Lost Opportunities Haunt
Final Days of Bear Stearns
Over Raising Cash,
By KATE KELLY
May 27, 2008
Twelve hours after
agreeing to sell Bear Stearns Cos. for $2 a share, Alan Schwartz
wearily made his way to the company gym for a much-needed workout.
It was 6:45 a.m., March
17, and Bear Stearns's chief executive had slept little since hammering
out the ugly details of his fire-sale deal with J.P. Morgan Chase
When Mr. Schwartz, already
dressed in his business suit, trudged into the locker room, Alan Mintz,
still in his sweaty gym clothes, made a beeline for the boss.
"How could this happen to
14,000 employees?" demanded the 46-year-old senior trader, thrusting his
face uncomfortably close to Mr. Schwartz's. "Look in my eyes, and tell
me how this happened!"
Two and a half months
later, Mr. Schwartz still isn't quite sure. To Mr. Mintz and others, he
has blamed a market tsunami he didn't see coming. He told a Senate
committee last month: "I just simply have not been able to come up with
anything, even with the benefit of hindsight, that would have made a
But many who lived through
the seven tense months before the deal say Bear Stearns imploded because
it was at war with itself. Buffeted by the most treacherous market
forces in a generation and hobbled by indecision, the firm's leaders
missed opportunities that might have been able to save the 85-year-old
Those missteps are
expected to have a lasting impact beyond the people who once worked at
Bear Stearns or owned its stock. Unlike Wall Street meltdowns in decades
past -- from Drexel Burnham Lambert Inc. to Long-Term Capital Management
-- the Bear Stearns collapse spurred direct intervention from the
Federal Reserve. That step is likely to increase the central bank's role
in solving future financial catastrophes and bring securities firms
further regulation in the bargain.
Opportunities. As the firm's fortunes spiraled downward,
executives squabbled over raising capital and cutting its inventory
Part Two: Run
on the Bank. Executives believed they were about to turn a
corner, but rumors and fear sent clients, trading partners and
Deal or No Deal? The Fed pressured Bear Stearns to sell itself,
but a misstep in the hastily drawn agreement nearly scuttled the
As shareholders prepare to
approve the deal on Thursday -- at a price that angry investors forced
up to about $10 a share -- interviews with more than two dozen current
and former Bear Stearns executives, directors, traders and others
involved in the action paint the first detailed picture of the fractious
last weeks before the Fed helped underwrite J.P. Morgan's purchase of
the trading powerhouse.
Months before regulators
pressured the firm to sell itself, nervous traders futilely begged Mr.
Schwartz and his predecessor, James Cayne, to raise more cash and slash
Bear Stearns's huge inventory of mortgages and the bonds that backed
At least six efforts to
raise billions of dollars -- including selling a stake to
leveraged-buyout titan Kohlberg Kravis Roberts & Co. -- fizzled as
either Bear Stearns or the suitors turned skittish. And repeated
warnings from experienced traders, including 59-year Bear Stearns
veteran Alan "Ace" Greenberg, to unload mortgages went unheeded.
Top executives resisted,
in part, because they were concerned the moves would upset the delicate
calculus of appearances and perceptions that is as important on Wall
Street as dollars and cents. If Bear Stearns betrayed weakness, they
worried, skittish customers would pull their money out of the firm, and
other financial institutions would refuse to trade with it.
Instead of managing these
fickle forces, though, a brokerage whose culture and fortune were rooted
in the trading floor's steely manipulation of risk was swamped by them.
August conference call fails to calm investors.
An early harbinger of the
debacle to come appeared the first Friday in August. Bear Stearns
executives hosted a conference call that day meant to reassure
investors. The brokerage's stock had fallen sharply after the late-July
collapse of two internal hedge funds tied to subprime mortgages, home
loans made to the riskiest borrowers.
Mr. Cayne and his top
financial lieutenants touted the firm's strong cash holdings -- $11.4
billion, according to company officials -- and new longer-term borrowing
agreements. They also pointed out that Bear Stearns itself actually had
few subprime holdings. But executives' comments about the bleak state of
the market for interest-bearing securities stoked investors' fears,
helping spur a broad rout in stocks and driving Bear Stearns's own
shares to a 12-month low of $106.55.
Later that day, word
leaked out that Warren Spector, Bear Stearns's co-president and chief of
the division that oversaw the two failed hedge funds, was being forced
out by Mr. Cayne.
