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the ABX index, all but accused Bear Stearns of seeking to manipulate the market. The seller of credit protection (perhaps Bear Stearns) on mortgage-backed securities, the other side of Mr. Paulson’s trade, could use its investment in residual or servicing rights on a mortgage-backed security to buy out and revive defaulted loans.The protection seller could buy a loan at par, instead of its deeply discounted price, and it would artificially prop up the prices of the trust investments and the underlying securities that made up the ABX and other indexes. Since a protection seller in a lower-rated index has a leveraged position, for a relatively small investment it would gain (or protect) tens of times what it paid out. John Paulson maintained that Bear Stearns was trying to avoid making billions of dollars in payments on credit default swaps. “We were shocked,” said Michael Waldorf, a vice president at Paulson’s firm: He said Bear Stearns introduced language that “would try to give cover to market manipulation.”26 In March 2008, less than one year later, many market participants remembered Paulson’s concerns when Bloomberg revealed that assets backing the ABX indexes appeared wildly overrated and credit default protection sellers (perhaps Bear Stearns?) would possibly have to come up with more collateral to back these trades.

Bear Stearns withdrew its request to ISDA for additional clarification, claiming it now realized that market participants understood its right to modify loans, but the damage was done.With voices stentorian, the hedge funds had given ISDA and the entire subprime market a vote of no confidence in the motivations of Bear Stearns Companies, Inc.

Warren Buffett had admonished his managers not to do anything they wouldn’t want to read about in the newspapers. Bear Stearns and its affiliates were seeing themselves in the press constantly—and not in a good way.

On June 6, 2007, Bear Stearns Asset Management froze redemptions on the approximately $600 million Enhanced Leveraged fund that had been founded the previous August, whereas up until then, investors were accustomed to withdrawing funds with 30-days notice. Its value had fallen 23 percent from the start of the year, and by June 7, BSAM restated its May 15 statement of April 2007 losses from a 6.75 percent loss to a loss of 18.97 percent. BSAM had little choice. Bear Stearns’s lenders: Citigroup Inc., J.P. Morgan Chase & Co., Merrill Lynch & Co., Morgan Stanley, Goldman Sachs Group, Inc., Barclays PLC, Dresdner Kleinwort, Deutsche Bank, and others had begun marking down the value of the funds’ assets and demanded more collateral; the banks made margin calls.The Enhanced Leverage fund faced $145 million of margin calls as of June 8, and the less-leveraged fund faced $63 million of its own margin calls.27

Bear Stearns asked for forbearance. When that didn’t work, BSAM met with the funds’ lenders, and asked for a moratorium on margin calls and a return of derivative collateral back to the fund. In effect it was asking for more leverage and an extended loan.

The meeting was punctuated with a breathtakingly arrogant flourish when BSAM distributed handouts ending with what it needed from the funds’ counterparties. The creditors were not rookies. They had expected BSAM to announce some sort of solution worked out in concert with its parent, Bear Stearns. Of all of the hedge fund managers in the world, the last thing they expected was that Bear Stearns Asset Management would ask them to bend over and think of Ben Bernanke.

BSAM and Bear Stearns Companies, Inc. seemed unaware they had just made an enormous tactical error. They must have been walking around in a dissociative fugue. Bear Stearns Asset Management wanted new conditions from lenders? BSAM was worried about the prices its creditors might put on the assets it managed? The mood of at least one of the funds’ creditors had just shifted from “let’s see what they’ve come up with” to “#*?! those guys.”

In 1994, Bear Stearns had been very quick—some said much too quick—off the mark to seize and liquidate