A Con Game In Pinstripes

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By Steven Pearlstein
Friday, September 5, 2008

We're entering that exciting phase of any financial crisis when the lawsuits come fast and furious, criminal charges are lodged, and Wall Street firms agree to pay hundreds of millions of dollars for having snookered their customers once again.

In recent weeks, Merrill Lynch, Goldman Sachs, Deutsche Bank, Citigroup, J.P. Morgan Chase, Morgan Stanley, UBS and Wachovia have reached settlements with state regulators under which they agreed to pay more than $500 million in fines and penalties. They have also agreed to buy back more than $50 billion in so-called auction-rate securities from retail investors who had been misled into believing that those securities were as safe as shares in money-market funds.

On Wednesday, a federal grand jury in Brooklyn indicted two former brokers at Credit Suisse on charges of lying to corporate clients about how $1 billion of their money had been invested. The investors thought it was in securities backed by federally guaranteed student loans. In fact, it was put in riskier mortgage-backed auction-rate securities that earned higher fees for the brokers and their firms, prosecutors said. The alleged fraud may have caused losses to the clients of as much as $500 million.

Earlier this summer, two executives from Bear Stearns were charged with nine counts of fraud for allegedly telling investors in a conference call that their hedge funds were in fine shape while, in private e-mails, they fretted over recent losses and, in one case, had just pulled their own money out of the funds. A month after the call, the funds collapsed, costing investors $1.6 billion.

Now comes word from the Bloomberg News Service that the Justice Department has launched a criminal investigation of J.P. Morgan Chase and other banks following civil allegations that they conspired to overcharge local governments for hedging on the interest rate risks in their bonds. One such government customer, Jefferson County, Ala., which claims it was overcharged by as much as $100 million in financing a new sewerage system, is now on the brink of bankruptcy.

What is so telling about these stories -- and, rest assured, there will be many more before we're finished -- is that they come only a few years after these same companies reached similar settlements for defrauding many of the same investors during the telecom and dot-com boom. While the fraud back then had more to do with bogus research and accounting and manipulation of initial public offerings, it is clear that they sprang from the same slimy ethical culture that has produced the current credit crisis. Wall Street has become a fundamentally corrupt enterprise in which the motto is: "We'll do anything for a fee."

I refer not to the narrow legal definition of "corrupt," but to the general instinct to mislead clients, double-cross and collude with counterparties, and pull the wool over the eyes of investors. It is the kind of corruption grounded in the attitude that it's all just a game in which the only rules are "buyer beware" and "heads I win, tails you lose." In a corrupt business culture like that of modern-day Wall Street, cynicism is rampant, candor and accountability are first casualties, and a man is measured by the size of his bonus rather than the depth of his integrity. It's not so much immoral as amoral.

The tell-tale signs of this endemic corruption now litter the financial landscape.

To find it, look no farther than the televised bleatings of research directors and equity strategists who, until the last few weeks, were still talking about a stock market rebound in the second half of the year and have never once forecast a losing year for the S&P 500.

You can find it in the spectacularly misguided mergers and acquisitions that were conceived, negotiated, blessed and underwritten by investment bankers who are paid enormous fees no matter how things turn out for investors. Their latest bright idea: the merger of Fannie Mae and Freddie Mac.

It's right there in the Wall Street Journal, where it is reported without a trace of irony, that some master of the universe who was forced out of Citi for overseeing the loss of billions of dollars has been snatched up by Morgan Stanley while another is staked for a couple of billion dollars to start his own hedge fund.

There would have never been a subprime mortgage crisis if Wall Street's underwriters had not been on the phone to bankers and brokers with incessant calls for more "product," by which they meant any loan for any amount to any borrower that could be packaged and sold off without even a pretence of due diligence and shopped around to the rating agency most likely to trade a triple-A rating for a triple-A fee.

These people are not your friends. They have already racked up half a trillion dollars in credit losses, wiped out five years of shareholders' profits and taken the wind out of the sails of the global economy. Given the situation, you'd think the leaders of this industry would have stepped forward to acknowledge the extent of the damage and apologize for their deep complicity in it. Instead, they have pointed fingers at the media and short-sellers, offered lame excuses about unforeseen market forces and warned of dire consequences from increased regulation, as if things were not dire enough already.

This is an industry that has lost all credibility -- with investors, with corporate clients and with the public. Its fundamental problem is a corrupt culture that is shaped by inflated fees and excessive compensation that bear too little relation to the risk, skills and innovation involved. Until that excessive compensation is competed away and that culture is transformed, Wall Street will continue to serve up a steady diet of booms, busts and financial scandals.

Steven Pearlstein can be reached atpearlsteins@washpost.com.


© 2008 The Washington Post Company

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