WEBVTT 00:00:00.000 --> 00:00:02.520 Okay, let's start with a visual. It is Friday, 00:00:02.680 --> 00:00:05.700 March 14th, 2008. Right. And you are standing 00:00:05.700 --> 00:00:09.480 in the lobby of 383 Madison Avenue in Manhattan. 00:00:09.939 --> 00:00:13.990 It's this stunning building. an octagon, all 00:00:13.990 --> 00:00:16.890 glass and stone. It's designed to look like a 00:00:16.890 --> 00:00:19.850 cut diamond. A real monument. But the scene inside 00:00:19.850 --> 00:00:22.329 is, I mean, it's the total opposite of that. 00:00:22.429 --> 00:00:24.649 It looks like a funeral. Yeah, completely. You've 00:00:24.649 --> 00:00:27.149 got employees just flooding the elevators and 00:00:27.149 --> 00:00:29.510 they're all carrying cardboard boxes. And these 00:00:29.510 --> 00:00:31.870 aren't work files. This is personal stuff. You 00:00:31.870 --> 00:00:34.329 know, pictures of their kids, gym clothes, the 00:00:34.329 --> 00:00:36.630 little potted plant from their desk. It is the 00:00:36.630 --> 00:00:39.210 visual language of a bank run. It's a scene you 00:00:39.210 --> 00:00:40.969 usually, you know, you associate it with those 00:00:40.969 --> 00:00:43.509 old grainy black and white. photos from 1929. 00:00:43.770 --> 00:00:45.770 Men in hats lining up outside a bank that's just 00:00:45.770 --> 00:00:48.109 closed its door. Exactly. But this was 2008. 00:00:48.270 --> 00:00:50.469 And these people weren't lining up for cash from 00:00:50.469 --> 00:00:52.909 a vault. They were watching their entire net 00:00:52.909 --> 00:00:56.270 worth, everything, just evaporate in real time 00:00:56.270 --> 00:00:58.850 on their Bloomberg terminals. And that is exactly 00:00:58.850 --> 00:01:00.869 where we have to start this deep dive, because 00:01:00.869 --> 00:01:03.289 the speed of this collapse is what makes it so, 00:01:03.289 --> 00:01:06.590 so unique and, frankly, just terrifying. The 00:01:06.590 --> 00:01:09.510 speed is everything. In January 2007, so just 00:01:09.510 --> 00:01:12.409 a year before this scene. Bear Stearns stock 00:01:12.409 --> 00:01:17.780 is trading at $172 a share. $172. It's the fifth 00:01:17.780 --> 00:01:19.959 largest investment bank in the entire United 00:01:19.959 --> 00:01:22.879 States. It's been around for 85 years. It survived 00:01:22.879 --> 00:01:25.439 the Great Depression, World War II, the dot -com 00:01:25.439 --> 00:01:28.120 bubble. I mean, this thing was a fortress. And 00:01:28.120 --> 00:01:30.239 it wasn't just surviving. It was, by all accounts, 00:01:30.379 --> 00:01:32.900 thriving. Fortune magazine had just named it 00:01:32.900 --> 00:01:36.060 the most admired securities firm. The most admired, 00:01:36.180 --> 00:01:38.920 which is just incredible irony. It's unbelievable. 00:01:39.359 --> 00:01:41.680 They were the envy of the street. They were known 00:01:41.680 --> 00:01:44.599 for being smarter, scrappier, you know, grittier 00:01:44.599 --> 00:01:46.939 than... anyone else out there. And yet, just 00:01:46.939 --> 00:01:50.939 about one year later, that $172 stock is being 00:01:50.939 --> 00:01:55.640 valued in a shotgun merger at $2. $2? Yeah. That 00:01:55.640 --> 00:01:58.560 is a 99 % wipeout. I mean, for all intents and 00:01:58.560 --> 00:02:01.819 purposes, it is zero. So today, we are not just 00:02:01.819 --> 00:02:03.519 going to recount the timeline of what happened. 00:02:03.579 --> 00:02:06.019 We are doing a deep dive into the actual mechanics 00:02:06.019 --> 00:02:08.400 of how a global institution can just dissolve 00:02:08.400 --> 00:02:12.689 and what... 72 hours. We pull the SEC filings. 00:02:12.689 --> 00:02:14.650 We have the bankruptcy reports, the internal 00:02:14.650 --> 00:02:17.310 emails. We really want to understand the specific 00:02:17.310 --> 00:02:22.389 financial instruments, the toxic sludge that 00:02:22.389 --> 00:02:25.150 just completely clogged the gears of this machine. 00:02:25.349 --> 00:02:27.750 We need to understand why. And we really need 00:02:27.750 --> 00:02:30.349 to answer the biggest question that still kind 00:02:30.349 --> 00:02:32.509 of hangs over all of this in financial circles, 00:02:32.590 --> 00:02:36.439 which is, was this a case of murder? Or was it 00:02:36.439 --> 00:02:40.099 suicide? Right. Was Bear Stearns killed by malicious 00:02:40.099 --> 00:02:42.620 rumors and these predatory short sellers, like 00:02:42.620 --> 00:02:45.060 some of their executives claimed? Or was the 00:02:45.060 --> 00:02:47.919 business model itself just fundamentally broken? 00:02:47.960 --> 00:02:50.340 Was it, you know, a machine designed to self 00:02:50.340 --> 00:02:52.520 -destruct? Let's get into it. But before we get 00:02:52.520 --> 00:02:54.419 to the panic, I think we have to understand who 00:02:54.419 --> 00:02:56.280 these people were. Because, you know, reading 00:02:56.280 --> 00:02:58.810 through the history here. Bear Stearns wasn't 00:02:58.810 --> 00:03:01.430 like a Goldman Sachs or a Morgan Stanley. They 00:03:01.430 --> 00:03:03.449 had a really different DNA. Completely different. 00:03:03.590 --> 00:03:05.210 Yeah, if you look at the history, Bear was always 00:03:05.210 --> 00:03:07.729 the outsider, the underdog. It was founded in 00:03:07.729 --> 00:03:10.889 1923 by Joseph Bear, Robert Stearns, and Harold 00:03:10.889 --> 00:03:13.210 Mayer. And they started with, what, half a million 00:03:13.210 --> 00:03:16.969 dollars? $500 ,000, which is decent money back 00:03:16.969 --> 00:03:19.590 then, about $9 .2 million today. But they were 00:03:19.590 --> 00:03:21.770 not what you'd call a white shoe firm. They didn't 00:03:21.770 --> 00:03:24.550 rely on, you know, Ivy League connections or 00:03:24.550 --> 00:03:27.009 family dynasties to get business. I saw this 00:03:27.009 --> 00:03:29.849 famous acronym in our notes associated with their 00:03:29.849 --> 00:03:35.129 hiring policy. PSD. PSD, yes. Poor, smart, and 00:03:35.129 --> 00:03:39.229 a deep desire to get rich. Wow. That was the 00:03:39.229 --> 00:03:40.849 internal motto. They didn't care if you went 00:03:40.849 --> 00:03:43.409 to Harvard or Yale. In fact, a lot of the time 00:03:43.409 --> 00:03:45.270 they actually preferred it if you didn't. They 00:03:45.270 --> 00:03:47.189 wanted street fighters. They wanted people who 00:03:47.189 --> 00:03:49.490 were hungry, who had a chip on their shoulder. 