Tuesday, April 20, 2010

Bear Stearns turned down Goldman Sachs-type deal for failing ethics test

Bear Stearns, the Wall Street bank now part of JP Morgan Chase, turned down a similarly structured deal to the one under scrutiny between Paulson & Co and Goldman Sachs because it "didn't pass the ethics standards".
The bank, which collapsed during the credit crisis, "smelled trouble" when John Paulson, the hedge fund's founder, approached it with the idea of creating an investment that the fund could bet against, according to author Gregory Zuckerman in his book on Paulson, The Greatest Trade Ever.

Scott Eichel, a senior Bear Stearns trader, met Paulson to discuss the creation of a CDO (collateralised debt obligation, the toxic financial instrument at the heart of the credit crunch), but feared the hedge fund would push for especially risky mortgage assets to be put into it. He likened it to a gambler asking an American football team owner to bench a star quarterback so that he could bet against the team, the book says.

One one hand, Bear Stearns would be selling the deals to investors without telling them that a bearish hedge fund was the impetus for the transaction, Eichal told a colleague; on the other, it would be helping Paulson to wager against the deals.

Eichel told Zuckerman. "We had three meetings with John [Paulson, the hedge fund's manager], we were working on a trade together. He had a bearish view and was very open about what he wanted to do, he was more up front than most of them. But it didn't pass the ethics standards; it was a reputation issue, and it didn't pass our moral compass. We didn't think we should sell deals that someone was shorting on the other side."

The bank was more wary because some of the investors in the CDOs would be pension funds and endowments, not just hedge funds, the book says.

Read on.

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