Page 1 of 2 Bear's death and the US way of banking
By Julian Delasantellis
One of the most remarkable chapters in the long history of American
jurisprudence must certainly be the saga of the United States versus Anthony
Accetturo et al, sometimes known as the Lucchese trial. In 1985, following a
10-year investigation, the US Department of Justice delivered a 65-page
racketeering indictment against 21 members of the New Jersey branch of New
York's Lucchese crime family.
The trial that commenced in November 1986 took up 240 volumes of court record,
and is the longest Federal trial in American history, lasting 21 months. As
depicted in Sidney Lumet's 2006 movie Find Me Guilty, the trial
proceedings frequently descended into farce, in part due to the very unorthodox
and ribald efforts of one of the accused, Giacomo
DiNorscio, (played in the movie by Vin Diesel) to act as his own attorney
But the verdict that the jury delivered on August 26, 1988, was simple and
straightforward - not guilty, for all defendants on all charges. Following the
1995 OJ Simpson trial, when the former football star was acquitted of murdering
his former wife, legal observers would resurrect an old term for the
circumstance of juries acquitting presumably guilty defendants for reasons
other than the actual facts of their guilt or innocence - jury nullification.
After the Lucchese trial, observers speculated that, since most of the supposed
victims of the defendants' crimes were not uninvolved "civilians", but other
gang members also crawling across the web of organized crime in the
metropolitan New York area, the victims should have, must have, realized that
simply being involved in the orbit of organized crime would make them
vulnerable to the type of predatory, criminal activity that they subjected
others to. As Hyman Roth (Lee Strasberg) said in Godfather 2 explaining
why he did not seek vengeance for the killing of a protege, "this is the
business we've chosen."
That's what somebody should tell Bear Stearns when they start squawking about
what happened to them last March.
Finally, the fin-de-siecle for the Bush age has arrived in the US, and across
the agencies that regulate the financial markets the bonfires of the vanities
are being set alight. Holding high the burning torch of moral purification is
none other than a most unlikely Savonarola: Securities and Exchange Commission
(SEC) chairman Christopher Cox. Once a true devotee of the free market's
conventions and customs, he has most recently been going door to door among all
the great houses of American finance, ordering those inside to surrender for
immolation the free-market practices and techniques he only recently was
purported to have cherished.
Trying to earn a seat at the big kid's table where Treasury Secretary Henry
Paulson and Federal Reserve chairman Ben Bernanke are working on saving the
world, (while President George W Bush is off somewhere totally uninvolved in
all these events, perhaps seeking to assure that Cliff Notes are included in
the holdings at the future George W Bush Presidential Library at Southern
Methodist University in Dallas) Cox has now devised a unique soothing balm for
the raw, irritated financial markets. In trying to make life harder for what
are now seen as the parasitic invaders besieging the bodies, shares and souls
of financial companies, he seems to be hoping to be able to heal these
institutions simply through disarming the forces attacking them.
Last week, I explored how the new Wall Street moral purity crusade was cracking
down on the once winked upon practice of "naked" short selling (see
Bush turns to the dark side , Asia Times Online, July 23, 2008). Now,
it appears that Cox, seeking to stamp out sin wherever it may be found in Lower
Manhattan, is also sending his financial flatfoots back onto the street with
subpoenas to force all those unfortunates in receipt of one to, under pain of
all of the mighty state's tortuous sanctions, confess all they know about what
happened to the Bear Stearns investment house in the waning days of last
winter.
With all the calamities and catastrophes that have befallen the financial
markets just since the leaves returned to the trees in the Northern Hemisphere
you might have forgotten just what happened in between March 10 and 17 of this
year, but, for those who lived through it, it was a time of the most
fundamental and far-reaching change in the structure of American finance.
Bear Stearns, the blue collar (as opposed to the rest of the Street's
blue-blooded), sharp-elbowed, red in tooth and claw bond trading house, whose
bankruptcy of two subprime-mortgage-based hedge funds was the starter's pistol
for the entire financial crisis in the early summer of 2007, entered the week
fat and happy, sitting on an US$18 billion cash reserve. It would end the week
in abject destitution and penury, its stock, which had traded as high as $170
in 2007, then ordered by the government to be valued at $2.