00:03:49.629 --> 00:03:51.930 And that seems absolutely crucial to understanding 00:03:51.930 --> 00:03:55.810 2008. If your entire culture is built on being 00:03:55.810 --> 00:03:58.110 the aggressive underdog, you're just naturally 00:03:58.110 --> 00:04:00.580 going to take risks that the... You know, the 00:04:00.580 --> 00:04:02.219 gentleman bankers down the street might have 00:04:02.219 --> 00:04:04.639 always trying to prove something always. Exactly. 00:04:04.780 --> 00:04:06.759 And they were famous for the phrase eating what 00:04:06.759 --> 00:04:08.919 they killed. It was this ruthless meritocracy. 00:04:09.199 --> 00:04:11.900 If you made money, you were a king. If you didn't, 00:04:11.900 --> 00:04:15.389 you were out the door. And this grit, this whole 00:04:15.389 --> 00:04:18.649 identity, it was forged in fire. I mean, a key 00:04:18.649 --> 00:04:21.189 data point here is the crash of 1929. Right. 00:04:21.310 --> 00:04:23.449 When the Great Depression hits, banks are just 00:04:23.449 --> 00:04:25.610 failing left and right. Unemployment is through 00:04:25.610 --> 00:04:29.050 the roof. But Bear Stearns, they famously did 00:04:29.050 --> 00:04:31.389 not lay off a single employee following that 00:04:31.389 --> 00:04:35.490 crash. Which has to create this mythos of invincibility. 00:04:36.269 --> 00:04:38.470 We are the survivors. The whole world can burn 00:04:38.470 --> 00:04:40.829 around us and we will still be here trading, 00:04:40.930 --> 00:04:42.930 making money. It breeds a very specific kind 00:04:42.930 --> 00:04:45.290 of arrogance, you know. So fast forward to the 00:04:45.290 --> 00:04:48.350 2000s. They are massive. They've got 15 ,500 00:04:48.350 --> 00:04:51.730 employees, offices in Beijing, Tokyo, London, 00:04:52.009 --> 00:04:55.709 Sao Paulo, a global behemoth. Right. But inside 00:04:55.709 --> 00:04:58.410 the walls of 383 Madison, they still operated 00:04:58.410 --> 00:05:00.129 with that same trader mentality. They were not 00:05:00.129 --> 00:05:02.009 looking at five year strategic plans. They were 00:05:02.009 --> 00:05:03.790 looking at the P &L at the end of the day. And 00:05:03.790 --> 00:05:05.490 looking at the breakdown of their business in 00:05:05.490 --> 00:05:07.870 the. mid -2000s, it's pretty clear that the biggest 00:05:07.870 --> 00:05:11.490 driver of that daily T &L was housing. Securitization. 00:05:11.629 --> 00:05:14.470 That was the engine, 100%. Okay, so we hear this 00:05:14.470 --> 00:05:17.290 word constantly, securitization. It sounds so 00:05:17.290 --> 00:05:19.449 boring, so technical, like filing paperwork. 00:05:19.750 --> 00:05:23.009 But based on these sources, it effectively turned 00:05:23.009 --> 00:05:26.810 the entire global financial system into a casino. 00:05:27.769 --> 00:05:29.990 We really need to unpack this properly. I know 00:05:29.990 --> 00:05:33.069 Louis Ranieri, who was at Bear Stearns, was a 00:05:33.069 --> 00:05:36.529 pioneer here. What did they actually build? OK, 00:05:36.629 --> 00:05:39.790 so historically, a mortgage was a simple relationship. 00:05:40.050 --> 00:05:41.870 You'd go to your local bank. You know, I think 00:05:41.870 --> 00:05:43.949 it's a wonderful life. You borrow money for a 00:05:43.949 --> 00:05:46.589 house and you pay that specific bank back for 00:05:46.589 --> 00:05:49.009 the next 30 years. And the bank holds that risk. 00:05:49.110 --> 00:05:51.490 If you default, the bank is the one that loses 00:05:51.490 --> 00:05:54.420 money. Exactly. Which is a huge constraint. It 00:05:54.420 --> 00:05:56.300 limits how many loans the bank can actually give 00:05:56.300 --> 00:05:59.240 out. Eventually, the vault is empty and they 00:05:59.240 --> 00:06:00.759 have to wait for people to pay them back before 00:06:00.759 --> 00:06:02.560 they can lend out any more money. It's slow. 00:06:02.879 --> 00:06:05.339 It's very slow. And Ranieri and the team at Bear 00:06:05.339 --> 00:06:07.379 Stearns, they realized that was inefficient. 00:06:07.720 --> 00:06:09.860 They realized that if you take thousands of these 00:06:09.860 --> 00:06:12.459 individual mortgages, you bundle them all together 00:06:12.459 --> 00:06:15.660 into one giant pool, and then you slice that 00:06:15.660 --> 00:06:18.240 pool into pieces, you can sell those pieces to 00:06:18.240 --> 00:06:20.519 investors as bonds. And these are mortgage -backed 00:06:20.519 --> 00:06:23.899 securities, or MBS. So the local bank now sells 00:06:23.899 --> 00:06:26.439 the loan to Bear Stearns. They get their cash 00:06:26.439 --> 00:06:28.600 back immediately and they can go lend it to the 00:06:28.600 --> 00:06:30.620 next guy. Right. And Bear Stearns packages it 00:06:30.620 --> 00:06:33.959 up and sells it to, say, a pension fund in Norway 00:06:33.959 --> 00:06:37.620 or an insurance company in Japan. The risk is 00:06:37.620 --> 00:06:39.680 transferred to the investor. In theory, it's 00:06:39.680 --> 00:06:41.680 brilliant. It lubricates the housing market. 00:06:41.740 --> 00:06:44.540 It spreads risk around the globe. It lowers interest 00:06:44.540 --> 00:06:47.839 rates for everyone. But then they added complexity. 00:06:48.199 --> 00:06:52.040 Then they created CDOs, collateralized debt obligations. 00:06:52.040 --> 00:06:54.660 The Frankenstein monster of finance. That's a 00:06:54.660 --> 00:06:57.339 good way to put it. Imagine taking the riskiest, 00:06:57.379 --> 00:07:00.620 junkiest slices of those mortgage bonds. So the 00:07:00.620 --> 00:07:03.459 loans to people with bad credit, no income verification, 00:07:03.939 --> 00:07:07.319 the so -called NINJA loans. No income, no job 00:07:07.319 --> 00:07:09.399 or assets. Right. And you bundle those together. 00:07:09.500 --> 00:07:11.439 Then you repackage them, slice them up again, 00:07:11.579 --> 00:07:14.180 and you pay the rating agencies, Moody's, S &P, 00:07:14.300 --> 00:07:17.220 to stamp the top slice with a AAA rating. Because 00:07:17.220 --> 00:07:19.379 the underlying theory was, well, what are the 00:07:19.379 --> 00:07:21.540 odds that everyone defaults at the exact same 00:07:21.540 --> 00:07:24.610 time? Precisely. Diversification was supposed 00:07:24.610 --> 00:07:27.930 to be the magic shield. They truly believed that 00:07:27.930 --> 00:07:30.509 if you had a loan from Florida and a loan from 00:07:30.509 --> 00:07:33.230 California and a loan from Ohio, they couldn't 00:07:33.230 --> 00:07:35.970 possibly all go bad at once. It seems so obvious 00:07:35.970 --> 00:07:38.689 in hindsight. Well, yeah. And for a while, Bear 00:07:38.689 --> 00:07:41.129 Stearns was the absolute king of this. They weren't 00:07:41.129 --> 00:07:43.129 just packaging these loans. They were vertically 00:07:43.129 --> 00:07:46.089 integrated. They owned the mortgage originators 00:07:46.089 --> 00:07:47.829 who were lending the money in the first place. 