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How hedge funds sank Bear Stearns

Robert Peston | 20:52 UK time, Friday, 14 March 2008

Bear Stearns was taken to the very brink of insolvency over the past 24 hours by a sudden collapse in confidence on the part of its hedge-fund clients.

There was a wholly modern hedge-fund run on the investment bank.

Here’s how it happened.

One of Bear Stearns’s most profitable businesses was its prime brokerage, which provides lending and admin services to hedge funds with a fixed-income bent.

These hedge funds deposit their assets at Bear Stearns, which the investment bank uses as a source of liquidity.

But – according to a banker close to Bear Stearns – in the last day or so a number of those hedge funds decided to terminate their respective relationships with Bear Stearns.

They were spooked by the rampant speculation about Bear Stearns’ fragility and its supposedly excessive exposure to US mortgages.

The hedge funds stampeded to withdraw their assets, so the investment bank was deprived of a vital source of liquidity.

That’s why it had to go cap in hand to the New York Fed for financial succour.

Perhaps the most shocking aspect of this episode is that help was in sight for Bear Stearns at the very moment the hedge funds pulled the plug.

As of March 27, Bear Stearns would have been able to exchange its illiquid holdings of mortgage-backed securities for high-quality, liquid US Treasuries, under a scheme announced last Tuesday by the US Federal Reserve.

That would have provided Bear Stearns with sufficient liquid funds to continue as a going concern.

But its hedge-fund clients weren’t prepared to stick with it even for 13 days.

It’s a very frightening manifestation of the nervousness of even sophisticated investors such as hedge funds.

In today’s highly uncertain markets, they are not prepared to give an 80-year-old Wall Street firm the benefit of the doubt for even a fortnight.

Comments   Post your comment

  • 1.
  • At 10:17 PM on 14 Mar 2008,
  • Andrew Knight wrote:

Better and more secure returns can be found in gold for now, banks are stuck in a catch 22 situation, tell investors what they can expect to lose in the long term or drip feed the news as it happens and still scare off investors. It's common sense that these hedge funds are pulling out but the long term effect is only just being felt and could happen at other investment banks and commerical banks.

  • 2.
  • At 10:33 PM on 14 Mar 2008,
  • john white wrote:

In these difficult times thank goodness that we have that Titan of the global economy Mother Brown running the UK. Unlike the Americans we have no problems with deflation in the housing market, overstreched consumers and an iron grip on the public finances. Mother B has trimmed the sails of the SS Great Britain so that this modern argonaut can safely pass throught the hazards of any global credit crunch. Those whingers who look over the Pond and are heard to mutter there but for the grace of God go we are gravely mistaken. The British consumer will rise to the occasion despite the record tax burden. Mother B will contnue to spend taxpayers money as if there is no tomorrow and everything will turn out just fine. This was part of a conversation which my old friend Tubby Isaacs heard this lunchtime as Ally D was giving an interview to that well known TV pundit Robert Peston of the BBC. Hope you enjoyed the jellied eels Robert.

Robert,

Very impressed by the quality of your analysis and commitment to your (important) duty at 8.52pm on a Friday evening.

Thank you

  • 4.
  • At 10:57 PM on 14 Mar 2008,
  • merce wrote:

Just 2 days ago the CEO of Bear Stearns said on CNBC that he was not aware of any imminent threat to the bank's liquidity.

He also stated that he had numbers to back up his insistence that the bank's position was solid.

Who on earth would not pull out their
money with this joker in charge.

  • 5.
  • At 11:13 PM on 14 Mar 2008,
  • frank cassidy wrote:

Almost every time we turn on the TV we see financial 'experts' wringing their hands and cacking their trousers about the parlous state of the money markets.

If the system is so bad and causing so many people so much angst, why doesn't Robert Peston argue for capitalism to be scrapped and replaced with a planned economy?

  • 6.
  • At 11:51 PM on 14 Mar 2008,
  • Adrian P wrote:

C'mon all you credit-crunch deniers out there, I'm fascinated to find out how you are going to blame Robert Peston's supposedly 'irresponsible journalism' this time for triggering the run on Bear Stearns.

Or now will you finally admit Northern Rock was just a big ponzi-scheme disguised as a bank?

The pensioners who queued up in September outside Northern Rock weren't panicking morons as you have implied on these blogs, they were sensibly voting with their feet just like the citizens of any ideological disaster being promoted by a corrupt government, whether its Tyneside's New Labour or East Berlin's Honecker.

But then surely from your perspective the mass media are now doing a wonderful job by covering the Shannon Matthews story to the total news-black-out exclusion of the possible collapse of every high street bank on Monday! (Not my hyperbole but the front page of the final edition of the London Evening Standard tonight).

hang on then, perhaps I'll have a go instead ... Citigroup next?

  • 7.
  • At 11:51 PM on 14 Mar 2008,
  • John Evans wrote:

I think you will find it is much more than just hedge funds which have been pulling liquidity.

The core problem for Bear has been that its global banking counterparties have been pulling lines for days, probably ever since its CDS spiralled north of 700bps.

Because investment banks are so highly leveraged, they can un-ravel so quickly.

The Fed is seeing the market heamoraging all over the place.

First it was the hedge funds
Then it was the SIV's and their parent's.
Then it was the monolines & muni bonds.
Now it is a near-bulge bracket firm.

Oh dear.

  • 8.
  • At 11:58 PM on 14 Mar 2008,
  • Neil wrote:

The idea that Bear Stearns (specifically) would be one of the first investment banks to go to the wall and even that JPMorgan (specifically) would become the preferred vehicle of choice for the US government to engineer a de facto nationalisation has been going around for several months. The so-called conspiracy theorists no longer look so outlandish...

http://www.gold-eagle.com/editorials_05/willie062907.html

"Bear Stearns is GROUND ZERO for the bond market firestorm...the theory that JPMorgan will serve as the 'waste basket' to capture the brunt of the underwater credit derivatives." - June 2007

  • 9.
  • At 11:58 PM on 14 Mar 2008,
  • Steve wrote:

"Robert Peston argue for capitalism to be scrapped and replaced with a planned economy?"

Perhaps despite the fevered state of the money markets Robert Preston hasn't quite slipped into insanity....yet.