Amid the mounting bad
news, a lifeline appeared: Mr. Schwartz, then Bear Stearns's
co-president, and Henry Kravis, KKR's fearsome founder, had a
conversation about the buyout firm possibly purchasing 20% of Bear
By Sunday, Bear Stearns's
sleek, black tower in midtown Manhattan bustled with activity.
About 8:30 a.m., a team
from KKR assembled in the investment-banking department on the 43rd
floor to begin dissecting the firm's books. Buying a piece of Bear
Stearns was attractive to KKR as an entree into the lucrative brokerage
business at a time when prices were cheap. For Bear Stearns, it was a
chance to raise $2 billion or more in capital and gain a crucial seal of
approval by putting an éminence grise like Mr. Kravis on its
board -- a move Mr. Schwartz hoped would silence Bear Stearns's critics.
Within two weeks, though,
the talks would fall apart because each side had concerns. Among other
things, Messrs. Schwartz and Cayne feared a deal might turn off Bear
Stearns clients that competed with KKR.
While Bear Stearns's
mortgage team fielded questions from KKR that Sunday, the firm's risk
officers were meeting in the sixth-floor executive offices with staffers
from the Securities and Exchange Commission. The regulators had traveled
from Washington to make sure Bear Stearns had access to the day-to-day
loans it needed to fund its trading operation. After scrutinizing the
firm's $400 billion balance sheet well into the afternoon, the
regulators agreed to reconvene with Bear Stearns managers for daily
briefings until the market crisis passed.
Elsewhere in the building
that afternoon, Bear Stearns's board was deliberating over Mr. Spector's
resignation. Not everyone was convinced it was the right move --
including Mr. Schwartz, who had expressed his objections privately to
Mr. Cayne. But Mr. Cayne was adamant.
The collapse of the hedge
funds had exposed the then-73-year-old CEO to criticism inside and
outside of the company for being disengaged and for brushing off warning
signs. Early on, he seemed unconcerned. Mr. Cayne said the funds weren't
Bear Stearns's money: It belonged to big institutions, wealthy
individuals and lenders who all knew the risks going in. Soon, though,
the lenders forced Bear Stearns to extend one of the portfolios $1.6
billion of its own money to keep it afloat.
A glib and gruff former
scrap-iron salesman from Chicago with a penchant for cigars, golf and
cards, Mr. Cayne had often taken off Thursday afternoons and Fridays
that summer to play golf near his New Jersey vacation home. In mid-July,
when the funds were melting down, both he and Mr. Spector had spent more
than a week in Nashville, Tenn., competing in a bridge tournament. Mr.
Cayne, who declined to be interviewed for this article, was said by
people close to him to be particularly angry that Mr. Spector, who with
his partners won the event, had been away from the office at such a
Bear Stearns's board -- 12
men largely handpicked by Mr. Cayne -- approved Mr. Spector's departure.
Mr. Schwartz, a longtime investment banker more accustomed to rubbing
shoulders with clients like Walt Disney Co.'s Robert Iger than to
monitoring trades or capital levels, was named sole president.
Messrs. Spector and
Schwartz had been promoted to co-presidents and co-chief operating
officers in 2001. Mr. Cayne, the CEO, had leaned on them to keep their
divisions running smoothly.
Now, Mr. Schwartz, a
former star pitcher at Duke University, had to carry a heavier burden.
At age 57, he had little experience in the bond and mortgage businesses
that made up an outsized share of Bear Stearns's revenue. But he decided
to manage the firm's capital-market division himself rather than hiring
a replacement for Mr. Spector.
Mr. Schwartz moved to
tighten oversight of the company's trading. He also began keeping daily
tabs on the bond markets. Several times a week, he sat down with traders
who had bet a lot of the firm's money, questioning them about strategy
In the weeks after
rejecting KKR's approach, Bear Stearns received other offers of capital.
J. Christopher Flowers, a former Goldman Sachs Group Inc. partner, had
met with some of Bear Stearns's senior managers about the possibility of
taking a 20% stake. But the meeting left Bear Stearns's representatives
concerned that Mr. Flowers simply was trying to gauge their desperation.
The next day, they told the Flowers team they weren't interested.