00:07:48.050 --> 00:07:50.529 They owned the trading desk that packaged the 00:07:50.529 --> 00:07:53.350 loans into bonds. owned the hedge funds that 00:07:53.350 --> 00:07:55.290 bought the bonds at the other end. So they were 00:07:55.290 --> 00:07:56.990 cooking the meal, serving the meal, and eating 00:07:56.990 --> 00:07:59.470 the meal. Yes. And that is where the trap was 00:07:59.470 --> 00:08:03.449 set. Because by 2006 and early 2007, the housing 00:08:03.449 --> 00:08:05.970 market starts to cool off. Prices stop going 00:08:05.970 --> 00:08:09.230 up. Subprime borrowers start missing their payments. 00:08:09.649 --> 00:08:11.810 A prudent bank would look at this data and say, 00:08:11.949 --> 00:08:14.709 OK, the party's over. Let's reduce our inventory. 00:08:14.750 --> 00:08:17.430 Let's stop buying these toxic loans. Any prudent 00:08:17.430 --> 00:08:20.490 bank would. But Bear Stearns didn't stop. Why? 00:08:20.709 --> 00:08:24.269 I mean, was it just pure greed? Or did they genuinely 00:08:24.269 --> 00:08:26.170 believe their own height that they were smarter 00:08:26.170 --> 00:08:28.050 than everyone else? I think it was a combination 00:08:28.050 --> 00:08:32.090 of greed and, you know, sunk cost fallacy. They 00:08:32.090 --> 00:08:34.549 had built this massive, massive infrastructure 00:08:34.549 --> 00:08:37.870 just to process mortgages. Turning it off would 00:08:37.870 --> 00:08:40.350 mean firing thousands of people and losing market 00:08:40.350 --> 00:08:42.850 share. So they doubled down. They doubled down. 00:08:42.889 --> 00:08:45.070 They actually increased their exposure. And this 00:08:45.070 --> 00:08:47.169 brings us to what might be the most terrifying 00:08:47.169 --> 00:08:50.509 number in our entire research stack, the leverage 00:08:50.509 --> 00:08:53.529 ratio. I saw this in the 2007 annual report, 00:08:53.750 --> 00:08:58.610 35 .6 to 1. It is a staggering, staggering number. 00:08:58.769 --> 00:09:01.750 Let's explain what that means for your wallet 00:09:01.750 --> 00:09:03.330 because this is the mechanics of the disaster 00:09:03.330 --> 00:09:06.909 right here. Okay. Imagine you have $1 of your 00:09:06.909 --> 00:09:09.269 own money. That's your equity. You want to invest. 00:09:09.789 --> 00:09:12.590 So you go out and you borrow $35 from a lender. 00:09:12.750 --> 00:09:15.269 So I've got one of my dollars, $35 borrowed dollars. 00:09:15.490 --> 00:09:18.789 I'm controlling $36 in total. Right. And you 00:09:18.789 --> 00:09:21.769 take that combined $36 and you invest all of 00:09:21.769 --> 00:09:24.590 it in, let's say, housing bonds. Now, let's say 00:09:24.590 --> 00:09:26.970 the value of those bonds goes up by just 1%. 00:09:26.970 --> 00:09:30.860 You make $0 .36. On your original $1 investment, 00:09:31.179 --> 00:09:34.360 that is a 36 % return. You look like an absolute 00:09:34.360 --> 00:09:37.320 genius. And this is how Bear Stearns was generating 00:09:37.320 --> 00:09:39.720 those massive returns on equity that investors 00:09:39.720 --> 00:09:42.360 just loved. It's like printing money. It is until 00:09:42.360 --> 00:09:44.779 it isn't. Yeah. Because the math works both ways. 00:09:44.980 --> 00:09:47.960 Cruelly so. Yes. If the value of those assets 00:09:47.960 --> 00:09:52.870 drops by just 3%. which is roughly $1 in this 00:09:52.870 --> 00:09:56.529 example, your $1 of equity is gone. It's wiped 00:09:56.529 --> 00:09:59.090 out. You are at zero. You're bankrupt. A 3 % 00:09:59.090 --> 00:10:01.289 move in the markets is nothing. That can happen 00:10:01.289 --> 00:10:03.809 in a week, sometimes in a single day. Exactly. 00:10:03.970 --> 00:10:06.669 And Bear Stearns was running this 35 to 1 leverage 00:10:06.669 --> 00:10:09.529 on assets that were illiquid. This is the level 00:10:09.529 --> 00:10:11.610 three asset problem we need to talk about. By 00:10:11.610 --> 00:10:15.049 the end of 2007, they had about $28 billion of 00:10:15.049 --> 00:10:17.149 these level three assets sitting on their books. 00:10:17.350 --> 00:10:19.190 So define level three for us. What does that 00:10:19.190 --> 00:10:22.019 mean? Well, accounting rules categorize assets 00:10:22.019 --> 00:10:25.139 by how easy they are to price. Level one is simple. 00:10:25.279 --> 00:10:27.200 It's a stock on the New York Stock Exchange. 00:10:27.500 --> 00:10:29.740 You know the price down to the penny every second. 00:10:29.899 --> 00:10:32.259 Right. Level two is something similar to other 00:10:32.259 --> 00:10:34.120 things that trade, so you can make a good estimate. 00:10:34.240 --> 00:10:37.769 But level three... These are assets that trade 00:10:37.769 --> 00:10:40.909 so rarely there is no market price. You basically 00:10:40.909 --> 00:10:43.610 have to guess what they're worth using your own 00:10:43.610 --> 00:10:46.690 internal mathematical models. This is mark to 00:10:46.690 --> 00:10:48.610 model. Which critics at the time were calling 00:10:48.610 --> 00:10:51.929 mark to make believe. Right. Because there was 00:10:51.929 --> 00:10:55.570 no active market for these subprime CDOs. Nobody 00:10:55.570 --> 00:10:58.090 wanted to buy them anymore. Bear Stearns just 00:10:58.090 --> 00:11:00.350 used their own models to value them. They said, 00:11:00.350 --> 00:11:02.529 well, our model says this is worth 98 cents on 00:11:02.529 --> 00:11:05.179 the dollar. Meanwhile. if they had actually tried 00:11:05.179 --> 00:11:06.960 to sell it in the real world. The market might 00:11:06.960 --> 00:11:09.720 have only paid 40 cents, maybe less. So they're 00:11:09.720 --> 00:11:12.940 carrying $28 billion of this stuff, supported 00:11:12.940 --> 00:11:15.659 by a tiny, tiny sliver of their own money, and 00:11:15.659 --> 00:11:17.620 just pretending it was worth full price. Yes, 00:11:17.679 --> 00:11:19.340 and as long as they didn't have to sell it, they 00:11:19.340 --> 00:11:21.799 could keep up the charade. But then came the 00:11:21.799 --> 00:11:26.220 tremors. June 2007, the hedge funds. This feels 00:11:26.220 --> 00:11:28.580 like the first act of the tragedy. This is the 00:11:28.580 --> 00:11:30.840 canary in the coal mine. It was the warning shot 00:11:30.840 --> 00:11:33.600 that everyone, including them, Just ignored. 