"That was the business. That was, really, industry practice. In retrospect, in hindsight, I would say leverage was too high," a weary-sounding James Cayne told a nine-hour hearing of the Financial Crisis Inquiry Commission.
Cayne's admission under questioning came after he and other former Bear executives had testified that market rumors and a classic run on the bank were to blame for the firm's collapse in March of 2008 and fire-sale to JPMorgan Chase & Co.
The 76-year-old showed little emotion at the hearing, giving no hint of his reputation for profane and hot-headed outbursts during nearly 15 years at the helm of the company before stepping down in January of 2008.
Commission Chairman Phil Angelides said Bear Stearns seemed to have taken on an extraordinary level of risk involving high leverage, a concentration in mortgage-backed securities and short-term funding of its operations.
"There's a form of financial Russian roulette that Bear Stearns was playing along with other investment banks," said Angelides.
The congressionally-appointed commission is charged with chronicling the causes of the worst financial crisis since the 1930s and has been holding a series of hearings. It is due to deliver a report to lawmakers and White House by December 15.
Congress is already working on a bill to overhaul financial regulation but Angelides has said there will still be scope for further reforms, including possible changes to mortgage financing.
On Thursday, the commission is due to hear from former Treasury Secretary Henry Paulson and current Treasury Secretary Timothy Geithner on financial firms and markets falling outside the traditional bank regulatory structure.
TSUNAMI OF RUMORS
Cayne's admission over risk-taking was a departure from the general thrust of testimony by himself and four other Bear Stearns executives. They said the firm's collapse was beyond their control: a tsunami of rumors and loss of confidence that overwhelmed its risk management models and drained liquidity in a matter of days.
"The market's loss of confidence, even though it was unjustified and irrational, became a self-fulfilling prophecy," he said.
Similar market fears later in 2008 led to the bankruptcy of Lehman Brothers and the reorganization of other major investment banks.
Cayne's successor as Bear Stearns CEO, Alan Schwartz, told the panel he believed the Securities and Exchange Commission did investigate whether market players were manipulating Bear's stock. But Schwartz said he did not know whether the SEC could separate who started the rumors against the bank and who was responding to the rumors.
"In my heart, I believe something was going on," he said.
The former Bear Stearns executives were grilled over whether the investment bank's leverage level and lack of foresight on a looming collapse of the U.S. mortgage market made it the first major victim of the financial crisis.
Angelides said by the end of 2007, Bear was leveraged 38-to-one, when measured in terms of tangible assets versus tangible common equity.
About a month before its collapse, Bear had about $12.5 billion in loans with either deficient or no documentation -- more than the firm's total equity, said Angelides.
"It seems like there were a lot of warnings signs, a lot of red and yellow lights going off," he said.
Paul Friedman, Bear's former senior managing director, said the loss of confidence in the firm was unwarranted given the firm's strong capital position and substantial liquidity.
Samuel Molinaro, Bear's former chief financial officer, told the commission that fears, rumors and innuendo in March 2008 resulted in "irrational behavior that caused a quintessential run on the bank at Bear Stearns."
Bill Thomas, vice chairman of the financial commission, did not buy these arguments.
"How could you folks, as sophisticated as you were, with the models that everyone felt comfortable with, believe you were the victim... of unsubstantiated rumors, fears and innuendo -- that your colleagues did you in?" Thomas asked.
HELP TOO LATE
Bear's fall was swift in March of 2008. Despite an emergency line of credit from the Federal Reserve, it became clear within days the firm could not survive on its own, and the Federal Reserve and U.S. Treasury scrambled to arrange a sale to JPMorgan for the eventual price of $10 per share.
Cayne, who took criticism over reports that he attended a bridge tournament in 2007 as two of the firm's hedge funds failed, said the Fed's decision in March of 2008 to open its discount lending window to investment banks came 45 minutes too late to save Bear Stearns.
He described the sale to JPMorgan in cataclysmic terms. "The outcome, I believe, was the best that could be anticipated when the world ended -- for a lot of us."
In September 2008, Lehman filed for bankruptcy and the remaining large investment banks -- Merrill Lynch, Goldman Sachs and Morgan Stanley -- sought safety in the form of federal oversight. Merrill was bought by Bank of America. Goldman and Morgan became bank holding companies and are now subject to much stricter capital requirements and regulation.
All five investment banks were loosely supervised by the SEC for capital and liquidity requirements under the agency's voluntary Consolidated Supervised Entity program.
Angelides said the SEC was not on site examining Bear Stearns but said the agency still had the power to press firms to reduce their leverage.
Former SEC Chairman Christopher Cox, who was at the helm of the agency during the financial crisis, defended the regulator and said it was not set up to supervise investment banks for safety and soundness.
The agency's internal watchdog, however, criticized it for becoming aware of "numerous potential red flags" about Bear Stearns' risk-taking but not taking action.
The SEC monitoring program has since been dismantled.
