Wall Street Law Blog

Bear Stearns, Merrill Lynch Expected Housing Disaster (our all-time most viewed post; first published Oct. 2010)

"These aren't simply the comments of some junior level analysts" Lee Sherman, securities litigation consultant

the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them.

the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial.

UPDATE: Because Bear Stearns Execs' FCIC testimony largely focused on allegedly unforeseeable, "unprecedented" market forces to defend their lack of competent management, Wall Street Law Blog decided to re-post one of our favorites. 

Long before their respective employers ceased to exist as independent companies, former Merrill Lynch Top North American Economist David A. Rosenberg and former Bear Stearns Chief Equities Investment Strategist Francois Trahan published research reports with explicit warnings about asset and credit bubbles in the U.S. housing and mortgage markets.

As early as August 2004, Mr. Rosenberg, Chief Economist at Merrill Lynch for North America, published a detailed analysis regarding the precarious state of the American housing market. Rosenberg warned that there could serious problems ahead in an Economic Commentary entitled: "Housing: If not a Bubble Then an Oversized Sud."

Former Bear Stearns Chief Equities Investment Strategist Francois Trahan first published a report that raised serious questions about housing and real estate investments in a May 2005 report called "REIT all About it." Trahan and his team at Bear Stearns followed their 2005 report with publications in 2006 that explicitly warned about the difficult future facing the U.S. housing market and even raised the possibility of a global credit crisis. The 2006 Bear Stearns reports definitively described the housing market as an unsustainable "bubble" and further cautioned that the term bubble was not one the Bear team used lightly.

It was not until 2008 that overcommitments to mortgage-backed securities (a byproduct of the housing boom), CDO's and related products tied to residential and commercial mortgages caused Merrill Lynch and Bear Stearns to suffer backbreaking losses so severe that Merrill sold itself to Bank of America and Bear Stearns narrowly avoided bankruptcy with a Fed-assisted fire sale to JP Morgan.

--Background

Along with a number of other Wall Street firms, Merrill Lynch and Bear Stearns lost tens of billions of dollars because of their firms' respective commitments to securities backed by mortgages in the "subprime" and "Alt-A" categories. Subprime and Alt-A residential mortgages are considered risky loans because they carry higher default rates than "conforming" mortgages (also called prime mortgages, or agency-quality mortgages). Typical subprime or Alt-A borrowers cannot qualify for a conforming mortgage due to factors that include, but are not limited to, bad credit histories, personal bankruptcies, insufficient income, and the inability to make sufficiently large down-payments.

--Significance of the Merrill Lynch and Bear Stearns reports

While the ultimate import of the reports remains to be seen, The Sherman Law Firm says there is no doubt that the documents are crucial to the touchstone litigation element of foreseeability. "In a litigation sense," said Managing Attorney Brett Sherman, "the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them."

According to The Sherman Law Firm, the reports at issue may show that senior management at Merrill Lynch and Bear Stearns should have foreseen the liklihood of a looming financial crisis with ample time to permit business model shifts that may have prevented crippling losses and, ultimately, the end of these former pillars of Wall Street as independent companies.

--Likely Defenses and Response

When confronted with documents like the reports at issue, senior managers may respond that they cannot be expected to read the huge volumes of research produced by their companies. The view of Brett Sherman, securities fraud lawyer and Managing Attorney of The Sherman Law Firm is that "the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial."

Litigation strategist and recently retired attorney Lee Sherman - a frequent consultant to The Sherman Law Firm, former municipal court judge, and founding partner of a top Philadelphia area firm - concurred. "These aren't simply the comments of some junior level analysts," Sherman said. "I mean, we're talking about the Senior North American Economist of Merrill Lynch and the Chief Equities Strategist at Bear Stearns. Any claims by their CEOs and the other senior decision makers at these banks to the effect that they should not have been well-aware of the opinions and outlooks of the top economic and market experts at their companies are simply not credible." 

