A case that needed to be settled

NY Times:

THE Indiana Children’s Wish Fund, which grants wishes to children and teenagers with life-threatening illnesses, got an early Christmas gift nine days ago. Morgan Keegan, a brokerage firm in Memphis, made an undisclosed payment to the charity to settle an arbitration claim; the Wish Fund said it had lost $48,000 in a mutual fund from Morgan Keegan that had invested heavily in dicey mortgage securities.

Coming less than two months after the charity filed its claim, and as a reporter was inquiring about its status, the settlement is a rare consolation for an investor amid all the pain still being generated by the turmoil in the once-bustling mortgage securities market. Before the Wish Fund reached its settlement, its mortgage-related losses meant that nine children’s wishes would go ungranted.

Against the backdrop of all the gigantic numbers defining the subprime debacle, the Wish Fund’s losses look like small potatoes. The crisis has generated almost $100 billion in losses or write-offs at the world’s largest financial institutions, cost a couple of Fortune 100 chief executives their jobs, wiped out billions of dollars in stock market value and hammered the reputations of the nation’s top credit rating agencies. Reports of the devastation that foreclosures are wreaking on borrowers also bring home the effects of this remarkable financial mess.

Still, the Wish Fund’s experience is instructive because so little has emerged about the losses that investors have incurred in these securities, perhaps because few holders have wanted to disclose them. Some investors may still not know how much they have been hurt by the crisis.

As this debacle unfolds, accounts of investor losses in mortgage securities will come to light. And Wall Street’s role as the great enabler — providing capital to aggressive lenders and then selling the questionable securities to investors — will be front and center.

Richard Culley, a blind lawyer in Indianapolis, founded the Wish Fund in 1984; since then, it has granted 1,800 wishes to children ages 3 to 18. The fund has roughly $1 million in assets and is not affiliated with the national Make-A-Wish Foundation. Local medical centers submit names for potential recipients.

The Wish Fund’s foray into mortgage securities began in June, when Terry Ceaser-Hudson, the executive director, consulted her local banker, Steve Perius, about certificates of deposit coming due in the charity’s account. She said the banker, with whom she had done business for 20 years, suggested that she invest the money in a bond fund offered by Morgan Keegan. The firm is an affiliate of her banker’s employer, Regions Bank.

Ms. Ceaser-Hudson’s banker put her in contact with a Morgan Keegan broker to help her make a decision. Mr. Perius did not return a phone call seeking comment.

“I thought I was making a lateral move from the C.D.’s into this fund,” Ms. Ceaser-Hudson said. “The broker said he’d put some thought into this and he had something perfect for the Wish Fund that was extremely safe.”

That broker was Christopher Herrmann, and when Ms. Ceaser-Hudson met him at her banker’s office, she quizzed him about the risks in the Regions Morgan Keegan Select Intermediate Bond fund, which he recommended.

“The first thing I said to him when I sat down was, ‘I want to make sure that I understand this: you’re telling me that this is as safe as a money market or C.D., because we cannot afford to lose one single penny,’” she recalled. “He said, ‘This has been good for years,’ so I thought, ‘O.K.’”

On June 26, the Wish Fund put almost $223,000 into the Morgan Keegan fund. The charity’s timing could not have been worse. That same week, two Bear Stearns hedge funds, with heavy exposure to mortgages, were collapsing. Turmoil in the mortgage market, which had been percolating since late winter, was about to explode.

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The facts as presented make a compelling case for settlement. They also reflect a general ignorance on the part of the brokers and the issues of the inherent risks of these securities. The risk analysis by the investment bankers, the rating agencies and the insurers of these products was faulty in the extreme.

None of this group recognized the dangers of separating the lending decision from the lender through the use of mortgage brokers whose incentive was to lend. This led to loans to unqualified borrowers and, worse, loans to out right crooks who were engaging in fraudulent transactions to steal the lenders money. It was never a product that resembled a CD in any real sense.

If the arbitration had gone forward there might have been an issue over whether the representation was made concerning the safety of the investment, but the brokerage company would have had a steep hill to climb even if they had evidence that the representation was never made, because on its face it appears to be an unsuitable investment for this particular buyer.