WASHINGTON — With their arrest Thursday on a nine-count indictment, two former investment fund managers for banking titan Bear Stearns are now the public face of the nation's mortgage finance meltdown.
FBI agents made the first high-level arrests of Wall Street executives in connection with the nation's sub-prime meltdown, parading the handcuffed fund managers in front of cameras as the sun came up over Manhattan.
The U.S. Attorney's Office in Brooklyn brought the securities and wire fraud charges against Ralph Cioffi, 52, and Matthew Tannin, 46, respectively the founder of two Bear Stearns hedge funds for ultra wealthy investors and the funds' manager. The two were also charged with conspiracy, and the Securities and Exchange Commission brought civil charges against the pair Thursday.
The indictment alleges the two deceived investors into believing the hedge funds, which held special mortgage bonds that were backed with now-toxic sub-prime home loans, were healthy when they knew clearly they were not. The end result was that well-heeled investors like the one described in the indictment, Major Investor #1, collectively lost more than $1.5 billion.
"Hedge fund investors, like all investors in our national markets, are entitled to rely on those to whom they entrust their investment dollars," Benton Campbell, U.S. attorney for the Eastern District of New York, said in announcing the charges. "Honesty and fair dealing are at the foundation of this relationship of trust and confidence. These defendants chose to breach that trust, and they will now be held to account."
The indictment reads like a Hollywood script, citing e-mails in which the defendants allegedly concur that the "sub-prime market looks pretty damn ugly" and speculating that the entire market for sub-prime loans — which are given to the borrowers with the weakest credit histories — was "toast."
Despite that assessment, the pair allegedly told investors the market downturn was an "awesome opportunity" to buy, when in fact Cioffi transferred $2 million of his own money out of the fund, allegedly without disclosing that to investors who believed the pair had their own money at stake, too.
"The Bear Stearns indictments present a remarkable trail of emails regarding what the Bear Stearns managers knew, when they knew it, and what they told investors. The tale the alleged emails tell, if true, should make an investor's blood run cold," Kurt Eggert, a law professor at Chapman University in Orange, Calif., said in a written analysis of Thursday's indictment.
Although the case involves rich investors losing big sums, it has a great importance for ordinary Americans. It's a milepost in an unfolding national saga.
The collapse of the Bear Stearns hedge funds was the opening act of today's economic crisis, marked by the worst housing slump in modern times and a credit crisis gripping the banking sector that's crushing consumer lending and seems far from over.
At the core of today's economic slowdown are the sub-prime mortgages that were underwritten for virtually anyone, citizen or not, with a pulse. These began souring in 2006, reaching a crisis point in spring of 2007, and today are the reason for record foreclosures and mortgage delinquencies.
The indictment alleges that on March 3, 2007, Cioffi warned Tannin that "the worry for me is that sub prime losses will be far worse than anything people have modeled" in their risk assessments.