The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street
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The acclaimed New York Times bestseller-updated for the second anniversary of the collapse of Bear Stearns
The fall of Bear Stearns in March 2008 set off a wave of global financial turmoil that continues to ripple. How could one of the oldest, most resilient firms on Wall Street go so far astray that it had to be sold at a fire sale price? How could the street fighters who ran Bear so aggressively miscalculate so completely?
Expanding with fresh detail from her acclaimed front-page series in The Wall Street Journal, Kate Kelly captures every sight, sound, and smell of Bear's three final days. She also shows how Bear's top executives descended into civil war as the mortgage crisis began to brew.
Early on the evening of Thursday, March 13, Sam Molinaro, chief financial officer of The Bear Stearns Companies, called the firm's CEO, Alan Schwartz. "We have a serious problem," Molinaro said.
Up in his forty–second–floor office, Schwartz had been hearing snippets of bad news all afternoon. Bear traders, trying to do business with rival firms, were getting pointed questions about whether they could make good on their financial obligations, and hedge funds had been yanking money out of their Bear accounts. By the time he got the call from Molinaro, Bear's cash supply appeared to be draining fast.
"This is looking pretty serious," Schwartz replied. "I'll be right down."
Schwartz took the elevator to the sixth floor, where executives were slowly congregating outside Molinaro's corner office. Though no one had sent out an e–mail, the word got around that the firm's top managers were meeting at 6:00.
Like many meetings led by Molinaro, however, the tone seemed to be one of hurry up and wait. Bear's CFO was hopelessly disorganized, and had a knack for making important people hang around outside his office while he wrapped up a phone call or had an impromptu meeting. The delays sometimes lasted for hours. Molinaro's chaotic scheduling was so widely remarked on that Paul Friedman, the sardonic chief operating officer in the fixed–income division, liked to sum it up with a joke: "What time is our six o'clock meeting? "
This time, Molinaro was tied up in his office with his former secretary, now a managing director in the firm's operations department, which handled Bear's real estate dealings around the world. Knowing the urgency of the meeting they awaited, managers rolled their eyes as they glanced from their watches to their BlackBerrys outside Molinaro's adjoining conference room.
Finally Molinaro walked in and took a seat. Schwartz, at fifty–seven a towering, impeccably dressed former baseball star, sat near the door at the head of the table, legs crossed, silently leaning back in his chair. He had not expected this when he was named CEO barely three months earlier.
He was surrounded by a wily group of fellow executives who over the years had supported one another, challenged one another, and vied for one another's jobs and pay. Bear was a dysfunctional family, driven by greed and a complex code of internal politics. Far above the lower and middle ranks, where most of the firm's fourteen thousand employees worked, was an upper tier of some seven hundred senior managing directors, or SMDs, who made fat bonuses and enjoyed perks like a private lunch room, special expense accounts for ordering meals and flight upgrades, and unique access to key clients and public figures. Partly to justify their pay, management forced
SMDs to give a small portion of their annual compensation to charitable causes, and tax returns were reviewed to make sure people complied. ("Trust but verify" was the motto governing the philanthropic program. Though many of Bear's senior managers were civic–minded, enforcement was still in order.)
But the vast majority of Bear's SMD pool was blissfully unaware of the firm's inside workings. As at most investment banks, its levers were pulled exclusively by a short list of managers who ran divisions like fixed income, equities, and prime brokerage, which handled trading and lending to Bear's most important hedge fund clients. Managers in places like risk management and operations were considered less important to the firm's core franchise and therefore largely excluded from important decisions.
Tonight's gathering, at which nearly all the power players were present, guaranteed a clash of opinions and egos. For months Bear had been struggling with a choppy stock market, plummeting home values, and an exodus of the lenders and clients that were its lifeblood. The developments had created deep fissures within Bear's sharp–elbowed ruling class. The trader who ran mortgages had nearly come to blows with the cochief of equities the prior fall over whether the fixed–income department, which included the mortgage unit, deserved bonuses after such a terrible year. Bear's finance officers, who were advocating for safer ways to manage the firm's own cash, had been involved in screaming matches with their counterparts in equities who argued for the status quo. Some of Bear's top traders and executives had begged the mortgage team to divest their portfolios of its shakiest assets, to little avail. Now all the bad blood from those tumultuous months was coming to a boil.
