incurred if money is withdrawn within the first six to eight years. Finally, in many cases, the promised bonus is illusory.

Continue reading " Investors: Beware the "Safety Net" Trap Associated with Equity Indexed Annuities and Variable Annuities " »

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Posted In: Variable Annuities and Equity-Indexed Annuities

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According to analyst Richard Bove, Bank of America may take a $6.5 billion loss provision in the first quarter of 2008. Bove anticipates that this loss provision would be established to cover possible future losses in Bank of America’s subprime mortgage portfolio and home equity portfolio.

Recent reports have predicted that both of these segments of the market are likely to experience serious difficulties in 2008 and 2009. In late January, Business Week published an article, “The Home Equity Crisis Ahead” by Mara Der Hovanesian which described the deterioration of the $850 billion home equity market. In this article, Amy Crews Cutter deputy chief economist at Freddie Mac, was quoted as stating “The home-equity lender is going to get hosed.” Similar opinions have been expressed regarding the subprime mortgage market. In its March 31, 2008 edition, Fortune quotes Princeton economist Paul Krugman stating “I think there’ll be $1 trillion of losses on mortgage –backed securities showing up somewhere.” To date, securities firms and banks have disclosed only about $195 billion in losses related to the mortgage markets.

Continue reading " Bank of America: More Subprime Problems Ahead? " »

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Posted In: Bank of America , Money Market Funds , Subprime Mortgage & Collateralized Debt Obligation Problems

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Last week when J.P. Morgan announced a Fed-supported acquisition of Bear Stearns for the fire sale price of $236 million (roughly $2/share), it unleashed a frenzy of activity in various corners of the financial markets which will play out over the coming months. The transaction has already resulted in strong dissention from shareholders, in legal claims against Bear Stearns, in government investigations, and in competition over how Bear Stearns’ carcass will be devoured.

The background of Bear Stearns’ demise has been well publicized. Beginning at least as early as late 2006 and continuing through 2007 Bear Stearns experienced an array of problems arising out of the subprime securities crisis that lead to the ensuing credit crunch. Throughout this period, Bear Stearns consistently maintained that its finances and liquidity were more than adequate to sustain its business. As recently as the week of March 10 2008, Bear Stearns maintained that its book value remained at approximately $84/share. At the same time Bear Stearns CEO Alan Schwartz appeared on CNBC and stated “we don’t see any pressure on our liquidity, let alone a liquidity crisis.” Bear Stearns’ stock was trading at around $60/share. Several days later, Bear Stearns needed money to sustain operations. Still the value of Bear Stearns shares only dropped to about $26/share. Then came the announcement that J.P. Morgan, with support from the Fed, had agreed to buy Bear Stearns for $2/share.

Continue reading " Bear Stearns Fire Sale Creates a Frenzy in the Financial Markets " »

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Posted In: Bear Stearns , J. P. Morgan Chase , Subprime Mortgage & Collateralized Debt Obligation Problems

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Bear Stearns' pending acquisition by J P Morgan Chase has caused investors to question how Bear, which had nearly $400 billion in assets and $12 billion in shareholder equity, went from normalcy to near bankruptcy in seven days.

Some experts blame Bear's fall on opaque assets, derivatives exposure and liquidity demands. The fact however remains that a “run on the bank” led to the company’s sudden demise.

"If the market is driven by an irrational fear, then it's very difficult to come up with a strategy that can quell that," says Kris Niswander of SNL Financial.

Continue reading " Can Other Firms Avoid Bear Stearns' Fate? " »

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Posted In: Bear Stearns , Brokerage Firms

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According to the Financial Times, J P Morgan Chase will be “forced to improve its offer [to acquire Bear Stearns]--driving shares in the beleaguered [Bear Stearns] to nearly three times the price at which J P Morgan agreed to take it over.”

Investors bet that opposition from shareholders, which include Bear Stearns employees who own about a third of the shares, could force the takeover price to be raised. Meanwhile, J P Morgan executives express confidence that the deal will be approved.

If the offer goes through, Bear's shareholders will incur huge losses on the value of their investments. If Bear's board recommended another offer, the company would have to issue 20% of its share capital to J P Morgan at approximately $2 a share. Furthermore, even if the deal falls through, J P Morgan will be able to purchase Bear's Madison Avenue headquarters for $1.1 billion.

Continue reading " Investors Bet On Rival Bear Bids " »

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Posted In: Subprime Mortgage & Collateralized Debt Obligation Problems

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