Lee Sherman continued: "Remember, from mid-2004 until the subprime crisis had clearly arrived, the Fed steadily raised interest rates. For lesser quality borrowers, most of whom had adjustable rate mortgages, higher interest rates meant higher default rates. To say the least, there was great uncertainty as rates were rising about where we were headed. Then, the housing market slowed. I'm talking about 2005 now, before home values really fell off the table. It strikes me as incredible that the kinds of warnings in these reports were out there for years, yet seem to have gone unheeded."

The Sherman Law Firm represents investors in securities fraud / investment loss claims of all types, including claims against investment banks for losses related to mismanagement and other misconduct during the housing and credit bubbles.

Brett Sherman, The Sherman Law Firm

Time confirms Bryan Burrough's Bear Stearns article as nonsense (one of our most viewed posts)

 

VERIDCT? VANITY NOT FAIR -

BRETT D SHERMAN; WALL STREET LAW BLOG  

 

 

 

 

  

"Instead of evidence there's just pure speculation. 'Where there's smoke, there's fire,' might be a nice sound bite but its not evidence. Before we unleash the hounds of war on rumor mongers, shouldn't we require more than this?"  Dealbreaker.com 

PART ONE, INTRODUCTION 

"Bringing Down Bear Stearns" - which appears in the August 2008 edition of Vanity Fair Magazine - is supposed to be a work of serious journalism.   Instead of the crisp feel of hard news, however, writer Bryan Burrough's article comes across as a polished, slick page-turner.   Allusions to "shadowy" conspiracies, corporate sabotage, and a complicit media abound.   However, Burrough's near complete omission of actual evidence to support his story should consign "Bringing Down Bear Stearns" to the realm of pulp fiction.   

With an appealing film noir style potboiler about the fall of Bear Stearns, Vanity Fair and Bryan Burrough dispensed misinformation (sometimes called propaganda) to an unwitting public.   By creating a false perception of  "events" that may never have happened and almost certainly did not bring down Bear Stearns, VF and Burrough dangerously manipulated the truth.  Without objectively verifiable facts, without a reasonable number of reliable sources, and without better explanations of how Burrough's villains wrought  supposed mischief, there is nothing in the article to make  Burrough's "suggestions" credible.   

Still, Vanity Fair published the piece like it was gospel.  The writing, based on innuendo and rumor rather than on facts, was irresponsible.  The publishing was equally so.  "Bringing Down Bear Stearns" is dangerous because it portrays one man's theories as truths. Without a whole lot more evidence, Vanity Fair probably should not have published the article at all.  In the alternative, VF could have published the article with disclaimers about the lack of corroboration for Mr. Burrough’s hypothesis.  The magazine made the indefensible choice to present “Bringing Down Bear Stearns” as hard news.   

 

 

PART TWO:  BURROUGH’S MYTHICAL THREE-HEADED MONSTER 

 

 

The article is the work of Bryan Burrough  (co-author of the classic business expose  Barbarians at the Gate).  The basic idea of the VF article is that, between March 10 and March 16, 2008, Bear Stearns may have been the unwitting victim of a lightning-fast knockout by a three-headed monster.     

First, Burrough points to an unidentifiable cartel of ruthless financiers who may have successfully pulled off a secret plan to destroy Bear Stearns through a combination of aggressively spreading rumors about alleged liquidity problems at Bear Stearns while they were shorting Bear Stearns stock on a presumably massive scale.   We're talking James Bond villains, secret mountain hideaways, and a plot to rule the world.  Okay, I may be exaggerating - but not by much. 

In Burrough's words, many believe there was "a malicious attack by so-called short sellers, the Vultures of Wall Street, who bet that a firm's stock will go down."  Interestingly, Burrough fails to point out to Vanity Fair readers what short-selling is, or that shorting is a perfectly legal and important hedging strategy.  It is not even remotely a stretch to say that short-selling is a crucial component of everyday Wall Street trading.   Firms like Bear Stearns are (or were) shorted every day.  Moreover, Bear Stearns itself engaged in short-selling on a vast scale and made a lot of money loaning shares to short-sellers.   

If short sellers did illegally bring down Bear Stearns, why does "Bringing Down Bear Stearns" fail to ever touch on what the alleged illegal activity actually was and how it was accomplished?  Instead, Burrough - a talented writer - implies that all short-selling is evil .  Burrough also uses his skilled pen to convey the impression that he believes ‘the short-selling conspiracy’ is fact without devoting even a sentence to explaining the facts behind the alleged conspiracy.  Just what happened and when?  Burrough can’t help us out there.  

