All the Devils Are Here [180]
On April 19, for instance, Van Solkema did some preliminary analysis with a new credit model he was working on, in which he reverse engineered some mortgage-backed securities, drilling down to the individual mortgages. He wanted to be able to play around with default scenarios at the homeowner level, to see how different default rates would affect CDO tranches. It is both telling and stunning that a firm of the size and supposed sophistication of Bear Stearns didn’t have the ability to do this before launching hedge funds whose prospects would be dependent on that very thing.
Van Solkema later told the jury that when he ran his model, “the bad [mortgages] looked even worse than what I thought they were.” After getting the results, Tannin e-mailed Cioffi’s wife, Phyllis, from his personal e-mail account: “[T]he subprime market looks pretty damn ugly... if we believe the runs Steve has been doing are anywhere close to accurate, I think we should close the funds now. The reason for this is that if [the runs] are correct then the entire subprime market is toast.... If AAA bonds are systematically downgraded then there is simply no way for us to make money—ever.”
In mid-March, Cioffi sent an e-mail listing “problem positions,” next to which he noted his stress level. Among them: $120 million worth of Abacus bonds, which he had bought from Goldman Sachs. Stress level: medium to high.
And yet at the same time, the two men simply couldn’t bring themselves to believe that the picture was as dire as the model suggested. In that same e-mail to Cioffi’s wife, Tannin stated that Andrew Lipton, the head of surveillance at Bear Stearns Asset Management—and a former Moody’s executive—was still positive. “I sat him down on Friday and asked how serious he thought the situation was. He calmly told me that the situation wasn’t going to be as bad as people are saying,” Tannin wrote. Tannin also wrote that Bear’s CDO analyst, Gyan Sinha, had issued an optimistic report about subprime mortgages in February.
Denial seemed to be rampant at Bear Stearns. On March 1, two Bear analysts upgraded New Century’s stock. The stock of Bear itself hit an all-time high of $172.69 on January 17, 2007; a few months earlier, S&P had upgraded the firm’s credit rating to A+ (one notch up from a single-A), partly due to the strength of its mortgage business. Thanks largely to Cioffi’s friendship with Warren Spector, Bear itself put $25 million into the funds in late April 2007.
And even as Cioffi and Tannin began to recognize that a triple-A rating might not mean anything, they clung to the belief that their triple-As were different. Van Solkema testified that after running his model, he still thought the funds would survive. On an April 25 conference call, Tannin told investors, “[I]t is really a matter of whether one believes that careful credit analysis makes a difference, or whether you think that this is just one big disaster. And there’s no basis for thinking this is one big disaster.”
By then, though, big investors were warning that they were thinking about withdrawing their money, and the funds’ repo counterparties were starting to demand yet more collateral. In fact, on March 11, Ray McGarrigal, who worked on the funds with Cioffi and Tannin, wrote to the others, “I would move as much away from Goldman as possible. I do not wish to trade them in any fashion at this point. I would highly recommend moving any and all positions away from them as soon as is feasible and only be a net seller to them going forward.” The Goldman “get closer to home” meeting in David Viniar’s office had taken place back in December, and the firm was aggressively