WASHINGTON (MarketWatch) — The market lost confidence in all brokerage houses and there was nothing that Bear Stearns could have done that could have prevented the firm’s collapse in March 2008, its top former executives told a financial-crisis watchdog on Wednesday.
“Bear Stearns was the smallest of the major investment banks, and I do not believe that obtaining more long-term secured financing or making any other changes in Bear Stearns’ funding strategies would have enabled the firm to overcome these unprecedented market forces or withstand the liquidity crisis that the firm experienced in March 2008,” said Paul Friedman, former senior managing director at Bear Stearns, to a financial-crisis inquiry commission.
Asked what he would have done differently, Bear’s former chief executive, James Cayne, replied: “That is a question I have asked myself for the close to three years that I have been retired, and I don’t have an answer.”
Alan Schwartz, who was chief of Bear Stearns at the time of the collapse, said: “I can’t think of anything we could have done within the context of our business model.”
The firm might have survived if it had put on very significant shorts against the housing market in 2007, Schwartz added. “It is just rare when you are running a business that you have to make one decision like that, and get it 100% right in timing and magnitude.”
The Bear Stearns executives are testifying before the panel in the first of two days of hearings about the role of the $450 trillion derivatives market, also known as the shadow banking system, in the financial crisis that took the economy to the brink in 2008.
To avert the collateral damage to the markets from the Bear Stearns collapse, the Federal Reserve provided major government guarantees to assist J.P. Morgan Chase & Co.
to acquire the institution in March 2008.
The panel members queried the Bear executives, indicating that they relied too heavily on highly rated mortgage securities as funding collateral and on short-term funding for the institution’s operations. Members of the crisis panel also argued that the institution was overly leveraged.
Cayne said he was “shocked beyond belief” when Bear Stearns failed. He agreed the firm just had too much leverage. “In retrospect, in hindsight, I would say the leverage was too high,” he commented.
The executives said they were the victims of rumors that were not true until the telling of the rumor created the truth. “In my heart, I believe there was some stuff going on,” Schwartz remarked.
He said he spoke with SEC officials about his concerns, but said it may be tough for regulators to tell who yelled the equivalent of fire in the metaphorical theater.
Cayne added that it would be a “miracle” if the SEC was able to prove there was a conspiracy to bring down Bear.
For his part, Samuel Molinaro, a former chief financial officer of Bear Stearns, said that in the buildup to the financial crisis the firm’s risk models did not anticipate the extent of the crisis that took place, where they could not finance the most liquid assets on their balance sheet.
Brooksley Born, former chairwoman of the Commodity Future Trading Commission, questioned whether Bear Stearns relied too heavily on AAA-rated mortgage securities as collateral when seeking short-term, overnight borrowing from other institutions. “Was AAA-rated mortgage securities the first type of collateral that was not accepted?” she asked.
“We did see early cracks there,” answered Molinaro. As the crisis began to emerge, “it was more that institutions, such as money funds, didn’t want to be involved in the name [Bear Stearns]. If there was a problem, they didn’t want to be there.”
Bill Thomas, the panel’s vice chairman and former lawmaker, said that regulators had set up a system to protect against a “run on the bank” for traditional depository institutions, but hadn’t developed a similar system for the exploding derivatives market.
“We set up a system to protect against a run on the bank for old-fashioned, deposit-insurance companies; then we created all this money outside of that. That’s what worries me a lot about what is going on today,” he remarked.
Later on Wednesday, the panel heard from former Securities and Exchange Commission heads William Donaldson and Christopher Cox — both of which oversaw a program to regulate large broker-dealers, including Bear Stearns.
Cox defended an SEC voluntary program known as the Consolidated Supervised Entity program, under which the five largest financial institutions with broker-dealer units registered with the agency.
Critics have said that the program failed to require investment banks registered with the agency, such as Bear Stearns and Lehman Brothers Holdings Inc.
to maintain sufficient capital standards and for failing to give an early warning of Bear Stearns’ trouble.
The CSE program represented the “best thinking” of the SEC and was well constructed, according to Cox.
Between 2004 and the peak of the financial crisis in 2008, Bear Stearns, Lehman Brothers, Goldman Sachs Group Inc.
J.P.. Morgan Chase and Morgan Stanley
had their whole holding companies registered with the SEC under the CSE program. It was terminated in September 2008, and the institutions that didn’t fail registered their global operations with the Federal Reserve instead.
In response to the panel’s questions, Molinaro, Bear’s former finance chief, said that in the period prior to the firm’s failure, its bankers had “extensive dialogue” with SEC officials about capital and liquidity. However, he added that SEC officials did not make any recommendations.
“I do recall extensive dialogue, and my thoughts were that they were comfortable with our capital levels,” Molinaro said.
The hearing comes as Congress considers a series of new regulations for big banks, such as possible new capital and leverage requirements for large institutions that have broker-dealer units. Responding to the crisis, large financial institutions may be required to divest derivatives units, based on one provision under consideration on Capitol Hill. Lawmakers also are working on creating a mechanism to resolve a large financial institution so that its collapse doesn’t unsettle the financial markets.
View more information: https://www.marketwatch.com/story/bear-stearns-nothing-we-could-do-to-stop-failure-2010-05-05-111100