Live-blogging the crisis panel hearingMay 5, 2010: 9:23 AM ET
I will be blogging the back and forth at the Financial Crisis Inquiry Commission today. Five former Bear Stearns execs including ex-CEO Jimmy Cayne will testify in panels starting this morning and running into the early afternoon.
Then, four regulators including ex-Securities and Exchange Commission chief Chris Cox will testfiy in the afternoon. The lineup and prepared testimony are here.
10:12 Bear Stearns and the kindness of strangers
Was Bear Stearns brought down by a naïve faith that its creditors would keep lending no matter what? Bill Thomas, the former Congressman who is vice chairman of the Financial Crisis Inquiry Commission, seems to think so. He told former Bear execs Sam Molinaro, Paul Friedman and Warren Spector that he is struck that "you were so dependent on others for your daily bread," referring to the firm's massive use of overnight repo funding.
Predictably, the Bear execs don't agree. "We certainly did not think we were immune to this," Molinaro, the firm's financial officer till its collapse in March 2008, said. He then went on to say the firm had a large liquidity pool – though at $18 billion, it is just about 10% of the pool Goldman Sachs has been holding in recent quarters. 10:25 Repo 105
The shadow of Repo 105, the program Lehman Brothers used to make it look like it was borrowing less than it actually was, looms over the FCIC hearing with three former Bear Stearns execs. Phil Angelides, the real estate developer and former California treasurer who is the chairman of the panel, noted that it was Bear's practice to hold more assets during the quarter than at the end of the period. He asked Molinaro if this practice showed management thought Bear was overlevered.
Molinaro, as bankers tend to, responded with a series of nonanswers. The practice of lowering leverage ratios "ensured we weren't ballooning the balance sheet with assets we wouldn't be able to sell," he said. "We didn't try to hide any of this. The assets that would go away at end of quarter were low margin and very liquid." Until they weren't, that is.
10:37 How Bear managed risk
Warren Spector, the top Bear Stearns exec who got bounced by CEO Jimmy Cayne as the firm began to unravel in late 2007, tells the FCIC that he
believes the firm had "a robust and efficient risk management culture." He says the firm focused more on things like stress tests and "scenario analysis" than the value-at-risk measure whose usefulness has long been debated on Wall Street.
Molinaro, asked if those scenarios included one in which housing prices fell, replied, "Not to the degree that they did."
Asked if it wouldn't have been prudent to expect a big decline after a record runup in house prices, he responded essentially that that wasn't his department.
10:53 The collapse of the hedge funds
Spector describes Bear's belated efforts to fix the problems that led to the collapse of two internal hedge funds in the summer of 2007.
He said that once it became clear the funds were suffering losses, the managers were directed to sell some positions. Some they could reduce "quite quickly," Spector said. But on others, "they couldn't get a price."
He called that phenomenon "very surprising," but soon came to realize that the problem was that the securities themselves were "quite complex" – Wall Street speak for "basically worthless pieces of paper churned out at the height of the credit bubble."
When Bear realized the funds, known ironically enough as the High-Grade
funds (and run by two managers who last year were acquitted on fraud charges), couldn't sell, it took actions such as adding new management and meeting daily to discuss the problems. But even with those efforts, he recounts, "it was too late."
10:59 The compensation question
Molinaro says the structure of Bear's compensation plan "was not a factor" in the firm's response to the crisis. Angelides notes, however, that the firm's 2006 annual report says that the size of the compensation pool for top execs was determined by the firm's after-tax return on equity – which suggests execs had a strong incentive to boost earnings now to increase their pay.
11:10 Bear's mortgage team
Commissioner Peter Wallison notes that subprime and related mortgages made up half the total in the bubble years of 2006 and 2007, and asks if Bear considered factors like the quality of mortgages in its risk management process. Spector replies that within the mortgage business, "all of these things were being discussed on a constant basis." He says Bear had an "expert" mortgage team and that mortgage traders were provided with "reams of statistics" about the market.
