The End of the World as We Know It

"House of Cards – A Tale of Hubris and Wretched Excess on Wall Street,” by William D Cohan, 2009

It seems that every time a great American capitalist institution bites the dust, a book is written about its fall.  We have “Smartest Guys in the Room,” a documentary and book, and “Power Failure,” a book, both about the bankruptcy of the massive energy trader Enron; “When Genius Failed,” the story of the collapse of the hedge fund Long Term Capital Management; “The Last Tycoons,” Cohan’s own tale of the near fall of Lazard Freres; “Liars Poker,” (reviewed below) about the 80s junk bond and mortgage trading at Salomon Brothers; “Barbarians at the Gate,” the ending of RJR Nabisco, and “A Colossal Failure of Common Sense,” the inside story of the bankruptcy of Lehman Brothers.  And on and on.  It seems the books are piling up.  If you enjoy watching rich people fail, you will enjoy books like this.

This one is about Bear Stearns (“BS”), an 85 year old brokerage that ended in March 2008 when it was forced to merge with JP Morgan Chase by the government.  The story behind these events is the increasing consolidation of financial capital, as the weaker capitalists are killed or absorbed by the stronger.  Now perhaps 6-7 major firms dominate Wall Street, and increasing oligopoly is the order of the day.  Yet no one mentions this rather obvious process in the ‘financial press’ or even among the pro-capitalist writers of these books – it is looked at as natural or invisible.  This consolidation is a direct result of the financial collapse in 2007-2008, and is a normal result of every crisis under capital. 

These firms are now much too big to fail, and survive off the ultra-cheap interest rates at the Fed window. Every time there is talk about the government doing some fiscal ‘easing’ – raising these rates - the market plunges.  “Moral hazard’ barely exists for them. Yet if these firms can’t go through the normal bankruptcy procedure, ultimately during the next crisis these firms will have to be completely nationalized by a government. Leading one to think that the capitalist financial sector has reached the end of its rope as independent institutions under capitalism.  Marx pointed out that capital will one day burst its own bounds and this is what is happening.  Social ownership of banking is the only logical conclusion one can reach.

Cohan tells the gripping story of 10 days that shook the Bear Stearns world in March 2008.  In those 10 days, it went from a firm worth $67 a share to a firm worth $2, then $10 a share.  It was unable to continue without a $30B line of credit from the U.S. government and a shotgun marriage with Jaime Dimon’s JP Morgan.  This really would have been a better main storyline for the film, “Money Never Sleeps,’ (reviewed below) though one scene borrows from the Bear Stearn’s / Lehman story.  Ultimately Timothy Geithner and Hank Paulson of the US Federal Reserve got involved when investors withdrew money, overnight lenders refused to loan, short-sellers attacked the stock price, credit default swaps ‘insurance’ rates went sky high and margin loans came due - all this because of BS’s massive positions in souring mortgage securities.  The NY Fed did this because Bear had over 5,000 trading and credit-default counter-parties. 

What is astounding is how disorganized Bear was during some of these events, with directors scattered all around the country – at bridge tournaments, swanky vacation spots, golf courses, posh restaurants and hotels, or ensconced in Westchester.  All these multi-millionaires were blindsided by the failure of the institution they helmed. Every prediction was always rosy until its too late.  To this day they don’t admit any mistakes.   

Cohan then covers the long history of the firm, and its 3 principals – the towering, loud Cy Lewis, the mid-western shop-keeper ‘Ace’ Greenberg and the street gambler, Jimmy Cayne.  You might have never heard of these people, but they were well known on Wall Street.  Their main interest was to ‘make money’ and that was the only purpose of Bear Stearns.  Lewis began Bear’s fortune gambling on railroad bonds during World War II, which he bought cheap and held until the war was over, when they skyrocketed back to par – 100% value.  Greenberg specialized in arbitrage trading with Cy Lewis.  Cayne bought up many NY muni-bonds for cheap during the near bankruptcy of that city in the mid-1970s, and when the city recovered, so did Bear Stearns.   

Bear was mainly a bond house, which means it specialized in corporate, government and municipal bonds.  This is what led it to take such a large position in mortgage bond derivatives like CDOs and other structured products full of sub-prime mortgages, and what led to its failure.  It also did a large business in clearing small brokerages’ accounts, which is basically a license to print money, with little legal exposure.  You can’t quite tell when you read this material if Cohan admires these people or not.  We are treated to their stories of financial ‘genius,’ as if we are reading typical biographies of great businessmen, but then he lets the air out, and illuminates the fact that their ‘strengths’ become their weaknesses.

