Tag Archives: Wallstreet

$50 Billion Fraud At WallStreet

Source Reuters

 

Bernard Madoff, a quiet force on Wall Streetfor decades, was arrested and charged on Thursday with allegedly running a $50 billion Ponzi scheme in what may rank among the biggest frauds ever.

The former chairman of the Nasdaq Stock Market is best known as the founder of Bernard L. Madoff Investment Securities LLC, the closely-held market-making firm he launched in 1960. But he also ran a hedge fund that U.S. prosecutors said racked up $50 billion of fraudulent losses.

Madoff told senior employees of his firm on Wednesday that “it’s all just one big lie” and that it was “basically, a giant Ponzi scheme,” with estimated investor losses of about $50 billion, according to the U.S. Attorney’s criminal complaint against him. A Ponzi scheme is a swindle where early investors are paid off with money from later investors.

The $50 billion allegedly lost to investors would make Madoff’s fund one of the biggest frauds in history. When Enron filed for bankruptcy in 2001, one of the largest at the time, it had $63.4 billion in assets.

U.S. prosecutors charged Madoff, 70, with a single count of securities fraud. They said he faces up to 20 years in prison and a fine of up to $5 million.

“Madoff stated that the business was insolvent, and that it had been for years,” Lev Dassin, acting United States Attorney for the Southern District of New York, said in a statement.

The Securities and Exchange Commission filed separate civil charges against Madoff.

Authorities said that, according to a document filed by Madoff with the U.S. Securities and Exchange Commission on January 7, 2008, Madoff’s investment advisory business served between 11 and 25 clients and had a total of about $17.1 billion in assets under management. Those clients may have included other funds that in turn had many investors.

The SEC said it appeared that virtually all of the assets of his hedge fund business were missing.

CONSISTENT RETURNS

An investor in the hedge fund said it generated consistent returns, which was part of the attraction. Since 2004, annual returns averaged around 8 percent and ranged from 7.3 percent to 9 percent, but last decade returns were typically in the low-double digits, the investor said.

The fund told investors it followed a “split strike conversion” strategy, which entailed owning stock and buying and selling options to limit downside risk, said the investor, who requested anonymity.

Jon Najarian, an acquaintance of Madoff who has traded options for decades, said … “Many of us questioned how that strategy could generate those kinds of returns so consistently.”

Najarian, co-founder of optionmonster.com, once tried to buy what was then the Cincinnati Stock Exchangewhen Madoff was a major seatholder on the exchange. Najarian met with Madoff, who rejected his bid.

“He always seemed to be a straight shooter. I was shocked by this news,” Najarian said.

‘UNFORTUNATE SET OF EVENTS’

“Bernard Madoff is a longstanding leader in the financial services industry,” his lawyer Dan Horwitz told reporters outside a downtown Manhattan courtroom where he was charged. “We will fight to get through this unfortunate set of events.”

A shaken Madoff stared at the ground as reporters peppered him with questions. He was released after posting a $10 million bond secured by his Manhattan apartment.

“Our complaint alleges a stunning fraud — both in terms of scope and duration,” said Scott Friestad, the SEC’s deputy enforcer. “We are moving quickly and decisively to stop the scheme and protect the remaining assets for investors.”

Madoff had long kept the financial statements for his hedge fund business under “lock and key,” according to prosecutors, and was “cryptic” about the firm. The hedge fund business was located on a separate floor from the market making business.

Bernard L. Madoff Investment Securities has more than $700 million in capital, according to its website. It is a market maker for about 350 Nasdaq stocks, including AppleEBay and Dell, according to the website.

The website also states that Madoff himself has “a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark.”

The company’s web site may be found here: http://www.madoff.com/

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Credit Crisis demystified

When:

Seeds were sown way back in 1977. Known as Community Reinvestment Act  , is a United States federal law that requires banks and thrifts to offer credit throughout their entire market area and prohibits them from targeting only wealthier neighborhoods with their services. The bill encouraged the Federal National Mortgage Association, commonly known as Fannie Mae, to enable mortgage companies, savings and loans, commercial banks, credit unions, and state and local housing finance agencies to lend to home buyers.

Why

National grassroots pressure for affordable housing. Though there was considerable opposition from the mainstream banking community. Only one banker from ShoreBank in Chicago, testified in favor of the act.