Hunt of malfeasance
Cox wants to know if there was any criminal malfeasance involved in these
circumstances; failing finding that, failing discovering the proverbial
"smoking gun" that forensic tests can match with some supposed bullet lodged in
Bear's now entombed corpse, it seems that Cox would be satisfied with finding
practices, accepted and allowed during the long languid summer of financial
markets' deregulation, that, during the current winter of reproach and rebuke,
he can say that, after taking a second look, actually were crimes after all.
Whatever Cox's gendarmes' discover, it will probably be very similar to an
extraordinary, 10,000 word (and you thought I was long-winded) narrative
published in this month's Vanity Fair (online at
http://www.vanityfair.com/politics/features/2008/08/bear_stearns200808).
Authored by respected financial journalist Bryan Burrough (the co-author, with
Jon Helyar, of the definitive 1990 account of the 1988 leveraged buyout of RJR
Nabisco, Barbarians at the Gate) "Bringing Down Bear Stearns" certainly
should be the first stop for those, from concerned citizens to Cox's corybantic
cerberuses, interested in the events of the Ides of last March, for it seems
that all the principals involved have been well and thoroughly interviewed by
Burrough.
So just what did happen to Bear Stearns?
On Monday, March 10 of this year, in no way was there any reason to assume the
travails that Bear was soon to undergo. The mephitic rank of last summer's Bear
hedge-fund collapse was mostly dissipated; the company felt that, with a
capital reserve of $18 billion, it was as well fortified to weather what the
remainder of the credit crisis storm would bring as any other of Wall Street's
great houses of money. The stock had fallen from $170 in early 2007 to open
that day at $70.28, but that was roughly in line with the performances of the
rest of Wall Street's more aggressive hands at the table. If they could
survive, Bear thought, so could we.
By the middle of that afternoon, Bear Stearns' principals must have been
looking at their quote screens with horror. The stock was selling off, was
doing it hard, and nobody could figure out why. The stock closed that Monday at
62.30, down over 11% on the day, on massive trading volume.
But what about that $18 billion war chest? To their absolute horror, Bear soon
realized that they were under attack from rumors spreading across the Street of
a "liquidity crisis", and, for that manner of siege, not even a fortress
constructed of eighteen billion one dollar bills would be enough to fend off
the scaling of the walls by the attackers.
Maybe you think of a bank as a place where an elderly woman comes in to deposit
her government pension check and later in the day, the bank, in order to earn
the interest it has promised to pay the woman, finds someone who is willing to
borrow the money at a higher rate of interest than what it is paying on her
deposit.
You're correct in assuming that this is the core of modern banking and finance,
except that you've got the order in which these procedures occur precisely in
reverse. Modern financial institutions do not wait until the old woman hands
her check to the teller before rushing onto the street to try to find someone
to lend the money to. No, they're ever out there pounding the street (these
days, they're more likely to be pounding their broadband data feeds), looking
for profitable investments that can be made even before they get the funds to
make them. These can be in US and foreign Treasury securities, corporate bonds,
stocks, warrants, futures, options - even, as the financial system has now
learned to its abject misery, in subprime mortgage paper.
If left to their own devices these institutions would make these types of
investments, would do this type of lending, until swine self-levitate. This is
what happened in capitalist economies until the introduction of modern central
banking and bank regulation in the early 20th century. Banks would lend and
lend and lend, all the while creating massive monetary liquidity based on
nothing of any real value, until the last fool would see through the trick and
the whole teetering edifice would collapse. From boom to bust and then back to
boom again economies would lurch, until government regulation came in and,
hearing the terrified screams of those on the ride, pulled the throttle back a
bit on the roller coaster.
In what is called fractional reserve banking, banks and other financial
institutions can make loans and investments only in set and defined multiples
of what they actually have in the bank. In 1988, the first of two Bank for
International Settlements' Basel accords adjusted the formulas according to the
risk of the investments the financial institution was making: the less risky
the investment (such as short-term government Treasury Bills), the less that
had to be held in reserve against it; the more risky, the greater the reserve
requirement.
