Bear Stearns: The ‘Immaculate Calamity’
Courtesy of Econophile
From The Daily Capitalist
The Financial Crisis Inquiry Commission (FCIC) had the former execs of Bear Stearns under the hot lights on Wednesday. It seems it wasn’t their fault, they said. Which caused Chairperson Phil Angelides to quip that the whole thing must have been an “immaculate calamity.” Great line and it’s been going around the blogosphere like a virus.
Here is what the executives said:
- None of the former Bear Stearns executives could point to particular actions they took that they felt contributed to the collapse.
- “The market’s loss of confidence, even though it was unjustified and irrational, became a self-fulfilling prophecy,” Former Bear Stearns Chief Executive Officer James Cayne told the Financial Crisis Inquiry Commission in Washington.
- Mr. Molinaro said that “market fears surrounding mortgage-backed securities and rumors and innuendo in the end resulted in fear-induced, irrational behavior that caused a run on the bank.”
- Cayne said Wednesday that his firm’s risk level was too high in the year before it collapsed. ”That was the business,” Mr. Cayne told a hearing held by the Financial Crisis Inquiry Commission, a congressional panel scrutinizing the financial crisis. “That was really industry practice. In retrospect, in hindsight, I would say leverage was too high.[42:1]
- Alan Schwartz, who became CEO at Bear Stearns after Mr. Cayne, agreed that the firm’s leverage was high, but he also said gross leverage is “one of the most misleading” measurements. Schwartz told the panel the firm was well capitalized and blamed its failure partly on market rumors and speculation. He called Bear Stearns “the first firm to fall victim to the credit and liquidity crisis.”
- Former President Warren J. Spector said Bear Stearns had better risk management than many of its competitors.
- Mr. Cayne said he had hoped that the Securities and Exchange Commission would launch an investigation into a possible conspiracy against Bear Stearns as rumors began circulating that the firm was sinking.
- “Regardless of whether there was a conspiracy or not, the bottom line was that the firm came under attack,” Mr. Cayne said. ”In my heart I believe there was some stuff going on,” Mr. Schwartz said. “Can I prove it? It’s very hard to distinguish when a bunch of people are running out of a crowded theater, which one yelled, ‘Fire.’”
In other words, insanely high leverage (up to 42:1), large holdings of MBS, poor risk management, and overnight borrowing from the repo market ($50 to $60 billion) had nothing to do with their collapse. They did nothing wrong and were the victims of a conspiracy of evil traders who seized upon their temporary lack of liquidity and sent them over the edge when investors irrationally lost confidence. Talking about an alternate universe, these folks should be sent to St. Helena to think about cause and effect for a while. Jimmy Cayne would probably just play bridge there.
It is rather interesting that a couple little books came out in 2001 and 2004 that turned all conventional risk models Wall Street were using on their head. Unfortunately no one read them. At least no one interested in believing that their methods of risk analysis may be wrong even though they had failed Wall Street time and time again.
These books were, Fooled By Randomness: The Hidden Role of Chance in the Markets and Life (2001) by Nassim Nicholas Taleb (based on the work of Benoit Mandelbrot) and The (Mis)Behavior of Markets (2004), a brilliant introduction to fractal financial analysis by Mandelbrot. Taleb’s Black Swan came out in 2007; it was too late for that book to do any good.
Had these Bear executives picked their heads up from the herd, maybe they wouldn’t have stumbled. But they didn’t. Somehow mortgages where the borrower’s FICA score was 500, with a 3% down payment, and liar loan documents, were wrapped up into AAA securities. The premise was, that since housing prices hadn’t fallen since the Great Depression, they wouldn’t ever crash.
My problem is that the same people who got us into the mess in the first place are still running the farm. They have not changed their investment or risk methodologies to account for the crash and its causes. Worse, most of them were bailed out. This only reinforces bad behavior. Regardless of what the financial reform bill does, the government has set a precedent that they will backstop Wall Street and the innocent will pay for the incompetent. And everyone on Wall Street knows that. Moral hazard.
Let me make myself clear: neither Bear Stearns nor Lehman nor greed caused the boom and bust. Only the Fed can do that. Money flows into opportunity and a lot of money, a lot of easy money, will mask risk with rising prices and cause malinvestment.
The big problem is that when the Fed starts the next business cycle, investors will be encouraged to take even more risks because of the bailouts. If Congress wishes to reform Wall Street, then we should let them fail. The cure is worse than the disease.
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