So if everyone knew what was going on in housing, why the panic in March 2008 when Bear faced a run on its funding? "I don't have an explanation for what happened," Spector said. "I don't think there is any question that the difficulties in the U.S. housing market … played a large role in the loss of confidence," Molinaro adds.
The Bear Stearns guys are still in denial. Friedman, asked what he or the firm should have done differently or regrets having done, says there is "barely a day I haven't asked that same question of myself." He then goes on to offer a nonanswer, saying it is "hard for anyone who wasn't in the trenches to appreciate" the fear that spread through the markets in the late summer of 2007 when bank lending stopped.
"I'm not sure what the firm could have done differently," he said.
11:29 Molinaro dodging and weaving
Commissioner Keith Hennessey, an economic adviser during President George W. Bush's administration, thinks batting ninth in baseball constitutes "hitting cleanup." This is not a good sign. Hennessey also thinks Bear Stearns is at the wrong hearing, on the grounds that the firm's problem was a reliance on short-term financing rather than dependence on so-called shadow banking. It is not clear where the distinction lies.
But his question is right on point. He asks Molinaro to explain why the common story of Bear's failure – it was overleveraged, bet too heavily on housing and relied too much on overnight funding – is incorrect. Molinaro disagrees with the notion that Bear was "doubling down" on housing, but is otherwise unable to debunk the narrative.
"It's very complex," he said. "We were pursuing a strategy of trying to build our firm."
11:33 Maybe it was partly us
Why did Bear Stearns fail first?
Hennessey asks Friedman whether firm-specific factors that were to blame. Friedman says he believes the issue is simply that Bear was the smallest Wall Street firms – but also allows that the firm's mortgage holdings made it look toxic to creditors.
That suggests the problem was counterparty risk, Hennessey says. "There's some truth to that," Friedman allows.
11:49 More denial
Commissioner Heather Murren points out that Bear's executive committee met 115 times in 2007 and the risk committee twice. She says that suggests the executive committee was somewhat more important in the firm's operation than the risk panel, which seems to have been created in a belated bid to impress the rating agencies. Molinaro had earlier said he wasn't sure he'd say the panel was created for that reason.
Angelides reiterates that he's dubious that the crisis that brought down Bear and then later Lehman was really an "immaculate" one that couldn't have been foreseen. What was it, he asks Spector, that you didn't see at a time when the press was full of warnings about the housing bubble and subprime lenders were starting to collapse in droves?
Spector replies that peddling mortgage securities and "betting on housing" are different things, and adds that while he was there "we did a good job managing the mortgage business." Angelides, looking slightly perplexed, replies, "So be it."
11:52 First panel ends
12:21 Second panel (featuring Cayne) begins
Taxes were killing Jimmy Cayne. The former Bear CEO, who was chairman when the firm collapsed in March 2008, says he never sold a share except to pay taxes.
With any luck he will share his views on the value-added tax that Fortune's Shawn Tully is such an ardent fan of.
Former CEO Alan Schwartz, who took over for Cayne after it became apparent that no one could take another day with Cayne at the helm, is also testifying.
12:31 Was Bear overleveraged?
Cayne says having huge leverage "was industry practice" at the time, but he allows that "in retrospect I would say leverage was too high."
Schwartz says the leverage was "high" but takes issue with how Angelides characterized the firm's risk profile. "I have always believed gross leverage is one of the most misleading statistics you can look at with financial institutions," he said.
He then says Bear's capital was very strong on a risk-adjusted basis. And the
thing where Bear was dependent on $50 billion of overnight repurchase funding that got pulled when the market turned "was not something we entered into consciously."
But he adds, "I don't know another model we could have pursued."
12:37 Why didn't Bear raise equity?
Cayne says he doesn't believe it was necessary for the firm to raise capital by selling stock and adds that the firm's compensation structure was "absolutely not" a factor in the decision not to sell stock.
