Tuesday, March 18, 2008

What We Really Need is an Investigation or Two...

The SEC has decided to open an investigation into possible manipulation of Bear Stearns' stock by evil traders during the crazy events of the past week that ultimately led to the demise of the firm.

SEC investigation

Furthermore, New York City's Comptroller, who oversees the city's pension funds, will investigate if there was any deception by Bear Stearns or if the bank failed due to sheer stupidity. Apparently, the city's pension funds owned some Bear stock and they want their money back.

NYC Comptroller Investigation

So which is it? Was the firm manipulated and ruined by a bunch of traders as the SEC suspects? Or did Bear mislead investors and mismanage itself into bankruptcy within two days as the NYC Comptroller alleges? Because it can't be both, can it? In any case, if I had to guess, I'd bet that the SEC may be on to something. The amount of Bearish activity (the pun is intended) in the options at the beginning of the week was very suspicious (please refer to previous posts). Significant bets were placed on the stock dropping over 50% before options expiration (March 21st). You just don't see that kind of trading in options unless a biotech company is waiting for the results of a phase III trial which will determine if the company ever makes money. Or a company with significant intellectual property is waiting for a ruling on a patent dispute. In any case, it just doesn't happen during the normal course of trading. If I were the SEC, I would start in the credit default swap market. Apparently buyers of credit default swaps drove the spreads wider, and the sellers of the swaps went to the options market to buy puts to hedge their risk. So if the options buyers were just hedging, then the CDS buyers were really speculating that the company would default on its debt. The irony is that the CDS buyers may have gotten scorched as JP and the Fed are now backing Bear's debt, which means the spreads have narrowed significantly. It's the CDS sellers who hedged with options that printed cash. At any rate, there's a great story in here somewhere of who was behind the rumors, because the rumors were incredible. As much as Alan Schwartz, Bear's CEO, tried to quell them, he couldn't keep the rumors from destroying the firm.

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