Cohan has an interesting section on the effect of Clinton and Bush I efforts against red-lining in poor and minority neighborhoods, starting with the 1977 Community Reinvestment Act.  This is the traditional Republican explanation for the crash, but it is only part of the story, yet Democrats ignore it completely.  A more nuanced look shows that capitalism, by either party, cannot provide housing for poor people, period.  “Red-lining” – i.e. not making loans in certain neighborhoods - was turned on its head when mortgage companies realized they could securitize these loans as products on Wall Street, and then they went to ‘green-lining’ certain neighborhoods and people.  Which meant giving ‘no paper’ loans to people that could not possibly afford them, and ultimately fabricating court documents and mortgages themselves.  The purpose is never putting a roof over a family’s head – it is always profit, in the case of either ‘red’ or ‘green’ lining. 

Cohan shows how Bear Stearns as a firm calcified under its iron-fisted multi-millionaires, especially towards the end under Jimmy Cayne.  Cayne refused to diversify the firm into asset-management or retail, into real M&A, into buying other clearing firms or companies that would expand its financial base.  They rode their gold horse into the grave.  Cayne was a guy who never read a book except a fitting one about Machiavelli and Wall Street.  He was a champion bridge player, hired other bridge players, built a large, expensive building in lower Manhattan on Madison Avenue, and kept a Chinese motorcycle in his office that he never rode.

Bear Stearns was an outsider firm that talked tough, paid the largest executive payouts on Wall Street and went its own way.  The slipped through the 1987 crash, as bonds recovered.  They escaped the ‘tech wreck’ of 2000 in better shape than most.  The moment this attitude all came to together was when Long Term Capital Management (“LTCM”) was failing in 1998.  Bear cleared trades and operational issues for LTCM, so their opinion was vital.  Some of the firms in Wall Street called a meeting to decide what to do, as LTCM was a contra-party to all of them – they owed each other money.  All but Cayne and Bear pledged to loan LTCM money to stave off a larger collapse.  The other firms did anyway, postponing LTCM’s problems for awhile, but many never forgot.  When Bear’s time came in 2008, no one really wanted to help them stay afloat.  Instead they got a run on their ‘bank’ as firms refused to trade with them or loan them money or keep money inside the firm. 

How did it exactly happen?  It is instructive but perhaps boring to wade through the convoluted assets and personalities running this outfit, but ultimately it’s a familiar picture.  They started two very, very profitable hedge funds under guys named Spektor and Cioffi that claimed they had 6% sub-prime mortgages, but actually had 80% in sub-prime.  As lawsuit documents show, Cioffi lied on customer statements, hid the declining value of the assets and had no compliance relationship with the BS holding company.  The hedge funds became insolvent in 2007, Bear letting one collapse and the other rescued and then closed after investors redeemed millions, margin calls were made and overnight ‘repo’ loans stopped coming in.  In August 2007 after this debacle, Bear was leveraged at 44-1 – i.e. they actually had only $1 for every $44 in debt, and their stock had dropped precipitously.  This, mind you, is a firm that was worth billions.  However, this was allowed by SEC rules for ‘investment banks.’  Bear financed itself every day with millions of dollars in short-term debt.  The also used depositors money (again, legally) to finance other parts of their business.  

As the Republicans say, would you run a household like this?  ‘House of cards’ or ‘paper tiger’ is not far off. At the end, BS worked on half-hearted merger deals with the Chinese Citric Finance group, turned down the Japanese Sumitomo Bank, and refused to raise new capital as every other firm was doing. They still thought that doubling-down on investments in mortgage bonds was the answer! Cioffi and others were indicted for the obvious misrepresentations of the BS hedge funds, but as per the ‘velvet glove’ treatment of the Obama administration, no conviction has been pursued.  (See reviews of "Griftopia,", "The Big Short" and Greenwald's "With Liberty & Justice for Some," re the failure of prosecutions, all below.)

But were they unique?  Cohen ends the book with more falling dominoes – Lehman, AIG, Merrill Lynch, Fannie Mae & Freddie Mac, Bear only being the first large one.  Reading these books is instructive because, while I work in the securities industry, knowing how your economy works might help us all read the tea-leaves the next time.  And there will be a next time.  Just look at the markets, which are the literal heart-beats of modern capitalism.

And I got it for free at work

November 13, 2013

Red Frog

P.S. - Geithner, former head of the Federal Reserve, has just announced he will be joining Warburg Pincus as a director of this private equity firm.  The revolving door revolves.