Today's post may be unsettling, to say the least. And it is a bit longer than usual. But even though these events are ten years in our past, they serve as an educational example of how our world is run.
With much gratitude, I will quote profusely from an article written by John Olagues and published at ITulip.com. I’m not an expert in these things, but he is. I tried to rewrite this using the info I found in his article, but I just didn’t find a better way to explain all this. And it’s important to get this right.
The Killing Floor
Financial markets are stranger things than we might imagine. Out here in the “real” world, if you want to sell something, you have to own it first. Not so in the hustle-bustle world of finances. On the trading floor, it’s not only possible to sell something without owning it, it’s a valid strategy and practiced by nearly every successful trader.
The logic is this: for every buy transaction there must be a sell transaction. Timing is irrelevant--it doesn’t matter which comes first. With that in mind, let’s look Bear Stearns. Specifically, let’s look at what happened with Bear Stearns on the trading floor in March 2008. John Olagues begins our journey about a week before the fiasco became public knowledge:
‘March 10, 2008, the closing price of Bear Stearns was 70. The stock had traded at 70 eight weeks prior. On or prior to March 10, 2008 requests were made to the Options Exchanges to open new April series of puts with exercise prices of 20, and 22.5, and a new March series with an exercise price of 25.
Their requests were accommodated and new series were opened March 11, 2008.
Since there was very little subsequent trading in the call series with exercise prices of 20, 22.5 or 25, it is certain that the requests were made with the intention of buying substantial amounts of the puts. There was, in fact, massive volumes of puts purchased in those series which opened on March 11, 2008.
For example, between March 11-14 inclusive, there was 20,000 contracts traded in the April 20s, 3700 contracts traded in the April 22.5s, and 8000 contracts traded in the April 25s. In the March 25s there were 79,000 contracts traded between March 11-14, 2008.
Question: Why did the options exchanges not open the far out of the money puts for trading the first time that BSC hit 70, when the Aprils and Marchs had far more time to expiration. Certainly if the requesters were legitimate hedgers or speculators, buying the March and April with two and three months to expiration was more appealing.
Answer: The insiders were not ready to collapse the stock and did not request the exchanges to open the new series then.’
Call Me Up, Put Me Down
I’m not the most savvy investor around. That’s why I use little phrases to remind me what’s going on. Markets have basically 2 types of transactions, Puts and Calls. The way I remember them is this: “Call UP, Put DOWN”. If I am betting that something goes down in price, then I remember to name it a Put. That’s what these guys were doing, betting that BS was going down within the month. But that’s not the end of the story. David continues:
‘On or prior to March 13, 2008, an additional request was made of the Options Exchanges to open more March and April put series with very low exercise prices even if that meant those March put options would have just five days of trading to expiration. The exchanges accommodated their requests, knowing that the intentions of the requesters was to buy puts. They indeed bought massive amounts of puts. For example the March 20 puts traded nearly 50,000 contracts (i.e. contracts to sell 5 million shares at 20). The March 15s traded 9600, the March 10s traded 13,000 and the March 5s traded 6300 all on March 14 (the first day of trading of the new March series).
The introduction of those far-out-of-the-money put series in the April and March months immediately before the crash, provided a vehicle whereby extreme leverage was available to the insiders. In other words if you had $100,000 and you knew that Morgan would buy Bear Stearns at two dollars, you could make five to 10 times more on the $100,000 by using the $100,000 to buy the newly introduced March puts. This is so because the soon to expire far out-of-the-money puts were far cheaper than the July or October out of the money puts. And that is why the inside traders requested the exchanges to introduce the far out of the moneys just days before the crash.
But this scenario has enormous implications. It means that the deal was already arranged on March 10 or before. That contradicts the scenario that is promoted by SEC Chairman Cox, Fed Chairman Bernanke, Bear CEO Schwartz, Jamie Dimon of J.P. Morgan (who sits on the Board of directors for the New York Federal Reserve Bank) and others that false rumors undermined the confidence in Bear Stearns making the company crash, notwithstanding their adequate liquidity days before. I would say that the deal was arranged months before but the final terms and times were not determined until maybe March 7 or 8, 2008.