To Schwartz's left was Richie Metrick, his longtime friend and right arm in the investment–banking business. Metrick was Schwartz's foil in nearly every respect. Short and impatient, the sexagenarian investment banker often had a stain on his shirt or a sleeve unbuttoned. Colleagues considered him something of a ball buster, a man more than willing to take them to task over disagreements. Friends praised a strong intellect that ran in his family—his son, Andrew Metrick, was a professor at the Yale business school—but many of those gathered in the conference room that evening had seen scant evidence of it since he joined Bear twenty years earlier. Mainly they knew him as Schwartz's gruff number two.
Next to Metrick was Gary Parr, the respected financial services banker from Lazard Ltd. Parr, at fifty–one, had seen his share of deals as cohead of the mergers–and–acquisitions practice at Morgan Stanley and copresident of the boutique firm Wasserstein Perella before that. More than once he had worked with insurance companies and banks on the verge of pennilessness.
The conference room they sat in had been ground zero for the internal battles of recent months, and, like much of Bear's headquarters, it was careworn from the many meetings it had hosted. The building, a forty–five–story tower of stone and glass crowned by an octagonal fixture that could be illuminated at night, was emblematic of the firm's grand visions. Designed by the noted architect David Childs, 383 Madison Avenue had been unveiled in 2001, with Bear occupying nearly every floor. It featured a square lobby with open space on all sides and a sleek, black base, just steps from Grand Central Station. A third–floor gym provided workouts and showers. The boardroom and private dining rooms were on the twelfth floor, where a private chef prepared meals. Trading floors were below, and investment banking was high above. Departments like legal, treasury, and research were on the levels in between.
Bear's new abode had already been put to good use. The prior year, the firm had hosted an array of early candidates for U.S. president, including senators Hillary Clinton and John McCain. (Barack Obama, then an Illinois senator, was invited but never committed to a date.) The private dining rooms were used to entertain clients, Wall Street analysts who watched Bear's stock, and other notables. Chairman Jimmy Cayne's office, which included a private conference room, a tricked–out motorcycle from a Chinese client whose firm Bear had taken public, and a stash of high–end imported cigars under the desk, was a particular draw.
But despite those trimmings, the inside of Bear's building was not particularly fancy. Even the sixth floor, where Molinaro, Cayne, a group of board members, and other heavy hitters resided, was essentially a warren of cubicles ringed by offices with views—mostly of the other high–rise buildings that surrounded Bear. Carl Glickman, one of Bear's longest–serving directors, had furnished his own office, spending thousands of dollars on ornate furniture, and Molinaro had a couple of nice chairs and a couch. But many executives had little other than family snapshots to look at, and the tables and chairs that Bear provided were not extravagant.
On either end of a scratched–up wood conference table, the walls in Molinaro's conference room featured symbols of a more euphoric time. One displayed a lithograph of the cover of the Wall Street Journal the day after the Dow Jones Industrial Average had closed at 10,000 in March 1999. If This Is a Bubble, It Sure Is Hard to Pop, read the headline, which was covered by a transparent bubble magnifying the zeroes in the index's record level. On the opposite wall was a framed cover of Barron's from 2004, when the publication had run an admiring cover story on Bear. Under the teaser "Throughout the market slide, Bear Stearns had outperformed its brethren" was a cartoonlike drawing of a brown bear dipping its paw into a honey pot as saliva dripped from its chops. The story inside called the firm "the Rodney Dangerfield" of the brokerage industry, with shareprice growth that was finally generating the respect Bear had long deserved. Back then, the stock was trading at $84 a share.