I wanted to say thanks for the last two posts on the Bear Stearns case, it made interesting reading and for someone a bit cut off it summed up the issues and the comparisons to NR quite succinctly.

These two episodes with NR and BS have really shown up how ridiculously fragile our banking system is, and how much of it is based on the idea that John will rob Peter to pay Paul today.

I mean I live on a low income, I live like that, I didn't realise that our entire financial system also worked on that basis.

  • 10.
  • At 12:01 AM on 15 Mar 2008,
  • Neil wrote:

The idea that Bear Stearns (specifically) would be one of the first investment banks to go to the wall and even that JPMorgan (specifically) would become the preferred vehicle of choice for the US government to engineer a de facto nationalisation has been going around for several months. The so-called conspiracy theorists no longer look so outlandish...

http://www.gold-eagle.com/editorials_05/willie062907.html

"Bear Stearns is GROUND ZERO for the bond market firestorm...the theory that JPMorgan will serve as the 'waste basket' to capture the brunt of the underwater credit derivatives." - June 2007

  • 11.
  • At 12:26 AM on 15 Mar 2008,
  • ~n wrote:

Is it me or do these major crises tend to occur more on a friday than other times? i.e. allowing the weekend to cool off any panic?
Or is it just my mistaken impression?

BTW I'm getting tired of people bitching about Mr. Peston reporting (he reports on, but did not create this fragile, over-extended state of interlocking debt) nor do I find it edifiying for his concerned reporting to be exploited to make vacuous political statements ie. post #2. If you have something informative to add, or a relevant question, then say/ask it and do so concisely, otherwise it's just clutter.

  • 12.
  • At 01:25 AM on 15 Mar 2008,
  • Robin wrote:

Why is it 11.13 and no one else is awake to comment on the sad demise of western capitalism. Have all our avid commentators all retired to bed with their cup of horlicks and copy of the Economist? Here is Spain, we hardy souls will be up all night wondering why this is happening and why our prime minster looks like Mr Bean. For those of you interested in rapid asset depreciation, look no further than our burnt and pleasant land where here in Marbella, the percieved net worth of such sterling prime assets such as Luxury Penthouses and Fairline 46 motorboats are now beginning to look as cheap as chips. Johnny Brit isnt coming her anymore as he can buy his pint cheaper in the Dog and Duck and even the Spanish are suddenly realising that they have been had - no one told them about the cyclical nature of property bubbles or that borrowed money might cost more than 5% in the real world. Sun´s still smiling here - but no one else is.

The fundamental problem is actually the hedge funds. They are so highly geared that they themselves are having liquidity difficulties. Hence they now need their cash back quickly in the current climate. ALL banks rely on only a relatively small proportion of institutions and depositors wanting their money back quickly. Otherwise they could not lend for longer periods. Trouble is a bank may well be sound, but is not perceived to be sound. The only way to prove soundness involves breaking up the bank, liquidating assets and paying off liabilities. It kills the bank. A bit like proving someone is healthy by killing them and doing a post-mortem to show that they were in really good health. Bit pointless.

  • 14.
  • At 03:13 AM on 15 Mar 2008,
  • ordinary joe wrote:

BEAR STERNS .BEAR MARKET BIG WHOOPEE THIS MELTDOWN IS COMMING THESE PEOPLE AT THE HELM OF THESE PARASITIC HEDGE FUNDS ,BANKS ARE BEGININING TO SEE THERE IVORY TOWERS FALL DOWN .

I'm puzzled by one aspect of the Fed's intervention.
If it accepts mortgage backed securities as collateral, and these go down in value, does this increase the level of America's national debt?

  • 16.
  • At 10:24 AM on 15 Mar 2008,
  • Alfred P. Bright wrote:

Million pound bonuses for selling dodgey products which land the whole banking world in "kaki strasse" now seem to be bordering on grand theft. Will the so-called regulators who are also paid in telephone numbers be called to account in the aftermath of the sub-prime scandal? No wonder gold is in such high demand!

  • 17.
  • At 10:32 AM on 15 Mar 2008,
  • CG wrote:

I thought all these assets that the hedge funds are withdrawing from Bear Sterns were bought with yen, so at 98.98 yen to the dollar, how come we are not hearing anything about the yen carry trade? Was that another bit of media cobblers by Peston and Co.?

  • 18.
  • At 02:58 PM on 15 Mar 2008,
  • Toni wrote:

Bear Stearns should have been forced into bankruptcy. It is a major securities firm and a significant part of the global financial system but its customers have had plenty of warning that it is inadequate at its percieved function as a wealth management company. The hedge funds that it managed, which were the first victims of the sub-prime crisis, should have given fair warning that the firm was at best inept. A bigger question is why Bernanke is allowing his obsession with a stable financial system and Milton Friedman in general to further damage the economy of the US. America is already highly indebted and increasing liabilities in the way it has is just absurd. The country continues to believe it can always find buyers of its government bonds but when they make the rate cut next week surely foreign investors must begin to ask themselves how much of a devaluing dollar based asset they can afford to own. The Saudis are already saying the dollar is a buy at these prices but they are just talking their own book as they remain dollar linked in their own currency and of course their revenues are denominated in dollars. The fed is behaving in a highly irresponsible way but Brits must recognize this from our own economic problems of the 70's when the IMF was brought in, (it doesn't just happen to 3rd world nations you know). Bernanke thinks he is buying time but I personally think he has completely underestimated the scale of the problem and the US and the UK lying about inflation will not make things any easier. Gold is a good investment even at these levels. Hugh Hendry, (a maverick fund manager and something of a genius in my opinion), has stated in the past that he can easily see gold over $2,000 - I tend to agree.
Bloomberg reported that Jimmy Cain, chairman of Bear Stearns was in a bridge tournament for the last 2 days while his company nearly went insolvent. Whatever oversized payoff he gets is too much and is an example of the moral hazard that the Fed is supporting. Bloomberg also, and I would like Prestons opinion on this, reported that S&P rating agency lowered Bear Stearns rating to BBB only 4 hours after JP Morgan and the Fed bailed the company out. Isn't it time to expose the rating agencies for the snake oil salesmen that they are?