00:11:34.519 --> 00:11:38.200 Bear Stearns managed these two really high profile 00:11:38.200 --> 00:11:40.940 hedge funds, the high grade structured credit 00:11:40.940 --> 00:11:43.720 fund and the high grade structured credit enhanced 00:11:43.720 --> 00:11:46.240 leveraged fund. Even the name sounds dangerous. 00:11:47.259 --> 00:11:49.700 Enhanced leverage. Yeah. It just sounds like 00:11:49.700 --> 00:11:51.980 we take your money and we risk it twice as fast. 00:11:52.179 --> 00:11:54.039 That's essentially what it was. And these funds 00:11:54.039 --> 00:11:56.080 were just stuffed to the gills with those toxic 00:11:56.080 --> 00:12:00.610 CDOs we were talking about. In June 2007, as 00:12:00.610 --> 00:12:02.830 subprime borrowers started defaulting in greater 00:12:02.830 --> 00:12:05.769 numbers, the value of the assets inside those 00:12:05.769 --> 00:12:08.750 funds just plummeted. And the lenders banks like 00:12:08.750 --> 00:12:11.009 Merrill Lynch, who had lent money to these funds, 00:12:11.230 --> 00:12:13.669 they got nervous. They issued a margin call. 00:12:13.809 --> 00:12:15.830 OK, explain a margin call in this context. What 00:12:15.830 --> 00:12:17.610 are they asking for? The lender is basically 00:12:17.610 --> 00:12:19.909 saying, hey, the collateral you gave us, those 00:12:19.909 --> 00:12:22.879 mortgage bonds. It's dropping in value. You need 00:12:22.879 --> 00:12:24.720 to give us more cash right now to cover the loan 00:12:24.720 --> 00:12:27.440 or we are going to seize your bonds and sell 00:12:27.440 --> 00:12:29.659 them ourselves. And Bear Cern's funds didn't 00:12:29.659 --> 00:12:32.919 have the cash. The funds didn't. No. So Merrill 00:12:32.919 --> 00:12:36.100 Lynch seized the collateral $850 million worth 00:12:36.100 --> 00:12:38.720 of bonds and they tried to auction them off to 00:12:38.720 --> 00:12:40.240 get their money back. And this is the moment. 00:12:40.320 --> 00:12:42.220 This is when the mark to make believe fantasy 00:12:42.220 --> 00:12:45.559 ends. This is it. Correct. Because when Merrill 00:12:45.559 --> 00:12:48.259 tried to auction off that $850 million, they 00:12:48.259 --> 00:12:52.259 hit a wall. Nobody showed up. No one wanted to 00:12:52.259 --> 00:12:54.320 buy it. Wow. They only managed to sell about 00:12:54.320 --> 00:12:56.879 $100 million worth. And even that was at deep, 00:12:56.940 --> 00:12:59.379 deep discounts. And suddenly the curtain was 00:12:59.379 --> 00:13:02.419 pulled back. The entire world could now see that 00:13:02.419 --> 00:13:05.139 these so -called AAA assets were essentially 00:13:05.139 --> 00:13:07.779 toxic waste. And Bear Stearns, the parent company, 00:13:07.940 --> 00:13:10.320 had to step in and bail out their own funds, 00:13:10.399 --> 00:13:12.700 right? They threw in. What was the number? Something 00:13:12.700 --> 00:13:16.399 like $3 .2 billion. $3 .2 billion. And here's 00:13:16.399 --> 00:13:19.179 a fascinating detail from the reports. Originally, 00:13:19.340 --> 00:13:22.120 Bear Stearns had only invested. $25 million of 00:13:22.120 --> 00:13:24.259 their own money in these funds. So they had very 00:13:24.259 --> 00:13:26.700 little skin in the game. Almost none. But when 00:13:26.700 --> 00:13:29.179 the collapse started, they threw $3 .2 billion 00:13:29.179 --> 00:13:31.919 of the firm's capital right into this black hole. 00:13:32.100 --> 00:13:34.720 So why? Why throw good money after bad like that? 00:13:35.179 --> 00:13:38.320 Reputation. That was it. James Caan, who was 00:13:38.320 --> 00:13:41.179 the CEO at the time, and the other top executives 00:13:41.179 --> 00:13:44.000 were terrified that if these funds collapsed, 00:13:44.259 --> 00:13:46.379 it would just destroy confidence in the bank's 00:13:46.379 --> 00:13:48.600 ability to manage risk. They tried to plug the 00:13:48.600 --> 00:13:51.279 dam with cash. But the dam broke anyway. It did. 00:13:51.360 --> 00:13:54.059 The funds lost nearly all their value. And this 00:13:54.059 --> 00:13:56.259 is where the legal drama really starts to heat 00:13:56.259 --> 00:13:59.259 up. We have emails from the two fund managers, 00:13:59.600 --> 00:14:02.779 Ralph Schiaffi and Matthew Tannen. This is the 00:14:02.779 --> 00:14:05.320 smoking gun part of the story. What were they 00:14:05.320 --> 00:14:07.440 saying in these emails? Well, publicly, they 00:14:07.440 --> 00:14:09.759 were on conference calls with their investors 00:14:09.759 --> 00:14:11.980 saying things like, we are comfortable with where 00:14:11.980 --> 00:14:14.700 we are and the market looks robust. Right. Everything's 00:14:14.700 --> 00:14:17.840 fine. Exactly. But privately, Tannen sent an 00:14:17.840 --> 00:14:20.580 email to Schiaffi saying, quote, the subprime 00:14:20.580 --> 00:14:23.659 market looks pretty damn ugly. He even suggested 00:14:23.659 --> 00:14:25.720 they should just close the fund and sell everything 00:14:25.720 --> 00:14:28.519 they could. So they knew. They were telling investors 00:14:28.519 --> 00:14:31.240 to hang on and stay calm. while they were privately 00:14:31.240 --> 00:14:34.039 panicking. It certainly looked that way to prosecutors. 00:14:34.620 --> 00:14:38.179 They were arrested in June of 2008 and charged 00:14:38.179 --> 00:14:40.840 with fraud. Now, to be fair to the legal record, 00:14:40.980 --> 00:14:43.460 we have to note they were found not guilty in 00:14:43.460 --> 00:14:46.659 criminal court. OK. The burden of proof for criminal 00:14:46.659 --> 00:14:49.899 fraud is incredibly high. You have to prove intent 00:14:49.899 --> 00:14:53.080 to deceive beyond a reasonable doubt. And the 00:14:53.080 --> 00:14:55.500 jury decided the prosecution just didn't meet 00:14:55.500 --> 00:14:58.259 that bar. But the civil suits and the reputational 00:14:58.259 --> 00:15:00.850 damage. That was fatal. So that's the summer 00:15:00.850 --> 00:15:04.710 of 2007. The hedge funds implode. Profits at 00:15:04.710 --> 00:15:07.649 the main bank plunge by 61 percent. Standard 00:15:07.649 --> 00:15:09.710 & Poor's downgrades their credit rating for the 00:15:09.710 --> 00:15:12.690 first time in 83 years. But they stagger on. 00:15:12.850 --> 00:15:15.490 They survive the fall. They survive the winter. 00:15:15.649 --> 00:15:17.450 Why didn't they just fold right then and there? 