Bear Stearns Neared Collapse
Twice in Frenzied Last Days
Paulson Pushed Low-Ball Bid,
Relented; a Testy Time for Dimon
By KATE KELLY
May 29, 2008; Page A1
It had been a rough day,
but when Alan Schwartz headed for home on Friday, March 14, the Bear
Stearns Cos. chief executive thought he'd have a month to find a
buyer for his teetering firm.
Missed Opportunities2 As the firm's fortunes
spiraled downward, executives squabbled over raising capital and
cutting its inventory of mortgages.
Run on the Bank3 Executives believed they were
about to turn a corner, but rumors and fear sent clients, trading
partners and lenders fleeing.
Deal or No Deal?4 The Fed pressured Bear Stearns
to sell itself, but a misstep in the hastily drawn agreement nearly
scuttled the deal.
A quickly concocted loan,
guaranteed by the government for up to 28 days, allowed the brokerage to
open its doors that morning. But its stock continued to spiral down, its
clients continued to flee and its trading partners continued to
disappear. It grew obvious to Treasury Secretary Henry Paulson Jr. that
Bear Stearns wouldn't last the weekend. It was time for an awkward
Mr. Schwartz was in the
dark back seat of a car whisking him from Manhattan to Greenwich, Conn.,
when he got a call from Mr. Paulson and New York Federal Reserve Bank
President Timothy Geithner.
"You need to have a deal
by Sunday night," said Mr. Paulson, a seasoned former Wall Street
Mr. Schwartz was stunned.
Now, with the market in shock at Bear Stearns's travails and its stock
price cut to ribbons, he'd have to find the best offer he could to fend
The confusion over the
financing was a testament to the speed with which Bear Stearns had
fallen and the urgent need government officials felt to cushion the
impact on the financial system.
At their gloomiest,
regulators believed a bankruptcy filing could stoke global fears,
threatening to topple other financial institutions and to send the Dow
Jones Industrial Average into a 2,000-point nose dive.
The phone call to Mr.
Schwartz capped a helter-skelter week -- and presaged another 10 days of
chaos. Interviews with more than two dozen executives and others
directly involved show that Bear Stearns nearly died not once, but
That weekend, the firm
agreed to sell itself to J.P. Morgan Chase & Co. for a mere $2 a share
after Mr. Paulson personally urged the bank to cut a higher bid. But a
single clause tucked in the 74-page deal agreement set off a series of
increasingly dire events that nearly scuttled the rescue brokered and
financed by the Fed.
At one point, J.P. Morgan
threatened to pull financing it had promised to provide for Bear
Stearns. In turn, Bear Stearns executives considered suing J.P. Morgan,
and the firm nearly was forced to liquidate its assets. Finally, Bear
Stearns agreed to a price of about $10 a share, which stockholders are
poised to approve at a meeting Thursday.
By the time Mr. Schwartz
faced investors on a midday conference call on March 14, he had been at
the office for more than 24 tense hours.
On the call, Mr. Schwartz
said that while Bear Stearns's cash on hand had "deteriorated," the
funding from the Fed, routed through J.P. Morgan, would allow the firm
to resume doing "business as usual." Bear Stearns had moved its
first-quarter earnings announcement up from March 20 to March 17, he
added, and he felt "comfortable" with the range of analyst estimates,
some of which placed Bear Stearns's expected profit at more than $1 a
share. Longer term, Mr. Schwartz added, Lazard Ltd. had been hired to
generate a possible deal for Bear Stearns.
In fact, teams from J.P.
Morgan and J.C. Flowers & Co., the leveraged-buyout outfit that had
briefly been interested in a stake in the company last summer, were in
the firm's Madison Avenue offices that afternoon, scouring its books.
It was painfully apparent
that neither the Fed's moves nor Mr. Schwartz's reassurances were having
their desired effect. The rescue was seen in the market as a sign of
weakness rather than one of hope.