  • 19.
  • At 04:52 PM on 15 Mar 2008,
  • michele wrote:

whilst all of this turmoil in the money markets is very painful and worrying,I am certain that the credit crunch was inevitable and in the long run will put borrowing/lending on a realistic footing instead of the cloud cuckoo land it has inhabited in the last few years.It seems to boil down to people wanting things they cannot afford and lenders encouraging them.Unsustainable borrowing corporate or individual was always going to lead to the present situation.Lets hope the credit crunch is a sharp lesson learned not something worse.

  • 20.
  • At 05:00 PM on 15 Mar 2008,
  • ordinary joe wrote:

BEAR STERNS.MORE LIKE BEAR MARKETS,YES THEY MIGHT HAVE HAD SOME LIQUIDTY PROBLEMS,BUT IT APPEARS THAT THERE WAS A LOT OF TRADER GOSSIP.IN THOSE TYPE OF CONDITIONS AND FEAR FROM EACH OTHER,IT WONT BE LONG TO THE NEXT FINANCIAL CASUALITY.

  • 21.
  • At 11:39 PM on 15 Mar 2008,
  • Scamp wrote:

The only error I can see in Robert's piece is describing hedge funds as sophisticated.

  • 22.
  • At 11:51 PM on 15 Mar 2008,
  • Yummy Carol Kirkwood wrote:

Re: #6 Adrian P

But then surely from your perspective the mass media are now doing a wonderful job by covering the Shannon Matthews story to the total news-black-out exclusion of the possible collapse of every high street bank on Monday! (Not my hyperbole but the front page of the final edition of the London Evening Standard tonight).


Funnily enough, only this very morning was I myself remarking on the continuous mass coverage of the Shannon Matthews story on BBC News 24, without even so much as a mention of the Bear Stearns story, yesterday's big drops on the US markets, etc., etc.

  • 23.
  • At 11:54 PM on 15 Mar 2008,
  • Dana Mauch wrote:

It does not make total sense that the hedge funds sunk Bear, as the funds' liquidity, is not that liquid in that it supports leveraged investments, which Bear was big into.The leveraged assets are not, for the most part, saleable right now at a break even proposition. Watch the waves, funny that the first guy said his money was safe in gold, which is the next area of depreciation. Someday, in the next few weeks commodities will get clobbered. As for now, I am going to have a beer for the Brit who lost 800 million on Friday.

  • 24.
  • At 08:44 AM on 16 Mar 2008,
  • John Evans wrote:

Post 13 & 14.

Please educate yourself on what a hedge fund is and then come back and comment with some authority. To blame this all on 'hedge funds' is ridiculous. Hedge funds have actually had a good month, with the global Tremont index showing 2.2% return for Feb.

Bear has always.... always been the bottom of the pile with the bulge bracket banks. Doing the things the other institutions wouldn't, taking the risks, furthest on the edge of acceptable banking behaviour.

To say that all IB's will fail because of Bear is fallacious. Did they all go bust when Drexel did? Read the background to the days when the Fed was trying to resolve LTCM. The biggest problem to a solution was James Cayne, and this is coming back round to bite them. No one on the street wants to help Bear when it is sliding down, so they start pulling lines, cutting Bear's liquidity. It doesn't have the retail franchise to rely on like Merrill's or JP, and was much more over exposed than Goldman.

Will it go bankrupt? No. Will it be the same? No. Will it be broken up and bought out? Most likely.

Where will the next big bang happen?

Those banks that are heavily exposed to leverage finance, and those funds / CTA's which are riding the current commodity bubble.

The bursting of oil will cause a lot of pain over the coming month.

  • 25.
  • At 12:19 PM on 16 Mar 2008,
  • Old Nick wrote:

Neil #10 - You are spot on.
Excellent link - chillingly prophetic.
I recommend it to all - expecially the 'ostriches' who keep whinging about Robert Peston's superb reporting over the past 8 months.
One passage caught my eye (and this from June 07)

"The fresh money in colossal volumes used in rescue, called monetary inflation by the wise, called liquidity by the deceitful, will be the harbinger of the march to $1000 gold."
http://www.GoldenJackass.com

Wake up folks, open your eyes - The Emperor Has No Clothes and has been stark naked for years.

On a practical level I think the only sensible solution is to string every thieving, lying banker (at least from director level upwards & all their sychophantic economic advisors and toadying, cringing politicians) from the highest lamposts and let them rot there for eternity - while the rest of us try and figure out a more sensible approach to handling our lives, money and economy.
Perhaps this is the approach...
http://www.prosperityuk.com/prosperity/prosperity.html

  • 26.
  • At 01:20 PM on 16 Mar 2008,
  • eddie garcia wrote:

i don't believe that the fed's should have bailed out bear sterns. the new york federal reserve came into the picture is because high profile investors wanted the government to step in for a quick fix. this is wrong. what will happen when other firms like bear sterns are in the same situation? will the american tax payer again be ask to give up more of their money to help out corporations that were not thinking about "WHAT IF" our investment doesn't work. i have a small computer/printer repair service business. do i ask the fed's for money to help pull me out of an investment i made knowing that it may not work?? we americans are sick and tired of coming to everyone help when someone cries WOLF. let bear sterns and other firms like them go out of business. its hard times like these that make the strong, stronger.
i don't believe that it will get any better till the end of 2009 or the start of 2010. get ready for hard times my friends. its world wide.

good day--
eddie garcia from the republic of texas

  • 27.
  • At 01:44 PM on 16 Mar 2008,
  • joe 2 wrote:

dito

  • 28.
  • At 03:22 PM on 16 Mar 2008,
  • Frank Upton wrote:

The hedge funds have behaved rationally, just as the Northern Rock investors did. There was a real threat to their money, so they withdrew it. It is not the hedge funds' fault that Bear Stearns accepted more and more of their money without being able to re-invest it in a sufficiently safe and diversified way. Like Northern Rock, this was just bad banking, lending too much to the wrong people and failing to spread risk.

P.S. Northern Rock was not a Ponzi scheme, as someone suggested, because NR actually sold on its mortgage loans. It wasn't paying interest out of new investors' savings.

