BY JOHN BESSLER

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BACKGROUND

I decided to do this case analysis based on both Case 9: Countrywide Financial and Case 10 Banking Industry Meltdown: Barings Bank and Bear Stearns because these are 3 important financial institutions that were big players in the market place that no longer exist. Barings and Bear Stearns demise were from derivatives. In Barings case the derivatives were futures and options and in Bear Stearns the derivatives were mortgage backed securities and credit default swaps that the subprime mortgage debacle brought down. With Countrywide it was risky lending products designed for the subprime mortgage market.

 

 

 

 

 

 

 

 

 

 

BARINGS BANK

Barings Bank was founded by Sir Francis Baring in 1763 and ceased to exist on February 26, 1995when its chief futures trader Nick Leeson lost approximately $1.4 billion in company assets.

Nick Leeson was the son of a plasterer in England who at age eighteen went to for Coutts and Company in 1985 and then in June 1987 went to work for the American investment bank Morgan Stanley where he worked in settlements for futures and options deals. Leeson began to realize that the big money was being made by the traders. Two years later Leeson went to work for Barings Bank. Leeson started off working in the Settlement Division for Futures and Options just like he had done at Morgan Stanley.

 

During the 1980s one of Barings most successful ventures was to set up in Asia. Barings began trading on the Japanese Stock Exchange. Barings also started doing business in the “tiger economies” of Asia such as Hong Kong, Singapore, Indonesia and other Far East countries

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Leeson got assigned to the Jakarta Office in Indonesia were he cleaned up a tremendous mess of unreconciled accounts in their settlements office. For his efforts Nick Leeson got a promotion.

 

Barings had acquired a seat on the Singapore Monetary Exchange – SIMEX and Nick Leeson was assigned the position of General Manager in Barings’ Singapore office.  He had authority over both the front office (trading) and the back office (settlements). This lack of internal controls made it easy to hide losses on the trading floor by hiding them in an errors account the 88888 account from which got its name from Chinese numerology as a lucky number. It first Leeson originally used this account for errors made by his inexperienced staff such as misunderstanding a buy signal for a sell signal. Barings downfall started from wanting to save money. Simon Jones, Leeson’s immediate supervisor made Nick the manager of both the front office and the back office because hiring two managers would cost more money. In the movie “Rogue Trader” Simon Jones tells Nick that he is a bottom-line kind of guy and that there is no need to pay “top dollar” for traders that Nick is to hire them “young and hungry” and than train them. This was why the errors happened which Leeson would replenish the account when the market was doing well.

Leeson got a high roller client who was trading long on the NIKKEI INDEX (Japanese Stock Exchange) this person was the second largest investor on the NIKKEI next to George Soros.

Leeson was soon becoming a rising star at Barings Bank making large bonuses. The head of Barings Derivative Department, Ron Baker started touting Nick Leeson as a role model and warned other managers in his department that their jobs were at risk unless they got themselves behind an “Arbitrage Information Curve” like Nick Leeson had discovered. In reality Leeson had lost his major account to the French bank, Societe Generale. Leeson who along with his star trader George Seow was intoxicated at least half the time (Leeson and another trader were arrested by Singapore Police for exposing their rears in a bar to Singapore Airline attendants) started borrowed heavily from the bank for margin calls which was just an attempt to cover losses. Soon the 88888 account was hiding several million dollars of losses. Leeson was using the bank’s own money instead of the customer’s account which definitely illegal.

 

Than in early 1995 a massive earthquake hit Kobe, Japan and as a result the NIKKEI plummeted.

 

The house of cards collapsed and Nick Leeson fled Singapore along with his wife and was arrested at the Frankfurt Airport by the German Police who shipped him back to Singapore where wrote “Rogue Trader” and was released after 5 years because of colon cancer from which he recovered. Leeson was bitter that his superiors got off the hook. He is now remarried and went to college and got a BA in Psychology and is the CEO for an Irish football team where he is now a resident of Ireland instead of the UK.

 

Barings Bank suffered losses of $1.4 billion dollars and on February 26, 1995 after a bailout package from the Sultan of Brunei fell thru, Peter Barings, Chairman of Board declared Baring insolvent and it was sold for one pound to the Dutch Bank IMG.

 

 

 

 

 

 

 

 

 

 

COUNTRYWIDE HOME LOAN

 

Countrywide Home Loans was founded in March 1969 by Angelo Mozilo and David Loeb and it became the symbol of home ownership in America In 2008 Bank of America purchased Countrywide’s assets and it ceased to exist.

 

Countrywide grew rapidly under the charismatic leadership of Angelo Mozilo becoming one of the top mortgage lenders in America.

The story about the fall of Countrywide and the Subprime mortgage market collapse is the subject of the book “The Foreclosure of America – Life inside Countrywide Home Loans and the Selling of the American Dream” by Adam Michaelson, Senior Vice President of Online Marketing from 2003 to 2008.

 

During 2004 the housing and mortgage market boom hit unheard of levels and it seemed the sky was the limit. In July 2004 Michaelson attended a meeting at corporate headquarters where the “finance jocks” as he called the financial engineers, had announced the creation of a new product, the Pay Option Loan. After attending the meeting Michaelson remarked to his boss, “I think I may have just witnessed the beginning of the end of Countrywide and maybe the entire US economy.” Michaelson saw the dangers in the new product that would lead eventually to people not being able to pay especially if home values fell. The Pay Option Loan was an Adjustable Rate Mortgage (ARM) that allowed the borrower the choice of 4 payments two of which were negative amortization resulting in the principal growing because the borrower is making “interest only payments” with the loan balance increasing.

