Fans of the 1987 movie “Wall Street” remember the perp walk. The feds ambush the young financial hotshot Bud Fox, played by Charlie Sheen, as he enters his office. They cuff him and parade him past his fellow brokers.
A similar scene played out Thursday when federal agents arrested two former Bear Stearns hedge fund managers at their New York area homes, then marched them in handcuffs to their arraignment in Brooklyn federal court.
Later, FBI Director Robert Mueller held a rare press conference to announce that a nationwide sweep had netted more than 400 real estate industry players arrested during the past several weeks. He said the government was pursuing 19 other corporate fraud investigations against major firms with ties to the subprime mortgage debacle. Hundreds of other investigations are under way against local firms and players, including dozens in Minneapolis-St. Paul, described by the FBI as one the nation’s 10-worst cities for mortgage fraud.
“This operation is an example of our united commitment to address this significant crime problem,” Mueller said. “The FBI will continue to direct investigative and analytic resources towards mortgage fraud and corporate securities fraud that threaten our nation’s economy.”
The government’s response to the crisis was intended to send a strong message to the lending industry and to help restore the trust of investors and consumers as the economic slump deepens, MSNBC’s John Schoen concluded in his analysis. But it’s unclear, he said, whether the government’s actions will positively affect the economy, or protect future home buyers from similar fraud.
Quicker reforms sought
Meanwhile, Treasury Secretary Henry Paulson urged quicker reforms that would give the Federal Reserve more authority to regulate Wall Street.
Referring to the “outdated nature of our financial regulatory system,” Paulson said in a speech that the government must “move much more quickly” to restore public confidence in its policing powers, keeping in mind the balance between free markets and needed oversight.
At a hearing on Capitol Hill, regulatory officials told the Senate Banking Committee that they have already stepped up oversight of investment banks.
Before the crisis broke, Paulson had referred to the bundling and marketing of risky mortgages as “innovation.” With an election on the horizon it’s likely that federal agencies are feeling pressure to cut a higher profile in addressing problems in the financial markets and pursuing cases against fraudulent mortgage dealings.
The former Bear Stearns executives arrested were Ralph Cioffi, 52, and Matthew Tannin, 46. Charged with mail fraud, wire fraud and conspiracy, they were the first top Wall Street figures to face criminal charges in connection with the crisis.
Misleading investors with optimistic assessments
The indictment contends that the hedge fund managers misled investors by offering optimistic assessments while they, themselves, held deep reservations about the health of the funds. Cioffi, also charged with insider trading, moved $2 million of his personal money out of one mortgage fund while delivering upbeat reports. Both men “deceived” investors and other financial managers by “fraudulently concealing” the funds’ true condition, according to the indictment.
In an April 2007 email, sent two months before the funds imploded, Tannin told Cioffi that the subprime market “looks pretty damn ugly.” If the company’s internal modeling is accurate “I think we should close the funds now,” he wrote. If internal modeling is correct, “then the entire subprime market is toast.”
His prediction proved hauntingly accurate.
Of the 406 people arrested in recent weeks, 60 were charged on Wednesday alone, as agents moved in on suspects in Chicago, Houston, Miami and a dozen other cities. Real-estate developers, brokers, agents and appraisers were among those charged, as well as lenders, lawyers and straw buyers, the FBI said.
Federal agents described Minneapolis-St. Paul as a hotbed of illegal activity and one of the nation’s 10-worst areas for mortgage fraud. Dozens of criminal investigations are under way in the Twin Cities, the FBI told the Star Tribune’s Dan Browning. Included are inquiries into Parish Marketing and Development of Eagan, involving 200 homes in the south metro, and TJ Waconia of Roseville, involving 165 homes in Minneapolis.
While housing markets vary, home prices are down an average of 20 percent from their peak in 2006 and continue to fall rapidly in many areas. Some experts predict an additional 15 percent decline in the coming year. Martin Feldstein, president of the National Bureau of Economic Research and an economics professor at Harvard University, says the danger is that home values could decline even further, pushing the economy into deep recession.
Writing in the Washington Post, Feldstein said that about one-fifth of all homeowners with mortgages, about 10 million Americans, already carry mortgage debt that exceeds the value of their homes.
That number could double if home prices continue to decline, he said. Mortgage defaults and foreclosures hit a 30-year high in the first quarter of this year. If the gap between value and debt continues to widen, the incentive to default could increase at a pace that would send values into a downward spiral. “It is impossible to know where such a self-reinforcing process would stop,” he said.
Feldstein’s remedy is for the federal government to create a firewall to prevent precipitous decline. All homeowners could replace a portion of their mortgage with a government loan with a lower rate. Such a loan would remove the foreclosure incentive, he said, pointing out that when housing values fall beneath the value of mortgage debt, walking away from the home becomes the best financial option. It’s that option that must be removed, he said, adding that Congress should not hesitate to act.
The movie “Wall Street” isn’t about the mortgage industry, but, in explaining the root of corruption, the film and the subprime crisis share a common theme. “Greed is good,” declares the swashbuckling CEO Gordon Gekko, played by Michael Douglas.
The hundreds, perhaps thousands, of perpetrators of the subprime crisis may be having second thoughts about that credo. The FBI isn’t finished with its sweep. More perp walks lie ahead.
Steve Berg, a former Washington, D.C., bureau reporter, national correspondent and editorial writer for the Star Tribune, reports on urban design, transportation and national politics. He can be reached at sberg [at] minnpost [dot] com.