Bryan Burrough on Bear Stearns’ Demise: A Dark Possibility

Bryan Burrough is legendary in M&A circles for co-writing Barbarians at the Gate (Harper & Row, New York, 1990) with John Helyar, the cautionary tale of RJR Nabisco’s leveraged buyout and the winner’s curse faced by deal-maker Henry Kravis.

Burrough’s latest investigation for Vanity Fair contends that short sellers used CNBC and other media outlets to spread rumours that destabilised Bear Stearns and sparked a liquidity run on the investment bank’s capital.  Burrough’s thesis has sparked debate that overshadows his investigation’s strengths: a strong narrative and character portraits, new details of the negotiations with JPMorgan Chase and the Federal Reserve, and a cause-effect arc that shifts from CNBC’s internal editorial debate to the effects its coverage has on the marketplace and the subjective perceptions of individual investors and senior decision-makers.

In the absence of a ‘secret team’ or a ‘smoking gun’ how could Burrough’s thesis be tested?

Theoretically, Burrough’s hypothesis fits with: (1) a broad pattern over two decades of how media outlets respond to media vectors, systemic crises and geostrategic surprises; (2) the causal loop dynamics and leverage points in systems modelling; (3) the impact that effective agitative propaganda can have in psychological operations; and (4) the complex dynamics and ‘strange loops’ in rumour markets (behavioural finance) and rumour panics (sociology), notably ‘information cascade’ effects on ‘rational herds’.

This is likely a ‘correlation-not-cause’ error although it does suggest a dark possibility for strategic intervention in financial markets: could this illustrative/theoretical knowledge be codified to create an institutional capability, deployed operantly, and which uses investor fears of bubbles, crashes, manias and various risk types as a pretext for misdirection?  Behavioural finance views on groups and panics, and George Soros‘ currency speculation against the Bank of England’s pound on Black Wednesday suggest the potential and trigger conditions may lie in the global currency/forex markets (using stochastic models like Markov Chain Monte Carlo for dynamic leverage in hedge funds) and money markets (using tactical asset allocation).  If possible, this capability could also create second- and third-order effects for regulators, the global financial system and macroeconomic structures, and volatility in interconnected markets, which may actually be more dynamic and resilient than this initial sketch indicates.

To meet quantitative standards and validate Burrough’s hypothesis a significant forensic and data analytics capability with error estimates would also be required.  ‘Strong’ proof may not be possible: Burrough’s hypothesis is probably an unsolvable ‘mystery’ rather than a solvable ‘puzzle’ (a distinction by intelligence expert Gregory Treverton that The New Yorker‘s Malcolm Gladwell later popularised).

Ironically, several CNBC analysts have already decided: they used parts of Burrough’s hypothesis to explain the subsequent short-selling driven volatility of Fannie Mae and Freddie Mac‘s stock prices in mid-July 2008.

US Accounting Rules & Global Governance

The Securities & Exchange Commission (SEC) in the United States plans to adopt the International Financial Reporting Standards (IFRS) in order to enhance US competition in global markets.  The IFRS would be harmonised with, and may even replace the existing US accounting rules, the Generally Accepted Accounting Principles (GAAP) that the Financial Accounting Standards Board (FASB) oversees.

 

Critics are concerned the shift from GAAP to IFRS is an ill-fated intervention by US regulators comparable to the administrative burdens of Sarbanes-Oxley (SOX) compliance.  The perceived ‘institutional creep’ taps deep US fears on the potential for global governance institutions like the United Nations to interfere with US legal jurisdictions, Administration policies and national will.

 

To manage this resistance the SEC released a public roadmap and conducted a roundtable in December 2007.  However the Federal Reserve Chairman Ben Bernanke and US Treasury Secretary Henry Paulson upstaged this initiative in the issues-attention cycle due to their attempts to dampen the fallout in financial markets from the 2007 subprime crisis.  Collectively the SEC, Federal Reserve and US Treasury proposals signal major changes to the US financial system’s regulatory framework.

 

The SEC’s initiative has (at least) three possible side effects.

 

The planned harmonisation with IFRS will increase the tension between the SEC and US business leaders and policymakers over gaps in the IFRS, cultural differences, and the compliance mechanisms for regulatory oversight.  The coevolution of the US financial system and global governance will need to be reframed as a systems-level opportunity to overcome partisan interests.

 

The Australia-US Free Trade Agreement (AUSFTA) may be the ‘test case’ for US implementation of IFRS accounting rules.  AUSFTA establishes a bilateral framework on intellectual property rights and strengthens the positive correlation between the US and Australian financial markets.  If it’s really ‘outsourcing’ the US accounting/taxation regulatory regime as its critics believe the SEC is doing so to a ‘friendly’ nation-state.

 

Enterprise Resource Planning vendors such as Infosys and SAP could also benefit in the SEC’s shift to IFRS.  ERP systems enable trans-national corporations to be scalable and integrate their subsidiaries’ financial reporting through a centralised database, called master data management.  SAP for instance has business rules that harmonise the taxation reporting of different countries.  If the SEC’s roadmap unfolds then SAP and other ERP vendors will have to update their configurable platforms.  IFRS rules could reinvigorate the ERP market for enterprise application integration which uses systems architectures to integrate different computer systems, software, and data.