The downfall of Matt Tannin and Ralph Cioffi’s Bear Stearns hedge fund duo might be the closest thing we can point to that was the tipping point at the start of the subprime crisis.
But just days before their hedge funds hit the point of no return, Tannin and Cioffi had no idea they were about to lose every last dime of their investors’ money.
On March 2, 2007, the group of hedge fund guys taking shots of “very good vodka” in paper cups weren’t sitting on an ominous signal of big trouble in the subprime market to the rest of the industry yet.
It’s all very ironic. They had very good vodka in disposable little cups, they were dreaming of a better future with the feeling like they’d just won the powerball.
Below is an excerpt from All The Devils Are Here:
On Friday, March 2, 2007, a man named Ralph Cioffi, who ran two hedge funds at Bear Stearns that had some $20 billion invested in asset-backed securities, held a small, impromptu meeting in his office. Matt Tannin, who managed the two funds with him, was there, as was Steve Van Solkema, a young analyst who worked for the two men and another partner in the funds. They had gathered to discuss the deteriorating market conditions. The week had opened with a drop in the stock market of more than 400 points, the largest one-day decline since the aftermath of 9/11. Cioffi described February as “the most treacherous month ever in the market.” They talked about the plunge in value of the riskier tranches of the ABX index. Even some of the triple-A—the triple- A—were showing a strange wobbliness. That wasn’t supposed to happen—ever. The men were anxious.
On paper, their two hedge funds hadn’t performed that badly: one fund was down a little; the other was up a little. But it had suddenly become difficult to obtain prices on the securities they owned, so they couldn’t be sure what their funds were truly worth. Plus, they’d often told investors that the funds operated like a boring, old-fashioned bank—they were supposed to earn the difference between their cost of funds (a good chunk of which were provided through the repo market) and the yield on the super-safe, mostly triple- and double-A-rated securities that they owned. Investors expected fairly steady, low-risk returns. Any losses, no matter how small, could spook them. The Bear team had made money on short positions they had placed on the ABX, but the volatility was worrisome. Because the higher-rated securities were supposed to be nearly riskless, the Bear Stearns hedge funds were highly leveraged: only about $1.6 billion of the $20 billion was equity. The rest was borrowed. Earlier in February, they’d started to get margin calls, meaning that their lenders were demanding more collateral. They’d met the margin calls, but their fears had not abated.
Trying to calm the others, Cioffi told them about the time he and Warren Spector, Bear’s co-president, with whom Cioffi had risen through the ranks, had been caught with a big bond position way back when. They didn’t panic, and they ended up making a lot of money. Tannin commiserated with Van Solkema about how the stress made it hard to get any sleep. For Van Solkema, it was comforting to hear that even the “big senior guys,” as he later called them, weren’t sleeping, either. And then Cioffi opened a small fridge in his office and took out a very good bottle of vodka. They all did a shot out of paper cups, toasting to better times ahead.
Cioffi also suggested that they keep the discussion among themselves, which Van Solkema interpreted to mean that they should try to avoid worrying other employees. At 6:32 a.m. the next morning, Cioffi sent a message to Tannin, trying to put their stress in perspective. He wrote: “1. We have our health and our families. 2. We are not a 19 year old Marine in Iraq. 3. We have each other and a great team.” Tannin responded: “We are not marines—in fact—we have all triple won a Powerball lottery a few times over.”
Within six months, both funds were bankrupt. A terrible storm was gathering.
Excerpted from ALL THE DEVILS ARE HERE: THE HIDDEN HISTORY OF THE FINANCIAL CRISIS by Bethany McLean and Joe Nocera by arrangement with Portfolio, a member of Penguin Group (USA), Inc., Copyright (c) Bethany McLean and Joe Nocera, 2010.