Subprime Explained

Mr A seeks a housing loan to give shape to his dream home. But he doesn’t have good credit rating. This means that he is unable to clear all the stringent conditions that a bank imposes on an individual before it sanctions a loan. Since his credit is not good enough, no bank will give him a home loan as there is a fear that the chances of a default by him are high. Here enters , Mr B (a robust financial institution)who has good credit rating and is willing to take on some amount of risk and make profit.

 Given his good credit rating, the bank is willing to give Mr B a loan. The bank gives the loan at a certain rate of interest.Mr B then divides this loan into a lot of small portions and gives them out as home loans to lots of others like Mr A who do not have a great credit rating and to whom the bank would not have given a home loan in the first place.

Mr B gives out these loans at a rate of interest that is much higher rate than the rate at which he borrowed money from the bank. This higher rate is referred to as the sub-prime rate and this home loan market is referred to as the sub-prime home loan market.

By giving loan to many Mr A’s , Mr B is expecting to make lot of profit.  Mr B does not wait for the principal and the interest on the sub-prime home loans to be repaid, so that it can repay its loan to the bank (the prime lender), which has given it the loan.

So what does Mr B do? He goes ahead and securitises’ these loans. Securitisation means converting these home loans into financial securities, which promise to pay a certain rate of interest. These financial securities are then sold to Mr C (Institutional Investors)

 

And how is Mr C repaid? The interest and the principal that is repaid by Mr A through equated monthly installments (EMIs) is passed onto Mr C.

This looks so simple so what went wrong

 

The sub-prime home loans were given out as floating rate home loans. A floating rate home loan as the name suggests is not fixed. As interest rates go up, the interest rate on floating rate home loans also go up. As interest rates to be paid on floating rate home loans go up, the EMIs that need to be paid to service these loans go up as well.

What happened next is that people started defaulting on their obligations. Once more and more sub-prime borrowers started defaulting, payments to the institutional investors who had bought the financial securities stopped, leading to huge losses.  The housing bubble collapsed and mortgage-backed securities (bought by Mr C) were almost worthless . As defaults kept rising, Mr B could not service their loans that they had taken from banks. So they turned to other financial firms to help them out, but after a while these firms too stopped extending credit realizing that the collateral backing this credit would soon lose value in the falling real estate market.

 

Now burdened with tons of debt and no money to pay it back, the back of these financial entities broke, leading to the current meltdown.

Ok this is an American problem , so why are markets around the world crashing

Mr C who had invested in securitised paper from the sub-prime home loan market in the US, saw his investments turning into losses. Most big investors have a certain fixed proportion of their total investments invested in various parts of the world.  Once investments in the US turned bad, more money had to be invested in the US, to maintain that fixed proportion. In order to invest more money in the US, money had to come in from somewhere. To make up their losses in the sub-prime market in the United States, they went out to sell their investments in emerging markets like India where their investments have been doing well. So these big institutional investors, to make good of their losses in the sub-prime market, began to sell their investments in India and other markets around the world.


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Bail out taxpayer , not AIG

Is the govenment doing anything for the common man whos on the street because of the financial crisis? Is the governemnt here to bail out big companies only and not the common man who is on the street? Why are profits privatized and tax payer money is being used to bail out companies which no other private comapny wants to buy?

Between the $29 billion the Fed pledged to swing the Bear Stearns sale to JPMorgan in March, $100 billion apiece to rescue mortgage finance firms Fannie Mae and Freddie Mac, up to $300 billion for the Federal Housing Authority, Tuesday’s $85 billion loan to insurer AIG and various other rescue deals and loans, taxpayers are potentially on the hook for more than $900 billion.

Why is that no one is punishing heads of these organization who are responsible for this crisis?

Earlier this year, Fuld, a 30-year veteran of the once-venerable Wall Street investment bank that filed for bankruptcy protection this past weekend, was awarded $22 million in retirement pay. Merrill Lynch chief E. Stanley O’Neal picked up $161 million from the Wall Street brokerage when he left last October after $40 billion of subprime-related write-downs. Former Citigroup head Chuck Prince stepped down with a $68 million package. Even former Bear Stearns chairman Jimmy Cayne picked up a reported $60 million after selling some of his Bear stock in the aftermath of that firm’s fire sale to J.P. Morgan earlier this year- Forbes

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