Cryptically, Burrough sums up by telling the reader that the short-selling conspiracy "theory is surprisingly difficult to prove..."  Why is it difficult to prove?  What type of evidence is required.  Just what are you saying specifically Mr. Burrough?   Without any answers, the writer simply moves on, leaving this reader thoroughly confused. 

 

Though Mr. Burrough apparently is comfortable discussing short-sellers without at least a rudimentary definition of what short-sellers do, I am not.  Please forgive the digression, but here is Wall Street Law Blog's short explanation of short selling -

 

Short selling is the act of selling shares you don't actually own because you are betting that the share price will fall.  In a winning short-sale, you borrow shares you don't actually own from institutions like Bear Stearns, and sell them at today's price.  If the price does go down, then your bet was right.  You buy an equal amount of shares at the lower price, return them - called covering your short - and the spread between your sell price and the later lower buy price, minus the cost of borrowing the shares, is your profit.

Villain number two in Burrough’s rogues’ is financial news network CNBC.  According to Burrough, CNBC drove Wall Street into a frenzy the week of March 10 by near-constant  reporting of a rumored liquidity problems at Bear Stearns - a rumor that Burrough paints as unquestionably false without much explanation outside of his (or Bear's) oft-repeated mantra that Bear Stearns had $18 billion in cash reserves.  Burrough claims that CNBC's reporting was a huge factor in scaring banks and other financial institutions into pulling assets from Bear Stearns and, by week's end, refusing to extend Bear the credit the firm needed to stay in business.   

It is preposterous to blame CNBC for the end of Bear Stearns.  A rumor of a liquidity crisis at Bear Stearns (assuming the story is properly sourced) is a news story worthy of reporting.  The financial media reports rumors every day of the week.  More importantly, rumors are an important factor that drive market activity on Wall Street every single day.  With respect to Bear Stearns, the primary activity during the week of March 10 was that assets were pouring out of the investment bank.  

The story of a rapid weakening of Bear's financial position - whether started by fact or fiction - was certainly true by midweek.  It was the type of news that CNBC, given its central role in the financial media, had a duty to report.  For Burrough to imply that CNBC merits responsibility for Bear's rapid death because the network reported on a dynamic, evolving situation regarding Bear's liquidity (or lack thereof) tells me that he lacks a fundamental understanding of the role of the broadcast news media in America.

In a New York Post piece, CNBC anchor Charlie Gasparino - singled out by Burrough as one of the alleged rumor-mongers regarding problems at Bear Stearns - responded strongly to the Vanity Fair story: "What we were talking about [the week of March 10, 2008] was market activity. . . In those critical hours we were reporting what was happening in the markets. What are we going to do? Ignore it?" Gasparino continued: "If Bryan Burrough wrote something substantively and factually accurate about the way we covered the story there would be a problem [with CNBC's coverage], but he didn't. He was incredibly sloppy." CNBC's Ticked at Vanity Fair, New York Post, July 11, 2008. 

In the very same New York Post article,  even Bryan Burrough (one would guess with a lawyer whispering in his ear) backtracks from his attack on CNBC.  Burrough now "says his intention wasn't to place the blame on CNBC.  'The idea that CNBC did in Bear Stearns [Burrough now claims] is ridiculous. ..' "  Perhaps Burrough needs to spend some time re-reading Vanity Fair article before making such an indefensible claim.   

To cite just one example of Burrough's numerous attacks on CNBC, describes the alleged fallout from an on-air exchange between CNBC's David Faber and Bear Stearns CEO Alan Schwartz after Faber asked Schwartz about a trade that another firm allegedly refused to complete with Bear Stearns (the trade eventually was completed): 

  

"It was a killer statement: Faber was saying, in essence, that Bear’s status as a trader, the basis of its business, was in question." 

“You knew right at that moment that Bear Stearns was dead, right at the moment he asked that question,” a Wall Street trader of 40 years told me. “Once you raise that idea, that the firm can’t follow through on a Trade, it’s over. Faber killed him. He just killed him.” 

