Bear Stearns and the Narratives of Systemic Risk

In May 2007, Bear Stearns – one of the crown jewels of Wall Street – traded at nearly $160 per share. The S&P 500 peaked five months later, in October 2007. Five months after that, in March 2008, Bear Stearns was taken out in the street and shot in the head by regulators. The stock closed at $2 per share that day. A few weeks later, the Bear Stearns carcass was sold to Jamie Dimon and JP Morgan for just under $10/share, although the effective price (long story) for most people who hung on to the bitter end (employees mostly) was $5/share.

So ended the House that Ace and Jimmy built.

Everyone who has been in markets long enough has their Bear stories, and I’m no exception. I liked Bear Stearns the company and I loved Bear Stearns the people! Bear was one of my two prime brokers (Morgan Stanley was the other), and we had a wonderful business relationship. Didn’t stop me from shorting them from $145 down to the bottom (with a borrow from Morgan Stanley, natch), and it didn’t stop me from moving our prime business over to JP Morgan in January 2008, but as Hyman Roth said, this is the business we have chosen. Nothing personal.

Anyhoo … while Bear Stearns was enduring an old-fashioned run on the bank in March of 2008 (it was hedge funds taking their money out of the prime brokerage that killed the company), the overall market was in a severe correction. Not a bear market, mind you (no pun intended), but a severe correction. When Bear went out, the S&P 500 was down 18% from the October highs and down 12% from the Jan. 1 year start.

You can see here how Bear was highly correlated with the S&P 500 from May 31, 2007 onwards, which makes sense given Bear’s poster child status for that market on the way up … and the way down.

And then we had the Bear Stearns Bounce.

The overall market came roaring back over the next 8 weeks, so that by May 19 the S&P was only off 1% for the year. Still down 8% or something like that from the highs of 2007, but no one cared about that. Long or short, you get paid in this business on the calendar year, and every January 1 is a clean slate. Shorts like me who were feeling pretty pleased with themselves on March 17 were enduring a crisis of confidence on May 19, and the longs who were despondent in March were feeling prettay, prettay good in May.

Why did the market come roaring back from mid-March to mid-May? Because narrative.

Because according to every market media Missionary, Bear Stearns was the bad Wall Street apple in an otherwise reasonably decent Wall Street barrel. Oh sure, there were still problems here and there in mortgage portfolios, and sure we were in a recession, but there was no longer a risk of the system falling down. Eliminating Bear didn’t mean that the tough times were over for the financial system, but it did mean that the crisis was over.

Sacrificing Bear Stearns to the regulatory gods meant that – and I’ll never forget this phrase – “systemic risk was off the table.”


From May 31, 2008 to March 9, 2009, the S&P 500 fell by more than 50%. Because, of course, systemic risk was NOT off the table with the execution of Bear Stearns. Because, of course, the Wall Street banks were ALL bad apples.

And so here we are in 2020. Nice bounce!

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What’s the Bear Stearns equivalent in this morality play? What’s the bad apple? What’s the singular source of systemic risk that we are now hearing is “off the table”, so that investors can enjoy a well-deserved V-shaped rally?

It’s the New York/New Jersey surge.

It’s the fact that we really and truly flattened the curve and we really and truly avoided a healthcare disaster in San Francisco and Kansas City and Nashville and Los Angeles and Birmingham. It’s the fact that New Orleans and Houston did not become New York City. It’s the fact that NO city in the United States suffered an overwhelmed medical system except New York City.

And now that the worst is over even in the uniquely hard-hit area of New York/New Jersey … now that our daily death rate has peaked at 2,000+ Americans dying every freakin’ day from this disease, so that improvement to “only” 1,000+ Americans dying every freakin’ day becomes the “good news” that allows markets to climb a wall of worry …

“Yay, systemic risk is off the table!”

That’s the narrative you’re going to hear from every market media Missionary, that New York was the bad COVID-19 American apple in an otherwise reasonably decent COVID-19 American barrel. Oh sure, there are still problems here and there in clusters of cases in this state and that, and sure we are in a recession, but there is no longer a risk of the system falling down. Blaming New York (and make no mistake, that IS the thinly veiled subtext here) doesn’t mean that the tough times are over for the rest of the country, but it does mean that the crisis is over.

It’s already starting. Here’s Bret Stephens in the New York Times last Friday.

America Shouldn’t Have to Play by New York Rules (New York Times)

No wonder so much of America has dwindling sympathy with the idea of prolonging lockdown conditions much further. The curves are flattening; hospital systems haven’t come close to being overwhelmed; Americans have adapted to new etiquettes of social distancing. Many of the worst Covid outbreaks outside New York (such as at Chicago’s Cook County Jail or the Smithfield Foods processing plant in Sioux Falls, S.D.) have specific causes that can be addressed without population-wide lockdowns.