On March 14, the April 17.5s, the 15s, the 12.5s and the 10s traded 15,000 contracts combined. Each put gives the right to sell 100 shares. So for example, these 15,000 April puts gave the purchaser(s) the right to sell 1.5 million shares at prices between 10 and 17.5. Those purchasers expected to make profits on 1.5 million shares because they knew the deal was coming at $2.00.
That is the only plausible explanation for anyone in his right mind to buy puts with five days of life remaining with strike prices far below the market price. So there were requests, during the period of March 10 to 13, to the exchanges to open the March and April series for buying massive amounts of extremely out-of-the-money puts, which were accommodated by the Options Exchanges. Did the Exchanges aid and abet the insider trading scheme? We are not able to have a clear opinion on that.’
Sell Low, Buy Lower
So, what’s going on at this point is that somebody, or several somebodies, were selling millions of shares of future BS stock (constituting a short sale) at anywhere from 12.50 to 25 dollars a share, even though the going rate, the “market price”, was hanging solidly at 70. Remember, for every short sale there must be a buy from the same person. Can you imagine anybody with a brain selling anything, knowing they had to buy it back next week at 3 times that price or lose that cash?
If they sell it for 12.50 and buy it back at any amount below 12.50, then they make a profit. If the price remains at 70, then they lose a fortune. With the time factor inherent in trading these kinds of options, these puts had to be called within a week. That means that these guys, for some reason, believed that BS stock would be dirt cheap in less than seven days. Read on…
‘Reuters, however, on March 10, 2008 was citing Bear Stearns sources that there was no liquidity crisis and that there was no truth to the speculation of liquidity problems. And none other than the Chairman of the Securities and Exchange Commission on March 11, 2008 was stating that “we have a good deal of comfort with the capital cushion that these firms have.”
We even had the “mad” Jim Cramer proclaiming on March 11, 2008 that all is well with Bear Stearns and that the viewers should hold on to their Bear Stearns.
And on March 12, 2008, Alan Schwartz CEO of Bear Stearns was telling David Faber of CNBC that there was no problem with liquidity and that “We don’t see any pressure on our liquidity, let alone a liquidity crisis.”
The fact that the requests were made on March 10 or earlier that those new series be opened and those requests were accommodated together with the subsequent massive open positions in those newly opened series is conclusive proof that there were some who knew about the collapse in advance, while Reuters, Cox, Schwartz and Cramer were telling the public that there was no liquidity problem.
This was no case of a sudden development on the 13 or 14th, where things changed dramatically making it such that they needed a bail-out immediately. The collapse was anticipated and prepared for, even while the CEO of Bear Stearns and the SEC Chairman of the SEC were making claims of stability.
What was the reason that Cramer, Cox and Schwartz were all promoting Bear Stearns immediately before its collapse. That will be speculated upon for years to come.
Cramer has admitted that “truth” was not his friend and that he manipulated stocks to influence investors behavior. Was this one of his acts? But no apologies from Cramer as he claims now that he was referring to keeping money in Bear Stearns Bank not in Bear Stearn’s stock.’
Trading 101, Insiders Out
So, while all these puts were quietly being traded on Wall St, the public was being led to believe that BS was in fine shape. (Interestingly, their balance sheet from that week shows that they were more than 11 billion to the good. Like I said before, I ain’t the most savvy guy when it comes to markets. Maybe 11 billion in cash just ain’t enough to keep you afloat.)
All this makes a rational mind think two words: Insider Trading. Personally, I can’t see any other explanation for it. Somebody obviously knew what was getting ready to happen, somebody who was heavily invested in BS stocks. There is no other plausible explanation for millions of shares to trade at a 70% discount, less than a week before that discount would become a 100% premium or higher. From David’s article:
‘To prove the case of illegal insider trading, all the Feds have to do is ask a few questions of the persons who bought puts on Bear Stearns or shorted stock during the week before March 17, 2008 and before. All the records are easily available.
If they bought puts or shorted stock, just ask them why. What information did they have access to which the CEO and the SEC did not have? Where did they get the info? Why are Cramer, Cox, Paulson, Faber, and Schwartz not subject to a bit of prosecutorial pressure to get to the bottom of this?
Maybe the buyers of puts and short sellers of stock just didn’t believe Reuters, Cox, Schwartz, Cramer, and Faber and went massively short anyway buying puts that required a 70% drop in a week. Maybe they had better information than Schwartz or Cox. If they did then that’s a felony, with the profits made subject to forfeiture….’
