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Alan "Ace" Greenberg spent 15 years running the investment bank Bear Stearns before being pushed out by Jimmy Cayne in 1993. In his memoir Memos from the Chairman, Greenberg recounts some of the wise -- and often idiosyncratic -- platitudes he shared with the Bear family during his time at the top.
Humans tend to get sloppy when making money is easy... Bear Stearns will NOT get caught up in the hysterical optimism, and the people at Bear Stearns will NOT get careless or conceited.
Saturday is the five-year anniversary of the fall of the 85-year-old institution and its purchase by JPMorgan Chase (NYSE:JPM). While it wasn't the first failure of the financial crisis, it was one that let Wall Street know that the threat of cataclysm was starting to hit close to home.
Main Streeters may indeed think of the bankers at Bear and the other Wall Street firms as crooks. But the less cynical can also take the label "con men" at its face value -- that is, confidence men. And banks are, of course, nothing if not a confidence operation.
Even for staid, conservative banks like Wells Fargo (NYSE:WFC), confidence is an essential ingredient. At the end of 2012, Wells had loaned out around $800 billion of its $1 trillion in deposits and had a tangible equity cushion of just over $100 billion. If depositors lost confidence in Wells and rushed to pull out their deposits all at once, there's no way the bank could meet the demands.
But the FDIC stands behind much of the deposits at banks like Wells. With a confidence booster like that, there's no reason for depositors to flee en masse.
The same doesn't hold for investment banks like Bear. While they finance themselves in part with short- and long-term debt, a significant amount of their financing -- particularly at that time -- comes from repurchase agreements ("repos").
In the case of repo loans, the "depositors" are large financial institutions that agree to provide financing in exchange for holding some of the bank's assets as collateral. Functionally, Bear would sell an asset to the other party and agree to repurchase the same asset at a later date -- thus, "repurchase" agreement.
That "later date" on many repos is 24 hours later, meaning that repo lenders can pull their money nearly as fast as a vanilla-bank depositor.
Confidence in the safety of these repo loans is helped by the fact that they're collateralized. However, if that confidence starts to wane, the wheels can come off very quickly. At first it may be small. The lender may charge a higher rate for the transaction. Or they may demand a bigger "haircut" -- provide, say, a loan worth 90% of the value of the collateral instead of 93%. But as the deterioration of confidence snowballs, the lender may close the repo line altogether.
At that point, it's a scramble to sell assets to repay the loan. In an isolated instance, for a company with plenty of cash, that may not be a big deal. For a highly leveraged company that's the subject of rumors about liquidity and asset quality, however, it can trigger asset fire-sales, further loss of financing, and a speedy death spiral.
For the quarter ending in February 2008, just over two weeks before the company's fire-sale curtain call, Bear Stearns reported a bottom-line profit of $110 million. But at the same time the company was leveraged to nosebleed levels -- 34-to-1, to be precise -- and had nearly $100 billion of its financing coming from repo lines.
At some point in early 2008, the facts started to matter little. Bear was bleeding and vulnerable. Not only was there money to be lost for the counterparties on the other end of its loans, but there was money to be made for those actively betting against the bank.
The Federal Reserve and other regulators later came to the rescue, backstopping Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS). But it all came too late for Bear. Blood was in the water, and the sharks were circling.
Confidence evaporated, and with it, any chance that the bank could survive.