Now it was at $57—a breathtaking drop from $172, where it had topped out in January 2007 during the froth of the housing boom. Record issuances of new mortgages and skyrocketing home prices throughout the United States were now collapsing under their own weight. Loans issued to "subprime" borrowers whose incomes couldn't support the expense of high–interest mortgages had, in many cases, gone into default. The defaults had prompted a wave of bank foreclosures on subprime borrower homes, forcing people to move out and harming the safety and value of other homes in surrounding neighborhoods. Fast–growing areas of states like Nevada, California, Arizona, and Florida had been especially hard hit.
In reaction to the disastrous lending practices of the housing boom, banks were providing credit to only the wealthiest, most stable consumers, leaving many potential home buyers unable to make purchases. Many of the country's most active mortgage providers, including OwnIt Mortgage Solutions and New Century Financial Corp., had gone into bankruptcy, saddled with the unwieldy costs of mortgages to subprime borrowers that had ceased to be paid down. Increasingly now, the third parties that held bonds connected to subprime loans, once those loans were "securitized" or bundled into new investments, were taking huge losses on those bonds. In a catch–22 effect, the mortgage lenders that still had money to lend were becoming leery of issuing new loans, since their ability to lay off the risk of those loans to other investors was diminishing, and the market overall was slowing to a crawl. As an issuer of new mortgages as well as a trader and holder of mortgage–backed securities, Bear was being hurt by the convulsions in the housing sector—and that was before the events of the last few days.
The mood around the table was lousy. Bear's old hands had seen more than a few competitors come and go over the years, and now their firm was uncomfortably close to becoming a Wall Street casualty. Fixed–income chief operating officer Friedman and others, who had been anxious about the firm's financing since at least last summer, were deeply frustrated. Their suggestions that the firm should sell itself or raise capital had gone largely unheeded, now with disastrous results. Schwartz, Molinaro, and some others were more shocked. They had been working their tails off for months, courting clients and shareholders and trying desperately to return Bear to profitability after its recent November quarter loss. In recent days, they'd labored to counteract the negative rumors in the market, with no success. Now, suddenly, their prized firm was on the brink of oblivion.
Dispensing with the introductions, Molinaro, who had taken a seat on the long side of the conference table not far from Schwartz, began running through a laundry list of questions. "What collateral do we have that we could repo?" he asked the group.
He was referring to repurchase agreements, otherwise known as "repo loans." Repo loans were short–term, often overnight, funding pacts, usually struck between two Wall Street firms or one firm and one investor, like a hedge fund. As the borrower, Bear would offer its counterparty—the other bank in the transaction—a bundle of securities in exchange for immediate cash. Bear could then use the cash to help fund its operations for some brief period of time, often the next twenty–four hours. Afterward, the counterparty could then return the securities to Bear, which would repay the counterparty the cash.
Much of Wall Street relied on repo loans to help finance its day–to–day operations, but Bear was more dependent on these short–term loans than its competitors were. With a leverage, or debt–to–cash ratio, of 30 to 1—meaning that for every $1 it actually held in cash, Bear had borrowed $30 from other parties—the firm had one of the heaviest debt loads of any firm on the Street. That made it more vulnerable than other firms when repo lenders faced a crisis of confidence.
To streamline the daily lending process, Bear operated financing desks in the fixed–income and equities units staffed by people whose job it was to "roll," or renew, expiring loan agreements on a nightly, weekly, or monthly basis. Eyes turned now to Tim Greene, one of the two heads of Bear's fixed–income financing desk. Greene, a West Point graduate with a soldier's sense of loyalty, had been working at Bear for twenty–four years, rising through the ranks to help run the bond unit's repo desk, which handled about $160 billion of funding at any given point—about half of Bear's entire balance sheet. He had met his wife, Maryann, on that desk, and he loved the job.
Greene was used to operating under pressure. From the time he arrived at work from suburban Connecticut at 7:00 a.m. to the time he finalized the day's funding agreements around 2:00 p.m., every day was a scramble to renew the firm's loans and keep the cash coming. Ironically, just as the stress was amping up, Greene had tried to reverse years of unhealthy eating habits with a 1,100 calorie–per–day diet and had already lost thirty pounds.
