Courts reject Bear Stearns hedge funds' bankruptcy claims - 02-Sep-07 - Generational Dynamics

Ever since Bear Stearns announced that its two major hedge funds are almost worthless, investors have been trying to get their hands on any assets that the hedge funds still own that might have any value. This would be done by forcing the hedge funds into bankruptcy (though the Bear Stearns firm itself would not be bankrupted).

Bear Stearns had hoped to be able to file for bankruptcy in the Cayman Islands, where its hedge funds are officially registered, and thereby prevent investors from selling off the assets.

However, a US bankruptcy judge rejected this claim, saying that "The only adhesive connection with the Cayman Islands that the funds have is the fact that they are registered there."

He added, "There are no employees or managers in the Cayman Islands, the investment manager for the funds is located in New York, the administrator that runs the back-office operations of the funds is in the United States along with the funds' books and records, and prior to the commencement of the foreign proceeding, all of the funds' liquid assets were located in the United States."

This is being treated as a technical inside story, but in my opinion it has much broader significance in terms of how the mood of the entire country is changing.

There's an atmosphere of universal suspicion blame that's growing, and will continue to grow.

There are lots of hedge funds and other corporations that are registered in the Cayman Islands in order to avoid the penalties of American laws. Standard interpretations of the bankruptcy laws, as applied to foreign corporations liquidating overseas, may indeed have always been interpreted in the way that Bear Stearns wanted, but attitudes are changing rapidly and laws are being interpreted differently.

This is significant because ALL laws are going to be reinterpreted in an increasingly harsh manner.

The mentality of the Baby Boomer generation and Generation-X can be summarized in the 1960s saying, "If it feels good, do it." This is what led to the 1990s dot-com bubble, it led to the housing bubble, it led to the credit bubble, all based on their debauched abuse of debt and credit.

And as long as everyone was making money in the growing credit bubble, then laws were interpreted liberally. Now that people are losing their homes and their bank accounts, the laws are being interpreted differently because public attitudes are changing.

The phrase "stated income" is used with loans where the borrower states what his income is, but is not required to prove it with documents. It's not as unreasonable as it sounds, since the borrower can be held liable for civil or criminal charges if he misstates his income.

In the case of Partow, the borrowers stated their incomes correctly. It was Partow who changed the amount on the application. In one case, Partow listed the income as $20,000 per month -- "an amount that significantly overstated [the client's] true income."

These things used to be OK, since it got a family into a home of their own, which was the American dream, and that "feels good," so it was OK to do it.

When the bubble was growing, and money was everywhere, anyone could get away with anything. Now that people are losing their homes, they're looking for people to blame.

Many financial crimes are clear violations of the law -- fraud (as in the case of Partow) and embezzlement.

But what's changing is that many crimes that AREN'T clear violations of the law will be prosecuted as if they were. Many of these fall under the general category of "fiduciary responsibility." Thus, if you're a professional with clients that you advise, and it can be shown that your advice was tainted because of some conflict of interest, then you're going to be blamed, and you're going to face criminal and civil charges.

This is what Bear Stearns is discovering. They were counting on the "small print" in laws that allow them to register their hedge funds in the Cayman Islands to escape American laws. Now the laws are changing, and the "small print" no longer applies.

When people are desperate, then they have nothing to lose by blaming someone else. The point is that blaming someone else will become almost universal. And the easiest way to blame someone is to identify a conflict of interest.

Many professionals have fooled themselves by believing that they're because they've been absolved of responsibility by forcing clients to sign agreements.

Have you ever signed on to a web site and had to click a box that says, "I've read the user agreement and agree to its terms"? When you clicked that box, were you telling the truth? Probably not. No one reads these agreements.

So brokers have their clients sign multi-page agreements saying "The client has no right to sue the broker because the client was stupid enough to depend on the broker's advice." I believe that, in time, many of these agreements are going to be struck down, simply nobody ever reads them, and it will be argued that you can't hold a large mass of people responsible for agreements that they were forced to sign, that nobody ever reads, and that they wouldn't understand even if they did read them.

