House of Cards (25 page)

Not surprisingly, Bear Stearns's eleventh-hour capitulation to JPMorgan was gargantuan news around the world, making for banner headlines in newspapers in the major money centers of New York, London, and Hong Kong and on television screens the world over. The general reaction was no different from that of Steve Schwarzman, Ron Perelman, John Mack, or the 14,153 Bear Stearns employees—utter and complete disbelief. “The hard capitalist truth is that Bear's most senior managers have mainly themselves to blame,” the
Wall Street Journal
editorialized. “They bought their second and third homes with fabulous bonuses during the good times, and they must now endure the losses from Bear's errant investment bets. Bear took particular pride in its risk management, but it let its standards slide in the hunt for higher returns during the mortgage mania earlier this decade. There's no joy in seeing a venerable firm expire, but it has to happen if financial markets are going to have any discipline going forward.” Added Andrew Ross Sorkin in the
New York
Times,
“Make no mistake: this was one of the greatest corporate euthanizations of all time. And Wall Street played its own gleeful role in it.” And Paul Krugman, the
Times's
economics columnist, picking up on his colleague Gretchen Morgenson's criticisms of Bear Stearns from the morning before, opined: “Bear, in other words, deserved to be allowed to fail—both on the merits and to teach Wall Street not to expect someone else to clean up its messes. But the Fed rose to Bear's rescue anyway, fearing that the collapse of a major investment bank would cause panic in the markets and wreak havoc with the wider economy. Fed officials knew that they were doing a bad thing, but believed the alternative would be even worse. As Bear goes, so will go the rest of the financial system.”

Alan Greenspan, the former chairman of the Federal Reserve Board whom many blamed for lowering interest rates too far too fast after September 11 and thus inflating the credit bubble that burst in the conflagration that consumed Bear Stearns, weighed in with his own thoughts on the financial crisis in an opinion piece in the
Financial Times
. He made no mention of Bear Stearns, its liquidity crisis, or its sale to JPMorgan (probably because the deadline for the piece preceded the events of the previous week), but in his opaque way he did capture the zeitgeist of the unprecedented events. “We will never be able to anticipate all discontinuities in financial markets,” he wrote. “Discontinuities are, of necessity, a surprise. Anticipated events are arbitraged away. But if, as I strongly suspect, periods of euphoria are very difficult to suppress as they build, they will not collapse until the speculative fever breaks on its own. Paradoxically, to the extent risk management succeeds in identifying such episodes, it can prolong and enlarge the period of euphoria. But risk management can never reach perfection. It will eventually fail and a disturbing reality will be laid bare, prompting an unexpected and sharp discontinuous response.”

B
UT IN THE
face of
this
“unexpected and sharp discontinuous response,” there was not a lot of time for reflection and Monday-morning quarter-backing. In accordance with the contract, JPMorgan started moving into Bear Stearns's offices almost immediately. Black and Winters, the co-heads of investment banking, reminded their colleagues to be gentle. “As we now begin the important work of integrating the two firms, we are counting on you to embrace our new partners at Bear Stearns in a first-class way and ensure they feel welcome at our firm,” they wrote in an e-mail. So warned, the JPMorgan army tried to be understanding. “My office looked out across the street over at their window and their trading floor,” Friedman said. “They actually put a sign up that we couldn't quite
read, but which we think was actually well-intentioned, as some sort of ‘Welcome to the JP Morgan family' or something, trying to be good guys. I stood at the window and they waved. They may have been making some nasty, sarcastic aside. They may have been thumbing their noses at us. It felt like they were trying to be
mensches
about the thing. They then started to come over, and by and large, they were extremely sympathetic. They treated it with great sensitivity. They were very clear that this was a tragedy. That they thought this was unfair, what had happened to us, and so let's get through this the best that we can. Considering that they had no interest in having to go through all of this, they were remarkably grown-up.”