00:15:17.590 --> 00:15:21.190 Because the main bank was still on paper. profitable 00:15:21.190 --> 00:15:23.309 or it appeared to be. They had other businesses, 00:15:23.470 --> 00:15:25.830 clearing services, wealth management. They honestly 00:15:25.830 --> 00:15:27.370 thought they could ride it out. They thought 00:15:27.370 --> 00:15:29.190 the housing market would bounce back. A huge 00:15:29.190 --> 00:15:31.429 miscalculation. A fatal one because they were 00:15:31.429 --> 00:15:33.490 bleeding from a wound they couldn't see or maybe 00:15:33.490 --> 00:15:37.029 chose to ignore the repo market. OK, we need 00:15:37.029 --> 00:15:38.769 to stop and explain the repo market, because 00:15:38.769 --> 00:15:40.870 every time I read about the 2008 crisis, this 00:15:40.870 --> 00:15:43.330 comes up as the mechanism of death for these 00:15:43.330 --> 00:15:46.110 firms. But most people have no idea what it is. 00:15:46.169 --> 00:15:49.159 Right. It stands for repurchase agreement. And 00:15:49.159 --> 00:15:52.820 it is the absolute plumbing of Wall Street. It's 00:15:52.820 --> 00:15:55.299 how investment banks fund their daily lives. 00:15:55.720 --> 00:15:57.940 You have to remember, Bear Stearns didn't have 00:15:57.940 --> 00:16:00.100 customer deposits like a Bank of America. They 00:16:00.100 --> 00:16:03.120 didn't have savings accounts to lend out. So 00:16:03.120 --> 00:16:05.700 to fund their daily operations, to pay the electric 00:16:05.700 --> 00:16:08.799 bill, to fund trades, to pay salaries, they borrowed 00:16:08.799 --> 00:16:11.440 massive amounts of money overnight. Every single 00:16:11.440 --> 00:16:13.120 night. Every single night. They would take their 00:16:13.120 --> 00:16:15.440 assets, those mortgage bonds, and pledge them 00:16:15.440 --> 00:16:17.419 as collateral to another bank or a big money 00:16:17.419 --> 00:16:21.100 market fund. here's $100 million in bonds. Lend 00:16:21.100 --> 00:16:24.200 me $98 million in cash until tomorrow morning. 00:16:24.360 --> 00:16:26.840 I'll buy the bonds back from you tomorrow for 00:16:26.840 --> 00:16:29.259 a slightly higher price. So it's basically a 00:16:29.259 --> 00:16:31.360 high finance pawn shop. You pawn your watch every 00:16:31.360 --> 00:16:33.620 evening to buy dinner, and then you buy it back 00:16:33.620 --> 00:16:35.789 in the morning when your paycheck clears. It's 00:16:35.789 --> 00:16:37.769 the perfect analogy, and it works beautifully 00:16:37.769 --> 00:16:39.730 as long as the pawn shop owner trusts that your 00:16:39.730 --> 00:16:42.429 watch is real. Right. But in March 2008, the 00:16:42.429 --> 00:16:44.570 pawn shop owners, the lenders in the repo market, 00:16:44.789 --> 00:16:47.429 they looked at Bear Stearns Collateral, those 00:16:47.429 --> 00:16:49.250 mortgage bonds, and they said, you know what? 00:16:49.629 --> 00:16:52.070 We don't want this anymore. This watch looks 00:16:52.070 --> 00:16:54.429 fake. Or we don't know what this watch is worth, 00:16:54.529 --> 00:16:56.230 but we know for sure we don't want to be holding 00:16:56.230 --> 00:16:58.929 it if you go bust tomorrow morning. It became 00:16:58.929 --> 00:17:01.629 a crisis of confidence, not just a crisis of 00:17:01.629 --> 00:17:04.009 capital. And this leads us directly to the week 00:17:04.009 --> 00:17:08.180 of panic. March 10th, 2008. Monday, Bear Stearns 00:17:08.180 --> 00:17:11.880 has a liquidity pool of $18 .1 billion. That 00:17:11.880 --> 00:17:14.960 is their cash on hand to operate. $18 billion. 00:17:15.180 --> 00:17:17.299 I mean, that seems it's a lot of money. It's 00:17:17.299 --> 00:17:19.619 a fortune. Most companies couldn't dream of having 00:17:19.619 --> 00:17:22.630 that much cash. It wasn't nearly enough. On that 00:17:22.630 --> 00:17:25.009 Monday, rumors start circulating that Bayer is 00:17:25.009 --> 00:17:27.670 having trouble processing trades. By Tuesday, 00:17:27.950 --> 00:17:29.849 major clients start pulling their money out. 00:17:29.910 --> 00:17:32.450 By Wednesday, the repo lenders stop rolling over 00:17:32.450 --> 00:17:34.690 the loans. They're demanding their cash back. 00:17:34.930 --> 00:17:37.690 When you are leveraged 35 to 1, you can't pay 00:17:37.690 --> 00:17:40.460 everyone back at once. There's no way. You can't. 00:17:40.460 --> 00:17:43.039 It's a classic bank run. But instead of people 00:17:43.039 --> 00:17:45.000 standing in a line on the sidewalk, it's all 00:17:45.000 --> 00:17:47.680 electronic. Billions of dollars leaving in seconds. 00:17:47.960 --> 00:17:52.380 By Thursday, March 13th, that $18 .1 billion 00:17:52.380 --> 00:17:55.660 cushion had dropped to just $2 billion. They 00:17:55.660 --> 00:17:58.299 burned through $16 billion in three days. It 00:17:58.299 --> 00:18:01.500 just evaporated. Their CEO at the time, Alan 00:18:01.500 --> 00:18:04.460 Schwartz, he even went on CNBC on Wednesday to 00:18:04.460 --> 00:18:06.940 try and calm the markets down. He said, our balance 00:18:06.940 --> 00:18:09.319 sheet has not changed. We have plenty of liquidity. 00:18:09.859 --> 00:18:12.440 Famous last words. It actually made things worse. 00:18:12.599 --> 00:18:14.700 It signaled to the entire market that they were 00:18:14.700 --> 00:18:16.779 desperate enough to have to go on TV. It's like, 00:18:16.799 --> 00:18:18.819 you know, a pilot coming on the intercom and 00:18:18.819 --> 00:18:21.259 screaming, everything is fine. You immediately 00:18:21.259 --> 00:18:23.759 assume the engines are on fire. Exactly. So it's 00:18:23.759 --> 00:18:25.940 Thursday night. They have $2 billion left. They 00:18:25.940 --> 00:18:27.680 probably can't even open for business on Friday. 00:18:28.279 --> 00:18:30.559 What happens next? This is the call. They make 00:18:30.559 --> 00:18:32.920 the call that no bank ever wants to make. They 00:18:32.920 --> 00:18:35.279 call the Federal Reserve. They call Timothy Gaithner 00:18:35.279 --> 00:18:37.559 at the New York Fed and basically say, we're 00:18:37.559 --> 00:18:40.779 done unless you help us. We are filing for bankruptcy 00:18:40.779 --> 00:18:43.240 tomorrow morning when the market opens. Now, 00:18:43.339 --> 00:18:46.859 traditionally, the Fed lends to commercial banks, 00:18:47.019 --> 00:18:49.500 right? Banks that take deposits from regular 00:18:49.500 --> 00:18:53.420 people. Bear Stearns is an investment bank. The 00:18:53.420 --> 00:18:55.099 Fed isn't supposed to bail them out. That's right. 