Putting A Face On The Credit Crisis

One year since the collapse of two Bear Stearns hedge funds signaled the beginning of the credit crisis, law enforcement officials came out swinging Thursday to hold people accountable.

The managers of those Bear Stearns funds were indicted on multiple charges of fraud, conspiracy and, in the case of one, insider trading.

At about the time the indictments were unsealed in New York federal court, the Federal Bureau of Investigation announced it has charged 406 people since March in a nationwide dragnet known as "operation malicious mortgage."

Sixty of those arrests happened Wednesday. The Justice Department calculates $1 billion in losses arising from the mortgage fraud alleged in the cases.

The ongoing investigation demonstrates the Justice Department's "commitment and determination to combat these criminal schemes, hold their perpetrators accountable and help restore stability and confidence in our housing and credit markets," said Deputy Attorney General Mark Filip on Thursday.

The Justice Department is also investigating fraud in the mortgage securities market. The announced indictments of the two former Bear Stearns executives, Ralph Cioffi and Matthew Tannin, featured a classic "perp walk" to the Federal courthouse in Brooklyn, where they were to be arraigned Thursday afternoon. The two, who managed the funds that collapsed last summer, are accused of misleading investors about the conditions of the funds while privately believing the funds were in grave condition.

The prosecution is hanging its case on what it says are damning e-mails between the two discussing the deteriorating state of the mortgage markets in which the funds were heavily invested, and statements the two made to investors of the fund seeming to invite more investment. Tannin, the prosecutors said, told investors he was increasing his investment in the funds when in fact he had not.

Cioffi is also accused of transferring $2 million of his $6 million invested in one of the funds to another Bear Stearns fund over which he had supervision, and he continued to let investors believe he had $6 million invested in the fund that would collapse.

The Securities and Exchange Commission also filed civil charges against the two Thursday. "Hedge fund managers owe serious obligations to investors in their funds," said SEC Chairman Christopher Cox. "Those who commit fraud at the expense of investors will always be the target of a relentless SEC."

The collapse of the two funds, together with the failure of a few high-profile mortgage lenders earlier in 2007, notably New Century Financial, indicated a chain of unprecedented events was about to occur.

The credit crisis erupted last July, seizing the debt markets and forcing banks to write down their mortgage-related holdings since then. Estimated losses and write-downs for the industry so far total more than $300 billion. Bear Stearns became a victim of the crisis, forced into a deal with JPMorgan Chase (nyse: JPM - news - people ) and the Federal Reserve after a run on its liquidity brought it to the brink of collapse in March.

The toll is rising. On Thursday, Citigroup's (nyse: C - news - people ) chief financial officer told analysts that the company, which has already written down more than $40 billion worth of toxic assets, faces more write-downs in the value of leveraged loan financings and subprime-related mortgage holdings and bigger losses from consumer loans gone sour.

Loan losses are a mounting problem for large numbers of small and regional U.S. banks, which face a second wave of the credit crisis as those losses accelerate through the next year. Big regional banks like National City (nyse: NCC - news - people ), Fifth Third, KeyCorp (nyse: KEY - news - people ), Washington Mutual (nyse: WM - news - people ) and Wachovia (nyse: WB - news - people ) have been badly stung by the crisis, forced to raise capital, cut dividends and otherwise shore up their balance sheets.

The government is eager to put faces on the crisis by pointing the finger. But at least in the view of one defense lawyer, it might be over-reaching. "When they do react, they over react," says Frank Rubino, a defense lawyer specializing in mortgage fraud in Florida, one of the worst-hit housing markets.

In Washington, the credit crisis hits during an election year and politicians are eager to show they are acting with due haste. "The Bear Stearns episode and market turmoil more generally have placed in stark relief the outdated nature of our financial regulatory system," Treasury Secretary Henry Paulson said in a speech Thursday in Washington.

Don't expect much to come of it, however. For months, the Treasury Department has been working with federal regulators to make the financial system more robust, such as updating the SEC's rules on due diligence and conflicts on interest. And in March, Paulson announced a blueprint for sweeping overhaul of the financial regulatory system.

But his proposals, at best, are the seeds of ideas to be implemented years down the road. The Bush administration is losing influence by the day, and regulators are still concerned with the more immediate task of stemming the fallout from the mortgage crisis and credit crunch.

Banks reported nearly 53,000 cases of suspected mortgage fraud last year, up from more than 37,000 a year earlier and about 10 times the level of reports in 2001 and 2002, according to the Treasury Department's Financial Crimes Enforcement Network. Misstatement of income or assets is the most commonly reported mortgage fraud.

The FBI has been investigating 1,300 mortgage fraud cases including more than one dozen focusing on subprime lending practices.

--Brian Wingfield contributed to this report

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