Marginal Utility

by Ken Houghton

Metro reported yesterday that CBS's Les Moonves was so impressed by Britney Spears's appearance on How I Met Your Mother that they decided to make her the centerpiece of a show—a remake of the Mary Tyler Moore Show.

It wasn't until I read the link at this post from Steve Gould of EoB that I realized that yesterday was more than the traditional birthday of our cat.*

So I'm gullible. But even I'm not as gullible enough to believe the claim of Lehmann's CEO today that he has evidence that hedge funds "conspired" to destroy Bear Stearns by short-selling.

It's not that I don't believe multiple hedge funds shorted the firm, or even that some of them spoke with each other. But the conversation was more likely,"Are you short BSC?" "Better believe it. You too?" "Of course." than some clandestine activity.

Let's be clear: when your firm is leveraged over 30x itself, when most of your revenues come from an area that hasn't generated enough volume to support your structure in over a year (even after two major rounds of layoffs), and when your swap spreads blow out by a factor of 15 or 20 in the course of a few weeks, short sellers (who have to risk a lot more capital than derivatives traders) are the least of your concerns. Or just the icing on the cake.

Mark Gilbert mostly gets it right here:

U.S. and U.K. regulators are wasting their time threatening traders who profit from speculation about the deteriorating health of the financial community. The gossips aren't to blame for the demise of Bear Stearns Cos., and they won't be at fault when the next firm goes bang, either.

Brokers, futures traders, collateral managers and compliance officers are ranking their counterparties from strongest to weakest, and choosing to stop doing business with whichever company comes bottom. If the same name gets crossed out on every list, it spells game over for the loser -- deserved or not.

And, to be clear, when you have done Jack about it in the month leading up to the day before Ben Bernanke decides he needs to help you because no one else will, two dollars a share is for the other shareholders; getting punched out in the gym (note the correction at 7:53a.m. on 3/28) is Getting Off Easy.

But the seeds of Alan Schwartz's destruction-by-inaction were, as Gilbert notes, planted in 1998:

In his 2001 book When Genius Failed, Roger Lowenstein details the Fed's crucial 1998 meeting to convince Wall Street that it should shoulder the financial burden of keeping Long-Term Capital Management LP afloat or risk financial meltdown.

James Cayne, the CEO of Bear Stearns, told his peers—including Philip Purcell of Morgan Stanley and Herbert Allison of Merrill Lynch—that his company wouldn't join the 14 securities firms paying for the rescue.

"In unison, the CEOs demanded an explanation," Lowenstein writes. "This only made Cayne more resolute. Bear had enough exposure as a clearing agent, Cayne said. He wouldn't say more. Suddenly these paragons of individual enterprise seethed with communitarian fervor. Purcell of Morgan Stanley turned beet red. He fumed, 'It's not acceptable that a major Wall Street firm isn't participating!' It was as if Bear were breaking a silent code; it would pay a price in the future, Allison vowed."

Only the Stevens Levitt and Dubner might be surprised by that reaction. The rest of us noticed that, when rumors of an illiquid Lehmann started spreading, the first thing that happened was that Goldman Sachs trotted out a Senior Executive to confirm that they view Lehmann as (something like) "a strong, viable competitor."

When rumors started about Bear, there was about three days of silence, followed by the negotiations of March 14-16 to avoid Chapter 11 on the 17th.

That may be a case of revenge being a dish best served cold. Maybe the calls were made and no one was willing to do what Goldman did for Lehmann.

But all of the other evidence is that upper management just didn't realise that its job isn't to manage departments so much as to manage public perception by making certain that anything that might worry investors—say, the market for your CDS swap spreads going well past junk levels—is handled quickly and publicly.

That's why they pay the CEO—and the Board of Directors—the big bucks and bigger stock options. In early March, several "leaders" of BSC proved they were overpriced.


*No picture, in keeping with this plea.

Labels: hedge funds, High Finance, leverage, liquidity, The Old Firm