House Of Cards

This is a much better book about Bear Stearns than "Street Fighters" which I previously commented on (6/5/09).


House of Cards (A Tale Of Hubris and Wretched Excess On Wall Street), by William D. Cohan, Doubleday, 2009, 450 Pages.

On March 5, 2008, at 10:15 A.M., a hedge fund manager in Florida wrote a post on his investing advice Web site that included a startling statement about Bear Stearns & Co., the nation’s fifth-largest investment bank: "In my book, they are insolvent."

This seemed a bold and risky statement. Bear Stearns was about to announce profits of $115 million for the first quarter of 2008, had $17.3 billion in cash on hand, and, as the company incessantly boasted, had been an extremely profitable enterprise in the eighty-five years since its founding.

Ten days later, Bear Stearns no longer existed, and the financial meltdown of 2008 had begun. Bear Stearns was absorbed into JPMorganChase at $2 per share which was then raised to $10 per share because of a colossal blunder by the JPMorgan lawyers. A year earlier the stock had traded as high as $172.69.

How this happened – and why – is the subject of William D. Cohan’s book. He explains how a combination of risky bets, corporate political infighting, lax government regulations, rating agencies paid by those they are called on to rate, warped pay incentives, and truly bad decision-making wrought havoc on the world financial system. The Bear Stearns leader, 74 year old Jimmy Cayne, provides the comedy. He is off to a Bridge tournament during the middle of the meltdown. At the tournament he relaxes in the men’s room smoking pot with a woman companion. And much, much more; you cannot make this stuff up. Apparently he was out of his $140 Cuban cigars and had to resort to his stash of pot.

Cohan’s beginning chapters offer a detailed account of those ten days in March as Bear Stearns struggled to contain the series of events that would doom the firm. He then follows these chapters with the entire history of Bear Stearns which I found enlightening, particularly as on 6/5 ago I read "Street Fighters" on Bear Stearns which only chronicled the ten days.

House of Cards is a chilling tale about greed, arrogance, and stupidity in the financial world, and the consequences for all of us. I found little reason to believe that these traits are only confined to a few financial institutions.

My notes:
Pg. 4: Unlike a bank, which is able to use the cash from its depositors to fund most of its operations, financial institutions such as Lehmann Brothers and Bear Stearns had no depositors’ money to use. Instead they funded their operations in a few ways: either by occasionally issuing long-term securities, such as debt or preferred stock, or most often by obtaining short-term, often overnight, borrowings in the unsecured commercial paper market or in the overnight “repo” market, where the borrowings are secured by the various securities and other assets on their balance sheets. These fairly routine borrowings have been repeated day after day for some thirty years and worked splendidly—until there was perceived to be a problem with either the securities or the institutions backing them up, and then the funding evaporated like rain in the Sahara. Every one of the investment banks funded their business in this way to varying degrees, and every one of them was always just twenty-four hours away from a funding crisis. On the other hand, Commercial banks could borrow from the Fed’s discount window, a privilege of long standing that came with the cost of giving the Fed direct oversight over them and their capital requirements (which were generally quite high as compared to pure investment banks). For instance, the ratio of assets to equity capital in Investment banks often approached 50:1; Commercial banks, by contrast, had leverage ratios of around 10:1.

Pg. 75: During the ten day meltdown, Meredith Whitney, the Oppenheimer research analyst, wrote “The problem that Bear Stearns and other financials face is a great unwind of leverage. A company is only as solvent as the perception of its solvency. When a company that is leveraged over 30:1 (Bear Stearns was actually at 50:1) faces a crisis of liquidity and confidence of creditworthiness, that company will be unable to leverage its collateral and its leverage will be forced down to 1:1.
List of some Bear Stearns transgressions:
• Only member of the Wall Street fraternity not to participate in the billion-dollar, Fed-orchestrated 1998 bailout of LTCM.
• Bear Stearns willingness to provide its balance sheet and imprimatur to bucket –shop brokerages like Stratton Oakmont for with the firm was fined #438 milion in 1996 and its head of clearing fired.
• Being one of the engines of the mortgage securities business and the originator of subprime mortgages.
• The 2007 collapse of two Bear Stearns hedge funds that had cost investors $1.6 billion in losses.
• Bear Stearns roles in both the mutual-fund scandal and the scandal involving the exchange of favorable research coverage for investment banking business.

Pg. 195: In the 1970’s the legal structure of banking and accounting firms made a very important change from shared-liability partnerships to corporate structures that spread liability from the partners according to their capital contributions to shareholders based on their ownership. The holy grail of investment banking became increasing short-term profits and short-term bonuses at the expense of the long-term health of the firm and its shareholders.