 Does anyone who read the article honestly believe that Bryan Burrough did not intend to place blame on CNBC?   

The third and final pillar of  Burrough’s  ‘Kill the Bear’ triumvirate is the great novation scandal.  If you don't remember this part of Burrough's Vanity Fair article, that is because Burrough pretty much lets the topic linger until beyond the point in a very long magazine article where all but the most attentionally- gifted readers toss the magazine aside and start looking around the room for the remote control.   

#a2a2a2;">Late in his article, Burrough halfheartedly (or maybe I was just tired) point a finger at investment bank Goldman Sachs and hedge funds SAC Capital Partners and Citadel, for instigating a "flood" of novation requests that gathered steam on March 11-12  (where investors looked to other investment banks to replace Bear Stearns as counter-parties in certain transactions).  The flood of novation requests allegedly reached the point where Goldman itself (a rival of Bear in the lucrative business area of Prime Brokerage), Deutchebank, and Credit Suisse eventually felt that they had to refuse or delay decisions about whether to accept orders for Bear novations.  

According to Burrough, Bear Stearns believes that this information was then intentionally leaked to - you guessed it – CNBC, in order to create a crisis of confidence in Bear.  To date, former Bear Stearns executives have done a fair share of shouting about the novation issue as a deliberate attempt to bring the firm down.  There hasn't been any publicly disclosed evidence of misconduct by Goldman or any other firm.  Still, Burrough reports this part of  the story as though Deep Throat had whispered the information to him in a dark parking garage.  

PART THREE:  A LESSON IN SPIN AND INNUENDO 

As I read and re-read "Bringing Down Bear Stearns," it sure seemed that the writer's agenda was to exonerate the investment bank from any substantial blame for its own demise.  At the very least, Burrough wanted to convince readers that there is a strong possibility that Bear Stearns fell due to some premeditated conspiracy, with villians and all.   

After all, how many magazines can you sell by suggesting that bad leadership, multiple scandals, lousy finances, poor risk management, almost non-existent supervision, and plain poor business practices were the chief causes of Bear's death?  How much buzz would a piece like that generate?  No need to answer.

Although Burrough devotes a number of pages to descriptions of  Bear's "self-inflicted wounds" in 2007 and early 2008, and admits that Bear's missteps did substantial damage to Bear's reputation and finances, Burrough is all too willing to discount these issues, consigning them to the dustbin of pre-March 10, 2008 history. It felt to me like Burrough wanted readers to believe that Bear's financial scandals, huge losses, change in leadership, etc., etc., etc., were in the past, events Bear was watching through its rear view mirror as they disappeared over the horizon into irrelevancy.

Consider the manner in which Burrough described the optimistic outlook of the CFO of Bear Stearns early on the morning of March 10, 2008:

[A]s he drove in from his Connecticut home to the glass-sheathed Midtown Manhattan headquarters of Bear Stearns, Sam Molinaro wasn’t expecting trouble. Molinaro, 50, Bear’s popular chief financial officer, thought he could spot the first rays of daylight at the end of nine solid months of nonstop crisis.

What impression could Burrough possibly intend to create in this passage other than that the bad times were over for Bear Stearns?  Following Burrough's imagery-rich description of CFO Molinaro's conclusion that, on March 10, 2008, everything at Bear Stearns was A-OK, most readers cannot help drawing the logical next inference -  since Bear Stearns was (allegedly) financially healthy in March 2008, the company must have been destroyed by the outside.  Bear Stearns - the Vanity Fair article seems to repeatedly shout - cannot be responsible for its own downfall.

But Mr. Burrough, were is the evidence?  Any evidence?  A few anonymous sources, some creative innuendo, and rank speculation are a poor substitute for objectively verifiable facts and specific explanations about how key players (such as the evil, secret short-sellers)  could have possibly been responsible for "Bringing Down Bear Stearns."  For that matter, in a magazine like Vanity Fair, shouldn't you have explained what short-selling even is? Do your editors even know?