  • 29.
  • At 04:26 PM on 16 Mar 2008,
  • eddie garcia wrote:

i don't believe that the fed's should have bailed out bear sterns. the new york federal reserve came into the picture is because high profile investors wanted the government to step in for a quick fix. this is wrong. what will happen when other firms like bear sterns are in the same situation? will the american tax payer again be ask to give up more of their money to help out corporations that were not thinking about "WHAT IF" our investment doesn't work. i have a small computer/printer repair service business. do i ask the fed's for money to help pull me out of an investment i made knowing that it may not work?? we americans are sick and tired of coming to everyone help when someone cries WOLF. let bear sterns and other firms like them go out of business. its hard times like these that make the strong, stronger.
i don't believe that it will get any better till the end of 2009 or the start of 2010. get ready for hard times my friends. its world wide.

good day--
eddie garcia from the republic of texas

  • 30.
  • At 04:48 PM on 16 Mar 2008,
  • james edwards wrote:

There are really some nutters reading this blog. No there will not be an end to capitalism because of this credit crisis it has withstood many shocks since its 200 year inception and it will probably withstand this episode. However obviously there will be many changes after this. Robert Peston keep up with your great journalism in this important time of uncertainties.

  • 31.
  • At 05:35 PM on 16 Mar 2008,
  • Adam wrote:

Unlike Northern Wreckers, which was a domestic operation Bear Stearns does have international operations. So does anyone have any suggestions as to how JPMorgan/Fed are going to feel about them?

Also nobody has so far suggested that everything is going to be fine once the liquidity position is fixed, this is strange given Bear is a profitable company given text book early support. Are you becoming guilty of irrational pessimism?

  • 32.
  • At 05:59 PM on 16 Mar 2008,
  • noam chomsky? wrote:

In today’s highly uncertain markets, they are not prepared to give an 80-year-old Wall Street firm the benefit of the doubt for even a fortnight.

They wood give the benefit of doubt..But not to Bear Sterns.Bear Sterns perpetuates lies its better that they go they are part of the problem if they dont deal with Bear now it will be a Causation later as they are now..

  • 33.
  • At 06:32 PM on 16 Mar 2008,
  • JayKay wrote:

I could not agree more with Toni. The ratings agencies lowered BS ratings soon after the Fed came into its rescue.Its like saying "hey u know what, it had rained yesterday". The funny thing is there are lot many people who still believe in these agencies.

  • 34.
  • At 07:20 PM on 16 Mar 2008,
  • michael griffiths wrote:

Two years ago I read a book Wake Up by Jim Mellon and Al Chalabi. This book forecast much of what is happening today including the down of the dollar/ rise of gold/housing market colapse and the demise of a major us bank.And much more....
Everyone should read this book

  • 35.
  • At 07:24 PM on 16 Mar 2008,
  • Ian in London wrote:

Hi Rob,

Who do you think you are fooling, when you say 'high quality US Treasuries?'

That is an oxymoron if ever I have heard one. The US Treasury is bust. There is now way it could repay all the debt it owes without driving the US into a spiral of hyper-inflation.

The only reason the reckless monitary policies of the Fed and the US government have got this far is because the central banks in China, Japan and the Middle East are either extremely gullible or extremely thick, or a combination of the two.

US debt is not worth the paper it is written on. The gold reserves in Fort Knox have not been audited since 1947 and most likely been given away to debtors.

I would not touch US debt with a barge pole. The sooner all US debtors realise this the better they all will be.

  • 36.
  • At 07:40 PM on 16 Mar 2008,
  • Robert Cowley wrote:

Perhaps the world would be a better place without all such organisations. You all seem brainwashed into thinking that there is no other way in which we might live.

  • 37.
  • At 07:56 PM on 16 Mar 2008,
  • jeremy tree wrote:

'Hedge-fund run on a bank'

Well the question is whether this hedge-fund run was an example of a huge 'shark-attack' - i.e., a situation when hedgefunds take large short positions on a share-price (usually leverage to obtain maximum profit) and then orchestrate a situation that will promote selling. (You see the same the other way, with 'bid rumours' always breaking on a friday)

Someone asked why do these things tend to happen on Fridays? Well fridays are often days with low volumes, and hence a much bigger effect of larger trade positions accompanied with a 'shark-attack'.

You may ask, why would hedgefunds try to make money on causing a run on a bank, when they have assets in that bank?

Well the answer is simply, they knew their assets were protected anyway - by a third party, the FED.

So this is an easy win scenario, short the bank you are threatening to remove your assets from. (Of course BS's share has fallen some 40% in a day) - wait for the
FED to step in, and then reverse your shorts (by going long) off the back of the inevitable 'bounce' when the panic is over - all the while, the only thing you were risking (your assets with BS) are under in fact no risk at all.

Paranoid, moi?

  • 38.
  • At 08:03 PM on 16 Mar 2008,
  • Chris Thomas wrote:

The apparent stupidity of people in high finance is astonishing to an ordinary working bloke like me. Do they have any self-control? This is the down side of having ultra-competitive people running the world's finances. It is a disaster just waiting to happen and, eventually, it surely will.

The sub-prime mortgage problem is absurd. Why didn't the lenders renegotiate with the borrowers so that they don't lose the entire value of all the bad loans? No, they couldn't do that. How ridiculous! They have to destroy their assets in some sort of collective suicide which shows that financiers have evolved from lemmings.

Looks like the liquidity problems which prevailed in 1929 will revisit us 80 years on. Perhaps we need to screw up big time as a kind of ritual cleansing. Looking on the bright side, a depression would go a long way to saving the earth's climate.

  • 39.
  • At 08:05 PM on 16 Mar 2008,
  • Pat B wrote:

24. John Evans
"Please educate yourself on what a hedge fund is and then come back and comment with some authority..Hedge funds have actually had a good month."

Excuse me?

Peloton Partners' £1bn fund collapsed, and Jersey-based Carlyle Capital Group £8bn fund imploded.

How this was a good month for hedge funds?