00:18:55.769 --> 00:18:58.890 This was completely uncharted territory. But 00:18:58.890 --> 00:19:01.309 Ben Bernanke, who was the Fed chair, and Tim 00:19:01.309 --> 00:19:04.349 Gaithner, they were terrified of contagion. The 00:19:04.349 --> 00:19:07.650 domino effect. Absolutely. If Bear Stearns collapsed, 00:19:07.930 --> 00:19:10.490 they owed money to everyone. J .P. Morgan, Citi, 00:19:10.630 --> 00:19:13.049 Goldman, they were all counterparties on trillions 00:19:13.049 --> 00:19:15.349 of dollars of derivatives. If Bear didn't pay 00:19:15.349 --> 00:19:17.690 them, they might fail too. And that could take 00:19:17.690 --> 00:19:20.390 down the whole global economy. So the Fed tries 00:19:20.390 --> 00:19:22.849 a Band -Aid first. Right. On Friday morning, 00:19:23.009 --> 00:19:25.410 March 14th, they announce a secured loan facility. 00:19:26.000 --> 00:19:28.420 JP Morgan will funnel money from the Fed to Bear 00:19:28.420 --> 00:19:30.480 Stearns for 28 days. It was just supposed to 00:19:30.480 --> 00:19:33.099 buy them some time. OK, 28 days to find a buyer 00:19:33.099 --> 00:19:35.700 or fix the books. That sounds reasonable. It 00:19:35.700 --> 00:19:38.180 lasted for about 12 hours. The market saw the 00:19:38.180 --> 00:19:40.839 loan and panicked even harder. The stock crashed 00:19:40.839 --> 00:19:44.900 by 47 % that day alone. Customers fled. By Friday 00:19:44.900 --> 00:19:46.839 night, the Fed realized the loan wasn't working. 00:19:47.019 --> 00:19:49.819 It wasn't enough. So they changed the plan. Drastically. 00:19:50.359 --> 00:19:53.259 They called Bear Stearns and said, the 28 -day 00:19:53.259 --> 00:19:56.529 deal is off. You have until Sunday night to sell 00:19:56.529 --> 00:19:59.130 this company. If you do not have a signed deal 00:19:59.130 --> 00:20:01.069 by the time the Asian markets open on Sunday 00:20:01.069 --> 00:20:03.710 night, you are filing for bankruptcy Monday morning. 00:20:03.829 --> 00:20:06.190 Talk about a high -pressure deadline. You have 00:20:06.190 --> 00:20:09.349 48 hours to sell a company that was worth $20 00:20:09.349 --> 00:20:12.029 billion a year ago or just... dies. And there 00:20:12.029 --> 00:20:14.910 was really only one serious buyer at the table, 00:20:15.130 --> 00:20:18.349 JPMorgan Chase. Enter Jamie Dimon. Yes. And Jamie 00:20:18.349 --> 00:20:20.829 Dimon is a shark. He smells blood in the water 00:20:20.829 --> 00:20:23.589 and he knows he holds all the cards. Bear Stearns 00:20:23.589 --> 00:20:26.049 has zero leverage in this negotiation. None. 00:20:26.250 --> 00:20:28.450 But Dimon also had a problem. He had his team 00:20:28.450 --> 00:20:30.990 look at Bear's books over the weekend. I mean, 00:20:31.009 --> 00:20:32.769 they pulled a complete all -nighter and they 00:20:32.769 --> 00:20:35.589 saw all that toxic waste, those subprime assets. 00:20:35.809 --> 00:20:38.250 And he said, I'll buy the company, but I am not 00:20:38.250 --> 00:20:40.329 taking that garbage. So who takes the garbage? 00:20:40.359 --> 00:20:43.039 You do. I do. The American taxpayer. And this 00:20:43.039 --> 00:20:44.579 is where the Maiden Lane deal comes in. Yes. 00:20:45.039 --> 00:20:47.480 The Federal Reserve Bank of New York created 00:20:47.480 --> 00:20:49.960 what's called a special purpose vehicle, basically 00:20:49.960 --> 00:20:52.980 a shell company, and they called it Maiden Lane 00:20:52.980 --> 00:20:55.759 LLC. Named after the street next to the Fed building 00:20:55.759 --> 00:20:58.440 in Manhattan. That's the one. So how did it work? 00:20:58.480 --> 00:21:00.599 What was the structure? The Fed lent this new 00:21:00.599 --> 00:21:05.079 company, Maiden Lane, $29 billion. Maiden Lane 00:21:05.079 --> 00:21:08.700 then used that money to buy $30 billion of Bear 00:21:08.700 --> 00:21:12.920 Stearns' worst, most toxic, unsellable assets. 00:21:13.339 --> 00:21:16.079 So the bad loans get moved over into a government 00:21:16.079 --> 00:21:19.569 -funded trash can. Essentially, yes. JP Morgan 00:21:19.569 --> 00:21:22.769 put in a $1 billion subordinated loan, which 00:21:22.769 --> 00:21:25.470 just means that if the assets lost value, JP 00:21:25.470 --> 00:21:27.490 Morgan would lose its billion dollars first. 00:21:27.890 --> 00:21:31.109 But after that first billion, any and all losses 00:21:31.109 --> 00:21:33.569 were on the Fed. This was the only way Diamond 00:21:33.569 --> 00:21:35.849 would agree to buy the rest of the firm. So the 00:21:35.849 --> 00:21:38.839 deal is, JP Morgan takes the good stuff. The 00:21:38.839 --> 00:21:40.900 shiny headquarters building, the client list, 00:21:41.019 --> 00:21:43.259 the technology, and the Fed takes the bad stuff. 00:21:43.420 --> 00:21:45.279 Now the price. This is the insult added to the 00:21:45.279 --> 00:21:47.559 injury. Bear Stearns executives, they were still 00:21:47.559 --> 00:21:50.819 hoping for maybe $20 a share, maybe $15. They 00:21:50.819 --> 00:21:52.099 knew they were in trouble, but they thought there 00:21:52.099 --> 00:21:54.500 was still some value there. And on Sunday afternoon, 00:21:54.799 --> 00:21:57.220 Jamie Dimon puts his offer on the table. $2. 00:21:57.279 --> 00:22:01.819 $2 per share. I mean, why? Why humiliate them 00:22:01.819 --> 00:22:04.640 like that? $2 is basically zero. It's a rounding 00:22:04.640 --> 00:22:07.500 error. Well, it wasn't just humiliation. It was 00:22:07.500 --> 00:22:10.410 also protection. Diamond was worried his own 00:22:10.410 --> 00:22:12.609 shareholders would revolt if he paid too much 00:22:12.609 --> 00:22:15.369 for a failing bank. He wanted a price that was 00:22:15.369 --> 00:22:18.650 so low, so essentially zero, that he could go 00:22:18.650 --> 00:22:20.609 to them and say, look, even if everything goes 00:22:20.609 --> 00:22:23.509 wrong, we basically paid nothing for it. It valued 00:22:23.509 --> 00:22:26.730 the entire company at, what, $236 million? Something 00:22:26.730 --> 00:22:29.269 like that, which was less than the value of their 00:22:29.269 --> 00:22:31.930 headquarters building alone. The building was 00:22:31.930 --> 00:22:34.250 worth over a billion dollars. They were buying 00:22:34.250 --> 00:22:36.390 the company for less than the value of the real 00:22:36.390 --> 00:22:38.759 estate it sat in. Exactly. Just imagine. Imagine 00:22:38.759 --> 00:22:41.039 being an employee at that moment. You've worked 00:22:41.039 --> 00:22:44.500 there for 20 years. Your entire 401k is in Bear 00:22:44.500 --> 00:22:46.660 Stearns stock. You thought you were a millionaire 00:22:46.660 --> 00:22:48.619 on paper, and now you can't even buy a used car 00:22:48.619 --> 00:22:51.339 with your retirement savings. It was total devastation. 