Yet Americans are being told they must still play by New York rules — with all the hardships they entail — despite having neither New York’s living conditions nor New York’s health outcomes. This is bad medicine, misguided public policy, and horrible politics.

And so we’re going to start reopening local and state economies. And so because of the biology of this virus and the nature of exponential functions, I think we’re going to have at least a solid month of still more “good news” from states like Georgia in regards to their re-opening “data” before you have any resurgence of clusters. And so even then, I expect the new clusters will be explained away, lost in the shuffle of 500 to 1,000 Americans dead from COVID-19. Every freakin’ day.

See, that’s the thing about narrative-world, both for markets and politics. People can get used to ANYTHING in narrative-world. As the COVID-19 narrative becomes that of a chronic and excusably lethal event for the United States, as opposed to an acute and unforgivably lethal event, we WILL get used to it.

I’m not saying this is good or bad. I’m just saying it is. And it’s constructive for things that are driven by narrative. Things like markets. Things like this White House.

And that constructive narrative will last until something acute and unforgivably lethal happens again in real-world, until real-world events give the lie to narrative-world complacency. Which they will. Because of the real-world severity of this virus and the entwining of TRILLIONS of dollars worth of assets in business models that are not just damaged but obliterated by that severity.

Just like real-world events gave the lie to narrative-world complacency in the summer of 2008. Which they did. Because of the real-world severity of nationwide housing price declines and the entwining of TRILLIONS of dollars worth of assets in business models that were not just damaged but obliterated by that severity.

The systemic risk question you need to ask yourself today is the same question you needed to ask in 2008:

What is the micro-level truth of the potential real-world shock (home price appreciation then, virus biology today), and does that micro-level truth threaten the common knowledge surrounding a levered business model and securitized asset class of enormous size (mortgage-backed securities then, global trade finance and collateralized loan obligations and similar debt securitizations today)?

I know that last sentence was a mouthful. But it’s worth parsing.

History doesn’t repeat when it comes to outcomes. it doesn’t even rhyme. But the PROCESS of history never changes. That’s what I’m describing here … the historical process of systemic risk manifestation in social systems like markets and elections.

I’m not here to sell you an Answer. I’m here to show you a Process.

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  1. Your description brings back the grooves and divots from that period. It felt nothing like a process then. Yet now it does as we are in the second 100-year event in twelve years. Thanks for taking the time to put things into context. “Yet today, with all the winning chips in our favor, capitalism appears to have morphed into a “technology,” like social media, that is designed to find the clearing price for our values and beliefs.”

  2. Excellent note, as always.

    “See, that’s the thing about narrative-world, both for markets and politics. People can get used to ANYTHING in narrative-world. As the COVID-19 narrative becomes that of a chronic and excusably lethal event for the United States, as opposed to an acute and unforgivably lethal event, we WILL get used to it.” … " And so even then, I expect the new clusters will be explained away, lost in the shuffle of 500 to 1,000 Americans dead from COVID-19. Every freakin’ day."

    I’m immensely curious how the new ‘get used to’ interacts with the old ‘get used to’. The new ‘get used to’ in the way I’m defining it isn’t the eupepsia of the 500-1k deaths per day. That’s just a diluted version of the old ‘get used to’. And I agree it will be completely explained away.

    The new ‘get used to’ is the juxtaposition of experience vs. expectation. The first casual dining sit-in meal. The first televised major sports event (with no fans). Major office building re-openings. And I think initially this will be met with a hopeful fascination, if not celebration - a new iteration of something that we all want back so desperately. But after 3, 6, or 8 weeks of adjustment, will this new ‘get used to’ clash with the hope that came from the old ‘get used to’? Particularly in the absence of a new CV-related mortality impulse. Will the “Necessary, Painful, and Very Temporary” that was coated to the first pill attach itself to the second? My guess is yes, for a while. And then no, as the juxtaposition of day-to-day expectations vs reality asserts itself.

    I’m reserving the implications of post-re-opening lethal and severe events to a different category entirely. The lie will be given at some point.

    I suppose I am making the hypothesis that something in narrative-world may shift (more positively, then negatively) before/independently (of) the big lie is given to complacency. That’s fair, and maybe too cute.

  3. Admittedly I do not read the New York Times , however , the news I do consume seems to be trying to paint the opposite narrative.