Given the guarantee, JPMorgan was very focused on getting as much information as quickly as possible about Bear Stearns's trading positions. “They were trying very early on to take control of the risk, because as of that moment, they were effectively guaranteeing everything that we did,” Friedman said. “They were immediately interested in all the positions, all of the customer exposure—everything that we had that could cause losses to them, they took command of almost instantly.” JPMorgan immediately got a computer feed on all of Bear Stearns's long and short trading positions. “It's great to have 180,000 people, I guess,” he continued. “You just keep putting people to work. They ran it through their models. They sat with our traders. They came back with marks, with hedges. They were obviously most focused on the mortgage positions. I spent hours and hours and hours with them, going through the credit risk that we had and what was our customer exposure. They didn't particularly care for our list of customers that we were dealing with. The orders came very quickly. Any material transaction—and the definition of material kept getting smaller and smaller—had to be approved by JPMorgan.”

On Monday morning, just hours after he had reluctantly agreed to approve the merger with JPMorgan, an agreement that perfected for him a loss of more than $1 billion on the Bear Stearns stock he had accumulated since joining the firm in 1969, Cayne walked into his ebony-paneled sixth-floor office at 383 Madison and found Bruce Sherman waiting for him. Sherman, the CEO of Private Capital Management and a Naples, Florida, activist money manager, owned some 5.5 million Bear Stearns shares at the beginning of 2008. Sherman had lost around $475 million, based on the stock price at the beginning of 2008 (and more than double that amount if the stock's peak value in January 2007 is the measurement stick), by the time he showed up on Cayne's doorstep. “I walk into the office and he's sitting in the anteroom,” Cayne recalled. “I don't have a date with him or anything. He said, ‘We got mugged.' I said, ‘I agree.' He
says, ‘Can I spend a few minutes?' I said, ‘Sure.' Comes in with this guy; ‘I don't want to be alone,' he says. I get Vincent [Tese]—that's our lead director—because I want a witness. I have no fucking idea what he's going to do. He may be carrying a wire, I don't have any idea.”

Cayne had known Sherman for years. “I've had many, many conversations with him,” he said, “and never once, not once, did he say, ‘Jimmy, you're not doing the right thing' or ‘I'm not happy with what you've done.' Not one. Forget irate, not one upset call.” Indeed, in 2006, when Bear stock was approaching its all-time high, Sherman said, “They're a wealth-creation machine. Jimmy's leadership over the past decade has been central to that.” But by January 2008, Sherman had turned on Cayne and played a crucial role in convincing the board that Cayne had to go.

“Sherman starts talking about the absurdity of the $2 per share JPMorgan deal,” Cayne said. “He's sitting there and he's talking about shareholders' actions and campaigns. I said, ‘Bruce, let me get this really straight with you. I agree there was a mugging. I agree that the Fed did something. We had Jamie. We had Flowers in here. He wasn't given the Fed backing or whatever. So it was just a good old-fashioned fucking.' He says, ‘Well what about the vote?' I said, ‘I want to make it very clear. I'm not discussing the vote. You vote the way you want to vote for $2 a share. And I vote the way I want to vote.' He says, ‘Well, how can they possibly win the vote?' And I said, ‘I'm not saying they will.' He said, ‘Jimmy, they have no chance of winning the vote because you've got five guys that own 40 percent of the company. They're all going to vote it down.' I said, ‘That's a conversation I'm not having. I vote the way I want to vote.’” Sherman left Cayne's office after about ninety minutes. (Sherman did not respond to requests for comment.)

By then, Bear Stearns stock had opened for the day and was trading at around $3.50 per share, 75 percent higher than JPMorgan's offer (the stock traded as high as $5.50 that day and closed at $4.81), a clear signal that the market believed that the deal was not going to happen at the original price. This could have been just a hopeful bet by merger arbitrageurs wanting more or a clever analysis of the deal's dynamics—as Sherman had pointed out, five shareholders controlled 40 percent of the company's stock (and the employees as a group, including Cayne, controlled 30 percent). With the stock at $2 a share, after having traded as high as $172.69 little more than a year before, investors had little to lose and everything to gain by voting no—especially since JPMorgan's guarantee apparently would stay in place for a year if shareholders continued to vote down the deal, although it's unlikely that anyone had yet figured out that subtle wrinkle.

