Bear Stearns

Remembering a day that was too big to forget

Posted on by j.giglio

This month marks the anniversary of the collapse of Bear Stearns, once Wall Street’s fifth-largest investment bank. The demise of the 85-year old institution signaled the real start of the 2008-2009 financial crisis. Eight years later, we can only hope our leaders learned something from the experience.

The collapse and Bear’s subsequent bailout by the Federal Reserve, with the support of the Treasury Department and JPMorgan Chase sent shockwaves throughout the financial system. Bear’s incredibly rapid demise raised serious questions about the banking industry’s use of leverage, inadequate oversight of commercial and investment banks, and the role of the Fed and other regulators in preventing the failure of major financial institutions.

Late on Sunday afternoon, March 16, 2008, Bear’s board of directors accepted JPMorgan Chase’s offer to purchase the company. Less than 18 months after its stock was trading at an all-time high of $172.61 a share, Bear Stearns had little choice but to accept the humiliating offer of $2 a share.

JPMorgan Chase later raised the bid to $10 per share and the Fed provided $30 billion in collateral guarantees to facilitate the deal. The Fed considered Bear too large and too interconnected to fail and saw no choice but to arrange a bailout to prevent a global market crisis. It was hoped that the Bear rescue would nip the problem in the bud and avoid the damage to the larger financial world that many policymakers thought would result from the failure of a major investment bank.

The precise nature of the transaction seemed unclear, but the Fed appeared to be accepting responsibility for the toxic, illiquid assets on Bear’s balance sheet if their eventual liquidation resulted in a loss. In this sense, it appeared that the Fed became the residual owner of these securities and put the federal taxpayer on the hook for Bear’s reckless risk taking activities. Some believe that this action exceeded the Fed’s power.

The first sign of trouble at Bear was the July 2007 collapse of two of its hedge funds. The funds had invested heavily in collateralized debt obligations backed by subprime mortgages, and their failure alerted the rest of the financial system to this contagion.

The hedge funds’ collapse also raised concerns about the firm’s own exposure to mortgage-related securities. It damaged the firm’s reputation, weakened its finances and served as the precursor to Bear’s ultimate collapse. Within a year “the plumbing had stopped working” and credit ceased to flow through the financial system.

Hopes that a global financial crisis could be averted proved misplaced just six months later when Lehman Brothers, another bank that was heavily involved in the mortgage business and was even larger than Bear filed for Chapter 11 bankruptcy on September 15, 2008. The public backlash against the Bear bailout made rescuing the 158 year-old Lehman Brothers politically untenable, especially just weeks before a hotly contested presidential election.

The 2008-2009 financial crisis proved to be the most expensive in history. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd­ Frank), one of the most sweeping financial reforms in U.S. history.

The law’s stated aim is to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.” Essentially, Congress’s intent was to reduce system-wide risk and to prevent another financial collapse.

Let’s hope policy makers actually learned enough about how the economy and the financial system fit together from the 2008-2009 financial crisis to avoid future learning experiences. They would be well advised to recall the words of that prolific author, anonymous, who said, “The past is prologue: but which past?”

originally published: March 5, 2016

Not ‘too big to fail,’ too interconnected to fail

Posted on by j.giglio

At about 12:30 a.m. on the morning of Monday, Sept. 15,2008, a press release went out from the 158- year-old investment bank Lehman Brothers announcing it was seeking bankruptcy protection. Lehman’s downfall would become the watershed event of the financial crises.

While this event may not be seared into American memories like the Sept. 11 terrorist attacks, the collapse of Lehman triggered the worst financial tsunami since the Great Depression and was a seismic shock to global financial markets.

It was the largest Chapter 11 bankruptcy in American history to that point, and triggered the longest and deepest recession in generations. Within 21 months, $17 trillion in household wealth evaporated; the unemployment rate doubled to 10.1 percent in October 2009; and the nation’s credit system froze up, costing millions of Americans their jobs, homes and savings.

The weakest recovery since World War II drags on. Despite unprecedented monetary policy in which trillions spent on quantitative easing and near-zero interest rates benefited those who wear Zegna and Ferragamo, it has not helped the average working American.

Main Street has taken a beating. Wages have been rising at the slowest pace since the 1980s, while the rising gap between workers’ productivity and their wages is diverted to stockholders and management.

The government underestimated the repercussions of letting Lehman fail by failing to anticipate the systemic risks posed by Lehman’s bankruptcy. Both Lehman’s size and its interconnectedness with companies worldwide effectively created a credit event that far surpassed the magnitude of any that had come before.

Financial firms were not “too big to fail,” they were too interconnected to fail. The companies were reliant on one another in a variety of ways that were essential to the smooth running of the financial system. The feds failed to grasp the impact of a mortgage written in California that had been sliced and diced and sold several times and ended up in the portfolio of a Norwegian pension fund.