Bear Stearns executives
had heard rumors that some of the firm's big clients -- including
Citadel Investment Group, a powerful Chicago hedge fund -- had made big
bets that Bear Stearns's shares would fall. The brokerage's leaders
feared that word of a big player taking a so-called short position could
lead others to make the same moves, helping to depress the share price
Early that afternoon,
Citadel CEO Kenneth Griffin called Tom Marano, the head of Bear
Stearns's mortgage division, to ask, "Is there anything I can do?"
"There's such concern that
you're short that I wouldn't even go there," Mr. Marano said.
"I'm not short," Mr.
Griffin insisted. Any doubters could visit Citadel, he said, and review
its trading positions themselves.
CEO Kenneth Griffin denies to a Bear Stearns executive that he is
betting against the firm's stock.
Bear Stearns's shares
continued to fall. By day's end, nearly 190 million of the firm's shares
had changed hands -- 17 times the daily average -- and the price had
fallen 47% to $30 a share.
Bear Stearns Chief
Financial Officer Samuel Molinaro Jr. -- tired and in the same suit he'd
left home in 36 hours before -- had stopped at a Mobil gas station on
the Merritt Parkway for a cup of coffee on his way home to New Canaan,
Conn., when Mr. Schwartz phoned him that Friday night with the bad news.
Messrs. Paulson and
Geithner wanted a deal to sell Bear Stearns in place by early Sunday
evening when Asian markets opened for business.
"You've got to be kidding
me," Mr. Molinaro said. "I thought we had 28 days."
"So did I," Mr. Schwartz
replied. "Now we have to get a deal done this weekend." By 8 a.m. the
next morning, the two men were back at the office meeting with J.P.
The Bear Stearns and J.P.
Morgan buildings, less than a block from each other, were hives of
activity. As J.P. Morgan and Flowers furiously conducted due diligence,
Bear Stearns's directors met periodically throughout the day in Mr.
Molinaro's sixth-floor conference room.
Early that afternoon,
Flowers presented a tempting proposal: It would buy 90% of the company
for $3 billion in cash, or roughly $28 a share. But the deal was
contingent upon Flowers lining up a consortium of lenders to provide $20
billion to finance Bear Stearns's continuing operations.
Hours later, J.P. Morgan
said it might be willing to pay between $8 and $12 a share. That would
value the company at between $945 million and $1.4 billion.
At J.P. Morgan, more than
200 of the bank's top managers were holding round-the-clock discussions
in a suite of offices on the eighth floor of the bank's Park Avenue
building. Food was brought in; executives grabbed sleep on couches.
There were misgivings
about consummating the lightning-quick deal, but on Sunday morning, J.P.
Morgan sent Bear Stearns a rough draft of a merger plan with the share
price left blank.
Shortly after 8 a.m., Mr.
Schwartz gathered the roughly 50 Bear Stearns employees who were in the
building to help the firm's suitors sift through its financial records.
Flowers was having difficulty lining up operating funds. He knew the
J.P. Morgan bid was likely to win out and wanted to manage expectations
about the price.
"We have a deal," he told
the group, "but you're not going to like it."
Then, at about 10 a.m.,
J.P. Morgan suddenly withdrew its offer. Buying the brokerage after such
a brief review of its books was simply too risky, the bank told Gary
Parr, the investment banker representing Bear Stearns.
The bank had gotten cold
feet after its senior managers returned to Park Avenue from assessing
Bear Stearns's books. Besides losing clients, the firm was facing a rash
of lawsuits from the collapse of two hedge funds the previous summer,
and its large mortgage portfolio left it widely exposed to further
problems in the housing market.
A deal with Flowers wasn't
looking any more likely. By midday Sunday, the buyout firm knew it would
be impossible to raise $20 billion fast enough to keep Bear Stearns
operating. Flowers now toyed with alternatives: It asked Mr. Parr if
Bear Stearns's large rivals would consider buying the firm's
prime-brokerage business, a prized asset that processed and financed
trades with big clients. Perhaps then, Flowers reasoned, it could
proceed with a purchase of Bear Stearns's core bond and stock units.
