Since the fall of Bear Stearns people have been wondering who was responsible for the crisis of confidence in the firm, and it turns out Kyle Bass played a role.
On Wednesday March 12 2008, reporter David Faber asked Bear Stearns chief Alan Schwartz if it was true that Goldman Sachs wouldn’t “accept the counterparty risk of Bear Stearns” during a 9am interview. Although Schwartz said that firms were still trading with the bank, the damage was already done, writes John Carney for The Wall Street Journal.
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Faber question sparks downfall of Bear Stearns
Confidence in Bear Stearns evaporated rapidly, and the firm was struggling. That night the firm found it hard to borrow in the overnight repurchase market, and the following evening Bear Stearns told the Securities and Exchange Commission (SEC) that it would be “unable to operate normally on Friday.”
The Federal Reserve backed a rescue loan from J.P. Morgan Chase & Co., before Bear Stearns was forced to sell itself to the bank over that weekend. Now it has come to light just how the incident occurred thanks to materials released as part of the government investigation into the financial crisis.
The documents reveal that Kyle Bass, well-known hedge fund manager of Hayman Capital Management LP, was the source that provoked Haber’s line of questioning. Bass used to work for Bear Stearns.
Documents from government inquiry reveal role of Kyle Bass
Details were revealed after the National Archives released records in the Financial Crisis Inquiry Commission earlier this month. One document was an interview with Thomas Marano, former head of mortgages at Bear Stearns, in which he told investigators that Bass was Faber’s source.
Hedge funds were concerned by Bear Stearns at the time of the crash. Most were trying to limit their exposure to Bear Stearns by getting other Wall Street firms to take their place in trades with the bank. These swaps are known as novations.
“There were several investors who tried to novate, but Kyle Bass was memorable because I reached out to him to find out his concerns. I heard on CNBC that he had told them that he had tried to novate with Goldman, and they said that they would maybe take it, but he wasn’t sure,” Mr. Marano is quoted in the memo.
Faber has never publicly named source
Faber has never said who his source was. Marano said that Bass was shocked to hear that Faber had put the details of their conversation on air.
Faber has been criticized for his role but government records show that Goldman Sachs had refused to take on counterparty risk the day before the interview. Goldman traders were pushing up against the limits of exposure to a single firm due to the high volume of requests.
Records show that Hayman Capital Partners tried to close a $5 billion subprime derivative position with Goldman late on Tuesday. Goldman declined to consent to the novation in an email.
“Our trading desk would prefer to stay facing Hayman. We do not want to face Bear,” wrote a Goldman representative early Wednesday morning.
However in another email sent shortly afterward at 9:04am, Goldman agreed to accept Bear. Around that time Faber was questioning Schwartz on the rejected trade.
“The news hit the Street that Goldman had refused a routine transaction with one of the other big five investment banks. The message: don’t rely on Bear Stearns,” the FCIC report said.
Some other interesting excerpts from the report:
Bowen told the Commission that after he alerted management by sending emails, he went from supervising people to supervising only , his bonus was reduced, and he was downgraded in his performance review.
Some industry veterans took their concerns directly to government officials. J. Kyle Bass, a Dallas-based hedge fund manager and a former Bear Stearns executive, testified to the FCIC that he told the Federal Reserve that he believed the housing securitization market to be on a shaky foundation. “Their answer at the time was, and this was also the thought that was—that was homogeneous throughout Wall Street’s analysts—was home prices always track income growth and jobs growth. And they showed me income growth on one chart and jobs growth on another, and said, ‘We don’t see what you’re talking about because incomes are still growing and jobs are still growing.’ And I said, well, you obviously don’t realize where the dog is and where the tail is, and what’s moving what.
As Kyle Bass of Dallas-based Hayman Capital Advisors testified before the House Financial Services Committee, CDOs that purchased lower-rated tranches of mortgage-backed securities “are arcane structured finance products that were designed specifically to make dangerous, lowly rated tranches of subprime debt deceptively attractive to investors. This was achieved through some alchemy and some negligence in adapting unrealistic correlation assumptions on behalf of the ratings agencies. They convinced investors that of a collection of toxic subprime tranches were the ratings equivalent of U.S. Government bonds.”
Bear Stearns also encountered difficulties stepping into trades. Hayman Capital Partners, a hedge fund in Texas wanting to decrease its exposure to subprime mortgages, had decided to close out a relatively small 5 million subprime derivative position with Goldman Sachs. Bear Stearns offered the best bid, so Hayman expected to assign its position to Bear, which would then become Goldman’s counterparty in the derivative. Hayman notified Goldman by a routine email on Tuesday, March 11th 4:06P.M. The reply 41 minutes later was unexpected: “GS does not consent to this trade.”
That startled Kyle Bass, Hayman’s managing partner. He told the FCIC he could not recall any counterparty rejecting a routine novation.Pressed for an explanation, Goldman the next morning offered no details: “Our trading desk would prefer to stay facing Hayman. We do not want to face Bear.”Adding to the mystery, 16 minutes later Goldman agreed to accept Bear Sterns as the counterparty after all. But the damage was done. The news hit the street that Goldman had refused a routine transaction with one of the other big five investment banks. The message: don’t rely on Bear Stearns.