FBI Raids Hedge Fund Offices Over Alleged Insider Trading

Monday, Nov. 22, saw yet another alleged action by financial firms that could further erode the public's trust in the financial sector. Patricia Hurtado and Saijel Kishan write in their Bloomberg report that FBI agents raided the hedge fund offices of Level Global Investors LP, Diamondback Capital Management LLC, and Loch Capital Management over allegations of insider trading.

Insider trading is particularly harmful to the public's trust in Wall Street because it involves people using information that isn't publicly available in order to profit on a company's fortune or failure. If the public sees investing in stocks as a rigged market in which only insiders profit, stock markets could crash, triggering another widespread recession, or greater depression. This FBI raid is just another in a long series of wrongdoings by some financial firms.

Accounting Firm: Arthur Andersen

Say their names and what do you envision? Enron. WorldCom. Both were massive companies with one thing in common. Accounting firm Arthur Andersen was cooking their books to make them look more profitable to investors than they really were. Enron would become, according to the CitizenWorks Corporate Scandal Sheet, the largest U.S. bankruptcy on record at that time due to "off-the-book partnerships" that hid debt from public disclosure.

WorldCom reportedly was able to hide $3.85 billion in losses and expenses and report $1.38 billion in net income in 2001, immediately prior to its collapse, and overook Enron as the largest bankruptcy in American history. Both companies were clients of Arthur Andersen, who could have blown the whistle on the fraudulent activity, but either chose not to or was so inept that the firm didn't catch it.

Home Lender: Countrywide Financial Corp

Countrywide Financial Corp was one of the early financial companies in the latest recession to go under as a result of sketchy loans to people with bad credit. Daniel Golden writes in his article that broke the scandal and congressional involvement in it that, among the people who received preferential treatment via reduced lender fees and points and minimal qualification scrutiny, were two U.S. Senators: Christopher Dodd and Kent Konrad. A conflict of interest for any member of Congress, this was egregiously so because both were chairmen of the Banking Committee and Budget Committee, respectively, and, as Golden put it, were "in a position to advance Countrywide's interests."

Countrywide found a method of attracting people with marginal credit or insufficient income to purchase houses they wouldn't otherwise be able to afford via an option ARM loan, in which interest rates were adjustable and ultra-low payments could be made which didn't even cover the interest owed. Can't make your payment? That's ok, you can wrap this payment into the loan. This eventually resulted in tens of thousands of defaults when homeowners could no longer afford their ballooning mortgages.

Countrywide was one of the major contributors to the downturn and crash in home prices. The very people who could have stopped Countrywide's abuse in lending standards were reportedly receiving incentives from Countrywide.

Credit Market Seize-Ups: Lehman Brothers

Almost immediately after the failure of Countrywide, Lehman Brothers would fail in what is largely seen as the last straw that led to the near-collapse of our banking system. According to Sam Mamudi in his MarketWatch article, Lehman collapsed in 2008 with a record-breaking $613 billion in debt, far surpassing the bankruptcy of Worldcom. Lehman Brothers' folly was in being over-leveraged and, in a familiar note, hiding this from investors and creditors. When the world economy began to sour in late 2007 and early 2008, Lehman had enormous sums of money tied up in what it considered assets -- that is, subprime mortgages and packaged loans whose value was unknown.

In August of 2008, writes Reuters and the Associated Press, Lehman Brothers had "$600 billion of assets financed with just $20 billion in equity." As losses continued to mount, and the value of these "assets" plummeted, Lehman Brothers was forced into bankruptcy.

Effect of Today's News on the Public's Trust

Frankly, the public already has the perception that Wall Street and financial firms are shams that rob from everyone to give even more to the wealthiest. Today's news, inconsequential to the majority of people, outside of folks like myself who are invested in select financial firms, simply reinforces this view. Nothing has changed in the minds of Americans. The Feds breaking down the doors of three hedge fund trading companies for insider trading isn't news when people think the whole system is corrupt.

Short of meaningful reform and regulations, by people who aren't beholden to the companies they are supposed to regulate, what's going to change this? Financial firms sure aren't doing a good job policing themselves, now are they?

Sources:

Golden, Daniel. (2008). Countrywide's Many 'Friends'.
Hurtado, Patricia and Kishan, Saijel. (2010). FBI Searches Offices of Level Global and Diamondback Funds. Bloomberg.
Citizen Works. (2010). The Corporate Scandal Sheet.
Mamudi, Sam. (2008). Lehman Folds with Record $613 Billion in Debt.
Reuters and the Associated Press. (2008). Lehman Brothers Files For Bankruptcy, Scrambles to Sell Key Businesses.