Those deals never materialized.
Stearns CFO Samuel Molinaro finds out that the federal government
wants his firm sold in two days.
Soon, though, J.P. Morgan
was back, floating the price of $4 a share. Under the plan, the Federal
Reserve would take responsibility for $30 billion in hard-to-trade
securities on Bear Stearns's books, with potential for both profit or
Bear Stearns directors
were getting angry. How could the deal price go from $8 to $4 in a few
hours? Chairman James Cayne -- himself a large shareholder and the
firm's chief executive for 14 years until forced out in January -- was
"Let's play the bankruptcy
card," he said to the group as they discussed the bid in a conference
room high in the Madison Avenue tower.
A large team from the law
firm Cadwalader, Wickersham & Taft was already in the building,
preparing for a potential Chapter 11 filing, which technically would
allow Bear Stearns time to work out its problems with creditors. But the
option would have been suicidal: Under changes to the bankruptcy code
made in 2005, regulators would wrest control of the firm's customer
accounts, leaving it with little or no business. Many of Bear Stearns's
pending trades in investments known as derivatives, which are tied to
underlying assets like stocks and bonds, would be subject to seizure by
The start of the business
day in Asia loomed at 6 p.m. New York time. If the firm filed for
bankruptcy, it would have to notify its Asian trading desks before
markets there opened.
Throughout the weekend,
the Fed's Mr. Geithner had been consulting Mr. Paulson, a former
investment banker who had run Goldman Sachs Group Inc. for seven years
before becoming Treasury secretary. After they talked on Sunday
afternoon, they decided that Mr. Paulson should call J.P. Morgan CEO
He reached Mr. Dimon, who
put the call on the speakerphone in his Park Avenue office. The bank was
mulling a price of $4 or $5 a share.
"That sounds high to me,"
Mr. Paulson said. "I think this should be done at a low price."
Given the unprecedented
level of government involvement in rescuing the troubled firm, the
secretary was leery of appearing to bail out Wall Street investors at a
time when homeowners were losing their houses to foreclosure in record
numbers. He also was concerned about "moral hazard," the danger that too
generous a price would encourage future risky behavior.
By midafternoon, as Bear
Stearns directors hashed out these issues, Mr. Parr took a call from
Doug Braunstein, head of investment banking at J.P. Morgan. "The
number's $2," Mr. Braunstein told him.
Morgan CEO James Dimon tries to woo upset Bear Stearns employees.
"You surely don't mean
that," Mr. Parr replied. After years of advising companies, he no longer
reacted emotionally to bad news on a deal negotiation, but he knew how
tough the revised price would be for his clients to swallow when he
returned to the boardroom.
"I need to interrupt and
give an update from J.P. Morgan," he told the Bear Stearns directors,
relaying matter-of-factly what he'd been told.
Directors were shocked.
Mr. Cayne said there was no way he would approve the $2 deal.
Mr. Schwartz didn't want
to buck the Treasury and the Fed. He also knew that as the CEO of a
company incorporated in Delaware, he was obliged by law to consider the
interests of creditors over shareholders if his company faced
insolvency. Besides, he had employees to think about, and he didn't want
the company's workers to face abruptly canceled paychecks and padlocked
offices the next morning.
"Two dollars is better
than nothing," he told directors. He spent 30 minutes arguing his case.
A price of $2 and the right for shareholders to vote, he explained, was
better than a price of zero and a bankruptcy filing. He also pointed out
the untold consequences a bankruptcy could have on world markets -- a
scenario Bear Stearns directors didn't want to be held responsible for.
Mr. Schwartz looked around
the room to each board member. "Do I have anyone who's opposed?" he
asked. No one spoke. At about 6:30 p.m., the deal was unanimously
approved. Bear Stearns's advisers notified J.P. Morgan, which scheduled
a conference call for investors to discuss the deal at 8 p.m.
The Bear Stearns CEO,
exhausted and deflated, did not participate.
