Pressed to admit that Bear Stearns's over-leveraged, subprime-fueled nature was responsible for the failed investment bank's eventual demise, three top former executives on Wednesday chose to instead blame market "rumors." None of them took responsibility, and neither should the firm, they all argued.
The Financial Crisis Inquiry Commission kicked off its fourth round of hearings this morning with an examination into what's been referred to as the "shadow banking system," in other words sources of funding -- investment banks, mutual funds and the like -- that don't come from traditional banks.
The former head of Bear Stearns's fixed income repo desk -- "repo" refers to overnight repurchase agreements, a source of funding banks use to maintain liquidity -- the firm's former president and co-chief operating officer, and the firm's former chief financial officer were all asked, in one form or another, about the firm's stratospheric leverage ratio and its reliance on short-term funding.
The firm's assets ballooned from about $185 billion to nearly $400 billion in 2007 over just a few years, noted Commission chairman Phil Angelides. The firm had a 2007 year-end 38 to 1 ratio of tangible assets to tangible common equity (essentially it had just $1 to support every $38 in assets like loans and securities). Bear had a "significant concentration" of its assets locked into mortgages and mortgage-linked securities, much of it in the form of no-documentation and other crummy loans, Angelides continued. In fact, the value of those risky loans -- more than $12 billion -- was greater than the firm's total equity.
So, Angelides asked the former Bear executives, why would you think that a business model based on "extraordinary leverage" and overnight funding would be sustainable through any type of "market disruption"?
It was "part of the investment banking model for many, many years," replied former Bear COO and CFO Samuel Molinaro.
Angelides countered with the fact that Bear relied on some $50 to $60 billion in oversight funding -- money that could easily be pulled (which it eventually was). In 2007, Angelides noted, the firm held Level 3 assets -- those assets that are illiquid, meaning they have no ready discernible value -- in excess of triple (269 percent) the firm's tangible common equity. During any time of significant market disruption, Angelides said, the firm could be in trouble.
Despite those facts, the commission never got a firm answer from any of the three former Bear executives.
Instead, the Commission was treated to such claims as:
- "We didn't think we were over-levered by any stretch." (Molinaro)
- The firm's shareholders thought the firm was "overcapitalized," and often asked when the firm would buy back shares. (Molinaro)
- And that investors had long valued the firm's "outstanding risk management culture." (Also Molinaro)
Underscoring the firm's apparent unpreparedness for the coming burst of the housing bubble, Molinaro said Bear Stearns's internal stress tests never modeled for a decline in home prices.
Essentially, the firm never thought home prices would ever decline.