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