00:22:51.619 --> 00:22:53.519 Employees owned about 30 % of the company. They 00:22:53.519 --> 00:22:56.319 were just wiped out. James Cain, the former CEO, 00:22:56.599 --> 00:22:59.700 lost hundreds of millions. Joseph Lewis, a billionaire 00:22:59.700 --> 00:23:02.039 investor, lost over a billion dollars personally. 00:23:02.339 --> 00:23:04.220 So there must have been a revolt from the shareholders. 00:23:04.559 --> 00:23:07.759 There was a huge one. Class action suits were 00:23:07.759 --> 00:23:10.279 filed almost immediately. The employees were 00:23:10.279 --> 00:23:13.359 all threatening to vote no on the merger. And 00:23:13.359 --> 00:23:16.059 you have to remember, a merger needs shareholder 00:23:16.059 --> 00:23:18.619 approval. And at two dollars a share, the shareholders 00:23:18.619 --> 00:23:21.140 were saying, forget it, let it go bankrupt. We'd 00:23:21.140 --> 00:23:23.079 rather see it burn than give it to Jamie Dimon 00:23:23.079 --> 00:23:25.220 for two bucks. So they had to go back to the 00:23:25.220 --> 00:23:27.980 negotiating table. But for a very, very weird 00:23:27.980 --> 00:23:31.700 reason, it turns out in the absolute mad rush 00:23:31.700 --> 00:23:34.250 to write the contract on that Sunday night. I 00:23:34.250 --> 00:23:36.549 mean, you have to picture lawyers working on 00:23:36.549 --> 00:23:40.029 zero sleep, eating cold pizza at 3 a .m. They 00:23:40.029 --> 00:23:42.829 made a mistake. A typo. Basically, a loophole 00:23:42.829 --> 00:23:45.470 in the guarantee language. The contract was supposed 00:23:45.470 --> 00:23:47.970 to say that J .P. Morgan guarantees bears trades 00:23:47.970 --> 00:23:50.269 until the shareholder vote. But the way it was 00:23:50.269 --> 00:23:52.829 drafted, the guarantee was open ended. What does 00:23:52.829 --> 00:23:54.589 that mean? It basically said J .P. Morgan is 00:23:54.589 --> 00:23:57.849 on the hook for all of bears debts forever, even 00:23:57.849 --> 00:24:00.089 if the shareholders vote no on the deal. Oh, 00:24:00.089 --> 00:24:02.849 wow. So if the shareholders voted no just to 00:24:02.849 --> 00:24:05.759 spite him. J .P. Morgan would be stuck guaranteeing 00:24:05.759 --> 00:24:09.559 a bankrupt company's debts. Yes, exactly. And 00:24:09.559 --> 00:24:11.740 when Jamie Dimon found out about this drafting 00:24:11.740 --> 00:24:14.859 error, the reports say he was apoplectic. He 00:24:14.859 --> 00:24:17.579 was just furious. I can hear the yelling from 00:24:17.579 --> 00:24:20.029 here. So they had to fix the contract. But to 00:24:20.029 --> 00:24:22.450 get the shareholders to agree to the fix and, 00:24:22.490 --> 00:24:25.069 you know, to approve the deal at all, J .P. Morgan 00:24:25.069 --> 00:24:27.170 had to sweeten the pot. They had to raise the 00:24:27.170 --> 00:24:29.809 price? They raised the bid from $2 to $10 per 00:24:29.809 --> 00:24:31.910 share. Which is still a complete tragedy compared 00:24:31.910 --> 00:24:35.630 to $172. But, I mean, it's five times better 00:24:35.630 --> 00:24:38.009 than $2. It brought the total value of the deal 00:24:38.009 --> 00:24:41.910 up to about $1 .2 billion. It was just enough 00:24:41.910 --> 00:24:45.230 to quiet the revolt. And on May 29, 2008, the 00:24:45.230 --> 00:24:48.069 shareholders officially approved the sale. Bear 00:24:48.069 --> 00:24:50.880 Stearns was gone. Just like that. 85 years of 00:24:50.880 --> 00:24:53.000 history. Just swallowed up. Swallowed up into 00:24:53.000 --> 00:24:55.779 JPMorgan Chase. And by January 2010, JPMorgan 00:24:55.779 --> 00:24:58.180 stopped using the Bear Stearns brand name entirely. 00:24:58.559 --> 00:25:01.200 The name just ceased to exist. I want to zoom 00:25:01.200 --> 00:25:02.720 out a bit. We talked about the mechanics, the 00:25:02.720 --> 00:25:05.140 CVOs, the repo market, the leverage. But what 00:25:05.140 --> 00:25:07.819 about the people, the leadership? We mentioned 00:25:07.819 --> 00:25:10.900 James Cain, the CEO. Yeah. Time magazine famously 00:25:10.900 --> 00:25:13.640 named him one of the 25 people to blame for the 00:25:13.640 --> 00:25:16.299 financial crisis. Wow. They said he was asleep 00:25:16.299 --> 00:25:18.599 at the switch. And there were all these reports 00:25:18.599 --> 00:25:20.900 that while the hedge funds were imploding back 00:25:20.900 --> 00:25:23.980 in the summer of 2007, he was away playing in 00:25:23.980 --> 00:25:27.509 bridge tournaments. As in the card game. High 00:25:27.509 --> 00:25:30.369 level competitive bridge. He was apparently obsessed 00:25:30.369 --> 00:25:32.589 of it. He would just disappear for weeks at a 00:25:32.589 --> 00:25:34.890 time to play in tournaments in Nashville or Detroit. 00:25:35.130 --> 00:25:37.690 And he was also reportedly playing a lot of golf, 00:25:37.750 --> 00:25:40.509 especially on Fridays. So it's the modern version 00:25:40.509 --> 00:25:43.150 of Nero fiddled while Rome burned. But in this 00:25:43.150 --> 00:25:45.869 case, it's Kane played bridge while the repo 00:25:45.869 --> 00:25:49.170 market froze. It became a symbol of this huge 00:25:49.170 --> 00:25:52.289 disconnect between Wall Street leadership and 00:25:52.289 --> 00:25:54.470 the reality of the risks they were taking. I 00:25:54.470 --> 00:25:57.009 mean, this was the only CEO on Wall Street who 00:25:57.009 --> 00:25:59.569 didn't have a computer in his office. He didn't 00:25:59.569 --> 00:26:02.150 use email. You're kidding me. In 2008, he relied 00:26:02.150 --> 00:26:04.890 on printed memos delivered to him. It just speaks 00:26:04.890 --> 00:26:06.890 to a culture that was completely out of touch 00:26:06.890 --> 00:26:09.490 with the speed and complexity of modern finance. 00:26:10.009 --> 00:26:11.609 There's also this other theory, you hear it from 00:26:11.609 --> 00:26:14.210 the diehard Bear Stearns defenders, the naked 00:26:14.210 --> 00:26:17.269 short selling argument. Right. The idea that 00:26:17.269 --> 00:26:19.690 we didn't fail, we were murdered. The argument 00:26:19.690 --> 00:26:23.369 is that these predatory traders sold phantom 00:26:23.369 --> 00:26:26.599 shares. So shares that they didn't actually own 00:26:26.599 --> 00:26:29.480 or borrow to artificially drive the price down 00:26:29.480 --> 00:26:32.579 and force the collapse. Matt Taibbi wrote a really 00:26:32.579 --> 00:26:35.019 famous piece on this in Rolling Stone, arguing 00:26:35.019 --> 00:26:37.480 that naked short selling played a major role. 00:26:37.599 --> 00:26:39.400 So is there any evidence for that? It's highly 00:26:39.400 --> 00:26:42.299 controversial. The SEC looked into it. A major 00:26:42.299 --> 00:26:44.420 academic study by the University of Oklahoma 00:26:44.420 --> 00:26:47.240 looked at the trading data for both Bear Stearns 00:26:47.240 --> 00:26:50.240 and Lehman Brothers, and they found, quote, no 00:26:50.240 --> 00:26:52.839 evidence. that the stock price declines were 00:26:52.839 --> 00:26:55.500 caused by naked short selling. So what was their 00:26:55.500 --> 00:26:57.720 conclusion? Their conclusion was that the price 00:26:57.720 --> 00:26:59.380 dropped because the company was fundamentally 00:26:59.380 --> 00:27:02.460 broken, not because of some secret market manipulation. 