The former chairman and chief executive of Bear Stearns conceded on Wednesday that the failed investment bank had taken on too much risk.
That was the business. That was, really, industry practice. In retrospect, in hindsight, I would say leverage was too high, a weary-sounding James Cayne told a hearing of the Financial Crisis Inquiry Commission.
Cayne's admission under questioning came after he and other former Bear executives had testified that market rumors and a classic run on the bank were to blame for the firm's collapse in March of 2008 and fire-sale to JPMorgan Chase & Co.
Commission Chairman Phil Angelides said Bear Stearns seemed to have taken on an extraordinary level of risk involving high leverage, a concentration in mortgage-backed securities and short-term funding of its operations.
There's a form of financial Russian roulette that Bear Stearns was playing along with other investment banks, said Angelides.
The congressionally-appointed commission is charged with chronicling the causes of the worst financial crisis since the 1930s and has been holding a series of hearings. It is due to deliver a report to lawmakers and White House by December 15.
Congress is already working on a bill to overhaul financial regulation but Angelides has said there will still be scope for further reforms, including possible changes to mortgage financing.
Cayne's admission over risk-taking was a departure from the general thrust of testimony by himself and four other Bear Stearns executives. They said the firm's collapse was beyond their control: a tsunami of rumors and loss of confidence that overwhelmed its risk management models and drained liquidity in a matter of days.
The market's loss of confidence, even though it was unjustified and irrational, became a self-fulfilling prophecy, Cayne said.
Similar market fears later in 2008 led to the bankruptcy of Lehman Brothers and the reorganization of other major investment banks.
Cayne showed little emotion at the hearing, giving no hint of his reputation for profane and hot-headed outbursts during his near 15-year time at the helm of the company before stepping down in January of 2008.
Cayne and the other former Bear Stearns executives were grilled over whether the investment bank's leverage level and lack of foresight on a looming collapse of the U.S. mortgage market made it the first major victim of the financial crisis.
Angelides said by the end of 2007, Bear was leveraged 38-to-one, when measured in terms of tangible assets versus tangible common equity.
About a month before its collapse, Bear had about $12.5 billion in loans with either deficient or no documentation -- more than the firm's total equity, said Angelides.
It seems like there were a lot of warnings signs, a lot of red and yellow lights going off, Angelides said.
Paul Friedman, Bear's former senior managing director, said the loss of confidence in the firm was unwarranted given the firm's strong capital position and substantial liquidity.
Samuel Molinaro, Bear's former chief financial officer, told the commission that fears, rumors and innuendo in March 2008 resulted in irrational behavior that caused a quintessential run on the bank at Bear Stearns.
Bill Thomas, vice chairman of the financial commission, did not buy the former executives' arguments.
How could you folks, as sophisticated as you were, with the models that everyone felt comfortable with, believe you were the victim... of unsubstantiated rumors, fears and innuendo -- that your colleagues did you in? Thomas asked.
Cayne's successor as Bear Stearns CEO, Alan Schwartz, laid part of the blame on credit ratings agencies, which gave top-tier ratings to mortgage securities that Bear Stearns sold and used as collateral. When it became clear that the underlying securities were too risky to deserve their ratings, Bear's market counterparties pulled back.
The rating agencies were part of the problem. The biggest part of the problem was the reliance on the rating agencies without any other measure of transparency, Schwartz said.
HELP TOO LATE
Bear's fall was swift in March of 2008. Despite an emergency line of credit from the Federal Reserve, it became clear within days the firm could not survive on its own, and the Federal Reserve and U.S. Treasury scrambled to arrange a sale to JPMorgan for the eventual price of $10 per share.
Cayne, who took criticism over reports that he attended a bridge tournament in late 2007 as two of the firm's hedge funds failed, said the Fed's decision in March of 2008 to open its discount lending window to investment banks came 45 minutes too late to save Bear Stearns.
He described the sale to JPMorgan in cataclysmic terms. The outcome, I believe, was the best that could be anticipated when the world ended -- for a lot of us.
In September 2008, Lehman filed for bankruptcy and the remaining large investment banks -- Merrill Lynch, Goldman Sachs and Morgan Stanley -- sought safety in the form of federal oversight. Merrill was bought by Bank of America. Goldman and Morgan became bank holding companies and are now subject to much stricter capital requirements and regulation.
All five investment banks were loosely supervised by the Securities and Exchange Commission for capital and liquidity requirements under the agency's voluntary so-called Consolidated Supervised Entity program.
SEC Inspector General David Kotz said in prepared testimony for the crisis commission that Bear Stearns was a highly leveraged firm with less capital and less diversification than other investment banks.
He criticized the SEC for becoming aware of numerous potential red flags about Bear Stearns' risk-taking but not taking action.
The SEC monitoring program has since been dismantled.
(Reporting by David Lawder, Rachelle Younglai, Karey Wutkowski, additional reporting by Jonathan Stempel; Editing by Tim Dobbyn)