All the Devils Are Here [213]
But $13 billion was a drop in the ocean for Fannie and Freddie. By 2008, the two companies held a total $84 billion in capital—less than 2 percent of what was, by that point, a combined $5.3 trillion in mortgages they owned or guaranteed. Even more than the banks, Fannie and Freddie could not afford major write-downs. There was absolutely no margin for error.
Yet Fannie and Freddie were taking write-downs. In February 2008, the GSEs announced their 2007 earnings: both lost money—$2.1 billion in the case of Fannie Mae, while Freddie Mac lost $3.1 billion, its first annual loss ever. The reason was deteriorating mortgages. Yet at the same time, they were taking on more and more risk—because nobody else could, or would. By early 2008, Fannie and Freddie were buying four out of every five U.S. mortgages, double their market share from two years earlier. In mid-February, President Bush signed a law that included a provision to raise the size of the jumbo mortgages Fannie and Freddie could buy, from $417,000 to $729,750 in high-cost areas—a stunning, unnecessary increase that was supported by both Democratic Speaker of the House Nancy Pelosi and Republican John Boehner, the House minority leader. (Paulson opposed the increase.)23 It was insanity. Jim Lockhart, a Yale fraternity buddy of Bush’s who had become the chairman of OFHEO, told Congress, “The GSEs have become the dominant funding mechanism for the entire mortgage system in these troubling times. In doing so, they have been reducing risks in the market, but concentrating mortgage risks on themselves.”
It was Bear Stearns that went first, in March of 2008.
If the failure of the two Bear Stearns hedge funds in July 2007 served as a kind of prologue to the financial crisis—a taste of what was to come—then the collapse of Bear Stearns itself was a rousing act one. There wasn’t much substantive difference between the two failures except in scale. Bear Stearns was awash in mortgage-backed securities of all sorts. It used them as collateral for its repo transactions. It had them on its balance sheet. It traded in CDOs and CDOs squared. Because it was both the smallest of the five major American investment banks and the most obviously exposed to mortgage risk, the market started asking questions about the value of its collateral. The answers didn’t really matter; the questions were all it took to kill the firm.
“The interdependent relationships between banks and brokerages and institutional investors strike most laymen as impenetrably complex, but a simple ingredient lubricates the engine: trust,” wrote Alan “Ace” Greenberg, former Bear Stearns chairman, in a memoir co-authored by Mark Singer. “Without reciprocal trust between the parties to any securities transaction, the money stops. Doubt fills the vacuum, and credit and liquidity are the chief casualties. Bad news, whether it derives from false rumor or verifiable fact, then has an alarming capacity to become contagious and self-perpetuating.”
Which is exactly what happened. On Monday, March 10—the beginning of its last week as an independent firm—Bear Stearns’s stock stood at around $70 a share. It had bank financing of about $120 billion and $18 billion in cash. But, recalled Greenberg, “some of our counterparties were expressing skepticism about our liquidity and were wary of dealing with us.” On Tuesday, Christopher Cox, the chairman of the SEC, told the press, “We have a good deal of comfort about the capital cushions at these firms.” It didn’t help. Bear’s cash fell to $15 billion as hedge funds began pulling their money out. One hedge fund withdrew all the securities it kept at Bear—“tens of billions of dollars’ worth,” wrote Greenberg. “Before the trading day closed, the Dutch bank Rabobank Group had told us that they weren’t renewing a $500 million loan due to mature at the end of the week and probably wouldn’t renew a $2 billion line of credit the following week.” On Wednesday, CEO Alan Schwartz went on CNBC, where he denied that Bear Stearns was having liquidity problems. If anything, that only made matters