Meanwhile, JPMorgan and Dimon were receiving near-universal plaudits for their deal savvy and their opportunism. There was an avalanche of glowing publicity. JPMorgan's stock was up nearly 10 percent, to around $40 per share. The
Wall Street Journal
referred to him as “Wall Street's banker of last resort.” To the
New York Times,
Dimon had “suddenly become the most talked about—and arguably the most powerful— banker in the world today.”
Bloomberg Markets
wrote, “In a Wall Street convulsed by crisis, it's Dimon, grandson of a Greek immigrant and son of a stockbroker, who has emerged as the closest thing modern finance has to a statesman.” On Monday at around noon, Andrew Bary, at
Barron's,
provided some analysis. “Jamie Dimon appears to have pulled off the coup of his career,” he wrote. “The best analogy for the Bear Stearns deal could be the government-orchestrated takeovers of savings and loans in the late 1980s that turned out to be windfalls for well-connected buyers, including financier Ron Perelman and the Bass brothers of Texas.” Just how sweet a deal was it for Dimon? “JPMorgan is paying a tiny fraction of Bear's previously stated book value of $84 a share,” Bary continued. “It is also getting the company's valuable clearing business, which generated $566 million in pretax earnings last year, and Bear's headquarters building on Madison Avenue in Manhattan, which could be worth $1.5 billion.” Bary also noted that JPMorgan predicted it would generate $1 billion in annual after-tax earnings from the Bear Stearns deal. Brad Hintz, a former CFO of Lehman Brothers and a research analyst at Sanford C. Bernstein & Co., told his clients that Bear Stearns's “good businesses” were worth $7.7 billion, or $60 per share. The discrepancy—between $60 and $2—came as a result of assuming the estimated $6 billion in transaction-related expenses—litigation, severance payments, and absorbing the losses of the sale of big chunks of Bear Stearns's $395 billion of assets. (On May 14, JPMorgan upped its reserve for the deal by 50 percent, to $9 billion, as the cost of liquidating the assets climbed along with the cost of running Bear between signing and closing; it wound up costing another $1 billion.)

Dimon tried to take the coronation in stride. He praised Black, Winters, Paulson, and Geithner. “Same with the team at Bear Stearns,” he said. “God knows what pressure they had to be under.” He added, “You are on an emotional roller coaster on any deal, but much more so on this one. For all the drama today, it could have been much worse.” He hoped to get some sleep now that it was over. “There are two types of not getting sleep,” he said. “There is not getting sleep because there is a lot of work. The other is because you can't sleep. I had a little of both.”

B
UT, IN ITS
coolly efficient way, the market was already in the process of rendering its judgment on the idea that JPMorgan stood behind Bear Stearns's obligations. On Monday, “Bear Stearns' customers continued to withdraw funds, counterparties remained unwilling to make secured funding available to Bear Stearns on customary terms, and funding”— other than from JPMorgan and the Fed—“was not available,” according to the proxy statement about the deal. It became increasingly clear that the market would no longer fund Bear Stearns, despite all the public statements of support from the Fed and JPMorgan. That meant the burden would fall solely on JPMorgan and the Fed. There were now serious doubts about whether the deal, struck at $2 per share less than twenty-four hours earlier, could ever be completed at that price, and so the long-term viability of the guarantee was also suspect. “What happened that week was that despite the guarantee, the market, of course, was shocked by the price,” Molinaro said. “Nobody believes the deal's going to get consummated at that price. We're never going to be able to get the shareholder approval. Customers were therefore spooked by that. I would say the arb community clearly doesn't think the deal's happening at that price because the stock's trading well above the offer price. And as a result, customers were not showing a willingness to do business with us, even though we had a guarantee from JPMorgan, and that was becoming a particular problem in the stock borrow world, because the State Streets and big securities lenders weren't prepared to lend us securities for fear that the guarantee wouldn't be there.”