Find Insurance Online

While creating and selling mortgage-based securities to some of its clients, Deutsche Bank AG was not only advising other clients to bet the other way, but also sometimes doing it itself, according to the Wall Street Journal. A trader at the bank would help create an index that made it easy for the bank to bet against housing even as sales people at the bank were selling the securities as if there were no downside to the American housing market. Then some of the tax-payer money was paid by the US Government to AIG to reimburse Deutsche’s hedge-fund clients who had bought the mortgage securities. American regulators looked at whether there were misrepresentations made to the hedge fund managers who bought the mortgage-backed securities even as Deutsche Bank was betting against the housing market.

The structural conflict of interest wherein a bank’s interest is antipodal to that of its clients raises the spector of misrepresentation. A spokesperson for Deutsche said, "We served clients whatever their investment objective, but only after being satisfied that they had arrived at their view after thorough consideration.” Furthermore, although Deutsche made tens of millions of dollars betting against the housing market, overall it “maintained a net long position in the housing market and ultimately suffered billions in losses, even after factoring in our hedges and offsetting positions.”  The more even proprietary position would relieve the bank of the conflict of interest; it is where the bank’s own position is skewed dramatically in one direction while it sells to clients in the other that at the very least the appearance of a conflict of interest arises.  The way out of this is to severely limit proprietary trades to those that are needed for clients (i.e., to manufacture a counter-party for a transaction desired by a client rather than the bank itself).  A second way out may have been illustrated by Deutsche. That is, a bank can hold a relatively balanced proprietary position such that the bank itself does not have an interest in the market going one way or the other. However, even with a balanced position, bankers can believe that a market will go down and lie to potential clients in order to sell long. 

For example, The Wall Street Journal reports that Deutsche trader Greg Lippmann encouraged an investor to go short against subprime bonds, telling him, “you should get some [courage] and do some shorts” because “these bonds are ging much lower.” Deutsche, however, continued to market new mortgage-bond deals predicated on the mortgage-securities market staying strong. The next day, M&T Bank of Buffallo, NY paid $82 million into a Deutsche deal known as Gemstone 7. Within ten months, the company had lost 98% of its investment.  A Deutsche spokesperson claims that employees bearish on the housing market had spoke at client meetings to make their views known and there is no indication that Lippmann was among those in sales urging clients to buy.  Even so, it would be odd were M&T managers willing to sink so much money into mortgage bonds after being told that the bonds would go much further down. Even if the bank’s proprietary interest was balanced, the information it had on the housing market went against its profit-motive in sales, so there may have been a conflict of interest even without a proprietary position to back it up.  Telling M&T managers that the “underlying structures in these bonds are built to withstand” adverse conditions shortly before the value of M&T’s holdings go from $82 million to $1.9 million strongly suggests that Deutsche’s bankers were at the very least incompetent. Given Lippmann’s email, there is evidence that Deutsche bankers knew that the bond’s underlying structures were vulnerable.  Withholding information in order to lie in order to profit is of course fraud. My point is that it can be looked at as a structural conflict of interest between one’s belief in one’s opinion and one’s profit-motive that can exist even where there is no (or a balanced) proprietary financial interest.

Carrick Mollenkamp and Serena Ng, “Dual Role in Housing Deals Puts Spotlight on Deutsche,” The Wall Street Journal (August 3, 2010), pp. A1.