Six months before the Lehman crisis, the feds kicked in almost $30 billion to facilitate the shotgun marriage of Bear Steams to JP Morgan. But this time they refused to backstop losses from Lehman’s toxic mortgage holdings. Why did the government step in to bail out Bear but fail to rescue Lehman, a firm twice Bear’s size?

In part, Lehman Brothers was allowed to fail because of Bear Steams. The political fallout from Bear’s bailout worked against Lehman. Public backlash against taxpayers potentially assuming Bear’s losses made rescuing Lehman Brothers politically untenable. The feds believed they could not enact a second bailout just weeks before a presidential election.

They also thought a bailout might lead other firms to expect a similar treatment. The feds were reduced to jawboning Bank of America, HSBC, Nomura Securities, and Barclay’s Bank to “rescue Lehman on their own”. This proved fruitless without government assistance.

So the second domino would fall; it would not be the last. Only days later, all hell broke loose and the feds had another change of heart; they opened their checkbook and bailed out insurance giant AIG, which was on the verge of collapse. Since there were no “white knights” with sufficiently deep pockets to buy AIG, they had only one option: To effectively “nationalize” the company. They provided an $80 billion credit line from the Federal Reserve, plus additional loans and other direct investments that eventually totaled more than $170 billion, in exchange for an 80 percent equity stake in its ownership.

So the die was cast. Henceforth, the feds would be the business community’s sugar daddy; passing out allowance money by the billions to unruly children such as General Motors and Chrysler, while trying to keep them from squandering too much of it on “tooth-rotting candy” in the form of huge bonuses and lavish perks for top management.

To paraphrase Ralph Waldo Emerson: “A foolish inconsistency is the hobgoblin of little minds”.

Originally Published: September 5, 2015

Billions in bonuses on Wall Street at the expense of Main Street

Posted on by j.giglio

Seven years after the traumatic 2008 financial crisis, millions of Americans still have not recovered. But a few others are doing quite well, thank you. One of the first signs of the impending implosion in financial markets occurred in the summer of 2007 when two Bear Steams hedge funds with major investments in mortgage-backed securities collapsed. It was the beginning of the end for the world’s fifth largest investment bank, which, during its 90-year run, had developed a maverick reputation in the white-shoe culture of investment banking.

During the wee hours of March 24, 2008, just before Asian markets opened, the federal government forced Bear to announce its sale for a few pennies on the dollar to JPMorgan Chase, an offer that would not have been made without government assistance.

The deal was backstopped by the Federal Reserve’s commitment to buy upwards of $30 billion worth of mortgage-based securities in Bear’s portfolio that Morgan regarded as “too toxic to touch.” It was hoped that the Bear rescue would stem any fallout from spreading into the larger financial world, which many policymakers viewed as likely following the failure of a major investment bank.

Bear’s collapse was a critical event signaling the start of a great unraveling. One of the things that made Bear’s demise such a watershed event was the federal government’s direct involvement in orchestrating the deal that saved the company from having to file for bankruptcy.

Previously, the federal government would become so intimately involved only when a deposit-taking commercial or savings bank got into financial trouble.

If they screwed up and failed? Others would learn from their mistakes. That’s what was supposed to happen under capitalism. That is until the federal government got bushwhacked by Bear, a “don’t get no respect” underdog, and found itself in a jam.

So the feds had to throw out the standard game plan, even if it meant the Federal Reserve buying $30 billion worth of mortgage-backed securities from Bear that nobody else would touch as the financial tsunami of 2008 began rolling across the globe.

Bear Steams may have ceased to exist on March 24, 2008, but it continued to haunt the financial world like Marley’s ghost for months thereafter as the global meltdown continued, marked by formerly solid financial institutions turning into basket cases that could no longer survive on their own – after years of shooting up on short-term borrowings and boozing away on risky trades that blew up in their faces.

At the beginning of 2008, Merrill Lynch, Goldman Sachs, Morgan Stanley, Lehman Brothers and Bear were the five largest stand-alone investment banks in the world. By the end of the year all would be gone.

Goldman Sachs and Morgan Stanley were converted to bank holding companies while Lehman Brothers filed for bankruptcy and Merrill Lynch was acquired by Bank of America. These supposedly omnipotent institutions proved to be giants with feet of clay.

The financial crisis precipitated the worst economic downturn since the Great Depression, costing millions of Americans their jobs, homes, life savings and hopes for decent retirements. Since then, workers’ median incomes have effectively stayed unchanged while inequality between the top and bottom of the income scale has risen sharply.

Meanwhile, we recently learned from the New York State comptroller that Wall Street banks handed out $28.5 billion in bonuses in 2014. The average bonus was $172,860, more than three times the median household income of about $52,000. To say that anyone is surprised would be selling the truth below wholesale.

It’s reassuring to know that some folks have recovered very nicely from the financial crisis. But Main Street America will apparently have to learn to live with the wounds from the financial crisis.

originally published: March 28, 2015