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Liveblogging The Bear Stearns Hearing

5:00 Angelides is ripping Cox for claiming that the SEC's law enforcement operations were effective. "To suggest that the SEC was effective in those enforcement actions, frankly, is ludicrous," Angelides said. Cox then claimed that the SEC was able to enforce all of the laws that needed enforcing, and that bank regulators like the OCC and the Fed messed up, too. That's true-- but the SEC had clear authority over the toxic securities that Wall Street was concocting and selling-- mortgage-backed securities, etc-- and simply didn't exercise it. The SEC, in fact, had oversight not only over securities markets, but over rating agencies who said these securities were great. Cox didn't want to exercise that authority. This is Greenspan-esque denialism. ********************* 4:55 Cox just said he didn't approve of bailing out firms that operated "outside the traditional banking system," i.e., Bear Stearns, Lehman Brothers, Merrill Lynch. That's very nice. I don't believe in it either. But I saw what happened after Lehman Brothers, and I don't want to see it again. That means you have to regulate banks and restructure the markets. You can't just let banks run wild and then expect policymakers to let them fail when failure means terrible, immediate consequences for the entire economy. ********************* 4:45 "Too big to manage, that's what a lot of these holding companies are." --Chris Cox Bust 'em up. ********************** 4:40 Donaldson says proprietary trading is not a good thing for banks to be engaged in. Score another point for the Volcker Rule. *********************** 3:55 "Congress was incapable of legislating on the subject." That's Cox's explanation for why the derivatives market is so out-of-control. This is interesting on multiple levels. First, this is Chris Cox, the most anti-regulation ideologue in the Bush administration, saying that we need to bring transparency to the derivatives market. This man hates regulation, he hates government oversight of anything, and he's saying we need central clearing and exchange trading. Second, Congress quite obviously was not "incapable" of passing derivatives legislation. They passed a sweeping derivatives law in 2000 called the Commodity Futures Modernization Act, which banned regulation of the market. Cox is implying that Congress is simply nonfunctional on financial issues. That's not the problem (although the Senate has certainly become much less functional in general over the past couple of years thanks to unprecedented Republican obstructionism). The problem is that Congress was doing the bidding of big banks, and federal regulators sincerely believed that big banks knew what they were doing. Banks unquestionably still have a major, major lobbying presence on Capitol Hill. I'd say they are more influential than any other industry. We have to break that influence, now that even Chris Cox now believes that the policies preferred by the bank lobby (not regulating derivatives) have been detrimental to the economy and he public good. What's the best way to curb the bank lobby? Break up the banks. The Brown-Kaufman amendment would do that. ******************* 3:40 We're getting this line from Cox over and over again: We couldn't prevent the crisis because our regulatory program was inadequate. We couldn't change the program because . . . it was the program. ******************* 3:20 Don't blame me, says Cox, I tried to coordinate information sharing with the Federal Reserve! That's pathetic. Cox didn't believe in regulation and he didn't regulate. Angelides asks why Cox didn't send examiners into the investment banks. Cox says that on-site regulators just weren't "in the architecture" of the regulatory program for investment banks. But Cox was in charge of the SEC. He can change the architecture of the program. ******************** 3:10 Chris Cox is still beating the same drum he was hitting in March 2008. Basically, he notes that the international regulatory standards established under the Basel II arrangement didn't include any liquidity measures. Without any liquidity standards, there was nothing the SEC could do. But of course, one has to ask why the SEC relied on the Basel II standards alone and did not implement its own liquidity systems as well, at least to monitor how firms were doing, even if it didn't impose penalties on companies for violating liquidity standards. ******************** 3:00 William Donadlson, who chaired the SEC before Cox during the period in which the SEC lifted its leverage caps. He's pushing back against the idea that it was "deregulatory," because the SEC got access to a lot more information in exchange for lifting the caps. This helps explain why some Commissioners signed off on the deal. At the time of the vote, Annette Nazareth was quite explicit about the new access to investment bank books being the justification for her vote in favor of the move. But remember, leverage is the most important regulatory metric. So whatever else you get out of the deal, if you back away from leverage, you make it easier for banks to blow up. ******************** 2:35 "Invest with us, we have no way to predict the future." That's Angelides' characterization of Cayne's excuse that 99% of the people didn't see the housing/financial crash coming. First, Angelides notes that lots of people did see it coming (Dean Baker, Paul Krugman, etc.) Then he points out that, if it is indeed true that nobody could have seen this coming, why on earth should we have so much of our economy devoted to finance? Or pay financial executives so much money? ******************** 2:25 Jimmy Cayne is wondering why the SEC repealed the "uptick rule," which prevented massive short-seller raids from destroying company value. The answer is that the SEC was suffering from an insane deregulatory fever during the Bush years, particularly under Chris Cox. But part of this talk about short-selling stock is a distraction. It's true that this stuff can be damaging, particularly naked shorting, but the primary way that investors short other firms is not in the stock market. It's in the market for credit default swaps. This market is incredibly abusive, secretive and totally unregulated. ********************** 2:10 "I don't read Rolling Stone." That's Jimmy Cayne's response to a Matt Taibbi article