A crucial fact - apparently unrecognized, ignored, or forgotten by Burrough - is that Bear Stearns was in fact a very unhealthy investment bank during the week of March 10, as it had been for a long time.   For one thing, the firm still held far too many poorly regarded, and totally illiquid, “toxic” mortgage-backed securities in its portfolio.   Bear Stearns also was way over-leveraged.  Most reports put Bear's debt to equity ration at somewhere between 30:1 and 35:1, the highest of any big investment bank on Wall Street.  (In layman's' terms an investment bank that is leveraged 30:1 means it has borrowed 30  dollars for every one if its own dollars it spends).   

The fact was that, as a practical matter, Bear Stearns was insolvent the week of March 10, 2008.  While Bear’s officers were busy telling the public that nothing was wrong with its finances, the truth was that Bear carried $29 billion of mortgage-backed securities and related investments on the asset side of its balance sheet.  Bear certainly would have sold these securities to stay alive rather than just throwing in the towel and disappearing into the JP Morgan Chase behemoth.  There were no buyers for the portfolio.  It was illiquid. 

When there are no buyers for a security a company needs to sell, the securities are worthless.  Therefore, the so-called $29 billion in assets was, in reality, worth nothing to Bear Stearns.  JP Morgan certainly wanted no part of  the toxic securities portfolio.  Jamie Dimon has insisted time and again that he would not have agreed to purchase Bear if it meant taking on the risky securities.  Eventually, the federal government essentially bought the securities from JP Morgan in order to facilitate the deal between Morgan and Bear Stearns. 

Why is this important?  Because, during the week of March 10, 2008,  Bear Stearns had $29 billion of worthless “assets” listed on its balance sheet.  Subtract that $29 billion and Bear Stearns is insolvent.  Its senior executives and directors were responsible for knowing that the $29 billion had nominal value.   Officers like Ace Greenberg and CEO Alan Schwartz misled the public, including Bear’s shareholders, when they went on television or put out press releases to (falsely) assure the public that Bear’s financial condition was healthy and strong.  Bear’s balance sheet was, in reality, a disaster.   There is a legal term for this conduct – we call it fraud.

 

 

PART FOUR:  BRINGING DOWN THE HOUSE OF BEAR   

-CONCLUSION-

The BigPicture.com draws the main point against conspiracy theorists very well: "If your financial condition is so precarious that rumors can bring you down, then it is the finances, and not the rumors, that are to blame." The Big Picture; Who Killed Bear Stearns? 

What killed Bear Stearns is no mystery.  Bear died because the investment bank itself created an environment in which the banks with which it did business, and upon which Bear Stearns relied for the capital it needed to run its business, no longer had any faith in Bear Stearns.  The company began to seriously founder in June 2007 with the now infamous and possibly criminal failure of two subprime dominated hedge funds.  Bear Stearns never recovered from the hit to its finances or, perhaps more importantly, to its reputation from the hedge fund fiasco.

Thus, by March 2008, Bear Stearns found itself in very cold waters.  The once-respected investment bank was sailing alone; the Titanic waiting for an iceberg.  If the fatal blow had not come during the week of March 10, the odds are high that another disaster would have killed the firm another week. Bear Stearns was listing badly - undermined by scandal, massive financial losses, alleged criminal conduct, poor investment management decisions, questionable leadership, bad stock performance, and acts that put the company's integrity in question. 

Bear Stearns created an unsustainable business model. The week of March 10, 2008 was simply the iceberg that sent Bear Stearns to the bottom. 

 

BY BRETT SHERMAN, THE SHERMAN LAW FIRM

EDITOR - Wall Street Law Blog

Bear Stearns Executive Committee (minus Ace Greenberg) to Testify This Week

By Brett Sherman

The Sherman Law Firm

This should be very interesting-

The Financial Crisis Inquiry Commission, a bipartisan group examining the causes of the credit crisis, will hear testimony from four of the former big five members of the  Bear Stearns Executive Committee this week.

Cayne and fellow former CEO Alan Schwartz, for CFO Samuel Molinaro, and President and Co-Chief Operating Officer  Warren Spector all are expected to appear on Wednesday or Thursday.