  • 40.
  • At 08:47 PM on 16 Mar 2008,
  • Bob Wallum wrote:

In the past, banks would receive credits from the Bank of England, in the form of discounted treasury bills. Those credits would be further distributed throughout society based on sound banking practice. That is, the banks would ensure as far as possible that money lent would be repaid, with interest. Avoidance of default was a primary consideration. The banks, as wholesalers of credit, would lose money if they were not repaid and in turn would be unable to meet their obligations with the central bank.

The banks held a privileged role in society, and with it, responsibility for lending to society at large.

In this way governments, through their central bank, could regulate the amount of money at the disposal of society and enable them to control the state of the economy.

Globalisation of banks activities has changed this position and made it more difficult to control the economy. Raising currency through limiting issuance of bank notes through the central banks, ceased to be an adequate means of control. Global banks have created their own currency in the form of bonds linked to debt. These bonds have no territorial boundaries.

The global banks built a huge fiat currency economy based on debt that was, in part, irrecoverable. They built structures to disguise the origin of the debt, such that the debt based bond became an independent security in its own right. The collapse of this massive debt bubble is now apparent to the world at large.

The single action that enabled the bubble to build and develop was the separation of the debt obligation from the underlying account.

By separating the obligation from the account, new accounts have been generated and written off from the single obligation. Around 100 billion dollars of debt bonds have been written off by global banks over the past year or so. A significant proportion of the underlying debt accounts had been previously written off. On each occasion of writing off an account, tax credits were obtained.

The banks have undermined national economies so much that central banks now wish to deal with the commercial banks in secret, lest the public become alarmed. (Who owns your mortgage?) In order for the commercial banks to be kept afloat, governments are exchanging high quality treasury bills for junk bonds.

The banks are being kept alive to prevent collapse of the banking system and society as we know it. The preyed upon consumer has no such support. Unfortunately the damage has been done and secret dealings will not prevent the inevitable consequences. Northern Rock has been a highly visible example. Bailing out Northern Rock has pushed the government beyond it's own, long established lending criteria. Society will suffer the excesses of the commercial banks regardless.

The mechanisms used by the banks are highly fluid. It is difficult for national revenue authorities to keep track of the variations. Debt bonds are traded across national boundaries. They are incorporated into other funds, sliced and diced to 'spread risk' and reissued as investment bonds. The audit trail, linking the obligation to the issued bond, is deliberately obscured and in many cases completely lost.

The banks have, at any point in the process, options that enable them to take a number of courses. However they have been primarily interested in growing their institutions by accumulating large amounts of their self generated fiat currency based on debt obligations. The following notes show where the obligation has been split from the underlying account, where multiple accounts have been generated from a single obligation, how these accounts have subsequently been written off at the expense of the revenue authorities and society at large, and how sound banking principles have been put to one side to maximise the sale of debt irrespective of the ability of borrowers to pay the debt back.

The banks have become a major threat to the stability of national economies, leaving a trail of misery for millions of people in their wake. It goes beyond lack of duty of care. It goes beyond irresponsible and negligent lending practice.

I submit that this is fraud on a major scale by a cartel of commercial banks, their associates and the credit rating agencies.

The origin of this fiat currency can be traced back to the mid 80s. MBNA bank, founded in 1982, is largely credited with inventing the securitisation of credit card debt. In 1988 the Basel Accord, an agreement between global bankers, set limits of lending relative to value of assets held. This became a trigger for innovation that enabled the banks to both increase lending and at the same time use that lending to increase their assets, a process known as securitisation.

The Original Lender bank provides a loan to a consumer. The banks are not really interested in the ability of the consumer to pay the debt back. They have formulated the contract so that defaults carry no financial penalty to them and through the cartel have co-operating companies that turn the default into assets. It can be argued that the banks make more money from defaulted accounts than from accounts which run their normal course.

The loan amount, with interest added becomes considerably more than the sum advanced. In this way lending say £25,000 over five years at 7.9% becomes £30,148.20. The bank calculates a present worth value, based on an interest rate linked to inflation. That pay back amount has a present day value, discounted by inflation, of £28,000 (in round figures). The bank holds a book loan of £25,000, which burdens its lending allowance under the Basel Accord (now Capital Requirements Directive -Basel2), yet has an asset worth £28,000 as a future revenue stream, or debt. The debt is moved to a Special Purpose Vehicle (SPV), an 'independent' corporate body. An SPV can be administered by a charity. The debt is thus removed from the bank's balance sheet, the SPV forwards funds based on the £28,000 value, discounted slightly, to provide cash to say, £27,000.

The £25,000 loaned becomes £27,000 returned almost before the ink has dried on the loan contract, so to speak. The bank now has £27,000 to loan and so on. The consumer receives no benefit and the bank makes huge profits. The deficit (loan) in the bank's account is replaced by an asset of £27,000, almost overnight. The incentive to lend is very high but what about the balancing asset requirement? The banks simply buy back debt bonds but they buy lower quality debt, blended in a secondary market, at a much lower price, yet use the bond value as rated by a Credit Rating Agency (CRA) to put a value to the assets they hold in accordance with the Basel Accord. This potent cocktail of high cash flow and cheap assets drove the banks to throw caution to the wind and dash for growth. The outcome was manifest; bankers with multi million pound bonuses, mortgages above seven times income, increasing loan defaults and eventual seizure of inter bank lending.

The trick is the separation of the debt obligation from the underlying account. The debt account has moved but where is the obligation? The bank retain it, or so they say, and so the consumer keeps paying the bank. This is a fundamental step in making the cartel work and one that I submit is a keystone that supports the fraud.

The SPV collects many debts into its fund. It then issues bonds based on those debts. Structured Investment Vehicles (SIV) buy these debt bonds, mix them up in a number of ways and produce 'structured' investment bonds. As the debts become increasingly processed the origin is lost and the bonds develop a life of their own. The 'investment' bonds produced are sold back to the banks, to insurance companies and pension funds (fallout yet to be declared in this area).

The bonds are used as collateral to lend between banks, thus creating an ever increasing supply of fiat currency for the banks to lend even more to the unaware populace, with very little if any consideration about the probity of their lending.

The banks have full knowledge of the level of defaults they are likely to create. They run sophisticated risk models and have full control over the terms in a contract. Their activities are kept under a veil, usually one called 'confidential' or 'commercial'.