arguing that rampant, illegal naked short-selling played a huge role in destroying Bear Stearns. Schwartz says he asked the SEC to investigate naked shorting, and that he believes "in my heart" that there was illegal market manipulation going on. There were a lot of these investigations going at the time-- I remember Barney Frank got involved for a while asking regulators to look into market manipulation. The SEC made a big deal about banning short selling for a while, but we never really heard anything about fraud investigations from this era. This is where a lot of the fraud should be taking place, and we haven't seen much action here yet. Maybe we'll see more now that the Goldman suit has been filed. ********************* 1:10 "It created, I think, some unintended consequences." Pretty amazing to hear ex-Bear Stearns CEO Alan Schwartz say that repealing Glass-Steagall was a mistake, and even more amazing to hear his very interesting point. Glass-Steagall was a Depression-era law that separated commercial banking (boring stuff like accepting deposits and making loans) from investment banking (crazy securities trading). It was repealed in 1999 at the behest of Larry Summers, Robert Rubin, Alan Greenspan and Phil Graham. Most people who believe the repeal was a mistake, like myself, cite the merger binge this set off and note that relatively safe commercial banks also got involved in risky securities business that destabilized them (Citi, WaMu, etc.) But Schwartz is highlighting the funding mechanisms for both investment banks and commercial banks. When commercial banks got into investment banking, they still had access to the Fed's discount window for emergency loans. When the securities markets got into trouble, the only portion of the securities business that got help was the commercial banks who were also doing investment banking. Prior to the repeal, if an investment bank got into liquidity trouble with their securities business, they could go to a commercial bank and get a loan to get them through the crisis. The commercial bank, in turn, could go to the Fed and get a loan that would fund their loan to the investment bank. But without the Glass-Steagall separation, dislocation in the securities markets prevented funds from flowing all the way through to investment banks. Commercial banks got loans from the Fed, and used them for their own purposes. They didn't lend to investment banks. Of course, now investment banks have access to the Fed's discount window. But that situation isn't really very good, because investment banks aren't regulated the way commercial banks and commercial/investment bank hybrids are. All it does is allow the Fed to help investment banks in an emergency without exercising significant oversight to prevent those emergencies. It's very rare to see people argue that repealing Glass-Steagall destabilized the investment banking business. I think Schwartz has a point here. ********************** 1:00 "I don't think we were too big to manage, I don't think we were too complex to manage," says Schwartz. But he notes that the "lack of transparency" in the Bear Stearns balance sheet was the problem. By "lack of transparency" here he means that Bear Stearns had lots of complex mortgage securities on its balance sheet. These securities were so complicated, nobody could accurately value them, so they relied on ratings which everybody knew were bunk. Three cheers for financial innovation! ********************* 12:45 Jimmy Cayne is saying he doesn't think equity would have helped Bear Stearns hold off the run, because they would have needed an enormous amount of capital. This may well be true. But if they'd had more capital to begin with, it's not obvious that the run would have been so severe. *********************** 12:40 Alan Schwartz is not quite so straightforward. He's saying that leverage is a misleading metric, and that the funding was impossible to avoid: "I don't know another model that we could have pursued." ************************ 12:36 Cayne is hilarious. He just acknowledged that the funding model was bad, too. The other guys kept making excuses. ************************* 12:35 "In hindsight, I would say leverage was too high," Jimmy Cayne. *********************** 11:00 Here comes blame-the-poor Peter Wallison. He's saying now that investment banks may not be a "cause" of the financial crisis, but a "victim." And Wallison notes that many regulated commercial banks had problems, just as unregulated investment banks did. Wallison suggests there was an "underlying cause" behind both of these things. Yes, there was an underlying cause, and it is in no way mysterious. Both regulated banks and unregulated investment banks were active in the mortgage market and derivatives markets. The derivatives markets were not regulated, and consumer protections were not enforced in the mortgage market, allowing grotesque and reckless loans to be issued en masse. Then both commercial banks and investment banks made huge bets on these mortgages with derivatives, amplifying the size of the problem. **************************** 10:55 Bam! FCIC Commissioner Sen. Robert Graham just noted that Bear's compensation metrics were tied very closely to return-on-equity, meaning that if the company sold more stock, their bonuses would be smaller. Molinaro says no, because Bear Stearns execs owned the company's stock, and wouldn't want to see that devalued by decisions that wrecked the company. That's a lousy answer. ************************** 10:35 Douglas Holtz-Eakin on failure of banks to stress test for significant home price declines. All of these guys, not just Bear, but Jamie Dimon at JPMorgan Chase and others, keep saying that they didn't test for unprecedented home price declines. But of course, as Holtz-Eakin notes, for most of the decade, the housing market was experiencing an unprecedented run-up in prices. That people could not even think about the prospect of an unprecedented drop in prices shows some remarkable short-sightedness. Short-sightedness that scored very high bonuses for several years before it lead to disaster. ********************* 10:15 Hopefully somebody asks Bear Stearns what they learned from the failure of two of their in-house hedge funds during the summer of 2007. When most people think about the financial crisis, they think about Lehman Brothers and September 2008, but the mess