Angelides notes that the firm, by the end of 2007, was in the practice of carrying $450 billion of assets on $9 billion of equity -- meaning leverage was 50 to 1. Was there enough internal debate and could you have done more to prepare yourself, Angelides asks.
"I don't think equity would have made any difference at all," Cayne replies, characterizing Bear's demise as a run on the bank.
12:42 So what did bring Bear down?
Cayne said he has avoided answering that question but will oblige the commission. He heard the same rumors everyone else did, of hedge funds and the like ganging up on Bear -- "a big fat goose walking down the lane."
He said he was "enthusiastic" about an SEC probe of short-sellers, but adds it would have been a "miracle" if the SEC were to have found such a conspiracy.
12:44 How damaging were the rumors about Bear?
"It's hard to know," Schwartz replies. "There seemed to be a widespread rumor that Bear Stearns had lost a lot of money in the first quarter." He added that the period between the end of a quarter and the release of the quarterly financials is a "vulnerable time," and he sought to "calm people down" by telling investors about the "tone of the quarter" in an interview on CNBC.
"I thought Alan handled it very well," Cayne said of the March 2008 CNBC interview that took place as rumors about Bear were increasing.
12:52 How much capital is enough?
Thomas notes that a town in his district suffered two hundred-year floods in three years. This prompts Schwartz to claim for the umpteenth time that Bear was solvent, which means that equity wasn't the problem.
He then goes on to say there was a reliance on ratings and a lack of transparency and various other cliches. The rating agencies were part of the problem, he says, but investors' inability to compare like securities was "more of the problem."
Schwartz adds that moving derivatives onto clearing houses or exchanges would be a good idea.
12:58 Was Bear too big to manage?
Brooksley Born, the former Commodities Futures Trading Commission chair, notes the firm's size and asks Schwarz whether it was too big or complex. Schwartz says no and claims Bear's asset quality was better than others, though he concedes it was impossible for anyone to tell.
He adds that "transparency is always good," but notes that derivatives were taken on with the encouragement of policymakers who believed risk dispersion would make a market meltdown less likely.
What about your interconnectedness, Born asks. Schwartz replies that it's important to have derivatives cleared so traders face the market, not each other, doing away with counterparty risk.
1:03 Why did the Fed step in behind JPMorgan's purchase of Bear?
Cayne doesn't know. What's more, he has "no opinion about this too big to fail thing," he tells Born, though he adds that he doesn't believe Bear was big enough to be too big to fail.
"The outcome was the best that could be anticipated when the world ended," he says, before adding "for some of us."
Asked if Bear's rescue set the market up for a post-Lehman collapse, Cayne says, "I don't know." He gets right to the point, you have to say.
Schwartz says he doesn't think the Fed's role in the JPMorgan-Bear deal added to the so-called moral hazard problem. "It looked like a solvent institution being taken over by a third party," he said, though it's worth noting that "solvent" isn't probably the way most people outside Bear would have characterized the firm.
1:10 Shades of Omaha
The questioning of Schwartz and Cayne is starting to look like a bizarro version of the q-and-a sessions at the Berkshire Hathaway annual meeting. At Berkshire, Warren Buffett takes most questions and does 80% of the talking before turning the mike over to Charlie Munger, who often says nothing more than "Nothing to add."
At the FCIC, Schwartz responds articulately, thoughtfully and at length to just about every question. Cayne, playing the part of Munger, has responded to at least two questions with, I agree with Alan.
This just in: Cayne says "we frown on" skullduggery.
1:18 Still more denial
Schwartz insists Bear wasn't in "financial distress." The problem, he continues to say, is that there was no transparency on investment bank balance sheets, thanks to the widespread securitization of mortgage-related risks and the failure of the rating agencies to accurately rate those securities. Without that transparency, counterparties couldn't see that Bear was actually in the best shape of its life the week before it keeled over.