The Courts do not appear to see the banks machinations when a default is presented to them. They merely look at the original contract and enforce the terms therein. Assignation requires mere intimation. No contract of intimation is required for judgement. Attempts at calling the contract unfair are dismissed. As an analogy, consider a poacher, who crafts a clever fly and takes a salmon from the Tweed. Upon discovery of the distressed salmon, it is blamed for being caught and must suffer the consequences. It did, after all, have a choice on whether to take the fly or not. The poacher slips away to re craft his fly for another day.

Billions of dollars of debt bonds have been written off by banks in the past year. They obtain a tax credit in so doing. If they become insolvent as a result of their 'flawed business model' they are bailed out by central banks. What happens to all the debt obligations? The Courts appear to say that the debt obligation is distinct from the account and writing off the account does not write off the obligation. Will we see the trillions of dollars of debt obligations resurrected by some other future machination of the banks? The Courts would appear to say they can. In this way the Courts have given succour to the banks and encouraged their behaviour. This cannot be right.

As for choice, does the consumer really have a choice on whether or not to take up debt? Now, we even saddle our children with debt before they finish their education. We cannot purchase a home without lifetime debt. The economy is driven by consumers taking up debt and the central banks deliberately pump increasing amounts of debt into the economy for consumer consumption.

At default, further machinations come into play. How can the obligation be both sold and assigned?The debt, that was probably moved into a SPV earlier, is assigned with the flimsiest of formality. The debt obligation has been used again to create another account. It is sold by the Original Lender for a fraction of the outstanding balance. The difference between sale to debt collector and the outstanding balance is written off by the Original Lender for a tax credit.

The Courts obligingly endorse the outstanding balance value of the debt. The debt collector retains the debt and seeks to recover the full amount. The debt collector appears to be at arms length but has a Principal, a major global bank, in support of his registration with the Financial Services Authority. The account is again 'securitised' and moved off balance sheet into another SPV and through to a SIV to be blended with other debt and obscure the origin. This is another example of how the one obligation leads to the generation of multiple accounts. The bank buys bonds containing the debt and subsequently writes them off for tax credits when that particular bubble bursts. The bonds will contain elements of debts already written off for tax purposes and the same bank may be involved in both write off events.

The Courts resist any attempt to uncover the machinations of the banks. It may be that the Courts are instructed to dismiss any challenges to this practice in the interest of the greater good of society. I do not know and I am not privy to any such arrangements. Society does not benefit. The glut of fiat currency generated by the banks has forced up house prices to previously unseen levels. Millions of people will now suffer as the market collapses and defaults rise. The damage has been done and I believe it is time to lift the veil to avoid it happening in the future.

In particular I submit that the debt obligation of the debtor should be linked to a single account of the creditor. If the creditor reduces that account then the obligation is similarly reduced. If the creditor disposes of the account then that is assignation. The creditor must choose to gift the entire account, forgoing any tax credit, if he wishes the obligation to remain entire, or reduce the account accordingly if he wishes to use part of the balance for a tax credit or other purpose. The debt obligation and the underlying account are two sides of the same coin.

  • 41.
  • At 09:09 PM on 16 Mar 2008,
  • Matt wrote:

The Fed must be starting to realize by now that their sustained program of rate cuts isn't doing any good. Yet Benanke, as Jim Rogers puts it, "...continues to print money like a crazy person!" Perhaps we've only seen the tip of the iceberg and the Fed is wise to a much deeper crisis in the making. Why else would the continue down this path regardless of it's ineffectiveness? Their options are rapidly decreasing. The stock market is going down regardless.... Benanke just holds it up for another month when he cuts rates. His other desire to put more money in the consumers pocket is backfiring spectacularly. Mortgage rates have remained static and commodity prices have spiraled out of control.

It's quite clear that the weakening dollar is the route to a lot of these problems. So what should he do? How about this... At the next FOMC he should cut rates by 0.25% and say, 'that's your lot!, read my lips, no more rate cuts...' At the same time intervening in the currency...The dollar will explode... In doing so, it'll iron out a few speculators, making them think twice before they do it again. The stocks will fall, (but only to the price they would have gone to anyway, over a protracted painful few months) and after some initial volatility the long bond market will stabilize. Commodity price, inversely linked to the dollar, will fall and after a week or two everything will settle down.

He won't of course, because he's a spineless puppet of Wall Street's... Let the banks who took excessive risks fail. Other more prudent firms will simply take their places at the top of the league.

  • 42.
  • At 09:22 PM on 16 Mar 2008,
  • Divya wrote:

It is good to see some comment on an affair which has really not been covered in too much detail by the BBC (online or on News 24).

However, I do feel that the article misses the point about Hedge Funds removing their money. The Hedge Funds have a duty to their investors to make sure their money is as safe as possible.

Any Fund of Fund or Institution that saw a hedge fund leave their money with Bear Stearns and not transfer it to a 'safer' bank, would redeem their investment immediately.

  • 43.
  • At 09:33 PM on 16 Mar 2008,
  • ordinary joe wrote:

i dont know about bear sterns,its a bear market out there now.

  • 44.
  • At 09:41 PM on 16 Mar 2008,
  • Jeremy tree wrote:

'Hedge-fund run on a bank'

Well the question is whether this hedge-fund run was an example of a huge 'shark-attack' - i.e., a situation when hedgefunds take large short positions on a share-price (usually leverage to obtain maximum profit) and then orchestrate a situation that will promote selling. (You see the same the other way, with 'bid rumours' always breaking on a friday)

Someone asked why do these things tend to happen on Fridays? Well fridays are often days with low volumes, and hence a much bigger effect of larger trade positions accompanied with a 'shark-attack'.

You may ask, why would hedgefunds try to make money on causing a run on a bank, when they have assets in that bank?

Well the answer is simply, they knew their assets were protected anyway - by a third party, the FED.

So this is an easy win scenario, short the bank you are threatening to remove your assets from. (Of course BS's share has fallen some 40% in a day) - wait for the
FED to step in, and then reverse your shorts (by going long) off the back of the inevitable 'bounce' when the panic is over - all the while, the only thing you were risking (your assets with BS) are under in fact no risk at all.

Paranoid, moi?