really set in during August of 2007. Two of Bear Stearns hedge funds, heavily invested in mortgages, went down spectacularly, and markets really went wild. The company had more than seven months before it collapsed. How did they change the business? Born is asking how the company changed its business amid the crisis-conditions in the market during 2007 and 2008, particularly why they didn't raise equity. But I'm interested in the specific lessons from the hedge fund failure, which was a major wake-up call to everyone in the marketplace. Was it a wake-up call for Bear? ********************** 10:10 Brooksley Born is following the general line of questioning thus far, but more directly. Noting that short-term funding backed up 25% of the company's assets, she asks, "Why did you rely on the short-term funding?" The answer, of course, is that it was risky, and therefore profitable, until the risk backfired. You can say the same thing for an awful lot of what happened on Wall Street between 2004 and 2009. *************************** 9:50 An interesting line of questioning from Thomas. A lot of people on Wall Street thought they could benefit from the collapse of Bear Stearns. Short sellers, certainly, and ultimately JPMorgan Chase, which was able to buy the company for next to nothing with a $29 billion backstop from the Federal Reserve. So Thomas wants to know why, given that Wall Street can be a cutthroat place, Bear Stearns executives didn't prepare for a scenario in which they'd be intentionally undercut by their peers. Molinaro keeps emphasizing that Bear's overnight funding was backed by the highest-quality, most liquid collateral possible-- Treasury bonds, etc. But Thomas is pointing out that people might just refuse to deal with Bear because they see an opening they could exploit for profit. It's unquestionably true that some parties were trying to kneecap Bear for profit in mid-March 2008. And it's unquestionably true that overleveraged firms dependent on short-term funding are much more vulnerable to this kind of exploitation. In short, Thomas is saying, 'You work on Wall Street, you know how the place works, and you should have prepared for this.' ******************** 9:30 Great question from Chairman Angelides. He pointed out that Bear owned more "scratch and dent"-- that is, problem mortgages-- than it had equity. That business model is never going to hold up. Ex-CFO Molinaro says this leverage has been in the investment banking business for "many, many, many years." This is not true. The SEC lifted leverage caps in 2004, under pressure from investment banks. Molinaro says it was not the bank's business model that was crazy, but the market shock they went through. Angelides then points out Bear's reliance on short-term financing. Bankers have known for centuries that borrowing short and lending long is dangerous. Molinaro says they were backing up their overnight loans with top-quality collateral-- Treasurys and GSE securities. Well, great. But if people think you're insolvent, they're not going to do business with you. And if you've got more investments in troubled loans than you have equity, people are going to get uncomfortable with that. ****************************** 9:15 So here's the Bear Stearns defense: false rumors killed us. Former CFO and COO Samuel Molinaro Jr. is making the case that unsubstantiated rumors in the markets sparked a massive run on Bear Stearns that lead to the company's swift collapse. There were, in fact, a lot of crazy rumors circulating about Bear Stearns in mid-March of 2008. But the company also had a lot of actual, terrible problems. They were very heavily invested in the mortgage business, and they were leveraged at 38-to-1, which meant that a very slight drop in asset values would completely wipe out the firm. Short sellers had been targeting the firm for a long time, and the company never really changed its dependence on short-term funding. Banks can make money by borrowing short and lending/investing long. Longer-term investments carry higher interest rates, so by funding yourself with short-term investments, you can create a spread that results in profits. You borrow at 1% because the loan is due the next day, and you pay it off with returns from investments that reap 9% or 10%. The difference goes to shareholders and bonuses. But if you lose that overnight funding, your business, is kaput-- you wont' be able to pay your employees to show up for work the next day. Bear Stearns was totally dependent on overnight funding to keep its business going, and when people stopped being willing to provide the bank with overnight loans, they couldn't fund their day-to-day operations. How do you survive a run like this? Well, for one, you can have more capital on hand. When you're leveraged 38-to-1, by definition, you don't have any capital. They could also have established longer-term funding sources with other banks. They didn't, and they failed. Bear Stearns couldn't control the rumors-- and it must be noted that much of the information spreading about Bear Stearns was not rumor, but a reasonable loss of faith in the company's shaky business model-- but Bear Stearns could have made itself less vulnerable to this kind of event. **************************** 9:00 Here we go. Bill Thomas is offering a very silly analogy between the automobile and the financial system. Both were simple 40 years ago, then both got complicated, and now you need a very sophisticated specialist to fix problems with either cars or finance. Nice story. Except the financial markets got complicated not only to provide more useful, tailored services, but also to inject confusion into the marketplace, and allow architects of new products to charge higher prices. Whether you believe what Goldman Sachs did with its Abacus deal was criminal fraud or not, they clearly devised a complicated financial instrument and confused their own clients with it, and set up those clients for a fall. Obama, Geithner and Summers like to tell a similar story to the one Thomas is telling about how innovation in the financial system simply outpaced regulators. This kind of story completely ignores the deregulatory movement of the past 30 years, a movement in which Thomas, Summers and Geithner were all eager participants. It is not that our regulatory architecture became outdated, but rather that it was systematically dismantled.