Straight outta Theodore Dreiser and Sinclair Lewis
This is must reading, slow-it-down, and pass the popcorn reading, on the fall of the investment house, Bear Stearns, in this month's Vanity Fair.
Here is a sampling from this eight page (on the web) article:
"Eventually Bear, like most on Wall Street, branched into asset management, forming a series of large funds that put investor money to work in a variety of stocks, bonds, and derivatives. Unlike some firms, however, Bear promoted its own traders rather than outsiders to run these funds, and decided that each would specialize in a specific type of security, rather than a diversified mix. As co-president, Alan Schwartz, for one, questioned the move, thinking it was a bit risky, but deferred to the thinking of Spector and others.
"Everything went swimmingly, in fact, until poor Ralph Cioffi ran into trouble. Cioffi, 52, was a Bear lifer, a wisecracking salesman who commuted to Midtown from Tenafly, New Jersey, to oversee two hedge funds at Bear Stearns Asset Management, an affiliate known as B.S.A.M. His main fund, the High-Grade Structured Credit Strategies fund, plowed investor cash into complex derivatives backed by home mortgages. For years he was spectacularly profitable, posting average monthly gains of one percent or more. But as the housing market turned down in late 2006, his returns began to even out. Like many a Wall Street gambler before him, Cioffi decided to double-down, creating a second fund. Whereas the first borrowed, or “leveraged,” as much as 35 times its available money to trade, the new fund would borrow an astounding 100 times its cash.
"It blew up in his face. As the housing market worsened during the winter of 2006–7, Cioffi’s returns for both funds plummeted. He urged investors to stay put, promising an imminent turnaround. (Cioffi and a colleague, Matthew Tannin, were indicted in June for misleading investors.) When the market downturn accelerated last spring, leaving Cioffi with billions of dollars in money-losing mortgage-backed securities no one would take off his hands, he concocted an audacious way to rescue himself, planning an initial offering for a new company called Everquest Financial that would sell its shares to the public. Everquest’s main asset, it turned out, was billions of dollars of Cioffi’s untradable securities, or, as Wall Street termed it, “toxic waste.”
"Foisting his garbage onto the public might have worked, but financial journalists at BusinessWeek and The Wall Street Journal discovered the scheme in early June. Once the truth was out, B.S.A.M. had no choice but to withdraw Everquest’s offering, at which point Cioffi was all but doomed. Investors were beginning to flee. Worse, some of Cioffi’s biggest lenders, firms like Merrill Lynch and J. P. Morgan Chase, were threatening to seize his collateral, which was about $1.2 billion. In a panic, Cioffi and his aides convened a meeting of creditors, where they asked for more time and more money. The gathering turned angry when several in the audience urged Bear to pony up its own money to save the funds, an alternative Bear executives dismissed out of hand.
"Afterward, Warren Spector got on the phone with a series of Cioffi’s lenders, including a group of J. P. Morgan executives. “I’ll never forget this,” one recalls. “Spector gets on and goes, ‘You guys don’t know what you’re talking about—you don’t understand the business; only [Cioffi and colleagues] understand the business; only we are standing in the way of them finishing this [rescue] deal.”’ It was a classic display of Bear-style arrogance, and it incensed the Morgan men. Steve Black, Morgan’s head of investment banking, telephoned Alan Schwartz and said, “This is bullshit. We’re defaulting you.”
"Merrill Lynch, in fact, did confiscate Bear’s collateral—an aggressive and highly unusual move that forced Cayne into the unthinkable: using Bear’s own money, about $1.6 billion, to bail out one of Cioffi’s two troubled funds, both of which ultimately filed for bankruptcy. It was a massive blow not only to Bear’s capital base but to its reputation on Wall Street. Inside the firm, much of the blame fell squarely on Spector, who oversaw Cioffi and other B.S.A.M. managers.
“'Whenever someone raised a question, Warren would always say, "Don’t worry about Ralph—he’ll be fine,”’ one top Bear executive recalls. 'Everybody assumed Warren knew what was going on. Well, later, after everything happened, Warren would say, "Well, I never knew his actual positions." It was one of those things where everyone thought someone else was paying attention.”
"As one of Bear’s lenders told me, “The B.S.A.M. situation confirmed to me my impression, which was that [Bear’s] subsidiary businesses were run in silos—basically the guys ran their sub-businesses as they saw fit. So long as they were hitting their P&L targets, no one asked any real questions. To my mind, that contributed in a very large part to what happened later.”
This is, however, just the beginning of what appears in some ways to be a defense brief for the executives, but really, right out of Dresier's "The Financier" (1912) and Sinclair Lewis' "Babbitt" (1922).
Suffice it to say that, assuming the truth of this article, Bear Stearns was filled with arrogant jerks who took one too many reckless risks. But there was also reckless "reporting" at CNBC and other business outlets, and, worse, some power politics by those who fly below the radar who are also arrogant jerks, and who were not much better at recognizing the growing housing bubble that was bound to burst.
This primer on the Glass-Stegall Act from the New Deal, essentially repealed in 1999 by Clinton and the Republican leadership in Congress, shows why New Deal values trump Wall Street values--which reigned in the 1920s and in the 1990s and 2000s--nearly every time (The article is written in that "government regulation=bad, private sector=good" style that looks rather silly in this instance at least). I was one of those lonely voices screaming at this repeal of an act that did far more good than any imaginable harm. I saw the repeal of the Glass-Stegall Act as opening the floodgates of greed. I admit, however, to thinking the housing bubble was going to collapse in 2003, not 2006 and 2007.
Bottom line: There is a reason for government regulation--because the guys (mostly guys) at the top are not as smart as they think they are, and certainly not worth the billions they accumulate at the expense of most everyone else.