  • 45.
  • At 10:05 PM on 16 Mar 2008,
  • DaveH wrote:

The Wall Street Journal is reporting now (Sunday evening) that BS will be sold to JPM for about USD20 a share - it was USD63 just last Monday!

  • 46.
  • At 10:48 PM on 16 Mar 2008,
  • Paul wrote:

I wonder if the hedge fund companies shorted Bear Sterns prior to their withdrawl demands...

Nah, they'll never do that :-)

Great blogs Robert, cheers

  • 47.
  • At 11:03 PM on 16 Mar 2008,
  • Patrick wrote:

High earners who , we plebs are assured, are paid such high salaries and bonuses and stock options to avoid precisely such "blips" in the market should really employ a bit of common sense: if it looks too good to be true then................

Professional engineers employ tried and tested theory in the design of projects. What happened when their advice was overruled by money men -
Space shuttle explosion due to rubber seal failure which was predicted by engineers.
New Orleans levee failures predicted by engineers but remedial works canceled - by money men.
regards
Patrick

  • 48.
  • At 11:24 PM on 16 Mar 2008,
  • ordinary joe wrote:

I AINT NO ECONOMIST I AM JUST A ORDINARY SO AND SO,BUT THIS IS HOW I SEE IT.MR AND MRS AMERICA FROM THE GARAGE ATTENDANT AND HIS WAITRESS WIFE,TO THE SMALL COMPANY CEO AND HIS REAL ESTATE WIFE, HAVE BORROWED 75% TO 100% ON THE EQUITY OF THEIR HOUSES,TO FURNISH A LIFESTYLE AND LEVEL OF EXPENDATURE,THAT QUITE HONESTLY THEY HAVE BECOME TO EXPECT AS THERE GOD GIVEN RIGHT. WELL HE DOES GET A MENTION ON THE EVER DEPRECIATING DOLLAR,ANYWAYS THE MONEY THAT HAS BEEN HANDED OUT FROM ALL THESE BANKS AND TRIBUTERIES THROUGHOUT THE WORLD TO FUND THIS SPENDING FRENZY HAS GONE VAMUSHED INTO THE WORLD PURSE,NOW BACK TO MR AND MRS AMERICA,DONT THINK FOR A MINUTE THAT GIVEN THE STARK RELIZATION THAT THERE HOUSES ARE NOW SERIOUSLY IN NEGATIVE EQUITY, AND THAT IN MOST CASES COULD TAKE TEN YEARS TO REGAIN THEIR INFLATED VALUE,ALL THIS WHEN FUEL COSTS,FOR HEATING AND THERE GAS GUZZELERS ARE UP A THIRD IN A YEAR,NOT TO MENTION THE MEDICAL INSURANCE AND FOOD,SO GUESS WHAT THE KEYS ARE GETTING PUT INTO A REGISTERED MANILA ENVOLOPE AND SENT BACK,AND MR AND MRS AMERICA ARE ONCE AGAIN A NATION OF RENTORS. AND LAST BUT NOT LEAST THE BANKS ARE CLAMARING TO BATTEN THE HATCHS AND TRUSTING NOBODY AND KNOWONE BECAUSE THE EXPOSURE COULD AND IS EVERYWRE AND FROM EVERYBODY,AND FEAR HAS SET IN AS BEAR STERNS GOES TO SHOW.

Communism looks pretty peachy right now. Cuba, lowest obesity in the modern world, excellent education system and brilliant healthcare. People who say that their freedom is limited are talking rot. The west interprets "freedom" as actually meaning "greed". As amply illustrated by our current economic difficulty, even freedom needs to be curbed or at least responsible.

I also agree about the lack of news coverage. The FTSE at an all time low, the U.S. announcing write-down after write-down, yet we're still stuck with "no news since she was found" Shannon Matthews.

You know what they say about the media "only worry about what you're not being told". A total blanket ban on the economy at present.

  • 50.
  • At 01:07 AM on 17 Mar 2008,
  • S McCabe wrote:

...And the FT is reporting tonight (Sunday) that JPM has agreed to buy Bear for the rock bottom price of $2 (yes two) Dollars a share. On Friday afternoon they traded at $30 and in Jan 2007 at $169.

Goodnight Bear Stearns!

  • 51.
  • At 02:28 AM on 17 Mar 2008,
  • Charles wrote:

The Bear Stern bailout,at a fraction of their previous share price-with help from the Fed-mirros what happened in Uk with N Rock.

If you're a bank you get bailed out.Any other non financial business will have to save itself.

  • 52.
  • At 06:37 AM on 17 Mar 2008,
  • Alex Brown wrote:

It's quite simple - these issues exist because they have been allowed to by the various Governments. The downside is that we all live in this bubble and when it goes, we go...

Jobs, investment, are all affected by credit, after all - most goods are bought either on short or long term credit. If every person in the 1st world cut up their credit cards, paid off their loans and refused to take another debt on (including mortgages), then we truly would be facing another recession like Black Monday (1929). The reason? Nothing around us is really owned, it's all borrowed. This is what is sinking the investment banks, a reality check on finances and the realisation that too much debt is very, very bad.

  • 53.
  • At 07:57 AM on 17 Mar 2008,
  • Geoff Brown wrote:

The turmoil in the money markets clearly demonstrates that the large investment banks are little more than money scams. These large institutions are not, as some would have us believe, genuine wealth creating businesses and it is now becoming evident that their recorded growth and profit figures were only achieved by deliberately and continually over inflating their true worth.

The people running these insitutions are not some hard working entrepreneurs using sound business techniques and principles to achieve the desired results. Instead they are being run by greedy uscrupulous people using dubious methods to reward themselves huge sums of money in the shortest possible time before they are found out.

  • 54.
  • At 08:32 AM on 17 Mar 2008,
  • Andrew wrote:

Some market commentators say better returns can be had holding commodities, say gold. They would do well to note that investors who bought at the top of the last peak in the gold market lost 90% of their capital in the first 10 years and still haven't recovered their losses. Gold pays no dividends or interest, it has enormous volatility, and its price is controlled by central banks who have no interest in preserving its value. It's the financial equivalent to betting on the horse with the nice name.

