• Choose a category
• All
• Classic-Fiction

Kevin O’Leary, the managing director of Boston’s Tibbar Capital, was in St Bart’s with other hedge fund managers. The hedge fund managers did not mess around. O’Leary said they felt Bear Stearns might be forced into bankruptcy, and it was not worth the risk of losing a part of their cash by leaving it tied up in margin accounts at Bear Stearns. They simply pushed the button and boom, billions moved out of their trading accounts and into custodian accounts, so Bear Stearns was no longer able to borrow against these assets.43 That made quite a dent in Schwartz’s cash and unpledged collateral at the subsidiaries.44

The CEO of a small New York investment bank said he was concerned about his clearing account, given that Bear Stearns’ sources of liquidity were turning their backs. He explored other alternatives. He was relieved after Jamie Dimon announced his bid for Bear Stearns a few days later and told me: “It doesn’t get better than a guarantee from JPMorgan Chase and the Fed.”

On Friday March 14, 2008, there was still hope for Bear Stearns; it was not yet dead. The Fed announced a stop-gap loan (Bear Stearns later found out it was only good for a day), but since its lending program was not yet operational, it agreed to accept collateral via JPMorgan Chase. It was odd. If JPMorgan Chase had confidence in Bear Stearns’s collateral, it could have accepted the collateral itself (on a recourse basis) and made the loan to Bear Stearns. JPMorgan Chase has access to the Fed and could meet its own liquidity needs there.The announcement made it seem as if JPMorgan Chase did not trust the value of the assets. The market will price the assets, but you may not like the price.

That day, I discussed this move both Bloomberg Television and Canada’s business news network, BNN. The market still questioned the survival of Bear Stearns, but Lehman Brothers was able to get financing. There seemed to be a view that “a firm is only as solvent as people think it is.” I pointed out that is not true. If you are liquid, solvent, have a positive cash flow and you have no leverage—you do not have to borrow money—and it does not matter what the market thinks about you.

If you are solvent but not liquid (you need cash but the value of your assets make you more than good for it) and you can prove you are solvent, you tend to get the liquidity, since people will lend you money. But if you are highly leveraged, it only takes a small negative change in the perception of the value of your collateral for you to be in trouble.

The investment banks were playing a very dangerous game, and they were losing that game. They could not prove they were solvent (if they were). No one trusted their own pricing, and there was no transparency.

If no one can figure out if an investment bank is solvent, short-term financing disappears. In fact, the investment bank itself may not know whether or not it is solvent.

If you lend a brother-in-law $100,000 for the down payment on a $1 million home, and the price of the home goes to $1.1 million, you might be willing to give him a short-term loan of $1,000 knowing he’s temporarily short of cash, but he’s good for it. If you know, however, that the price of all of the homes in his neighborhood are down to $900,000, you know he will be lucky to pay you any of the money you originally lent him.You might say no to an additional short-term loan of $1,000.

Warren Buffett and Charlie Munger avoid leverage so that they are not at the mercy of the manic depressive Mr. Market. By supplying investment banks with liquidity, the Fed introduced huge moral hazard. The Fed rewarded those who brought down the housing market.

I told Bloomberg: The $200 billion lending program “is really bad for the dollar; the Fed is now practicing junk economics.”The Fed agreed to accept ersatz AAA rated paper in exchange for treasuries, and the rating agencies now had further incentive not to downgrade these securities. The problem is lack of trust in the underlying collateral.