Taking all this into consideration, it's still not as if the banks are making
risky investments and then calling the old woman to see if she's coming in with
her check today so they can close the daily books in compliance with their
reserve requirements. What the banks do is to find out the amount that they
need to have in reserve for that day, and then have their trading desk go out
and get the funding.
For the most part, the bulk of the daily variability in their funding
requirements is met through operations in what is called the short term
repurchase market, or repos. There, if one bank finds it has a short-term,
perhaps if only for one night, need to meet a reserve requirement it can borrow
the funds it needs; the funds here may be being lent by another institution
that at the end of the day finds it has more in reserves than its traders have
made profitable loans that day for.
Repo loans can be in the range of tens to hundreds of millions of dollars, and
they are in no way, shape, or form insured by the Federal government. That's
the problem. If you do an overnight loan of, say, $100 million, and the next
day the bank you lent the money to is out of business, with a "Coming Soon - A
New Baby Gap" sign on the door, it'll be a long, long time before you ever see
that money again. You'll get in line behind all the rest of the dead bank's
creditors, and, since repo loans are unsecured, you'll be a long, long way from
the front of the line as well.
By the end of that first day, Bear determined that it was fear that it was
going under that was driving the stock price down. Rumors were spreading like
wildfire that Bear was not long destined for the financial world, and, as a
result, it rapidly began to lose access to the overnight repo market. In
something of a self-fulfilling prophecy, without being able to fund its loan
portfolio, Bear would soon be forced out of business.
CNBC in the rumor line
Burrough reserves particular vilification in this process to US cable
television network CNBC. All that week its highly competitive and aggressive
young reporters were continually interrupting each other's segments with
breathless "breaking news" reportage on the allegedly increasingly dire
situation at Bear. Burrough notes that CNBC is wired through the world
financial markets as if it was its nervous system; anyone who might have been
thinking of doing a repo deal with Bear would, of course, see these reports and
be dissuaded, knowing that if the repo deal was done and Bear subsequently went
belly up, there could be no excuse that the trader did not know what was going
on that would save his head from the chopping block.
But for Burrough, the more interesting question is, where, and from whom, was
CNBC getting its negative, market moving news from?
By Wednesday, March 12, it was clear that the contest was between Bear's $18
billion reserve and the much larger amount that the market could either reward
or withdraw from Bear with but a twitch of a trader's finger on a mouse, and
that the twitching fingers were winning. By late in the day, Bear's reserves
were down to $15 billion, and urgent feelers were being extended to New York
Federal Reserve Bank president Timothy Geithner about an emergency loan, which,
as an investment, not a commercial bank, Bear technically was not supposed to
be eligible for.
By Thursday, the flight away from Bear in the repo market had become a
stampede. The bank was looking at a $30 billion shortfall in what it needed in
overnight financing, far more than what it could fund from its now dwindling
reserves. Then again, even if Bear emptied the piggybank to fund Thursday's
needs, there was absolutely no guarantee that the bank would not need that or
more on Friday, or the day after that, or the next day after that as well.
For vainglorious and prideful Bear Stearns, the choices that faced it that
Thursday night would have seemed unthinkable just the previous Monday morning.
Either a savior had to be found who would either lend billions to Bear or buy
it outright, or the next morning the august bank would be standing in line with
all the people with excess medical or credit card bills waiting to file papers
at the bankruptcy court.
Bear did some of its own banking with Morgan Stanley (whose offices were right
across the street), so the first person Bear chief executive Alan Schwartz
called was Morgan CEO Jamie Dimon, that night celebrating his birthday with his
family at a Manhattan Greek restaurant.
As recounted by Burrough, Dimon was none too pleased when his private cell
phone rang during dinner. To paraphrase the famous exchange between F Scott
Fitzgerald and Ernest Hemingway, the rich really are different; their cell
phone calls are a lot more interesting than
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