How Bear Died

Bryan Burrough has a compulsively readable 10,000-word blow-by-blow account of the demise of Bear Stearns in August’s Vanity Fair. Go read it: it’s the best thing yet on what happened. And it does a good job of answering two of the biggest unanswered questions surrounding the episode. First, how and why did a 28-day credit line become a 48-hour sell-or-go-bankrupt deadline? And second, how did the Fed end up taking on $30 billion in Bear assets as part of the deal?

The weakness of the article, in my view, is its attempt to point fingers, and to say that the collapse of Bear was "the biggest financial crime ever perpetuated". I don’t think the article comes remotely close to making that allegation – that Bear was brought down by a deliberate and orchestrated bear raid – stand up. The closest thing it has to a smoking gun is a wave of "novation requests" which hit Goldman Sachs, Credit Suisse, and Deutsche Bank on the Tuesday before the collapse; it’s pretty thin stuff on which to base an enormous conspiracy theory involving billions of dollars.

If you look at what happened to financial stocks during the period of Bear’s demise and in the months since then, I think it’s pretty clear that large financial institutions like Goldman Sachs and Citadel had no incentive whatsoever to see Bear go bust. I don’t think that they should have been named by Burrough as suspects in Bear’s demise, and I certainly don’t think they were part of "a shadowy group of short-sellers" engaged in some kind of illegal rumor-mongering scheme.

But the rest of the piece is excellent. It explains that the 28 days which Bear executives thought they had were never really negotiated or meant:

By four a.m. the outlines of a deal were taking shape. Morgan would give Bear a credit line; the money would come from the Fed. It took three more hours for the details to be pounded out. At the last minute Morgan’s general counsel, Stephen Cutler, inserted a line into the press release stating the credit line would be good for up to 28 days.

Around six Schwartz slipped into the back of a black town car for the drive home to Greenwich. Somehow Bear was still alive, if barely. Thanks to the Morgan credit line, they could probably open on Monday. Now he had 28 days–28 days to raise new capital, find a merger partner, or sell Bear outright. It wouldn’t be easy, he knew, but it was doable. Then, as the car cruised northeast, Schwartz’s phone rang. It was Tim Geithner of the Fed, with the Treasury secretary, Hank Paulson. Paulson came right to the point. “You’ll recall I told you when we cut this facility [that] your fate was no longer in your hands,” he told Schwartz. “Well, we don’t plan on being here on Sunday night like we were last night. You’ve got the weekend to do a deal with J. P. Morgan or anyone else you can find. But if you’re not done by Monday, we’re pulling the plug.” And, like that, Bear’s 28-day cushion evaporated. The Fed’s credit line was good only till Sunday night.

The 28-day line, in other words, was a 28-day line in name only: there’s a good chance that Paulson and Geithner never signed off on its length, only on its size. And then decided that the last thing they needed was the risk of Bear Stearns bankruptcy hanging over the market’s head for a month.

What about the bail-out part of the final acquisition – the fact that not only JP Morgan but also the Fed put up funds? It turns out to be a function of the fact that Jamie Dimon and his lieutenant Steve Black really didn’t want to buy Bear:

Steve Black broke the news to Schwartz. “Whatever other things you are working on, you should actively pursue them,” he said. Downtown, at the Fed, Tim Geithner stepped out of his conference room to hear the news from Dimon. “I remember he came back in a minute later, with this look on his face that said, ‘Huh?”‘ recalls a member of the Fed team.

“They’re not going to do it,” Geithner said.

Geithner believed he couldn’t let Bear die. The repercussions were unthinkable. “For the first time in history the entire world was looking at the failure of a major financial institution that could lead to a run on the entire world financial system,” a Fed official recalls. “It was clear we couldn’t let that happen.”

Within minutes Geithner was back on the phone with Dimon. There ensued a series of conversations where, in one Fed official’s words, “they kept saying, ‘We’re not going to do it,’ and we kept saying, ‘We really think you should do it.’ This went on for hours. Finally, [the conversation] shifted to ‘Well, maybe if.’ They kept saying, ‘We can’t do this on our own.”‘

Essentially, Dimon was happy for Geithner to call his bluff. Yes, there was potential upside to buying Bear, but the potential downside was even greater, and he took quite a bit of persuading to do the deal. Then, one Dimon and Geithner came to terms, the final price was determined not by them, not by Schwartz, but rather by Paulson. Bear’s board and executives were, says Burrough, no more than spectators at their own firm’s funeral.

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