Caught up with some reading on the collapse of Bear Stearns:
1. And then the Roof Caved In by David Faber
2. Street Fighters by Kate Kelly
3. Bear Trap by Bill Bamber
4. Fool's Gold by Gillian Tett
5. House of Cards by William Cohan
The most remarkable thing that struck me in reading about the collapse of Bear Stearns from all the books was that NOTHING really happened that precipitated the collapse. Nothing in the sense of macroeconomic news or event or anything else besides an apparent and sudden refusal by Bear's banks to rollover its short term paper. From this perspective, its hard to shake the sense that there was some kind of conspiracy (by other investment and commercial bank) to force Bear's failure.
One surprising discovery from reading these books (esp. Kate Kelly's version of events) was how close Hank Paulson came to becoming the dictator that I had wanted him to be. It was clear that it was he who set the low ball price of $2 for the sale of Bear Stearns (subsequently adjusted to $10) and it was clear that there was great desire on his part to punish Bear Stearns and its shareholders as well as to set the tone that there would be consequences from a bailout. Thus, it changed my opinion of Paulson - though it is hard to tell whether he was part of the conspiracy (as a Goldman alumni) to force Bear's collapse.
Another discovery was that the much maligned Jimmy Cayne held a lot of Bear Stearns stock - his paper wealth fell from 1 billion to 200 million. (One third of Bear stock was employee owned.) This points to the failure of stock ownership to align incentives. In Mr. Cayne's case, it also shows that when you have a billion dollars, losing a several hundred million is really no big deal, you still have a couple of hundred million when all's said and done and besides he had already taken a few hundred million out by the time of the collapse.
Gillian Tett's book made me appreciate the phrase "super-senior tranche". These are the toxic assets that nobody wants to touch - the triple A rated stuff that were held by Bear. The irony was that because it was triple A, it could only offer low returns and Bear (and other investment banks) wasn't able to offload it.
Of the books listed above, Street Fighters was definitely the most gripping, with more detail (than perhaps the average reader might want) provided by House of Cards. Bear Trap was disappointing - as a purported insider's view it offered nothing - no naming and shaming - just a philosophical wandering and wondering of the author. David Faber's book was a real surprise - it provided a lot of anecdotes on the start and the end of the subprime crisis - yet like Giant Pool of Money it did not provide the most juicy detail - who are these investors that flooded the market with liquidity. Ben Bernanke claims that it is caused by sovereign wealth funds which provided a global savings glut. If this is indeed the case then we should see some of these funds being wiped out. In fact I see no evidence of this - which still leaves me wondering who or what the culprit is. Here is an earlier blog post on Faber's book.
Gillian Tett's book was also revealing - being told from the side of JP Morgan and the band of derivatives traders who created the credit derivatives including the woman who built the financial weapon of mass destruction Blythe Masters. Again, I looked to this book as being the most likely to identify the source of liquidity and was only left with a very sneaky suspicion that the source of the increased liquidity were none other than the investment and commercial banks themselves. CDS were invented as a way to get around Basel capital requirements - freeing up capital. This freed up capital is the increase in liquidity. The volume of the liquidity from this capital is too small, you say. Yes, initially. But coupled with euphoria and exuberance which lead to higher asset prices and increased leverage, this initial pool of freed up capital became huge.
The reason the subprime crisis has only (initially) affected the financial sector and not SWFs is because they were the ones who generated the liquidity which led to the boom (and hence the apparent increase in working capital) and then the bust. The banks were making up the alphabet soup of derivatives and selling them to one another reaping huge fees and profits (and bonuses) at the same time. As Michael Lewis points out about Iceland, the secret to a bubble really is nothing more than getting two people to agree about the higher asset price (emphasis mine):
A handful of guys in Iceland, who had no experience of finance, were taking out tens of billions of dollars in short-term loans from abroad. They were then re-lending this money to themselves and their friends to buy assets—the banks, soccer teams, etc. Since the entire world’s assets were rising—thanks in part to people like these Icelandic lunatics paying crazy prices for them—they appeared to be making money. Yet another hedge-fund manager explained Icelandic banking to me this way: You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets. “They created fake capital by trading assets amongst themselves at inflated values,” says a London hedge-fund manager. “This was how the banks and investment companies grew and grew. But they were lightweights in the international markets.”
So would I conclude that these securities that the financial sector were trading amongst themselves constituted fake capital? Well, yeah.