E-mails Suggest Bear Stearns Cheated Clients Out of Billions

The Atlantic
25.01.2011

Lawsuit alleges the bank took extreme measures to defraud investors, and now JPMorgan may be on the hook

Former Bear Stearns mortgage executives who now run mortgage divisions of Goldman Sachs, Bank of America, and Ally Financial have been accused of cheating and defrauding investors through the mortgage securities they created and sold while at Bear. According to e-mails and internal audits, JPMorgan had known about this fraud since the spring of 2008, but hid it from the public eye through legal maneuvering. Last week a lawsuit filed in 2008 by mortgage insurer Ambac Assurance Corp against Bear Stearns and JPMorgan was unsealed. The lawsuit’s supporting e-mails, going back as far as 2005, highlight Bear traders telling their superiors they were selling investors like Ambac a “sack of shit.”

News of internal whistleblowers coming forward from Bear’s mortgage servicing division, EMC, was first reported by The Atlantic  in May of last year. Ex-EMC analysts admitted they were sometimes told to falsify loan-level performance data provided to the ratings agencies who blessed Bear’s billion-dollar deals. But according to depositions and documents in the Ambac lawsuit, Bear’s misdeeds went even deeper. They say senior traders under Tom Marano, who was a Senior Managing Director and Global Head of Mortgages for Bear and is now CEO of Ally’s mortgage operations, were pocketing cash that should have gone to securities holders after Bear had already sold them bonds and moved the loans off its books.

Mike Nierenberg, who ran the adjustable-rate mortgage trading desk at Bear and is now the head of mortgages and securitization for Bank of America, was a key player ensuring the defaulting loans Bear was buying would move off their books right after they bought them, with little concern for the firm’s due diligence standards. He was joined in this scheme by Jeff Verschleiser, his peer and Senior Managing Director on the mortgage and asset-backed securities trading desk and head of whole loan trading. He is now an executive in Goldman Sachs’ mortgage division.

According to the lawsuit, the Bear traders would sell toxic mortgage securities to investors and then sell back the bad loans with early payment defaults to the banks that originated them at a discount. The traders would pocket the refund, and would not pass it on to the mortgage trust, which was where it should have gone to be distributed to the investors who owned the bonds. The Marano-led traders also cut the time allowed for early payment defaults, without telling the bond investors. That way, Bear could quickly securitize defective loans, without leaving enough time for investors to do their own due diligence after the bonds were sold and put-back any bad loans to Bear.

The traders were essentially double-dipping — getting paid twice on the deal. How was this possible? Once the security was sold, they didn’t have a legal claim to get cash back from the bad loans — that claim belonged to bond investors — but they did so anyway and kept the money. Thus, Bear was cheating the investors they promised to have sold a safe product out of their cash. According to former Bear Stearns and EMC traders and analysts who spoke with The Atlantic, Nierenberg and Verschleiser were the decision-makers for the double dipping scheme, and thus, are named as individual defendants in the suit.

Bear deal manager Nicolas Smith wrote an e-mail on August 11th, 2006 to Keith Lind, a Managing Director on the trading desk, referring to a particular bond, SACO 2006-8, as “SACK OF SHIT [2006-]8″ and said, “I hope your [sic] making a lot of money off this trade.”

It’s this blatant internal awareness inside the Bear mortgage trading division that the Ambac suits says led Bear to implement an across-the-board strategy to disregard its contractual promises and conceal the defective loans. By JPMorgan taking over Bear, it became the successor of interest in Bear Stearns. As the lawsuit lays out, JPMorgan is responsible for the flagrant accounting fraud started by Bear designed to avoid, and has continued to avoid, recognition of vast off-balance sheet exposure relating to its contractual repurchase agreements. This allowed executives to reap tens of millions of dollars in compensation from a bank that wouldn’t have been able to buy Bear without tax payer assistance.

80% of Loans Went Bad Almost Immediately

In 2007, when Ambac started to realize something was very wrong with its high-rated bonds, it demanded Bear provide loan-level detail and reviewed 695 non-performing loans in its portfolio. Ambac’s audit concluded that 80 percent of the loans showed an early payment default. This meant they should have never have been packed in the bonds Bear sold and were required to be repurchased. Bear refused, and of course had already been pocketing buyback money for itself from the originators. Bear also never told investors that its auditor Price Waterhouse and Coopers submitted an internal review in August 2006 that this repurchase process was not in-line with its due diligence standards and not typical for the industry. By January 2007, a Bear internal audit also reported the firm had collected $1.7 billion in repurchase claims — a 227% increase over the previous year. Yet Marano’s group of traders continued their double-dip payment scheme and kept selling the toxic loans with full awareness of the poor quality of the due diligence.

Jeffrey Verschleiser even said in an e-mail that he knew this was an issue. He wrote to his peer Mike Nierenberg in March 2006, “[we] are wasting way too much money on Bad Due Diligence.” Yet a year later nothing had changed. In March 2007, Verschleiser wrote to Nierenberg again about the same due diligence firm, “[w]e are just burning money hiring them.”

Then in November 2007, Verschleiser wrote to his risk committee that he knew insurers for mortgage securities were going to have big financial problems. He suggested they multiply by ten times the short bet he’d just made against stocks like Ambac. These e-mails show Verschleiser’s trading desk bragging to firm leadership that he made $55 million off shorting insurers’ stock in just three weeks.

Eventually, as Ambac kept demanding a repurchase of the bad loans, Bear acknowledged in late 2007 it would have to buy some back. The lawsuit lists over $600 million in claims with $1.2 billion in damages from the soured mortgage securities it invested in and insured against. But according to the lawsuit, in the spring of 2008, JPMorgan dismissed an outside audit review of the loans’ need to be repurchased and once again refused to pay Ambac. The suit asserts JPMorgan knew a repurchase would result in a huge accounting liability that would put their balance sheet in serious trouble at that time.

Last week, JPMorgan CEO Jamie Dimon said it will take years to get through mortgage litigation risk the bank inherited and had set aside around $9 billion for litigation-related risk. Yet in the bank’s January earnings call, Dimon suggested that the bank may not have to buy back any soured mortgages from private investors and said that the issue is “not that material” for JPMorgan. Still, Ambac recently won a court order in December to add accounting fraud against JPMorgan to its suit, which can double or triple lawsuit awards. So it’s hard to tell whether America’s largest bank is prepared to pay for the sins of Bear. JPMorgan did fight tooth and nail for the Ambac suit not to be made public, however, because the firm argued it could damage the reputations of senior bank executives currently working in the industry. Individuals named as defendants in the amended complaint include: Jimmy Cayne, Alan “ACE” Greenberg, Warren Spector, Alan Schwartz, Thomas Marano, Jeffrey Mayer, Mary Haggerty, Baron Silverstein, Jeffrey Verschleiser, and Michael Nierenberg. But the court chose to fold these individuals into the charges against JPMorgan as the case goes through appeal.

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