Hot Air Comes Out Of Which End Of A Politician?
There was a congressional inquiry into the whole fiasco. Well, there was the pretense of one, anyway. It seems that only a few of the congressmen investigating were actually there to find out what happened. The rest were just warming their chairs. One more long quote from the article over at ITulip.com…
‘In the first session there were the following witnesses. Bernanke of the Federal Reserve Board, Cox from the SEC, Geithner representing the New York Reserve Bank and an incidental player Mr. Steel from the Treasury. The only Senators that seem to be willing to attack these bankers were Bunning, Tester, Menedez and Reed. All the rest were useless and very respectful….
…All witnesses did their best to keep their stories consistent but they did slip up a bit. They all agree that the bail-out was necessary without any proof that it was.
They all agreed that what caused the cash liquidity to dry up within one day was the rumor mongers. Apparently it is claimed that some people have the ability to start false rumors about Bear Stearns’ and other banks liquidity, which then starts a “run on the bank.” These rumor mongers allegedly were able to influence companies like Goldman Sachs to terminate doing business with Bear Stearns, notwithstanding that Goldman et al. believed that Bear Stearns balance sheet was in good shape. (Goldman between March 11-14 warned their average customers that Bear Stearns stock was “hard to borrow” for shorting due to the fact that other customers had used up all of the stock available for borrowing for short sales) .
That idea that rumors caused a “run on the bank” at Bear Stearns is 100% ridiculous. Perhaps that’s the reason why every witness were so guarded and hesitant and looked so mighty strained in answering questions.
Loans to J.P. Morgan total $55 Billion from the Fed
The Private New York Fed lent $25 Billion to Bear Stearns and another $30 billion to J.P. Morgan. So the bail out cost was $55 billion not the $30 billion that is promoted. This was revealed at second session of the Senate hearings in a James Dimon response to a question from Senator Reed.
Who gets the $55 billion? J.P. Morgan got the money on a loan pledging Bear Stearns assets valued at $55 billion; $29 Billion is non-recourse to Morgan.
Effectively the Fed got collateral appraised by Bear Stearns at $55 Billion for a loan to J.P. Morgan of $55 Billion.
If the value of the secondary facility of $30 Billion ($29 Billion of which is non-recourse) is worth only $15 Billion when all is said and done, then J.P. Morgan has to pay back only $1 Billion of the $30 Billion and keeps the $14 Billion the the Fed loses. If the $25 Billion primary facility is worth only $15 Billion when all is said and done, J.P. Morgan has to pay $10 Billion of the $25 Billion received. If J.P Morgan can not pay, then the Fed loses the $10 Billion.
If after all is said and done the $25 Billion primary assets are sold for more that $25 Billion, the difference goes to J.P. Morgan regardless of the outcome on the secondary facility of $30 Billion. No matter how you cut it, J.P. Morgan wins. If the $55 Billion assets turn out to be worth only $20 billion when all is said and done, J.P. Morgan owes $1 Billion on the $30 Billion and the difference between $25 Billion and the value received on the primary facility.
The Fed would have been far better to just buy the assets at Bear’s and J.P.Morgan’s valuation. Now best the Fed can do is get their money back with interest and the worse they can do is lose about $25 -$40 billion.’
And The Winner IS
And so at last, we’ve made it to the last section of today’s post. Damned long trip, wasn’t it? And not such a happy one. How does it feel to know that not only did these investment banker types rip us off, but that the Federal Reserve and the US Treasury were in on it all the way, helping to set it all up? And who were those guys short-selling the collapse to the tune of hundreds of millions of dollars? We never found out.
Was the whole thing just a smokescreen? Could the intention have been to pre-emptively bail out a much bigger fish in the finance industry pool? The only real winner in the whole deal is JP Morgan. Any way you look at it, they got billions of dollars with no requirement to ever repay most of it.
But if the real issue was a hidden bailout of JPMorgan, why all the misdirection from the Fed and the Treasury? Aren’t these the guys we trust to control our economy and keep us all in the lifestyle we’ve become accustomed to? Why would they feel so compelled to hide the truth from us? If they’re really working for the common good of Americans, why would they turn on us like this?
The answers are out there, but we might have to travel the world a bit to find them. Perhaps we'll do just that--a world tour looking for reasons.