  • 55.
  • At 10:04 AM on 17 Mar 2008,
  • Lloyd wrote:

I thought under a capitalistic financial structure companies went bust if they got it wrong?? Why are governments bailing out financial institutions?? Would they do the same for all companies? Of course they won't/don't. The question has to be why? Why are governments afraid of letting one or more of these financial institutions go bust? The message it would send would concentrate the minds of these firms and maybe stop these crazy situations.If not then let's stop pretending that we operate a capitalistic system and extend the safety net to all companies not just the big ones.

  • 56.
  • At 10:55 AM on 17 Mar 2008,
  • Sebg wrote:

#26
'we americans are sick and tired of coming to everyone help when someone cries WOLF'

A little piece of info from outside the Grand U S of A....
Other nations do not want your help!

The US economy is driving the global credit crunch, and perpetuating it into stages 2 and 3.

The incessant interferance in 'free markets' is part of the problem, not the solution.

The hallucination of Americans wanting to live beyond their means is the main contributing factor to why your economy, other nations' economies, and the financial markets are suffering.

Get your own house in order before you try and play 'saviour' to the world...

  • 57.
  • At 03:50 PM on 17 Mar 2008,
  • LouiLoui wrote:

Peston - get a life mate. Just because the world's markets are in turmoil, central banks are panicking like roaches with the light on and the whole financial system is falling on it's arse - there's no need to be up working at 8:52pm on a Friday night.
I have just enrolled on an SAS style survival course so I can cook on an open fire and gather nuts and berries from the woods for survival. I suggest you do the same...

  • 58.
  • At 06:16 PM on 17 Mar 2008,
  • Matt Hayden wrote:

It seems like a replay of the great depression of the 20's. JP, Rockfeller and their likes come in, buy distressed units, and put a choke hold on the economy. Maybe this is what they are after, a way to promote the "Amero."

Its amazing how the "capitalist" governent rushes to mitigate financial institution losses but it could care less what manufacturing loses!!

#.53 is correct. The government has no legal grounds to bail out BS. If it goes broke, it goes broke. The government will not bail out any old poor Joe Shmoe going broke. Unless maybe they are a friend of Boosh and company.

  • 60.
  • At 08:38 AM on 18 Mar 2008,
  • Deb wrote:

The SEC did away with the "short tick rule" in June 2006. Hedge Funds add volatility to the markets, thus, ensuing large swings in the Dow Jones, Nasdaq, etc.

Hedge Funds are not regulated by the SEC in the U.S.A. where as Institutional Investors are indeed regulated and can only buy and hold then sell.

Hedge Funds can SHORT the market. Institutional investors are not allowed.

Subprime mortgages 'aka' as ARM's (adjusted rate mortgage rates) were lent to people who didn't have any downpayment and didn't have to prove statement of income were given these loans because of spotty credit woes. Then the banks gave them (home equity loans) so, most went and spent their home equity loan on furniture, auto's etc.. Then within months, they discovered the negative amortization were to reset at higher rates+ the value of their homes went down in value over $50,000.00 (in some areas)within a matter of months. They walked away and handed the keys back to the bank. They had nothing to lose. Most of these people have no scruples. So, who pays in the end? The American taxpayers and the rest of us that's who.

BTW, I am a Canadian and we always have to show proof of income when purchasing propery or purchasing a loan. We have to bring in a copy of our two past years of income taxes from Revenue Canada plus a letter from our employers with proof of salary on the company's letter head and sometimes they will call the employer to ensure that you still work there and verify your salary. This is not new neither, its always been that way as far back as I can remember (since my first mortgage in 1975). Canadians have to put a minimum of 5 percent of the 'mortgage' for a down payment.

We don't know what a home equity loan is in this country, Canada. It doesn't come automatically with a mortage that's for sure.

As for Bear and Stearns who purchased 25,000 Put contracts on Wednesday? $30.00 puts sold for .15 cents to .75 cents each and today they are selling for $6.00 for one Put contract, which controls 100 shares.

Option Expiry is the third Friday of March. Somebody gambled and won. Who was it hmmmmmmm?

Thanks for the rant.
Good luck we'll all need it.
Bonne journee

  • 61.
  • At 03:02 PM on 18 Mar 2008,
  • Robert Layton wrote:

Has anyone done a comparison of the bonuses paid by these financial institutions in recent years against the losses they are now suffering?

  • 62.
  • At 04:32 PM on 18 Mar 2008,
  • John Subtle wrote:

I understand much of the debate here but would someone be kind enough as to explain to me (a) why the banks need liquidity, is it to show that they have assets which they can then lend against themselves?; and (b)what type of liquid assets do the hedge funds deposit with the banks. Is it investors money or assets of companies invested in by the fund.

Would really appreciate any input.

Thanks

John

  • 63.
  • At 11:44 PM on 18 Mar 2008,
  • Hayden Clark wrote:

Grr. Too many nicely-suited grandees of the financial industry will walk away from this with their pensions, bonuses, and nice houses in the county intact. Unfortunately, it seems that gross carelessness with other people's money isn't actually a crime.

If it was, most pension/endowment/unit trust companies would go bust!

  • 64.
  • At 07:34 AM on 20 Mar 2008,
  • Geoff Brown wrote:

Some time ago and in response to one of Robert Preston's blog's about the credit crunch I wrote to say that in the past I read about small but powerful and unscrupulous groups of people who occassionally come together to bring about violent changes in the financial markets.

Their primary intentionof course was to make vast sums of money for themselves and the way they go about it is to spread fear about what is happening in the money market and property markets in order to panic people into making irrational decisions.

The first time I heard about such people was back in the 1960's when the sterling was under pressure and Harold Wilson then reffered to them as the Gnomes of Zurich. Since then there have been a number of similar collapses in the money/property markets and on each occassion the banks soon bounced back and certain individuals appeared to have made vast fortunes from the market mayhem.

I strongly suspect that the present hysteria in the financial markets is a repeat run of what has gone on the past. Except this time the mischief makers are aided and abbetted by the fact that corrupt information can now be more easily communicated to a much wider audience.

Unfortunately city editors and such like are also willing desciples when it comes to giving credence to whatever mis-information these people wish to communicate in order to achieve their goals.

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