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Bear Stearns – Fat Cats Profit

Updated on April 8, 2008

Bear Stearns – Fat Cats Profit

Wall Street – what does that mean to you? I bet you thought first of the stock market, and all those financial wizards who do mysterious things, keeping the money flowing around. They aren’t particularly short of money themselves, of course. Whether the market is up or down, they still get their bonuses, in some cases measured in millions of dollars.

Some of the best paid are those in the investment banks, who are responsible for large amounts of money. Of course, you may have heard of Bear Stearns, the investment bank that fell flat on its face, and had to be rescued by JPMorgan with the help of the Federal Reserve guaranteeing the funds. Despite this, some have survived with their fortunes intact, and meanwhile the other bankers must be congratulating themselves on being in the right business to command government assistance.

Bear Stearns hasn’t always been good to its clients. For instance, in 2007 they had two of their hedge funds collapse and lose their investors’ money, after the banks forced them to sell off the funds’ assets, and they subsequently froze a third, even though it had less than 1% of the $900 million in sub-prime based securities. The CEO, James Caine, resigned in January, having been in charge when the company posted its first ever quarterly loss. His personal stake in the company was $168 million just before disaster struck, which left him with less than $20 million. Not so lucky were the 14,000 employees, who were required to invest about a third of their salaries in the company shares. In addition to these staggering losses, many can expect to lose their jobs in the takeover by JPMorgan.

Nonetheless, those that do have the savvy or the luck to succeed in the higher reaches of the financial world do have extraordinary wealth. The system is set up to reward handsomely those who are responsible for the movement of the funds. Consider this – mortgages used to be arranged with your local bank, who knew you, and could assess the risks of lending. In the 1970s, inflation meant that, while the long-term mortgages remained at a low interest rate, the rate to depositors rose sharply, which pushed many small lenders out of business, as they couldn’t get the deposits that they wanted to cover the lending.

This led to “securitization”, where, instead of the applicant dealing with the lender, they applied to a mortgage banker or broker who was only the loan “originator”. This was sold on to a broker, who packaged many loans together into a security, which could be sold on to investors. This disconnected the borrower from the source of the funds, and in effect made no-one really responsible for the quality of the loans. The originator would express the applicant’s qualifications in the best light, as he wanted to get a commission; the broker certainly wasn’t concerned about the detail of each application; and the investor really didn’t have any idea where his money was allocated. In any case, with the advent of Fannie Mae and Freddie Mac, which government sponsored entities guarantee most mortgages, the investor really didn’t feel that he had to know about the details. As it was in the interest of all the salesmen in the chain to lend more and qualify for higher commissions, aggressive marketing pulled in riskier prospects, and ensured that they were successful in obtaining their loans.

While you might think that this centralization of the mortgage market would result in cheaper mortgages, this is not the case. In the early 1970s, before the inflationary problems, the average differential between Treasury bonds and 30 year mortgages was about 1%. In recent times, but before the crash made mortgages even more expensive, the average differential was more than 1½%. While a free market theory may indicate otherwise, the increase is a direct result of commissions for aggressive originators, and profits for Wall Street “securitizers”. By inventing and investing in different sorts of financial vehicle, those cognoscenti have achieved enormous personal wealth.

Better still, there is now a new lease of life for the financial moguls. By taking the unprecedented step of stepping in to bail out Bear Stearns, the Federal Reserve have shown that private companies can take inordinate risks for huge profits, and still be saved by public money if disaster strikes. The Federal Reserve Act does not say anywhere that they are to bail out Wall Street, but by example they have shown that they are willing to. With the uncertainty surrounding the markets this is a great time to take control and take the free trading course at to make yourself better informed.


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