Let's make a list of people who are currently being blamed, or soon will be blamed, and who will be the subject of investigations, civil lawsuits and possible prosecution:

This has all happened before. In fact, the next-to-last international generational financial crisis, the Hamburg crisis of 1857 (panic of 1857), was triggered by a small event -- an employee of the New York branch of the Ohio Life Insurance and Trust Company was found to have embezzled money.

There was a great deal of embezzlement leading up to the last generational financial crisis. I've quoted a portion of this passage before, but it's worth posting the whole thing. John Kenneth Galbraith described what happened -- and what will happen again -- in his 1954 book, The Great Crash - 1929, as follows:

"In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in -- or more precisely not in -- the country's businesses and banks. This inventory -- it should perhaps be called the bezzle -- amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

The stock market boom and the ensuing crash caused a traumatic exaggeration of these normal relationships. To the normal needs for money, for home, family and dissipation, was added, during the boom, the new and overwhelming requirement for funds to play the market or to meet margin calls. Money was exceptionally plentiful. People were also exceptionally trusting. A bank president who was himself trusting Kreuger, Hopson, and Insull was obviously unlikely to suspect his lifelong friend the cashier. In the late twenties the bezzle grew apace.

Just as the boom accelerated the rate of growth, so the crash enormously advanced the rate of discovery. Within a few days, something close to universal trust turned into something akin to universal suspicion. Audits were ordered. Strained or preoccupied behavior was noticed. Most important, the collapse in stock values made irredeemable the position of the employee who had embezzled to play the market. He now confessed.

After the first week or so of the crash, reports of defaulting employees were a daily occurrence. They were far more common than the suicides. On some days comparatively brief accounts occupied a column or more in the Times. The amounts were large and small, and they were reported from far and wide. ...

Each week during the autumn more such unfortunates were reveled in their misery. Most of them were small men who had taken a flier in the market and then become more deeply involved. Later they had more impressive companions. It was the crash, and the subsequent ruthless contraction of values which, in the end, exposed the speculation by Kreuger, Hopson, and Insull with the money of other people. Should the American economy ever achieve permanent full employment and prosperity, firms should look well to their auditors. One of the uses of depression is the exposure of what auditors fail to find. Bagehot once observed: "Every great crisis reveals the excessive speculations of many houses which no one before suspected." [pp. 132-35]

Galbraith's point was that there were many criminal activities going on before the 1929 crash, but nobody cared, as long as everyone was making money. But once the crash occurred, any irregularity was viewed with suspicion and led to an investigation. These investigations turned up many cases of embezzlement -- people who had "temporarily borrowed" money that wasn't theirs to invest in the stock market, and then got caught in the crash.

It's a time of universal suspicion: "Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks."

The relevance of all this to what's happening today is that, so far, we've only seen the tip of the iceberg of embezzlement and other financial crimes, such as Partow's fraud.

I would tell my web site readers this: This is the time to put your affairs in order.

As I've said before, it's possible that some people reading this have committed crimes, such as embezzlement, thinking that no one would check and they wouldn't be caught. It's true that no one checks as long as everyone's making money, but when things go wrong, everything is checked and double-checked, and criminals are caught.

If you've committed a crime out of desperation, then you should try to find a solution immediately; even if you're going to be bankrupt and homeless, you don't want to be a criminal as well. Don't tell a friend or family member of your crime, because you'll make that person an accessory after the fact. Go talk to a lawyer or confess to a priest immediately, and examine the choices available to you. (02-Sep-07) Permanent Link
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Generational Dynamics Web Log for 02-Sep-07
Courts reject Bear Stearns hedge funds' bankruptcy claims

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Generational Dynamics Web Log for 02-Sep-07 Courts reject Bear Stearns hedge funds' bankruptcy claims

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Generational Dynamics Web Log for 02-Sep-07
Courts reject Bear Stearns hedge funds' bankruptcy claims