Humpty Stearns Can't Go Back on the Wall

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Includes: BSC, JPM
by: Mike Steinhardt

I really respect Bloomberg, but their story on the demise of Bear Stearns isn’t that impressive to me when they suggest that Bear was “brought down” in March (I suggest it was sooner than that - and not by stock manipulators).

“All the king’s horses and all the king’s men” cannot put…. Humpty Stearns back together again. And while I guess we can learn from what happened and maybe punish some people, I don’t think it will prevent much, if anything.

If we could undo this mess and prevent the supposed trading manipulation, I’d gladly do that as long as we could simultaneously undo Paulson and Bernanke’s actions and the FEDERAL unRESERVEd lending facilities and the $29 billion fiasco. Maybe Bear Stearns execs want to find a way to blame someone else. Maybe regulators want to blame someone else. But nonetheless, Bear Stearns is gone and none of this investigation will undo anything about the damage that has been done as a result and the damage I am talking about was not done by manipulators of the non-regulatory, non-political kind.

I agree it looks like there was odd option activity and short selling (probably even the naked variety) that contributed to the decline. But in the end, executive mismanagement and negligent regulators put Humpty Stearns on the wall. If odd options activity and naked short selling is judged to be the primary reason that companies become worthless, then we should see numerous failures like Bear Stearns. Alas, companies with risky management become worthless even without strange options activity or naked short selling. And we have companies that are targeted by aberrant options activity and short selling, but the companies don’t fail or require the most obscene violation of capitalism (aka Fed Bailout) yet to occur in American history.

Instead, we have a constant desire to avoid the bigger issue of ineffective or missing regulation and excessive leverage and counterparty risk and derivatives. Options traders and short sellers didn’t do that. Bear Stearns and the investment banking community and the politicians and the regulators made that happen over many years. And worse yet, they haven’t done much, if anything, to get rid of it since mid-March.

By the way, since the options activity being complained about and investigated occurred when BSC stock was trading at about $62 per share, would someone please investigate who was responsible for the stock’s decline from $170 per share in mid-January 2007? Was that all the work of the options crowd or short sellers?

And as for the massive decline that made those suspicious put options generate a large percentage gain…. well, that happened on Friday March 14th due to the arranged and suspicious looking sneaky way to lend money to a primary dealer to avoid violating Federal law by using a conduit (NYSE:JPM) to lend to a Primary Dealer (Bear Stearns) before the PDCF was announced. The Fed did that. The rest of the gain was orchestrated on Saturday and Sunday when there was no trading by the sneaky shorts and option monsters. Who was working through the weekend back then? Did the manipulators tell Bernanke and Paulson that they should price the “buyout” at $2 per share? If Bernanke and Paulson had priced it at $30 per share (Friday’s close), then I probably wouldn’t be writing this post.

And another odd thing… just go back through the prior testimony of Schwartz and Paulson and Bernanke and everyone else who were “familiar with the matter.” The timeline doesn’t seem right to blame this on March 10th and March 11th manipulative activity. Didn’t they all previously say that they didn’t know there was trouble at Bear until Thursday March 13th (click here for NY Times article)? Here is a snippet from Bernanke’s prepared testimony to Congress on April 2, 2008:

On March 13, Bear Stearns advised the Federal Reserve and other government agencies that its liquidity position had significantly deteriorated and that it would have to file for Chapter 11 bankruptcy the next day unless alternative sources of funds became available.

It seems to me that if all the insiders (execs and regulators) firmly believed (and are on record to that effect both in contemporaneous public statements and subsequent Congressional testimony) that there was no problem with Bear Stearns liquidity or solvency until the afternoon of March 13th when Schwartz called the SEC et al, then how could there be insider trading on March 10th and March 11th, if not March 12th on the day Schwartz gave his interview with CNBC? HMMMM!?! One more time… if there was “no problem” at Bear until the afternoon of March 13th, then it is impossible that any previous trades could be based upon insider information of a problem that did not yet exist in fact. If the facts and the timeline are not as previously testified to, then I can understand how their might have been inside info. But that opens up a whole new set of very uncomfortable problems… doesn’t it?

To me, there was either very suspicious trading based upon speculators speculating or there was insider trading based upon information that was only known to a select few. Unless of course you want to suggest there was a massive conspiracy with the manipulators and customers and lenders who were pulling away from Bear. Good luck proving that.

I am not defending any insider activity or manipulative trading. If that happened, then the SEC needs to punish it big time. On this site, I have repeatedly lectured about the importance of trading ethics and anti-manipulation. For the record, this is not the first time it looks like there is a leak at the Fed (or in some other high place). I wrote this post in August about someone I named “CutThroat” and as expected, I never heard about an investigation back then. HMMMM!

Regardless, the point of this post is that we should not get distracted about the reasons that Bear Stearns failed. I know blaming short sellers and options traders is a hot topic these days, especially for regulators. But please remember that Bear Stearns management had a significant hand in setting up this company to fail and wiping out share prices from $170 to $70 before the suspicious trading. If they try to close this chapter and blame short sellers or illegal option traders, then we are destined to miss out on the real risks that caused Bear Stearns to fail and more importantly, we will fail to deal with all the other Humpty Dumptys that are still hanging out on that wall.