Notably, Ace Greenberg - another former Bear Stearns CEO, and the fifth member of the infamous quintet that (according to a Harvard University Study) split more than $1.4 billion in CASH compensation between 2000 and 2008 (annual cash bonuses plus proceeds from selling Bear Stearns common stock paid to them as part of their bonus packages in previous years) - is not scheduled to appear.

In recent post, Wall Street Law Blog pointed out Ace Greenberg's seemingly damning comments about his own conduct in an interview with PBS shortly after Bear Stearns collapsed in March 2008.

Perhaps the FCIC does not read our Wall Street Law Blog yet...

Two Years A.B.S. (after Bear Stearns, not "asset backed security") and a question:

Did Bear Stearns have a liquidity crisis before 

CEO Alan Schwartz finally copped to it on

Thursday, March 13, 2008? 

Wall Street Law Blog fearlessly weighs in...

Let's start with a few definitions... 

The term LIQUIDITY means cash and cash equivalents.  "Cash equivalents" are highly liquid assets (assets that can easily be sold) like Treasury bonds.

ILLIQUID ASSETS are items that have little or no market demand and, therefore, cannot be easily turned into cash.

A LIQUIDITY CRISIS occurs when there is a threat to a company's ability to access enough cash to meet its financial obligations as they come due.

 

And add a little bit of perspective...

When a CEO (like Alan Schwartz) tells the public there is no pressure on his company's liquidity, let alone a liquidity crisis (as he did on March 11 and March 12), we take that to mean that the company has no current OR reasonably foreseeable problems that might make it hard for the company to access enough cash to meet its financial obligations.

It is not possible for a large company with "no pressure" on its liquidity on one morning to be so cash poor by the close of business the very next day that it needs billions of dollars in emergency financing from the federal government to avoid bankruptcy.  And yet, that is precisely what happened to Bear Stearns.

By a show of hands the crew at Wall Street Law Blog voted on the question of whether Bear Stearns had a liquidity crisis on or before the Alan Schwartz's vehement denials on March 12, 2008.  There was no need to tally the number of outstretched arms.  We all said Schwartz was wrong when he denied liquidity problems two years ago.  Predictably (I know these folks pretty well), no one changed his or her mind.

Author Lewis explains Wall Street's willful blindness (plus Happy 2nd anniversary to Cayne, Ace and Alan Schwartz)

Brett Sherman, 

The Sherman Law Firm

Mission accomplished!

Master nonfiction writer Michael Lewis - author of Liar's Poker, 

Money Ball (our favorite Lewis title), The Blindside, and other bestsellers - 

has a brand new book on the financial crisis.  

Mr. Lewis successfully tells the tale of the housing and credit meltdown with

his unique flair for using simple language to create a highly readable intriguing

and educational tale. Lewis' latest work is an original and important supplement to

the rapidly building library of high quality books on the meltdown.

On Sunday night, 60 Minutes ran a half hour segment on Lewis and 

his new book.  

Here is a quote from the piece that is typical of the Lewis style 

(which we like a lot) -

"This was an episode where capitalism was almost destroyed, 

just by the capitalists.  And, in the most sensational way, 

they were sort of destroyed by their own folly..." 

For the interview, transcript and some worthwhile bonus features,

visit Sixty Minutes by clicking here.

----

HAPPY 2ND ANNIVERSARY BEAR STEARNS

 

Today is the two year anniversary of the Bear Stearns to JPM fire-sale! 

Jimmy Cayne (pictured) and friends are still counting the money Bear Stearns

shareholders paid them for destroying the company and igniting the global

financial crisis.

Kind of warms the heart...

Would Bear Stearns sales have exposed "mark to market" fraud?

    Did Bear Stearns maintain a massive mortgage-related securities portfolio to avoid huge write-downs, cover fraud, or even hide insolvency?  

We'd sure like to know.

 

• After the subprime crisis began in 2007, senior managing directors at Bear Stearns reportedly urged the firm's Executive Committee to raise capital by, among other actions, selling off chunks of the firm's massive portfolio of mortgage-related products.

• Mortgage boss Tom Marano consistently fought the idea of any substantial liquidation of Bear's mortgage holdings.  