At about 7 p.m., when
The Wall Street Journal's Web site broke the news5 of the
$2 price, people at rival firms were stunned. Morgan Stanley CEO John
Mack and his financial team -- who were preparing for the firm's
upcoming earnings announcement -- wondered aloud whether $2 was a typo
and should have read $20.
Late Sunday night, as
lawyers raced to finalize the merger agreement, executives of the New
York Fed convened a call for Wall Street CEOs. So many people were
dialing in that officials were repeatedly interrupted by the
announcement of new participants.
Messrs. Geithner and Dimon
led off with some brief remarks, noting that J.P. Morgan would be
guaranteeing Bear Stearns's debts and that if the pact hadn't come
together, the market impact may have been catastrophic. During the
question-and-answer session, Citigroup Inc.'s new CEO, Vikram
Pandit, spoke up.
Mr. Pandit -- who did not
initially identify himself -- asked a shrewd but technical question: How
would the deal affect the risk to Bear Stearns's trading partners on
certain long-term contracts?
The query irked Mr. Dimon.
"Who is this?" he snapped. Mr. Pandit identified himself as "Vikram."
Offended that Mr. Pandit was taking up time with what he considered
granular inquiries, Mr. Dimon shot back, "Stop being such a jerk." He
added that Citigroup "should thank us" for staving off further mayhem on
In the next few hours, Mr.
Dimon would have a bigger reason to be annoyed. The hurried deal had a
loophole that could give angry Bear Stearns investors powerful leverage
to seek a higher price: J.P. Morgan had pledged to finance Bear
Stearns's trades for a year -- even if shareholders rejected the deal.
biographical details of the major players in the Bear Stearns deal.
It was the beginning of
another long week. By Tuesday morning, J.P. Morgan's lawyers were
arguing with their counterparts at Bear Stearns over the yearlong
"Don't you understand that
we have a problem?" Mr. Dimon asked Mr. Schwartz the next time the two
talked. "Shareholders may vote this down!"
Mr. Schwartz, who had been
taking a beating over the low price, knew an opening when he saw one.
"What do you mean, 'we' have a problem?"
It was a rare moment in
his three months as CEO when something wasn't Mr. Schwartz's problem. He
was inclined to make some concessions, he told his advisers, but not
without a higher offer.
On Wednesday evening, Mr.
Dimon visited Bear Stearns to talk with hundreds of restive managers in
the firm's second-floor auditorium. He knew he needed to placate this
important group of stockholders, who along with directors owned about
30% of the firm.
Hostile audiences were
unusual these days for Mr. Dimon. J.P. Morgan had largely avoided many
of the pitfalls that were sinking other banks, and now the 52-year-old
banker had become the go-to executive for frustrated regulators.
The Queens, N.Y.-born son
of a Greek immigrant stockbroker, Mr. Dimon began his career under
Sanford Weill, as the famed deal maker snapped up troubled companies to
stitch together Citigroup. Mr. Dimon, widely seen as Mr. Weill's
heir-apparent, was later ousted, though, after repeated clashes with Mr.
Weill and his daughter, then an executive at the bank. Mr. Dimon moved
on to Chicago's Bank One Corp., where he slashed costs and sacked
managers he viewed as ineffective. In 2004, he arranged the sale of Bank
One to J.P. Morgan for $58 billion and quickly rose to chairman and CEO
of the combined bank.
Standing on the dais with
two senior lieutenants, Mr. Dimon tried to strike a conciliatory tone.
Bear Stearns's "shotgun
marriage" to J.P. Morgan "is not the sort of thing we set out to do," he
told the audience. Noting the pain for Bear Stearns managers facing the
prospect of unemployment and big losses on their Bear Stearns stock, he
added: "We can't begin to imagine how difficult this is."
In the tense
question-and-answer session that followed, Ed Moldaver, a stocky,
40-year-old broker, stood up.
"This isn't a shotgun
marriage," he said. "This is more like a rape."