    According to Worldometer the number of deaths in the US yesterday was the lowest since March 31. After seeing that I jumped on My trusty CNBC app to see how the futures were responding—-the first story was about a spike in Singapore- yes Singapore , and it was followed by a story about the number of total worldwide cases going over 3 million. not active cases—-total cases.

    AS I write this the same app has a picture of Jeffrey Gundlach discussing his plans to short the market. 8 mins ago the Dow was up 300 but oil was PLUNGING.
    NJ Gov needs more Federal aid to avoid ARMAGEDDON scenario. These are the actual headlines on the CNBC app as I write this.

    The last thing the media in America wants is a higher stock market and the economy moving forward in an election year where Donald Trump is running for re-election. At least that’s my reading.

    I live in KY and not New York , I know exactly 2 people personally that have been diagnosed with Covid 19 , both have been released and are recovering - including my 85 year old uncle. I know or should say knew 2 people who were in recovery from addiction that have died in the past month from overdoses. I read this morning about cancer patients not being able to get treatments because the nation’s resources are focused exclusively on Covid 19. My point is only this - there is a human casualty count on both sides of the lockdown debate—-I don’t pretend to know what it is and none of us know the counter factual involved.

    To paint this debate as people who care about lives on side and money on the other is a bit disingenuous.

  4. Ben, first, thank you for teaching me about a process of thought. Show me the “how” and I’ll get myself to the “what.”

    Where can I learn more about the narrative construction process? This question has probably been asked a million times before, so forgive me, but where can I find a list of the most important books and authors on this subject, presuming that I have the background to digest academic expository works? (Feel free to point me to works and authors that I will not understand. In my view, it is no use reading works that you can understand without a long struggle.)

  5. I wanna short the whole goddamn system… how do I do that?

  6. Buy physical Gold?

  7. I am not knowledgable in the financial aspects of this post. But we can learn something from the medical side. George Giles on LRC today posts about Epidemiology. The important point is that the CDC reports the raw data from various causes of death per year. Giles reports that the latest data on the CDC are from 2017. These data can be used to create a cause of death histogram for any year which can then be normalized by the total number of deaths in the histogram for that year. Each year’s histogram will have a shape. Most likely, an unusual medical event like a pandemic or plague will have a substantial effect on the shape of the normalized histogram when compared to other years.
    My assessment, as well as many of my colleagues, is that the normalized histogram of the causes of death for 2020 will show a spike associated with Covid19 as well as a significant decrease in several of the other lines. Unfortunately, we can’t know this now.

  8. Intellectually it’s possible with a bit of re-reading to grasp the essence of all this—possible but not easy. A recent quote you cited: “Hope has two beautiful daughters; their names are Anger and Courage. Anger at the way things are, and Courage to see that they do not remain as they are. – St. Augustine” is a problem for the narrative for ME (It’s always about me!—to me) in that as I sit in Monterey CA, at almost 74, well travelled and friendly enough to have acquaintances–friends and family-- all over the globe and on every continent but Antarctica, I still have knowledge of exactly 1 person, indirectly, who has succumbed to CV19—(my daughter’s friends elderly and very sick father.) That’s as close as I can get to the ‘ultimate downside’ of CV19.
    Anger and Courage…
    Contrast that to 9/11 and/or the 2008/09 Crash. I knew 5 souls lost that day. My sister and husband in NYC knew so many victims of the WTC collapse they ended up drawing a chart to decide which funerals they could attend together-- or had to go separately. EVERYONE we knew was hit by the Financial Cancer that ate out a large chunk of the Nation’s internal organs a dozen years ago…BUT in 2020, from Monterey to Thailand to Lugano to Cork to Manchester to Beijing to Des Moines to Miami the direct known ‘fatality count’ is Zero…and indirect is a grand total of 1. I’ve asked every one of the folks in the aforementioned sites, and more, and the count remains.
    Tough to create a meaningful narrative…at the same time, 100% of us have been affected (inconvenienced?) by C19 and/or the governmental response to same. Perhaps the ‘narrative’ will be an honest-to-God examination of when subsidiarity makes sense, or when it’s OK to actively oppose the wannabe dictators who think they have the authority to say it’s fine to go kayaking but not motor-boating—and DO NOT EVEN think about buying seeds for a garden!!
    Anger and Courage…
    Whose ‘science’ do I buy into? The science that creates models that turn out to be off by a factor of @ 35:1 or the ‘new science’ with hard data that finally give us BOTH a numerator and denominator we should have had confidence in before we shut down the world…??
    Anger and Courage…
    As it stands now I do not see, hear or sense a ‘pack’…none. Not here on the Central Coast of CA…I do sense a growing disgust with and an increasing loss of respect for every layer of government and while my Libertarian fraction applauds that, my traditional conservative urges react with more than a little alarm. Is that a pack?
    Anger and Courage…

  9. The thumbs up button doesn’t work under the ‘read more’ mode, so thumbs up!
    Meanwhile, our practice had a meeting yesterday to prepare for opening here (in Georgia). The manager asked if anyone had any medical events in their family or friends from cv19. One person out of more than 60 people present had an elderly uncle die. That’s it. Maybe mitigation worked. Maybe people didn’t want to admit to being a witch or a communist.
    But more and more, I am worried that those repo gyrations are not coincidental. Shoot me now, preferably with a young sweetgum seed.

