Monday, May 11, 2009

Determining the Origins of A Dreadful Fall....

...Once upon a time there was an old lady, an ancient lady, bent over from age and the cares of the world. And one day, this frail, elderly woman found herself being chased by seven violently angry men. In an effort to escape the violence of the rage-filled men, she bounded up a very steep hill with surprising agility, for one so old and decrepit.

The seven angry men chased after the bent, ancient woman because they hated her – enraged because she'd given an apple to their housekeeper, a gift that was perceived by the men to be a terrible threat to the woman who cooked and cleaned for them.

So the ancient crone found herself on top of a cliff, fighting for her very life. As she worked to push a boulder down to crush the men and save herself, fate intervened - a bolt of lightening hit the cliff where she stood, toppling the ancient crone off the cliff.

Lightening struck; the old lady fell a dreadful fall to her death; the seven angry men rejoiced in her demise.

Interesting, isn't it, to start the story of Snow White and the Seven Dwarves well after the story actually begins? When you pick up the narrative here, when the old lady is being chased by seven men, we get to eliminate some key plot details - first and foremost, that the crone is Snow White's insanely jealous wicked stepmother whose offer of the apple to Snow White was not a gift. This isn't really a story about a harmless old lady being chased by seven angry men; it's the tale of a wicked woman's attempt to rid the world of a young woman's beauty forever.

And the seven enraged men - of course, they're the dwarves who want to rid the world of the evil stepmother who's done her best to kill their young and pretty housekeeper.

(Haven't seen the Disney film in forever - so I relied on the Wikipedia description of the plot, FYI....)

I offer the story to point out the confusion that can come when you start telling a story several plot points after the story's true beginning. I feel like we're beginning to do this now with the some of narratives I'm reading about the economic crisis.

There was one such narrative published last weekend in the Wall Street Journal - "Inside the Fall" - which chronicles the last 72 hours of Bear Stearns as an independent entity.

Yes, yes - I understand that the story focuses on the end of Bear Stearns - the last 72 hours of its existence, but it is puzzling, I think, to pick up the Bear Stearns narrative precisely at the point of its doom, when it was rescued from bankruptcy by a deal with JP Morgan Chase. As reporter Kate Kelly notes:

"The firm spiraled from being healthy to practically insolvent in about 72 hours.

The meltdown began in earnest the evening of Thursday, March 13, 2008, when Bear executives made a shocking discovery: They were nearly out of cash."

And so the story begins....

Beginning the story in this way, however, leaves out the all important detail of how this firm found itself so woefully undercapitalized. How can healthy firms become insolvent in 72 hours?

Bear Stearns insider Alan "Ace" Greenberg addressed this in a Frontline documentary called "Inside the Meltdown." Prior to the crash, Greenberg says, investment banking firms were companies that "risk[ed] their capital to help their clients accomplish certain things -- give them bridge loans, buy their securities, hold them for a while, resell them."

According to Greenberg, this way of doing business is now gone forever – "because it's been proven without a question of a doubt in the last year that a rumor can put any of these firms at peril. You certainly saw it with us."

The August 2008 issue of Vanity Fair also addressed the collapse of Bear Stearns. In this story, writer Bryan Burrough also points the finger of blame at the "rumors" that killed the Bear:

"The fall of Bear Stearns wasn’t just another financial collapse. There has never been anything on Wall Street to compare to it: a “run” on a major investment bank, caused in large part not by a criminal indictment or some mammoth quarterly loss but by rumor and innuendo that, as best one can tell, had little basis in fact. Bear had endured more than its share of self-inflicted wounds in the previous year, but there was no reason it had to die that week in March."

So in the narratives being written about the collapse of Bear Stearns, what figures prominently in these stories is a financial system so rickety that the whisper of a rumor will cause a healthy company to topple for no reason.

But wait a minute. The Vanity Fair article also talks about some internal issues within Bear Stearns that might have exacerbated the firm's vulnerability to rumors:

"Everything went swimmingly, in fact, until poor Ralph Cioffi ran into trouble.

"Cioffi, 52, was a Bear lifer, a wisecracking salesman who commuted to Midtown from Tenafly, New Jersey, to oversee two hedge funds at Bear Stearns Asset Management, an affiliate known as B.S.A.M. His main fund, the High-Grade Structured Credit Strategies fund, plowed investor cash into complex derivatives backed by home mortgages. For years he was spectacularly profitable, posting average monthly gains of one percent or more. But as the housing market turned down in late 2006, his returns began to even out. Like many a Wall Street gambler before him, Cioffi decided to double-down, creating a second fund. Whereas the first borrowed, or “leveraged,” as much as 35 times its available money to trade, the new fund would borrow an astounding 100 times its cash.

"It blew up in his face."

Then the story goes on to mention the billions in toxic waste Cioffi had accumulated in those two Bear Stearn funds that he ran. And it talks about how Merrill Lynch confiscated Bear's collateral, an "unusual move," apparently. And it notes that these two funds managed by Cioffi ended up in bankruptcy. And it reminds us that back in 2007, Bear Stearns was just one of many financial firms beset with issues stemming from the mortgage-related losses.

And, oh yeah, before the rumors swirled about the insolvency of Bear Stearns in March of 2008, people were openly discussing the federal investigations into the collapse of Cioffi's hedge funds.

All that said, apparently in the narrative of the Bear Stearns collapse, Bear Stearns was a healthy company that didn't deserve the rumors that killed it.


The fall of Bear Stearns gave us a foreshadowing of the greater fall to come in September. And there are several ways to look at the story of the 2008 collapse of our economy. The true beginning of the story about the Fall of 2008 can take us back to the development of a financial system so frail the softest whisper of a rumor will cause a healthy firm to collapse in just 72 hours.

Or it takes us to a business culture that is so obsessively focused on raking in the dough that it forgets some common-sense business rules that are foundational within any economic system:

1) Debt doesn't magically disappear.
2) Debt isn't a very secure investment - especially when it belongs to people given loans who don't have a hope in hell of paying them back.
3) Gambling is not an investment "strategy" that will be successful over the long haul.
4) Massively over-leveraging certain funds can lead to whispers of "liquidity problems" that can topple a financial firm overnight.
5) Debt can drag down the economy.

Another version of the story of the Fall could take us to a Wall Street culture so virulently focused on winning that certain people in certain firms would spread blatantly false rumors about a competitor to destroy it - not realizing that the rumors that then could take down the entire economy.

(But hey - Goldman Sachs is having a profitable year, thus far, right? So all is well with the world....)

Whatever narrative you choose, what is clear is that in 2008, we were forced to run up a steep cliff in an attempt to protect ourselves from catastrophe - for reasons that are murky at best - but in doing so, in running up this cliff, we became vulnerable to lightening strikes and terrible, deadly falls.

Whether it was the result of rumor, the result of evil competitors whispering lies into the ears of CNBC reporters, or the result of the fact that all the financial firms on Wall Street decided to turn bad debt into investment instruments that made them money as they toxified their books, one thing is clear.

The US economy fell off a cliff in 2008.

To understand the reasons why - so that we can prevent such a catastrophe from ever happening again - we will need to discover the true beginning of the story to determine the true causes of the fall.

Otherwise, we can end up feeling sympathy for the devil who offered up poisoned apples that killed the economy - instead of making sure he can't offer up such deadly fruit ever again.

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