Instead, Bear Stearns
executives began working on what Messrs. Schwartz and Cayne saw as a
more compelling option: a joint venture with Citic Securities Co. They
reasoned a deal with the Chinese investment bank would bring in money
and help increase Bear Stearns's miniscule presence in Asia. Smarting
from criticism of his hands-off style, Mr. Cayne spent the Labor Day
weekend on a whirlwind trip to Beijing to discuss terms with Citic
Into early autumn, the
mortgage market continued to slump. Housing prices had plunged, and most
major financial firms were slashing the value they placed on holdings
backed by home loans.
Bear Stearns -- with its
immense stockpile of mortgages and related securities -- was
particularly vulnerable. Despite months of price declines, those
holdings were valued at about $56 billion -- a large portfolio for a
firm its size. Still, SEC staffers -- who now were phoning in for weekly
Wednesday-evening conference calls with the firm -- appeared
comfortable. By Thanksgiving, some senior regulators were calling in
'We've Got to Cut!'
Greenberg argues to dump mortgage inventory.
Inside Bear Stearns,
though, skirmishes about its mortgage holdings at times grew heated.
Some veteran traders insisted that Tom Marano, the head of mortgages,
needed to trim his portfolio. Among them were Wendy de Monchaux, who as
head of proprietary trading invested Bear Stearns's own money, and Steve
Meyer, co-head of stock sales and trading.
"Cut the positions, and
we'll live to play another day," Ms. de Monchaux said often, invoking
one of the firm's venerable maxims. But Mr. Schwartz, still boning up on
the details of the mortgage markets, urged caution.
For some of the assets,
the market was frozen, Mr. Schwartz reasoned, so selling was out of the
question. On others, he had mixed feelings. He didn't want to unload
tens of billions of dollars worth of valuable mortgages and related
bonds at distressed prices, creating steeper losses.
Mr. Schwartz believed the
portfolio at least should be better protected from further price
declines. Spearheaded by Mr. Marano, a bearded 46-year-old trader with a
Grateful Dead tattoo on his right shoulder, the mortgage team unfurled a
hedging strategy known as "the chaos trade."
The trade was a deeply
pessimistic bet -- essentially a method for making money if the mortgage
and financial markets cratered. The traders bet that the ABX, a family
of indexes made up of securities backed by subprime mortgages, would
fall. They made similar moves on indexes tracking securities backed by
commercial mortgages. Finally, they placed a series of bets that the
stocks of major financial companies with exposure to mortgages,
including Wells Fargo & Co., Countrywide Financial Corp. and Washington
Mutual Inc., would decrease in value as well.
Late in September, with
Bear Stearns and other financial stocks rallying, members of the firm's
executive and risk committees gathered in Mr. Cayne's smoky, dark and
secluded sixth-floor offices to discuss the hedges. Negotiations for
Allianz SE's Pacific Investment Management Co. to take a nonequity stake
of as much as 10% in Bear Stearns had recently fallen apart. That cost
the brokerage a chance for capital and a coveted endorsement of Bear
Mr. Cayne had just
returned from the hospital where he'd been treated for an infection, and
he looked thin and drawn. Mr. Greenberg, the firm's storied trader and
former CEO, took center stage. As head of the risk committee, he had
been reviewing the Wells Fargo and other negative stock bets. He wasn't
happy. The financial-stock hedges were too risky, he warned, and should
be closed out immediately. Moreover, he wanted the mortgage inventory
"We've got to cut!" Mr.
Greenberg demanded. Ms. de Monchaux and Mr. Meyer concurred.
Missouri-educated, Mr. Greenberg was the embodiment of the "PSDs" --
poor, smart employees with a deep desire to get rich, upon whom the firm
had been built. Mr. Greenberg, who ran the firm for 15 years before Mr.
Cayne nudged him aside, was known on Wall Street for his voluminous
memos, in the voice of a fictional character, urging traders on issues
large ("it doesn't pay to get too arrogant") and small (save paper clips
to cut costs).
But it was Mr. Greenberg's
trading style that had most defined Bear Stearns: Sell losing trading
positions -- quickly. Mr. Greenberg still recalled what his father, an
Oklahoma City clothier, told him: "If something isn't moving, sell it
today because tomorrow it will be worth less."
The hedges had made close
to half a billion dollars and stood to make more as the stocks continued
to fall. But since they had first employed the chaos trade, Mr. Marano
and his team had been hectored almost daily by complaining phone calls
from colleagues. Some of Bear Stearns's more superstitious traders even
objected to the strategy's name: They were tempting fate by invoking
Faced with the fierce
divide among his top executives, Mr. Schwartz, who was generally
supportive of the chaos trade, decided to abandon it. He wanted specific
pessimistic plays that would offset specific optimistic bets, rather
than the broader hedges Mr. Marano had employed. Frustrated, Mr. Marano
ordered the trades undone.
