All the Devils Are Here [182]
On June 11, Cioffi wrote to Tannin and George Buxton, who worked in Bear’s private client services, “Right now we’re fighting the Battle of the Bulge with our repo lenders. So far so good but it is very tough and stressful...” He was trying to convince the lenders that if they grabbed the collateral and tried to sell it into a shaky market, everyone would get hurt. After all, the Bear team argued, they all had the same positions, and panicked selling would turn theoretical declines in the market value of the securities into hard cash losses.
The men were also deeply frustrated. While Wall Street’s repo desks were demanding money, the trading desks at the same firms were refusing to reflect the value of the Bear team’s short positions. They were being squeezed from both sides. “The pressure was tremendous,” says one person who was there. “And everyone was scared.” On June 14, Bear held a meeting with the repo lenders to try to cut deals. At that meeting, according to House of Cards, William Cohan’s book about the fall of Bear Stearns, the Bear executives gave a presentation showing the exposure the rest of the Street had to the firm’s hedge funds. Overall, sixteen Wall Street firms had lent the funds $11.1 billion in the repo market. Among them were Citi, with nearly $1.9 billion outstanding, and Merrill Lynch, with $1.46 billion outstanding.
A few days later, one firm broke from the pack. Merrill Lynch seized $850 million in collateral, which it said it would sell on the open market. Any chance of an orderly wind-down of the funds was now gone. It was a classic run on a bank—except that those racing to pull their money out weren’t depositors. They were bankers.
When Merrill tried to sell the assets, it discovered that Cioffi had been right: nobody wanted to buy the collateral, at least not at the price that Merrill was valuing the securities. The firm largely abandoned the effort. J.P. Morgan and Deutsche Bank, which had followed Merrill’s lead, canceled their plans to sell assets, too. Here was the moment of truth: triple-A tranches of CDOs stuffed with subprime mortgages simply weren’t salable, not at a hundred cents on the dollar, and maybe not at any price. In fact, mortgage-backed securities weren’t salable, period. “All these guys grabbed for Bear’s mortgage-backed securities thinking they’d be able to write them up, not realizing they’d have to write them down,” says one person who was there. “All of a sudden, it became an internal witch hunt everywhere. How much of this do we own?”
As Goldman’s Josh Birnbaum later wrote, “The BSAM situation changed everything. I felt that this mark-to-market event for CDO risk would begin a further unraveling in mortgage credit.” Goldman, which had covered its short position, quickly began to rebuild it.
Although Bear itself did eventually put up $1.6 billion to try to save the High Grade fund, it wasn’t enough. On July 31, 2007, both funds filed for bankruptcy.
But Wall Street was still too blind to see that the line between the Bear hedge funds—highly leveraged entities dependent on the repo market with big exposure to toxic subprime mortgages—and the firms themselves—highly leveraged entities dependent on the repo market with big exposure to toxic subprime mortgages—was a very thin one indeed. That lesson was yet to come.
As the prices on triple-A-rated notes plunged in the early summer of 2007, the rating agencies continued to insist to the outside world that everything was just fine. At the beginning of the year, S&P had predicted that 2007 would bring