As some in the room shook
their heads and muttered uncomfortably, Mr. Dimon stared stonily at the
Around 9 p.m. the next
day, Bear Stearns lawyer H. Rodgin Cohen -- Sullivan & Cromwell chairman
-- was running on his treadmill at home in Westchester County, N.Y.,
when an executive from J.P. Morgan called.
"This has been a disaster
for everyone," the executive said. He wanted an assurance that Bear
Stearns would agree to allow J.P. Morgan to hold 51% of Bear Stearns's
shares as part of the deal. That way, they'd control enough votes to
approve the deal without having to persuade any disgruntled investors.
Delaware courts, however, had frowned upon an acquirer being given an
option to buy such a large stake without shareholder approval. To ensure
court approval, J.P. Morgan would have to opt for something lower.
The next day, March 21,
was Good Friday. J.P. Morgan turned up the heat, telling Mr. Cohen that
if Bear Stearns didn't make the desired concessions, the bank didn't see
how it could provide funding for the brokerage to trade the following
Monday. In an ugly replay of the weekend before, Bear Stearns was
If J.P. Morgan wouldn't
guarantee Bear Stearns's trades on Monday, the firm would most likely
have to file for bankruptcy protection.
But this time around, Bear
Stearns's business was so weak, it wasn't eligible for a Chapter 11
reorganization filing. Instead it faced a Chapter 7 liquidation, in
which a court-appointed trustee would take over the firm, likely
throwing out management and launching a sale of its assets to repay
The firm's directors
talked briefly about suing J.P. Morgan to continue the financing. But
they quickly realized their position was untenable. With Bear Stearns's
core business eroding, how would regulators and investors react to a
Chapter 7 filing and a new spate of litigation? They decided it was time
to talk to the government again.
While Mr. Cohen telephoned
his contacts at the New York Fed, Mr. Schwartz called Kevin Warsh, a
former investment banker at Morgan Stanley who had been a member of the
Federal Reserve Board for two years. "We're under a perceived threat,"
Mr. Schwartz told Mr. Warsh, explaining that J.P. Morgan appeared to be
playing hardball in order to garner a bigger chunk of Bear Stearns's
shares. While Bear Stearns was prepared to renegotiate, Mr. Schwartz
said, it needed a higher price. Mr. Warsh pressed him for details on the
firm's situation but declined to take sides.
On Easter morning, Mr.
Schwartz called Mr. Dimon. "There's a psychological limit here," he
said. Bear Stearns's directors needed a sale price in the double digits
to feel comfortable. "Don't come back to me at $9.99," he cautioned Mr.
With tension so high
between the two sides, Messrs. Geithner and Paulson were concerned that,
far below the markets' radar, Bear Stearns was again becoming a threat
to the financial system. In a call to Mr. Dimon, Mr. Paulson reluctantly
agreed to bless a higher price.
Before markets opened the
next morning, J.P. Morgan countered with a final bid: about $10 a share,
valuing the brokerage at $1.2 billion, for 39.5% of the firm's stock. To
make it palatable to the Fed, J.P. Morgan assumed responsibility for the
first $1 billion of any potential losses, reducing the government's
exposure to $29 billion.
The deal was approved,
markets opened smoothly and most investors remained happily unaware of
the week's turmoil. Yet for Bear Stearns, the federal government and
J.P. Morgan, it was an unsatisfying denouement in many ways.
Bear Stearns investors
took their lumps, if not as painful as Mr. Paulson had envisioned. The
Fed got stability in the markets, but at a risk of tens of billions of
dollars and by setting an uncomfortable precedent. And J.P. Morgan
picked up prized clients, talented Bear Stearns employees and a sleek
new building at a bargain price, but now faces at least $9 billion in
liabilities and the chore of integrating two wildly different cultures.
But the Dow did not plunge
2,000 points, other trading houses did not fail and the global financial
system, while wheezing, did not collapse.
If there were hazards,
moral and otherwise, lurking in the deal, the future would have to sort
--Greg Ip, Robin Sidel and David Enrich contributed to this article.
Write to Kate Kelly