  10. It’s still too early to expect a lot of victims in your direct line of sight. Talk to emergency room personnel across the world to get a reality check.

    I do personally know two victims (both male 37 and 51 years old). Neither died, but both seriously sick (weeks on a ventilator) with months of expected rehab time ahead.

    The narrative described here is the one in the Financial Markets where the S&P 500 is still at Summer 2019 levels.

  11. The Index is …but lot’s of companies trading 40-60% off their highs.

  12. The narrative and the ability to accept any concept may be best exemplified by Sweden where the highest death rate in Scandinavia from Covid is dismissed as mostly affecting people in nursing homes and by extension those whose lives had ended anyway. Even millennial liberals in Sweden explain their hedonist attachment to this concept as who is disposable. A variant of this thesis is embraced by many rural areas in the US not directly appreciative of the threat they face - yet.

  13. And yet today (5/5) we are told that the White House/CDC expect daily new cases to triple this month and deaths to at least double. Minus NYC, the national figures for cases and deaths continue to rise. Other data shows CEO’s and economists are far more pessimistic than investors. How has the narrative you describe continue to drive the markets higher?

  14. A comment and some contrarian thoughts.
    Long Tail Event: this virus isn’t one, nor are states’ governmental responses. The fact of some breakout contagion was fully predictable (and remains so for the next one); the stochastic variable is always ‘when’. While it is conceivable to maintain robustness margins against these events, eg material stockpiles or on-call idle medical capacity, absent any immediate threat, financial logic quickly relegates these to the category of inefficient capital or cost structures, which therefore must be eliminated. Optimization of the immediate moment in time.
    Deaths in Context (every freakin day): yes, it is going to happen. So do deaths from many other causes. We must stop telling ourselves the narrative that deaths are fully avoidable. This is not a univariate problem; it is multivariate, vector-valued. Death gets a weighting in the optimization, but not 100%. Personal livelihoods, aggregate economic health, avoidance of abject personal despair, et al. These variables are in the vector. AND NO government gets to assign the weightings. Free people decide these for themselves.
    Narrative Construction: yes, it can be used to nefarious ends. It is also part of a human healing process. We construct narratives - backward and forward - to bridge the abyss from the horrific now to a calming future. We acquiesce to believe such things as: she’s in a better place now, he was such a good person when he was young, yes mistakes were made, the company is on a good path forward, etc. Else wise -if we don’t- we must wallow in the despair of now.

  15. The thumbs up isn’t working…

  16. I remember very few academic experiences from high school, but one classroom discussion during Macroeconomics has never left me. It took place during the second semester of my senior year (March 2008). The teacher presented the following question to the class, “Are we in a recession?” I don’t remember the specifics of the discussion but I’m sure topics such as “what defines a recession”, GDP growth, and unemployment numbers were brought up. 
    I cannot recall the result of the discussion, but it was a discussion with one side arguing that we were in a recession and the other arguing against. We all know how the story ends a few months later with the bottom falling out of the economy. It would become known as the Great Financial Crisis.
    Over the ensuing few years, I watched the toll the recession took on my family and the families of my friends in that econ class. Later, I reflected on the econ class discussion and it seemed so quaint. We students were so innocent, but so were the teachers. 
    After the economy recovered, I would ask people about how they got through the Great Financial Crisis. They would recount their experiences and my follow-up questions were about the idea it could happen again. And the following phrase was used with relative frequency, “It was a once in a lifetime event.”   
    I’m going to make a historical comparison here, which is a dangerous, confirmation bias enforcing thing to do. In early 20th century Europe, there had not been a major war since Napoleon. Following the assassination of Archduke Franz Ferdinand, the continent was plunged into war. It was called the Great War. The war to end all wars.
    After the fighting ended, the world was largely structured the way it was at the beginning of the war. There were some window dressing changes, but the power distribution before and after the war were largely the same. 
    Are there econ teachers asking students if they think we’re in a recession?   

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