Up to now, borrowing $10 billion or $20 billion in a day generally wasn't a problem. But Friday was likely to be no average day, and the firm needed $14 billion in new money to fund its operations. On top of that, Bear had to replace, or roll, more than $10 billion.
Greene, who was facing Molinaro on the opposite side of the room, tried to sound optimistic. His relationships with lenders ran deep, and he didn't think they'd abandon Bear overnight. "I'm confident I can do it," he told the group.
"How?" asked Molinaro.
"I can do it without anybody knowing, on the screen," Greene told him, referring to a popular computer–driven lending system in which participants could trade anonymously, without revealing their identity to the other party in the transaction.
Next to him, Greene's boss, the fifty–two–year–old Friedman, doubted it. Ever since the prior August, when two internal hedge funds had failed—giving the lie to Bear's long–vaunted prowess in careful risk management—Friedman had felt like the sky was falling. He joked to associates that he spent his days on Bear's seventh–floor mortgage–backed–securities trading hub either hiding under his desk or puking into a trash can. He hated that the funds' embarrassing failure had thrust his insular company into the spotlight.
Now Friedman told the group he thought there was no way that at least half of the next day's repo loans were going to roll in order to help fund Friday's operations. Like any trading firm, Bear spent the day buying and selling securities for itself and for clients, processes that required bundles of cash at the ready. More days than not, the firm was profitable and not losing money, but it had to be prepared to refund loans or provide additional collateral when asked. Now, with rumors sweeping Wall Street about Bear's cash drain, Friedman worried that Bear's usual lenders might be too spooked to lend as they normally would, for fear that the firm would never pay them back.
He suggested that Greene might try raising the $14 billion or so the firm had in bonds backed by Fannie Mae and Freddie Mac, government–sponsored housing agencies that were considered safer than loans packaged by other players. Those were the bonds tradable "on the screen," where no one would know it was Bear making the transactions.
Molinaro turned to his treasurer, Bob Upton, who sat across from him next to Friedman. "Where are we with cash?" he asked.
Upton studied the legal pad in front of him, on which he had jotted down his best estimates of the credits and debits in Bear's various accounts.
He felt beaten down. An unsmiling father of two, Upton had spent years toiling as an analyst of securities firms and international banks for Fidelity Investments, hoping to someday actually manage the cash at a big Wall Street firm. Since April 2006, when he had been named treasurer of Bear, the workload had been brutal. During a three–year period his dark brown hair turned almost totally white. Though he was trim, didn't drink, and watched his diet carefully, Upton now looked far older than his forty–seven years.
Like Greene, Friedman, and others, Upton and his team had suffered fallout from the hedge fund failures, as funding the firm became more difficult. For much of the past year, Upton had been arriving at work from his suburban home at 5:00 a.m., and not leaving until as late as 10:00 p.m. Many nights he got as little as four hours of sleep. I'm fucking killing myself, he often thought. Yet he, too, adored the place.
The firm's troubles had been building throughout the week. On Monday, a batch of home loans it had packaged and sold were found to be exceedingly high risk by a major rating agency, which meant that conservative investors would have to sell any of the bonds they held that were backed by those loans. Based on the headlines, some market watchers mistook the finding as a downgrade of Bear as a whole, seeing it as an indication that the company was very likely to default on its debt. Its shares tumbled. Bear was now trading at about $65 on the New York Stock Exchange.
Overnight, some of Bear's lenders—the dozens of American and overseas banks that extended it billions of dollars a day to conduct business—began tightening the reins. The Dutch bank ING refused to refresh some of Bear's credit, and others soon followed suit. Right away, Bear's major clients heard the message: The firm was no longer safe. Hedge funds like Renaissance Technologies Corp., the enormous trading firm that had long been a top client, began reducing their balance levels immediately, worrying that if Bear went down, their money would be stuck on a sinking ship. Bear shares fell further, even amid public denials by Molinaro and others that any real trouble was afoot.
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