00:27:02.759 --> 00:27:04.380 It's always easier to blame a villain in the 00:27:04.380 --> 00:27:06.880 shadows than to admit you leveraged your entire 00:27:06.880 --> 00:27:10.299 company 35 to 1 on bad mortgages. Exactly. The 00:27:10.299 --> 00:27:12.440 short sellers were the vultures circling the 00:27:12.440 --> 00:27:14.779 dying animal, but they didn't kill it. The animal 00:27:14.779 --> 00:27:16.920 died of gluttony and a flawed business model. 00:27:17.119 --> 00:27:20.220 You simply cannot be leveraged 35 to 1 on illiquid 00:27:20.220 --> 00:27:22.779 assets. and survive a downturn. It is simple 00:27:22.779 --> 00:27:25.859 math. So looking back on all this, was Bear Stearns 00:27:25.859 --> 00:27:28.740 sort of the sacrificial lamb? In a way, yeah. 00:27:28.819 --> 00:27:31.380 The Fed thought that by facilitating the sale, 00:27:31.440 --> 00:27:33.980 by sort of engineering this rescue, they had 00:27:33.980 --> 00:27:36.440 solved the problem. They thought, OK, we prevented 00:27:36.440 --> 00:27:38.480 a chaotic collapse. The market will calm down 00:27:38.480 --> 00:27:41.460 now. But it didn't calm down at all. No, it actually 00:27:41.460 --> 00:27:44.279 set a very dangerous precedent. It taught the 00:27:44.279 --> 00:27:46.640 market that the government might intervene in 00:27:46.640 --> 00:27:49.200 a crisis, but that shareholders would get completely 00:27:49.200 --> 00:27:51.759 wiped out. It also showed the Fed stretching 00:27:51.759 --> 00:27:54.599 its powers to the absolute limit. It did. Paul 00:27:54.599 --> 00:27:56.920 Volcker, the former Fed chair, was very, very 00:27:56.920 --> 00:27:58.920 critical of the deal. What did Volcker say about 00:27:58.920 --> 00:28:01.740 it? He said the Fed took actions that extended 00:28:01.740 --> 00:28:04.680 to the very edge of its lawful and implied powers. 00:28:05.140 --> 00:28:07.640 The Federal Reserve is supposed to manage inflation 00:28:07.640 --> 00:28:10.099 and employment for the whole country, not buy 00:28:10.099 --> 00:28:12.740 toxic mortgage bonds from one specific investment 00:28:12.740 --> 00:28:15.559 bank using a shell company it just created. It 00:28:15.559 --> 00:28:18.519 really crossed a line. And crucially, the Bear 00:28:18.519 --> 00:28:21.230 Stearns bailout. set the stage for the Lehman 00:28:21.230 --> 00:28:23.809 Brothers crisis later that same year because 00:28:23.809 --> 00:28:25.529 everyone in the market assumed the Fed would 00:28:25.529 --> 00:28:28.349 save Lehman too. And then when they didn't save 00:28:28.349 --> 00:28:31.130 Lehman, the panic was 10 times worse. But you 00:28:31.130 --> 00:28:33.549 know what? That is a story for another deep dive. 00:28:33.829 --> 00:28:36.549 It certainly is. So as we wrap this up, let's 00:28:36.549 --> 00:28:39.009 just summarize the tragedy here. You have a firm 00:28:39.009 --> 00:28:42.319 founded in 1923. It survives the Great Depression. 00:28:42.460 --> 00:28:45.400 It builds this incredible reputation as a savvy, 00:28:45.500 --> 00:28:48.240 gritty survivor. And then, completely seduced 00:28:48.240 --> 00:28:51.059 by the easy, almost unbelievable profits of the 00:28:51.059 --> 00:28:53.920 housing bubble, they bet the farm. They just 00:28:53.920 --> 00:28:56.779 bet the entire firm. They ignored every single 00:28:56.779 --> 00:28:59.440 warning sign in 2007. They thought they could 00:28:59.440 --> 00:29:01.380 hold on until the market turned back in their 00:29:01.380 --> 00:29:03.960 favor. But confidence is fragile. And once the 00:29:03.960 --> 00:29:06.309 rumors started... the liquidity just vanished. 00:29:06.589 --> 00:29:11.190 From $172 a share to a $10 buyout and 15 ,500 00:29:11.190 --> 00:29:13.250 people left wondering what happened to their 00:29:13.250 --> 00:29:15.690 careers and their life savings. Employees lost 00:29:15.690 --> 00:29:18.529 about $5 billion in personal wealth. That is 00:29:18.529 --> 00:29:21.049 the real human cost of that 35 to 1 leverage 00:29:21.049 --> 00:29:23.269 ratio. It really makes you think about the whole 00:29:23.269 --> 00:29:25.829 concept of value in the modern financial system. 00:29:25.990 --> 00:29:28.009 That is the provocative thought I think we should 00:29:28.009 --> 00:29:30.940 leave listeners with. We think of money as something 00:29:30.940 --> 00:29:33.559 solid, right? A dollar is a dollar. A building 00:29:33.559 --> 00:29:36.720 is a building. But Bear Stearns proved that in 00:29:36.720 --> 00:29:41.220 modern finance, value is really just... It's 00:29:41.220 --> 00:29:44.400 a confidence trick. It is, literally. Bear Stearns 00:29:44.400 --> 00:29:47.019 had the exact same assets on its books on Monday 00:29:47.019 --> 00:29:49.380 as it did on Thursday. The buildings were still 00:29:49.380 --> 00:29:51.160 there. The trading contracts were still there. 00:29:51.319 --> 00:29:53.599 But because the belief in their ability to pay 00:29:53.599 --> 00:29:56.380 their bills evaporated, the value evaporated 00:29:56.380 --> 00:29:58.579 right along with it. If people stop believing 00:29:58.579 --> 00:30:01.319 you can pay your bills, you are bankrupt, no 00:30:01.319 --> 00:30:03.359 matter what your spreadsheet says. Precisely. 00:30:03.359 --> 00:30:06.660 The entire system relies on faith. And in March 00:30:06.660 --> 00:30:09.559 2008, for Bear Stearns, that faith just broke. 00:30:09.980 --> 00:30:12.220 A very sobering thought to end on. If you want 00:30:12.220 --> 00:30:13.859 to dig deeper, definitely check out the full 00:30:13.859 --> 00:30:16.759 timeline of the 2008 crisis. It only gets crazier 00:30:16.759 --> 00:30:19.119 from here. But for now, that is the story of 00:30:19.119 --> 00:30:21.160 the fall of Bear Stearns. Thanks for taking the 00:30:21.160 --> 00:30:23.240 deep dive with us. Thank you. Keep asking questions. 00:30:23.400 --> 00:30:23.920 See you next time.