As October dawned, Messrs.
Cayne and Schwartz had high hopes that a deal with Citic would bolster
Bear Stearns's fortunes. On Oct. 22, Bear Stearns announced a joint
venture in Asia that included a $1 billion cross-investment between the
two companies. If regulators approved, Bear Stearns could count on
getting $1 billion in the first half of 2008. But it would spend the
same amount over a longer period for a complementary stake in Citic.
impressed. Bear Stearns shares rose meagerly but backtracked days later.
Over the next few weeks,
Bear Stearns's competitors disclosed losses from bad mortgage-related
bets. Merrill Lynch & Co. announced a loss amid write-downs of $8
billion; Morgan Stanley revealed losses of nearly $4 billion.
To outsiders, it was
beginning to look as if Bear Stearns had navigated the crisis relatively
deftly. Inside the firm, that view wasn't as prevalent. Its mortgage
holdings were still hefty, and its bond business was reeling.
The firm continued to
explore ways to raise money, hiring investment banker Gary Parr of
Lazard Ltd. to try to bolster the firm's prime-brokerage business, which
handled trading and lending to hedge funds and other big clients. Mr.
Schwartz had also discussed a merger with hedge fund Fortress Investment
Neither effort would bear
Time to Move On
Schwartz tells James Cayne he needs to step down as CEO.
In late November and early
December, tension mounted as Bear Stearns executives contemplated a
bonus pool down significantly from a year earlier. Executives in the
stock division blamed their counterparts in bonds.
"Why should we pay those
guys anything?" Mr. Meyer, the stock sales and trading executive, at one
point demanded in a compensation meeting.
Things only got testier
when Bear Stearns announced abysmal fourth-quarter results on Dec. 20.
Dragged down by a drop in the value of its mortgage inventory, the
company reported its first quarterly deficit since it opened for
business in 1923. The bond division, always the firm's cash cow, had a
loss of $1.5 billion for the quarter.
At lunchtime the next day,
as employees prepared for the holidays, Bear Stearns received bleak
news. An email from Pimco, the influential bond fund, said it had become
uneasy about the financial sector in general. And the fund wanted to
immediately unwind several billion dollars of trades it had agreed to
with Bear Stearns.
"This doesn't make any
sense," Jim Egan, Bear Stearns's co-head of global sales, said in a
hastily arranged conference call with William De Leon, a Pimco risk
manager, and William Powers, a Bear Stearns alumnus and Pimco managing
director. How could a snap decision throw cold water on such a
longstanding relationship with such little warning? If Pimco planned to
take such drastic action, Mr. Egan and his colleagues added, the
decision should be made "corner office to corner office."
Messrs. De Leon and Powers
ultimately agreed to hold off on dramatic moves until January, when
they'd have a chance to sit down with senior Bear Stearns executives.
But before hanging up, Mr. Powers issued a stern, if familiar, warning:
"You need to raise equity," he said.
Many Bear Stearns veterans
began pushing hard for Mr. Cayne's ouster, arguing the firm needed a
more engaged leader. The dissatisfaction had been building since the
summer. It grew after a Nov. 1 story in The Wall Street Journal
documenting Mr. Cayne's frequent absences from the office for golf and
bridge during the worst of the summer's hedge-fund crisis. The article
also mentioned that Mr. Cayne had used marijuana in the past. He told
employees in an email the same day that he hadn't "engaged in
Mr. Schwartz was reluctant
to push Mr. Cayne out. He had led the company through some great years,
Mr. Schwartz believed, and could be trusted to step down on his own.
"Stand calm," he told the
protesters. "We've got it under control."
Several top managers began
joking that they should hold a sit-in in Mr. Schwartz's 42nd-floor
office until he agreed to unseat Mr. Cayne as CEO.
Investors were growing
impatient, too. Bear Stearns's fourth-largest shareholder -- Bruce
Sherman, chief executive of money manager Private Capital Management
Inc. -- was agitating for a change at the top.
Shortly after the New
Year, Mr. Schwartz stopped by Mr. Cayne's office. The pressure inside
and outside of the firm for his departure had become too great, he told
his boss. It was time to move on.
Write to Kate Kelly