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Arrest of Fund Managers Raises Risk Questions

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Arrest of Fund Managers Raises Risk Questions


Arrest of Fund Managers Raises Risk Questions

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This is Weekend Edition from NPR News. I'm Scott Simon. Federal prosecutors say that two former hedge fund managers who were arrested this week on fraud charges told clients that the funds were doing just fine, even as they exchanged emails that said the funds were dropping sharply. Soon thereafter, the funds collapsed, and the investment giant Bear Stearns went belly up. Which funds were they talking about? How did they contribute to bringing one of Wall Street's premium investment banks to ruin? Joe Nocera, New York Time's columnist joins us from our studios in New York. Joe, thanks so much for being with us.

Mr. JOE NOCERA (Business Columnist, New York Times): And thanks for having me, Scott.

SIMON: And your newspaper described these two funds as, I'm going to quote "filled with some of the most explosive and high-risk securities available."

Mr. NOCERA: That sounds about right.

SIMON: Now who were these securities?

Mr. NOCERA: They were the classic, subprime mortgage-backed securities that have hammered everybody on Wall Street. Wall Street was buying bundles of subprime mortgages and they have AAA ratings and they turned out of course to be not nearly as secure and safe as something with a AAA rating should be. And when the housing market started to decline, and subprime borrowers began to walk away from houses or be foreclosed on, those securities were worthless. The reason you would buy these securities is to supercharge your portfolio in good times, but what nobody really anticipated was how fast and far they would drop in bad times.

SIMON: But I'm interested that there are two hedge fund managers who were arrested. That's Ralph Cioffi and Matthew Tannin. Now, they're not accused of manipulating these funds, right?

Mr. NOCERA: Well, they didn't manipulate them. I mean, they were probably marked appropriately internally at Bear Stearns. What they're accused of doing is lying to their investors about the state of the funds. They have internal emails where they're saying to each other, boy, this is scary. This is trouble. And one of them actually pulled out two million dollars from the fund at a time when the outside investors were not allowed to do so. So, investors were really scared. They could see these things dropping, and there was some meeting of four or five days after the emails were exchanged and the two of them got up there and said, hey, don't worry, investors. Everything is going to be fine. We've got it under control. And so the case will ultimately revolve around their state of mind, their intent when they said this to investors.

SIMON: But hedge fund managers are there to manage risks, aren't they?

Mr. NOCERA: Yes. There is a larger issue here. Hank Paulson made a speech on Thursday, Scott, where he laid out the fundamental view, which almost everyone in Washington now has, that we need greater regulation of investment banks. And this is sort of part and parcel of that. These hedge funds were inside Bear Stearns. They were taking in extraordinary amount of risk. And the nation's regulators have not really been able to get their arms around investment banking risk. Investment banks now are as powerful and as important as the banking system. You have four regulators for banks. And you only have one, the SEC, for investment banks. And risk isn't really what they're about. And yet, it was the excess risk in the system that has caused this current meltdown and that is what the government is trying to get its arms around.

SIMON: Apparently, Mr. Cioffi allegedly transfered some of his own assets out of the riskiest funds and put them into something safer. Now, had he just restrained himself, had he either gone down with everyone else, would he be in a legally, a lot better position?

Mr. NOCERA: Yes, absolutely. That's a killer before a jury when you're up telling investors one thing and you're doing another. And I'll give you the name of another famous executive who was accused of doing that, and that's Ken Lay. At the time when he was telling his own employees to keep all their money in Enron stock because it was coming back, he was secretly selling his own stock. And boy, the jury did not take kindly to that. So, I think that causes him an additional problem.

SIMON: Joe Nocera, New York Times business columnist. Thanks very much for being with us.

Mr. NOCERA: Thanks a lot, Scott.

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