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MARCH : THE FALL OF BEAR STEARNS
The total included . billion in CDOs that included mortgage-backed securities,
putting it in the top in that business. As was typical on Wall Street, the company’s
view was that Bear was in the moving business, not the storage business—that is, it
sought to provide services to clients rather than take on long-term exposures of its
own.
Bear expanded its mortgage business despite evidence that the market was begin-
ning to falter, as did other firms such as Citigroup and Merrill. As early as May ,
Bear had lost million relating to defaults on mortgages which occurred within
days of origination, which had been rare in the decade. But Bear persisted, assuming
the setback would be temporary. In February , Bear even acquired Encore
Credit, its third captive mortgage originator in the United States, doubling its capac-
ity. The purchase was consistent with Bear’s contrarian business model—buying into
distressed markets and waiting for them to turn around.
Only a month after the purchase of Encore, the Securities and Exchange Commis-
sion wrote in an internal report, “Bear’s mortgage business incurred significant market
risk losses” on its Alt-A mortgage assets. The losses were small, but the SEC reported
that “risk managers note[d] that these events reflect a more rapid and severe deteriora-
tion in collateral performance than anticipated in ex ante models of stress events.”
“I REQUESTED SOME FORBEARANCE”
Vacationing on Nantucket Island when the two Bear-sponsored hedge funds declared
bankruptcy on July , , former Bear treasurer Robert Upton anticipated that
the rating agencies would downgrade the company, raising borrowing costs. Bear
funded much of its operations borrowing short-term in the repo market; it borrowed
between and billion overnight. Even a threat of a downgrade by a rating
agency would make financing more expensive, starting the next morning.
Investors, analysts, and the credit rating agencies closely scrutinized leverage ra-
tios, available at the end of each quarter. By November , Bear’s leverage ratio had
reached nearly to . By the end of , Bear’s Level assets—illiquid assets diffi-
cult to value and to sell—were of its tangible common equity; thus, writing
down these illiquid assets by would wipe out tangible common equity.
At the end of each quarter, Bear would lower its leverage ratio by selling assets,
only to buy them back at the beginning of the next quarter. Bear and other firms
booked these transactions as sales—even though the assets didn’t stay off the balance
sheet for long—in order to reduce the amount of the company’s assets and lower its
leverage ratio. Bear’s former treasurer Upton called the move “window dressing” and
said it ensured that creditors and rating agencies were happy. Bear’s public filings re-
flected this, to some degree: for example, its annual report said the balance
sheet was approximately lower than the average month-end balance over the
previous twelve months.
To forestall a downgrade, Upton spoke with the three main rating agencies,
Moody’s, Standard & Poor’s, and Fitch, in early August. Several times in —