• The ever-worsening mortgage and credit crises meant that Bear Stearns could sell mortgage-related products for only a fraction of their original values.  However, there came a point in 2007 (at the latest) when Bear Stearns management knew or should have known that the market for mortgage-backed securities and related investments was dead in the water.  The housing and credit bubbles had popped.  The party was over.

• Still, according to the estimated values Bear Stearns was assigning to its mortgage holdings in 2007 and 2008, substantial liquidations from Bear's mortgage portfolio at deep discounts could have yielded billions of dollars for the firm's war chest.    

• SEC records show that Bear Stearns had significant liquidity problems by late summer, 2007.  

• In light of Bear's documented liquidity issues and falling demand / prices for MBS and CDO's, there seems to be no logical reason why Bear Stearns would keep huge amounts of the firm's capital locked inside mortgage securities were (a) consistently losing value, (b) had virtually no chance for any real, sustained recovery, and (c) would be difficult to sell quickly if Bear Stearns needed to raise cash quickly (which, of course, is precisely what happened when Bear was undone by a severe liquidity crisis in March 2008).

• Nevertheless, Tom Marano continued to argue against any substantial reduction in the firm's mortgage holdings.  

• THE QUESTION IS WHY:  Why would Marano fight liquidations of mortgage securities?  Why would CEO Jimmy Cayne allow Bear Stearns to keep the over-concentrated mortgage portfolio largely intact when that portfolio obviously was a huge albatross for the firm?  Why would Cayne's successor as CEO, Alan Schwartz, also side with Marano?  

• POSSIBLE ANSWERS (what follows is speculation. However, if there is a better explanation for Bear's inexplicable refusal to sell off chunks of its mortgage securities book, we sure would like to hear it...)  

• Maybe the reason Bear Stearns kept most of its massive mortgage portfolio after the subprime crisis began in 2007 was that the firm knew it had marked the value of its mortgage securities way too high. 

• Maybe Bear Stearns knew that the real prices the market would pay for mortgage securities were far less than the prices Bear was using to value its portfolio (which accounted for a large portion of the total assets on Bear's balance sheet). 

• Maybe Bear Stearns knew it could not sell its mortgage holdings without exposing the firm's false valuations.  

• Bear Stearns certainly knew "mark to market" accounting rules meant sales of large blocks of mortgage securities on the open market would immediately set new benchmark prices for repricing similar, hard to value securities.  

• If Bear Stearns knew that it was over-stating the value of MBS, CDO's and related products, then Bear also knew that using new benchmark market prices to revalue the balance of the firm's mortgage holdings would reveal that the portfolio was worth far less than Bear Stearns was reporting on its balance sheet.  

• If Bear Stearns knew that the value of mortgage-related assets on the firm's balance sheet was substantially lower than Bear was telling the public, then maybe Tom Marano and Bear Stearns senior management resisted any sizable liquidation of the mortgage portfolio to avoid exposing Bear's unreasonably high marks.

• Maybe it is even true that Bear Stearns senior management knew (or believed / feared) that a large sale of mortgage-related assets, and a subsequent revaluation of the balance of the portfolio using new benchmark prices, would show that Bear Stearns was actually insolvent during the second half of 2007 and early 2008.  

Whether some, all, or none of our conjecture is accurate, Wall Street Law Blog firmly believes that any explanation would cast a bad light on the business practices of Bear Stearns. As always, we welcome your thoughts, information, criticism, and wisdom.

By Brett Sherman, The Sherman Law Firm 

 

Comparing Wall Street Comp. to payrolls in the NFL and MLB (Greatest Hits)

 

ByBrett Sherman

In 2006, total compensation for five Bear Stearns senior executives, including CEO Jimmy Cayne, exceeded the payrolls of the NFL's New York Giants and MLB's Philadelphia Phillies.  The payrolls of these two professional sports teams make for a particularly interesting comparison with the total compensation that was wasted on Bear Stearns’ five executive officers in 2006 (which blew away the money the Giants spent on their 50 plus players and the combined salaries of more than 25 Phillies).   What's our point? Well, only two years later, in 2008, the Giants won the Super Bowl, the Phillies won the World Series and Bear Stearns was out of business.