1:29 Would you do anything different?
Cayne and Schwartz, like the other Bear execs before them, have asked themselves this hard-hitting question every single day since the firm collapsed. Over the intervening 775 days they have failed to come up with an answer. Schwartz ventures that maybe they should have been betting against housing but contends that wasn't an easy thing to do.
1:32 Were you expecting a bailout?
Cayne was "shocked beyond belief" that Bear failed but had no other views on the question. Schwartz hoped the Fed would open the discount window to broker-dealers but didn't expect the government would do anything special for Bear.
1:35 Were you shocked Bear was permitted to fail?
"I think I was just shocked," Cayne said in response to a question from Douglas Holtz-Eakin, a former director of the Congressional Budget Office. He said the Monday before Bear's collapse was "business as usual," but then he got a call Thursday night that he characterized as "bad -- very bad."
Schwartz didn't think anyone had Bear's back.
1:43 Why did the banks want to raise their leverage?
Cayne says the 2004 SEC ruling that allowed investment banks to expand their borrowings was "an easy decision" tied to regulatory consolidation. Schwartz tells the questioner, former Sen. Bob Graham, that regulatory consolidation will be a key factor in the financial overhaul.
1:57 Mark to market accounting
Fair value accounting was "a factor" in Bear Stearns' demise, Schwartz said, but wasn't as large an issue as it became later in the crisis.
2:05 Does Cayne recall saying unfavorable things about the nation's Treasury secretary, Timothy F. Geithner?
He didn't read William D. Cohan's book, he testifies, nor does he read "Rolling Stone," even when Vampire Squid guy is writing. This comes as a grave disappointment to commissioner Byron Georgiou, who seems to have been prepared to ask about one certain passage in "House of Cards" but decides instead to withdraw the question in the name of "fairness."
2:25 What is up with that Chris Cox cat?
Cayne is done with the five-word answers and is now generously offering the panel a series of questions it might pose to former SEC chief Christopher Cox, who is to testify this afternoon.
Asked if regulators should adopt rules giving them more insight into what hedge funds are doing, Cayne rails about the SEC's 2007 decision to remove the so-called uptick rule that prevented short-sellers from riding a stock straight down.
He continues to argue that there was a conspiracy against Bear, and notes a request in March 2008 that one of the Chicago options houses make a market in Bear puts at a price that was more than $50 below the going market rate.
The removal of the uptick rule is "something in my mind that is completely illogical," Cayne said. "It created a self-fulfilling precipitous drop that couldn't be checked. I don't know why they did it."
2:35 Did Wall Street's participation in the housing bubble put it at risk?
"In hindsight I agree," Cayne said. Schwartz says it's more complicated but concedes "we were part of that."
The second panel ends.
3 p.m. Regulators panel under way
The headliner on this panel is Chris Cox, who was SEC chairman when the world blew up. His great accomplishment as chairman was to get screamed at by Henry Paulson on Sept. 14 as the government tried to prepare for a Lehman Brothers bankruptcy.
Paulson expected Cox to tell Lehman's board to make a prompt bankruptcy filing, according to Andrew Ross Sorkin's "Too Big to Fail," but Cox wasn't sure it was appropriate for him to do so. This led to a memorable scene in which Paulson bellows that the SEC is "the gang that couldn't shoot straight."
3:05 Cox calls liar loans "notorious"
3:21 Cox has strong feelings about the Basel capital standards
"If you try to tell people how to run their business, you're going to need an army," he says, totally explaining the SEC's utter failure to do anything for the better part of decade.
3:24 Weren't the Wall Street leverage ratios just plain crazy?
"We needed to have more information," says William Donaldson, Cox's predecessor atop the SEC, in explaining why the agency started the so-called consolidated supervised entities program that allowed leverage levels to rise. He acts perplexed when asked whether the agency had the power to bring those levels down.