 

Countrywide was not the only player, other mortgage companies started offering similar products. Wachovia Mortgage called their product “Pick-A-Payment.”

 

Another product that Countrywide was aggressively marketing was Home Equity Loans known as “HELOCs” in the industry. With home equity increasing at that time people could use their homes as an ATM. Countrywide’s culture saw rising home equity for the distant future. Countrywide sold people who qualified for traditional mortgages on taking out riskier ARM mortgages so they could enjoy the lower rates and one the rates reset they could refinance the loan at a lower interest rate.

 

In 2007 the housing market started turning sour and foreclosures started rising and by 2008 home values had plummeted. Countrywide was being investigated for predatory lending and its officers for insider trading (selling off their stock). Countrywide’s assets were purchased by Bank of America who fired the officers and got rid of the now toxic Countrywide name.

 

 

 

 

 

 

 

BEAR STEARNS & COMPANY

 

Bear Stearns was founded on May Day 1923 and it ceased to exist on March 17, 2008 when it was purchased by JP Morgan for $10 a share to avoid a lethal bankruptcy.

 

Bear Stearns along with Lehman Brothers had packaged and sold several derivatives known as Mortgage Backed Securities. Subprime mortgages were bundled together as a security and sold as shares to investors.

 

Between 1997 to 2005 the average price of a house more than doubled. Countrywide Home Loans press releases bragged about their special 103 percent loans, “We don’t just cover your mortgage we’ll lend the closing costs too!” Without the surge in housing prices the subprime market would have never taken off. Bear Stearns and other investment bankers saw a gold mine in securitizing subprime mortgages and selling them as invests.

 

Mortgage Backed Securities are an example of a Derivative which is a securities value is based on the value of an underlying financial product in this case mortgages. Derivatives became popular when investment banks started hiring Physicists and Engineers to design new products because of their strong mathematics skills. A new discipline “Financial Engineering” was born in which derivatives which helped investors hedge their bets was created. Derivatives (options, futures, junk bonds, mortgage backed securities, swaps, etc.) are harder to value than traditional investment products since their value depends on the performance of another product.

 

Bear Stearns and Lehman Brothers went full force into marketing subprime mortgage backed securities they thought were protected by Credit Default Swaps and when the housing and mortgage went down wreaked havoc on these companies and the investors who bought these.

 

On March 6, Tim Geithner, CEO of the Federal Reserve Bank of New York gave a speech about the unfolding financial crisis to the Council On Foreign Relations. Geithner explained that a number of unusual factors had come together undermining the country’s economic foundation: A. The irresponsible availability of credit to the less-than-creditworthy, allowing them to buy homes, cars, and other goods and services they could not afford but thought they needed. B. A historic and ongoing increase in real estate values. C. A “rapid innovation” on Wall Street that made credit risk easier to manufacture, to trade, and in theory to hedge.

 

Bear Stearns was all of sudden collapsing and buyer had to be found as the economy started unraveling. On March 17, 2008 JP Morgan purchased Bear Stearns and Company.

 

The Wall Street editorialized, “The hard capitalist truth is that Bear’s most senior managers have mainly themselves to blame. They bought their second and third homes with fabulous bonuses during the good times, and they must now endure the losses from Bear’s errant investment bets. Bear took particular pride in its risk management, but it let its standards slide in the hunt for higher returns during the mortgage mania earlier this decade. There is no joy in seeing a venerable firm expire, but it has to happen if financial markets are going to have any discipline going forward.”

 

The New York Times summed the Bear Stearns debacle as “One of the greatest corporate euthanizations of all time.”

 

 

LEGAL ANALYSIS

 

Much of this is covered in the Background however to summarize it here are the main points.

 

Baring Bank – Communication of false information to auditors, computer fraud involving the 88888 account hiding losses, using the bank as the customer to receive funding for unauthorized positions

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Countrywide Home Loans – Predatory lending, Insider trading by the chief executives of the firm, conflict of interest loans to “friends of Angelo’s”

 

Bear Stearns & Co. – Misleading investors by concealing that hedge funds were failing as the mortgage market crumbled.

 

ETHICAL ANALYSIS

 

Egoism – All of these institutions had individuals who were intent on maximizing their own self-interest. Utilitarianism – All of these institutions believed that were maximizing total utility especially Countrywide with its drive to help more people realize the American Dream. Deontology – Missing in action at all three institutions. Relativist – All three institutions subjectively evaluated ethics.

 

CONTRIBUTING FACTORS: CORPORATE CULTURE AND GOVERNANCE

 

All three companies had aggressive, high achievement, risk taking corporate cultures and a lack of ethical guidelines in corporate governance.

ETHICAL DE

CISION FACTORS AND RECOMMENDED ACTION

The financial services industry is highly competitive and will remain an environment for aggressive ambitious people. However internal controls were lacking and the worst example was Barings were they were basically flushed down the toilet. Where ever there is huge sums of money internal controls are needed which I personally know from my audit background. Their must be a culture that encourages instead of punishing people who bring to the attention of management ethical violations.

 

 

 

 

 

 

 

 

 

 

REFERENCES

The Legal Environment of Business 5^th edition by Kubasek, Brennan and Brown

Business Ethics 2010 Custom Edition by Ferrell

Rogue Trader by Nick Leeson with Edward Whitley, reprinted by Sphere 2008

The Foreclosure of America, by Adam Michaelson, Berkeley Publishing Group April 2010

House of Cards, by William D. Cohan, Anchor Books February 2010